In August 2007, well into a JPMorgan Chase & Co. campaign to cut subprime mortgage exposure, a senior executive told the bank's investment management staff to stop telling clients that they were "reasonably comfortable" with subprime securities bearing investment-grade ratings.
Instead, advisers were to tell clients they were "extremely comfortable" with the investments, the directive stated.
The executive's memo is cited in an odd collection of lawsuits from high-net-worth investors accusing JPMorgan Chase of sticking them with over $1 billion in losses by stuffing accounts with inappropriate, illiquid and risky investments and then misrepresenting the nature of the holdings. Investor grievances tend to sprout like weeds after a financial crisis, but what could make this spate particularly nettlesome is the allegation that JPMorgan Chase knowing stuffed supposedly conservative client accounts with just the sort of assets it was keen to get off its own books.
CMMF LLC, a vehicle controlled by the billionaire Len Blavatnik's Access Industries, alleges that the bank and its affiliates "were themselves simultaneously ridding their own investment portfolios … of risky subprime and alt-A mortgage securities" even as they were "initiating, maintaining and even increasing CMMF's investments in these same products."
CMMF and the other plaintiffs go to great lengths to make the case that JPMorgan Chase's asset management division steered them into investments that it was in some cases selling while stopping short of accusing the bank of directly offloading securities from its own accounts or those of preferred clients.
CMMF said it was assured that its mortgage bonds were agency guaranteed when in fact only two of 52 bonds were. NM Homes One Inc. said its JPMorgan Chase adviser bought it bonds with maturities in excess of 40 years for an account it believed was holding short-term securities.
The suits touch on an issue that's become a flashpoint in the wake of the financial crisis — that big banks used their insight into a crumbling market to fob off risky assets on clients. Such claims were at the crux of the case involving Goldman Sachs' Abacus subprime vehicle. Goldman paid $550 million to settle that case without admitting or denying wrongdoing.
"We believe we acted appropriately with respect to the management of the client's account," JPMorgan Chase spokesman Darin Oduyoye told ASR's sister publication American Banker. "These allegations are meritless, and we will defend ourselves vigorously."
With an institution the size of JPMorgan Chase, it's not unsurprising that some bankers anticipated subprime would recover even as others distributed memos stating that the "market meltdown continues" and has "begun to move up the capital structure."
JPMorgan Chase circulated just such a note in February 2007, even as managing director Todd Ufferfilge added subprime bonds to its account, CMMF charges.
"Portfolio stuffing is as old as the hills," said Bert Ely, an indepdent banking consultant, "but it's not at all unusual or inappropriate for the bank to be doing one thing and the client another."
Plaintiffs appear keen on using discovery to find how JPMorgan Chase chose the securities, and where it got them.
"We are aggressively pursuing discovery … to determine who actually evaluated, recommended, and picked the securities that were purchased for CMMF's account," said Rick Werder, a partner at Quinn Emanuel Urquhart & Sullivan LLP, which represents the fund.
Beyond CMMF and NM Homes, litigation has been delayed by a legal brawl. Two plaintiffs had their cases dismissed in lower courts and then reinstated upon appeal. The New York Court of Appeals, the state's highest judicial body, is scheduled to hear the issue soon.
Meanwhile, the Securities Industry and Financial Markets Association submitted an amicus brief arguing that the claims amount to an illegal private action under New York's Martin Act, while the state attorney general has taken the opposite position.
One point beyond contention: JPMorgan Chase's investment advisers loaded client accounts with some truly lousy securities. Each of the plaintiffs had set out conservative investment guidelines — CMMF sought to earn merely the three-month London interbank offered rate. The largest allocations were to be to Treasuries, agency-backed securities and money market funds. JPMorgan Chase was allowed to place up to 20% of CMMF's assets in highly rated mortgage securities and up to 40% in asset-backed securities.
CMMF ended up holding a disproportionately large quantity of securities that at least some JPMorgan Chase analyses later identified variously as "the worst," to be sold "ASAP" due to deteriorating credit and "bonds that we don't want to own," according to documents produced in discovery,
CMMF argued that it suffered greater losses because Ufferfilge exceeded its maximum mortgage exposure guidelines and a JPMorgan Chase suggestion in January 2007 to increase subprime exposure. Despite its refusal, CMMF alleged that in mid-2007 JPMorgan Chase bought it $100 million in additional mortgage bonds, describing some subprime mortgage bonds as home equity-based "asset-backed securities." Meanwhile, Ufferfilge and JPMorgan Chase risk managers debated whether CMMF's portfolio was, as Ufferfilge put it in internal communications, "over the limit on total mortgage exposure."
Ufferfilge, who is still a managing director at JPMorgan Chase, did not respond to a request for comment. He maintains that CMMF knew and approved of JPMorgan Chase's strategy, a Financial Industry Regulatory Authority broker database filing indicated.
"All investments that JPMorgan purchased for the account were permitted within the investment guidelines and entirely suitable for this strategy," Ufferfilge wrote.
Other suits against JPMorgan Chase's private bank and investment management division have been filed by funds linked to AMBAC and Assured Guaranty. They charge JPMorgan Chase with a reckless drive to push them into mortgage bonds.
"You see in the pleadings in those other lawsuits certain similarities in terms of what was put in and how things were handled," said Steven Perlstein, an attorney for Kobre & Kim LLP, who is handling the NM Homes case.
Questions of possible misrepresentation should be treated as fundamentally distinct from allegations that JPMorgan Chase is at fault for not aligning its clients' positions with its own, Ely said. Though unfamiliar with the specifics of the cases, he said the existence of internal documents showing certain JPMorgan Chase analysts considered the plaintiffs bonds' to be toxic doesn't by itself prove their point.
"The problem with picking out individual memos is you will have divergent points of view," he said. "Did that list [of bad securities] come anywhere close to the person running this account? He may have been in another department two buildings over."