“It took until after the arrest of Madoff, one of the worst crooks this office has ever seen, for J.P. Morgan to alert authorities to what the world already knew.”
George Venizelos, FBI
Financial juggernaut J.P. Morgan agreed to pay over $2.5 billion in criminal and civil penalties after it "failed miserably" in its duties by missing telltale signs that its customer, Bernard Madoff, was perpetrating a massive Ponzi schemes that would rank as the largest fraud in history. In an announcement that had been expected for several weeks, the bank agreed to a series of settlements with federal authorities, civil regulators, and the bankruptcy trustee appointed to recover funds for Madoff's victims to resolve claims it was "willfully blind" to Madoff's $65 billion fraud. In addition to forfeiting $1.7 billion and entering into a Deferred Prosecution Agreement with the Department of Justice, the bank will also pay $350 million to the Office of the Comptroller of the Currency and approximately $550 million to trustee Irving Picard.
Madoff's "Primary Banker"
Madoff shifted the majority of his banking to JP Morgan back in 1986, which involved the frequent transfers of billions of dollars through Madoff's accounts. Despite these significant transfers, virtually none of the funds were used to purchase securities. However, as Madoff's success continued, JP Morgan began to sell structured products based on Madoff feeder funds, and even became an investor. Despite the massive flow of money, virtually none of those funds were used to trade securities - an event that may have triggered obligations under the Bank Secrecy Act ("BSA") to file a suspicious activity report ("SAR") with federal regulators.
Even while JP Morgan became more and more intertwined with Madoff's business, which reaped it an estimated $500 million in fees and commissions, bank employees increasingly voiced their skepticism as to Madoff's ability to generate such consistent returns. This included concerns by JP Morgan's internal due diligence team, as well as employees. Some of these concerns, made by email internally, included:
“The Private Bank chose not to invest with any BLMIS feeder funds because it had never been able to reverse engineer how they made money”; and
"For whatever it[']s worth, I am sitting at lunch with [JPMC Employee 1] who just told me that there is a well-known cloud over the head of Madoff and that his returns are speculated to be part of a [P]onzi scheme."
While these concerns were voiced internally, no steps were taken by the bank to alert auditors until October 2008 when it submitted a "filing of suspicious activity" with the U.K. Serious Organized Crime Agency indicating it knew Madoff was "too good to be true." Indeed, authorities alleged that JP Morgan's computer system raised red flags surrounding Madoff's conduct in both 2007 and 2008. However, bank employees "closed the alerts" on both occasions. At about the same time, the bank redeemed its $276 million investment in a Madoff feeder fund, and Madoff's fraud was exposed just weeks later.
According to Irving Picard, the bankruptcy trustee appointed to oversee asset recovery efforts for Madoff victims, Madoff's use of his JP Morgan accounts to "wash" investor funds violated the bank's anti-money laundering guidelines. In addition to providing banking services to Madoff's firm, Bernard L. Madoff Investment Securities, JP Morgan also sold structured products tied to various BLMIS "feeder funds." In total, JP Morgan's profits from its relationship with Madoff were nearly $500 million.
Deferred Prosecution Agreement, No Criminal Charges for JP Morgan Employees
A key aspect of the settlement involved JP Morgan's ability to avoid pleading guilty to criminal charges, a move that would have had serious implications for the bank's national charter. Instead, authorities agreed to let the bank enter into what is known as a deferred prosecution agreement ("DPA"). Pursuant to the DPA, authorities charged the bank with two violations of the Bank Secrecy Act, but agreed that the charges would be dismissed after two years upon the bank's compliance with certain conditions. DPA's have become increasingly popular in recent years, with their use skyrocketing from 2 in 2002 to at least 35 in 2012 alone. While authorities pointed to suspicions raised by employees as an example of the bank's failure to spot Madoff's scheme, none of the bank's employees were indicted or named in the allegations.
Majority of Penalties Will Go To Madoff's Victims
Authorities announced that the entirety of the $1.7 billion in funds forfeited by JP Morgan will go into the fund established by the DOJ to return funds to Madoff victims that were obtained through criminal and civil forfeiture actions. The Madoff Victim Fund ("MVF"), overseen by former Securities and Exchange chairman Richard Breeden, had previously amassed over $2.3 billion largely as the result of the settlement of clawback charges against Madoff's largest investor, Jeffrey Picower. The addition of the $1.7 billion will bring the total amount of assets in the MVF to over $4 billion - in addition to the approximately $10 billion separately amassed by Picard.
While those holding claims approved by Picard will be eligible to apply for distributions from the MVF, so will thousands of other so-called "indirect" victims whose claims had previously been denied by Picard because their exposure to Madoff came through "feeder" funds, investment groups, and other investment vehicles.
Latest Bank to Acknowledge Deficiencies in Anti-Money Laundering Program
While JP Morgan may be the first bank to pay penalties based on providing assistance to a Ponzi scheme, the settlement is the latest in several recent settlements by other high-profile banks over deficiencies in anti-money laundering programs. This includes a $55 million fine by American Express Bank, a $1.256 billion fine by HSBC, and a $160 million fine by Wells Fargo/Wachovia.
A copy of the Deferred Prosecution Agreement is below: