Hefty Penalties Haven’t Sent JPMorgan Investors Running

Money

JPMorgan Chase’s (NYSE:JPM) 2013 was dominated by the federal government’s investigation of several egregious business missteps made by the bank in recent years and the subsequent punishment of the bank’s violation of federal statutes and its slack internal control system — punishments that most often came in the form of hefty fines. In total, to settle the deluge of criminal and civil charges brought by various government agencies, JPMorgan shelled out $20 billion in penalties — an amount so large it could cover the education budget of the city of New York.

That sum included a $13 million dollar payment to the Department of Justice to settle allegations that Bear Stearns and Washington Mutual sold risky mortgage securities during the housing bubble, a $4.5 billion settlement with institutional investors who suffered massive losses on those bubble-era troubled mortgage securities; and a $1.02 fine levied the Office of the Controller of the Currency, the Securities and Exchange Commission, the Federal Reserve, the U.K. Financial Conduct Authority, and the Commodities and Futures Trading Commission. The latest addition to JPMorgan’s settlement load was the $1.7 billion penalty federal prosecutors imposed on the bank on Tuesday for failing to report Bernie Madoff’s suspicious financial activities to regulators.

Twenty billion dollars in penalties is also an amount that few banks other than JPMorgan could pay out and remain financially viable. So many other banks, including Bank of America (NYSE:BAC), were weakened by the financial crisis, yet JPMorgan has become so large and powerful since 2008 that the institution can pay the government’s onerous fines and thrive. Wall Street analysts expect the bank will earn as much as $23 billion in profit in 2014, earnings far greater than any other lender. Although the bank’s stock has lost 0.27 percent of its value this year to date through Tuesday’s close, much of that loss was due to investors’ initial reactions to the Madoff settlement. As of Monday, the stock had gained 0.89 percent this year to date, and on Wednesday morning, investors were once again bidding shares of JPMorgan higher. Plus, shares advanced 35.25 percent in 2013, despite the heavy settlement load, an indication that investor are not worried about the impact the penalties will have on the company’s finances.

It is thanks to the injection of $28 billion in the bank’s legal reserves in the past four years that JPMorgan has been able to handle the $20 billion in settlement payments. After the legal expenses that have been withdrawn from the reserves through the third-quarter of 2013, analysts believe there is about $10 billion remaining, according to the New York Times. However, it is expected the bank will be able to cover any further settlements.

“The fines have been manageable in the context of the bank’s earnings capacity,” Barclays banking analyst Jason Goldberg told the Times. “It makes $25 billion in revenue per quarter and has record capital.” Plus, “JPMorgan’s shareholders may believe these billions of dollars don’t count because they see them as extraordinary expenses,” as University of Michigan Law School Professor Erik Gordon told the publication. “But they keep popping up one after another — and the bank could have done something about them.”

That is the opinion held by the federal government; the bank could have avoided many of these legal entanglements had its internal controls system been stronger. In the eyes of regulators, JPMorgan has disappointed. U.S. Attorney Preet Bharara of the Southern District of New York told reporters from the Wall Street Journal during a press conference following the settlement announcement that JPMorgan “failed miserably” as an institution in failing to warn regulators about Madoff, noting that the bank ignored warnings about the investor despite “plenty of reasons to be uniquely suspicious.” He further noted that that while individuals had played a role in the failure, penalizing the bank’s “overall systemic failure” was the proper response.

Of course, regulators can do more to improve banking ethics that levy fines; they can hold individual executives responsible, and in the case of the London Whale banking scandal, certain traders involved in the more-than-$6-billion loss on botched derivative traders were blamed for recklessly manipulating trading strategies. However, in the case of Madoff, no individuals were held accountable, a fact that shows systemic barriers exist to holding particular executives responsible for a bank’s faulty risk mismanagement controls. For example, the statement of facts released by Bharara’s office as part of the bank’s deferred prosecution agreement described how the chief risk officer of JPMorgan’s investment bank, John Hogan, permitted the institution to increase its financial exposure to Madoff’s Ponzi scheme in 2007, even though the investor made clear that he would not “authorize any further direct due diligence of Madoff Securities.”

After the settlement was made public, a JPMorgan spokesperson said, “we recognize we could have done a better job pulling together various pieces of information and concerns about Madoff from different parts of the bank over time” but “we do not believe that any J.P. Morgan Chase employee knowingly assisted Madoff’s Ponzi scheme.” The spokesperson added that the bank is “making significant efforts” to improve its practices, and “we believe the lessons we have learned will make us a stronger company.”

Many banking experts believe the problem is that banks like JPMorgan Chase are too large to effectively manage all employees. “With respect to the big banks, it is not so much a culture problem but a complexity problem,” Kurt N. Schacht of the CFA Institute, an organization that promotes ethics and standards at financial firms, told the Times. “We think these firms are so large that they are always going to be plagued by rogue operators.”

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