Banks have been at the forefront of the financial system for as long

as they have existed and have captured the attention of

stakeholders on both controversial grounds as well as being
undisputed with regards to the many helpful services they provide.
JP Morgan & Chase is one such bank, surrounded by hostile news
articles and excessive scrutiny but rightfully so as it has of recent
been the topic of much controversy as turning a blind eye to the
moral codes established by the Securities and Exchange
Commission (SEC) and assisting Ponzi Scheme masterminds in
swindling unsuspecting investors.

On January 7th, 2014, JP Morgan was accused of assisting its high

profile client of two decades, Bernard Madoff, a mastermind ponzi
schemer in executing his goal of duping investors into parting with
their savings worth a whopping $17.3billion of which included
pension funds that belonged to JPM shareholders. The bank was
fined a penalty of close to $2billion stemming from two felony
violations of the Bank Secrecy Act, which is a federal law that
requires banks to alert authorities to suspicious activity. The bank
was further required to pay $543million in resolving private claims
over losses tied to the scheme. A reported $9.5billion has been
recovered whilst almost $4.9billion has been returned to investors. It
can be agreed that this by far does not compensate for the losses
the investors incurred. The Justice Department and Comptrollers
office is adamant that the JPM case is over and agree that further
action will be warranted.

JP Morgan (JPM) however, faced a similar lawsuit in 2008 that

accused the bank of assisting another ponzi scheme perpetrated by
William Wise, who managed to defraud his customers sums of
money worth between $68-$200millon, was dismissed on the
grounds that JPM was not liable for fraud committed as they had
only acquired Wise as a client subsequent to buying Washington
Mutual Bank. Currently JPM is facing a fresh lawsuit after new
documents have been uncovered that include an investigative
report that was filed on October 8th, 2008 which showed that the
bank was aware of the fraudulent activities that were taking place
following the purchase of Washington Mutual Bank. JPM did not take
the step of alerting the relevant authorities as was the case with the
Madoff Ponzi scheme, thus again turning a blind eye to wrong doing.

The question at hand would be why JP Morgan officials decided to

remain tight lipped about the irregular activities that were taking
place. Upon further probing it was apparent that JPM was not new to
scandal. Of recent the bank was ordered to pay $15.7billion in
resolving its selling of questionable mortgage bonds as well as
energy trading that led to the financial crisis. This thus highlights
the greed that JP Morgan officials have which brings to light the
moral hazard problem that exists within the corporate structure of
the bank. Moral Hazard is defined as a situation in which one party
gets involved in a risky event knowing that it is protected against
the risk and the other party will incur the cost (The Economic Times,
2014) . In this case Moral Hazard led to Conflict of Interest in which
one party in a financial contract had incentives to act in its own
interest rather than the interests of the other party (Mishkin &
Eakins, 2012).

In this instance JPM officials had the incentive to act in their own
interest by not alerting the Securities and Exchange Commission
(SEC) on the irregular activities regarding the ponzi schemes that
were taking place. The Compliance Manager at JPM testified to have
known of William Wises Washington Mutual Bank account but failed
to disclose this to SEC. During his court trial Bernard Madoff stated
that JPM officials from predecessor companies repeatedly confronted
him over irregularities in his business but turned a blind eye upon
being faced with the prospects of shutting down his accounts and
losing lucrative profits. Those that wanted to remain coy about their
knowledge stuck to their guns of having not been cautious to the
warning signs and the money laundering activities.

At face value one would conclude that JPM officials did so because
they had gains from such inaction. It was discovered that the
current Chief Executive Officer (CEO), Jamie Dimon and twelve other
current and former executives and directors knew about the Bernard
Madoff ponzi scheme but failed to disclose this information. As
Board of Directors and Executives it was within their primary job
description to maximize the profits of the company thereby reaping
higher returns for their shareholders. So one might assume their
inaction was for the benefit of shareholders and much to the
detriment of the unfortunate Madoff victims.

To combat this assumption it turns out large amounts of money of

the value of $300million was invested in Bernard Madoff accounts in
the form of pension funds. Some officials knew that the unscathed
performance of Madoff securities were too good to be true as their
prices consistently climbed up in spite the financial crisis. However,
still they pawned its own shareholders funds with the hopes of
jumping on the same band wagon as Madoff and reaping further
profits. Another angle at probing the case was that the CEO,
directors as well as executives were only looking out for themselves.
Evidently they had direct benefits in the form of handsome
compensation packages for retaining high profile clients such as
Madoff and Wise which endorses the moral hazard problem.

In addition to these assumptions one may also pay close scrutiny to

the moral hazard problem in terms of the bank being too big to fail.
JPM was knowledgeable that it was Washingtons biggest bank and
one of the few largest banks in United States of America and
therefore could warrant a bailout from the government in instances
where large amounts of money was lost. This therefore encouraged
JPM to take in risky endeavors of continuing to do launder money
knowing it would not pay for the dire consequences it would face.
Rightfully so as JPM was seemingly pardoned by having settled with
a Deferred Prosecution Agreement that allowed them to pay sums of
$2billion as well as not have upper management implicated. One of
the prosecutors in the JPM case stated that the bank only got
involved in Madoffs wrongdoings when its profits were in jeopardy
but failed to fulfill its legal obligation of reporting to relevant
authorities. This demonstrates just how calculating JPM officials were
in the practicing the moral hazard problem.

Whichever way one looks at it JPM is clearly a haven for bad

potatoes that continuously spoil the broth with their unethical
codes. Such controversy often times leads to a drop in demand for a
banks share price and so was the case with JPM as investors lost
confidence in the profitability and sustainability of the company they
invested in illustrated by the slight drop in share price. They also do
not trust that executives or directors will act in their best interest as
they entangle them in risky endeavors. Currently JPM still manages
to generate substantial profits but the future looks bleak if

revolutionary changes do not take place. Of late, investors have

become very sensitive to investing in companies that have the
same beliefs and take part in philanthropic activities so it would be
wise for JPM to reform and cater to investors needs.

In order to reform JPM would need to tighten its moral codes and
corporate culture to encourage good corporate governance within
the organization. Telephone conversations between customer and
banker should be recorded for ease of audit trails in order that
involved employees may be implicated. As is common practice the
company as an entity is usually sued and is liable to pay for any
lawsuits, this however disadvantages shareholders as their funds
are at risk. It would be fair to implicate involved employees directors
and management. Another reform would be to do a thorough
background check before accepting prospective clients as well as
alerting authorities when irregular activities are discovered to be
taking place. In the case of Madoff and Wises defrauding it would
be fair to have the SEC and Justice Department order that the bank
be liquidated to pay off the sums lost by their victims but this would
not seem practical as closing of a bank as large as JPM would affect
the financial system and economy of the country. JPM would also
benefit from encouraging anonymous whistle blowing and
employing individuals with a high ethical background by conducting
psychometric tests and other tests that may increase the chances of
proper employment. One can learn that it is upon individuals to do
the right thing rather than cave into the culture of remaining tight
lipped when unlawful activities are taking place as well as that the
financial system and industry still has a long way to go in terms of
ethical crimes committed by those instated to look out for the
stakeholders involved. It remains to be seen whether JPM will reform
its way of conducting business in order to stop its moral hazard
problem but with tightening of government regulations the bank will
either cave into pressures of changing its corporate culture or face
liquidation if it continues to dance around the law.

Bibliography

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Retrieved from www.bloomberg.com:
http://www.bloomberg.com/news/2014-01-07/jpmorgan-to-pay-1-7billion-to-madoff-fraud-victims-u-s-says.html

Matthews, C. (2014, March 14). CNN Money. Retrieved from

money.cnn.com:
http://finance.fortune.cnn.com/2014/03/14/jpmorgan-ponzi-schemesuit/?iid=obnetwork

Mishkin, F. S., & Eakins, S. G. (2012). Overview of the Financial

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Stempel, J. (2014, February 20). Thomson Reuters. Retrieved from

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The Economic Times. (2014). Retrieved from

www.economictimes.indiatimes.com:
http://economictimes.indiatimes.com/definition/moral-hazard
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