The JPMorgan Chase $2 Billion Blunder: Fraud or No Fraud?

Was fraud somehow involved in the massive headline-making trading loss at JP Morgan Chase?

June 2012

By Peter Goldmann

 

 

Was fraud somehow involved in the massive headline-making trading loss at JPMorgan Chase? Maybe. Maybe not. The Justice Department, the SEC, the CFTC and even the UK Financial Services Authority have all pounced on the $2 billion "mistake," issuing subpoenas for documents and monitoring trading activity in an effort clearly aimed at avoiding further public criticism of being asleep at the wheel. In addition, at least two class action lawsuits alleging fraud have already been filed.

 

Fraud or no fraud, the $2 billion-plus fiasco does tell us a lot about the attitudes of Wall Street's leaders four years after the calamitous financial meltdown that was to a large degree fueled by fraud — specifically, mortgage and securities fraud. By extension, the event tells fraud fighters across industries that much work still needs to be done to restore high standards of integrity and ethics – as the world's largest financial and government institutions continue to fail us in leading by example.

 

Fighting the Good Fight 

That work is now being intensified as pro-regulation forces redouble their efforts to influence government agencies to enforce the Dodd-Frank Act in the strictest possible way.

 

One high-profile leader of this movement is an organization called Better Markets, headed by attorney-turned-lobbyist, Dennis Kelleher. From a recent New York Times article: "In (Kelleher's) sound bites, the JPMorgan affair is a 'debacle.' Investment banks need to remember the 'hierarchy of guilt' for the crisis. (They are at the top.) A weak rule on swaps is an 'indefensible retreat' from tougher regulation and a 'poster child for the pernicious effect of (the financial) industry's army of lobbyists.'"

 

This comment rings eerily familiar to those made several years back by financial industry analysts and journalists about the epidemic of mortgage and securities fraud allegedly committed by Wall Street's biggest institutions in the years leading up to the housing market crash of 2008.

 

Which begs the question: "Has anything changed on Wall Street since the near-collapse of the financial system?"  The latest Chase debacle is pretty clear evidence that the answer is "no." Some analysts even go so far as to suggest that the latest Chase trading "mistake" came as close to being a fraud as a bank can come without actually committing an actionable violation.

 

Wayne State University Law School Professor Peter Henning, author of the "White-Collar Watch" blog for The New York Times, writes: "An SEC investigation (of the Chase transaction) would not focus as much on the decision to use complex derivatives or whether the bank took on too much risk, but on when (CEO James) Dimon and the bank's management knew about the losses, and what they said to investors about the problem.

 

"Federal securities laws prohibit a company from making false or misleading statements that involve material information… The question the SEC will have to ascertain is one asked in almost investigation involving corporate disclosure: 'What did you know, and when did you know it?' Therefore, the SEC will be determining when the bank's management became aware of the mounting losses, and the point at which the losses reached the level of being material so as to require public disclosure in light of the previous statements disclaiming any problems from the hedging."

 

The Bigger Problem 

The bottom line is that the government may or may not be able to build a civil fraud case against Chase for technically failing to comply with securities rules on disclosure. But even if it does, the bigger problem still remains the issue of management mindset. Or, as we in the anti-fraud community are accustomed to terming it, Tone at the Top.

 

Investors, business managers and executives, homeowners and hard working Americans building nest eggs for retirement have a right to know that what happened in 2008 — when the value of just about everything anyone owned crashed to post-Depression levels — won't happen again.

 

That is precisely what the small army of advocates including Dennis Kelleher and a few other meagerly funded outfits are trying to do. They are pressing regulators to enforce Dodd-Frank in its most stringent interpretation and pushing for other reforms that would neutralize much of the securities risk that the large Wall Street institutions appear to still thrive on.

 

Indeed, the Chase mess demonstrates that the mindset in the C-suites of Wall Street banks continues to embrace the "whatever it takes" standard of risk-taking. That is one of the key attitudes that propelled financial institutions to engage in a wide array of questionable or outright illegal activities in the sub-prime mortgage market in the early 2000s. It is also what justified the outlandish risk-taking that brought insurance giant AIG to its knees and closed the doors of other high-flying financial giants such as Lehman Brothers, Bear Stearns and Countrywide Financial.

 

Building Integrity: More Urgent Now 

The odds aren't looking good for Dennis Kelleher and his partners in the fight for more stable and customer-oriented financial markets. They are up against some formidable political players in the form of lobbyists for the financial services industry (According to CBS News, JPMorgan Chase is the largest single contributor to members of the Senate Banking Committee). 

 

This would mean that if the government can't do enough to help protect against another financial crisis, and the financial industry won't restore standards of ethics and integrity, businesses at the grassroots of the U.S. economy may need to take matters into their own hands. That means managing an organization's finances for the long haul — including the possibility of another rough patch or two.

 

But to achieve that, management will need to cultivate loyalty, dedication and commitment to ethical conduct on the part of all employees. Setting an example at the top is step one. This has been a central anti-fraud prescription for decades. But in today's climate of poor example-setters in government and finance, it is more urgent.

 

Communicating the organization's commitment to high standards of business integrity comes next, along with continuous training and communication about the organization's zero tolerance toward fraud and its willingness to reward employee for blowing the whistle.

 

Of course, a more fraud-focused approach to internal auditing wouldn't hurt, together with implementation of formal anti-fraud policies and regular monitoring of internal controls. 

 

Peter Goldmann, CFE, is president of White-Collar Crime 101 LLC/FraudAware. Contact Peter at pgoldmann@fraudaware.com.