Did deliberately cover up ’s fraud?
The documents released this week by federal prosecutors do not show it did, and I suspect it did not. JPMorgan was penalized for failing to report “suspicious activity†in Mr. Madoff’s account at the bank â€" the account that took in money from the Ponzi investors and paid out withdrawals.
What the documents do show, however, is a huge bureaucracy where employees stuck to their own silos and did not communicate well with others. Suspicions were there, but so were profits, and the profits seem to have outweighed any other concerns. Many people simply filled out and filed forms, oblivious to what those forms might, or might not, indicat..
And, in a way, that may be more troubling. If clear crimes had been committed, then people could go to jail and a lesson would be taught. But there is no evidence that anyone acted with impure motives â€" assuming that we accept that making money is a proper motive. A combination of turf wars and incompetence combined to facilitate the biggest ever.
My favorite disclosure in the documents is that JPMorgan had a requirement that a “client relationship manager†certify every year that each client complied with all “legal and regulatory-based policies.†This was no doubt viewed as a tiresome and routine requirement, both by the bankers who did the certifying and by the people in the compliance department who collected the certifications.
“In March 2009,†we are told in a “statement of facts†agreed to by the bank and prosecutors, the Madoff relationship manager “received a form letter from JPMC’s compliance function asking him to certify the client relationship again.â€
Evidently, whoever sent out that letter did not read it after a computer generated it. Or perhaps that person had somehow missed the report that Mr. Madoff had been arrested on Dec. 11, 2008. That would not have been easy. In the month after the arrest, The New York Times printed 15 front-page articles on the Madoff fraud, and it received exhaustive coverage everywhere else as well.
Another highlight is that on June 15, 2007, JPMorgan’s chief risk officer refsed to increase the bank’s exposure to Mr. Madoff’s fund â€" more than $100 million at the time â€" to $1 billion. Mr. Madoff had made it clear that he would not allow JPMorgan to perform due diligence on what he was doing with investors’ money.
“We don’t do $1 bio trust me deals,†the risk officer wrote in an email, using what was apparently his abbreviation for billion.
But 12 days later, that risk officer approved going up to $250 million in Madoff exposure. In the meantime, Mr. Madoff had agreed to talk with him but not to allow any new due diligence. Joseph Evangelisti, a JPMorgan spokesman, says the risk officer “relied on the current and past due diligence of our markets and credit risk units, as well as our broker-dealer group†in approving the quarter-bi! llion-dol! lar exposure.
So we have no fewer than three parts of JPMorgan voicing confidence in Mr. Madoff. That does not sound good, but Mr. Madoff fooled a lot of other people, too. At least the risk officer did not approve the full $1 billion.
Soon after his first decision â€" the one saying the bank did not do billion-dollar “trust me deals†â€" the risk officer heard from another bank executive that, as he put it in an email message sent afterward to top JPMorgan Chase executives, “there is a well-known cloud over the head of Madoff and that his returns are speculated to be part of a Ponzi scheme.†He asked that someone “google the guy†to find a negative article he had been told about.
In response, a lower-level bank employee conducted a search for the article but could not find it.
The article the bank could not find was published by Barron’s in May 2001. The article, “Don’t Ask, Don’t Tell,†by Erin E. Arvedlund, noted Mr. Madoff’s secrecy and said it appeared to be impossible that Mr. Madoff’s stated strategy had produced the reported profits. But she did not raise the possibility that it was a Ponzi scheme. Instead, she speculated that perhaps he was using information garnered about pending stock market trades handled by his brokerage firm to front-run those trades. Mr. Madoff’s denials are included.
My colleague Diana Henriques, author of the definitive Madoff book, “The Wizard of Lies,†says that the suspicion of fr! ont-runni! ng was perhaps Mr. Madoff’s greatest asset in avoiding exposure all those years. When he was investigated, it was for front-running. There could be no proof of that, because it was not happening. Instead, he was claiming to own securities for his clients that he did not own.
Why, you might wonder, was JPMorgan Chase facing any exposure to Mr. Madoff? Its principal relationship with him was that it held the Ponzi scheme’s bank account, into which money from the suckers â€" er, investors â€" was deposited and money to repay investors leaving the fund was withdrawn. The statement of facts notes that money from that account never went to buy securities, as Mr. Madoff told investors it would.
Another part of JPMorgan had the exposure. Based in London, the “equity exotics†desk â€" yu’ve got to love that name â€" was selling derivatives to investors that promised to duplicate the performance of the Madoff fund. Some of them even promised to pay triple what Mr. Madoff paid. To offset that risk, the bank would put money into hedge funds that in turn invested in the Madoff fund. The bank was to make money off a lot of fees connected to the derivatives.
In the end, after Lehman Brothers failed in September 2008, JPMorgan decided that was too risky and redeemed most of those investments in October and November. But it could not get out of many of the derivatives it had sold. That fact, notes the statement of facts, left JPMorgan “exposed to substantial risk in the event that Madoff Securities continued to perform successfully.â€
That JPMorgan was, in effec! t, bettin! g that Madoff would not continue to report good profits aroused suspicion when it was disclosed years ago, but the investigators seem to have found no evidence that those who made the decision knew a fraud was taking place. They just feared it. In October 2008, they filed a “suspicious activity report†with British regulators, saying there might be a Ponzi scheme going on. But they did not bother to mention those fears to the bankers handling the Madoff bank account in the United States, and no similar report was filed with United States regulators.
As a result of those timely redemptions, JPMorgan Chase was able to book a loss of only $40 million after the Ponzi scheme collapsed, well below the $250 million loss it would have otherwise faced. Of course, the $2.5 billion it will now pay dwarfs those savings. That figure counts a series of settlements announced this week, in addition to the $17 billion penalty it is paying to the Justice Department under the deferred prosecution agreement.
No Ponzi scheme can operate without a bank willing to take the money in and pay it out without noticing that it is not paying for the investments promised by the schemer. It is worth noting that the only time the charges say JPMorgan should have filed a suspicious activity report was in October 2008, two months before the Ponzi scheme collapsed â€" and many years after it began. The prosecutors also say JPMorgan’s internal controls regarding money laundering were woefully inadequate.
It is encouraging that JPMorgan Chase is admitting its failures but a bit disappointing that prosecutors did not say it should have noticed that a fraud was going on long before it collapsed. There i! s little ! here to inspire other banks to be more vigilant in assuring they are not the bankers to a Ponzi scheme.
It seems unlikely that anything would be radically different had that suspicious activity report been filed in October 2008. JPMorgan says it files more than 100,000 such reports a year, and most of them do not result in legal action.
Most of the facts laid out in this week’s deferred prosecution agreement have been known for years. What seems to be new is that prosecutors decided to find criminal behavior in actions that regulators had previously viewed more charitably. Add this to JPMorgan’s previous settlements and it is clear that bank regulators are far less trusting than they used to be.
But can they effectively regulate this, or any other, megabank? For that matter, can senior managers effectively monitor the multibillion-dollar risks their employees may be taking? On current evidence, it is hard to be confident that they can.
