Jefferson County Swaps are Outside SEC Purview, Former Bankers Argue

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BRADENTON, Fla. – Two former JPMorgan bankers facing pay-to-play charges related to bankrupt Jefferson County, Ala.’s bond and swap transactions have rekindled an argument that the swaps are not “securities-based” and therefore are outside the Securities and Exchange Commission’s antifraud authority.

In 2009, the SEC charged that Charles LeCroy and Douglas MacFaddin made $8.2 million in undisclosed payments to close friends of certain county commissioners and broker-dealers to ensure that JPMorgan would be selected as managing underwriter on certain Jefferson County’s bond offerings and that the firm’s affiliated bank would be chosen as swap provider.

In a joint motion for partial summary Oct. 7, LeCroy and MacFaddin contend that the SEC either has a “fundamental misunderstanding” of the Securities Industry and Financial Markets Association Index and financial instruments or the agency is making a “bold attempt” to expand its antifraud jurisdiction over swaps that were not security-based and were excluded by Congress from the SEC’s purview.

The bankers previously filed unsuccessful motions to dismiss the complaint arguing that the SEC did not have jurisdiction to bring charges relating to the swaps. In recent court papers, they said their new, partial summary motion is based on issues not previously considered.

The SEC alleged that the county’s swaps are “security based swaps,” and that the court has jurisdiction over them because they are based on the SIFMA Index, which is derived from a basket of variable-rate demand notes.

The SEC’s conclusion is wrong for two reasons, the bankers argue. One reason is that the SIFMA Index is not an index of securities - it is an interest-rate index, they argued. The second reason is that the SIFMA Index captures interest rates, not the “price, yield, value, or volatility” of any security or any group or index of securities over which Congress granted the SEC jurisdiction.

The bankers also said that the Internal Revenue Service has recognized that the SIFMA Index is a “tax-exempt interest rate index.”

“An interest rate is not a security, and an index composed of interest rates is not an index of securities,” they said, adding that swaps based on the SIFMA Index “provide almost no risk of fraud” with respect to the underlying variable-rate demand notes.

In a separate filing, LeCroy is seeking partial summary judgment on the grounds that injunctive relief sought by the SEC is prohibited by the five-year statute of limitations. He was barred from the securities industry in 2006.

Though the court rejected a similar motion by LeCroy previously, in a mid-October court filing he challenged, among other things, cases cited by the court to support its conclusion that the statute of limitations was inapplicable.

The SEC has until Nov. 18 to respond to the motion for partial summary judgment regarding the swaps, and until Nov. 25 to respond to LeCroy’s statute of limitations claim.

The latest filings in the case are the result of motion deadlines imposed by Federal Judge Abdul Kallon, who has refused to set a trial date because the bankers have been unable to depose CDR Financial Products Inc. senior vice president Douglas Goldberg.

Goldberg pleaded guilty to participating in a conspiracy to rig bids for municipal bond investment contracts. Kallon has prevented his deposition until after his sentencing, which is currently set for March 20.

CDR was the swap adviser to Jefferson County as it built a portfolio of derivatives during the issuance of nearly $3.2 billion of auction- and variable-rate sewer warrants sold to rebuild an aging regional sewer system under a federal consent decree.

The county filed for bankruptcy in November 2011 citing the $3.14 billion of sewer warrants among its debt.

A confirmation hearing on the plan of adjustment is set for Nov. 20, around the time $1.7 billion of refunding sewer warrants critical to the plan will be priced. Proceeds will be used to pay off creditors at an aggregate loss of less than 50 cents of the dollar.

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