A new lawsuit filed against JPMorgan says that the bank bet against its clients through repo financing to a SIV, a structured investment vehicle, that its clients were invested in.
A SIV is backed by an assortment of assets. To make money for its investors, it issues commercial paper in order to generate proceeds which are invested in other assets with higher yields.
A group of JPMorgan’s clients, the AFTRA retirement fund, invested $500 million in one of these SIVs, Sigma, according to the New York Times.
The group’s lawsuit against JPMorgan alleges that even though Sigma was so deeply in debt that it could not afford to issue any more commercial paper, JPMorgan fed it money so that it would stay afloat and keep generating fees for JPMorgan through repo transactions. The repo transactions would earn JPMorgan $2 on every $1 it invested if Sigma defaulted.
The lawsuit includes question-raising emails from JPMorgan execs.
In one, Mark Crawley tells Bill Winters, “There may be an opportunity to use the current volatility to do more repo trades with them which are in effect asset financing at very attractive levels on high quality assets with excellent structural protection (ie lever the structure in place but treat it as a trade rather than ‘support’ for sigma.”
In another, Brian Sankey, who was in the firm’s risk department, writes, “We should only do the repo as a stand alone and if we can satisfy ourselves around the legal/rep risk.”
In another, Andrew Cox, in the firm’s risk management division, asked his boss if they should consider the “firm-wide position,” on September 18th 2007,
“I do not believe there is a systemic bank problem with all SIVs going through an orderly liquidation, however is there a system asset management problem (the ‘break the buck’ argument)?
“I have heard JPM Asset Mgmt are large buyers of SIV and Sigma CP. Do we need to consider the firmwide position? This is most acute with the largest independent SIV manager.”
Worst of all, the head of risk management, John Hogan, wrote in response,”… my view is that we need to protect our position irrespective of the broader ‘break the buck’ issue or worry about what JPM Asset Mgmt has invested in.”
In an update on Sigma financing opportunities, JPMorgan execs acknowledge the risks associated with repo-financing the SIV. The risks they identified are as follows:
Reputation (by association with “sponsorship of Sigma”)
Legal (collateral enforcement, litigation)
Gap risk (Asset liquidation risk)
Emails about the risk were circulated as high up as Jamie Dimon.
All of the details and documents are available on the website of the lawyers representing the AFTRA retirement fund suing JPMorgan.
The prosecution is suing JPMorgan for breaching their fiduciary duty. JPMorgan says the plaintiffs are “wildly distorting the truth.”
Here’s what the retirement fund alleges in their lawsuit:
Sigma was the largest SIV in the world
“During the summer of 2007, Sigma [managed by the British firm Gordian Knot Limited] was the largest of approximately 30 SIVs in the world. As of July 2007, Sigma had outstanding debt of approximately $52 billion.”
JPMorgan kept its clients money invested in Sigma despite warnings
“As early as August 2007, just a few months after [JPMorganChase] invested millions of dollars of [the AFTRA retirement fund’s] money in the Sigma MTNs, analysts sounded alarm bells for the health of SIVs. According to Citi analysts… sharp declines in the market value of assets backing many SIVs had already caused forced selling of assets among the world’s major SIVs.”
JPMorgan kept Sigma afloat regardless of the risks to its clients
“Faced with an inability to issue new MTNs, Sigma was forced to finance its activities using repo transactions which encumbered an overwhelming majority– ~$25 billion — of its $27 billion in assets to the detriment of its MTN holders. Sigma’s survival was contingent on these repo counterparties continuing to lend money to Sigma collateralized against Sigma’s existing asset base.”
JPMorgan did this so that it could continue collecting fees and interest
“Despite repeated warnings, JPMorgan continued to invest the AFTRA Plan’s assets in Sigma MTNs. Simultaneously, JPMorgan earned fees and interest through its repo financing for Sigma… JPMorgan’s financial interest as Sigma’s repo financier was in direct conflict with its fiduciary responsibility to the AFTRA Plan.”
Sigma ultimately failed
“On September 29, 2008, JPMorgan, one of Sigma’s repo countertparties, terminated its repurchase agreement and served Sigma with a notice of default.”
And JPMorgan greatly benefitted from its failure
“Sigma’s repo funding came with significant terms whereby lenders, such as JPMorgan, were able to demand approximately $2 in collateral for every $1 in financing they provided.”