JPMorgan Chase Fined $228 Million for Rigging Municipal Bond and Swap Deals
July 8, 2011 (The Morning Call, Allentown, Pennsylvania) The U.S. Securities and Exchange Commission charged JPMorgan Chase & Co. Thursday with running nationwide bid-rigging schemes involving municipal bond and swap deals it handled for school districts, municipalities and other tax-exempt entities in at least 31 states, including Pennsylvania.
The charges, which include a $228 million settlement but no admission of guilt by the banking giant, come nearly 31/2 years after the SEC confiscated the Bethlehem Area School District's bond and swap records involving deals with JPMorgan and Morgan Stanley Bank. Swaps are complex derivatives that bet on the interest-rate swings of underlying municipal bonds.
The SEC settlement also ends parallel probes of JPMorgan's securities and swap divisions conducted by the Internal Revenue Service, U.S. Department of Justice, Office of the Comptroller of the Currency and state attorneys generals. The settlements, which must be approved by a federal judge, call for JPMorgan to return to the victimized governments about $143 million, which will be distributed in varying amounts by SEC, OCC and state attorneys general offices, according to the SEC. The rest goes to fines and government costs for conducting the probe.
Mary P. Hansen, assistant regional director of the SEC's Philadelphia office, the lead investigator, declined to say if Bethlehem Area or any other Lehigh Valley government agency fell victim to the bank's schemes. She said a list of victims will not be made public until a federal judge in Newark, N.J., approves the agreements.
"Hopefully it will be soon," Hansen said.
Nils Hagen-Frederiksen, spokesman for Pennsylvania Attorney General Linda Kelly, also declined to release a list of victims.
"All agencies that might benefit from this settlement will be contacted directly with information about filing a claim," he said in an email.
In a statement posted on its website, JPMorgan officials blamed rogue employees who no longer work for the firm and claimed to have cooperated with the probes and to have closed its municipal swap practice.
"These employees concealed their conduct from management," the statement said. "The firm's policies -- both now and during the period in question -- expressly prohibit the conduct that gave rise to these proceedings."
JPMorgan is the third major financial institution to agree to fines to settle SEC probes since the worldwide mortgage and credit meltdowns led to the Great Recession. In May, Union Bank of Switzerland (UBS), agreed to a $90.8 million fine, and Bank of America agreed to a $67 million settlement in December.
Bethlehem Area Superintendent Joseph Roy said Thursday he had not heard of the JPMorgan settlement and did not know if the district would be entitled to any proceeds.
"But I'd be happy to accept money," he said.
Bethlehem Area conducted 17 swap transactions -- the most by any school district in the state -- on five construction bonds between 2003 and April 2009 under former Superintendent Joseph Lewis and business manager Stanley J. Majewski Jr., according to a four-part investigation published by The Morning Call in June 2009.
Derivative swaps, which come with hefty fees, are contracts with investment banks that are layered on top of variable-rate bonds. Swaps are bets on interest rate swings in an effort to hedge against a potential increase in the underlying bonds' variable-rate interest.
The bond deals were orchestrated by the district's financial adviser at the time, Les Bear of Tredyffrin Township, Chester County. For the swap side of the deals, Bear brought in another financial consultant, Matt Kirk of Lancaster, because Bear's firm couldn't conduct the complicated swap formulas.
JPMorgan served as the investment bank on nine swap transactions conducted on three bonds. Morgan Stanley did the other swaps.
On all the deals, Bear's firms were paid to conduct multiple, conflicting roles such as financial adviser and bond underwriter. In at least one of the JPMorgan deals, the most costly one for the district, Kirk was paid by taxpayers at the same time he was serving as an "agent" for JPMorgan, the newspaper found.
In October 2008, the school district turned over its bond and swap records to the SEC as part of the federal agency's sweeping investigation into the municipal bond market.
The Morning Call found that the swap deals were a bust. Between 2003 and May 2009, taxpayers shelled out: $10 million in net payments on the swaps, $25.4 million in fees and termination payments, and $30 million in interest on the variable rate bonds.
On Thursday, school Director Benjamin M. Tenaglia III stressed that even though Bethlehem's swap problems are well-documented it doesn't mean it would be part of any state or federal settlement.
"We just have no official word on whether Bethlehem is one of the victims in the action,' he said. "But I hope so."
While the list of victimized agencies has not been disclosed, court records detail swap scenarios similar to Bethlehem's, even though court records do not name any JPMorgan employees or contract "agents."
The agreement states that JPMorgan relied on close relationships with municipal financial advisors, who often served as underwriters, to conceal fair market values on pending swap deals between 2001 and 2005. Advisers, on the advice of JPMorgan, would get clients "comfortable with swap prices," by giving them marketing material that would give JPMorgan a leg up on the competition. If the competition was close, JPMorgan's staff would call another investment bank and, in a quid pro quo arrangement, get the competitor to bid higher so JPMorgan could secure the deal.
"JPMC engaged in deceptive, collusive, unfair or fraudulent conduct that concealed or facilitated the anti-competitive activity," the agreement states. "As a result of these activities, JPMC and other participating providers were able to fix their profits on affected transactions at artificially high levels."
But it didn't have to be a swap deal for a bond issuer to have been ripped off, court records show. If another bond issuer was dealing with a straight municipal bond, JPMorgan was in a position to manipulate that deal, according to the SEC probe.
Documents show the SEC focused on JPMorgan Securities division, which handled the sale of municipal bonds sold by governments either for themselves or on behalf of tax-exempt organizations like hospitals.
In a municipal bond, individual or group investors purchase a piece of the total bond, requiring the government agency to place the sales proceeds into tax-exempt accounts that carry fair-market values, typically derived from a competitive bidding process.
But the SEC found that between 1997 and 2005, JP Morgan's Securities division and 11 unnamed "agents" rigged the bids by peeking at competitors' final quotes on 93 transactions worth $14.3 billion, "generating million of dollars in ill-gotten gains" [for the bank] court records show. The rigged bids jeopardized the tax-exempt status of the issuers.
"JPMS improperly won bids by entering into secret arrangements with bidding agents to get an illegal 'last look' at competitors' bids," Robert Khuzami, director of the SEC's Division of Enforcement, said in a statement. "Municipal issuers and investors didn't stand a chance against the fraudulent strategies JPMS and others used to guarantee profits."
None of that mattered to JPMorgan's bottom line on Thursday.
JPMorgan, which reported first-quarter 2011 net income of $5.6 billion, ended the day up 0.76 points to close at $41.32 on the New York Stock Exchange.