SEC Announces Fraud Charges Against Wing Chau, Collateral Manager of Octans I CDO; He was in Michael Lewis's Book "The Big Short"

Octans I CDO Prospectus via ProPublica
"The Magnetar Trade" is back in the news. Wing F. Chau and Harding Advisory LLC, the collateral manager of one of the CDOs Magnetar Capital and Merrill Lynch were part of in 2006, got charged with fraud by the SEC for misleading investors and breaching their fiduciary duties.

The SEC’s Enforcement Division alleges that Harding Advisory LLC and Wing F. Chau compromised their independent judgment as collateral manager to a CDO named Octans I CDO Ltd. in order to accommodate trades requested by a third-party hedge fund firm whose interests were not necessarily aligned with the debt investors.

The SEC’s Enforcement Division further alleges that Harding and Chau breached their advisory obligations to several other CDOs for which they served as investment managers.  As a favor to Merrill Lynch and Magnetar, Harding and Chau purchased bonds for those CDOs that Chau and Harding disfavored.  In accepting the bonds, Chau wrote in an e-mail to the head of CDO syndication at Merrill Lynch, “I never forget my true friends.”

According to Reuters, Chau was a character in Michael Lewis's book "The Big Short":

Chau appeared in Lewis' bestseller about the financial crisis and later sued the author for defamation but lost.

Here are quotes from his book via Simone Foxman at Quartz (emphasis mine):

The guy controlled roughly $15 billion, invested in nothing but CDOs backed by the triple-B tranche of a mortgage bond or, as Eisman put it, “the equivalent of three levels of dog shit lower than the original bonds.” A year ago, the main buyer of the triple-A-rated tranche of subprime CDOs–which is to say the vast majority of CDOs–had been AIG. Now that AIG had exited the market, the main buyers were CDO managers like Wing Chau. All by himself, Chau generated vast demand for the riskiest slices of subprime mortgage bonds, for which there had previously been essentially no demand. This demand led inexorably to the supply of new home loans, as material for the bonds. The soy sauce in which Eisman double-dipped his edamame was shared by a man who had made it possible for tens of thousands of actual human beings to be handed money they could never afford to repay…

More from her article:

As Lewis later describes, Chau sold off all but a small piece of the CDOs he managed to “German banks, Taiwanese insurance companies, Japanese farmers’ unions, European pension funds, and, in general, entities more or less required to invest in triple-A-rated bonds.” But Lewis depicts Chau as seeming to admire people on the other side of the trade, those who bet against the housing market. He quotes Chau as saying, “I love guys like [Eisman] who short my market. Without you I don’t have anything to buy.” 

Here's an article on Wing Chau by Jody Shenn on Bloomberg.com in 2010, but it was about a different CDO that went bust (via Zero Hedge: "A Look At The Lawsuit Against Michael Lewis, In Which We Find That Brad Pitt Has Bought The Movie Right To "The Big Short").

In early 2007, with subprime-mortgage defaults soaring, Wing F. Chau teamed with Merrill Lynch & Co. to create a $300 million pool of assets that shared a name with the main character in The Matrix movies who discovers reality isn’t what it seems.

Neo CDO Ltd. was a complex construction. More than 40 percent of its holdings were slices of collateralized debt obligations sold by Merrill, according to Moody’s Investors Service and data compiled by Bloomberg. Many of those were CDOs made up of other CDOs backed by bonds linked to home loans. About one-sixth of Neo was invested in junk-rated debt.

Eight months after the deal closed, Neo defaulted, wiping out most of its investors. It was one of seven transactions that Chau, 43, hatched with Merrill and Citigroup Inc. in 2007 as banks raced to offload mortgage assets, helping to make his firm, Harding Advisory LLC, the biggest manager of CDOs tied to risky mortgages and related derivatives issued that year.

“People on the outside thought the market was going gangbusters because of all the deals getting done,” said Gene Phillips, director of PF2 Securities Evaluations, a New York- based company that helps banks and funds evaluate CDOs. “People on the inside knew this was a last-gasp attempt to clear out the warehouses.”

Here is the full SEC release via SEC.gov (emphasis mine):

SEC Announces Fraud Charges Against Collateral Manager Of CDO

FOR IMMEDIATE RELEASE
2013-224

Washington D.C., Oct. 18, 2013 — The Securities and Exchange Commission today announced charges against a Morristown, N.J.-based investment advisory firm and its owner for misleading investors in a collateralized debt obligation (CDO) and breaching their fiduciary duties.

The SEC’s Enforcement Division alleges that Harding Advisory LLC and Wing F. Chau compromised their independent judgment as collateral manager to a CDO named Octans I CDO Ltd. in order to accommodate trades requested by a third-party hedge fund firm whose interests were not necessarily aligned with the debt investors.  Harding agreed to give the hedge fund firm rights in the process of selecting and acquiring a portfolio of subprime mortgage-backed assets to serve as collateral for debt instruments issued to investors in the CDO.  These rights, which were not disclosed to investors, included the right to veto Harding’s proposed selections during the “warehouse” phase that preceded issuance of the CDO’s debt instruments.  The influence of the hedge fund firm led Harding to select assets that its own credit analysts disfavored.

“A collateral manager’s independent selection of assets is an important selling point to potential CDO investors,” said George S. Canellos, co-director of the SEC’s Division of Enforcement. “Investors had a right to know that Harding and Chau had chosen to accommodate the interests of others and abandon their own obligations to act in the best interests of the CDO they advised.”

According to the SEC’s order instituting proceedings, the hedge fund firm was Magnetar Capital LLC, which had invested in the equity of the CDO.  Merrill Lynch, Pierce, Fenner & Smith Inc. structured and marketed the CDO, which closed on Sept. 26, 2006.  Merrill Lynch, Magnetar, and Harding agreed in the spring of 2006 that Harding would serve as collateral manager for the CDO.  Chau understood that Magnetar was interested in investing as the equity buyer in CDO transactions, and that Magnetar’s strategy included “hedging” its equity positions in CDOs by betting against the debt issued by the CDOs.  Because Magnetar stood to profit if the CDOs failed to perform, Chau knew that Magnetar’s interests were not necessarily aligned with investors in the debt tranches of Octans I, whose investment depended solely on the CDO performing well.

The SEC’s Enforcement Division alleges that while assembling the collateral for Octans I, Chau and Harding allowed Magnetar an undisclosed influence over the selection process.  Harding’s own credit analysis of many of the selected assets was disregarded, and Magnetar’s influence over the portfolio was omitted from materials used to solicit investors for the CDO. Chau and Harding misrepresented the standard of care that Harding would use in acquiring collateral for Octans I.

The SEC’s Enforcement Division further alleges that Harding and Chau breached their advisory obligations to several other CDOs for which they served as investment managers.  As a favor to Merrill Lynch and Magnetar, Harding and Chau purchased bonds for those CDOs that Chau and Harding disfavored.  In accepting the bonds, Chau wrote in an e-mail to the head of CDO syndication at Merrill Lynch, “I never forget my true friends.”

The SEC’s Division of Enforcement alleges that by engaging in the conduct described in the SEC’s order, Harding and Chau violated Section 17(a) of the Securities Act of 1933 and Section 206 of the Investment Advisers Act of 1940.  Chau also is charged with aiding and abetting and causing Harding’s violations. The proceedings before an administrative law judge will determine what relief against Harding and Chau is in the public interest..


And today, "J.P. Morgan has reached a $13 Billion tentative deal with the Justice Department" over its mortgage fraud probe. Wow, all of this is such a joke. It's amazing that all of this was supposed to fuel prosperity in this country and instead we got trillions of dollars of bailout money, which will probably end up destroying more wealth than all of this financial fraud. How much tuition money was given to the top business schools in the U.S. to send grads to these fraudulent TBTF banks, insurance companies, hedge funds and broker-dealers?

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