J.P. Morgan can’t seem to catch a break lately as on December 12th (yes I know I’m late), the banking giant was charged $2 billion for ignoring red flags related to Bernie Madoff’s Ponzi scheme. To understand this story, we have to go back several years.
This is Bernie Madoff, the villain behind the whole debacle. In 1960, Madoff founded Bernard L. Madoff Invesment Securities, a wealth management firm. Over the decades, he gained the reputation of being a spectacular money manager as he consistently generated highly successful returns for his investors. However, as the 2008 financial crisis loomed over the markets, it turned out that Madoff’s entire firm was a fraud, a fake, as fake as this Chinese rip off of Apple.
You see, Madoff was running something called a Ponzi scheme. A Ponzi scheme occurs when a wealth manager gathers money from a group of investors and funnels it to other investors but says that they are the returns he earned from his investing strategies. In reality, there is no fancy trading strategy. Its all just one giant loop and it relies on a continous flow of funds. If investors stop giving or demand their money back, then the scheme falls apart. But with his wit and charm, Madoff kept this scheme afloat for decades. He built relationships with the most powerful and influential figures in the business world and convinced them to invest in his fund. Eventually he also attracted funds from less wealthy individuals and even various charity organizations.
Madoff’s investors were extremely pleased with Madoff’s consistent returns. Even during the periods when the market was on the decline, Madoff’s firm generated positive returns. However, this eventually drew the attention of other investing specialists on Wall Street. Madoff’s investing strategy revolved around buying large-cap firms such as Coke and AT&T and also purchasing options in those stocks as well. Ideally, this strategy should have limited the portfolio’s volatility. Nevertheless, his portfolio should still have been correlated with the market. However, Madoff even made positive returns in times when the market was falling. In the early 2000s, several other investors brought the issue up to the Securities and Exchange Comisssion, the regulatory body that governs the financial sector. However, their pleas were to no avail.
The house of cards collapsed in 2008. As the financial crisis caused the economy to plummet, a large group of investors wanted their money back. Due to the nature of the Ponzi scheme, Madoff did not have enough money on hand and was unable to repay his investors. Eventually, he confessed to his crimes and was brought into custody by the FBI and charged with 150 years in prison.
Well what does this all have to do with J.P. Morgan then? Bernie Madoff operated his wealth management firm through J.P. Morgan. 4 years after Madoff’s imprisonment, J.P. Morgan agreed to settle for a fine of $2 billion following allegations by federal prosecutors that the the bank had ignored various red flags regarding Madoff’s operations. Madoff opreated out of J.P Morgan for roughly 15 years. I don’t know how deep bank’s usually track the activities of their clients but I just got my debit card cancelled for a possible suspicious activity when I hadn’t even used it in over 6 months. My guess is that in 15 years, a couple of hints may have dropped on a desk somewhere in the J.P. Morgan office. Of course, as I covered on this segment before, J.P. Morgan is looking to settle all its legal issues and be done with them once and for all. Thus, it is possible that they might have just accepted to settle case even though they could have pooled their resources to summon enough evidence to prove them innocent.
Its always nice to see crime pay. But its a tragedy that the crime wasn’t detected earlier. If you leave aside the millionaires and billionaires, a lot hardworking people and charities trusted their money in Madoff’s hands. Its heartbreaking to hear about their life’s savings vanish over night. If you’re interested, this 45 minute documentary regarding the scandal contains interviews with various people who had to come out of retirement and start working again at an old age because they lost their savings thanks to Madoff. Though certain regulations can be tedious and disruptive to business, I’m all in favor for regulations that makes it easier to catch any future similar cases that could hurt so many innocent people.
“In today’s regulatory environment, its virtually impossible to violate the rules”