JPMorgan: MF Global-like Segregation of Client Funds

Josh Rosner (@JoshRosner) is co-author of the New York Times Bestseller “Reckless Endangerment” and Managing Director at independent research consultancy Graham Fisher & Co. He advises regulators, policy-makers and institutional investors on banking and financial services (a more complete bio appears at the end of this column).

This is part 5 of 5; Yesterday evening, we published the Introduction. We will be releasing a different part each evening and morning culminating in the release of Rosner’s complete report on Friday morning. On that date, the Senate Permanent Subcommittee on Investigations will release their final report on JPM’s CIO Group (aka the London Whale).

Prior installments are here: Intro, part 2 part 3, and part 4.

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Segregation of Client Funds

JPMorgan’s handling of customer monies should be another cause for concern.  The Company’s executives and its Board have repeatedly failed to address ongoing problems and have exposed shareholders to the costs associated with repeated fines. The problems appear only to come to light only after being discovered as a result of customer problems but, once discovered the Firm is routinely permitted, without admitting wrongdoing, to make an offer for civil settlement. These offers are accepted on the expectation that internal control violations will be remedied and, as a result, matters that might otherwise have potentially led to criminal charges are settled for fines.

On September 9, 2009, the CFTC sanctioned JPMorgan for failing to properly segregate customer funds and for failing to report these “under-segregations” on a timely basis[i]. The CFTC accepted JPMorgan’s offer of settlement without requiring the Company to either admit or deny wrongdoing, as a result the firm was able to avoid an administrative proceeding that could have uncovered more regulatory and legal violations. This matter relates to activities that occurred between May and June 2007 but it is unknown if this was the entirety of the period of violations or if it was only the period the regulator chose to identify. According to the CFTC, JPM failed to segregate $725 million of its own money from a $9.6 billion account. The CFTC cited numerous violations resulting from “under segregation”, ”untimely computation of segregation”, “untimely notification of under segregation” and “failures to supervise”. The Company was allowed to settle for $300,000.

In June 2010, in demonstration that the failures to segregated funds that the CFTC had settled were not isolated occurrences, the British Financial Services Authority fined JPMorgan a record 33.32 million British pounds for failing to “adequately protect between $1.9 billion and $23 billion of client money between November 2002 and July 2009.”[ii] In this instance, the FSA determined that the error remained undetected for nearly seven years”.

On April 4, 2012, JPM was again found, by the CFTC, to be in violation of segregation rules. Once again, to avoid administrative proceedings in the face of findings of violations of law, the Company made an offer of settlement that the CFTC accepted without requiring the Company to admit or deny wrongdoing. The Company was fined $20 million in civil money penalties and, once again, directed to remedy control problems[iii]. As in prior instances the firm’s internal controls were inadequate and failed to discover these violations before a problem arose.

The CFTC found that from at least November 2006 though September 2008, JPM accepted deposits of customer funds from Lehman Brothers, Inc. In violation of law JPMorgan extended credit to Lehman Brothers for 22 months based on these customer funds because JPM determined, wrongfully, those funds were to be included in Lehman Brothers net free equity. After the bankruptcy of Lehman Brothers, again in violation of law, JPMorgan refused repeated requests by the Trustee and the Commission to release those Lehman customer funds to the Trustee of Lehman’s estate.

While there have been no findings against JPMorgan, ongoing legal wrangling by the Company seems to offer some basis to believe that similar problems in the segregation of funds may have also occurred related to the failure of Peregrine Financial[iv] and MF Global[v].