Wing F. Chau, the bond manager who sued Michael Lewis over his depiction in the 2010 book “The Big Short,” was accused by regulators of violating his fiduciary duty by accommodating requests from Magnetar Capital LLC in managing financial products linked to subprime mortgages.
Mr. Chau, 46, and his firm Harding Advisory LLC didn't disclose giving Magnetar veto rights over selection and acquisition of mortgage-backed assets for a 2006 collateralized debt obligation known as Octans I, the SEC said in an administrative order filed Friday. Magnetar bet against the CDO, which cost outside investors $1.1 billion when it collapsed in April 2008, the SEC said. Harding got $4.5 million for its role in the transaction.
“A collateral manager's independent selection of assets is an important selling point to potential CDO investors,” George Canellos, co-director of the SEC's enforcement division, said in a statement. “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.”
Managers such as Mr. Chau were integral to the proliferation of mortgage-linked CDOs in 2006 and 2007 as defaults on subprime loans increased. Collateral managers picked the securities that went into CDOs and held themselves out as independent agents.
The SEC has focused on those financial products' role in helping fuel financial market turmoil in 2008, reaching record settlements with the banks that underwrote them. In 2010, Goldman Sachs Group Inc. agreed to pay $550 million to resolve claims it misled investors about a hedge fund's role in selecting assets for such an investment.
The SEC last year dropped a lawsuit against former GSC Capital Corp. executive Edward Steffelin related to his work as a collateral manager for a CDO involving Magnetar. JPMorgan Chase & Co. agreed to pay $153.6 million over claims it misled investors in underwriting the deal.
Mr. Chau understood that Magnetar was interested in investing as an equity buyer in CDO transactions, and that the firm's strategy also included hedging that position by betting against the debt issued by the same instrument, the SEC said. Because Magnetar stood to profit if the CDO failed to perform, Mr. Chau knew that Magnetar's interests were not necessarily aligned with other Octans I investors, whose investments depended solely on the CDO performing well, according to the order.
Magnetar's influence over the portfolio was omitted from materials used to solicit investors for the CDO, and Mr. Chau and Harding misrepresented the standard of care that Harding would use in acquiring the collateral for Octans I, the SEC said.
Evanston, Illinois-based Magnetar has said it offered limited input on the creation of CDOs and made bets that would pay off if they soured as part of a market neutral portfolio designed to profit no matter what happened, according to a 2010 letter to investors. Magnetar was not accused of wrongdoing.
The SEC is seeking proceedings to determine whether financial penalties are appropriate for Mr. Chau and Harding, according to the order.
Steven Molo, a lawyer for Mr. Chau, didn't immediately return a phone call seeking comment.
Reuters reported in April that a federal judge in Manhattan rejected Mr. Chau's claim that Lewis had defamed him in a chapter of his book about the housing bubble that led to the biggest financial crisis since the Great Depression.