This is a very misleading article in my opinion. Investment banks provide investors access to risks which they want, in this case investors WANTED access to Madoff structured notes because Madoff had been outperforming, therefore JPM had a find a way to hedge themselves to reduce their risk. After investing a tremendous amount in madoff, JPM probably realized that they could hedge easier by going long the general market on roughly a 1.1 to 1 ratio I would imagine or the structured desk wanted to use their short to hedge another long position they couldn't get out of while retaining some idiosyncratic risk that Madoff was in fact a fraud (this type of tail hedge is very valuable on the st btw). When assessing risks of this size, I am glad that JPM seemed to be asking all the right questions about Madoff (which no one else, not even the SEC, was asking), it is funny JPM is being penalized for this.
Creating a similar idiosyncratic risk could be to sell a gold ETF and own physical gold, paying maybe 30 bps a year for a real outperformance during a) hyperinflation if real gold is needed or b) some gold bars at the ETF turn out to be fake/not there (some have been found to be tungsten) c) another unforseen event. These options are hard to create and very valuable to a huge investment bank such as JPM which is generally very long the mkt in general and actually allows them to make more loans.
Also, most benefiting from rising prices in madoff claims are distressed hedgefunds and investment banks btw. They own probably 90% of the claims now, 'vicitms" selling at roughly 20 cents on the dollar. Anyone really pointing the finger at JPM is very naive about the whole system.
... Did you miss the part about JPM also being Madoff's bank? They sold investments run by their own client (who would not allow due diligence!) to other clients while finding evidence that there was no way the returns could be genuine. Instead of following the law in this situation they ended up trying to make money off the phony securities before they were publicly discovered to be fraudulent.
Yes but there should be chinese walls between investment brokers and those managing a companies account. They should have reported to the US authorities (they did report to the UK ones) but revealing to other departments or worse to investment customers information from a customer's bank account would be highly unethical wouldn't it?
I knew nothing about this case before this article and am assuming the article is correct.
If they really though there was fraud, why wouldnt they have taken a huge short position and reported to the SEC, accelerating the winddown process. This is what saba did with the JPM whale trades, they took a huge CDS position and reported the "whale", making 100mm+.
They didnt do this because a) they didnt know about the fraud, or b) didnt want to hurt their clients.
Everyone likes to point the finger at someone else, but if you were buying madoff structured notes /investing in madoff and knew nothing about the fund and did no research, it is your fault if you lost money.
The issue at hand (and for which JPMorgan was fined) wasn't whether they definitively knew, or "thought" there was a fraud or not. It was for specific violations of the Bank Secrecy Act: failing to report suspicious activity, and failing to create specific controls against money laundering.
All of the recent press articles are really quite clear about this. You may not agree with the SEC's findings of JPM's culpability in these charges; you may not be even particularly fond of the Bank Secrecy Act, for that matter. But you might want to do a little bit of research into what JPM was, you know, actually prosecuted for before engaging in engaging in naked speculation about how what JPM may have "thought" about Madoff's activities based on the extent to which one particular unit may have been shorting his positions.
Everyone is required to act like police to some extent. If someone comes into your sporting goods store looking to buy a baseball bat to attack his neighbor, you're required not to sell it to him (and in some jurisdictions, you're required to call the police).
TFA defends JPM and skeptically deconstructs the accusation, so this comment is forehead-slappingly stupid.
If someone comes to an investment bank and asks for access to something that the investment bank knows is a fraud, and the bank provides it and takes the fee, while ending up short the fraud... that's a bit of a problem.
As Madoff's banker with billions of dollars on deposit, JPMorgan can see every cash flow. But apparently, they don't notice the disconnect between the business he claims to be doing and the cash, because the banker doesn't even know what the account is for. So much for asking all the right questions.
Late in the game, a different part of JPMorgan does a tiny amount of due diligence, and realizes Madoff is a fraud.
They don't tell the SEC.
They don't talk to Madoff's banker.
They take the money out of Madoff funds, effectively going short.
They don't tell clients it's a fraud, but basically we don't like it and we like either stuff better, try to move them into other investments.
They're in a conflicted position as his banker, to rat him out to clients or authorities.
But basically they should have realized something was amiss sooner, and they should have notified the authorities.
They didn't tell Madoff's banker probably because they couldn't as a result of Chinese wall requirements between the two businesses. They didn't tell the SEC because they were in London, but they did tell the UK authorities. Why didn't the UK authorities figure it out? Why should JPM, which sort-of has the job of detecting fraud, be expected to do better than the regulators for whom it is their primary purpose?
SEC examiner gets duped by fake records and doesn't check the real bank records -> should probably be fired and the agency investigated
JPMorgan banker, who has all the cash flows, doesn't bother to notice they don't add up and billions are missing -> should probably be fired and JPMorgan should be fined.
One person's incompetence doesn't excuse the other's. Especially when one gets fake records and the other knows the real numbers.
Out of all of this the failure of the SEC to say "shit guys, we really could have noticed this, sorry" is pretty damned aggravating.
JPM has plenty they could and should have done better doubtless deserve censure, but it would be nice for the regulators to admit that they did a poor job.
> When assessing risks of this size, I am glad that JPM seemed to be asking all the right questions about Madoff (which no one else, not even the SEC, was asking), it is funny JPM is being penalized for this.
It's amazing what JPM is being held liable for. I think it sets a terrible precedent that they were basically fined $13B for acquiring WaMu and Bear Sterns in the financial crisis. I can't imagine another bank cooperating with the government to takeover another failed bank. You would simply need too much time for due diligence to ensure that there was no illegal activity - ever - at the bank to be acquired.
His point is that the majority of the fine levied (80%) against JPM was in relation to WaMu and Bear Stearns behaviour BEFORE JPM bought them. The real crazy tho is that JPM _knew_ that some potentiually dodgy stuff had been going on at WaMu/BS and sought assurance from the regulators that they would not be held liable if they bought these two firms - which they were basically doing as a favour for the US Gov. Then the regulators fucked them anyway.
[They] sought assurance from the regulators that they would not be held liable if they bought these two firms... Then the regulators fucked them anyway.
Not doubting you, but can you provide more substantiation / detail on that assertion, please? What kind of assurances were given, and when? And more to the point: were they contractual assurances, or were they not? I highly doubt that JPM went into the deal blind, and even more so, that they would have taken on any significant risk of open-ended liabilities on the basis of a handshake.
And they certainly didn't go into the deal as a "favor" to anyone -- they did it to save their tender, pink skins, knowing full well what the future liabilities would likely be.
You know perfectly well that when companies make acquisitions, that they assume both the liabilities along with all the other assets they're acquiring.
going long the general market on roughly a 1.1 to 1 ratio
I don't think they could have hedged this way. Madoff's volatility was too low, so there weren't comparable instruments. The only options were investing in Madoff himself, or not hedging on the assumption that it would blow up sooner rather than later.
Nice summary of the situation. This is the takeaway for me:
"If you think of JPMorgan's businesses as operating more or less independently, but occasionally making each other money by cross-selling, then this mess makes more sense. A London investment bank that considered and rejected a derivative-linked investment in Madoff would have no obligations to report its suspicions to U.S. regulators. A boring custody bank that ran Madoff's checking accounts but had no derivatives traders to get suspicious about him also probably wouldn't be in trouble for missing the Madoff red flags. Combine the two businesses and the same behavior gets you in trouble."
Also, quite refreshing to read an article by someone who apparently has some experience with Wall Street. On a related note: I've been really happy with Bloomberg's coverage recently, of Wall Street specifically and the business world generally. Especially now what WSJ has decided to go full-on partisan.
Also, quite refreshing to read an article by someone who apparently has some experience with Wall Street.
According to his bio he worked in investment banking at Goldman and was an M&A lawyer before that. When I first found his column I went through and read a bunch of them. They're all all pretty good. If you like that sort of financial journalism from the perspective of former practitioners, another good one is Matthew C Klein who I guess used to work at Bridgewater Associates. If you want to kill the rest of your afternoon:
Agreed. All I could think reading this was how much I wish every Matt Taibbi "bankster" screed posted to hn or reddit had been replaced with a link like this.
I worked for JPM for a little over 3 years and this quote is bang on. I was in the custodial bank and we rarely spoke with the IB guys.
Until about 2 years ago they were completely different LOBs, with separate executive teams. Org-chart wise, the only guy tying the businesses together at the top was Dimon.
The reality on banks like this is that they are very hard to manage. There are specialists in every corner, and somehow the head of the bank has to keep tabs on all of them. Almost always, the money makers outearn the risk managers and compliance folks, so it's a game of catch-up. (Any bank that flipped it would go out of business - like the one honest used car salesman would.)
It depends on your point of view. Too big for what? Big can come in different manners. # of people to watch when 1 or 2 can cause trouble. Size of assets. # of distinct businesses. Size of risk position. Size of counterparty risk.
That dimon is still being targeted astounds me. This is an example of why even those in power should not be the nail that sticks out. In case you're wondering why dimon, why JP Morgan it all traces back to this [1] event.
1. in 2008/2009, can't find it on Google bc why have a date search anymore. Jamie Dimon was called before the finance committee to explain the financial meltdown. He allegedly stormed out after representatives asked him truly epically stupid questions, and told one of his aides, "Don't ever put me in front of those fucking morons again". There is no reason other than visibility and a personal grudge that this is targeted at JPMorgan v. the other banks.
There is no reason other than visibility and a personal grudge that this is targeted at JPMorgan v. the other banks.
This is, at best, very tenuous speculation.
The charges against JPM were quite specific, related to violations of the Bank Secrecy Act during 2007-2008. And the physical record -- in the form of subpoenaed evidence in support of JPM's culpability in these charges -- were apparently obvious and damning enough that JPM agreed to the penalties to forego criminal prosecution.
Whether Mr. Dimon got huffy after a committee meeting in 2009 has nothing to do with it.
Congress shouldn't have that much influence over the SEC. I always assumed it was because Dimon is the only CEO able to admit he's not infallable. I also think JPM is ahead of the curve on action against them. Again, they'll admit mistakes and take the fines. The rest of the street is denying everything but I believe they'll eventually be targetted as well.
I think you're framing the situation incorrectly. Wall Street is at a state of regulatory capture. Sorry I'm not an SEC apologist, but from what I've seen they walk a fine line between incompetence and brilliance. Everyone on Wall Street makes 'mistakes', and that's because individuals make decisions but there are more rules/laws/best practices than an individual can know. When everyone is operating under prosecutorial discretion, the law disappears, and it's cheaper to cut in, see regulatory capture, your oversight than it is to attempt compliance. Though the litigation industry on wall street might have a bone to pick here. The problem for Dimon is that capture is industry wide, not by an individual or company, as in the case of GE or the big three.
Lets take a real example. Bad things happened in 2008. Congress has to come in and 'clean up'. But Congress is a second order proxy for Wall Street, so clean up means they have to figure out a way to look good to their 'voters' while not putting any of their 'donors' in jail. This is harder than it seems. They tried for a few years to do nothing, because it was 'confusing' and 'complex', people weren't buying it. There was seriously bad mojo for congress, that could possibly threaten a reset on regulation for the entire financial industry. So they needed to find a scapegoat. A few congressmen were pissed at having their hands tied, and Dimon is probably the most visibly brilliant guy on wall street, and he had pissed people off, so he was chosen to be thinned from the heard.
What surprises me is that they haven't stopped. this is probably due to dimon's success, if he had been a little less competent in the intervening years, my bet is he would be less under the gun now. Still this is a valuable lesson to all of us paying attention.
Did you read the full article? I was expecting some evil screwing of their customers and putting themselves massively short on Madoff and them to have got off lightly but actually (based solely on this Bloomberg article) got the impression that the punishment was harsh.
From the TFA they were long but in the process of unwinding their position (albeit slightly faster than they helped their customers to do) and they filed the report of suspicions in London but not in the US (by oversight). The other problem seems to have been that the chinese wall between the speculators and the account managers was respected.
They were obligated to unwind their customers. They were obligated to report the crimes to UK authorities. I'm not impressed by the fact that there are aspects of this where they actually didn't break any laws, and it isn't a compelling defense for why they shouldn't be fined for the parts where they did.
I'm not saying that some punishment may have been appropriate but 1.7Bn plus damages on top seems plenty based on my understanding from the article rather than that they got off lightly as suggested by the post I was responding to.
The relevance of the report in the UK is that it suggests not reporting to the US was oversight rather than a decision to take commercial advantage of the knowledge rather than bring in the authorities (unless they were counting on the UK authorities being useless).
So, you think the punishment should fit the revenue rather than the crime? JPM reported Madoff to the SEC in the 90's. They also reported him to the British banking authorities much more recently. The "crime" is actually looking at Madoff's activities and divesting themselves from him.
I have no problem with JPM shorting or otherwise taking advantage of this fraud. Given that the SEC is asleep at the switch, the shorts are the best way to protect the financial system.
JPM reported Madoff to the SEC in the 90's. They also reported him to the British banking authorities much more recently.
Also: the actions for which JPM was recently fined concern primarily the years 2007 and 2008. JPM may have acted differently in the 1990s, but that's practically irrelevant to what happened ten years later -- especially given the extent to which the size, and the number of unsophisticated investors lured into Madoff's scheme (with JPM's help) increased geometrically.
Similarly, whether they reported him to British banking authorities is also of little relevance. U.S. laws concern JPM's obligations to report suspicious activities to the SEC and other domestic agencies -- not the Brits.
It was a UK trading desk at JPM that identified it as suspicious and reported it in the UK. It's pretty blurry about what the reporting requirements should be in such cases.
Should firms be required to report any suspicious activity found by any team in any location to every regulator that covers them ?
(generally the rule at most banks is to report it to the legal team who then figures out who should be notified)
Should firms be required to report any suspicious activity found by any team in any location to every regulator that covers them ?
Don't know about "any activity, any location", but the SEC's position is that JPM failed to report specific activities to U.S. Treasury's enforcement unit (FinCEN), as per the requirements of its charter.
If you need more clarification as this finding, you might want to look into the court documents.
If you believe, say, that Apple has been faking its revenue and profit numbers for the last 10 years, you can go ahead and short them on the expectation that they'll get caught, Tim Cook will go to jail and the stock will tank. In the meantime, the presence of your short will in some small way drive down the price of AAPL, or at least signal to the rest of the market that somebody believes things are not as rosy for the company as the current price indicates.
That's profiting from crime, in a way, but it's all you can do when it's not within your power to subpoena Apple internal memos or what have you.
As I read this article, this is more or less this is what JPM is being punished for doing, because in theory the small exotics group in the UK could have called the US headquarters and inspired them to contact the SEC, which didn't happen.
It's not a very good example, and hardly comparable to the JPM situation, since it was in JPM's power to raise the alarm (and keep raising it when no-one first paid attention).
Your crimes aren't magically washed away because the SEC wasn't doing their job well.
No, the Apple example is excellent. I forget what the name of the blog is but there's an investor who investigates firms for fraud, shorts their stock, then publishes his finding. It's not illegal in the slightest and is a public service.
Now, you seem to think that there should be communication between a trading desk and Madoff's custodian. Any compliance officer would disagree. There is simply too much risk of front running the client's account to allow this (especially when the account is as large as Madoff's).
> No, the Apple example is excellent. I forget what the name of the blog is but there's an investor who investigates firms for fraud, shorts their stock, then publishes his finding. It's not illegal in the slightest and is a public service.
Err... If you're thinking about the handful of self-proclaimed "activist investors" who frequently end up massively short after "investigating" the stocks they abandon, please spend some time reading http://www.deepcapture.com. You'll find their names in rather dubious company -- including Madoff, incidentally -- and associated with mountains of illegal activity.
I've never really looked into shorting, so sorry that this inevitably sounds really dumb, but if a short is public and works as that kind of signal, can it be abused? Say, if a big investment bank shorts a stock, and then advise all their clients to do so, and in some way convince a significant number of others to short that stock. Does it eventually become a sort of self-fulfilling prophecy where the number of shorts can damage confidence so much that they either sell or sell+short themselves and the stock ends up spiralling? If enough people wanted to take down a stock, is there some kind of protection that stops them doing this?
I know generally you can just start selling low or whatever, but shorting would make you a huge profit if this worked while selling low potentially a loss?
Shorting is absolutely open to abuse, especially naked shorting (i.e. you sell the stock without buying it first). Google the CEO of Overstock.com. He had a lot to say about naked shorts being abused. Regular shorts aren't abused as much because the company's dividends have to be paid to the owner by the borrower (i.e. the short) this makes the varying cost of holding a short on a good company high. I also never understood why people lend their stock to shorts. You're just helping them put downward preassure on a position that you're long.
If they are short Madoff, it's in their interest for its value to go to zero - i.e. him getting shut down by law enforcement makes them a lot of money, so their incentives are very much aligned with those of the regulators. (If you're cynical, you might argue that in an ideal world they'd like the rest of the world to remain in the dark for long enough for them to build up a sizeable position first). Conversely, investors would benefit from it finding more investors before being shut down so they could cash out first.
Let's say I had a short equity position in some company. Now, some bad guy comes and murders the CEO of that company, tanking the equity. A crime was committed, and I profited. Did I profit from a crime? Did I do something wrong?
If I know of a criminal conspiracy and don't report it am I a criminal? It sounds unfair, doesn't it? I mean I didn't take part in the conspiracy or the crime...
Does not sound unfair to me, by not reporting it you have taken part in the conspiracy in my mind, that is if you actually believe it is a real conspiracy and not a bunch of talk.
So, you think the punishment should fit the revenue rather than the crime?
It should be whatever the law says it should be.
In an ideal world... it should be in proportion to the pain and suffering caused by JPM's "willfully" (as concluded by investigators) failing to adhere to its legal obligations to report on Madoff's activities, once it became aware of them internally. Perhaps then some, given obvious indifference (on the part those responsible at JPM) to the potential for harm caused to unsophisticated investors while they were busy looking covering their... annual bonuses.
Quoting from yesterday's NYT article[1]:
On two occasions, in 2007 and 2008, JPMorgan’s own computer system raised red flags about Mr. Madoff, according to prosecutors. But both times, prosecutors say, JPMorgan employees “closed the alerts.”
“JP Morgan failed to carry out its legal obligations while Bernard Madoff built his massive house of cards,” George Venizelos, a senior F.B.I. official, said in a statement.
The F.B.I. and prosecutors traced the problem to JPMorgan “willfully” failing to create sufficient controls against money laundering. “There was no meaningful effort by the Bank to examine or investigate the Madoff Securities banking relationship,” prosecutors said.
The fact that the SEC was also asleep at the switch does not in any way absolve JPM of its own culpability in this disaster.
Even so, in human terms, the worst of the penalties "suffered" by anyone at JPM is unlikely to begin to compare to the losses suffered by Madoff's non-institutional investors as a result of JPM's actions.
Nobody has a problem with JPM being right; They have a problem with JPM selling wrong while buying right, as that generally suggests negligent advice or fraudulent advice. They can choose, and pay the fine accordingly, like all our citizens.
With the know your customer laws http://en.wikipedia.org/wiki/Know_your_customer it's increasingly the bank's responsibility to do the job of regulators. This is not new. It might be dumb, but it's how the system works(or doesn't work) right now.
KYC is about not doing business with terrorists or other undesirables. Madoff was not one of those. He was running a ponzi scheme but was otherwise an upstanding citizen. No bank would have any reason not to do business with him due to KYC due diligence.
I don't disagree that JPM has a responsibility to share any information they may have about financial fraud. I guess my point is that yeah, the $1.7B fine isn't much to JPM, but at the same time, it seems inline with their degree of negligence.
The basically got fined for not doing the SEC's job.
No, that's not what they were fined for. They were fined for not doing their job, according to the Bank Secrecy Act. Which they agreed to comply with when they decided to become a bank.
You might want to read a couple of news articles about the case, before pulling "facts" out of the air like this.
The SEC's job would have been a lot easier if Madoff had chosen to keep all of his scam's money in an account with the SEC... JPM got to see both sides of the scam and at least one department figured it out and decided to profit on the knowledge.
I thought they settled in order to avoid the felonies they committed by not reporting the suspicious activity? They paid to not go to jail. Obviously, they think $1.7B is cheaper than fighting it with their huge legal team. It's not like the Feds are picking on someone defenseless here.
Revenue is not income. $1.7 bn is a non-trivial amount even for them. Add to that the $13 bn they had to pay on fraudulent mortgage-bonds some weeks ago and things are starting to sum up.
This is the problem. "They" made billions of dollars illegally. Now, "they" are paying back 1.7 billion dollars. The question is- is it still the same "humans" behind the pronoun?
Certainly Madoff is not paying the lifetime of fuck-you money he has blown. At least now he is in jail (or "camp" as he thinks of it).
The rest of "them" wont do a single day in prison.
They paid taxes on the ill-gotten gains, so when the gains are taken away in a judgement, there is no need to pay whatever weird quasi-reverse taxes you are thinking of. If the judgment isn't enough after a tax deduction, then just up the judgement.
Don't complicate the tax code even further making it start taxing losses.
(One fair point might be if they paid capital-gains rates or foreign taxes in Ireland or something on the gains from shorting Madoff and yet could deduct the judgment from full US taxes. I don't think that was the case.)
The Complete Guide to Capital Markets for Quantitative Professionals by Alex Kuznetsov is what I generally recommend developers entering investment banking to read.
(despite "Quantitative Professionals" being in the title it's not math heavy, although you need to be able to think technically - should be fine if your developer)
well the whole Madoff thing is quite interesting and informative. You should start with Harry Markopolos "No One Would Listen: A True Financial Thriller", here's the article quoted in this post (which quotes the book itself) : http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a9Aa_...
It's pretty clear, and has been pretty clear for years now, that JPM is not only too big to fail, but too big to manage.
In short, JPM needs to be broken up. Most everyone will benefit--JPM managers, line workers, JPM customers, and shareholders, and the worldwide financial system. The only who does not benefit from a break-up is Jamie Dimon whose primary goal is to manage the largest bank around.
Creating a similar idiosyncratic risk could be to sell a gold ETF and own physical gold, paying maybe 30 bps a year for a real outperformance during a) hyperinflation if real gold is needed or b) some gold bars at the ETF turn out to be fake/not there (some have been found to be tungsten) c) another unforseen event. These options are hard to create and very valuable to a huge investment bank such as JPM which is generally very long the mkt in general and actually allows them to make more loans.
Also, most benefiting from rising prices in madoff claims are distressed hedgefunds and investment banks btw. They own probably 90% of the claims now, 'vicitms" selling at roughly 20 cents on the dollar. Anyone really pointing the finger at JPM is very naive about the whole system.