The Securities and Exchange Commission may soon file suit over a mortgage securities deal involving JPMorgan Chase and a hedge fund called Magnetar, Bloomberg reported. Two individuals have been notified of potential charges. They include a former executive at JPMorgan, the bank that created and marketed the security, and a former executive at GSC Capital, the firm that managed the selection of assets.

As we reported last fall, regulators have been investigating whether JPMorgan misled investors about the role that Magnetar, a hedge fund, played in selecting the assets that went into a $1.1 billion collateralized debt obligation created by the bank in 2007. The deal, known as “Squared,” was made up of slices of other CDOs backed by subprime mortgages. (See the prospectus for the deal.)

Squared was one of more than two dozen CDO deals that Magnetar did in the waning days of the housing boom, ultimately helping to create at least $40 billion of CDOs. (It was also one of several deals managed by GSC that also involved Magnetar.) As we detailed last year, Magnetar often pushed for riskier assets to be included in CDOs as part of a strategy to bet against the housing market. Magnetar has consistently denied that strategy and has told us that it would have made money regardless of the direction of the housing market.

Magnetar earned about $290 million off its bet on Squared. The firm does not appear to be a target of the SEC's investigation and declined to comment to Bloomberg. It previously told us it “did not choose the assets in any CDO,” though emails recently published by the Financial Crisis Inquiry Commission suggest otherwise. 

The former JPMorgan executive at the center of the investigation, Michael Llodra, was global head of the bank's CDO business. Bloomberg reported that Llodra disclosed in his broker registration filings that he received a notice of potential legal action, or Wells notice, from the SEC in January. Llodra's attorney, Sean Hecker, declined our request for comment.

JPMorgan earned about $20 million for creating the deal, we were told, but the bank ultimately lost about $880 million when the safest slices of the CDO—which the bank kept on its books—lost value. Investors in Squared also suffered significant losses.

The SEC also sent a Wells notice to Edward Steffelin, a former executive at GSC Group, the firm that helped manage the “Squared” deal. Steffelin also declined our request for comment. CDO managers, like GSC, are supposed to select assets for the CDO with the interests of investors in mind.

Spokesmen for JPMorgan, GSC Capital and the SEC declined to comment to Bloomberg.

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