DOJ, STATES AND D.C. ENTER INTO $1.375 BILLION SETTLEMENT WITH S&P RELATED TO STRUCTURED FINANCIAL PRODUCTS

FROM:  U.S. JUSTICE DEPARTMENT 
Tuesday, February 3, 2015
Justice Department and State Partners Secure $1.375 Billion Settlement with S&P for Defrauding Investors in the Lead Up to the Financial Crisis

Attorney General Eric Holder announced today that the Department of Justice and 19 states and the District of Columbia have entered into a $1.375 billion settlement agreement with the rating agency Standard & Poor’s Financial Services LLC, along with its parent corporation McGraw Hill Financial Inc., to resolve allegations that S&P had engaged in a scheme to defraud investors in structured financial products known as Residential Mortgage-Backed Securities (RMBS) and Collateralized Debt Obligations (CDOs).  The agreement resolves the department’s 2013 lawsuit against S&P, along with the suits of 19 states and the District of Columbia.  Each of the lawsuits allege that investors incurred substantial losses on RMBS and CDOs for which S&P issued inflated ratings that misrepresented the securities’ true credit risks.  Other allegations assert that S&P falsely represented that its ratings were objective, independent and uninfluenced by S&P’s business relationships with the investment banks that issued the securities.

The settlement announced today is comprised of several elements.  In addition to the payment of $1.375 billion, S&P has acknowledged conduct associated with its ratings of RMBS and CDOs during 2004 to 2007 in an agreed statement of facts.  It has further agreed to formally retract an allegation that the United States’ lawsuit was filed in retaliation for the defendant’s decisions with regard to the credit of the United States.  Finally, S&P has agreed to comply with the consumer protection statutes of each of the settling states and the District of Columbia, and to respond, in good faith, to requests from any of the states and the District of Columbia for information or material concerning any possible violation of those laws.

“On more than one occasion, the company’s leadership ignored senior analysts who warned that the company had given top ratings to financial products that were failing to perform as advertised,” said Attorney General Holder.  “As S&P admits under this settlement, company executives complained that the company declined to downgrade underperforming assets because it was worried that doing so would hurt the company’s business.  While this strategy may have helped S&P avoid disappointing its clients, it did major harm to the larger economy, contributing to the worst financial crisis since the Great Depression.”

Attorney General Holder was joined in announcing the settlement with Acting Associate Attorney General Stuart F. Delery, Acting Assistant Attorney General for the Civil Division Joyce R. Branda and Acting U.S. Attorney for the Central District of California Stephanie Yonekura.  Also joining the Department of Justice in making this announcement are the attorneys general from Arizona, Arkansas, California, Connecticut, Colorado, Delaware, Idaho, Illinois, Indiana, Iowa, Maine, Mississippi, Missouri, New Jersey, North Carolina, Pennsylvania, South Carolina, Tennessee, Washington and the District of Columbia.

“This resolution provides further proof that the Department of Justice will vigorously pursue investigations and litigation, no matter how challenging, to protect the best interests of the American people,” said Acting Associate Attorney General Delery.  “As part of the resolution, S&P admitted facts demonstrating that it misrepresented itself to investors and the public, allowing the pursuit of profits to bias its ratings.  S&P also agreed to retract its unsubstantiated claim that this lawsuit was initiated in retaliation for the decisions S&P made about the credit rating of the U.S. government.  Today's announcement is the latest result of our dedicated effort to address misconduct of every kind that contributed to the financial crisis.”

“Today’s historic settlement demonstrates that we will use all of our resources and every legal tool available to hold accountable those who commit financial fraud,” said Acting Assistant Attorney General Branda.  “Thanks to the tireless efforts of our team in Washington and California, S&P has not only paid a record-setting penalty, but has now admitted to the American people facts that make clear its own unlawful role in the financial crisis.”

Half of the $1.375 billion payment – or $687.5 million – constitutes a penalty to be paid to the federal government and is the largest penalty of its type ever paid by a ratings agency.  The remaining $687.5 million will be divided among the 19 states and the District of Columbia.  The allocation among the states and the District of Columbia reflects an agreement between the states on the distribution of that money.

In its agreed statement of facts, S&P admits that its decisions on its rating models were affected by business concerns, and that, with an eye to business concerns, S&P maintained and continued to issue positive ratings on securities despite a growing awareness of quality problems with those securities. S&P acknowledges that:

S&P promised investors at all relevant times that its ratings must be independent and objective and must not be affected by any existing or potential business relationship;

S&P executives have admitted, despite its representations, that decisions about the testing and rollout of updates to S&P’s model for rating CDOs were made, at least in part, based on the effect that any update would have on S&P’s business relationship with issuers;

Relevant people within S&P knew in 2007 many loans in RMBS transactions S&P were rating were delinquent and that losses were probable;

S&P representatives continued to issue and confirm positive ratings without adjustments to reflect the negative rating actions that it expected would come.
In addition, S&P acknowledges that the voluminous discovery provided to S&P by the United States in the litigation does not support their allegation that the United States’ complaint was filed in retaliation for S&P’s 2011 decisions on the credit rating of the United States.  S&P will formally retract that claim in the litigation.

“S&P played a central role in the crisis that devastated our economy by giving AAA ratings to mortgage-backed securities that turned out to be little better than junk,” said Acting U.S. Attorney Yonekura.  “Driven by a desire to increase profits and market share, S&P blessed innumerable securitizations that were used by aggressive lenders to offload the risks of billions of dollars in mortgage loans given to homeowners who had no ability to pay them off.  This conduct fueled the meltdown that ultimately led to tens of thousands of foreclosures in my district alone.  This historic settlement makes clear the consequences of putting corporate profits over honesty in the financial markets.”

Today’s settlement was announced in connection with the President’s Financial Fraud Enforcement Task Force.  The task force was established to wage an aggressive, coordinated and proactive effort to investigate and prosecute financial crimes.  With more than 20 federal agencies, 94 U.S. Attorneys’ Offices and state and local partners, it is the broadest coalition of law enforcement, investigatory and regulatory agencies ever assembled to combat fraud.  Since its formation, the task force has made great strides in facilitating increased investigation and prosecution of financial crimes, enhancing coordination and cooperation among federal, state and local authorities, addressing discrimination in the lending and financial markets and conducting outreach to the public, victims, financial institutions and other organizations.  Over the past three fiscal years, the Justice Department has filed nearly 10,000 financial fraud cases against nearly 15,000 defendants including more than 2,900 mortgage fraud defendants.

TruPS CDOs RULE APPROVED BY AGENCIES

 FROM:  FEDERAL DEPOSIT INSURANCE CORPORATION 
January 14, 2014

Agencies Approve Interim Final Rule Authorizing Retention of Interests in and Sponsorship of Collateralized Debt Obligations Backed Primarily by Bank-Issued Trust Preferred Securities

Five federal agencies on Tuesday approved an interim final rule to permit banking entities to retain interests in certain collateralized debt obligations backed primarily by trust preferred securities (TruPS CDOs) from the investment prohibitions of section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, known as the Volcker rule.

Under the interim final rule, the agencies permit the retention of an interest in or sponsorship of covered funds by banking entities if the following qualifications are met:

the TruPS CDO was established, and the interest was issued, before May 19, 2010;
the banking entity reasonably believes that the offering proceeds received by the TruPS CDO were invested primarily in Qualifying TruPS Collateral; and
the banking entity’s interest in the TruPS CDO was acquired on or before December 10, 2013, the date the agencies issued final rules implementing section 619 of the Dodd-Frank Act.
The federal banking agencies on Tuesday also released a non-exclusive list of issuers that meet the requirements of the interim final rule.

The interim final rule defines Qualifying TruPS Collateral as any trust preferred security or subordinated debt instrument that was:

issued prior to May 19, 2010, by a depository institution holding company that as of the end of any reporting period within 12 months immediately preceding the issuance of such trust preferred security or subordinated debt instrument had total consolidated assets of less than $15 billion; or
issued prior to May 19, 2010, by a mutual holding company.
Section 171 of the Dodd-Frank Act provides for the grandfathering of trust preferred securities issued before May 19, 2010, by certain depository institution holding companies with total assets of less than $15 billion as of December 31, 2009, and by mutual holding companies established as of May 19, 2010. The TruPS CDO structure was the vehicle that gave effect to the use of trust preferred securities as a regulatory capital instrument prior to May 19, 2010, and was part of the status quo that Congress preserved with the grandfathering provision of section 171.

The interim final rule also provides clarification that the relief relating to these TruPS CDOs extends to activities of the banking entity as a sponsor or trustee for these securitizations and that banking entities may continue to act as market makers in TruPS CDOs.

The interim final rule was approved by the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the Commodity Futures Trading Commission, and the Securities and Exchange Commission, the same agencies that issued final rules to implement section 619. The agencies will accept comment on the interim final rule for 30 days following publication of the interim final rule in the Federal Register.

SEC CHARGES HEDGE FUND MAMAGER IN BATON ROUGE, LA., WITH DEFRAUDING INVESTORS



Credit:  Wikimedia Commons

FROM: SECURITIES AND EXCHANGE COMMISSION

Washington, D.C., Nov. 8, 2012 — The Securities and Exchange Commission today charged a hedge fund manager in Baton Rouge, La., with defrauding investors by hiding millions of dollars in losses suffered during the financial crisis from investments tied to residential mortgage-backed securities (RMBS).

The SEC alleges that Walter A. Morales and his firm Commonwealth Advisors Inc. caused the hedge funds they managed to buy the lowest and riskiest tranches of a collateralized debt obligation (CDO) called Collybus. They sold mortgage-backed securities into the CDO at prices they had obtained four months earlier while knowing that the RMBS market had declined precipitously in the meantime. As the CDO investments continued to perform poorly, Morales instructed Commonwealth employees to conduct a series of manipulative trades between the hedge funds they advised (called cross-trades) in order to conceal a $32 million loss experienced by one of the funds in its Collybus investment. Morales and Commonwealth lied to investors about the amount and value of mortgage-backed assets held in the hedge funds, and they created phony internal documents to justify their false valuations.

"Morales and Commonwealth Advisors concealed significant hedge fund losses from investors, including pension fund investors, instead of owning up to them and facing the consequences," said Robert Khuzami, Director of the SEC’s Division of Enforcement. "Investors put their fundamental trust in the hands of their investment adviser, and they deserve better than being manipulated and lied to through deceptive trades and phony documents."

According to the SEC’s complaint filed in U.S. District Court for the Middle District of Louisiana, Commonwealth’s hedge fund clients included pension funds and individual investors. Morales and Commonwealth invested a significant portion of hedge fund assets in RMBS. When the mortgage markets began to decline dramatically in 2007, bond rating agencies began to aggressively downgrade subprime RMBS. Therefore, Commonwealth clients were sustaining heavy investment losses and Morales knew those losses would probably continue.

The SEC alleges that rather than come clean with investors, Morales directed Commonwealth to execute more than 150 deceptive cross-trades from two hedge funds they advised to another one of their hedge funds in June 2008 at prices below Commonwealth’s own valuation for those securities. After the trades, Morales directed a Commonwealth employee to mark the securities at fair market value, which created a fraudulent $19 million gain for the acquiring hedge fund at the expense of the funds that sold. Morales ordered the cross-trades even though Commonwealth had represented in forms filed with the SEC that it would not execute such trades between these hedge fund clients. Moreover, when the trades raised concern from the prime broker, Morales falsely represented that the transactions were for a legitimate business purpose and at prevailing market prices.

The SEC further alleges that Morales deceived Commonwealth’s largest investor about its exposure to the CDO. Morales agreed to limit the investor’s exposure to Collybus through its investment in a particular Commonwealth hedge fund to 10 percent of that hedge fund’s equity. Morales, however, abided by this agreement only temporarily, and the investor’s exposure to Collybus more than doubled by mid-2008. After the large investor learned that Commonwealth was not following its stated valuation procedures, the investor requested valuation committee meeting minutes to review. Morales prepared false minutes that were delivered to the investor purporting to describe meetings that never occurred.

The SEC’s complaint charges Morales and Commonwealth with violations of Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, and Sections 206(1), 206(2), and 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-8. The SEC also alleges that Commonwealth violated Sections 204, 206(4), and 207 of the Advisers Act and Rules 204-2, 206(4)-2, and 206(4)-7, and that Morales aided and abetted Commonwealth’s violations of Section 10(b) of the Exchange Act, Rule 10b-5, and Sections 204, 206(1), 206(2), 206(4), and 207 of the Advisers Act and Rules 204-2, 206(4)-2, 206(4)-7, and 206(4)-8. Morales was a controlling person of Commonwealth pursuant to Section 20(a) of the Exchange Act, and is therefore liable as a control person for Commonwealth’s violations of the Exchange Act.

The SEC’s investigation, which is continuing, has been conducted by Gary M. Zinkgraf, Carol E. Schultze, Jacob D. Krawitz, and Paul Gunson in coordination with members of the SEC Enforcement Division’s Structured and New Products Unit and Asset Management Unit. Matthew Rossi and Jan Folena will handle the SEC’s litigation.

ICP, FOUNDER, SETTLE CDO FRAUD CASE FOR $23 MILLION

FROM: U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C., Sept. 7, 2012 – The Securities and Exchange Commission today announced that New York-based investment advisory firm ICP Asset Management and its founder and president Thomas C. Priore have agreed to settle the agency’s charges that they defrauded several collateralized debt obligations (CDOs) they managed.

ICP, Priore, and related entities have agreed to pay more than $23 million to settle the case the the SEC filed in federal court in Manhattan. The SEC alleged they engaged in fraudulent practices and misrepresentations that caused the CDOs to overpay for securities and lose millions of
dollars. Priore and the ICP companies also improperly obtained fees and undisclosed profits at the expense of the CDOs and their investors.

"The settlement with Priore and ICP sends a clear message that investment advisers must always act in the best interests of their advisory clients, even if those clients are sophisticated investors," said George S. Canellos, Deputy Director of the SEC’s Division of Enforcement. "When advisers put their own interests ahead of their clients’ interests, the SEC will seek to hold them accountable."

The court approved the settlement terms on September 6. The final judgment orders Priore to pay disgorgement of $797,337, prejudgment interest of $215,045, and a penalty of $487,618. ICP and its holding company Institutional Credit Partners LLC are required, on a joint and several basis, to pay disgorgement of $13,916,005 and prejudgment interest of $3,709,028. ICP also must pay a penalty of $650,000. An affiliated broker-dealer ICP Securities LLC is ordered to pay disgorgement of $1,637,581, prejudgment interest of $301,893, and a penalty of $1,939,474. Priore also agreed to settle an administrative proceeding against him and be barred from association with any broker, dealer, investment adviser, municipal securities dealer, or transfer agent, and from participating in any offering of a penny stock. He has a right to reapply for association or participation after a period of five years.

Priore and the ICP companies also consented, without admitting or denying the SEC’s allegations, to permanent injunctions enjoining them from future violations of the securities laws that they were alleged to have violated, which include Section 17(a) of the Securities Act of 1933, Sections 10(b) and 15(c)(1)(A) of the Securities Exchange Act of 1934 and Rules 10b-3 and 10b-5, and Sections 206(1), (2), (3), and (4) of the Investment Advisers Act of 1940 and Rules 204-2, 206(4)-7 and 206(4)-8.

The SEC’s investigation was conducted by Celeste A. Chase, Joseph Boryshansky, Joshua Pater, Susannah Dunn, and Kenneth Gottlieb of the New York Regional Office. Joseph Boryshansky led the litigation with assistance from Jack Kaufman, Mark Germann, Joshua Pater, and Susannah Dunn.

SEC CHARGES BIG BANK FOR SELLING MORTGAGE-BACKED SECURITIES WHILE UNINFORMED

FROM: U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C., Aug. 14, 2012 – The Securities and Exchange Commission today charged Wells Fargo’s brokerage firm and a former vice president for selling investments tied to mortgage-backed securities without fully understanding their complexity or disclosing the risks to investors.

The SEC found that Wells Fargo improperly sold asset-backed commercial paper (ABCP) structured with high-risk mortgage-backed securities and collateralized debt obligations (CDOs) to municipalities, non-profit institutions, and other customers. Wells Fargo did not obtain sufficient information about these investment vehicles and relied almost exclusively upon their credit ratings. The firm’s representatives failed to understand the true nature, risks, and volatility behind these products before recommending them to investors with generally conservative investment objectives.

Wells Fargo agreed to pay more than $6.5 million to settle the SEC’s charges. The money will be placed into a Fair Fund for the benefit of harmed investors.

"Broker-dealers must do their homework before recommending complex investments to their customers," said Elaine C. Greenberg, Chief of the SEC Enforcement Division’s Municipal Securities and Public Pensions Unit. "Municipalities and other non-profit institutions were harmed because Wells Fargo abdicated its fundamental responsibility as a broker to have a reasonable basis for its investment recommendations to customers."

According to the SEC’s order instituting settled administrative proceedings against Minneapolis-based Wells Fargo Brokerage Services (now Wells Fargo Securities), the improper sales occurred from January 2007 to August 2007. Registered representatives in Wells Fargo’s Institutional Brokerage and Sales Division made recommendations to institutional customers to purchase ABCP issued by limited purpose companies called structured investment vehicles (SIVs) and SIV-Lites backed largely by mortgage-backed securities and CDOs. Wells Fargo and its registered representatives did not review the private placement memoranda (PPMs) for the investments and the extensive risk disclosures in those documents. Instead, they relied almost exclusively on the credit ratings of these products despite various warnings against such over-reliance in the PPM and elsewhere. Wells Fargo also failed to establish any procedures to ensure that its personnel adequately reviewed and understood the nature and risks of these commercial paper programs.

The SEC’s order finds that Wells Fargo and its registered representatives failed to have a reasonable basis for their recommendations. They also failed to disclose to their customers the risks associated with the complex SIV-issued ABCP investments, including the nature and volatility of the underlying assets. A number of customers purchased SIV-issued ABCP as a result of Wells Fargo’s recommendations, and many of them ultimately suffered substantial losses after three SIV-issued ABCP programs defaulted in 2007.

The SEC charged former vice president Shawn McMurtry for his improper sale of SIV issued ABCP. McMurtry exercised discretionary authority in violation of Wells Fargo’s internal policy and selected the particular issuer of ABCP for one longstanding municipal customer. McMurtry did not obtain sufficient information about the investment and relied almost entirely upon its credit rating.

Wells Fargo and McMurtry were, at a minimum, negligent in recommending the relevant ABCP programs without obtaining adequate information about them to form a reasonable basis for recommending these products and without disclosing the material risks of these products. As a result, they violated Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933.

The SEC’s order finds that Wells Fargo has taken a number of remedial measures since 2007 to ensure that its registered representatives have adequate information about the nature and risk of the securities they recommend to customers, and that relevant information about those securities will be fully disclosed to customers.

Wells Fargo and McMurtry consented to the SEC’s order without admitting or denying the findings. Wells Fargo agreed to pay a $6.5 million penalty, $65,000 in disgorgement, and $16,571.96 in prejudgment interest. McMurtry agreed to be suspended from the securities industry for six months and pay a $25,000 penalty.

The SEC’s investigation was conducted by Peter K.M. Chan, Rebecca Goldman, and Sally Hewitt of the Enforcement Division’s Municipal Securities and Public Pensions Unit and the Chicago Regional Office with assistance by Steven C. Seeger of the Chicago office’s trial unit, and Daniel R. Gregus, George Jacobus, and Christopher L. Caprio of the Chicago office’s broker-dealer examinations group.

The SEC has filed more than 50 enforcement actions related to the financial crisis, charging 33 entities and 79 individuals for monetary sanctions totaling more than $2.1 billion. Summaries of the cases are available at: http://www.sec.gov/spotlight/enf-actions-fc.shtml