Magnetar Probed Over NIR-Linked CDO

May 18 2012 | 4:15am ET

Magnetar Capital's name has been bandied about in several collateralized debt obligation investigations in recent years. The hedge fund has never been formally accused of wrongdoing.

That could change, however: The Securities and Exchange Commission is probing the Evanston, Ill.-based firm's role in building some of the $30 billion in CDOs that it invested as much as $5 billion or more in 2006 and 2007, including a CDO that embattled NIR Group served as collateral manager.

The regulator is trying to determine whether Magnetar's influence on the CDOs amounted to its serving as collateral manager, which would give it a fiduciary duty to a CDO's investors. Magnetar reportedly put more than twice as much money into shorting CDOs it was involved with than it invested on the long side.

The hedge fund, which has denied any wrongdoing, was previously investigated over its role in a 2007 CDO structured by JPMorgan Chase. But while the bank had to pay $153.6 million to settle the SEC's probe, the regulator decided that Magnetar didn't have too much control over the asset selection process or what investors were told about its role.

Now, however, investigators have turned their attention to a CDO created by Merrill Lynch that collapsed in 2008. NIR, a Long Island hedge fund accused by investors of overstating its returns, was the collateral manager for the $1.5 billion CDO, called Norma.

That CDO has already been the subject of litigation; Rabobank settled its lawsuit against Merrill in 2010. But the suit includes some juicy allegations, including one that Magnetar "teamed up" with Merrill to create the CDO, The Wall Street Journal reports.

"Merrill knew NIR had abdicated its asset selection duties to Magnetar, an important Merrill client," a Rabobank lawyer said in a letter before the settlement. The same letter quoted a 2006 e-mail from a Merrill executive asking, "Is Magnetar allowed to trade for NIR?" and cited an e-mail from a Magnetar executive saying he wanted to "approve" the assets that went into Norma.

In addition, the Financial Crisis Inquiry Commission came across a document showing that Magnetar received $4.5 million in expenses from the Norma deal. Magnetar told the Commission that the money was a "discount in the form of a rebate" and not payment for services rendered.

The SEC inquiry is looking into both NIR and Merrill in addition to Magnetar. The lawyer for Corey Ribotsky, founder of the former, told the Journal that NIR "did not improperly abdicate any asset selection duties." Ribotsky was sued last year by the SEC for allegedly misappropriating more than $1 million in client funds, but said he was "vindicated" by the fact that the SEC did not accuse him or NIR of overstating the value of its funds, charging too much in fees or running a Ponzi scheme.

For its part, Magnetar dismissed the Journal article as "an unfortunate re-packaging of previously-reported information."

"Our role and interactions did not diminish nor replace the roles of other parties in the transaction, specifically including the role of the collateral manager," a Magnetar spokesman said. Magnetar also said it has been cooperating and continues to cooperate with the SEC.

Should the SEC bring an enforcement action against Magnetar, it would be the first against a hedge fund in a CDO case. In April, the hedge fund was sued for the first time over a CDO, when Italian bank Intesa Sanpaolo accused it and Crédit Agricole of defrauding it in a 2006 CDO.

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