United States Securities and Exchange Commission v. J.P. Morgan Securities LLC
266 F. Supp. 3d 225
D.D.C.2017Background
- J.P. Morgan packaged ~10,000 subprime loans into the WMC4 RMBS trust in 2006 and sold certificates to investors after issuing a Prospectus Supplement that materially understated loan delinquencies.
- The Trust used a tranche (waterfall) structure: Senior and Mezzanine certificates with payment priority; Mezzanine later wiped out (~$300M) and Seniors suffered substantial losses.
- SEC sued J.P. Morgan (2012); defendants consented to a judgment turning over ~$74.5M; funds were placed in a Fair Fund for potential distribution to harmed investors.
- SEC proposed a pro rata distribution plan to compensate initial purchasers; Court previously rejected the plan because the consent Judgment required IRS consultation (later removed by Modified Judgment).
- The Amended Plan: (1) pays eligible investors pro rata (excluding those who sold before Jan 25, 2007), and (2) caps recoveries at actual losses (including expected future losses); objector CXA-13 renews objections.
- Court reviews whether the Amended Plan is a fair and reasonable allocation of limited Fair Fund proceeds under SEC Fair Fund precedent and approves the plan in full.
Issues
| Issue | Plaintiff's Argument (SEC) | Objector/Defendant Argument (CXA) | Held |
|---|---|---|---|
| Priority of payments (waterfall vs. pro rata) | Pro rata is fair because the misrepresentations uniformly affected all initial purchasers | Payments should respect Trust waterfall: Seniors paid before Mezzanine | Court approved pro rata; waterfall priority not required for Fair Fund distribution |
| Eligible claimant cutoff date | Limit to purchasers who held through Jan 25, 2007 (first Investor Report) focuses relief on those most affected by Prospectus misstatements | Cutoff should be as late as complaint filing (Nov 16, 2012); earlier cutoff is arbitrary | Court upheld Jan 25, 2007 cutoff as reasonable line-drawing by SEC |
| Recovery cap methodology | Cap recoveries at actual losses (including expected future income losses) to avoid windfalls | Pricing non-exchange securities is unreliable; cap should exclude speculative future losses | Court found cap workable using common pricing data and including expected losses reasonable |
| Standard of review / court discretion | SEC has broad discretion to propose distribution; court must approve if plan is fair and reasonable | Objector argues SEC’s choices are arbitrary and unfair to subclasses | Court applied precedent that investor compensation is secondary and affirmed the Amended Plan as fair and reasonable |
Key Cases Cited
- Official Comm. of Unsecured Creditors of WorldCom, Inc. v. SEC, 467 F.3d 73 (2d Cir.) (Fair Fund distributions prioritize deterrence; courts may permit line-drawing)
- Kokesh v. SEC, 137 S. Ct. 1635 (2017) (disgorgement treated as a penalty; primary purposes include punishment and deterrence)
- Credit Bancorp, Ltd. v. SEC, 290 F.3d 80 (2d Cir.) (pro rata distribution favored where victims were commingled and similarly situated)
- SEC v. Wang, 944 F.2d 80 (2d Cir.) (court defers to reasonable SEC line-drawing in distribution plans)
- CFTC v. Walsh, 712 F.3d 735 (2d Cir.) (assesses whether claimants were similarly situated to the fraud)
- SEC v. Byers, 637 F. Supp. 2d 166 (S.D.N.Y.) (rejecting insistence on adhering to investment-level priority in fraud-based distributions)