Vampire squid Goldman Sachs wasn't the only Wall Street firm allegedly sucking illegal profits out of mortgage bonds at the height of the housing credit bubble.
On Monday, the Securities and Exchange Commission (SEC) charged a former Harvard University quarterback, Thomas Priore, and his bond firm, ICP Asset Management, with defrauding the investors who bought the firm's collateralized debt obligations (CDOs), the highly structured debt securities that became popular with mortgage investors and bond managers in the late 2000s. Many of those deals have since busted, costing banks and investors hundreds of billions of dollars. Problems in the CDO market played a prominent role in the collapse of investment bank Bear Stearns and insurance giant AIG, making the financial crisis significantly worse. ICP's allegedly illegal trades cost the firm's CDO investors tens of millions of dollars. Bond insurers lost out as well. Two ICP deals were among many that had to be purchased by the Treasury Department in the government's late-2008 bailout of AIG.
For months, the SEC has been investigating what led to the extreme losses in the CDO market. In April, the SEC charged Goldman Sachs with colluding with a hedge fund to allegedly trick investors into buying a CDO backed by mortgage bonds that Goldman had set up to fail. The hedge fund, run by John Paulson, then bet against the deal. Both Goldman executives and Paulson, who has not been charged, say they did nothing improper.
The SEC case against Priore and New York Citybased ICP opens a new front in the agency's investigation of the CDO market. Investment banks like Goldman package and sell CDOs as bonds. But unlike a typical mortgage-backed bond, which are set portfolios, CDOs are set up similar to mutual funds in that they have investment managers who have the ability to buy and sell assets to profit and protect investors. In practice, says Gene Phillips, a principal at PF2 Securities Evaluations, which specializes in researching CDOs, managed CDOs appear to have done worse than bond offerings that were unmanaged.
"All of these deals were private, so you can't see when and what and at what price the managers were buying," says Phillips. "You just had to assume everything was being done properly, even though as a skeptical market participant one might know that very often it wasn't."
George Canellos, director of the SEC's New York office, said his agency was examining more than 50 firms that were in the business of managing CDOs but would not comment on whether the SEC is close to bringing cases against any others besides ICP.
Priore denies the charges and says that he and his firm did nothing wrong. "At all times ICP acted in the best interests of its clients," says Priore, who is ICP's chief executive. "We intend to vigorously defend the firm against these allegations."
In the mid-2000s, dozens of bond managers entered the then hot CDO market. More than $200 million in CDOs were issued in 2006 alone, according to trade publication Asset-Backed Alert. The largest manager of CDOs that year was Société Générale, in charge of buying and selling the assets for 15 deals worth $11.5 billion. Boutique firm Cohen & Co. was the second largest manager of CDOs in 2006, with eight deals worth more than $10 billion. Cohen has disclosed that it received a subpoena in the SEC investigation of the CDO market. The third largest manager of CDOs that year was ICP, heading up $7.7 billion in deals.