Interesting perspective on what went wrong.

April 10, 2008
JPMorgan Pays for Fiduciary Obligation Oversights
JPMorgan Chase agreed to pay nearly $2 million in disgorgement and interest to settle SEC charges it and Bank One Corporation (which JPMorgan Chase acquired in 2004), had been negligent in their conduct as asset-backed indenture trustees. They failed to pick up on improprieties carried out by a financing company that subsequently led to its collapse and investor losses of approximately $2.6 billion.

National Century Financial Enterprises was a privately-held Ohio corporation that is now defunct. During the relevant period, from 1999 through 2002, National organized and owned several special-purpose subsidiary programs - and sold nearly $3.5 billion of these programs' asset-backed notes to qualified institutional buyers (QIBs). According to private placement memoranda, National represented to investors that the proceeds of the note offerings would be used primarily for the purchase of health account receivables, and that the programs would maintain specified balances for 2 separate reserve accounts and an Equity Account that would be held by the indenture trustees (JPMorgan and Bank One).

What Went Wrong. National used a substantial portion of the private placement proceeds and Reserve Account funds to make either unsecured loans or loans secured by collateral other than healthcare account receivables, contrary to National's representations and contrary to the requirements of the master trust indentures that governed National's note offerings. A principal feature of the scheme that allow National to hide investor losses was to transfer huge amounts of Reserve Account funds on or around the first and last business day of every month. The indentures required that the programs maintain Specified Balances in the Reserve Accounts totaling about 17% of the value of the outstanding notes issued by the programs.

However, even though the indenture trustees for the programs had the ability to look at the balances in the Reserve Accounts at any time, the indentures only required the program to report on the balances in the Reserve Accounts as of one day of the month, called the "Monthly Payment Date." And JPMorgan Chase, a trustee for one large program, chose to test the balances as of the last business day of the month; Bank One, a trustee for another large program, chose to test as of the first business of the month. As a result of this testing methodology, National was able to "kite" large amounts of funds back and forth between the programs, making it appear that the programs were maintaining the Specified Balances - which they weren't. In fact, National was consistently and severely depleting the balances without telling investors.

At the instruction of National, Bank One and JPMorgan Chase made Reserve Account transfers that contradicted National's representations to investors about how the Reserve Accounts would be used and contravened the requirements of the indentures. [SEC Securities Act of '33 Release 8906, 3/27]

http://complianceinsights.typepad.com/what_went_wrong/2008/04/jpmorgan-pays-f.html