JPMorgan Weighs on Strong Banking Sector

NEW YORK (TheStreet) -- JPMorgan Chase  (JPM) was the biggest loser among mostly strong large-cap bank stocks on Tuesday, as it unveiled the latest in a string of legal settlements. The broad market was strong as investors cheered Janet Yellen's confirmation late Monday to chair the Federal Reserve after current Fed chairman Ben Bernanke's term ends at the end of January.

The Dow Jones Industrial Average and the S&P 500 seeing gains of 0.6%, while the NASDAQ Composite rose 1.0%, after Yellen's nomination by President Obama was approved by the U.S. Senate in a 56-26 vote, with 45 Democratic senators and 11 Republicans voting in Yellen's favor.

With the confirmation vote a done deal, many investors no doubt breathed a sigh of relief, as Yellen has been a very strong supporter of the extraordinary measures taken by the Federal Reserve to prop up the U.S. economy, including massive "QE3" purchases of bonds, meant to hold down long-term interest rates.  The Fed has also kept the target range for the short-term federal funds rate in a range of zero to 0.25% since late 2008.  The Federal Open Market Committee -- the Fed's policy making body -- has repeatedly said it would be unlikely to raise the federal funds rate target at least until the U.S. unemployment falls below 6.5%.  The unemployment rate during November improved to 7.0% from 7.3% in October.

Good economic news also bolstered stocks on Tuesday.  The Bureau of Economic Analysis said the U.S. trade deficit declined to $34.3 billion during November from $39.3 billion in October, beating economists' expectations. The BEA also reported that oil imports had fallen to their lowest level in three years.

Also on Tuesday, Core Logic  said U.S. home prices during November had risen 11.8% from a year earlier.

The KBW Bank Index (I:BKX) rose 0.4% to 69.96, with all but five of the 24 index components ending the trading session with gains.

Paying for Madoff

JPMorgan shares pulled back 1.1% to close at $58.36, after its main banking subsidiary JPMorgan Chase Bank, NA entered into a deferred prosecution agreement with the Department of Justice over the bank's role in the Bernard Madoff Ponzi scheme

JPMorgan's banking subsidiary consented to a two-count criminal information, through which the Justice Department charged the bank with "failure to maintain an effective anti-money laundering program... and failure to file a suspicious activity report."  The criminal information document is typical for a deferred prosecution, with the bank avoiding an indictment for its role in the Madoff affair, as long as it fully cooperates with the agreement, that runs two years.

JPMorgan agreed to pay $1.7 billion to the federal government as part of the agreement with the Justice Department, with all of the money going to Madoff's victims.  According to the court filing, the bank agreed "that it will not file a claim with the Court or otherwise contest civil forfeiture."

The bank also agreed to pay $350 million to the Office of the Comptroller of the Currency, its primary regulator, and also settled private lawsuits for $524 million, including a suit by Irving Picard, the court-appointed trustee seeking to resolve the claims of the victims of Madoff's Ponzi scheme.

The bank also agreed to cooperate fully in any criminal investigation of the Madoff affair and to continue improving its Bank Secrecy Act (BSA) and anti-money laundering (AML) compliance programs.

Madoff in 2009 was sentenced to 150 years in prison.

During an afternoon press conference on Tuesday, U.S. Attorney Preet Bharara said "the bank connected the dots when it came to its own profits, but was not so diligent about its legal obligations."  Bharara also said JPMorgan's settlement would not be tax deductible.

Bharara went through a timeline of events, describing how JPMorgan and predecessor institutions served as "the primary bank through which Madoff ran his Ponzi scheme," since 1986.

JPMorgan from early point had "plenty of reasons to be uniquely suspicious" about Madoff, Bharara said.  "Warning signs abounded," including the following:

In the mid-1990s, the bank learned that Madoff and a prominent client of JPMorgan's private bank, were engaging in what looked like round trip or check kiting transactions.  Large sums of money were being transferred back and forth between accounts for no apparent legitimate business purpose.  These transactions were sufficiently suspicious that another bank involved in those transactions filed a suspicious activity report, or SAR, and closed Madoff's account at the bank.  But JPMorgan, far from closing the account, allowed the transactions to continue for close to a decade or more, never filing a single SAR, or even notifying its own anti-money laundering compliance group.
Bharara added that "between 1986 and 2008, an astounding $150 billion went in and out of that account, and notably, none of it was used for the purpose and sale of securities, even though that was Madoff's stated business."

Numerous other examples of warning signs to JPMorgan Chase that Madoff's business was a fraud, were detailed during the press conference, as well as the bank's actions to mitigate its risk from Madoff's scheme, before it collapsed and became known to the public.

JPMorgan in an afternoon filing with the Securities and Exchange Commission said that although it was "substantially reserved for the settlements announced today," its fourth quarter net income would be lowered by $850 million, in part "as a result of the amounts of the settlement payments that are non-tax-deductible."

That's a pretty significant hit to earnings, although it pales when compared to JPMorgan's third-quarter net loss of $387 million, driven by $9.15 billion in provisions for litigation reserves.  The company's litigation reserves totaled $23 billion as of Sept. 30, more than covering JPMorgan's $17.5 billion in mortgage-related settlements with the Justice Department, other government authorities and institutional investors. 

Early on Tuesday, the bank had the following to say about its Madoff settlements:

We recognize we could have done a better job pulling together various pieces of information and concerns about Madoff from different parts of the bank over time.  We filed a Suspicious Activity Reports (SAR) in the U.K. in late October 2008, but not in the U.S.

We do not believe that any JPMorgan Chase employee knowingly assisted Madoff's Ponzi scheme.

Madoff's scheme was an unprecedented and widespread fraud that deceived thousands, including us, and caused many people to suffer substantial losses.

The Firm is making significant efforts to strengthen our BSA- AML-KYC practices across the board to be best-in-class. We believe the lessons we have learned will make us a stronger company.

The following chart shows the performance of JPMorgan Chase's stock over the past 12 months, against the KBW Bank Index and the S&P 500:

JPM Chart
JPM data by YCharts

-- Written by Philip van Doorn in Jupiter, Fla.

>Contact by Email.

Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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