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.
