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Is J.P. Morgan A Criminal Enterprise?

Persistent Business Fraud Endemic to J.P. Morgan

JP Morgan’s actions with respect to rigging bids on Municipal Bond sales, the packaging of mortgage loans as collateralized debt obligations, its relationship with Bernie Madoff Securities, and the facilitation of Enron’s special-purpose entities, together raise questions about whether the Company is working in furtherance of a continuing criminal enterprise I am not saying JP Morgan is a criminal enterprise but its actions make it appear to be so. The legal definition assumes a person is acting through an enterprise in the furtherance of criminal activity. A person is engaged in a continuing criminal enterprise if—

(1) He violates any provision of the Racketeer Influenced and Corrupt Organizations (RICO) law, the punishment for which is a felony, and

(2) Such violation is a part of a continuing series of violations of the Law

(A) which are undertaken by such person in concert with five or more other persons with respect to whom such person occupies a position of organizer, a supervisory position, or any other position of management, and

(B) from which such person obtains substantial income or resources.

Here are the facts to back up my claim. If you are not interested in the technicalities and prefer to skip to the ethical analysis, go to the last paragraph.

1.                  Criminal fraud charges were brought in July 2011, by the US Department of Justice against 18 former employees of JP Morgan Chase -- of whom nine have pleaded guilty. JP Morgan was accused of paying to have a sneak preview of rival bids to win contracts to invest cash on behalf of local and state governments, including those of California, Texas and New Jersey. The Securities and Exchange Commission alleged that from 1997 through 2005, the bank manipulated the municipal bond market using information obtained from bidding agents about competing bids, in a practice known as "last looks." The bank was accused of using "secret arrangements" to set up certain providers to win, either through deliberately submitting losing bids or by having bidding agents obtain losing bids from competitors. The company agreed last week to pay $228m to settle claims it rigged auctions. Here's how the money from the settlement will be divided:

-- The SEC will receive $51 million to settle civil fraud charges.

-- JPMorgan will pay the IRS $50 million because its actions violated rules governing municipal bonds, which are tax-exempt.

-- The bank's main regulator, the Office of the Comptroller of the Currency (OCC), will receive $35 million.

-- The settlement with the states is worth $92 million. That includes half of the $35 million JPMorgan agreed to pay the OCC. The settlements have a face value of $228 million because $17 million is counted twice.

2.                  The municipal bond settlement comes on the heels of an agreement to a $154m payout to settle charges of misleading buyers of its mortgage investments. Leading up to the financial meltdown, JP Morgan allegedly sold complex mortgage investments just as the housing market was collapsing. These collateralized debt obligations (CDO) were sold to investors without admitting that the bonds in the deal were selected by a hedge fund, Magnetar Capital, that was positioned to profit if the deal were to fail. That meant Magnetar had every incentive to pick the worst bonds it could find. And apparently it did. JPMorgan sold $150 million worth of bonds based on the Squared CDO in the first quarter of 2007. Magnetar reportedly made as much as $600 million on the deal. Among the investment firms and their clients or investors who were wiped out are Thrivent Financial and GM's pension fund.

3.                 Even though an appellate court dismissed a Bernie Madoff investor's racketeering claim against JPMorgan Chase, the company is facing a very similar $19 billion racketeering suit brought by Irving Picard, the bankruptcy trustee for Bernard L. Madoff Investment Securities. However, the ruling in the racketeering claim appears to foreclose the only possible route to recovery through federal court for securities investors suing defendants who aid and abet a company engaged in securities fraud. The logic is that The Private Securities Litigation Reform Act (PSLRA), enacted in 1995, includes an amendment to RICO. The PSLRA's so-called RICO amendment bars investors from bringing racketeering claims against securities fraud defendants. Congress' intent was to prevent wily plaintiffs’ lawyers from suing securities defendants under RICO -- which carries the potential for triple damages -- rather than under the securities laws. Plaintiffs’ lawyers are fighting back by putting a creative spin on the strict language of the PSLRA's RICO amendment. The provision holds that "no person may rely upon any conduct that would have been actionable as fraud in the purchase or sale of securities to establish a violation of [the RICO statute]." Securities class action lawyers seized on the word "actionable" and argued that they could still pursue RICO claims against securities fraud aiders and abettors -- because the conduct of aiders and abettors is not actionable under the securities laws. In other words, a law that was supposed to preclude RICO as an avenue to recovery against securities defendants was repurposed by investors to permit claims against defendants they otherwise couldn't go after.

It appears plaintiffs’ lawyers claims might have some legs. At least two well-regarded Manhattan federal court judges green-lighted racketeering claims against alleged aiders and abettors. Judges Shira Scheindlin and Lewis Kaplan accepted the proposition that investors can sue alleged aiders and abettors for RICO because they can't otherwise sue them for securities law violations.

4.                 Back in February 2011, JPMorgan Chase was sued by Allstate insurance company for fraud, claiming the bank knowingly sold a poor-quality product. In the lawsuit, the insurance company accuses the bank of knowing that the bundles of loans it was selling that kicked off the financial meltdown of 2008 were very likely to go bad. The suit joins a host of similar accusations from insurance companies and investors, who suffered losses when securities that were sold as high-quality instead turned sour. Allstate is claiming that JPMorgan and the banks it now owns fraudulently sold it more than $750 million of such mortgage-backed securities. In another lawsuit, recently unsealed, Ambac insurance company has accused Bear Stearns (now owned by JPMorgan) not only of knowing the loans it was selling were toxic, but also of accepting payments from mortgage companies to compensate for those loans.

5.                 J.P. Morgan also was implicated in the Enron fraud uncovered in early 2000. The SEC charged that the company aided and abetted Enron’s manipulation of its reported financial results through a series of complex structured-finance transactions, called "prepays," over a period of several years preceding Enron's bankruptcy. According to the Complaint, in December 1992, JP Morgan created and controlled an energy trading business set up as a special-purpose-entity, Mahonia Ltd. Mahonia operated out of the Channel Islands in the UK. Sixty percent of its transactions were made with Enron. These transactions were originally made by Enron in an attempt to defer taxes, but as the company's debt increased, and the energy industry continued to experience losses, the transactions became a means to finance its operations. Enron would sell Mahonia Ltd. a specified amount of gas and oil to be delivered incrementally, over a specified period of time. Enron would record the "pre-paid" purchases by customers as sales on its current ledger, although it hadn't actually delivered any product. This allowed Enron to record the sales on the company's current earning statement, and move its liability (delivering the pre-paid gas) to the following year's ledger. The company deferred taxes by acknowledging the pre-paid sales as debt, when necessary, in its tax statements.

Ethical behavior in accounting means to report financial information in an accurate and reliable manner. It requires the highest standards of integrity on the part of both the information content and, more important, the accountants and auditors who are charged with protecting the public interest. Transparency requires to record all the information an intended user (i.e., investors and creditors) has a right to know to assist their decision-making needs. The public relies on the ethics of accountants and auditors to achieve these goals. Top management, for its part, has a fiduciary responsibility to safeguard company assets for the benefit of shareholders in line with its obligation to act in good faith and with due diligence. To say that the ethical systems failed in the JP Morgan case is an understatement.

Blog by Steven Mintz, aka Ethics Sage, July 12, 2011