Fraud Without Fraudsters; Fraud Without “Fraud”

The SEC's settlement with JPMorgan Chase on a Magnetar deal

How is it possible to file a civil fraud lawsuit against a bank without filing them against a banker?

That’s the reasonable question posed by both The Wall Street Journal and Bloomberg’s Jonathan Weil today.

JPMorgan Chase defrauded investors including a Lutheran nonprofit by deceptively unloading toxic CDOs created for (and, essentially, by) the infamous hedge fund Magnetar earlier this week. I should note that JPMorgan “neither admitted nor denied wrongdoing” as part of its settlement—which is legalese for “guilty!”

The SEC got $154 million out of JPMorgan, which will take press favorite Jamie Dimon’s too big to fail bank 2.5 days to earn back at its current rate of profit. It also sued the CDO manager Edward S. Steffelin of GSC Capital for misleading investors about Magnetar’s role.

But not a single JPMorgan bankers was sued or will have to cough up a cent of ill-gotten compensation.

The Journal zeroes in on JPMorgan banker Michael R. Llodra, who worked on the CDO in question and headed the bank’s asset-backed CDO operation, and has this good reporting:

The outcome is another instance of the SEC deciding it doesn’t have the evidence to bring cases against individuals at financial firms blamed for triggering or worsening the financial crisis…

The first hurdle in bringing claims against Mr. Llodra was a lack of sufficient evidence that he intended to mislead investors, according to people familiar with the matter.

These people said the decision not to file charges against him also reflected the fact that J.P. Morgan’s in-house lawyers signed off on the relevant information related to the Squared deal. That information failed to disclose that Illinois-based hedge-fund firm Magnetar Capital LLC was betting against the deal while also helping choose the underlying assets. Any suggestion Mr. Llodra was personally liable for this lack of disclosure would have to address why he was wrong to rely on the advice of the bank’s legal experts, according to lawyers uninvolved in the case.

So that’s it, huh? You can’t sue the lawyers for offering “good faith” legal advice, and you can’t sue the bankers for following that advice, even though they knew it was incomplete. From now on, just make sure that you don’t write anything on email and that you have lawyers sign off on your documents and you’ll be cool, no matter how badly you’re misleading investors.

Which brings us to an important point Yves Smith makes in her book Econned, and one that you never seem to read about in the press (I don’t know if it has any bearing here, I just think it’s worth noting):

Legislators also need to restore secondary liability. Attentive readers may recall that a Supreme Court decision in 1994 disallowed suits against advisors like accountants and lawyers for aiding and abetting frauds. In other words, a plaintiff could only file a claim against the party that had fleeced him; he could not seek recourse against those who had made the fraud possible, say, accounting firms that prepared misleading financial statements. That 1994 decision flew in the face of sixty years of court decisions, practices in criminal law (the guy who drives the car for a bank robber is an accessory), and common sense. Reinstituting secondary liability would make it more difficult to engage in shoddy practices.

Weil reports that the SEC couldn’t even bring itself to say JPMorgan intentionally defrauded investors:

Why did the SEC decide that JPMorgan’s actions amounted only to negligent fraud and not fraud with scienter? The head of the SEC’s enforcement division, Robert Khuzami, didn’t answer that question when I put it to him in a conference call with reporters this week.

That would be former Deutsche Bank general counsel Robert Khuzami, who “oversaw a group of lawyers at his old firm, Deutsche Bank AG, that was closely involved in developing collateralized debt obligations.” Man is it baffling why that guy wouldn’t want to press too hard against bankers who created CDOs and the lawyers who gave them legal cover (it’s worth remembering too that an SEC whistleblower alleges Khuzami watered down Citigroup charges for a lawyer crony who represented the bank).

And that lays bare a shortcoming of the Journal’s story. It’s at base a defense of the SEC and “the Difficulties of Pinning Blame for Soured Deals.” Which is fine if you’re going to explore all the difficulties, including the self-imposed ones.

I mean, seriously. You don’t have to be a cynic to guess that when the feds hire a guy from Deustche Bank who oversaw the folks developing CDOs there—and Deutsche was one of the worst churners of those toxic assets—you’re not going to get very tough enforcement of the folks who churned out toxic assets. It’s sort of like hiring Tom Hagen to look into corruption in the olive oil industry.

For all I know Khuzami may be a fine gent, but he shouldn’t be in that position. And his history is probably worth mentioning in any story exploring the “challenges in chasing fraud.”

If there’s any real justice here, it’s that JPMorgan couldn’t unload the Squared CDO junk fast enough and got stuck with $880 million in losses itself. But it wasn’t for lack of trying:

The SEC also quoted an exhortation from an unnamed J.P. Morgan employee to a sales team, which was told to offload the rapidly deteriorating assets in Squared onto investors.

“We are sooo pregnant with this deal….Let’s schedule the cesarian, please!” the email, with its misspelling, said.

Fortunately by then everybody was wising up to the scam.

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Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at Follow him on Twitter at @ryanchittum. Tags: , , , ,