ProPublica is reporting today that the Securities and Exchange Commission is investigating possible improprieties in a deal completed in May 2007 between JP Morgan Chase & Co. (NYSE:JPM) and hedge fund Magnetar. The “Squared” deal was a collateralized debt obligation, or CDO, and the SEC is examining whether JP Morgan allowed the hedge fund to improperly select assets for the $1.1 billion deal backed by subprime mortgages. Magnetar Capital, based out of the Chicago suburb of Evanston, Illinois, purchased the riskiest slice of Squared as part of its best against the mortgage market.
ProPublica in April reported, in collaboration with NPR’s Planet Money, that Magnetar purchased the riskiest portion of CDOs while making side bets against those same assets. Magnetar’s purchase of these ultra high-risk assets allowed banks to complete deals, and JP Morgan actually held on to some of the ‘safer’ portions of the CDOs. Today’s report states that purchases by the hedge fund created at least $40 billion in risk CDOs in 2006 and 2007. The SEC is specifically investigating whether JPM failed to disclose to investors the role Magnetar, which held bets against segments of the deal, had in picking the securities that went into the deal.
The investigation and possible suit mirrors the SEC’s claims against Goldman Sachs Group Inc. (NYSE:GS) relating to the Abacus CDO dealings. In that case, Paulson & Co. was the party whose role in hand-picking assets was not disclosed to investors. While Paulson was found innocent of wrongdoing, the SEC eventually slapped Goldman with a $550 million fine as part of a settlement. In fact, the Squared deal actually included a piece of the CDO from one of those Goldman Sachs Abacus deals, Abacus 2006-17. E-mails obtained by the SEC allegedly show Magnetar executives discussing specific assets with JP Morgan bankers, and one would be led to believe the SEC would be heading toward a proportionate settlement with JPM.
JP Morgan reportedly sold parts of the CDO to 17 institutional clients. The bank earned $20 million in creating Squared, but ultimately lost about $880 million on the deal because it chose to keep the supposedly safe assets of Squared on its books without hedging. Magnetar, in contrast, reportedly earned $290 million on its bet against Squared. JP Morgan stock (NYSE:JPM) is trading down 0.8% on the day.
