With the Justice Department desperate to rehabilitate its image as a diligent prosecutor of financial fraud, securing headlines along the lines of “the largest fine against a single company in history” is a lifeline. In a tentative deal, the Department would force JPMorgan Chase to pay a $9 billion fine and commit $4 billion to mortgage relief, to settle multiple investigations into their mortgage-backed securities business. The bank stands accused of knowingly selling investors mortgage bonds backed by loans that didn’t meet quality control standards outlined in its investment materials. JPMorgan Chase wants to “pay for peace” in this deal, ending all civil litigation around mortgage-backed securities by state and federal law enforcement, though at least one criminal case would remain open.
But for the Justice Department to truly start fresh, and fulfill their mission of stopping corporate fraud and preventing it from occurring again, they will have to compel JPMorgan to admit full liability for deliberately selling rotten mortgage securities. And here, federal agencies have revealed themselves as more interested in extracting public relations value by getting banks to admit something resembling wrongdoing, rather than forcing them to confess more widespread transgressions which would increase their legal exposure. Though agencies like the Securities and Exchange Commission (SEC) have announced “get-tough” procedures on extracting admissions of wrongdoings in financial fraud settlements, in practice they serve as nothing more than insincere apologies.
Even massive fines, like in the mortgage-backed securities case, are not sufficient as deterrents against illegal corporate behavior that harms the public. JPMorgan has dedicated reserves to pay such fines, and the cash essentially comes out of the pockets of shareholders in the form of lower dividends and a reduced stock price. While corporate executives invested in their own company have a lot to lose there, so do relatively innocent holders of index funds that happen to include JPMorgan stock. Moreover, $3.5 billion of this particular cash settlement may come out of the hide of the FDIC, as part of a dispute over who owns liability for the failed bank Washington Mutual, which JPMorgan bought in 2008. And, the company gets to write off regulatory fines as a tax deduction, saving billions more. Finally, if this deal works like those drawn up by the feds in the past, the $4 billion in mortgage relief is hardly a punishment, allowing the bank to get credit for routine actions in its financial interest—modifying loans for borrowers brings in more money than foreclosing on them, for example, and donating homes they cannot sell frees them from maintenance and upkeep (JPMorgan recently donated $250 million in homes). So what looks like a debilitating $13 billion penalty is actually much lower, with no meaningful impact on future behavior.
The real exposure here for JPMorgan Chase concerns whether they will have to admit they knowingly sold mortgage securities to investors backed by shoddy loans. That’s because a damaging admission could be used as evidence in private litigation from investors worldwide, many of whom are actively suing JPMorgan and other banks. With mortgage-backed securities a multi-trillion-dollar market, this would defeat the purpose of a “pay for peace” deal, and cause many more headaches for the bank than it relieves. Outside of actually sending executives to jail, forcing serious admissions of wrongdoing in the settlements would create the best deterrent for future misconduct; if outside entities can capitalize on them and sue for damages, the crime would no longer pay.
JPMorgan Chase has conceded wrongdoing in regulatory actions recently. Earlier this month, they had to admit guilt in a $100 million settlement with the Commodity Futures Trading Commission (CFTC) and a $200 million settlement with the SEC, both over the “London Whale” trades, the bad derivatives bets that lost the bank over $6 billion and cost them over $1 billion in fines in all. The admissions are part of a new strategy by Mary Jo White, the new chairwoman of the SEC, to force companies accused of wrongdoing to declare guilt. Prior settlements allowed firms to “neither admit nor deny” the allegations that formed the complaint, turning regulatory enforcement into a mere cost of doing business. White vowed to stop using “neither admit nor deny” language in many of its enforcement actions. This has bolstered the resolve of other agencies, like the CFTC, to force their own admissions of culpability.
Unfortunately, in practice, the admissions of wrongdoing appear to be an end unto themselves, not a way to advance legal woes for misconduct. The wording in JPMorgan’s settlement with the SEC, for example, was carefully crafted to only relate to a lapse in internal risk management controls, such as a failure to ensure that public disclosures to investors were accurate. These comprise violations of federal regulations, and only the government could sue on the basis of these admissions, not outside litigants. Similarly, the JPMorgan settlement with the CFTC, which was softened through negotiations, only states that traders “acted recklessly” in making an aggressive series of trades that moved market prices. While this focuses on the actual trading practices of the bank instead of internal corporate governance practices, failing to force an admission of market manipulation, only the reckless use of “manipulative devices,” means that other participants in the market could not use the CFTC settlement to raise their own cases. JPMorgan Chase also limited the admission of reckless conduct to one trading day, February 29, 2012, with the bank neither admitting nor denying wrongdoing on subsequent trading. So a market participant would have to claim that they were in the market on February 29, and took losses that they were unable to recoup as a result of those activities. This raises the bar significantly for private lawsuits.
All of this makes the employment of admissions of wrongdoing more symbolic than legitimate. While it may be nice for Mary Jo White to say that she forced JPMorgan Chase to concede guilt, it doesn’t materially affect the bank’s legal exposure in any way. After all, the bank only had to admit to securities law violations that it already settled. The real victims of the misconduct—investors who were lied to about the stability of the bank’s trades—are out of luck. And this is not an isolated incident—Bloomberg’s Jonathan Weil noticed the use of a meaningless admission of guilt in the SEC’s settlement with hedge fund trader Philip Falcone, with language assuring that, despite the admission, Falcone retained the “right to take legal or factual positions in litigation or other legal proceedings in which the commission is not a party.”
Meanwhile, the SEC continues to use “neither admit nor deny” language in other settlements. And they’ve been credibly accused of padding their stats by targeting low-level offenders for enforcement actions, many on the final day of September in an effort to boost their total number of cases for the last fiscal year. This paints a dispiriting picture of White’s tenure, concerned more with maintaining a positive public image and following through on a “get-tough” promise, rather than actually getting tough.
So if and when the Justice Department secures this deal with JPMorgan Chase, looking at the fine print will be crucial. Will the DOJ follow the lead of the SEC and CFTC, and generate admissions of wrongdoing that look good in headlines but have no actual value? Or will they force a serious admission, aiding the multiple active lawsuits from investors in mortgage-backed securities?
Perhaps the Justice Department will fall back on their retaining the ability for criminal prosecutions to excuse a toothless admission of wrongdoing. But a criminal lawsuit out of California has apparently been set to go since late September without being filed. JPMorgan Chase CEO Jamie Dimon’s charm offensive has forestalled any damaging actions so far. To date, the only criminal prosecution of the bank over its string of misdeeds comes out of Italy, and it’s too small of a case to matter to the bank’s bottom line.
If this deal will be used by the Justice Department as a model for future cases, as reports suggest, then they must force JPMorgan Chase to explicitly state the reason they’re paying $9 billion and committing $4 billion in mortgage relief. Part of the role of regulators and law enforcement is to compel enough of a price for bad behavior to prevent it from ever happening again. Extracting unusable admissions that amount to statements of negligence only serves to try and shame the bad actors, which when it comes to Wall Street is a fairly impossible act.
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