Did JP Morgan Get a Break in CDO Case?

The SEC has filed a complaint against JPMorgan Securities for failing to disclose a material fact in connection with the creation, sale and distribution of a product. We commented on it earlier this week - JP Morgan to Pay $153.6 Million to Settle SEC Charges. In essence, the Commission alleged that JP Morgan failed to inform investorsin a CDO that it created that a hedge fund helped to select the assets in in the CDO portfolio, and the hedge fund was short those same assets. As a result, according to the SEC, the hedge fund was poised to benefit if the CDO assets defaulted.

The allegation was familiar, since the Commission brought almost identical charges against Goldman Sachs last year. We discussed that case at SECLaw.com -The Impact of the SEC CDO Fraud Complaint against Goldman Sachs and here - Goldman's Defense to SEC Fraud Case

JP Morgan settled by paying $153.6 million (and no executives were harmed in the settlement). Goldman initially fought the case, and ultimately settled for $550 million.

Now commentators are questioning the disparity between the two penalties. Bloomberg's Jason Weil writes that JP Morgan caught a break. Aside from the money, the charges against JP Morgan were for negligence, the charges against Goldman Sachs were for fraud.

Without knowing the intimate details of the two cases, if there was a difference in the scienter, or intent, part of the violation, then that would explain the disparity in the fine. Also, as litigators are well aware, defendants often get a better deal settling early.

But that doesn't explain the signficant difference in the fines, nor does it explain why there was no individual at JP Morgan included in the sanctions, whereas individuals were included in the Goldman Sachs case.

Bloomberg says that the SEC won't explain the disparity, but also notes that the Commission will have to have the approval of United States District Judge Richard Berman before the settlement is effective. If Judge Berman asks, the SEC will be forced to explain.

JPMorgan Gets a Break Where Goldman Got Nailed: Jonathan Weil - Bloomberg

Goldman's Defense to SEC Fraud Case

The WSJ has copies of Goldman's Wells Submission and its Wells Supplement on line. While the Wells Submission is not Goldman's answer to the complaint, it does offer insight into Goldman's defense of the SEC's claims. (See my article on Wells Notices at SECLaw.com for more background information).

The most interesting part of the submission is the claim that everyone in the transaction knew the facts that the SEC claims were misrepresented or omitted:

There was nothing unusual or remarkable about the transaction or the portfolio of assets it referenced. Like countless similar transactions during that period, the synthetic portfolio consisted of dozens of Baa2-rated subprime residential mortgage-backed securities (“RMBS”) issued in 2006 and early 2007 that were identified in the offering materials (the “Reference Portfolio”). As in other synthetic CDO transactions, by definition someone had to assume the opposite side of the portfolio risk, and the offering documents made clear that Goldman Sachs, which took on that risk in the first instance, might transfer some or all of it through a hedging and trading strategies using derivatives. Like other transactions of this type, all participants were highly sophisticated institutions that were knowledgeable about subprime securitization products and had both the resources and the expertise to perform due diligence, demand any information that was important to them, analyze the portfolio, form their own market views and negotiate forcefully at arm‟s length.

And this:

All participants in the transaction understood that someone had to take the other side of the portfolio risk, and the offering documents clearly stated that Goldman Sachs might lay off some or all of the short exposure to the portfolio that it had taken on. A disclosure that the relatively unknown Paulson was the entity to which Goldman Sachs transferred that risk would have been immaterial to investors in April 2007.

As always, there are two sides to every story, and the other side of this one is still developing.

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SEC Charges Goldman Sachs in CDO Fraud

In a complaint filed in the Southern District of New York, the SEC has filed civil charges against Goldman Sachs, alleging that it structured and marketed a synthetic collateralized debt obligation (CDO) that hinged on the performance of subprime residential mortgage-backed securities (RMBS). The Commission alleges that Goldman Sachs failed to disclose to investors vital information about the CDO, in particular the role that a major hedge fund played in the portfolio selection process and the fact that the hedge fund had taken a short position against the CDO. The SEC Press Release contains more details and a copy of the complaint.