Both the Securities & Exchange Commission and New York Attorney General Eliot Spitzer are investigating Bear Stearns' CDO trading practices with clients, the market learned last week.
The SEC's Miami office is recommending enforcement action against Bear for its involvement in the pricing, analysis and valuation of some $62.9 million of CDOs it sold to one of its clients, Bear disclosed in a 10-Q filing. The investment bank also received a subpoena from the Attorney General's office asking for information related to roughly $16 million of CDOs purchased by one of its clients, according to the filing. Bear did not disclose whether the two inquiries were related.
The inquiries come at a time when Bear is preparing to face a fine from the SEC in regard to its mutual fund trading practices. The company disclosed that the SEC has been authorized to bring an enforcement action against Bear Stearns and its subsidiary Bear Stearns Securities Corp. Bear increased its legal reserves by $100 million "in connection therewith and related mutual fund trading matters," it stated in a July 11 SEC filing. The move altered its second quarter earnings results, reducing net income to $298.1 million from $365.1 million, and reducing its diluted earnings per share by nearly $0.50, to $2.09.
Bear is the primary beneficiary of $887 million of assets held by variable interest entities, primarily CDOs, with a fair value of $350 million; it is a non-primary beneficiary to $3.8 billion of assets, with a $15.8 million exposure to loss, according to its second quarter report.
The SEC would not comment on the inquiry, and neither Bear Stearns nor the New York Attorney General's office could be reached for comment.
Although there have been several lawsuits between issuers, buyers, and others involved in the CDO structuring and trading processes, the inquiries may be the first regulatory probes into CDO trading in the U.S. that could result in a fine. The sector has come under increased regulatory scrutiny as it has grown in size, bringing more visibility and a broader investor base.
Most recently, Greenwich NatWest and National Westminster Bank, subsidiaries of The Royal Bank of Scotland, have been involved in a legal action against law firm Weil Gotshal & Manges for its role in the structuring and documentation of a CDO for them some six years ago. New York-based Weil's London office structured the poorly performing Sabre Funding No. 1 (see ASR 7/11/05). Bank of America Corp. and Banca Popolare di Intra last month each announced settlements in connection with BPI's allegations that BofA sold 95 million ($114.9 million) in CDOs in 2000 and 2001 without outlining all of the risk involved. HSH Nordbank settled a claim with Barclays Capital in November over a $151 million CDO.
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