Know your customer, or else
January 11, 2014
by T.E. | NEW YORK“JPMORGAN as an institution failed and failed miserably,” said Preet Bharara, New York’s federal attorney, when explaining earlier this week a $1.7 billion settlement in the case of the bank’s failure to detect horrendous fraud of Bernard Madoff (pictured). A more intellectually honest announcement might have included indignation about the various government enforcement agencies which were explicitly and repeatedly warned of Mr Madoff’s scam by, among others, another major bank—and then utterly blew inspections without any individual or entity facing censure.
A consequence of the Madoff case will be that all banks will need to be far tougher on their clients—and not just crooks. The 40 plus pages released along with the settlement do not make for easy reading, but the government’s case is built around two components. One is the relationship of Mr Madoff with JPMorgan Chase’s investment office in London. At times it invested with Mr Madoff through “feeder” funds, but never directly. It ultimately developed concerns about how these generated returns, and alerted British authorities.
Less well known, JPMorgan’s primary relationship with Mr Madoff in America was two large checking accounts. Which raises the question whether, because of these checking accounts, JPMorgan had an obligation to alert American authorities as well?
In agreeing to the settlement, JPMorgan has said it should have—though it was not in a position to argue (the simple issuance of a criminal indictment would have been devastating, regardless of whether it succeeded in court). The government’s case rests on the notion that America’s Bank Secrecy Act requires reporting anything that could have “a high degree of usefulness in criminal, tax or regulatory investigations.”
Given the expansiveness of America’s laws, that could be almost anything. The government’s information document cites the report sent to British authorities, which says that “the investment performance achieved…appear to be too good to be true—meaning that it probably is.” If that is the standard, American regulatory agencies should be prepared for an electronic tsunami of alerts. There is, apparently, no penalty for over-reporting.
The government statement is scathing about JPMorgan’s misunderstanding of Mr Madoff’s business. Banks are required to know their customers, but to what extent? Successful investment-management firms are often secretive about their approach, and rightly so: it is, after all, their secret sauce. Most businesses are complex. Should a checking account in America mean a company must spill all, or even that a bank must know all? The Madoff settlement suggests, strongly, that the answer is yes. So say goodbye to financial privacy. The government will see all.
There could be lots of other consequences. Beyond adding armies to monitor transactions and pass them on to regulators, banks will start firing clients because they happen to do business in newly suspect categories. The reasons may not be explained. They may not even be understood by the bank employee relaying the news to the fired customer. Among them will be pursuing business activities abroad in places thought to have activities that violate American law. Or it could be because of a relationship with a politician (making a bank liable to accusations of politically-induced lending) or because of employment with a government of a country that is accused of money laundering. The Madoff settlement will be just one reason for this worrying trend, but it is an important one. The payment of a $1.7 billion for having a toxic client will mean the imposition of rules everywhere. And because they are rules, they won’t merely cover toxic clients.
For non-crooks, these will seem arbitrary. Banks will become less like an efficient coffee shop competing with new products and more like airports, with oppressive security. The Madoff settlement may not be JPMorgan’s biggest, but it will have large implications—and not just for the bank. We will all pay.