Magnetar Deal Prompts SEC Settlement With JPMorgan Chase
This post has been updated.
The Securities and Exchange Commission announced today that JPMorgan Chase has agreed to a $154 million settlement for allegedly misleading investors in a mortgage-securities deal involving the hedge fund Magnetar.
As we reported last year, Magnetar often pushed for riskier assets to be included in deals and placed bets against many of the same investments, known as collateralized debt obligations, or CDOs. Our piece first detailed the JPMorgan deal, called Squared. (The story was part of a collaboration with our friends at Chicago Public Radio's This American Life and NPR's Planet Money. And so was this special CDO show tune. You can read our full Pulitzer prize winning series on Wall St. via our site or on your Kindle. )
The SEC’s complaint [PDF] underscores those findings. According to the complaint, JPMorgan allowed Magnetar to play "a significant role in the portfolio selection process" for Squared without disclosing Magnetar's role to investors. In the settlement, JPMorgan didn't admit to any wrongdoing. A court must still approve the deal.
As the housing market showed signs of trouble at the end of the boom, JPMorgan became desperate to sell Squared and get it off its books. In one 2007 email, a JPMorgan Securities employee wrote to the sales team, "we are soooo pregnant with this deal, we need a wheel-barrel to move around. ... Let's schedule the cesarian, please!"
Squared plummeted in value just months after it was sold. As the SEC noted, more than a dozen institutional investors—pension funds, a Lutheran nonprofit group, Asian financial institutions, and others—saw their investments reduced to almost nothing. As part of the settlement, the investors will be made whole, a relatively rare event.
Ironically, JPMorgan was among the losers. While the bank earned about $20 million for creating the deal, it ultimately lost $880 million on the parts of Squared that it didn't sell off to investors. We reported Magnetar earned about $290 million off its bet on Squared.
Other emails showed Magnetar, JPMorgan and GSC Capital—a supposedly independent manager tasked with representing investors' interests—communicating directly about what the hedge fund wanted to include in Square's portfolio.
"To be honest, I don't love it," a Magnetar employee wrote to GSC while Squared's portfolio was still being determined. "Some recent deals I'd like to get in there are missing. Also, think they're missing some of the trades to which we've already agreed. Lets discuss."
Magnetar initially declined to answer our questions about Squared but disputed our account months after the story ran, saying that it never required or expected any specific assets to be put in Squared. The hedge fund told us that GSC Capital "at all times exercised its own discretion and judgment" regarding the inclusion of assets.
Apparently, that's not what the SEC came to believe after it conducted its own investigation. The SEC separately filed suit [PDF] against Edward Steffelin, a former executive at GSC Capital, for also failing to tell investors about Magnetar's role. The SEC also noted that Steffelin was actually seeking a job with Magnetar at the same time he was working on the deal.
Steffelin could not immediately be reached for comment. He declined our request for comment in April, when it was first reported by Bloomberg that the SEC sent him notice of possible legal action.
The Associated Press has noted that the $154 million settlement is less than 1 percent of JPMorgan's income last year. Most of the money will go to repaying investors who lost out on the deal, and $27 million will go to the U.S. Treasury.
Today's penalty is relatively small compared to the $550 million paid by Goldman Sachs to settle nearly identical SEC charges over the firm's Abacus CDO. The U.S. Treasury also netted much more in that settlement, taking in $300 million.
Update: Magnetar's PR representative sent along a statement. Here it is in full:
The SEC’s settlement with respect to the Squared CDO transaction relates to the adequacy of disclosures during the marketing of the securities. Magnetar is not a party to the settlement nor a defendant in this case, and was not involved in the marketing of the securities. In fact, the SEC Staff issued a closing letter to Magnetar stating that it does ‘not intend to recommend any enforcement action’ against Magnetar, any of its funds or any current or former Magnetar personnel in connection with that investigation. Although the SEC has included certain descriptions of Magnetar’s role in the transaction in the complaint, we respectfully stand by our prior statements on these topics, specifically that we did not control the asset-selection process and our Mortgage CDO investment strategy was designed and implemented to maintain a market-neutral portfolio.
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.