JP Morgan Investment Consulting Fraud

Summary: 

When Jefferson County, Alabama, borrowed $3.2 billion in 2003 to refinance its sewer system, the county commissioners relied on advice from JP Morgan Securities to arrange the funding without competitive bidding.  The county set up a complex funding scheme of variable-rate bonds and interest-rate swaps that were lucrative for J.P. Morgan and other banks, but greatly increased the county's debt when the recession hit.  Sewer bills in the county quadrupled.

In 2009, the former president of the county commission was convicted of taking bribes to steer business to J.P. Morgan.  The federal Securities and Exchange Commission charged the bank with making illegal payments to consultants connected to the commissioners. In November 2009, the SEC ordered J.P. Morgan to cease its practices and pay $25 million in penalties and $50 million to Jefferson County.

 

History: 

In 2003, Jefferson County, Alabama, sold bonds to refinance the debt on its sewer system.  The county commissioners followed the advice of a consultant working for J.P. Morgan and set up an unorthodox financing scheme using adjustable interest rates, with no competitive bidding.  The county paid $120 million in fees -- six times the prevailing rate - to buy interest-rate swaps from J.P. Morgan, Bank of America, Lehman Brothers and Bear Stearns.

Within five years, the bad advice had increased the county's debt by $277 million. Low- income residents bore the consequences as the county raised sewer rates again and again to stave off bankruptcy.

According to the New York Times:  "The bonds and debt restructuring destabilized the finances of the county, which includes Birmingham, and its sewer system, helping to push the county to the brink of bankruptcy."

Birmingham Mayor Larry Langford, was convicted in October 2009 of accepting cash, clothing and jewelry when he was president of the county commission, in exchange for steering business to J.P. Morgan.

On Nov. 4, 2009 the Securities and Exchange Commission charged in a lawsuit that J.P. Morgan arranged for illegal payments to consultants tied to the county commissioners, in an effort to win the profitable business selling the county bonds and trading in derivatives. To settle, J.P. Morgan dropped its claim for $647 million in termination fees it had been demanding from the county to unwind the interest-rate swaps, and agreed to pay $25 million in penalties to the SEC and $50 million to Jefferson County "for the purpose of assisting displaced County employees, residents, and sewer ratepayers."  

The former J.P. Morgan managing directors have denied any wrongdoing and their case is expected to go to trial. The SEC is currently pushing for a uniform federal standard defining improper activity in this area, since current standards vary state by state, and has implemented its own new rules to control pay-to-play abuses.

 

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Key Issues
Key Issues: 

By recommending financial deals that were lucrative for themselves and other bankers, the consultants greatly increased the costs to the county.  Officials of many other municipalities around the country also relied on investment advice to get involved in financing schemes they poorly understood before the 2008 financial meltdown.

The illegal payments made by J.P. Morgan to ensure its noncompetitive monopoly on the county's business represents a classic example of pay-to-play corruption

Excerpt from the SEC complaint (pp. 5-6):

"In November 2002, Larry Langford became president of the County commission and head of the commission's finance committee that had significant authority over approval of County bond deals and swap agreements. Early in his administration, Langford made it clear to the County's financial advisor that he wanted William Blount, head of the Montgomery broker-dealer Blount Parrish & Co., involved in every County financing transaction. Langford and Blount were long-time friends and political colleagues.

Prior to Langford involving Blount in County bond and swap deals, Blount Parrish had not received any County business from 1997 through 2002. However, Langford was able to ensure Blount's selection because his positions as commission president and head of the finance committee effectively allowed him to control the selection process for underwriters and swap providers.

From January until May 1, 2003, J.P. Morgan Securities solicited the County, and Langford in particular, to hire the firm as underwriter on a new sewer bond offering and to enter into another swap agreement. During that period, LeCroy met several times with Langford and/or Blount regarding this deal, which became the 2003-B transaction. Because Blount Parrish could not serve as a swap provider under Alabama law, Blount solicited Langford to select Goldman Sachs Capital Markets Inc. to participate in the 2003-B swap transaction because Blount Parrish had a consulting agreement with Goldman Sachs.

Goldman Sachs and another New York-based broker-dealer were also pitching swap deals to the County. To prevent Goldman Sachs and the other firm from executing their own swap transactions with the County and ensure the County selected J.P. Morgan Securities instead, LeCroy and MacFaddin agreed to Langford's request that J.P. Morgan Securities make payments to Goldman Sachs and the other firm.

On February 25, 2003, Langford and the County commission approved a resolution authorizing the $1.1 billion 2003-B bond offering. J.P. Morgan Securities would serve as lead underwriter, and its affiliated commercial bank would serve as swap provider for the corresponding $1.1 billion swap agreement. The swap agreement was executed on March 28, 2003, with an effective date of May 1, 2003 to coincide with the bond offering.

In connection with the bond deal and swap agreement, LeCroy and MacFaddin agreed in their negotiations with Langford to pay Goldman Sachs $3 million, and the other firm $1.4 million. In turn, Goldman Sachs agreed to pay Blount-Parrish, its consultant, $300,000.

Neither Goldman Sachs nor the other firm entered into a swap agreement with the County, or served as an advisor to the County on this transaction. J.P. Morgan Securities ultimately negotiated a separate swap agreement between its affiliated bank and Goldman Sachs as a mechanism to make the $3 million payment.

The official documents related to the bond offering and the swap agreement did not disclose the payments from J.P. Morgan Securities to Goldman Sachs and the other firm, or the payment from Goldman Sachs to Blount Parrish."