In a one-two punch to its reputation, JPMorgan Chase & Co. was accused by regulators in separate cases of misleading big investors about the riskiness of mortgage-related securities it was selling just as the home-loan market was melting down.
The Securities and Exchange Commission sued the giant bank’s securities unit over its sale in 2007 of a complex investment product whose value was indirectly tied to a collection of residential mortgages. JPMorgan did not tell the product’s institutional buyers that it had been partly designed by a hedge fund that would profit if the security lost value, the SEC said in a complaint filed Tuesday in Manhattan federal court.
As it filed the complaint, the agency announced that JPMorgan, the second-largest U.S. bank by most measures, had agreed to pay $153.6 million to settle the case.
A day earlier, the National Credit Union Administration, a federal regulator of credit unions, sued JPMorgan and Royal Bank of Scotland, accusing them of selling mortgage-backed bonds that were “destined to perform poorly,” leading to losses that brought down five large credit unions. The suit, filed in federal court in Kansas, seeks $800 million from the banks. JPMorgan and RBS declined to comment on that case.
This week’s allegations are notable because unlike some Wall Street rivals, JPMorgan until now hadn’t been explicitly accused of misconduct that helped lead to the global financial crisis.
But Tuesday’s SEC case is very similar to one the agency brought last year against Goldman Sachs Group Inc. that did serious damage to Goldman’s reputation and share price.
In both SEC cases, hedge funds wanting to bet against the subprime mortgage market worked with banks to design securities whose value would depend on the value of home loans chosen for their low quality, according to the government, and the banks sold the securities without disclosing the roles played by the hedge funds. In the JPMorgan case, Magnetar, an investment firm based in Evanston, Ill., helped design the security, dubbed Squared CDO 2007-1.
Magnetar, which the SEC did not accuse of wrongdoing, issued a statement Tuesday saying it “did not control the asset-selection process” in the Squared CDO deal.
Fifteen institutional investors, including a Paris bank and a Minnesota nonprofit, bought the security in early 2007 and saw their investments plunge in value within months. They will be reimbursed for their losses with the money JPMorgan is paying to settle the case.
The Squared CDO case may do much less damage to JPMorgan than last year’s case against Goldman did to it.
One reason is that JPMorgan — which quickly settled, unlike Goldman — is paying less than one-third of the $550-million penalty that Goldman ultimately paid to settle the allegations over its Abacus security.
In addition, the SEC accused JPMorgan of acting negligently but not intentionally misleading clients who bought into the Squared CDO. And, unlike Goldman, JPMorgan kept a large portion of the Squared CDO deal for itself and ended up losing close to $900 million on it.
The SEC suit says that by March 2007, JPMorgan bankers realized that subprime mortgages were losing value because of growing defaults, and consequently rushed to sell the Squared CDO product to investors.
In an email quoted in the suit, a JPMorgan employee pushes salespeople to unload the security in March 2007, writing: “We are sooo pregnant with this deal, we need a wheel-barrel to move around . . . . Let’s schedule the cesarian please.”
In a statement Tuesday, JPMorgan said it was “pleased to have reached agreement with the SEC to put this matter concerning certain 2007 disclosures behind us.”
A company spokesman said the settlement, which requires court approval, would not have a material effect on the bank’s earnings.
JPMorgan shares rose 43 cents, or 1.1%, on Tuesday to $40.91, suggesting that some investors had feared more worrisome allegations from the SEC.
“The lack of something more onerous may be the positive here,” said Jeff Harte, a banking analyst at Sandler O’Neill.
The suit filed by the credit union regulator accuses JPMorgan of offering bonds to credit unions in late 2006 and early 2007 that “were significantly riskier than represented,” using marketing material that “contained untrue statements of material fact.”
U.S. credit unions lost $278 million on mortgage-backed bonds purchased from JPMorgan when their market value plummeted, the agency said. Five of the credit unions that bought the bonds had to be liquidated by NCUA, including Western Corporate in San Dimas, a so-called corporate credit union that served and was owned by retail credit unions.
The lawsuit joins a number of other actions seeking to recover losses on mortgage bonds sold by Wall Street banks before the crisis.