Nov. 5 (Bloomberg) -- JPMorgan Chase & Co.’s Charles LeCroy explained to a colleague in 2003 how he planned to keep his job as the chief bond banker to Jefferson County, Alabama.

“I got to get the politics lined up,” he said, according to a complaint filed by the Securities and Exchange Commission yesterday. “And, of course, we have to pick the partners who are going to get free money from us this time.”

Jefferson County was a money mill to JPMorgan as politicians refinanced $3 billion of debt with a combination of floating-rate bonds and interest-rate swaps that last year pushed it toward bankruptcy. According to the SEC, LeCroy and Douglas MacFaddin, head of JPMorgan’s municipal derivatives unit from 2001 to 2008, paid more than $8 million to politically connected firms to secure its role in the deals.

The complaint provides a window into how New York-based JPMorgan, the second-largest U.S. bank by assets, used fees on the unregulated derivative contracts -- and a trip to a New York spa for one elected official -- to curry political favor, a decade after the SEC adopted rules to drive out pay-to-play from the $2.8 trillion municipal bond market.

The ban was approved in 1994 and “we knew when we passed it there were all kinds of ways to get around it,” said Charles “Skip” Fish, a former chairman of the Municipal Securities Rulemaking Board. “There needs to be rules that are as stringent and as unambiguous covering the derivatives side of the business as there is covering the regular bond side.”

Settlement Agreement

Yesterday, JPMorgan separately agreed to a $722 million settlement with the SEC. The settlement included forgiving $647 million in fees which the county faced to unwind the derivative deals. JPMorgan neither admitted nor denied wrongdoing.

Richard Lawler, a lawyer for MacFaddin, said his client didn’t break the law and will fight the charges in court. LeCroy’s attorney, Lisa Mathewson, said the SEC has overstepped its authority because it has no jurisdiction over derivatives, financial instruments linked to stocks, bonds, currencies and commodities, loans, or specific events such as changes in interest rates or weather.

“The complaint is overreaching,” she said. “The SEC is overstating its own jurisdiction, and they’re labeling permissible business practices as fraudulent,” Mathewson said. “We looking forward to defending it.”

The SEC case against JPMorgan’s bankers, both former managing directors, is the latest legal challenge tied to the bond deals, which refinanced debt amassed building a countywide sewer system.

Shoes, Gifts

“J.P. Morgan is pleased to have reached a settlement with the SEC in connection with its investigation of Jefferson County,” the bank said in statement sent by spokesman Brian Marchiony. “The charges relate principally to municipal derivatives transactions that occurred six and seven years ago. J.P. Morgan has since discontinued that business, and the employees in question are no longer employed by the firm.”

Larry Langford, the Democrat who was once president of the Jefferson County Commission and Birmingham mayor, was convicted last week for accepting $235,000 in designer clothes, Rolex watches and cash from William Blount, an Alabama banker. JPMorgan paid Blount $2.8 million, according to the SEC complaint.

In 2008, Mary Buckelew, another former commissioner, pleaded guilty to lying about receiving $4,000 in gifts, including shoes and a purse, from an unidentified, Montgomery, Alabama, investment banker, according to the U.S. attorney’s office.

Arranging Swaps

The complaint draws on tape-recorded conversations between LeCroy, MacFaddin and an unidentified JPMorgan associate that offer an inside glimpse into how the bank won politicians’ votes.

The unnamed associate told LeCroy that to “randomly pay off people that have nothing to do with the deal just doesn’t sit well.” His reply: “That’s the deal; that’s the price of doing business.”

Among those to whom JPMorgan provided cash was Goldman Sachs Group Inc., which received $3 million for a $1.1 billion interest-rate swap JPMorgan entered into with Jefferson County in 2003.

Blount, a friend to then-Commission President Langford, earned $300,000 in his role as Goldman Sachs consultant and would later be paid another $2.8 million by JPMorgan, according to the complaint. Goldman Sachs spokesman Michael DuVally declined to comment.

Spa Trip

In 2003, the unnamed JPMorgan employee used her credit card to pay for a $1,122 spa trip in New York for Buckelew, which MacFaddin and LeCroy approved as a JPMorgan expense, according to the complaint. LeCroy told her not to itemize it as a county expense in the company’s reports, in case a reporter sought the records, the SEC said.

ABI Capital Management of Birmingham, received $500,000 in undisclosed payments on interest-rate swaps, while Mobile-based Gardnyr Michael Capital Inc. got $575,000.

Those firms’ involvement began in 2002 at the behest of Jeff Germany, who was about to leave office, and a fellow commissioner, according to the complaint. LeCroy apprised MacFaddin of his plan to win votes by promising fees to the firms.

“I said, ‘Whatever you want -- if that’s what you need, that’s what you get, just tell us how much,’” according to the complaint. “They want it done before they lose control, because they want to help all their friends,” referring to the participants leaving public office.

Explaining Payments

The complaint shows that MacFaddin and LeCroy struggled to explain the payments to Gardnyr Michael. After they submitted a $250,000 invoice to JPMorgan in October 2002, the two considered describing the firm as an adviser to JPMorgan.

“But in the end, he really didn’t advise us on the swap … or the structure … or anything like that,” MacFaddin told LeCroy. “What we’re saying is, it’s really Jeff Germany who is directing us to pay these guys. It’s not, we’re not paying them because they were our adviser.”

JPMorgan arranged to pay the firms in 2003 to sway the vote of Shelia Smoot, a Democrat, the SEC said. According to LeCroy, Smoot demanded that JPMorgan pay the two companies more, and the fees were raised to $250,000 each. Both firms hired a friend of Smoot as a consultant, SEC papers show. Smoot, who remains on the commission, didn’t return a call seeking comment.

‘Need Her Vote’

“You know we’re going to need her vote, and we’ve got to keep her happy,” LeCroy told the unidentified JPMorgan associate.

“She’s one of the three majority commissioners,” he added, referring to her political affiliation. LeCroy said he would rather contribute to a commissioner’s favorite charity than “handing money to a vote,” according to the SEC.

Brian Cash, a Birmingham lawyer representing Gardnyr Michael, said the firm stands by its work and is cooperating with the SEC. ABI’s number has been disconnected and officials couldn’t be reached to comment.

After Langford became county commission president and head of the finance committee in November 2002, work shifted to his friend Blount, a former chairman of the Alabama Democratic Party. Blount had a consulting agreement with Goldman Sachs and solicited Langford to select the bank for a 2003 swap deal.

To ensure that JPMorgan was chosen for the $1.1 billion deal, LeCroy and MacFaddin negotiated with Langford to pay Goldman $3 million and Rice Financial Products Inc., another derivatives broker, $1.4 million, the SEC said.

Separate Swap

JPMorgan entered into a separate swap agreement with Goldman “created solely as a mechanism to make this payment,” the SEC said. Goldman paid Blount a $300,000 consulting fee. None of the sums were disclosed in swap documents or county resolutions.

LeCroy later told MacFaddin about Goldman’s involvement. They were “giving a charitable donation to Goldman” for “taking no risk,” LeCroy said, according to the SEC.

Blount produced results, the SEC said. After a June 11, 2003, meeting in Langford’s office, LeCroy told the unidentified JPMorgan co-worker he was “pretty sure” Langford would approve another bond and swap deal.

“At some point, we’ll have to figure out who we have to pay off. I think instead of Goldman we’ll have, we’ll probably have someone like Bill Blount,” LeCroy said.

In a separate conversation with the unnamed associate in 2003, LeCroy made light of his firm’s largesse in Alabama.

“We like to give money away,” the associate said.

“That’s right, that’s right,” LeCroy replied. “Oh yeah, who’s in line for the freebies this time?”

To contact the reporter on this story: Martin Z. Braun in New York at mbraun6@bloomberg.net; To contact the reporter on this story: William Selway in San Francisco at wselway@bloomberg.net

Last Updated: November 5, 2009 03:15 EST