JPMorgan Chase probably had one of the worst years on record for a major bank. Well, the denouement to that year could come as soon as this week, when the bank is expected to reach what looks to be a landmark settlement with regulators and federal prosecutors for its failure to stop Bernie Madoff even though it had a mountain of evidence that he was running a Ponzi scheme. Sources close to the talks tell the New York Times that Chase is going to have to take some pretty tough medicine. Specifically, $2 billion in civil and criminal penalties, as well as a deferred-prosecution agreement--something which is only reserved for particularly egregious corporate misconduct.
The bank’s settlement talks with the authorities, reported by The New York Times last month, thrust JPMorgan into the spotlight on the fifth anniversary of Mr. Madoff’s arrest.
Under the terms of the deals, the bank will pay more than $1 billion to the prosecutors in Manhattan and the remainder to the Office of the Comptroller of the Currency and a unit of the Treasury Department investigating broader breakdowns in the bank’s safeguards against money-laundering. The government plans to earmark some of the payout for Mr. Madoff’s victims, according to the people briefed on the case, who spoke on condition they not be named because they were not authorized to discuss private settlement talks.
For those who don't know, Madoff ran his scheme by depositing his clients' money in his business account at Chase--and before 1996, Chemical Bank (which merged with Chase in 1996 and took the Chase name before merging with JPMorgan in 2000). He never invested a penny of his clients' money after 1991 (if not earlier)--instead, he simply paid them out of his Chase account.
The deferred-prosecution agreement will effectively force JPMorgan to admit to violating the Bank Secrecy Act, the federal law that requires banks to report suspicious financial activity to the government. Prosecutors seriously considered forcing JPMorgan to formally plead guilty to a Bank Secrecy Act violation--an action that would have put its banking charter in danger. The OCC had promised not to interfere had prosecutors gone that route. Apparently they decided to stick with the deferred-prosecution agreement because this probe started as a civil one. Still, a deferred-prosecution agreement is the equivalent of a rubber truncheon. No major New York bank has ever been forced into one before, and it's only been imposed on two other major American banks altogether.
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.
They also 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.
Granted, no individuals at Chase have been charged yet (though that hasn't been ruled out). Still, in and of itself, this is a BFD. Chase will be officially on record as having failed to stop the biggest financial crime in history. While it doesn't look like chairman Jamie Dimon will be pushed out directly as a result of this, hopefully the inevitable shareholder suits will do that job.