Money laundering controls fell prey to profits
Bernie Madoff once told a reporter from his prison cell in North Carolina that JPMorgan “doesn’t have a chance in hell” of avoiding liability in connection with his 20-year Ponzi scheme. After all, JPM served as Bernie’s principal banker from 1986 on and enabled him to launder the $17.3 billion he swindled from thousands of his clients.
Last week, JPM paid the piper. The bank settled criminal, civil and regulatory charges against it by ponying up $2.6 billion and entering into a deferred prosecution agreement with the Department of Justice. Its criminal offense was “turning a blind eye” on what should have been reportable transactions to the US Treasury under the Bank Secrecy Act1.
According to the DPA, the government’s case against JPM was based on three significant incidents – one early and two much later in the game — in which the bank failed to detect and report suspicious activity on Madoff’s part:
As far back as the mid-1990s, JPM learned that Madoff and another JPM client, Norman Levy, were engaged in check-kiting transactions in which each wrote checks to the other in order to inflate their respective bank balances. Another bank involved in these transactions (believed to be Bankers Trust) recognized them as suspicious round-tripping without any valid business purpose. In 1996, the second bank filed a suspicious activity report (SAR) with Treasury and closed Madoff’s account2. As a result, Madoff moved all of his accounts from that bank to JPMorgan, where his check-kiting became more substantial. During the month of December 2001, for example, Levy and Madoff engaged in a series of circular $90 million transfers that totaled a whopping $6.8 billion. JPM did not report any of this suspicious activity to Treasury (which ended in 2005 upon Levy’s death3).
Meanwhile, from its London office, JPM had been selling clients highly-profitable derivatives linked to the performance of so-called ‘feeder funds’ that invested with Madoff. London’s ‘equity exotics’ desk hedged its short positions by investing comparable amounts of proprietary capital in those feeder funds. Around October 2008, the desk got nervous that Madoff’s returns were “so consistently and significantly ahead of its peers . . . they seemed too good to be true.” It then redeemed most of its investments in the feeder funds but was only able to unwind a portion of its derivatives contracts, leaving JPM exposed to the risk of Madoff’s continuing to perform well. The London office also filed an SAR with the British authorities regarding the purported consistency of Madoff’s performance. The one thing it didn’t do, however, was notify JPM’s New York office of its concerns, and so no SAR was filed in the US. When Madoff Securities collapsed shortly thereafter, London’s timely redemptions saved JPM over $200 million.
By August 2008, the balance in Madoff’s accounts at JPM was $5.6 billion. Over the next four months, Madoff withdrew virtually all of it so that only $234 million was left in his accounts at the time of his arrest on December 11, 2008. Most of the withdrawals were transferred to the feeder funds in which JPM had earlier invested, including about $288 million that JPM itself got for its redemptions. Once again, JPM filed no SAR with Treasury on Madoff’s whirlwind withdrawals from his accounts.
Coup de Grâce
More than three months after Bernie was arrested, JPM’s computer system still generated its routine annual compliance certification on Madoff. This must have been the final straw for JPM legally since it showed how dysfunctional its money laundering controls actually were. Concerns arising in one area of the bank simply didn’t make it to compliance or get escalated. Preet Bharara, the US attorney who managed the case against JPM, summed it up this way: “JPMorgan connected the dots when it mattered to its own profit but was not so diligent otherwise.”
Preet Bharara, the US attorney who managed the case against JPM, summed it up this way: “JPMorgan connected the dots when it mattered to its own profit but was not so diligent otherwise.”
It’s also been brought out that JPM missed a May 2001 article in Barron’s that questioned Madoff’s reported results. The article speculated that Madoff’s consistently successful returns may have been attributable to front-running his brokerage clients rather than a Ponzi scheme. Diana Henriques, author of a book about Bernie called The Wizard of Lies, says that suspicion of front-running was Madoff’s greatest asset. Apparently, whenever Madoff Securities was investigated by regulators, the focus was on front-running, which of course was never found because Bernie never actually traded for his clients.
One other thing about Bernie that should have been a ‘red flag’ for JPM was that he didn’t even allow his principal bankers to do due diligence on his trading activity or custody of assets. In 2007, JPM was nevertheless asked to increase JPM’s proprietary investment in the feeder funds from around $100 million to $1.3 billion. “We don’t do $1 [billion] trust me deals,” wrote JPM’s chief risk officer in New York at the time, who thereupon increased the Madoff credit line to only $250 million. Little did he suspect the possibility of last week’s ten-tuple settlement.
1 The Bank Secrecy Act (1970) requires financial institutions to keep records of cash transfers exceeding $10,000 and to report to the Treasury any suspicious transactions that might signify money laundering, tax evasion or other criminal activity.
2 Tellingly, the second bank’s SAR in 1996 did not lead to the dismantling of Madoff’s house of cards.
3 Levy’s estate was subsequently sued by the Madoff bankruptcy trustee and settled for $220 million.