Italian Banking Scandal Has Landed JPMorgan a New Legal Fight

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Monte dei Paschi di Siena — Italy’s third-largest and oldest bank —  was forced to ask for an 3.9 billion euros ($5.128 billion) in taxpayer bailout in January, and with its finances under government scrutiny, regulators became aware that the bank’s previous management carried out a string of loss-making derivative contracts and allegedly colluded to misrepresent its finances.

That discovery resulted in a large investigation in which regulators closely examined instances in which Monte dei Paschi needed to obtain regulatory approval for financial transactions — such as its acquisition of Banca Antonveneta, which was completed in May 2008. The wide probe has even swept JPMorgan Chase (NYSE:JPM) under its lens.

When Monte dei Paschi was preparing to acquire its smaller rival, Banca Antonveneta, from Spain’s Banco Santander (NYSE:SAN), Siena prosecutors alleged that an unidentified employee of JPMorgan Securities, a unit of the New York-based bank, withheld information about the deal’s financing from regulators, according to a July 30 filing obtained by Bloomberg.

In particular, the document claims that securities firms received an “indemnity letter” meant to protect the bank from potential losses related to the 1 billion euro ($1.3 billion) hybrid financial instrument known as Fresh, which was partly used to fund the purchase of Antonveneta.

The financial instruments in question were notes that could be converted to shares of Monte dei Paschi. As part of its role, JPMorgan arranged for these notes to be sold to a number of investors, and the proceeds were used to finance the deal. Not only did the U.S. bank fail to oversee its employees properly, the Siena prosecutors say, but the lender benefited from the alleged crime by earning commissions.

Under Italy’s 231 law, a company can be held responsible if it is found to have failed to prevent a crime from being committed by an employee that benefited the company, according to Reuters. In court documents, Italian prosecutors alleged that the JPMorgan employee in question failed to inform the Bank of Italy about the financial instruments used to fund the deal. Prosecutors also claim the deal managed to hide the real risks faced by Monte dei Paschi — a bank already overstretched and struggling to afford the 9 billion euro acquisition of Antonveneta.

The problem with the financial instruments used is that they violated requirements mandated by the Bank of Italy, requirements that would have made Fresh more like a bond rather than an hybrid equity instrument, according to the documents.

To complete the takeover, Monte dei Paschi need to show the central bank that it had enough equity capital in place, Reuters reports. Based on inaccurate information the Bank of Italy received from Monte dei Paschi, the regulator allowed the notes to be calculated as core Tier 1 capital, which is a measure of an institution’s financial strength. Thanks to those notes, Monte dei Paschi was able to demonstrate that its finances were strong enough to absorb Antonveneta.

The court document claims that the alleged crime was committed “in the interest and to the benefit of JPMorgan,” according to Reuters. But so far, JPMorgan has denied any wrongdoing. “We believe that JPMorgan and its employees acted correctly at all times,” the bank said in a statement emailed to the publication. “No claim was ever made under this indemnity…either for the benefit of JP Morgan or any of its employees.”

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