Municipal Bond Fraud Charges Cost $228m on JPMorgan Securities

Jack Humphrey, Regulatory journalist
July 11, 2011 /

The Securities and Exchange Commission (SEC) has charged JP Morgan Securities LLC with fraudulent bidding practices that involved investment of at least 93 municipal bond reinvestment transactions in 31 states, generating millions of dollars in ill-gotten gains.

Without denying or admitting the allegations, JP Morgan conceded to pay $228 million in a settlement arranged by the SEC which continues with its fight against corruption in the municipal reinvestment industry.

Last February, the SEC has expanded its investigation into municipal bond offerings to include Rhode Island following its previous investigation into the state of Illinois relating to its pension funds disclosure. Questions were raised whether it provided the necessary information to the buyers of bond or misled them from the actual magnitude of risk they were facing.

On December 7, 2010, the SEC charged Banc of America Securities LLC with securities fraud for similar conduct. The bank agreed to pay more than $36 million in disgorgement and interest to settle the SEC’s charges, and paid an additional $101 million to other federal and state authorities for its misconduct.

On May 4, 2011, the SEC charged UBS Financial Services Inc. with securities fraud for fraudulently rigging bids as both a provider and a bidding agent. UBS agreed to pay $47.2 million in disgorgement, interest and civil penalties to settle the SEC’s charges and to pay $113 million to other federal and state authorities in connection with their parallel cases.

As part of the settlement, JP Morgan also agreed to pay approximately $51.2 million that will be returned to the affected municipalities or conduit borrowers. JP Morgan and its affiliates also agreed to pay $177 million to settle parallel charges brought by other federal and state authorities.

The SEC claimed from 1997 through 2005, JP Morgan’s “fraudulent practices, misrepresentations and omissions undermined the competitive bidding process, affected the prices that municipalities paid for reinvestment products, and deprived certain municipalities of a conclusive presumption that the reinvestment instruments had been purchased at fair market value.”

It added: “JPMS’s fraudulent conduct also jeopardized the tax-exempt status of billions of dollars in municipal securities because the supposed competitive bidding process that establishes the fair market value of the investment was corrupted. The employees involved in the alleged misconduct are no longer with the company.”

According to the SEC’s complaint filed in U.S. District Court for the District of New Jersey, JPMS, acting as the agent for its affiliated commercial bank, JPMorgan Chase Bank, N.A., at times won bids because it obtained information from the bidding agents about competing bids, a practice known as “last looks.”

In other instances, it won bids set up in advance for JPMS to win because the bidding agent deliberately obtained non-winning bids from other providers, and it facilitated bids rigged for others to win by deliberately submitting non-winning bids.

Robert Khuzami, Director of the SEC’s Division of Enforcement, said: “JPMS improperly won bids by entering into secret arrangements with bidding agents to get an illegal ‘last look’ at competitors’ bids.

“Municipal issuers and investors didn’t stand a chance against the fraudulent strategies JPMS and others used to guarantee profits.”

Elaine C. Greenberg, Chief of the SEC’s Municipal Securities and Public Pensions Unit, added: “When powerful financial institutions like JPMS conspire with each other to intentionally violate regulations designed to ensure fair investment prices, the integrity of the municipal marketplace becomes corrupted. Rather than playing by the rules, the rules got played.”

Typically, purchasing of municipal bond is associated with municipal reinvestment of the proceeds of sales until the money is used for the intended purposes. The proceeds of tax-exempt municipal securities generally must be invested at fair market value under relevant Internal Revenue Service regulations. This can be done through a competitive bidding process in which bidding agents search for the appropriate investment vehicle for a municipality.

JP Morgan consented to the entry of a final judgment enjoining it from future violations of Section 15(c)(1)(A) of the Securities Exchange Act of 1934 and has agreed to pay a penalty of $32.5 million and disgorgement of $11,065,969 with prejudgment interest of $7,620,380. The settlement is subject to court approval.

In a related enforcement action, the SEC barred former JPMS vice president and marketer James Hertz from association with any broker, dealer, investment adviser, municipal securities dealer, municipal advisor, transfer agent, or nationally recognized statistical rating organization, and from participating in any penny stock offering.

This sanction stems from Hertz’s December 6, 2010 guilty plea to two counts of conspiracy and one count of wire fraud for engaging in misconduct in connection with the competitive bidding process that involved the investment of proceeds of tax-exempt municipal bonds.

Deputy Chief Mark R. Zehner and Assistant Municipal Securities Counsel Denise D. Colliers, who are members of the Municipal Securities and Public Pensions Unit in the Philadelphia Regional Office, conducted the SEC’s investigation into this matter.

 

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