SEC COMMISSIONER AGUILAR SPEAKS ABOUT BANKS AND FINANCIAL CRISIS

The following excerpt is from the SEC website: The following excerpt is from the SEC website: SEC Open Meeting Washington, D.C. October 12, 2011 “In the years leading up to the financial crisis, the largest banks in America came to rely on proprietary trading to generate an ever greater percentage of their revenues.1 The financial crisis subsequently demonstrated how this trading contributed to the banks’ vulnerability, and put the American financial system at risk. As market conditions deteriorated, trading losses increased exponentially and undermined the banks’ capital.2 No one can forget that the banks were rescued from the brink of failure by the commitment of hundreds of billions of taxpayer dollars. Also, as a recent Commission case demonstrated, propriety trading creates the opportunity for banking entities to increase their profits by misusing client trade information.3 To mitigate systemic risk, rein in the speculative activities of banks, and realign the interests of banks with those of their customers, Paul Volcker and many others advocated for new prohibitions. As Paul Volcker explained, “Hedge funds, private equity funds, and trading activities unrelated to customer needs and continuing banking relationships should stand on their own, without the subsidies implied by public support for depository institutions.”4 In response, Congress added Section 619 to the Dodd-Frank Act – popularly known as the “Volcker Rule.”5 This section requires the Commission, the federal banking regulators, and the CFTC to adopt consistent rules to prohibit banking entities6 from engaging in proprietary trading and from owning or sponsoring certain private funds, while permitting specified activities, including market-making, underwriting, and risk-mitigating hedging.7 Crafting a rule to achieve the objectives set by Congress presents a considerable challenge. The statute does not contain an outright ban on all propriety trading – rather it permits certain principal trades while banning others. Giving life to this provision is not easily done and, as reflected in numerous press reports, there are different, and strongly held, views about the approach that should be taken. I look forward to receiving comments that will enable us to craft a final rule that will meet the objectives of the Dodd-Frank Act. In closing, I would like to thank the staff for their hard work over many months on this proposal. 1 Sen. Jeff Merkley & Sen. Carl Levin, The Dodd-Frank Act Restrictions on Proprietary Trading and Conflicts of Interest: New Tools to Address Evolving Threats, 48 Harv. J. on Legis. 515, 522 (“Trading revenues at the largest banks had increased from under fifteen percent of net operating revenues in 2004 to nearly thirty percent at the start of the crisis.”). 2 Id. (“[I]n the fourth quarter of 2007 losses from trading almost entirely offset positive net operating revenues from all other sources combined, with trading losses equaling nearly 250 percent of net operating revenue, devastating the capital bases of many firms.”) 3 See, e.g., In the Matter of Merrill Lynch, Pierce, Fenner & Smith Incorporated, Exchange Act Release No. 63760 (Jan. 25, 2011) (The Commission fined Merrill Lynch $10 million for misusing customer order information and for charging improper mark-ups and mark-downs on riskless principal trades), available at http://sec.gov/litigation/admin/2011/34-63760.pdf. 4 Statement of Paul A. Volcker Before the Committee on Banking, Housing, and Urban Affairs of the United States Senate, at 1-2 (Feb. 2, 2010), available at http://banking.senate.gov/public/index.cfm?FuseAction=Files.View&FileStore_id=ec787c56-dbd2-4498-bbbd-ddd23b58c1c4. 5 Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. 111-203 § 619 (2010). 6 For purposes of the Volcker Rule, a “banking entity” is any insured depository institution, any company that controls a depository institution, any bank holding company, and any affiliate or subsidiary of any of these entities. Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. 111-203 § 619(h)(1) (2010). 7 With respect to trading as a principal, banking entities may, among other things, engage in underwriting or market-making activities to the extent that these activities do not exceed the reasonably expected near term demands of clients, customers, or counterparties. Banking entities may also engage in risk-mitigating hedging. With respect to sponsoring or investing in private funds, a banking entity may do so only with respect to the provision of bona fide trust, fiduciary, or investment advisory services and only if it holds no more than a de minimus investment in the fund. Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. 111-203 § 619(d)(1) (2010).”

J.P. MORGAN SECURITIES LLC WILL PAY $153.6 MILLION IN SETTLEMENT

The SEC has settled its case against J.P. Morgan for misleading investors. It looks like good news for harmed investors. The following is an excerpt from the SEC website:

"Washington, D.C., June 21, 2011 – The Securities and Exchange Commission today announced that J.P. Morgan Securities LLC will pay $153.6 million to settle SEC charges that it misled investors in a complex mortgage securities transaction just as the housing market was starting to plummet. Under the settlement, harmed investors will receive all of their money back.
In settling the SEC’s fraud charges against the firm, J.P. Morgan also agreed to improve the way it reviews and approves mortgage securities transactions.
The SEC alleges that J.P. Morgan structured and marketed a synthetic collateralized debt obligation (CDO) without informing investors that a hedge fund helped select the assets in the CDO portfolio and had a short position in more than half of those assets. As a result, the hedge fund was poised to benefit if the CDO assets it was selecting for the portfolio defaulted.
The SEC separately charged Edward S. Steffelin, who headed the team at an investment advisory firm that the deal’s marketing materials misleadingly represented had selected the CDO’s portfolio.

“J.P Morgan marketed highly-complex CDO investments to investors with promises that the mortgage assets underlying the CDO would be selected by an independent manager looking out for investor interests,” said Robert Khuzami, Director of the Division of Enforcement. “What J.P. Morgan failed to tell investors was that a prominent hedge fund that would financially profit from the failure of CDO portfolio assets heavily influenced the CDO portfolio selection. With today’s settlement, harmed investors receive a full return of the losses they suffered.”
According to the SEC’s complaint against J.P. Morgan filed in U.S. District Court for the Southern District of New York, the CDO known as Squared CDO 2007-1 was structured primarily with credit default swaps referencing other CDO securities whose value was tied to the U.S. residential housing market. Marketing materials stated that the Squared CDO’s investment portfolio was selected by GSCP (NJ) L.P. – the investment advisory arm of GSC Capital Corp. (GSC) – which had experience analyzing CDO credit risk. Omitted from the marketing materials and unknown to investors was the fact that the Magnetar Capital LLC hedge fund played a significant role in selecting CDOs for the portfolio and stood to benefit if the CDOs defaulted.
The SEC alleges that by the time the deal closed in May 2007, Magnetar held a $600 million short position that dwarfed its $8.9 million long position. In an internal e-mail, a J.P. Morgan employee noted, “We all know [Magnetar] wants to print as many deals as possible before everything completely falls apart.”
The SEC alleges that in March and April 2007, J.P. Morgan knew it faced growing financial losses from the Squared deal as the housing market was showing signs of distress. The firm then launched a frantic global sales effort in March and April 2007 that went beyond its traditional customer base for mortgage securities. The J.P. Morgan employee in charge of Squared’s global distribution said in a March 22, 2007, e-mail that “we are so pregnant with this deal…Let’s schedule the cesarian (sic), please!” By 10 months later, the securities had lost most or all of their value.
According to the SEC’s complaint, J.P. Morgan sold approximately $150 million of so-called “mezzanine” notes of the Squared CDO’s liabilities to more than a dozen institutional investors who lost nearly their entire investment. These investors included:
Thrivent Financial for Lutherans, a faith-based non-profit membership organization in Minneapolis.
Security Benefit Corporation, a Topeka, Kan.-based company that provides insurance and retirement products.
General Motors Asset Management, a New York-based asset manager for General Motors pension plans.
Financial institutions in East Asia including Tokyo Star Bank, Far Glory Life Insurance Company Ltd., Taiwan Life Insurance Company Ltd., and East Asia Asset Management Ltd.
Without admitting or denying the allegations, J.P. Morgan consented to a final judgment that provides for a permanent injunction from violating Section 17(a)(2) and (3) of the Securities Act of 1933, and payment of $18.6 million in disgorgement, $2 million in prejudgment interest and a $133 million penalty. Of the $153.6 million total, $125.87 million will be returned to the mezzanine investors through a Fair Fund distribution, and $27.73 million will be paid to the U.S. Treasury. The settlement also requires J.P. Morgan to change how it reviews and approves offerings of certain mortgage securities. In addition, J.P. Morgan’s consent notes that it voluntarily paid $56,761,214 to certain investors in a transaction known as Tahoma CDO I. The settlement is subject to court approval.
In a separate complaint filed against Steffelin, who headed the team at GSC responsible for the Squared CDO, the SEC alleges that Steffelin allowed Magnetar to select and short portfolio assets. The complaint alleges that Steffelin drafted and approved marketing materials promoting GSC’s selection of the portfolio without disclosing Magnetar’s role in the selection process. In addition, unknown to investors, Steffelin was seeking employment with Magnetar while working on the transaction.
The SEC’s complaint charges Steffelin with violations of Sections 17(a)(2) and (3) of the Securities Act and Section 206(2) of the Investment Advisers Act of 1940. The SEC seeks injunctive relief, disgorgement of profits, prejudgment interest, and penalties against Steffelin.
Separately, GSC’s bankruptcy trustee has consented to the entry of an administrative order requiring the firm to cease and desist from committing or causing violations or future violations of Sections 17(a)(2) and (3) of the Securities Act and Section 204 and 206(2) of the Advisers Act and Rule 204-2 thereunder. GSC is in bankruptcy, and its settlement is subject to approval by the bankruptcy court.
The SEC’s investigation was conducted by the Enforcement Division’s Structured and New Products Unit led by Kenneth Lench and Reid Muoio. The SEC investigative attorneys were Carolyn Kurr, Jason Anthony, Jeffrey Leasure, and Brent Mitchell. The SEC trial attorneys that will handle the litigation against Steffelin are Matt Martens, Jan Folena, and Robert Dodge.”