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SEC Mulling Bear Stearns Probe

Mar 20, 2008 | Parker Waichman LLP

Bear Stearns, the investment bank recently rescued by a massive bailout engineered by the Federal Reserve, hasn't seen the end of its troubles.  Already facing lawsuits by angry shareholders and employees whose stock in the company is worth far less than it was two weeks ago, Bear Stearns could also soon be subject of a probe by the Securities and Exchange Commission (SEC).  According to the Associated Press, securities regulators have not ruled out legal action over potentially misleading comments about Bear Stearns' financial health made days before JP Morgan arranged to buy the investment bank.

Bear Stearns was once one of the biggest investment banks on Wall Street before being acquired by JP Morgan Chase over the weekend in an effort to salvage the failing institution.  Two of its hedge funds, heavily invested in subprime mortgages, folded in July. Bear’s investors became increasingly reluctant to do business with the company. Despite the company’s assurances that it had plenty of cash on hand to continue operations, it collapsed  last Friday.

The buyout of Bear Stearns by JP Morgan Chase - termed a “shotgun marriage” by some - was consummated after the Federal Reserve agreed to provide up to $30 billion in non-recourse financing to JP Morgan, with Bear Stearns’ illiquid mortgage and other securities as collateral.  When the dust settled, JP Morgan ended up buying Bear Stearns for a paltry $2.00 a share, a fraction of what it was once worth.  

In the days leading up to the Bear Stearns failure, several of the investment bank's executives made reassuring statements about its prospects.  Last Monday, when rumors started to circulate that Bear Stearns might not have enough cash to do business, the firm's executives sent out a press release to calm fears. It said Bear Stearns' "balance sheet, liquidity and capital remain strong. ... There is absolutely no truth to the rumors of liquidity problems that circulated today in the market." On Wednesday, Bear Stearns CEO Alan Schwartz appeared on CNBC to reassure investors that the firm had ample liquidity and said he was "comfortable" that it would turn a profit in its fiscal first quarter. By Thursday, Bear Stearns' solvency was being called into question and by Friday it told regulators it was ready to file for bankruptcy.

While Schwartz and others were trying to quell panic, Bear Stearns' stock was in a freefall.  Bear Stearns' shares traded last Monday at $62.30 and remained close to that level until Thursday, when they dipped to $57. On Friday, they plunged to $30. Yesterday, it closed at $5.33 per share.  

Now, those reassurances issued by Bear Stearns last week could have both the bank and its buyer in hot water.  The SEC enforcement division has written a letter to JP Morgan that discussed "investigations and potential future inquiries into conduct and statements by Bear Stearns" before the announcement of the takeover, the agency said.  In the letter, the SEC enforcement attorneys "declined to provide assurances about possible future enforcement actions" and said it would be premature to reach conclusions about their inquiry. However, they added that the staff "would favorably take into account" the circumstances surrounding the takeover when considering whether to recommend enforcement action against JP Morgan for public statements made by Bear Stearns.

According to the Associated Press, in the past the SEC has shown leniency toward companies that acquire firms that may have violated securities laws, since the parent company did not play a part and the acquisition ceases to exist as an independent entity. The agency, however, still has brought enforcement actions against individuals.


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