SEC Settles Charges Against JPMorgan

WASHINGTON — The Securities and Exchange Commission announced yesterday that it has settled securities fraud and other charges against JPMorgan Securities Inc. and is pursuing charges against two of the firm’s former managing directors, Charles LeCroy and Douglas MacFaddin, in connection with muni bond and swap transactions done with Jefferson County, Ala.

Without admitting or denying the SEC's charges, JPMorgan agreed to pay a penalty of $25 million to the federal government and $50 million to Jefferson County, as well as to forfeit more than $647 million of claimed termination fees. The $25 million payment will be placed in a Fair Fund to compensate harmed investors and the county, the SEC said.

But LeCroy and MacFaddin refused to settle. In a complaint filed with a federal court in Birmingham, the SEC said the two made more than $8 million in undisclosed payments to close friends of certain Jefferson County commissioners and broker-dealers to ensure that JPMorgan would be selected as managing underwriter of the bond offerings and that its affiliated bank would be chosen as swap provider. The friends owned or worked at local dealer firms that performed few or no services in the transactions, the SEC said, citing documents related to the bond and swaps transactions and taped conversations with LeCroy and MacFaddin.

JPMorgan did not disclose any of the payments or conflicts of interest in the swap confirmation agreements or bond-offering documents, but passed the cost of the payments on to the county through higher interest rates on the swap transactions, the SEC said.

“The transactions were complex but the scheme was simple. Senior JPMorgan bankers made unlawful payments to win business and earn fees,” said Robert Khuzami, director of the SEC’s division of enforcement.

The settlement and civil suit come a week after Larry Langford, the former president of the Jefferson County Commission and Birmingham mayor, was convicted on 60 federal felony charges. Those charges were initiated by the SEC’s investigation of bonds and swaps sold by the county in 2002 and 2003 and led to a separate SEC complaint that was put on hold at the request of Langford’s lawyers until the criminal matter could be resolved. That case is still pending.

The suit also alleges that secret payments totaling $4.4 million were made to Goldman, Sachs & Co. and Rice Financial Products Inc. in 2003 so that both firms would agree to stop pitching bond and swap deals to the county, and so that Goldman would pay William Blount of Blount Parrish & Co. $300,000. Blount was close to Langford and had been hired by Rice as a consultant. 

A Goldman spokesman declined to comment. Rice Financial did not return a phone call.

SEC officials declined to say their investigation is ongoing, suggesting they may not bring any charges against certain other firms tied to the county’s bonds and swaps. They also suggested that the SEC’s action yesterday is unrelated to the SEC’s ongoing civil investigation into bid-rigging and anti-competitive behavior in the muni market.

As part of a parallel probe in that matter, the Justice Department last week brought its first criminal charges against Beverly Hills-based CDR Financial Products Inc., its founder David Rubin, and both a current and a former employee there.

Asked about the SEC settlement, JPMorgan spokesman Brian Marchiony said that the firm is “pleased to have reached a settlement with the SEC.”

“The charges related principally to municipal derivatives transactions that occurred six and seven years ago,” he said in a statement. “JPMorgan has since discontinued that business, and the employees in question are no longer employed by the firm. The settlement does not impair any outstanding Jefferson County bonds and JPMorgan continues to work to achieve a responsible restructuring of Jefferson County’s financial affairs.”

Although the troubled county has received swap termination notices from its counterparties, it has not paid them. The JPMorgan termination fees were by far the largest, but Lehman Brothers says it is owed $59.1 million, Bank of America NA says it is owed $31.2 million, and Bear, Steans says it is owed $9.1 million.

Richard Lawler, a partner at Winston & Strawn LLP in New York, said his client MacFaddin “at all times acted properly with Jefferson County” and denied that MacFaddin had violated any of the securities laws. He said his client would be vindicated after trial.

Lisa Mathewson, who has her own practice in Philadelphia and is representing LeCroy, said she would dispute some of the factual details in the complaint and that the SEC is “trying to retroactively expand their jurisdiction through enforcement.”

The remark refers to the SEC’s previous civil litigation against Langford, in which the commission maintained that it has antifraud authority over securities-based swaps based on the municipal swap index created by the Securities Industry and Financial Markets Association.

Langford and the industry disputed some of the SEC’s arguments, and the issue was never fully resolved by the courts before the civil case was suspended.

LeCroy, 55, left JPMorgan in March 2004, currently lives in Winter Park, Fla. In early 2005, he pleaded guilty to two counts of wire fraud for engaging in a scheme to make payments to obtain muni business from Philadelphia, on behalf of JPMorgan, and was sentenced to six months in prison, the SEC said. He was barred from the financial markets in October 2006.

MacFaddin, 48, of Cos Cob, Conn., served as managing director and head of JPMorgan’s municipal derivatives department from 2001 until March 2008, according to the SEC. 

The plan to pay for Jefferson County business allegedly started in early 2002, when LeCroy, then JPMorgan’s lead investment banker for the county’s public finance projects, e-mailed his superiors with the new strategy.

In a series of e-mails, LeCroy discussed a rival firm’s “purportedly successful” tactic to win muni business by paying small local firms in unrelated transactions to enlist their political support for the rival firm on bond and swap transactions.

The plan relied on an Alabama law that requires swap agreement counterparties to either have a net worth of at least $100 million or arrange for an entity with a net worth of at least $100 million to guarantee the obligations, making the small, local firms ineligible to do the swap transactions themselves.

LeCroy initially suggested paying two small local broker-dealers, Gardnyr Michael Capital Inc. and ABI Capital Management LLC, payments of between $5,000 and $25,000 per deal.

“One of LeCroy’s superiors reacted favorably, and suggested following up to 'know which firms [LeCroy] wants us to target,’” the SEC said in its complaint.

However, far from the relatively small payments originally discussed, the firm wound up paying millions of dollars to these and other firms “and cost the county because JPMorgan incorporated many of [the payments] into the cost of the swap transactions, even though LeCroy and MacFaddin knew these firms performed virtually no services for the county,” the SEC said.

In July 2002, LeCroy and MacFaddin solicited the county for a $1.4 billion sewer bond deal, and knew that several county commissioners wanted to complete the transaction before November, when two commissioners would leave office and would lose their ability to funnel payments to their supporters’ firms.

As a result, the pair targeted their solicitations to Commissioner Jeff Germany and another, unnamed commissioner, both of whom had lost their primary elections and would leave office in November.

The solicitation was successful and LeCroy told MacFaddin in a taped telephone call about his efforts to persuade the two commissioners to select JPMorgan for the deal, boasting of beating out a rival firm with the new strategy.

“And we kind of co-opted their — the minority firms they teamed up with because, the two black commissioners [Germany and the unnamed commissioner] said, 'Look, if we support the synthetic refunding, you guys have to take care of our two firms [Gardnyr Michael and ABI Capital],’” LeCroy said in the call.

“And I said, 'Whatever you want — if that’s what you need, that’s what you get — just tell us how much.’.... And I’ve been told by the other four [commission] members now that if I don’t get it done by Nov. 1, they’re gonna fire [me] because they want it done before they lose control, because they want to help all their friends.”

The county later increased the total bond deal to $1.8 billion, and broke it up into three small transactions, all of which closed with a five-week period ending on Nov. 1, 2002. Meanwhile, LeCroy and MacFaddin made sure JPMorgan paid the two small firms $250,000 each, the SEC said, citing taped conversations between the duo and Germany.

Though MacFaddin expressed concern that if someone discovered the payments “they could have a field day with it” because they were “fairly large,” LeCroy allayed MacFaddin’s fears by stating that the other commissioners “didn’t have a clue” about the payments. 

The following year, after Langford had become the president of the commission and instructed the county’s financial team to include Blount’s firm on all of the county’s transactions, JPMorgan was able to essentially scuttle plans to hire Goldman and Rice Financial on a deal that Blount was working to set up.

In exchange for selecting JPMorgan as the underwriter and swap counterparty, the firm agreed to pay Goldman $3 million and Rice Financial $1.3 million, and Goldman paid Blount $300,000, according to the complaint.

LeCroy later joked with MacFaddin in a taped phone call about JPMorgan’s “philanthropic work” by “giving a charitable donation to Goldman” for “taking no risk,” the SEC said.

On a third swap with JPMorgan scheduled for later in 2003, Blount insisted on being paid 15% of JPMorgan’s fees, the equivalent of $2.6 million. According to taped conversations cited by the SEC, LeCroy agreed it was worth paying Blount such a large sum because the transaction was so large and Blount would not not to interfere with JPMorgan. In addition, the firm also agreed to pay Gardnyr Michael and ABI Capitol an additional $250,000 each, at the direction of County Commissioner Shelia Smoot, the SEC said.

Smoot, who is still on the commission, is a Democratic candidate for a congressional seat currently held by Democrat Rep. Artur Davis. Byron Perkins, a managing attorney with the Cochran Firm in Birmingham, said that Smoot would make a statement at a later date.

Shelly Sigo contributed to this story.


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