Sell Side

JPMorgan to End Muni Derivatives Practice

JPMorgan yesterday announced it will stop structuring interest-rate derivative products for governmental municipal issuers, while also instituting a number of measures designed to tighten controls across its tax-exempt capital markets business.

The changes come as JPMorgan and other firms face legal scrutiny over their role in the muni derivative market.

The broker-dealer exited the business because the risk-return profile of providing the derivative products to municipal issuers did not justify the resources it required, according to an internal memo.

"We don't think this will hurt profitability at all," Matt Zames, head of tax-exempt capital markets, global rates, and currencies said an interview with The Bond Buyer yesterday. "We actually think, in the medium term, we're going to be viewed as a leader, and that, in fact, our clients are going to realize we have their best interests in mind."

Municipal issuers' demand for many of the derivative products used to create synthetic financings has already decreased amid the current market turmoil, according to Mark Melio, head of TECM investment banking. Issuers now prefer more conventional fixed- and variable-rate products, he said.

The municipal derivatives business represented a very small portion of JPMorgan's tax-exempt capital markets business, the company said. It will continue to market derivatives products to all non-municipal issuers, including 501(c)(3) clients, nonprofit health care organizations, private educational and cultural institutions, and for-profit clients. In addition, JPMorgan will still assist municipal issuers with commodity derivatives to hedge expenses such as energy costs.

The moves will not affect any existing derivative contracts. JPMorgan is one of the leading creditors involved with talks on the restructuring of Jefferson County, Ala.'s nearly $3.2 billion of variable- and auction-rate debt, which has placed the county in danger of filing for the largest municipal bankruptcy ever.

The firm was a lead book-runner on all but one of the county's outstanding sewer deals and has swap exposure on a notional amount of debt totaling $2.47 billion plus three swaps assumed from Bear, Stearns & Co. as counterparty for a total notional amount of $1.56 billion. The bond and swaps deals have since led the Securities and Exchange Commission to file charges of securities fraud and other charges against a politician, an Alabama bond dealer, and a lobbyist.

The changes come as JPMorgan itself appears to be one of the firms at the center of parallel Justice Department and SEC criminal and civil probes of the muni derivatives and investment markets, including allegations of bid-rigging, price-fixing, and other anticompetitive practices.

Regulatory filings have disclosed the names of at least seven JPMorgan bankers or alumni who have been named targets by a federal grand jury investigation under the Justice Department's criminal probe. In addition, JPMorgan disclosed recently that it received a Wells notice from the SEC in Philadelphia in March warning that it is preparing to recommend possible enforcement action.

Further, a number of issuers have filed suits against JPMorgan and other banks, brokers, investment advisers, and insurance companies in regards to anti-competitive behavior in the muni derivative market.

In its internal memo yesterday, JPMorgan also announced a number of other changes designed to tighten controls in its tax-exempt capital markets unit.

"We will reduce the number of underwriters' counsel with whom we work, centralize the number of tender agents and trustees on transactions we lead, and introduce more targeted internal training programs," the memo reads. "We also will enhance our already strict discipline around employee compliance policies and credit standards."

The company will also consolidate its 19 TECM investment banking units into 10 core regional centers, to ensure better collaboration, communication, and control across the firm. JPMorgan will continue to service the nine areas where its offices will close - Albany, Lansing, Mich., Sacramento, San Antonio, Seattle, Columbus, Pittsburgh, Philadelphia, and Jacksonville, Fla. - and the changes will not have a "significant" impact on clients, according to the memo.

JPMorgan said it hopes the changes will make it "set a new standard around controls".

"We absolutely want to have a highly controlled business," said Jeff Bosland, head of TECM sales, trading, and syndicates, as well as credit portfolio and analysis. "If you just read the newspapers, you'll see the need for controls in the municipal space, both across the issuers' side and dealers' side. And we are definitely going to be at the forefront of that effort."

Most of the staff affected by the changes will be absorbed into other parts of the business. Hugh Nickola, who had formerly co-headed TECM sales, trading, and syndicates with Bosland, will head municipal exotics trading and the structured high-rate, risk-taking effort for Global Fixed Income Exotics and Hybrids, the memo said.

The changes are not part of a deal related to any pending legal action. However, this is not the first time JPMorgan will have adjusted its policies amid legal probes.

In 2004, JPMorgan backed a ban on the use of consultants by broker-dealers, even though it had been one of the industry's biggest users. Federal law enforcement officials indicted two former JPMorgan bankers on wire fraud charges for creating a fictitious invoice to circumvent disclosure rules on consultants less than two months later. They later pleaded guilty to those charges.

The SEC also filed administrative charges against the two former bankers for violating an industry disclosure law on consultants. The two former bankers were barred from the securities industry, but an administrative law judge later dismissed the SEC charges against them.

Shelly Sigo and Lynn Hume contributed to this story.


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