Litigation Release No. 22417 / July 19, 2012
Securities and Exchange Commission v. Mizuho Securities USA Inc., 12-Civ.-5550 (RA) (Abrams, J.) (S.D.N.Y. filed July 18, 2012)
Mizuho to Pay $127.5 Million to Settle SEC Charges of Misleading Investors in CDO
The Securities and Exchange Commission has charged the U.S. investment banking subsidiary of Japan-based Mizuho Financial Group and three former employees with misleading investors in a collateralized debt obligation (CDO) by using "dummy assets" to inflate the deal's credit ratings. The SEC also charged the firm that served as the deal's collateral manager and the person who was its portfolio manager.
According to the SEC's complaint filed July 18 against Mizuho Securities USA Inc., the firm made approximately $10 million in structuring and marketing fees in the deal. Mizuho agreed to pay $127.5 million to settle the SEC's charges, and the others charged also agreed to settle the SEC's actions against them.
The SEC alleges that Mizuho structured and marketed Delphinus CDO 2007-1, a CDO that was backed by subprime bonds at a time when the housing market was showing signs of severe distress. The deal was contingent upon Mizuho obtaining credit ratings it used to market the notes to investors. When its employees realized that Delphinus could not meet one rating agency's newly announced criteria intended to protect CDO investors from the uncertainty of ratings downgrades, they submitted to the rating firm a portfolio containing millions of dollars in dummy assets that inaccurately reflected the collateral held by Delphinus. Once the firm rated the inaccurate portfolio, Mizuho closed the transaction and sold the notes to investors using the misleading ratings. Delphinus defaulted in 2008 and eventually was liquidated in 2010. Mizuho sustained substantial losses from Delphinus.
According to the SEC's settled administrative proceedings against the three former Mizuho employees responsible for the Delphinus deal, Alexander Rekeda headed the group that structured the $1.6 billion CDO, Xavier Capdepon modeled the transaction for the rating agencies, and Gwen Snorteland was the transaction manager responsible for structuring and closing Delphinus. Delaware Asset Advisers (DAA) served as Delphinus's collateral manager and the DAA portfolio manager was Wei (Alex) Wei.
Mizuho Securities USA Inc.
According to the SEC's complaint against Mizuho filed in federal court in Manhattan, all of the collateral assets for Delphinus had been purchased by July 17, 2007, and the transaction was scheduled to close on July 19. However, around noon on July 18, Standard & Poor's (S&P) issued a press release announcing changes to its CDO rating criteria requiring certain categories of subprime residential mortgage-backed securities (RMBS) to be adjusted downward for purposes of calculating their default probability. The Mizuho employees knew that Delphinus's actual portfolio contained a substantial amount of RMBS that were subject to the downward ratings, and that Delphinus, as constructed, could not meet its rating targets under these tougher standards. To enable Delphinus to close anyway, the Mizuho employees e-mailed multiple alternative portfolios to S&P that contained dummy assets that were superior in credit quality to the assets that had been actually acquired for the CDO. Once the necessary ratings were secured by the use of dummy assets, the Delphinus transaction closed by mid-afternoon on July 19 and securities were sold based upon these higher ratings. Investors were thus misled to believe that the Delphinus notes had achieved the advertised ratings that the actual closing portfolio would not support.
According to the SEC's complaint, in connection with Delphinus's subsequent request for a required rating confirmation from S&P, Mizuho employees provided and arranged for others to provide further inaccurate information about the composition of Delphinus's assets. Primarily, they misrepresented that Delphinus's effective date was August 6 rather than July 19. S&P then provided Delphinus with the ratings confirmation using the improper effective date of August 6.
As a result of Mizuho's conduct, the SEC has alleged that Mizuho violated Sections 17(a)(2) and (3) of the Securities Act of 1933. Without admitting or denying the allegations of the SEC's complaint, Mizuho agreed to settle by consenting to the entry of a final judgment that permanently enjoins Mizuho from violating those provisions of the Securities Act, and requires Mizuho to pay $10 million in disgorgement, $2.5 million in prejudgment interest and a $115 million penalty, for a total of $127.5 million. The settlement is subject to Court approval.
Rekeda, Capdepon, and Snorteland
In the related administrative proceedings against Rekeda, Capdepon, and Snorteland, the SEC found that Rekeda violated Sections 17(a)(2) and (3) of the Securities Act, and Capdepon and Snorteland violated Section 17(a). Rekeda and Capdepon each agreed to pay a $125,000 penalty while the decision on whether there will be a penalty for Snorteland will be decided at a later date. Rekeda agreed to be suspended from the securities industry for 12 months, Capdepon and Snorteland each agreed to be barred from the securities industry for one year, and all three agreed to cease and desist from further violations of the respective sections of the Securities Act they violated.
Delaware Asset Advisers and Wei
In related administrative proceedings against DAA and Wei, the SEC found that, as a result of the roles they played in providing misleading information in August and September 2007, DAA violated Sections 17(a)(2) and (3) of the Securities Act, and Section 206(2) of the Advisers Act, and Wei violated Section 17(a)(2) and (3) of the Securities Act, and caused DAA's violation of Section 206(2) of the Advisers Act. Without admitting or denying the SEC's findings: (1) DAA consented to the entry of an order requiring it to cease and desist from committing or causing violations or future violations of Sections 17(a)(2) and (3) of the Securities Act and Section 206(2) of the Advisers Act, and requiring it to pay disgorgement of $2,228,372, prejudgment interest of $357,776, and a civil money penalty of $2,228,372; and (2) Wei consented to the entry of an order requiring him to cease and desist from committing or causing violations or future violations of Sections 17(a)(2) and (3) of the Securities Act and Section 206(2) of the Advisers Act, suspending him from associating with any investment adviser for six months, and requiring him to pay a civil money penalty of $50,000.
The SEC's investigation into the Delphinus transaction is continuing.