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SEC Files Charges in Magnetar Deal

The Securities and Exchange Commission has charged an asset manager with fraud for its role in one of the most notorious groups of mortgage securities deals behind the financial crisis.

The Securities and Exchange Commission has charged an asset manager with fraud for its role in one of the most notorious groups of mortgage securities deals behind the financial crisis. (Brendan Smialowski/Getty Images)

The Securities and Exchange Commission has charged an asset manager with fraud for its role in one of the most notorious groups of mortgage securities deals behind the financial crisis.

Harding Advisory and Wing Chau, the head of the firm, failed to disclose that a hedge fund, Magnetar Capital, had a significant role in selecting the securities that went into one of its collateralized debt obligations, or CDOs, the agency alleges. CDOs were bundles of mortgage securities that helped fuel the financial meltdown.

As ProPublica detailed in 2010, Magnetar worked with investment banks to build CDOs that the hedge fund also bet against.  Magnetar would buy the riskiest part of the CDO, which gave it influence in picking which bonds would be included in the CDO. In turn, the hedge fund pushed riskier bonds that would make the investment more likely to fail.

Harding was a collateral manager, which was supposed to act independently and in the interests of the deal. In selling their CDOs, Wall Street investment banks relied on investor expectations that collateral managers would act independently. As ProPublica wrote in 2010, that independence was often compromised.

In its complaint, the SEC alleges that Harding and Merrill Lynch gave Magnetar an undisclosed veto over the assets that went into a $1.5 billion deal called Octans I, which closed in September 2006. Octans 1, which was arranged and sold by Merrill Lynch, failed in April 2008, costing investors $1.1 billion. Harding received $4.5 million in fees for the deal.

The SEC alleges that Harding’s disclosures were “materially misleading” and its behavior violated securities laws. The agency alleges that Harding and Chau “knew or at least recklessly disregarded” their standards to accommodate trades requested by Magnetar. Chau “understood that, because Magnetar stood to profit if the CDOs failed to perform, Magnetar’s interests were not aligned with those of potential investors in the debt tranches of Octans I,” the complaint says.

Harding put assets into Octans that it would not have if Magnetar hadn’t pushed them, the SEC complaint says. A Harding analyst wrote in an email, “we had to pick the lesser of evils” at Magnetar’s insistence.

Chau did additional favors for Merrill Lynch and Magnetar, to the ultimate detriment of investors in the CDOs his firm managed. At one point, Chau agreed to purchase bonds from another Merrill Lynch/Magnetar deal that it was managing, called Norma. Chau indicated he was reluctant to buy them.

A Magnetar representative chided him in an email saying “Remember who was there for u when u were a little guy.” Chau later emailed the Merrill executive, “I never forget my true friends.” He placed the bonds in other Harding-managed CDOs.

Over the next year, Harding managed four more CDOs arranged by Merrill Lynch, as well as three other Magnetar deals.

Wing Chau was prominently featured in Michael Lewis’s bestseller, “The Big Short.” Chau later sued Lewis, alleging the book defamed him. Lewis prevailed in the suit earlier this year.

Harding’s lawyer Steven Molo did not return a call seeking comment. Through a spokesman, Magnetar declined to comment.

There have been a series of settlements related to Magnetar CDOs. Previously, the SEC brought charges against another CDO manager for its role in another Magnetar deal, but eventually dropped them. The SEC has not filed charges against Magnetar over its activities.

The latest case will go before an administrative law judge who is required to rule within 300 days. If the SEC wins, the agency may demand the disgorgement of profits, civil penalties and seek to ban Chau from the securities business.

Harding continues to serve as collateral managerfor nine CDOs with total assets of approximately $1 billion.

Ooh, a mid-level, no-name manager has been cast as the villain of the piece!  Yeah, that’s justice.  I’m sure his trial will involve naming names in upper management and bringing the entire house of cards down.

Kidding.  He’ll take the blame for everything, was working against the orders of his bosses (and his family will cash a nice monthly check, no doubt), and the people who actually caused and allowed this to happen get to enjoy their winnings.

John - you are so right.  Same thing with Paulson/Goldman, with Paulson cherry-picking what went into the CDO, then he and Goldman shorting it.  Round them all up and throw away the key!

Thievery and fraud.

This article is part of an ongoing investigation:
The Wall Street Money Machine

The Wall Street Money Machine

Enticed by profits and bonuses, Wall Street took advantage of complicated mortgage-based instruments to reap billions, only to exacerbate the eventual crash.

The Story So Far

As the housing market started to fade, bankers and hedge funds scrambled for ways to maintain the lavish bonuses and profits they had become so accustomed to, repackaging mortgages in complex securities called collateralized debt obligations. The booming CDO market masked how weak the housing market was, and exacerbated its collapse.

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