A secret Magnetar management deal?

Posted by Tracy Alloway on Jun 23 14:40. Comment | Share

Somewhat lost amongst the JPMorgan/Magnetar news on Tuesday, was a name.

Edward Steffelin.

Steffelin, the SEC says, was in charge of the team at GSCP that helped select the investment portfolio for the Squared 2007-1 synthetic CDO — parts of which were infamously shorted by hedge fund Magnetar. More…

Somewhat lost amongst the JPMorgan/Magnetar news on Tuesday, was a name.

Edward Steffelin.

Steffelin, the SEC says, was in charge of the team at GSCP that helped select the investment portfolio for the Squared 2007-1 synthetic CDO — parts of which were infamously shorted by hedge fund Magnetar. He was also allegedly trying to get a job at the fund, at the same time that he was dealing with Squared.

Intriguing no? It kind of adds another layer to marketer JPMorgan’s $154m settlement.

(JPMorgan settled without admitting liability. Magnetar is not the subject of any complaint.)

Here are the details, from the SEC’s seperate civil suit against Steffelin:

During the collateral selection process for Squared, from early January through late February 2007, Steffelin sought employment with Magnetar and, specifically, inquired about the possibility of starting a collateral management business for Magnetar.

On January 5, 2007, the employee at Magnetar primarily responsible for the firm’s participation in the Squared transaction (“Magnetar Employee”), sent his supervisor an electronic mail message stating, “Steffelin wants to leave GSC and start a manager for us . . .” His supervisor replied, “Perfect,” to which the Magnetar Employee responded, “I knew u’d like that!!”

On or about January 18, 2007, Magnetar prepared a 9-page Power Point presentation entitled “Manager of Managers.” According to this presentation, Magnetar was considering establishing a network of CDO managers. The presentation represented in relevant part, “Identified potential first manager; based on: interest, apparent skill; [claimed] infrastructure.”

On January 30, 2007, Steffelin sent an electronic mail message to the Magnetar Employee that read, “Feel[s] like times are right to start a company.” Later that day, the Magnetar Employee responded to Steffelin via email, “Yes! . . . Partners committed to do it for sure . . . putting finishing touches on bus[iness] plan.”

In early February 2007, Magnetar incorporated portions of the January 18 presentation into a 27-page power point entitled “Structured Credit Business Update.”

On February 22, 2007, the Magnetar Employee sent his supervisor an electronic mail message with the subject line “Gsc blowing up” and the text “Ed [Steffelin] eager to get something going. We could get whole team and all deals.” The Magnetar Employee’s supervisor sent a reply electronic mail message asking, “Why are they blowing up?” and the Magnetar Employee explained “They’ve been having [a] big fight over comp[ensation]. Think 10 [the head of GSC’s structured credit department] is going to split, rest of team not that happy at how they’ll be treat[ed] if they stay. As u know, Ed [Steffelin] was already planning to leave.”

On February 26, 2007, the Magnetar Employee sent his supervisor by electronic mail message another update, stating, “Just got off the phone w Ed [Steffelin] . . . Ed thinks whole team can be lifted, will be able to take along 5 deals currently in warehouse, makes it cash flow positive day 1.”

Steffelin did not reach an employment agreement with Magnetar.

Steffelin did not disclose his employment interest in and inquiries to Magnetar to J.P. Morgan Securities, Squared CDO Caymans, or Squared CDO Delaware.

Yes, it ends rather abruptly.

Steffelin’s lawyer told the Wall Street Journal that the SEC’s assertion that Steffelin was seeking a job at Magnetar while working on Squared was a “misstatement,” adding “there is no proof” of fraud.

Starting a ‘manager of managers’ fund might have been a natural step for Magnetar, which in 2007 was busy spurring the creation of as many as 30 CDOs to short as part of a strategy to bet against the subprime housing market. The selection process was supposedly a key aspect of the Magnetar Trade, according to ProPublica, though the hedge fund has insisted it never selected the CDOs’ assets.

According to the SEC, JPMorgan rather smartly failed to mention Magnetar’s role in selecting the Squared’s portfolio when marketing it to investors. Steffelin, the SEC says, “should have known that failing to disclose Magnetar’s involvement in the selection process made the presentation materially misleading.” The quality of collateral managers was a major selling point of CDO deals at the time, so you wouldn’t want to let slip that a CDO-shorting hedge fund might have had a hand in the process.

Though even that apparent lack of disclosure didn’t mean finding investors was easy…

J.P. Morgan Securities embarked upon a worldwide effort to sell the mezzanine tranches of Squared in March and April 2007. J.P. Morgan Securities’ sales force faced a number of challenges as the United States housing market was showing signs of distress … A number of traditional United States and European CDO investors rejected Squared. According to a contemporaneous, internal document, J.P. Morgan Securities responded by launching an “opportunistic global distribution” that focused on “[a]lternative pockets of cash beyond the historic go-to-guys” and “alternative investor appetite in Japan and Non-Japan Asia, Australia and the Middle East.”

Eventual investors included Far East life insurers and a faith-based financial manager.

The case against Steffelin has been passed to a Manhattan federal district court.

Related links:
Challenges in chasing fraud – WSJ
JPMorgan agrees to pay $154m to settle SEC fraud claim – American Lawyer
JPMorgan gets a break where Goldman got nailed – Jonathan Weil

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