Two cases regarding the failure of J.P. Morgan Chase (NYSE:JPM) to reduce or eliminate the risk from pools of toxic mortgages are now in trial before the New York State Supreme Court: Orkney Re II Plc v. JPMorgan and Ballantyne Re plc v. JPMorgan.
JPM needs to settle these cases now, a pro-active move that should materially improve its stock price. It's been ten years since the mortgage crisis and the company needs to pull itself out of the shadow of litigation once and for all. The stock market hates uncertainty, but rewards certainty and clarity. A settlement should do wonders for the stock. A loss, which is growing increasingly likely, is going to add billions in losses to the company's bottom line - on top of the $33 billion it has already paid out in fines and settlements over the past few years.
The cases enter around the plaintiffs' claims that JPM dumped billions in toxic mortgage assets for other clients before the majority of the crisis hit, but literally ignored those same toxic assets resting in accounts the plantiffs' had invested with JPM. Of the $1.65 billion invested in May of 2006, the plaintiffs' lost a billion dollars before they pulled the plug in October of 2008.
This investment was guaranteed by Ambac Assurance UK, and they are currently on the hook to pay the plaintiffs because they guaranteed the investment…but only if JPM adhered to investing guidelines.
As it is, the case already took two bad turns against JPM during pre-trial hearings.
For starters, the court found that the two plaintiffs had cases that were so similar that the judge agreed to hear them simultaneously. Second, the aforementioned investing guidelines were ignored. They called for JPM to adhere to the Delaware Insurance Code, in which an insurance company cannot invest more than 50% of assets in MBS (mortgage-backed securities).
JPM dumped almost 90% of the money into those assets, which it admits, yet tried to argue that there was no 50% limit. Because the judge found for the plaintiffs, they don't have to prove that point. Instead, the legal issue surrounds whether JPM committed gross negligence and has to shell out a billion dollars to Ballantyne, and even more to Orkney.
The idea that it is now only a question of defining gross negligence and if JPM's behavior fits that description is a highly unenviable position to be in. The facts bode poorly for JPM.
Even though 90% of the money was in MBS', JPM did nothing even when the subprime market was obviously faltering. Dimon admitted in a Fortune Magazine article that subprime "could go up in smoke" and thus had his securitized loan division sell many of the positions JPM held. Even earlier, in late 2006 according to the litigation, JPM was already selling $12 billion in subprime assets that the bank itself had originated.
Dimon further stated at a conference that loan defaults were increasing and that home equity was risk of faltering.
Despite all this, JPM let the plaintiffs' investment sit untouched.
In the above-linked pre-trial hearing, the facts are even worse for JPM. The judge wrote that the man in charge of the investments testified in deposition "that he did not recall whether he sought any legal advice on whether the investments complied with the Delaware Insurance Code; or whether JPMIM undertook any steps to track the investment portfolio's compliance with the provision of the Delaware Insurance Code."
This trial seems highly unlikely to turn in JPM's favor. It needs to settle the case and get on with business.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.