SEC Urges Judge Not to Dismiss Suit Against Ex-JPMorgan Bankers in Jefferson Case

WASHINGTON — The Securities and Exchange Commission is defending its antifraud authority over certain interest-rate swaps and urging a federal judge not to dismiss its suit against two former JPMorgan bankers for allegedly making more than $8 million in undisclosed payments to secure swaps for the firm with Jefferson County, Ala.

The SEC made its appeal in a response brief filed Tuesday in a federal court in Birmingham, about three weeks after the two former bankers, Charles LeCroy and Douglas MacFaddin, asked the court to dismiss the suit, which the commission filed against them in November.

The SEC said the former bankers’ motions to dismiss “present a series of inaccurate facts, incorrect legal standards, and matters improperly outside the scope of the complaint.”

The commission had charged the former bankers made more than $8 million in undisclosed payments to close friends of certain county commissioners and broker-dealers to ensure that JPMorgan would be selected as managing underwriter of bond offerings and that the firm’s affiliated bank would be chosen swap provider in 2002 and 2003.

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 swap transactions and taped conversations with the two former bankers.

The suit also alleged 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 Goldman would pay consulting fees to a local banker close to the then-president of the Jefferson County Commission, Larry Langford, who went on to become the mayor of Birmingham.

The SEC repeatedly warned that in seeking to throw out the case, the former bankers had strayed beyond legal arguments for dismissal and were instead challenging the facts of the SEC’s complaint. The distinction is important because motions to dismiss must assume that the facts in a complaint are true.

LeCroy and MacFaddin now have until Wednesday to respond to the SEC’s brief, after which Judge Abdul Kallon, who sits on the U.S. District Court for the Northern District of Alabama, may schedule a hearing or rule on the matter based on the briefs.

The case is notable because LeCroy and MacFaddin are challenging the SEC’s enforcement jurisdiction over the swaps at issue, which were entered into in connection with three Jefferson County bond transactions in 2002 and 2003 and are at least partly pegged to the Securities Industry and Financial Markets Association’s muni swap index.

The former bankers argued that the SIFMA swap index is an index of rates — not securities — and that the swaps therefore fall outside the SEC’s antifraud jurisdiction. Their claim mirrors an argument that SIFMA made two years ago in a friend-of-the-court brief in a separate case that also involved Jefferson County swaps in which Langford and two others were charged. The judge never ruled in that case, pending the outcome of separate criminal charges against Langford. Langford was convicted in a criminal trial and is awaiting sentencing next month.

In its response this week, the SEC dismissed as semantics LeCroy and MacFaddin’s argument that the municipal swap index is an index of rates and not securities.

“This linguistic exercise ignores the larger and more relevant questions of what the index is, how it is computed, and the relationship between interest rates and bonds that make up the index,” the SEC wrote. “The defendants’ argument ignores the fact that the interest rates are on bonds, which are undisputedly securities.”

The SEC also notes that SIFMA is an advocacy group for the financial services industry, whose members include JPMorgan — “the entity that made the very payments in question in this case.”

But more importantly, the commission warns it is inappropriate for the court to rule on such contested facts at this early in the suit.

Only if the complaint is “patently without merit” can a court dismiss its suit, the SEC argued, urging the court to deny the motion to dismiss, allow the case to proceed, and weigh in on the merits later.

Asked about the SEC’s brief, Lisa Mathewson, who has her own practice in Philadelphia and is representing LeCroy, said yesterday, “The SEC is still trying to sidestep long-established limits on its enforcement authority.”

An attorney for MacFaddin could not be reached.

Meanwhile, the SEC also refuted LeCroy and MacFaddin’s claims that the suit against them should be dismissed because it failed to cite specific instances in which they committed fraud. The commission said the facts in its complaint “either directly or through reasonable inferences” allege each of the necessary elements of a securities fraud violation.

Those elements generally must show material misrepresentations or omissions made in connection with the sale or purchase of a security or security-based swap, done with intentional wrongdoing or scienter, and performed through interstate commerce, the latter of which was not challenged by the pair of former bankers, the SEC said.

The SEC refuted another key argument floated by LeCroy and MacFaddin — that they had no duty to disclose the payments and their conduct in connection with the swaps because the SEC has no jurisdiction over them.

In fact, the court must accept as true the SEC’s allegations in its complaint that the swaps were security-based. When that happens, “the defendants’ argument as to why they had no disclosure obligations in connection with the swap agreements then collapses on itself,” the commission said.

Further, though the SEC agreed with the defendants that there was no fiduciary duty for the pair to disclose their alleged scheme to win business for JPMorgan, it argued there is always a duty to disclose one’s own fraudulent course of conduct. Silence that conceals illegal activity always violates the securities antifraud laws, it said.

In addition, the SEC said, LeCroy completely misstated the test for materiality in claiming that disclosure of the secretive scheme would not have any material impact on the terms of or issuance of the bonds.

“The test is not outcome-determinative, as LeCroy suggests,” the SEC said. “The test is whether the facts alleged would be significant to a reasonable investor’s decision in determining his or her course of action.”

LeCroy left JPMorgan in 2004 and 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 three months in prison. He was barred from the financial markets in October 2006.

MacFaddin, of Cos Cob, Conn., served as managing director and head of JPMorgan’s municipal derivatives department from 2001 until March 2008. The SEC settled charges with JPMorgan last year when it filed charges against LeCroy and MacFaddin.

Without admitting or denying separate charges brought by the SEC in November, JPMorgan agreed to pay a penalty of $25 million to the federal government and $50 million to Jefferson County, as well as forfeit more than $647 million of claimed termination fees.

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