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Securities & Exchange Commission v. J.P. Morgan Securities LLC

United States District Court, District of Columbia

July 20, 2017

SECURITIES AND EXCHANGE COMMISSION, Plaintiff,
v.
J.P. MORGAN SECURITIES LLC, et al., Defendants.

          MEMORANDUM OPINION

          JAMES E. BOASBERG United States District Judge

         When the Securities and Exchange Commission devises a settlement-distribution plan, a court does not consult a looking glass and ask whether it is the fairest of them all. The only question is whether such a plan is sufficiently fair and reasonable, given that investor compensation is secondary to punishment of the wrongdoer. This SEC action arises out of misrepresentations that Defendants J.P. Morgan Securities LLC and related entities made as to the soundness of residential-mortgage-backed-securities (RMBS) offerings. Over the years, misled investors lost hundreds of millions of dollars. The Commission subsequently settled with J.P. Morgan for roughly $75 million and established a Fair Fund to store those assets, preparing eventually to remunerate the victims. An initial distribution plan, however, faced objections from several outside entities, and the Court agreed in part with those dissenters, finding that the SEC had not yet complied with the Judgment's requirement to consult first with the Internal Revenue Service regarding certain tax consequences.

         The SEC now tries again. It has since obtained J.P. Morgan's consent to remove the IRS-consultation prerequisite from a Modified Judgment, which the Court has entered. The present Motion proposes a distribution plan that is slightly reformulated as well. Despite renewed objections, the Court will approve as fair and reasonable that present plan to reimburse initial investors on a pro rata basis.

         I. Background

         Although a full recap appears in the Court's prior Opinion, see SEC v. J.P. Morgan Securities LLC, 2017 WL 44209 (D.D.C. Jan. 4, 2017), it will briefly summarize the facts relevant to the current Motion. In doing so, it omits a review of the already-resolved portion of this suit against firms related to Defendant Bear Stearns Companies, LLC.

         In October 2006, J.P. Morgan purchased around 10, 000 subprime residential-mortgage loans from WMC Mortgage Corporation, a mortgage originator. Id. at *1. Defendants then packaged those loans into an investment vehicle known as the WMC4 Trust. Id.

         The Trust's ownership interests were arranged into a hierarchy of tranches, ordered by seniority. Id. at *2. To parse it more finely, the securities included two parallel, multi-tranche Groups of Senior Certificates and then subordinate Mezzanine Certificates. See ECF No. 45 (Declaration of Dr. Eugene P. Canjels), ¶ 11. Individuals could invest at their preferred level, depending on their appetite for risk. J.P. Morgan, 2017 WL 44209, at *2. While more junior securities carried a higher monthly rate of return (from homeowners' monthly mortgage payments), investors were generally paid in order of seniority, meaning that in austere times some junior certificate holders might receive nothing at all. Id. This setup is sometimes known colloquially as a “waterfall” distribution, though the Court's prior Opinion observed that it was more akin to a “champagne tower, ” as bottom investors had to wait for top-tier glasses to be filled before receiving any bubbly themselves. Id.; see Canjels Decl., ¶¶ 10-13.

         In setting up the Trust, J.P. Morgan disclosed information via a December 2006 Prospectus Supplement. See ECF No. 49-3 (Declaration of Benjamin Levi), Exh. B (December 15, 2006, Prospectus Supplement). The Supplement stated that no loan was 60 or more days delinquent and that only 4 loans (.04% of loans) were 30 or more days behind, id. at 18, but in actuality, J.P. Morgan had data indicating that those 4 were 60 days late and 623 more were 30 days past due (totaling 7.1% of loans). J.P. Morgan, 2017 WL 44209, at *2; see Compl., ¶ 91. Defendants nevertheless began selling shares in December 2006, grossing roughly $1.8 billion and earning an underwriting fee of almost $2.8 million. J.P. Morgan, 2017 WL 44209, at *2.

         Fast forward a few years to 2012. Thanks to widespread homeowner defaults during the financial crisis, the Trust had written down the value of all Mezzanine Certificates - some $300 million - to zero. See ECF No. 45-7 (July 26, 2010, Investor Report). Senior investors had taken hits as well, though to varying degrees. See Canjels Decl., ¶¶ 19-21; ECF No. 51 (Supplemental Declaration of Dr. Eugene P. Canjels), ¶ 7 (noting senior losses of $131 million).

         On November 16, 2012, the SEC brought this Securities Act action against J.P. Morgan for its non-disclosures, and Defendants consented to turning over $74.5 million in disgorgement, prejudgment interest, and civil penalties. See ECF No. 1-3 (Proposed Judgment). The consent Judgment - entered January 2013, see ECF No. 3 - mandated that if the SEC proposed compensating investors, it would “use reasonable efforts to confirm with the Internal Revenue Service” the possible tax consequences of distributing funds through the Trust's waterfall structure. J.P. Morgan, 2017 WL 44209, at *3. In March 2014, the Court approved a Fair Fund to hold the forfeited sums, in anticipation of a coming plan. See ECF No. 11 (Fair Fund Order).

         Over two years passed before the SEC proposed a Plan. See ECF No. 12-3 (Distribution Plan). Under the Plan, “Eligible Claimants” were persons who had purchased more than $250 in securities prior to the first Investor Report on January 25, 2007, which disclosed some of the concealed delinquencies. J.P. Morgan, 2017 WL 44209, at *4 (citing Plan, ¶¶ 15, 17-18); Canjels Decl., Exh. 5 (January 25, 2007, Investor Report). For those investors, proceeds would be paid not by seniority but pro rata - that is, proportional to their total investment. J.P. Morgan, 2017 WL 44209, at *4 (citing Plan, ¶¶ 55-57).

         Certain investors who preferred the waterfall distribution objected, and the Court rejected the Plan. It held that, though the SEC had some flexibility as to the distribution method, it had not yet satisfied the Judgment's IRS-consultation requirement. Id. at *6. The Opinion also noted that the Plan seemed to confer a windfall on initial investors who sold before the issuance of the January 2007 Investor Report. Id. at *7. The Court did not, however, opine on whether the Plan was sufficiently fair and reasonable. Id.

         The SEC soon offered a workaround. After considering the delay necessary to obtain an IRS letter ruling (six to twelve months), it sought to amend the Judgment to remove that consultation prerequisite. See ECF No. 43 (Motion to Modify), ¶ 6. J.P. Morgan expressed that it held no opposition to the changes. Id., ¶ 18. The Court then entered a Modified Judgment without the IRS provision in April 2017. Id.; ECF No. 47 (Modified Judgment).

         The SEC now seeks approval of a revised pro rata distribution plan, which is the same as the original but for two tweaks. See Mot., Exh. 1 (Amended Distribution Plan), ¶ 37. First, the Plan no longer compensates initial investors who had already sold their tickets before the January 2007 Investor Report. Id., ¶ 60(a). Second, it introduces a recovery cap so that claimants cannot recoup more money than they actually lost on their securities. Id., ΒΆ 60(b)-(c). All told, those investors are set to ...


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