JPMorgan Chase Gets Prosecution Deferred

JPMorgan Chase got what it wanted – a deferred prosecution agreement.

The company was charged with two felony violations of the Bank Secrecy Act in connection with the banks relationship with Bernie Madoff.

It had to pay a $1.7 billion penalty.

And it had to “accept responsibility” for its conduct and stipulate for a statement of facts.

But the government ended up deferring prosecution for two years, after which it will dismiss the charges, if JPMorgan abides by the agreement.

JPMorgan Chase was represented by John Savarese, Steven DiPrima and Emil Kleinhaus of Wacthell Lipton in New York.

“JPMorgan Chase paying $1.7 billion for its criminal conduct helping Bernard Madoff’s Ponzi scheme is good, but still inadequate to stop what can only be called a one-bank crime spree,” said Dennis Kelleher of Better Markets.

“First, once again, not a single individual working for JPMorgan Chase has been held accountable. Banks do not commit crimes; bankers do. Until individuals, including executives, are held personally liable, fined and jailed, the crime spree will continue.”

“Second, it is no penalty to let banks use shareholders money to pay fines. Other people’s money is meaningless to lawbreakers.”

“Third, while the settlement includes significant disclosure of JPMorgan Chase’s assistance to Madoff’s Ponzi scheme, the public deserves more.

“For example, how much money did JPMorgan Chase make servicing, investing and trading in Madoff’s businesses over the years? How many thousands of investors were ripped off and for how many billions of dollars as a result of JP Morgan Chase’s years-long failures, including repeatedly ignoring red flags of Madoff’s crimes? This information is critical to understanding the action taken today and must be disclosed to the public.”

“Finally, the U.S. Attorney for the Southern District of New York, Preet Bharara, should be congratulated for requiring unprecedented disclosure and actual admissions of illegal conduct. However, the real test for justice is whether individuals, including executives, will now be prosecuted and whether the settlement agreement will in fact be enforced against JP Morgan Chase over the next two years.”

Brandon Garrett of the University of Virginia Law School and author of the soon to be published Too Big to Jail: How Prosecutors Take On Corporations (Harvard University Press, 2014), also gave the government a mixed review.

“The JPMorgan agreement provides for the biggest forfeiture ever in a deferred or non-prosecution agreement – larger than the forfeiture in the HSBC last year,” Garrett told Corporate Crime Reporter.

“Unlike in the HSBC case, this agreement describes efforts to implement ‘significant remedial changes,’ but includes no detail regarding what those improvements are and does not require that a monitor supervise compliance.  The agreement merely requires that quarterly reports be made on the bank’s progress.”

“I can imagine that if the judge was concerned in the HSBC case that the monitor was not reporting to the court, that a judge might be even more concerned that here there is no monitor – and no detail concerning what compliance changes must be made,” Garrett said. “Indeed, only the companion OCC agreement describes larger compliance problems at the bank that were broader than just the failure to report Madoff related suspicions and the OCC agreement does detail compliance changes and requires reporting to OCC each quarter in its progress making changes.”

“As we have seen in all of these major Bank Secrecy Act cases settling in deferred or non-prosecution agreements, there are not yet any prosecutions of individual officers or employees,” Garrett said. “The agreements speaks to the requirement to cooperate in pending investigations, but whether that language means that individual prosecutions could actually occur seems doubtful, and news sources have already reported that none will occur.”

Since 1986, JPMorgan and its predecessor institutions served as the primary bank through which Madoff ran his Ponzi scheme.

Madoff Securities maintained a series of linked checking and brokerage accounts at JPMorgan – collectively referred to as the “703 Account.” Madoff was a client of the Bank’s broker/dealer banking group, an investment bank group that comprised personnel from various business lines that serviced the needs of broker/dealer clients. JPMorgan designated a banker as Madoff’s “relationship manager,” who was principally responsible for Madoff’s business with the Bank, as well as for the Bank’s first-line BSA responsibilities, including certifying that the Madoff relationship “complies with relevant legal and regulatory-based policies,” and “that the necessary due diligence has been performed.”

Early on in its relationship with Madoff Securities, JPMorgan, because of its unique vantage point as the firm’s banker, had reason to be suspicious about Madoff, federal officials alleged.

For example, in the early 1990s the Bank learned that Madoff and a prominent client of JPMorgan’s Private Bank were engaged in what looked like round-tripping, check-kiting transactions. Another bank involved in these transactions (“Madoff Bank 2”) recognized them as suspicious and without any legitimate business purpose. In or about 1996, unlike JPMorgan, Madoff Bank 2 not only filed a suspicious activity report (“SAR”) with law enforcement, but it actually closed down Madoff’s account. As a result, Madoff moved all of his accounts from Madoff Bank  to JPMorgan, where the size of these transactions became much larger.

For example, in December 2001 alone, the Private Bank Client engaged in approximately $6.8 billion worth of transactions with Madoff through a series of circular $90 million transfers.

Over the years, other parts of the Bank developed their own suspicions about Madoff. In 2006, an entirely different part of the Bank – a derivatives trading desk located in the London branch of JPMorgan’s Investment Bank – became interested in Madoff.

The trading desk began receiving requests to issue derivatives tied to the performance of various Madoff “feeder” funds – funds that sent investor money to Madoff Securities. In order to hedge and offset the risk created by these products, JPMorgan invested the Bank’s own capital directly in the feeder funds.

The Bank initially issued about $100 million of Madoff-linked products in 2006 and early 2007.

Then, because of continued demand for these products, in the summer of 2007, the traders on the London desk sought to write more than $1 billion in Madoff-linked derivatives – a large deviation from normal risk limits, which therefore had to be approved by the Investment Bank’s Chief Risk Officer.

In June 2007, the chief risk officer convened a committee to consider authorizing a request for more than $1.3 billion of the bank’s proprietary capital to be invested directly into Madoff feeder funds to hedge the issuance of additional derivative products tied to the performance of Madoff feeder funds.

Ultimately, the chief risk officer – who at one point was told by a senior colleague that there is a “well-known cloud over the head of Madoff and that his returns are speculated to be part of a Ponzi scheme” – rejected the proposal and set the Madoff risk limit at $250 million.

Over the next several months, JPMorgan began to have increasing concerns about its exposure to Madoff.

In late 2007, the London trading desk hired its own due diligence staff; on the first day of his job, the newly-hired head of hedge fund due diligence was directed to review the Madoff feeder fund positions and offer any insight into how Madoff was able to generate his purported returns.

Ultimately, in October 2008, the London desk’s due diligence team circulated a negative memorandum describing continuing concerns about Madoff. Among other things, the memorandum described the inability of JPMorgan to validate Madoff’s trading activity or custody of assets, questioned Madoff’s “odd choice” of a one-man accounting firm, and generally made the point that JPMorgan “seem[ed] to be relying on Madoff’s integrity” with little reason to do so.

About two weeks after the circulation of this memorandum, on October 29, 2008, JPMorgan filed a report with regulators in the United Kingdom, listing Madoff Securities as the “main subject – suspect” and repeating many of the concerns from that earlier memo.

The report to the UK regulators concluded that Madoff’s returns were “probably” “too good to be true,” and “as a result,” JPMorgan was withdrawing about $300 million of its own money from the Madoff feeder funds.

On November 19, 2008, the Bank filed a second report, notifying U.K. regulators about an additional planned transaction involving its position in the feeder funds, lest JPMorgan “be considered party to laundering the proceeds of crime.” As part of a broader directive to reduce generally the Bank’s exposure to hedge funds, between October 2008 and Madoff’s arrest on December 11, JPMorgan redeemed approximately $288 million of its approximately $370 million position in the Madoff feeder funds.

Although JPMorgan filed a report with UK regulators about its concerns relating to Madoff, it failed to do so in the United States. While the suspicions raised by the UK bankers led to JPMorgan’s own redemptions from Madoff feeder funds, during the same time, U.S.-based anti-money laundering compliance officers at JPMorgan never looked into Madoff, and nor was the relationship sponsor alerted about the London desk’s concerns.

And while certain senior compliance officers in the United States were provided with all of the relevant facts – critically, the London traders’ suspicions about Madoff and the fact of the decades-long banking relationship with Madoff – the U.S. compliance officers did very little to investigate those suspicions, failed to raise these concerns with the bank’s anti-money laundering department, and failed to file a SAR.

Meanwhile, the balance in the 703 Account that held the billions Madoff stole from his customers was being drained. In August 2008, the account held approximately $5.6 billion. But by October 16, 2008 – the date of the negative memorandum described above – the balance had fallen to $3.7 billion.

And on October 29, when the Bank filed its report in the U.K., the balance had fallen another $700 million, to about $3 billion. Over the next five weeks before Madoff’s arrest, a little over $2 billion exited the 703 Account. By the time Madoff was arrested on December 11, 2008, only about $234 million remained in the 703 Account.

Of those lost billions, the vast majority went to the very funds in which JPMorgan had built a position, including about $288 million that went back to JPMorgan itself to pay for its redemptions from the feeder funds.

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