SEC's Targeting of JPMorgan Draws Praise

BRADENTON, Fla. - Jefferson County, Ala., commissioner Jim Carns Friday said he was "extraordinarily encouraged" that the Securities and Exchange Commission had approved enforcement action against JPMorgan for securities law violations involving the county's bond and swaps sales.

The case, should it move forward, would be the first to test the limits of the SEC's authority over muni derivatives.

Carns urged "the SEC to condition any settlement" with JPMorgan upon the bank's assumption of financial responsibility for all swap termination payments owed to it by the county. He also wants the SEC to require JPMorgan to pay for "not less than $1.6 billion of revenue bonds recklessly issued by Jefferson County at the instigation of JPMorgan."

Carns also wants other banks involved with selling the rest of the more than $3 billion in troubled sewer debt to assume responsibility for it.

JPMorgan disclosed late last week that the SEC on April 21 authorized filing an action against it for alleged violations of securities laws and Municipal Securities Rulemaking Board rules with regard to "certain transactions" in 2002 and 2003 with the county.

"The firm has been engaged in discussions with the SEC staff in an attempt to resolve the matter prior to litigation," said JPMorgan's disclosure, which was filed under "Municipal Derivatives Investigations and Antitrust Litigation."

Jefferson County, home to Birmingham, has teetered on the edge of bankruptcy for well over a year while officials tried unsuccessfully to negotiate restructuring of $3.2 billion of variable- and auction-rate sewer warrants for which interest rates have skyrocketed as a result of the subprime mortgage debacle.

JPMorgan was involved with the sale of much of that debt in 2002 and 2003 and is counterparty to most of the county's swaps, which covered a notional amount of $5.6 billion.

"I have long advocated that Wall Street created most of this disaster, not the county's citizens," Carns said in a press release. "Sewer customers and citizens do not want (nor should they be required) to pay charges or taxes for debt fraudulently issued and where debt proceeds have been inappropriately spent."

While Carns has voiced support for a possible bankruptcy filing, County Commission President Bettye Fine Collins has opposed the notion of bankruptcy.

"The county's sewer debt is owed to eight banks, seven of which are not being investigated by the SEC," Collins said in a statement late Friday. "One of those seven banks is Regions Bank, headquartered in Birmingham, not Wall Street. The county's legal team is evaluating what, if any, impact this will have on the efforts to end the sewer debt crisis."

Commissioner Shelia Smoot, who also has opposed bankruptcy, said JPMorgan's disclosure might be a bargaining chip as the county continues to try to restructure the sewer debt.

"It may be the very thing we need to assist us with negotiations," she said. "I believe this is a positive for us."

The specific charges being considered against JPMorgan were not mentioned in the firm's disclosure. An SEC spokesperson would not comment because no charges have been filed.

It is somewhat unusual for the SEC to authorize an enforcement action without filing the charges and making them publicly known relatively soon, said Mitchell Herr, a partner at Holland & Knight and former chief trial counsel for the regional office of the SEC in Miami. After reading JPMorgan's disclosure, Herr noted that it has been more than two weeks since the SEC authorized filing charges.

"This is being handled a little bit out of the norm," Herr said. "I think what is clear is that the commission is prepared to settle at a level that is probably lower than they are willing to charge and it's not publicly committing itself until they see how the negotiations go."

Herr suggested the delay in filing charges could be related to the swaps, which have been a source of heated debate as to whether the SEC has jurisdiction

JPMorgan had six outstanding swaps in March when it terminated them at a cost to the county of $648.8 million. Bear, Stearns & Co., which JPMorgan purchased last year, also terminated its swaps at a cost to the county of $9 million.

As part of negotiations to restructure the sewer debt, JPMorgan and other banks reportedly have agreed to concede the swap termination payments. But in return the creditors want the county to find more sources of revenue to restructure the troubled sewer debt.

"I would assume that would be mitigating," Herr said about the swap termination concession.

If the SEC followed through on its threat to file enforcement action against JPMorgan over the Jefferson County swap transactions, the case likely would be the first to test the limits of the commission's authority over muni derivatives.

The Commodity Futures Modernization Act of 2000 amended the Gramm-Leach-Bliley Act to provide "legal certainty" to derivatives by exempting them from federal regulation. However the act allows the SEC to use its anti-fraud authority in connection with securities-based swaps. It defines such agreements as those "of which a material term is based on the price, yield, value or volatility of any security or any group or index of securities or any interest therein."

But the issue of what constitutes a securities-based swap is subject to interpretation and has already been under dispute in another SEC case involving the Jefferson County swaps. That case against former Jefferson County Commission chairman Larry Langford, Alabama bond dealer William Blount, and lobbyist Albert LaPierre is currently on hold until a parallel criminal case is resolved.

In that case, which was filed in a federal court in Birmingham in April 2008, the SEC charged that Blount and his firm provided Langford with $156,000 in payments and benefits, through LaPierre, in exchange for Langford's efforts to ensure Blount Parrish was chosen to participate in Jefferson County bond offerings and swap agreements, so that it could reap millions of dollars of fees.

Langford and Blount sought to have the case dismissed, claiming the SEC has no jurisdiction over the swaps. The SEC disagrees, saying, among other things, that the swaps were based on a municipal securities swap index created by the Public Securities Association, which became The Bond Market Association, and then the Securities Industry and Financial Markets Association.

SIFMA, in turn, has filed a friend-of-the-court brief in the case, claiming the index is an index of interest rates, not securities.

The SEC has countered that the rates are derived from securities. The index is a compilation of rates for variable-rate demand obligations that are reset on a weekly basis. The securities are all sold at par such that the interest rates are also the yields of the VRDOs.

The SEC contends it could proceed with its case against Langford, Blount and LaPierre without authority over the swaps and sources say it probably would be able to make the same claim in connection with any action against JPMorgan.

JPMorgan announced in September that it would stop structuring interest-rate derivative products for governmental municipal issuers.

Lynn Hume contributed to this story.

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