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A front-page story in yesterday's New York Times (below the fold) revealed that JPMorgan Chase may be about to face the music again--and this time for something major enough to merit a repost from yesterday.  Apparently the U.S. Attorney's office in Manhattan, the FBI and the Office of the Comptroller of the Currency have been quietly investigating Chase's role in Bernie Madoff's massive Ponzi scheme.   And they have amassed enough evidence to make Chase take some pretty severe medicine--either in the form of an unprecedented deferred prosecution agreement or worse.

Reflecting the magnitude of the investigation, prosecutors and JPMorgan have held preliminary discussions about a so-called deferred prosecution agreement, people briefed on the inquiry said. Such an arrangement would suspend criminal charges against JPMorgan in exchange for a fine, certain other concessions and an acknowledgment that the bank will face charges if it fails to behave. Prosecutors may also require JPMorgan, which has repeatedly said that “all personnel acted in good faith” in the Madoff matter, to hire an independent monitor.

While deferred-prosecution agreements are the Justice Department’s preferred tool for punishing corporate giants — they allow prosecutors to appear tough without imperiling a company’s health — they are typically deployed only when misconduct is severe. For a large American bank, they are nearly unheard-of.

But the government, the people added, has not ruled out a harsher punishment for JPMorgan Chase’s national banking subsidiary. Prosecutors could demand that the unit plead guilty to a criminal violation of the Bank Secrecy Act, a federal law requiring financial institutions to report suspicious activity to the government.

To review, when Madoff pleaded guilty in 2009, he admitted that he hadn't made any legitimate investments since 1991 (though both prosecutors and Judge Denny Lin thought his scheme began earlier).  Instead, he deposited his customers' money in his business account at Chase--and before 1996, Chemical Bank.  Chemical, for those who don't know, bought Chase Manhattan in 1996 and took the Chase name even though Chemical was the nominal survivor.  Whenever his marks wanted to make withdrawals, he simply paid them from the Chase account.  As we all know by now, this continued until Madoff's scheme finally blew up in late 2008.

The feds seem to be relying pretty heavily on emails that suggested Chase continued to do business with Madoff in the face of mounting questions about whether he was legitimate.  Apparently the feds believe that those questions were serious enough that Chase should have alerted them about it as required by law.  There's no word yet on how big the fine will be, but it's probably going to be a substantial one which will be on top of a civil penalty imposed by the OCC.  And this may not even be the end of it.  Additionally, prosecutors are seriously considering whether to bring criminal charges against Chase employees who worked with Madoff.  

If I'm reading this story right, the feds appear to be relying pretty heavily on evidence gleaned by the trustee who is responsible for cleaning up the Madoff mess, Irving Picard.  Back in 2010, Picard sued Chase for $6.4 billion in damages and restitution, arguing that some very senior people at Chase knew Madoff's wealth management business was a Ponzi scheme and did nothing.  For instance, apparently Chase knew as early as 2006 that Madoff's auditor, Friehling & Horowitz, was a two-person firm in rural Rockland County that was neither peer reviewed or registered with the Public Company Accounting Oversight Board.  As most of us know by know, Friehling & Horowitz had been falsely claiming for a decade that it didn't conduct audits.  Additionally, Chase was apparently suspicious enough about possible fraud by Madoff that by 2008, it yanked nearly every penny it had invested with him.  And yet, it didn't alert any regulators until October, when it told UK regulators that it felt Madoff's returns were "too good to be true."

Picard also claimed that if Chase's retail banking arm had performed even rudimentary oversight of Madoff's banking activities, it would have discovered evidence that would have made it obvious Madoff's operation wasn't legitimate.  Also, despite reporting its concerns to UK regulators, Chase allowed Madoff to conduct normal banking activities until his arrest.  Earlier this summer, federal courts ruled that Picard doesn't have standing to sue any banks who did business with Madoff.  Picard is appealing to SCOTUS, but it doesn't take much to figure out that Picard gave much of his evidence to the feds.

Those close to the talks think the feds are more likely to pursue a deferred prosecution agreement, even though making Chase plead guilty to Bank Secrecy Act violations hasn't been ruled out.  Prosecutors are required to consider possible collateral consequences, such as economic implications.  However, a deferred prosecution agreement is a BFD.  Prosecutors only demand one when they have evidence of really egregious wrongdoing by a corporation.  A New York money center bank has never had to enter one, and only two major American banks have ever had to enter into such an agreement before--Wachovia and American Express.  

It's one thing to have to admit to reckless trading and oversight breakdowns.  It's quite another to admit deceiving investors about risk.  But to even tacitly admit that it failed to stop the biggest investment fraud in history?  Hard to see how Jamie Dimon survives this.

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