Recently JP Morgan has received a Wells notice from the Securities Exchange Commission. A Well's notice is official notification that regulatory action is being considered. But what's interesting about this is there is some question whether the SEC actually has jurisdiction for the action it is considering.
The SEC has the responsibility to insure the effective and honest operation of the securities markets. Their primary jurisdiction is contained in the US Code at Title 15 Sections 77q(a) and 78j(b) and Rule 10b-5. It is a well settle point of law that fraudulent activity under these sections must happen in the "offer, purchase or sale" of a security. The problem the SEC has is that the security owned by the municipalities was sold to them at market value pursuant to the government's own regulations.
It is possible for the Commission to claim that if Morgan violated the bidding procedure detailed in the arbitrage regulations (see the following post), that the market value of the derivative in question was misrepresented. But first, the SEC would have to show what the correct market value should have been and how Morgan's alleged misbehavior caused the market value to be misrepresented.
It appears that the jurisdiction for this case may not rest with the SEC. The crux of the government's argument is that Morgan may not have followed bidding procedure, not that the derivative was sold at other than market value. The IRS may have a claim against Morgan, because Morgan's actions may have cost the government some measure of arbitrage profit, but that is a claim not involving the SEC. What should not be forgotten is that the owner of the derivative, the municipality, probably acquired the derivative at fair market value.
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