In re HARDING ADVISORY LLC and

   
 
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UNITED STATES OF AMERICA 
 Before the 
 SECURITIES AND EXCHANGE COMMISSION 
 
SECURITIES ACT OF 1933 
Release No. 9467 / October 18, 2013 
 
INVESTMENT ADVISERS ACT OF 1940 
Release No. 3696 / October 18, 2013 
 
INVESTMENT COMPANY ACT OF 1940 
Release No. 30746 / October 18, 2013 
 
ADMINISTRATIVE PROCEEDING 
File No.  3-15574 
 
In the Matter of 
HARDING ADVISORY LLC and 
WING F. CHAU, 
Respondents. 
 
ORDER INSTITUTING 
ADMINISTRATIVE AND CEASE-AND-
DESIST PROCEEDINGS PURSUANT 
TO SECTION 8A OF THE SECURITIES 
ACT OF 1933, SECTIONS 203(e), 203(f), 
AND 203(k) OF THE INVESTMENT 
ADVISERS ACT OF 1940, AND 
SECTION 9(b) OF THE INVESTMENT 
COMPANY ACT OF 1940 
 
I. 
 
The Securities and Exchange Commission (“Commission”) deems it appropriate that 
public administrative and cease-and-desist proceedings be, and hereby are, instituted pursuant to 
Section 8A of the Securities Act of 1933 (“Securities Act”), Sections 203(e), 203(f), and 203(k) 
of the Investment Advisers Act of 1940 (“Advisers Act”), and Section 9(b) of the Investment 
Company Act of 1940 (“Investment Company Act”) against Harding Advisory LLC (“Harding 
Advisory” and together with its predecessor, “Harding”) and Wing F. Chau (“Chau” and together 
with Harding Advisory, “Respondents”). 
 
II. 
 
 After an investigation, the Division of Enforcement alleges that: 
 

   
 
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A. Summary 
 
1. This matter involves violations of the federal securities laws by Harding and its 
principal Wing F. Chau in their role as investment managers for certain collateralized debt 
obligation transactions (“CDOs”). As the Collateral Manager of these CDOs, Harding was 
responsible for the selection, acquisition, and monitoring of portfolios of assets – the collateral – 
backing tranches of securities issued to investors by special-purpose vehicles (the “Issuers”), 
including one named Octans I CDO Ltd. (“Octans I”). 
 
2. Unbeknownst to investors and in conflict with the marketing materials and 
offering circular for Octans I, a third party named Magnetar Capital LLC (together with 
affiliates, “Magnetar”) – a hedge fund firm whose interests were not aligned with those of the 
debt investors in Octans I – had undisclosed rights over the selection of collateral for Octans I. 
Magnetar’s influence led Harding to select assets for Octans I that Harding’s own personnel 
disfavored. 
 
3. The Octans I transaction was a $1.5 billion CDO that closed on September 26, 
2006. The collateral for the transaction consisted mostly of credit default swaps (“CDS”) 
referencing subprime residential mortgage-backed securities (“RMBS”),
1
 as well as securities of 
other CDOs backed by RMBS. Octans I was structured and marketed by subsidiaries of Merrill 
Lynch & Co., Inc. (collectively “Merrill”), which also lent their balance sheet to store, or 
“warehouse,” collateral acquired for Octans I in the months leading up to the closing of the 
transaction. By April 3, 2008, Octans I had failed, costing the transaction’s outside investors 
approximately $1.1 billion. Harding received approximately $4.5 million in fees for its role in 
the transaction. 
 
4. The warehouse agreement governing the process of accumulating collateral prior 
to the closing of the Octans I transaction was actually a three-way agreement among Harding, 
Merrill, and Magnetar. The agreement gave Magnetar important rights, chief of which was the 
right to veto Harding’s selection of collateral for the Octans I portfolio. Consistent with the 
agreement, Magnetar exercised significant control over the composition of the portfolio, but this 
right, among the others granted to Magnetar, was not disclosed to the debt investors in Octans I. 
 
5. The so-called “pitchbook” and offering circular used to market Octans I, the 
relevant portions of which were drafted or reviewed by Harding, described Harding’s credit-
selection processes and represented that the collateral would be selected by Harding and housed 
at Merrill in accordance with a warehouse agreement between Merrill and Harding. These 
representations were materially misleading because they did not disclose Magnetar’s rights in 
and influence over the collateral selection process. 
 
6. The offering circular and a Collateral Management Agreement with the Octans I 
Issuer executed by Chau also represented that Harding, in selecting collateral for the CDO, 
would perform its obligations as collateral manager: 
                                                           
1
 RMBS are bonds backed by pools of residential mortgage loans, in this case subprime loans. CDS are 
explained below.
 

   
 
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with reasonable care (i) using a degree of skill and attention no less than that which 
[Harding] would exercise with respect to comparable assets that it manages for itself and 
(ii  ) without limiting the foregoing, in a manner consistent with the customary standards, 
policies and procedures followed by institutional managers of national standing relating 
to assets of the nature and character of the [Octans I collateral].  
 
This was a material misrepresentation in that Harding and Chau, as they knew or at least 
recklessly disregarded, compromised their standards to accommodate trades requested by 
Magnetar. 
7. Harding and Chau also later breached their obligations by purchasing, for 
inclusion in several other CDOs managed by Harding, tens of millions of dollars’ worth of notes 
from a troubled Magnetar-related CDO underwritten by Merrill known as Norma. Harding and 
Chau bought the Norma securities despite their basically unfavorable view of them, adding 
lower-rated notes to their prior Norma commitment only after receiving pressure from Merrill 
and a direct request from Magnetar. Chau was apparently trying to return a favor and show that 
he was a “team player” who “never forget[s] my true friends.” For each of the CDOs into which 
Harding placed the Norma notes, the collateral management agreement contained standard of 
care representations similar to that in the collateral management agreement for Octans I. 
 
8. Harding and Chau committed the breaches described in this Order because they 
wanted fees that could be earned only if Magnetar agreed to close the Octans I transaction, and 
because they were seeking to please Merrill and Magnetar. Merrill had arranged the Octans I 
transaction at the impetus and behest of Magnetar, which, together with Merrill, had selected 
Harding as the collateral manager. Merrill and Magnetar had sent, and were in a position to 
continue sending, significant CDO business to Harding. As such, Harding’s interests were in 
keeping Merrill and Magnetar happy, and Harding put those interests ahead of its obligations to 
the Issuers and their investors. 
 
B. Respondents 
 
9. Harding Advisory LLC is a registered investment adviser located in 
Morristown, New Jersey. Harding’s principal and near-100% owner i s Wing Chau. Harding was 
founded in or around July 2006 as the successor to an affiliate of Maxim Group LLC. Harding 
has been the adviser or sub-adviser to 21 CDOs, including Octans I. At its peak in 2007, Harding 
had approximately $20 billion in assets under management. Harding remains collateral manager 
for nine CDOs with total assets of approximately $1 billion. 
 
10. Wing F. Chau, age 46 and a resident of Basking Ridge, New Jersey, has served 
since 2006 as Harding’s CEO, Managing Member, and Chief Compliance Officer. 
 
C. Other Relevant Entities 
 
11. Merrill Lynch, Pierce, Fenner & Smith Incorporated (“MLPFS”), a registered 
broker-dealer and investment adviser based in New York, at all relevant times was the principal 

   
 
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U.S. broker-dealer subsidiary of Merrill Lynch & Co., Inc. MLPFS structured and marketed the 
Octans I transaction, and was one of the leading arrangers of CDOs between 2005 and 2008. 
Merrill was formerly one of the world’s leading investment banks. Merrill was acquired by Bank 
of America Corporation on January 1, 2009. 
 
12. Merrill Lynch International, a Merrill affiliate incorporated under the laws of 
England, was the warehouse provider for Octans I. 
 
13. Magnetar Capital LLC is a hedge fund manager headquartered in Evanston, 
Illinois. During 2006-07 Magnetar was involved in creating a series of CDOs with Merrill and 
other arranging banks. These CDOs were typically named after astronomical constellations, and 
so are sometimes known as “Constellation CDOs.” 
 
14. Octans I CDO Ltd. was a special-purpose vehicle incorporated in the Cayman 
Islands. 
 
D. Facts 
 
Background on CDOs and CDS 
 
15. A CDO is a special-purpose vehicle that issues debt to investors and uses the 
proceeds to invest in fixed income securities or loans. The CDO’s debt is issued in different 
tranches that feature varying levels of risks and returns. The senior tranche is the highest rated, is 
first in the priority of repayment through what is called the CDO’s waterfall and has the lowest 
risk of default. Because of the lower risk of default and the priority of repayment in the CDO’s 
waterfall, the holders of the senior tranche have lower rates of return. The inverse is true for the 
lowest-rated tranche in the CDO. Typically, that tranche (usually referred to as “equity”) is 
unrated, has the highest rate of return, is last in terms of the priority of repayment through the 
CDO’s waterfall and has the highest risk of default. 
 
16. A CDS is a type of derivative through which two parties transfer the risk of 
ownership of a particular reference obligation. The protection buyer (“short”) of a CDS pays to 
purchase protection upon the occurrence of certain events, such as an event of default, failure to 
pay interest, writedowns or substantial credit ratings downgrade of the reference obligation 
(collectively, “Credit Events”). The protection seller (“long”) sells that protection and assumes 
the risk of a Credit Event on the reference obligation. In 2006, the protection buyer normally 
paid the protection seller a premium or spread as part of the CDS.
2
 Reference obligations can 
take many forms but in this case took the form of RMBS or CDOs comprised of them. In 
essence, a CDS mimics the performance of the referenced asset. Thus, an investor can gain 
exposure to an asset by entering into a CDS that references the asset, instead of by purchasing 
the asset itself. 
 
                                                           
2
  For example, a protection buyer may agree to pay a protection seller 150 basis points to purchase 
protection against default on a $10 million of a designated reference obligation, or $150,000 per annum, 
paid periodically.   

   
 
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17. A CDO can be backed by bonds (a “cash CDO”) or by CDS (a “synthetic CDO”).  
A CDO backed by both bonds and CDS is called a “hybrid CDO.” Octans I was a hybrid CDO 
with approximately 90 percent synthetic assets. Typically, a collateral manager would acquire 
synthetic collateral by, among other things, sending out BWICs (bids wanted in competition) or 
responding to OWICs (offers wanted in competition). Generally speaking, BWICs were sent out 
by a “long” party seeking quotes from potential “short” counterparties on the assets referenced in 
the BWIC. The winner of a BWIC would be the party that offered to pay the highest premium 
amount. OWICs were sent out by a “short” party seeking quotes from a potential “long” 
counterparties on the assets referenced in the OWIC. The winner of an OWIC would be the party 
willing to accept the lowest premium amount. 
 
Roles of Harding and Merrill 
 
18. As Collateral Manager, Harding’s role was to act as investment adviser for Octans 
I, selecting and managing a portfolio pursuant to a Warehouse Agreement and a Collateral 
Management Agreement. 
 
19. In general, the collateral manager for a CDO must determine whether a potential 
asset is appropriate for inclusion in the CDO’s portfolio. A CDO transaction may or may not 
have a collateral manager. However, when a CDO was managed, the manager’s independent 
selection of assets was an important selling point to potential investors, and information on the 
collateral manager’s selection process was included in the marketing materials and offering 
circular by which the CDO’s debt was sold. 
 
20. Octans I was structured and marketed by Merrill, which also acted as the 
warehouse provider and as the initial counterparty on the CDS collateral that went into the 
transaction. A warehouse is essentially a segregated account through which the arranging bank 
finances the acquisition of collateral before the transaction closes. During the warehouse phase, 
Harding’s role was to select collateral that would be held in the warehouse until closing, at which 
point the collateral would be placed into the Issuer’s portfolio. 
 
Origin of Octans I CDO 
 
21. Octans I was a “reverse-inquiry” transaction, meaning that Magnetar approached 
Merrill to create the deal, as opposed to Merrill having been engaged by an asset manager to 
create the deal and then seeking out investors to purchase the securities issued in the transaction. 
 
22. In the spring of 2006, Magnetar approached Merrill to arrange a series of CDO 
transactions. At a meeting in May 2006, a Magnetar representative (“Magnetar Representative”) 
discussed with officials at Merrill, as the Merrill salesperson covering Magnetar (“Merrill 
Salesperson”) later put it in an email, an arrangement whereby Merrill and Magnetar would 
“pick mutually agreeable [collateral] managers to work with, Magnetar plays a significant role in 
the structure and composition of the portfolio . . . and in return [Magnetar] retain[s] the equity 
class and [Merrill] distribute[s] the debt.” 
 

   
 
6 
 
23. The equity piece of a CDO transaction was typically the hardest to sell and 
therefore the greatest impediment to closing a CDO. Magnetar’s willingness to buy the equity in 
a series of CDOs, including Octans I, therefore gave it substantial leverage in the assembly of 
these transactions. 
 
24. Magnetar and Merrill jointly agreed on Harding as the collateral manager for 
Octans I. On or about May 26, 2006, Merrill, Harding, and Magne  tar entered into an 
Engagement Letter that assigned the parties roles in the transaction. The agreement contemplated 
that Magnetar would purchase the equity piece of the transaction. Chau executed the 
Engagement Letter on behalf of Harding. 
 
25. Chau understood that Magnetar was interested in investing as the equity buyer in 
a series of potential CDO transactions. Chau also understood that Magnetar’s strategy included 
“hedging” its equity positions in CDOs, potentially by taking short positions on RMBS or certain 
tranches of CDOs, including the CDOs it was investing in. Chau therefore understood that, 
because Magnetar stood to profit if the CDOs failed to perform, Magnetar’s interests were not 
aligned with those of potential investors in the debt tranches of Octans I, whose investment 
depended solely on the CDO performing well. 
 
26. Octans I was the seventh CDO arranged by Merrill for which Harding became 
collateral manager. Over the course of the year following this Engagement Letter, Harding was 
selected as collateral manager for four more CDOs arranged by Merrill, as well as three other 
Constellation CDOs. 
 
The Three-Way Warehouse Agreement 
27. On or about May 26, 2006, Merrill, Harding, and Magnetar also entered into a 
Warehouse Agreement to govern the acquisition of collateral for the Octans I portfolio. Chau 
executed the Warehouse Agreement on behalf of Harding. The agreement gave Magnetar the 
right to receive 85% of the “carry” (essentially, the returns on the assets during the time they 
were warehoused) in exchange for taking 85% of the risk on the warehouse. Harding had never 
managed, nor had Merrill ever arranged, a CDO with a tri-party warehouse agreement prior to 
Octans I. 
 
28. The Warehouse Agreement also gave Magnetar a series of rights over the 
collateral selection process, including: 
 
• the right to veto collateral selected by Harding prior to purchase for the warehouse; 
 
• the right to mutually agree with Merrill and Harding on the price to be paid for 
collateral selected for the warehouse; and 
 
• the right to veto a designation by Merrill of any warehoused collateral as “Ineligible” 
for the Issuer’s portfolio because Harding or Merrill has determined that the collateral 
no longer satisfies certain criteria. 
 

   
 
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29. Chau understood that granting a veto right relating to collateral selection to a third 
party like Magnetar would cede some of the collateral manager’s authority and impair its 
independence. 
 
30. Harding, Merrill, and Magnetar were in close contact as Harding accumulated 
collateral for the Octans I portfolio. On the morning of May 30, 2006, a Harding vice president 
(“Harding VP”) emailed the Magnetar Representative, copying Chau and a  senior manager at 
Harding (“Senior Manager”): 
 
Now that we have the documents signed up, we just wanted to touch base with you 
regarding process. It sounds like you want us to send you a copy of our bid lists for your 
review prior to sending it to the street. If so, should we send the lists to you or to 
someone else at Magnetar? 
 
Please let me know how you would like this to work. 
 
The Magnetar Representative responded, copying Chau and the Senior Manager: “Yes . . . . 
Please send the lists to me. Also, would like to talk frequently so I’m up to date on your plan of 
action, how things are going, etc.” 
 
31. Harding complied, typically sending bid lists to Magnetar before circulating them 
to the market, and, at times with Merrill, seeking Magnetar’s approval before collateral was 
added to the Octans I warehouse. 
 
The ABX Trade 
Harding Agrees to Magnetar’s Request 
32. Magnetar was seeking, for reasons related to its own CDO investment strategy, to 
have the Constellation CDOs, including Octans I, acquire exposure to the RMBS bonds 
referenced in an investment product known as the ABX Index. 
 
33. Launched in January 2006, the ABX Index was a standardized CDS referencing a 
benchmark basket of 20 RMBS. The ABX Index was available at various levels of credit rating. 
The relevant levels in this case were BBB and BBB-. New ABX Indices became available twice 
per year, and in each case referenced RMBS issued in the preceding six months. Thus, for 
example, ABX 2006-1 referenced a basket of 20 RMBS issued in the second half of 2005. 
 
34. In late May 2006, Magnetar had discussions, first with Merrill and then with Chau 
and others at Harding, about acquiring exposure to the ABX Index at the BBB (Baa2) or BBB- 
(Baa3) levels for the Octans I warehouse. However, the Collateral Manager might not regard all 
of the bonds in the ABX index as acceptable. The parties therefore discussed having the Octans I 
warehouse first buy the index in a block and then exclude (via offsetting “short” positions on 
individual RMBS bonds) those bonds that Harding disfavored. 
 
35. Harding agreed to the concepts of acquiring exposure to the ABX Index and of 
excluding from that exposure selected bonds. In a three-way telephone conversation on the 

   
 
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afternoon of May 30, 2006, Magnetar and Merrill asked the Harding Senior Manager which 
RMBS bonds Harding wanted to exclude from the index. The Senior Manager said Harding 
would report back. After the call, t  he Merrill Salesperson promised the Magnetar Representative 
in an email: “We’ll push to get names [i.e. RMBS bonds] they [i.e. Harding] have issue with [i.e. 
want excluded from the index exposure] tomorrow am.” 
 
36. Shortly after the telephone call, the Harding VP, apparently unaware of the 
agreement on the ABX trade, sent the Magnetar Representative, with a copy to a distribution list 
of Harding’s CDO professionals, including Chau (“Group List”), “a list of names we’d like to 
circulate [i.e. to collect bids on in the marketplace for ultimate inclusion in the CDO] first thing 
tomorrow morning. We have not shown these to Merrill yet. Please let us know what you think.” 
The Magnetar Representative replied to the Harding VP: “  Great, these look fine,” and then later 
that evening sent the Harding VP another email, copying Chau and the Harding Senior Manager: 
“Noticed some index bonds in the list . . . . We’re going to do a big block trade of the index 
names, so please leave them off of any other lists you do.” 
 
37. In other words, the Magnetar Representative asked Harding not to acquire 
exposure to any constituent bonds of the index via the usual BWIC process because a separate 
block index trade was planned. The Harding VP agreed to comply in an email to the Magnetar 
Representative copied to the Harding Senior Manager and Chau. And Harding in fact complied 
with Magnetar’s directions as to how to acquire collateral for the CDO, stripping the index bonds 
from a bid list that Harding sent to Merrill on May 31. 
 
Harding’s Selections 
 
38. Shortly after the three-way telephone call on the afternoon of May 30, the Senior 
Manager sent a list of the ABX Index bonds to a credit analyst at Harding (“Analyst 1”), 
apparently so Harding’s credit team could identify constituents of the ABX Index to which 
Octans I should not be exposed. The Harding Senior Manager was aware that Magnetar would 
have preferred that Harding exclude as few bonds as possible. 
 
39. On the morning of May 31, 2006, even as the credit team was beginning its 
analysis of the ABX Index bonds, the Magnetar Representative continued to press Harding for 
the list of ABX Index bonds that Harding would exclude from the block index exposure. At or 
about 9:40 a.m., he emailed the Senior Manager, copying Chau: “you have abx names that you 
want out [i.e. excluded from the index], ready to trade?” In emails later that morning to the 
Harding Senior Manager, VP, and Chau, the Magnetar Representative followed up: “For our 
block index trade, u guys were going to let us know if there were any of the 20 index names you 
wanted to exclude, we had a call w [the Senior Manager] and [a Merrill trader] last nite.” The 
Senior Manager replied, copying Chau and the Harding VP: “Yes, we should have these names 
to you and [the Merrill trader] soon. Wing and I just got back from a meeting away from the 
office this morning.” 
 
40. At or about 4:22 p.m. on May 31, Analyst 1 sent the Senior Manager an email 
titled “ABX Index Rejections.” Attached to the email was a list of 12 bonds in the ABX Index. 
Four were at the BBB (Baa2) level; eight were at the BBB- (Baa3) level. This was the list for 

   
 
9 
 
which Magnetar had been pressing Harding. Over the next week, Merrill, Magnetar, and Harding 
worked together to acquire, for the Octans I portfolio, $300 million worth of block exposure to 
the ABX Index at the combined BBB (Baa2) and BBB- (Baa3) levels. The twelve bonds 
identified as “Index Rejections” were then excluded from the index exposure (which included 40 
bonds – 20 at each of the two rating levels), such that the Octans I portfolio was left with 
approximately $220 million worth of long exposure to 28 bonds.  In selecting twelve bonds to 
exclude from the index, therefore, Harding also effectively selected 28 index bonds for inclusion 
in Octans I (the “Accepted Index Bonds”). 
 
Harding’s Negative Analysis of the Selected Credits 
 
41. Harding’s internal communications indicate that many of the 28 Accepted Index 
Bonds were disfavored within Harding and would likely not have been included in the Octans I 
portfolio but for Magnetar’s desire to have the portfolio exposed to the ABX Index, and 
Harding’s desire to please Magnetar. 
 
42. At approximately 2 p.m. on May 31, a Harding trader sent an email to Harding’s 
Group List: “Here is an OWIC due at 4PM today. Maybe we can see if there are any names 
we’ve done the work on already to see if there is a fit for us.” The list of bonds attached to this 
email happened to be the same 40 bonds in the ABX Index at the BBB (Baa2) and BBB- (Baa3) 
levels. At or about 2:17 p.m., a Harding credit analyst (“Analyst 2”) asked a junior colleague to 
update Harding’s credit files on some of the 40 bonds. The junior colleague sent his results at 
2:28 p.m. to Analysts 1 and 2. 
 
43. At or about 2:49 p.m., Analyst 1 wrote to the trader and the Group List (emphasis 
added): “Out of the 40 bonds in this list, we have already looked at 29 bonds. Out of those, 10 
have been approved, and 19 have been rejected. These are the approved deals: [listing bonds].”  
 
44. At or about 3:04 p.m., Analyst 2 wrote to the trader and the Group List: “here’s 
the results for the 4 pm owic. Attached are the 40 bonds. [T]here is a correction. We are not okay 
on the MABS deal [i.e. an RMBS named MABS]. Some we have already seen as [Analyst 1] 
mentioned below.” The attached spreadsheet had a “Y” (signifying that Harding’s credit team 
approved the bond) next to 15 of the bonds, and a “N” (signifying that Harding’s credit team 
rejected the bond) next to the other 25 bonds, including the “MABS” RMBS at both rating 
levels. 
 
45. As noted above, however, the email from Analyst 1 at 4:22 p.m. reflected the 
selection of the 28 Accepted Index Bonds to which the Octans I portfolio ultimately became 
exposed. Those 28 accepted bonds included all of the 15 bonds marked “Y” at 3:04 p.m., and 
another 13 bonds that had been marked “N” in that email (including the “MABS” bonds). The 28 
acceptances and 12 exclusions, moreover, changed from the 2:49 p.m. email in which Analyst 1 
noted that previously “10 have been approved, and 19 have been rejected.”  
 
46. There is no contemporaneous record of Harding’s reasons for accepting many of 
these bonds. The only relevant credit work on May 31 of which there is any record (apart from 

   
 
10 
 
what is reviewed above) was circulated to Analyst 1 at or about 1:12 p.m., and it was largely 
negative. For most of the bonds analyzed (which included ten of the 13 bonds that Analyst 2 had 
marked “N”), the credit analysis indicated substantial write-downs. 
 
47. Subsequent communications confirm that Harding compromised, allowing into 
the Octans I portfolio bonds that it would have been unlikely to select but for Magnetar’s desire 
for ABX Index bonds. 
 
48. On the morning of June 1, 2006, the Harding VP wrote to Chau and the Senior 
Manager: “I don’t think we can do [$]15[ million] of each name even if we do a 1.5B deal since 
we are buying 2 classes of each issue” – i.e. each index bond at the Baa2 and Baa3 levels – “and 
the 1% limit applies to the issue. Most we can do is probably 7.5M.” The Senior Manager replied 
to the Harding VP and Chau (emphasis added): “That’s correct and we should push them to short 
[i.e. cause the Octans I portfolio to go long] the Baa2’s since we are less comfortable with some 
of these index names at the Baa3 level.” 
 
49. Later that morning the Harding Senior Manager sent the Magnetar Representative 
an email titled “Index names” in which he wrote: “Sent [Merrill] the list yesterday. Don’t know 
if you’ve got it, so here it is again” – listing the Accepted Index Bonds. The Senior Manager 
continued (emphasis added): “We can do $15mm each issuer (Baa2 and Baa3 together) and 
prefer the Baa2’s.” 
 
50. In other words, Harding disfavored some of the Baa3 assets within the set of 
Accepted Index Bonds but either was not fully in control of, or was willing to leave to others, 
how much exposure the portfolio gained to the Approved Index Bonds at the two different rating 
levels. 
 
“Lesser of Evils” 
 
51. Octans I was not the only Constellation CDO for which Harding accepted index 
bonds seemingly disfavored by its credit team. Harding later executed ABX Index trades for 
different Constellation CDOs for which it served as collateral manager.  In late August 2006 
Analysts 1 and 2 debated whether certain index bonds should be internally marked as a “N” or a 
“Y” on Harding’s central bid lists. The analysts did not approve of the bonds but apparently had 
been pressured by Harding’s portfolio managers to accept them in connection with ABX Index 
trades for a Constellation CDO. Analyst 2 wrote of one bond (emphasis added): “due to the fact 
we had to pick the lesser of evils when we were looking at the index we said ‘Y.’ . . . . I would 
stick to the ‘N’ and note that we are a ‘Y’ if it were an index trade. Can we do this? Too 
complicated?” 
 
52. Analyst 1 agreed with Analyst 2’s suggestion, and several days later, Analyst 2 
suggested doing the same with a different index bond (emphases added): “We had it on the index 
for a ‘Maybe’ because we knew we had to pick the less worse. So let’s . . . [s]witch it back to a 
‘N’ and make a comment noting that we did not short it for the index trade.” 
 

   
 
11 
 
53. In September 2006, after receiving information about ABX Index trades done for 
a third Constellation CDO, Analyst 1 wrote to a Harding trader, copying Analyst 2: “Not as bad 
as I thought. 2 rejected bonds traded with [the Magnetar Representative] from the index. . . . [T]o 
the extent that you can control it, please refrain from letting any index trades happen for [the 
third Constellation CDO and another CDO underwritten by Merrill].” 
 
Misrepresentations and Omissions Regarding Collateral Selection for Octans I 
 
54. Magnetar’s rights regarding, and role in, the selection of collateral for Octans I 
were not disclosed. 
 
55. The pitchbook used to solicit investors in the transaction, the relevant portions of 
which were drafted by Harding and had been reviewed by Chau, described Harding’s investment 
approach and credit processes, but said nothing about Magnetar’s control rights and actual 
influence over the Octans I portfolio. 
 
56. Similarly, the offering circular, which Harding had reviewed, represented that the 
collateral acquired by the Issuer from the warehouse on closing was “selected by [Harding] and 
held by [Merrill] pursuant to warehousing agreements between [Merrill] and [Harding].” This 
disclosure omitted any mention of Magnetar’s involvement in the warehouse phase. Harding and 
Chau knew or were reckless in not knowing of this representation and the reasons why it was 
false or misleading. Harding and Chau failed to ensure the accurate disclosure of Magnetar’s 
warehouse rights. 
 
57. In the Collateral Management Agreement (CMA), which Chau executed at 
closing on behalf of Harding, Harding represented to the Issuer that Harding in relevant part 
would “perform its obligations hereunder (including with respect to any exercise of discretion) 
with reasonable care (i) using a degree of skill and attention no less than that which [Harding] 
would exercise with respect to comparable assets that it manages for itself and (ii) without 
limiting the foregoing, in a manner consistent with customary standards, policies and procedures 
followed by institutional managers of national standing relating to assets of the nature and 
character of the Collateral.” In the CMA, Harding further represented as relevant here that all 
collateral acquired on closing – that is, the warehoused collateral – would satisfy the applicable 
terms and conditions of the CMA. 
 
58. The offering circular described the CMA, and repeated the standard of care 
representation quoted above. These representations to the Issuer and investors were materially 
false or misleading in that Chau and Harding, in order to accommodate Magnetar’s preferences, 
caused Octans I to acquire collateral that Harding’s personnel disfavored. Harding and Chau 
knew the standard of care representation in the CMA and knew or were reckless in not knowing 
that it was repeated in the offering circular and was false or misleading. 
 
59. These misrepresentations and omissions were material. Investors in the securities 
of Octans I would have considered it important that an undisclosed party with interests not 
aligned with those of the other investors had influence over or rights regarding collateral 
selection. 

   
 
12 
 
 
The Norma Purchases 
 
60. In January 2007, Merrill was in the process of marketing a Constellation CDO 
known as Norma. On January 9, Chau, after reviewing information about Norma, wrote to a 
Merrill salesperson: “Turbo structure is very weak.”
3
 On January 16, 2007, Merrill’s head of 
CDO syndication (“Syndicate Head”) asked Chau in an electronic conversation: “ready to talk 
about your participation [in the Norma offering]?” Harding then requested from Merrill certain 
information about the loan pools backing the RMBS referenced in the Norma portfolio. 
 
61. On January 19, 2007, after further conversation with Merrill’s sales staff, Chau 
and Harding agreed to purchase $40 million worth of Norma’s A-rated tranche for several CDOs 
managed by Harding. 
 
62. Chau at first did not agree to buy Norma’s lower-rated tranches. But on January 
23, the Magnetar Representative emailed Chau with the subject heading “ Pls buy some norma 
bbb.” The email continued: “Stop complaining about turbo. :) Remember who was there for u 
when u were a little guy.” Shortly afterwards, Chau wrote: “ Did ML tell u I am in for 40mm 
single-As in Norma – team player!!!” 
 
63. Also on January 23, the Syndicate Head wrote to Chau: “what’s your level” – i.e. 
what coupon rate would make the bond acceptable – “on BBB or BBB- if we can’t change the 
turbo?” Chau responded: “ah-so . . . let me sharpen the pencil,” to which the Syndicate Head 
replied: “sweet.” 
 
64. The next day, the Syndicate Head asked Chau if he had “‘sharpened your pencil’ 
on norma BBBs yet?” Chau replied: “I never forget my true friends,”  and subsequently agreed to 
acquire, at an improved coupon rate, $20 million worth of the Norma BBB notes. 
 
65. When a Merrill sales representative later asked Chau if he had heard the news that 
Merrill had decreased Harding’s allocation of the Norma BBBs from $20 million to $15 million, 
Chau replied: “ Now that’s what I’m talking about, the love is in the air” – further suggesting that 
he had not wanted to purchase those notes in the first place. 
 
66. Although Harding’s orders for Norma were placed in January 2007, Norma itself 
did not close, and its securities were not available for purchase, until March 1. Shortly before 
Norma’s close, an analyst circulated within Harding, including to Chau, a highly critical credit 
report. The commentary noted that “[t]here’s quite a large percentage of deals [i.e. RMBS to 
which the Norma portfolio was exposed] failing surveillance tests, on the watchlist and on the do 
not buy list. Also, there is almost 15% exposure to [two RMBS sponsors generally disfavored 
within Harding.]” 
 
                                                           
3
 “Turbo” is a feature in a CDO structure that, when triggered, diverts excess cash flow to pay down 
principal on the notes of certain debt tranches. 

   
 
13 
 
67. Harding nevertheless proceeded with the Norma purchases, placing the notes into 
the portfolios of several CDOs it managed. 
 
68. For each of those CDOs, Chau, on behalf of Harding, executed Collateral 
Management Agreements containing standard of care provisions similar to the one in the Octans 
I CMA. In each case, the offering circular for the transaction described the CMA and the 
standard of care set forth within it. 
 
69. Harding and Chau breached their advisory obligations to those Issuers. Without 
disclosure, they put their desire to please Merrill and Magnetar – which by January 2007 were 
together responsible for tens of millions of dollars of revenue for Harding –  ahead of the best 
interests of the portfolio, which they knew were not served by the Norma bonds. 
 
E. Violations 
 
70. As a result of the conduct described above, Respondents willfully violated Section 
17(a) of the Securities Act, which prohibits fraudulent conduct in the offer and sale of securities. 
 
71. As a result of the conduct described above, Chau willfully aided and abetted and 
caused Harding Advisory’s violations of Section 17(a) of the Securities Act. 
 
72. As a result of the conduct described above, Respondents willfully violated 
Sections 206(1) and 206(2) of the Advisers Act, which prohibit fraudulent conduct by an 
investment adviser. 
 
73. As a result of the conduct described above, Chau willfully aided and abetted and 
caused Harding Advisory’s violations of Sections 206(1) and 206(2) of the Advisers Act. 
 
III. 
In view of the allegations made by the Division of Enforcement, the Commission deems 
it necessary and appropriate in the public interest that public administrative and cease-and-desist 
proceedings be instituted to determine: 
A.  Whether  the  allegations  set  forth  in  Section  II  hereof  are  true  and,  in  connection  
therewith, to afford Respondents an opportunity to establish any defenses to such allegations; 
B.  What,   if   any,   remedial   action   is   appropriate   in   the   public   interest   against   
Respondents pursuant to Sections 203(e) and 203(f) of the Advisers Act including, but not limited 
to, disgorgement and civil penalties pursuant to Sections 203(i) and 203(j) of the Advisers Act; 
 
C. What, if any, remedial action is appropriate in the public interest against Respondent 
pursuant   to Section   9(b)   of   the   Investment   Company   Act   including,   but   not   limited   to,   
disgorgement  and  civil  penalties  pursuant  to  Sections  9(d)  and  9(e)  of  the  Investment  Company  
Act; and 

   
 
14 
 
 
D. Whether,  pursuant  to  Section  8A  of  the  Securities  Act  and Section  203(k)  of  the  
Advisers  Act,  Respondents  should  be  ordered  to  cease  and  desist  from  committing  or  causing  
violations of and any future violations of Sections 206(1) and (2) of the Advisers Act and Section 
17(a)  of  the  Securities  Act;  and  whether  Respondents  should  be  ordered  to  pay  disgorgement  
pursuant to Section 8A(e) of the Securities Act and Section 203(k)(5) of the Advisers Act. 
 
IV. 
IT IS ORDERED that a public hearing for the purpose of taking evidence on the questions 
set forth in Section III hereof shall be convened not earlier than 30 days and not later than 60 days 
from service of this Order at a time and place to be fixed, and before an Administrative Law Judge 
to be designated by further order as provided by Rule 110 of the Commission's Rules of Practice, 17 
C.F.R. § 201.110. 
IT  IS  FURTHER  ORDERED  that  Respondent  shall  file  an  Answer  to  the  allegations  
contained in this Order within twenty (20) days after service of this Order, as provided by Rule 220 
of the Commission’s Rules of Practice, 17 C.F.R. § 201.220.  
If Respondent fails to file the directed answer, or fails to appear at a hearing after being duly 
notified, the Respondent may be deemed in default and the proceedings may be determined against 
him  upon  consideration  of  this  Order,  the  allegations  of  which  may  be  deemed  to  be  true  as  
provided by Rules 155(a), 220(f), 221(f) and 310 of the Commission’s Rules of Practice, 17 C.F.R.  
§§ 201.155(a), 201.220(f), 201.221(f) and 201.310. 
This Order shall be served forthwith upon Respondent personally or by certified mail. 
IT  IS  FURTHER  ORDERED  that  the  Administrative  Law  Judge  shall  issue  an  initial 
decision no later than 300 days from the date of service of this Order, pursuant to Rule 360(a)(2) of 
the Commission’s Rules of Practice. 
In the absence of an appropriate waiver, no officer or employee of the Commission engaged 
in  the  performance  of  investigative  or  prosecuting  functions  in  this  or  any  factually  related  
proceeding will be permitted to participate or advise in the decision of this matter, except as witness 
or counsel in proceedings held pursuant to notice.  Since this proceeding is not “rule making” within 
the  meaning  of  Section  551  of  the  Administrative  Procedure  Act,  it  is  not  deemed  subject  to  the  
provisions of Section 553 delaying the effective date of any final Commission action. 
 By the Commission. 
 
        Elizabeth M. Murphy 
        Secretary 

1 
 

UNITED STATES OF AMERICA 
 Before the 
 SECURITIES AND EXCHANGE COMMISSION 
 

SECURITIES ACT OF 1933 
Release No. 9467 / October 18, 2013 
 
INVESTMENT ADVISERS ACT OF 1940 
Release No. 3696 / October 18, 2013 
 
INVESTMENT COMPANY ACT OF 1940 
Release No. 30746 / October 18, 2013 
 
ADMINISTRATIVE PROCEEDING 
File No.  3-15574 
 

In the Matter of 

HARDING ADVISORY LLC and 
WING F. CHAU, 

Respondents. 

 
ORDER INSTITUTING 
ADMINISTRATIVE AND CEASE-AND-
DESIST PROCEEDINGS PURSUANT 
TO SECTION 8A OF THE SECURITIES 
ACT OF 1933, SECTIONS 203(e), 203(f), 
AND 203(k) OF THE INVESTMENT 
ADVISERS ACT OF 1940, AND 
SECTION 9(b) OF THE INVESTMENT 
COMPANY ACT OF 1940 

 
I. 
 

The Securities and Exchange Commission (“Commission”) deems it appropriate that 
public administrative and cease-and-desist proceedings be, and hereby are, instituted pursuant to 
Section 8A of the Securities Act of 1933 (“Securities Act”), Sections 203(e), 203(f), and 203(k) 
of the Investment Advisers Act of 1940 (“Advisers Act”), and Section 9(b) of the Investment 
Company Act of 1940 (“Investment Company Act”) against Harding Advisory LLC (“Harding 
Advisory” and together with its predecessor, “Harding”) and Wing F. Chau (“Chau” and together 
with Harding Advisory, “Respondents”). 

 
II. 
 

 After an investigation, the Division of Enforcement alleges that: 
 



   
 

2 
 

A. Summary 
 

1. This matter involves violations of the federal securities laws by Harding and its 
principal Wing F. Chau in their role as investment managers for certain collateralized debt 
obligation transactions (“CDOs”). As the Collateral Manager of these CDOs, Harding was 
responsible for the selection, acquisition, and monitoring of portfolios of assets – the collateral – 
backing tranches of securities issued to investors by special-purpose vehicles (the “Issuers”), 
including one named Octans I CDO Ltd. (“Octans I”). 

 
2. Unbeknownst to investors and in conflict with the marketing materials and 

offering circular for Octans I, a third party named Magnetar Capital LLC (together with 
affiliates, “Magnetar”) – a hedge fund firm whose interests were not aligned with those of the 
debt investors in Octans I – had undisclosed rights over the selection of collateral for Octans I. 
Magnetar’s influence led Harding to select assets for Octans I that Harding’s own personnel 
disfavored. 

 
3. The Octans I transaction was a $1.5 billion CDO that closed on September 26, 

2006. The collateral for the transaction consisted mostly of credit default swaps (“CDS”) 
referencing subprime residential mortgage-backed securities (“RMBS”),1 as well as securities of 
other CDOs backed by RMBS. Octans I was structured and marketed by subsidiaries of Merrill 
Lynch & Co., Inc. (collectively “Merrill”), which also lent their balance sheet to store, or 
“warehouse,” collateral acquired for Octans I in the months leading up to the closing of the 
transaction. By April 3, 2008, Octans I had failed, costing the transaction’s outside investors 
approximately $1.1 billion. Harding received approximately $4.5 million in fees for its role in 
the transaction. 

 
4. The warehouse agreement governing the process of accumulating collateral prior 

to the closing of the Octans I transaction was actually a three-way agreement among Harding, 
Merrill, and Magnetar. The agreement gave Magnetar important rights, chief of which was the 
right to veto Harding’s selection of collateral for the Octans I portfolio. Consistent with the 
agreement, Magnetar exercised significant control over the composition of the portfolio, but this 
right, among the others granted to Magnetar, was not disclosed to the debt investors in Octans I. 

 
5. The so-called “pitchbook” and offering circular used to market Octans I, the 

relevant portions of which were drafted or reviewed by Harding, described Harding’s credit-
selection processes and represented that the collateral would be selected by Harding and housed 
at Merrill in accordance with a warehouse agreement between Merrill and Harding. These 
representations were materially misleading because they did not disclose Magnetar’s rights in 
and influence over the collateral selection process. 

 
6. The offering circular and a Collateral Management Agreement with the Octans I 

Issuer executed by Chau also represented that Harding, in selecting collateral for the CDO, 
would perform its obligations as collateral manager: 
                                                           
1 RMBS are bonds backed by pools of residential mortgage loans, in this case subprime loans. CDS are 
explained below. 



   
 

3 
 

 
with reasonable care (i) using a degree of skill and attention no less than that which 
[Harding] would exercise with respect to comparable assets that it manages for itself and 
(ii) without limiting the foregoing, in a manner consistent with the customary standards, 
policies and procedures followed by institutional managers of national standing relating 
to assets of the nature and character of the [Octans I collateral].  

 
This was a material misrepresentation in that Harding and Chau, as they knew or at least 
recklessly disregarded, compromised their standards to accommodate trades requested by 
Magnetar. 

7. Harding and Chau also later breached their obligations by purchasing, for 
inclusion in several other CDOs managed by Harding, tens of millions of dollars’ worth of notes 
from a troubled Magnetar-related CDO underwritten by Merrill known as Norma. Harding and 
Chau bought the Norma securities despite their basically unfavorable view of them, adding 
lower-rated notes to their prior Norma commitment only after receiving pressure from Merrill 
and a direct request from Magnetar. Chau was apparently trying to return a favor and show that 
he was a “team player” who “never forget[s] my true friends.” For each of the CDOs into which 
Harding placed the Norma notes, the collateral management agreement contained standard of 
care representations similar to that in the collateral management agreement for Octans I. 

 
8. Harding and Chau committed the breaches described in this Order because they 

wanted fees that could be earned only if Magnetar agreed to close the Octans I transaction, and 
because they were seeking to please Merrill and Magnetar. Merrill had arranged the Octans I 
transaction at the impetus and behest of Magnetar, which, together with Merrill, had selected 
Harding as the collateral manager. Merrill and Magnetar had sent, and were in a position to 
continue sending, significant CDO business to Harding. As such, Harding’s interests were in 
keeping Merrill and Magnetar happy, and Harding put those interests ahead of its obligations to 
the Issuers and their investors. 

 
B. Respondents 

 
9. Harding Advisory LLC is a registered investment adviser located in 

Morristown, New Jersey. Harding’s principal and near-100% owner is Wing Chau. Harding was 
founded in or around July 2006 as the successor to an affiliate of Maxim Group LLC. Harding 
has been the adviser or sub-adviser to 21 CDOs, including Octans I. At its peak in 2007, Harding 
had approximately $20 billion in assets under management. Harding remains collateral manager 
for nine CDOs with total assets of approximately $1 billion. 

 
10. Wing F. Chau, age 46 and a resident of Basking Ridge, New Jersey, has served 

since 2006 as Harding’s CEO, Managing Member, and Chief Compliance Officer. 
 
C. Other Relevant Entities 
 
11. Merrill Lynch, Pierce, Fenner & Smith Incorporated (“MLPFS”), a registered 

broker-dealer and investment adviser based in New York, at all relevant times was the principal 



   
 

4 
 

U.S. broker-dealer subsidiary of Merrill Lynch & Co., Inc. MLPFS structured and marketed the 
Octans I transaction, and was one of the leading arrangers of CDOs between 2005 and 2008. 
Merrill was formerly one of the world’s leading investment banks. Merrill was acquired by Bank 
of America Corporation on January 1, 2009. 

 
12. Merrill Lynch International, a Merrill affiliate incorporated under the laws of 

England, was the warehouse provider for Octans I. 
 
13. Magnetar Capital LLC is a hedge fund manager headquartered in Evanston, 

Illinois. During 2006-07 Magnetar was involved in creating a series of CDOs with Merrill and 
other arranging banks. These CDOs were typically named after astronomical constellations, and 
so are sometimes known as “Constellation CDOs.” 

 
14. Octans I CDO Ltd. was a special-purpose vehicle incorporated in the Cayman 

Islands. 
 
D. Facts 
 

Background on CDOs and CDS 
 

15. A CDO is a special-purpose vehicle that issues debt to investors and uses the 
proceeds to invest in fixed income securities or loans. The CDO’s debt is issued in different 
tranches that feature varying levels of risks and returns. The senior tranche is the highest rated, is 
first in the priority of repayment through what is called the CDO’s waterfall and has the lowest 
risk of default. Because of the lower risk of default and the priority of repayment in the CDO’s 
waterfall, the holders of the senior tranche have lower rates of return. The inverse is true for the 
lowest-rated tranche in the CDO. Typically, that tranche (usually referred to as “equity”) is 
unrated, has the highest rate of return, is last in terms of the priority of repayment through the 
CDO’s waterfall and has the highest risk of default. 

 
16. A CDS is a type of derivative through which two parties transfer the risk of 

ownership of a particular reference obligation. The protection buyer (“short”) of a CDS pays to 
purchase protection upon the occurrence of certain events, such as an event of default, failure to 
pay interest, writedowns or substantial credit ratings downgrade of the reference obligation 
(collectively, “Credit Events”). The protection seller (“long”) sells that protection and assumes 
the risk of a Credit Event on the reference obligation. In 2006, the protection buyer normally 
paid the protection seller a premium or spread as part of the CDS.2 Reference obligations can 
take many forms but in this case took the form of RMBS or CDOs comprised of them. In 
essence, a CDS mimics the performance of the referenced asset. Thus, an investor can gain 
exposure to an asset by entering into a CDS that references the asset, instead of by purchasing 
the asset itself. 

 

                                                           
2  For example, a protection buyer may agree to pay a protection seller 150 basis points to purchase 
protection against default on a $10 million of a designated reference obligation, or $150,000 per annum, 
paid periodically.   



   
 

5 
 

17. A CDO can be backed by bonds (a “cash CDO”) or by CDS (a “synthetic CDO”).  
A CDO backed by both bonds and CDS is called a “hybrid CDO.” Octans I was a hybrid CDO 
with approximately 90 percent synthetic assets. Typically, a collateral manager would acquire 
synthetic collateral by, among other things, sending out BWICs (bids wanted in competition) or 
responding to OWICs (offers wanted in competition). Generally speaking, BWICs were sent out 
by a “long” party seeking quotes from potential “short” counterparties on the assets referenced in 
the BWIC. The winner of a BWIC would be the party that offered to pay the highest premium 
amount. OWICs were sent out by a “short” party seeking quotes from a potential “long” 
counterparties on the assets referenced in the OWIC. The winner of an OWIC would be the party 
willing to accept the lowest premium amount. 
 
Roles of Harding and Merrill 

 
18. As Collateral Manager, Harding’s role was to act as investment adviser for Octans 

I, selecting and managing a portfolio pursuant to a Warehouse Agreement and a Collateral 
Management Agreement. 

 
19. In general, the collateral manager for a CDO must determine whether a potential 

asset is appropriate for inclusion in the CDO’s portfolio. A CDO transaction may or may not 
have a collateral manager. However, when a CDO was managed, the manager’s independent 
selection of assets was an important selling point to potential investors, and information on the 
collateral manager’s selection process was included in the marketing materials and offering 
circular by which the CDO’s debt was sold. 
 

20. Octans I was structured and marketed by Merrill, which also acted as the 
warehouse provider and as the initial counterparty on the CDS collateral that went into the 
transaction. A warehouse is essentially a segregated account through which the arranging bank 
finances the acquisition of collateral before the transaction closes. During the warehouse phase, 
Harding’s role was to select collateral that would be held in the warehouse until closing, at which 
point the collateral would be placed into the Issuer’s portfolio. 
 
Origin of Octans I CDO 
 

21. Octans I was a “reverse-inquiry” transaction, meaning that Magnetar approached 
Merrill to create the deal, as opposed to Merrill having been engaged by an asset manager to 
create the deal and then seeking out investors to purchase the securities issued in the transaction. 

 
22. In the spring of 2006, Magnetar approached Merrill to arrange a series of CDO 

transactions. At a meeting in May 2006, a Magnetar representative (“Magnetar Representative”) 
discussed with officials at Merrill, as the Merrill salesperson covering Magnetar (“Merrill 
Salesperson”) later put it in an email, an arrangement whereby Merrill and Magnetar would 
“pick mutually agreeable [collateral] managers to work with, Magnetar plays a significant role in 
the structure and composition of the portfolio . . . and in return [Magnetar] retain[s] the equity 
class and [Merrill] distribute[s] the debt.” 

 



   
 

6 
 

23. The equity piece of a CDO transaction was typically the hardest to sell and 
therefore the greatest impediment to closing a CDO. Magnetar’s willingness to buy the equity in 
a series of CDOs, including Octans I, therefore gave it substantial leverage in the assembly of 
these transactions. 

 
24. Magnetar and Merrill jointly agreed on Harding as the collateral manager for 

Octans I. On or about May 26, 2006, Merrill, Harding, and Magnetar entered into an 
Engagement Letter that assigned the parties roles in the transaction. The agreement contemplated 
that Magnetar would purchase the equity piece of the transaction. Chau executed the 
Engagement Letter on behalf of Harding. 

 
25. Chau understood that Magnetar was interested in investing as the equity buyer in 

a series of potential CDO transactions. Chau also understood that Magnetar’s strategy included 
“hedging” its equity positions in CDOs, potentially by taking short positions on RMBS or certain 
tranches of CDOs, including the CDOs it was investing in. Chau therefore understood that, 
because Magnetar stood to profit if the CDOs failed to perform, Magnetar’s interests were not 
aligned with those of potential investors in the debt tranches of Octans I, whose investment 
depended solely on the CDO performing well. 

 
26. Octans I was the seventh CDO arranged by Merrill for which Harding became 

collateral manager. Over the course of the year following this Engagement Letter, Harding was 
selected as collateral manager for four more CDOs arranged by Merrill, as well as three other 
Constellation CDOs. 
 
The Three-Way Warehouse Agreement 

27. On or about May 26, 2006, Merrill, Harding, and Magnetar also entered into a 
Warehouse Agreement to govern the acquisition of collateral for the Octans I portfolio. Chau 
executed the Warehouse Agreement on behalf of Harding. The agreement gave Magnetar the 
right to receive 85% of the “carry” (essentially, the returns on the assets during the time they 
were warehoused) in exchange for taking 85% of the risk on the warehouse. Harding had never 
managed, nor had Merrill ever arranged, a CDO with a tri-party warehouse agreement prior to 
Octans I. 

 
28. The Warehouse Agreement also gave Magnetar a series of rights over the 

collateral selection process, including: 
 
• the right to veto collateral selected by Harding prior to purchase for the warehouse; 

 
• the right to mutually agree with Merrill and Harding on the price to be paid for 

collateral selected for the warehouse; and 
 

• the right to veto a designation by Merrill of any warehoused collateral as “Ineligible” 
for the Issuer’s portfolio because Harding or Merrill has determined that the collateral 
no longer satisfies certain criteria. 

 



   
 

7 
 

29. Chau understood that granting a veto right relating to collateral selection to a third 
party like Magnetar would cede some of the collateral manager’s authority and impair its 
independence. 

 
30. Harding, Merrill, and Magnetar were in close contact as Harding accumulated 

collateral for the Octans I portfolio. On the morning of May 30, 2006, a Harding vice president 
(“Harding VP”) emailed the Magnetar Representative, copying Chau and a senior manager at 
Harding (“Senior Manager”): 

 
Now that we have the documents signed up, we just wanted to touch base with you 
regarding process. It sounds like you want us to send you a copy of our bid lists for your 
review prior to sending it to the street. If so, should we send the lists to you or to 
someone else at Magnetar? 
 
Please let me know how you would like this to work. 

 
The Magnetar Representative responded, copying Chau and the Senior Manager: “Yes . . . . 
Please send the lists to me. Also, would like to talk frequently so I’m up to date on your plan of 
action, how things are going, etc.” 
 

31. Harding complied, typically sending bid lists to Magnetar before circulating them 
to the market, and, at times with Merrill, seeking Magnetar’s approval before collateral was 
added to the Octans I warehouse. 

 
The ABX Trade 

Harding Agrees to Magnetar’s Request 

32. Magnetar was seeking, for reasons related to its own CDO investment strategy, to 
have the Constellation CDOs, including Octans I, acquire exposure to the RMBS bonds 
referenced in an investment product known as the ABX Index. 

 
33. Launched in January 2006, the ABX Index was a standardized CDS referencing a 

benchmark basket of 20 RMBS. The ABX Index was available at various levels of credit rating. 
The relevant levels in this case were BBB and BBB-. New ABX Indices became available twice 
per year, and in each case referenced RMBS issued in the preceding six months. Thus, for 
example, ABX 2006-1 referenced a basket of 20 RMBS issued in the second half of 2005. 
 

34. In late May 2006, Magnetar had discussions, first with Merrill and then with Chau 
and others at Harding, about acquiring exposure to the ABX Index at the BBB (Baa2) or BBB- 
(Baa3) levels for the Octans I warehouse. However, the Collateral Manager might not regard all 
of the bonds in the ABX index as acceptable. The parties therefore discussed having the Octans I 
warehouse first buy the index in a block and then exclude (via offsetting “short” positions on 
individual RMBS bonds) those bonds that Harding disfavored. 
 

35. Harding agreed to the concepts of acquiring exposure to the ABX Index and of 
excluding from that exposure selected bonds. In a three-way telephone conversation on the 



   
 

8 
 

afternoon of May 30, 2006, Magnetar and Merrill asked the Harding Senior Manager which 
RMBS bonds Harding wanted to exclude from the index. The Senior Manager said Harding 
would report back. After the call, the Merrill Salesperson promised the Magnetar Representative 
in an email: “We’ll push to get names [i.e. RMBS bonds] they [i.e. Harding] have issue with [i.e. 
want excluded from the index exposure] tomorrow am.” 

 
36. Shortly after the telephone call, the Harding VP, apparently unaware of the 

agreement on the ABX trade, sent the Magnetar Representative, with a copy to a distribution list 
of Harding’s CDO professionals, including Chau (“Group List”), “a list of names we’d like to 
circulate [i.e. to collect bids on in the marketplace for ultimate inclusion in the CDO] first thing 
tomorrow morning. We have not shown these to Merrill yet. Please let us know what you think.” 
The Magnetar Representative replied to the Harding VP: “Great, these look fine,” and then later 
that evening sent the Harding VP another email, copying Chau and the Harding Senior Manager: 
“Noticed some index bonds in the list . . . . We’re going to do a big block trade of the index 
names, so please leave them off of any other lists you do.” 

 
37. In other words, the Magnetar Representative asked Harding not to acquire 

exposure to any constituent bonds of the index via the usual BWIC process because a separate 
block index trade was planned. The Harding VP agreed to comply in an email to the Magnetar 
Representative copied to the Harding Senior Manager and Chau. And Harding in fact complied 
with Magnetar’s directions as to how to acquire collateral for the CDO, stripping the index bonds 
from a bid list that Harding sent to Merrill on May 31. 

 
Harding’s Selections 
 
38. Shortly after the three-way telephone call on the afternoon of May 30, the Senior 

Manager sent a list of the ABX Index bonds to a credit analyst at Harding (“Analyst 1”), 
apparently so Harding’s credit team could identify constituents of the ABX Index to which 
Octans I should not be exposed. The Harding Senior Manager was aware that Magnetar would 
have preferred that Harding exclude as few bonds as possible. 

 
39. On the morning of May 31, 2006, even as the credit team was beginning its 

analysis of the ABX Index bonds, the Magnetar Representative continued to press Harding for 
the list of ABX Index bonds that Harding would exclude from the block index exposure. At or 
about 9:40 a.m., he emailed the Senior Manager, copying Chau: “you have abx names that you 
want out [i.e. excluded from the index], ready to trade?” In emails later that morning to the 
Harding Senior Manager, VP, and Chau, the Magnetar Representative followed up: “For our 
block index trade, u guys were going to let us know if there were any of the 20 index names you 
wanted to exclude, we had a call w [the Senior Manager] and [a Merrill trader] last nite.” The 
Senior Manager replied, copying Chau and the Harding VP: “Yes, we should have these names 
to you and [the Merrill trader] soon. Wing and I just got back from a meeting away from the 
office this morning.” 

 
40. At or about 4:22 p.m. on May 31, Analyst 1 sent the Senior Manager an email 

titled “ABX Index Rejections.” Attached to the email was a list of 12 bonds in the ABX Index. 
Four were at the BBB (Baa2) level; eight were at the BBB- (Baa3) level. This was the list for 



   
 

9 
 

which Magnetar had been pressing Harding. Over the next week, Merrill, Magnetar, and Harding 
worked together to acquire, for the Octans I portfolio, $300 million worth of block exposure to 
the ABX Index at the combined BBB (Baa2) and BBB- (Baa3) levels. The twelve bonds 
identified as “Index Rejections” were then excluded from the index exposure (which included 40 
bonds – 20 at each of the two rating levels), such that the Octans I portfolio was left with 
approximately $220 million worth of long exposure to 28 bonds. In selecting twelve bonds to 
exclude from the index, therefore, Harding also effectively selected 28 index bonds for inclusion 
in Octans I (the “Accepted Index Bonds”). 

 
Harding’s Negative Analysis of the Selected Credits 
 
41. Harding’s internal communications indicate that many of the 28 Accepted Index 

Bonds were disfavored within Harding and would likely not have been included in the Octans I 
portfolio but for Magnetar’s desire to have the portfolio exposed to the ABX Index, and 
Harding’s desire to please Magnetar. 

 
42. At approximately 2 p.m. on May 31, a Harding trader sent an email to Harding’s 

Group List: “Here is an OWIC due at 4PM today. Maybe we can see if there are any names 
we’ve done the work on already to see if there is a fit for us.” The list of bonds attached to this 
email happened to be the same 40 bonds in the ABX Index at the BBB (Baa2) and BBB- (Baa3) 
levels. At or about 2:17 p.m., a Harding credit analyst (“Analyst 2”) asked a junior colleague to 
update Harding’s credit files on some of the 40 bonds. The junior colleague sent his results at 
2:28 p.m. to Analysts 1 and 2. 

 
43. At or about 2:49 p.m., Analyst 1 wrote to the trader and the Group List (emphasis 

added): “Out of the 40 bonds in this list, we have already looked at 29 bonds. Out of those, 10 
have been approved, and 19 have been rejected. These are the approved deals: [listing bonds].” 

 
44. At or about 3:04 p.m., Analyst 2 wrote to the trader and the Group List: “here’s 

the results for the 4 pm owic. Attached are the 40 bonds. [T]here is a correction. We are not okay 
on the MABS deal [i.e. an RMBS named MABS]. Some we have already seen as [Analyst 1] 
mentioned below.” The attached spreadsheet had a “Y” (signifying that Harding’s credit team 
approved the bond) next to 15 of the bonds, and a “N” (signifying that Harding’s credit team 
rejected the bond) next to the other 25 bonds, including the “MABS” RMBS at both rating 
levels. 

 
45. As noted above, however, the email from Analyst 1 at 4:22 p.m. reflected the 

selection of the 28 Accepted Index Bonds to which the Octans I portfolio ultimately became 
exposed. Those 28 accepted bonds included all of the 15 bonds marked “Y” at 3:04 p.m., and 
another 13 bonds that had been marked “N” in that email (including the “MABS” bonds). The 28 
acceptances and 12 exclusions, moreover, changed from the 2:49 p.m. email in which Analyst 1 
noted that previously “10 have been approved, and 19 have been rejected.”  

 
46. There is no contemporaneous record of Harding’s reasons for accepting many of 

these bonds. The only relevant credit work on May 31 of which there is any record (apart from 



   
 

10 
 

what is reviewed above) was circulated to Analyst 1 at or about 1:12 p.m., and it was largely 
negative. For most of the bonds analyzed (which included ten of the 13 bonds that Analyst 2 had 
marked “N”), the credit analysis indicated substantial write-downs. 
 

47. Subsequent communications confirm that Harding compromised, allowing into 
the Octans I portfolio bonds that it would have been unlikely to select but for Magnetar’s desire 
for ABX Index bonds. 

 
48. On the morning of June 1, 2006, the Harding VP wrote to Chau and the Senior 

Manager: “I don’t think we can do [$]15[ million] of each name even if we do a 1.5B deal since 
we are buying 2 classes of each issue” – i.e. each index bond at the Baa2 and Baa3 levels – “and 
the 1% limit applies to the issue. Most we can do is probably 7.5M.” The Senior Manager replied 
to the Harding VP and Chau (emphasis added): “That’s correct and we should push them to short 
[i.e. cause the Octans I portfolio to go long] the Baa2’s since we are less comfortable with some 
of these index names at the Baa3 level.” 

 
49. Later that morning the Harding Senior Manager sent the Magnetar Representative 

an email titled “Index names” in which he wrote: “Sent [Merrill] the list yesterday. Don’t know 
if you’ve got it, so here it is again” – listing the Accepted Index Bonds. The Senior Manager 
continued (emphasis added): “We can do $15mm each issuer (Baa2 and Baa3 together) and 
prefer the Baa2’s.” 

 
50. In other words, Harding disfavored some of the Baa3 assets within the set of 

Accepted Index Bonds but either was not fully in control of, or was willing to leave to others, 
how much exposure the portfolio gained to the Approved Index Bonds at the two different rating 
levels. 

 
“Lesser of Evils” 
 
51. Octans I was not the only Constellation CDO for which Harding accepted index 

bonds seemingly disfavored by its credit team. Harding later executed ABX Index trades for 
different Constellation CDOs for which it served as collateral manager. In late August 2006 
Analysts 1 and 2 debated whether certain index bonds should be internally marked as a “N” or a 
“Y” on Harding’s central bid lists. The analysts did not approve of the bonds but apparently had 
been pressured by Harding’s portfolio managers to accept them in connection with ABX Index 
trades for a Constellation CDO. Analyst 2 wrote of one bond (emphasis added): “due to the fact 
we had to pick the lesser of evils when we were looking at the index we said ‘Y.’ . . . . I would 
stick to the ‘N’ and note that we are a ‘Y’ if it were an index trade. Can we do this? Too 
complicated?” 

 
52. Analyst 1 agreed with Analyst 2’s suggestion, and several days later, Analyst 2 

suggested doing the same with a different index bond (emphases added): “We had it on the index 
for a ‘Maybe’ because we knew we had to pick the less worse. So let’s . . . [s]witch it back to a 
‘N’ and make a comment noting that we did not short it for the index trade.” 

 



   
 

11 
 

53. In September 2006, after receiving information about ABX Index trades done for 
a third Constellation CDO, Analyst 1 wrote to a Harding trader, copying Analyst 2: “Not as bad 
as I thought. 2 rejected bonds traded with [the Magnetar Representative] from the index. . . . [T]o 
the extent that you can control it, please refrain from letting any index trades happen for [the 
third Constellation CDO and another CDO underwritten by Merrill].” 

 
Misrepresentations and Omissions Regarding Collateral Selection for Octans I 

 
54. Magnetar’s rights regarding, and role in, the selection of collateral for Octans I 

were not disclosed. 
 
55. The pitchbook used to solicit investors in the transaction, the relevant portions of 

which were drafted by Harding and had been reviewed by Chau, described Harding’s investment 
approach and credit processes, but said nothing about Magnetar’s control rights and actual 
influence over the Octans I portfolio. 

 
56. Similarly, the offering circular, which Harding had reviewed, represented that the 

collateral acquired by the Issuer from the warehouse on closing was “selected by [Harding] and 
held by [Merrill] pursuant to warehousing agreements between [Merrill] and [Harding].” This 
disclosure omitted any mention of Magnetar’s involvement in the warehouse phase. Harding and 
Chau knew or were reckless in not knowing of this representation and the reasons why it was 
false or misleading. Harding and Chau failed to ensure the accurate disclosure of Magnetar’s 
warehouse rights. 

 
57. In the Collateral Management Agreement (CMA), which Chau executed at 

closing on behalf of Harding, Harding represented to the Issuer that Harding in relevant part 
would “perform its obligations hereunder (including with respect to any exercise of discretion) 
with reasonable care (i) using a degree of skill and attention no less than that which [Harding] 
would exercise with respect to comparable assets that it manages for itself and (ii) without 
limiting the foregoing, in a manner consistent with customary standards, policies and procedures 
followed by institutional managers of national standing relating to assets of the nature and 
character of the Collateral.” In the CMA, Harding further represented as relevant here that all 
collateral acquired on closing – that is, the warehoused collateral – would satisfy the applicable 
terms and conditions of the CMA. 

 
58. The offering circular described the CMA, and repeated the standard of care 

representation quoted above. These representations to the Issuer and investors were materially 
false or misleading in that Chau and Harding, in order to accommodate Magnetar’s preferences, 
caused Octans I to acquire collateral that Harding’s personnel disfavored. Harding and Chau 
knew the standard of care representation in the CMA and knew or were reckless in not knowing 
that it was repeated in the offering circular and was false or misleading. 

 
59. These misrepresentations and omissions were material. Investors in the securities 

of Octans I would have considered it important that an undisclosed party with interests not 
aligned with those of the other investors had influence over or rights regarding collateral 
selection. 



   
 

12 
 

 
The Norma Purchases 

 
60. In January 2007, Merrill was in the process of marketing a Constellation CDO 

known as Norma. On January 9, Chau, after reviewing information about Norma, wrote to a 
Merrill salesperson: “Turbo structure is very weak.”3 On January 16, 2007, Merrill’s head of 
CDO syndication (“Syndicate Head”) asked Chau in an electronic conversation: “ready to talk 
about your participation [in the Norma offering]?” Harding then requested from Merrill certain 
information about the loan pools backing the RMBS referenced in the Norma portfolio. 

 
61. On January 19, 2007, after further conversation with Merrill’s sales staff, Chau 

and Harding agreed to purchase $40 million worth of Norma’s A-rated tranche for several CDOs 
managed by Harding. 

 
62. Chau at first did not agree to buy Norma’s lower-rated tranches. But on January 

23, the Magnetar Representative emailed Chau with the subject heading “Pls buy some norma 
bbb.” The email continued: “Stop complaining about turbo. :) Remember who was there for u 
when u were a little guy.” Shortly afterwards, Chau wrote: “Did ML tell u I am in for 40mm 
single-As in Norma – team player!!!” 

 
63. Also on January 23, the Syndicate Head wrote to Chau: “what’s your level” – i.e. 

what coupon rate would make the bond acceptable – “on BBB or BBB- if we can’t change the 
turbo?” Chau responded: “ah-so . . . let me sharpen the pencil,” to which the Syndicate Head 
replied: “sweet.” 

 
64. The next day, the Syndicate Head asked Chau if he had “‘sharpened your pencil’ 

on norma BBBs yet?” Chau replied: “I never forget my true friends,” and subsequently agreed to 
acquire, at an improved coupon rate, $20 million worth of the Norma BBB notes. 

 
65. When a Merrill sales representative later asked Chau if he had heard the news that 

Merrill had decreased Harding’s allocation of the Norma BBBs from $20 million to $15 million, 
Chau replied: “Now that’s what I’m talking about, the love is in the air” – further suggesting that 
he had not wanted to purchase those notes in the first place. 

 
66. Although Harding’s orders for Norma were placed in January 2007, Norma itself 

did not close, and its securities were not available for purchase, until March 1. Shortly before 
Norma’s close, an analyst circulated within Harding, including to Chau, a highly critical credit 
report. The commentary noted that “[t]here’s quite a large percentage of deals [i.e. RMBS to 
which the Norma portfolio was exposed] failing surveillance tests, on the watchlist and on the do 
not buy list. Also, there is almost 15% exposure to [two RMBS sponsors generally disfavored 
within Harding.]” 
 

                                                           
3 “Turbo” is a feature in a CDO structure that, when triggered, diverts excess cash flow to pay down 
principal on the notes of certain debt tranches. 



   
 

13 
 

67. Harding nevertheless proceeded with the Norma purchases, placing the notes into 
the portfolios of several CDOs it managed. 
 

68. For each of those CDOs, Chau, on behalf of Harding, executed Collateral 
Management Agreements containing standard of care provisions similar to the one in the Octans 
I CMA. In each case, the offering circular for the transaction described the CMA and the 
standard of care set forth within it. 

 
69. Harding and Chau breached their advisory obligations to those Issuers. Without 

disclosure, they put their desire to please Merrill and Magnetar – which by January 2007 were 
together responsible for tens of millions of dollars of revenue for Harding – ahead of the best 
interests of the portfolio, which they knew were not served by the Norma bonds. 

 
E. Violations 
 
70. As a result of the conduct described above, Respondents willfully violated Section 

17(a) of the Securities Act, which prohibits fraudulent conduct in the offer and sale of securities. 
 
71. As a result of the conduct described above, Chau willfully aided and abetted and 

caused Harding Advisory’s violations of Section 17(a) of the Securities Act. 
 
72. As a result of the conduct described above, Respondents willfully violated 

Sections 206(1) and 206(2) of the Advisers Act, which prohibit fraudulent conduct by an 
investment adviser. 

 
73. As a result of the conduct described above, Chau willfully aided and abetted and 

caused Harding Advisory’s violations of Sections 206(1) and 206(2) of the Advisers Act. 
 

III. 

In view of the allegations made by the Division of Enforcement, the Commission deems 
it necessary and appropriate in the public interest that public administrative and cease-and-desist 
proceedings be instituted to determine: 

A.  Whether the allegations set forth in Section II hereof are true and, in connection 
therewith, to afford Respondents an opportunity to establish any defenses to such allegations; 

B.  What, if any, remedial action is appropriate in the public interest against 
Respondents pursuant to Sections 203(e) and 203(f) of the Advisers Act including, but not limited 
to, disgorgement and civil penalties pursuant to Sections 203(i) and 203(j) of the Advisers Act; 

 
C. What, if any, remedial action is appropriate in the public interest against Respondent 

pursuant to Section 9(b) of the Investment Company Act including, but not limited to, 
disgorgement and civil penalties pursuant to Sections 9(d) and 9(e) of the Investment Company 
Act; and 



   
 

14 
 

 
D. Whether, pursuant to Section 8A of the Securities Act and Section 203(k) of the 

Advisers Act, Respondents should be ordered to cease and desist from committing or causing 
violations of and any future violations of Sections 206(1) and (2) of the Advisers Act and Section 
17(a) of the Securities Act; and whether Respondents should be ordered to pay disgorgement 
pursuant to Section 8A(e) of the Securities Act and Section 203(k)(5) of the Advisers Act. 

 
IV. 

IT IS ORDERED that a public hearing for the purpose of taking evidence on the questions 
set forth in Section III hereof shall be convened not earlier than 30 days and not later than 60 days 
from service of this Order at a time and place to be fixed, and before an Administrative Law Judge 
to be designated by further order as provided by Rule 110 of the Commission's Rules of Practice, 17 
C.F.R. § 201.110. 

IT IS FURTHER ORDERED that Respondent shall file an Answer to the allegations 
contained in this Order within twenty (20) days after service of this Order, as provided by Rule 220 
of the Commission’s Rules of Practice, 17 C.F.R. § 201.220.  

If Respondent fails to file the directed answer, or fails to appear at a hearing after being duly 
notified, the Respondent may be deemed in default and the proceedings may be determined against 
him upon consideration of this Order, the allegations of which may be deemed to be true as 
provided by Rules 155(a), 220(f), 221(f) and 310 of the Commission’s Rules of Practice, 17 C.F.R.  
§§ 201.155(a), 201.220(f), 201.221(f) and 201.310. 

This Order shall be served forthwith upon Respondent personally or by certified mail. 

IT IS FURTHER ORDERED that the Administrative Law Judge shall issue an initial 
decision no later than 300 days from the date of service of this Order, pursuant to Rule 360(a)(2) of 
the Commission’s Rules of Practice. 

In the absence of an appropriate waiver, no officer or employee of the Commission engaged 
in the performance of investigative or prosecuting functions in this or any factually related 
proceeding will be permitted to participate or advise in the decision of this matter, except as witness 
or counsel in proceedings held pursuant to notice.  Since this proceeding is not “rule making” within 
the meaning of Section 551 of the Administrative Procedure Act, it is not deemed subject to the 
provisions of Section 553 delaying the effective date of any final Commission action. 

 By the Commission. 

 

        Elizabeth M. Murphy 
        Secretary