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Many banks are joining the crowded field of companies targeting the investment savings of the so-called mass affluent.
May 10
The Office of Comptroller of the Currency warned JPMorgan Chase (JPM) early last year that the bank had wrongfully steered clients into in-house investment products, according to a person with direct knowledge of the agency's findings.
OCC examiners concluded that the bank failed to comply in late 2011 with restrictions on sales of in-house financial products and its obligations to retirement plan investors under the Employee Retirement Income Security Act, according to this person, who spoke on condition of anonymity. As a result of its findings, the OCC required JPMorgan Chase to refund fees to an unknown number of customers.
Regulators require that examination findings be kept confidential, and JPMorgan Chase declined to comment specifically on the matter. Speaking of the bank's proprietary products broadly, J.P. Morgan Asset Management spokesman Darin Oduyoye cited a joint Barron's/Lipper Fund Family Ranking that dubbed the bank's fund family the
"Our business model is to offer both J.P. Morgan and third party products," Oduyoye said in an email. "We are proud of our platform and it is why many clients come to us for advice. We think it's best to be able to offer clients a broad selection of products to prepare a balanced portfolio."
OCC officials likewise declined to discuss specific examination findings. They did, however, emphasize that ensuring banks comply with their obligations as ERISA service providers has long been a part of the agency's supervisory mandate.
If examiners find a suspected violation, "The chances are very high that the bank has also deviated from other expectations for operating in a safe and sound manner," said Joel Miller, Group Leader for the OCC's Credit & Market Risk Division. "If that is the case, the bank should expect to be criticized through the examination process or through the enforcement process if warranted."
The specific problems identified by the OCC are unlikely in themselves to pose a significant challenge to JPMorgan Chase; the Department of Labor, which is the primary overseer of ERISA, typically allows financial institutions to settle such infractions confidentially by paying restitution. However, the alleged violation touches on what could be a growing source of regulatory friction between JPMorgan Chase and federal regulators, including the OCC.
It involves the bank's push to expand its proprietary investment management business, despite mounting criticism. Financial regulators, meanwhile, appear intent on putting behind them criticism that lax oversight contributed to the financial crisis by heading off issues involving conflicts of interest before they bust into the public.
Comptroller of the Currency Thomas Curry warned last year of regulators' need for vigilance regarding the "high and increasing" risk arising from a bank's routine business functions. Under Curry, the OCC also appears to have expanded its view of its prudential role to include steering banks away from any activities that involve undue "operational risks" and might result in legal or reputational damage.
Money Management Colossus
In terms of the operational risks posed by an asset management business, JPMorgan Chase has few peers. Some banking giants, including Citigroup (NYSE:C) and Morgan Stanley (MS), deemphasized or jettisoned in-house mutual fund families altogether after getting hit with hefty fines a decade ago for wrongful sales practices.
JPMorgan Chase has tacked in the opposite direction since the financial crisis.
Assets under management in its proprietary mutual funds increased to $223 billion at the beginning of 2013 from $96 billion in 2009. Total assets under the bank's supervision, including funds, alternative assets and retirement plans have grown for 16 consecutive quarters. That included a $31 billion gain in the first quarter of 2013, which brought total client assets to $2.1 trillion.
JPMorgan executives have expressed their intention to continue expanding the business at a rapid pace. Asset management brought in $9.9 billion in revenue last year, and the company has set a goal of increasing that figure to $13 billion over the next three years.
Industry giant BlackRock, with $3.8 trillion in assets under management, is purely a money manager. At Wells Fargo (WFC), commercial banking dwarfs investment management. What sets apart JPMorgan Chase is that it conducts commercial banking, securities underwriting and money management on a scale so large and intertwined as to merit additional regulatory scrutiny under guidelines outlined in the OCC's examination handbook.
Agency officials last year termed JPMorgan Chase's money management operations a cause for ongoing concern, according to the person familiar with its warning to the bank.
ERISA Early Warning
When it comes to money management, ERISA assets are among the most legally protected--and thus the most likely to pop up on regulators' radar. Under ERISA's section 406(b), JPMorgan Chase and other retirement fund fiduciaries are legally obligated to act first and foremost in the interest of clients.
Before a fiduciary can put an ERISA client into a proprietary product, it must comply with a series of exemptions. One, known as 77-4, permits advisors to employ affiliated mutual funds only if their use is explicitly authorized by the client, free of duplicative fees and supported by an impartial analysis indicating it's in the client's best interest.
In a brokerage or other non-ERISA relationship, by contrast, money managers and advisors are required to meet less stringent "suitability" and disclosure standards for the products they recommend and sell.
Since the OCC does not oversee ERISA directly, it views it through the lens of supervising a bank's broader obligations to conduct all of its operations in ways that minimize operational risk and the likelihood of legal and reputational damage.
During examinations, "we focus on higher-risk investments," says Stephanie Boccio, an OCC technical expert for credit and market risk. Starting with operational controls, the regulator works its way through a bank's approval processes, suitability determinations and internal review and audit functions.
"What we expect of our banks is that they have a governance structure in place," says Boccio. "There needs to be a committee structure to review and approve whether a product is offered and how it's offered."
The OCC's examination handbook has long included monitoring ERISA compliance. But some observers say that its focus on the Act, and the way in which banks sell proprietary investment products, appears to be new.
"I have not heard about noncompliance with 77-4 as being a particular hot-button issue" for bank regulators, says Ira Bogner, an ERISA attorney for Proskauer Rose in New York who represents financial services industry clients.
Informed by American Banker about the OCC's action but not the identity of the bank, Bogner said the Act's scope would make it a logical entry point for regulators to probe whether a bank's asset management business involved other conflicts of interest.
"In a lot of areas of law, you can disclose a conflict and get a waiver [from clients] of any objection to the potential conflict," Bogner says. "In ERISA, you can't always do that."
Focus on JPM
In addition to the OCC, the Securities and Exchange Commission is looking into JPMorgan Chase's sales of proprietary products, according to the person familiar with the OCC's ERISA concerns and another with direct knowledge of the SEC's activities. It is unclear whether the SEC's queries will lead to formal action.
Meanwhile, several former JPMorgan Chase financial advisors have filed lawsuits or arbitration claims over the past year accusing JPMorgan Chase of improperly pressuring them to invest client assets in in-house products.
Bryant Tchan, a former broker at J.P. Morgan Securities in Irvine California, alleged in a complaint filed with the Financial Industry Regulatory Authority in May that managers pressured him and other brokers to recommend its proprietary funds. Tchan also claims that JPMorgan Chase software directs brokers to in-house products and withholds sales commissions on outside products unless brokers justify sending client money elsewhere.
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JPMorgan Chase has denied wrongdoing in these cases.
Separately, the Department of Labor is investigating JPMorgan Chase's purchase for 401(k) plan stable value funds it manages of $1.7 billion in mortgage debt that it underwrote prior to the real estate crisis, Reuters reported last July. Investors in such funds have also filed court claims against JPMorgan Chase. The banking giant has denied any ERISA-related wrongdoing.
One allegation of misdeeds in JPMorgan Chase's money management business has been resolved with findings that were highly critical of the bank. It involved a FINRA complaint brought by American Century Investment Funds against a group of JPM investment management companies.
Specifically, the plaintiff claimed that JPMorgan Chase failed to live up to an agreement to sell American Century funds and instead favored its own stable value funds. FINRA's arbitration panel ultimately awarded American Century $373 million.
The case turned on JPMorgan's contractual commitment to use Retirement Plan Services, a unit that manages 401(k) plans, to promote American Century's products on par with its own.
In its harshly worded 72-page decision, the arbitrators declared that JPMorgan Chase had consistently blurred the lines across asset management subsidiaries in ways that improperly benefited the company. The overlapping of duties extended from James E. "Jes" Staley, head of Asset Management at the time, on down. As a result, RPS was effectively turned into a sales conduit for JPMorgan Chase products.
The bank's asset management division directly supervised RPS staffers, controlled their bonuses and assigned them to projects intended to favor the company's funds over American Century's, the arbitration panel found. Pamela Popp, RPS's chief executive, described the structure during a deposition as part of a broader "matrix management" strategy.
The lines between the RPS and asset management sales were so blurred that JPMorgan Chase's own employees and attorneys failed to distinguish between them during an arbitration hearing, the FINRA panel wrote. This approach "stacked the cards" in favor of JPMorgan Chase's in-house funds, it added.
The American Century ruling involved a contractual dispute and not the question of whether JPMorgan Chase fulfilled its ERISA duties, bank spokesman Oduyoye emphasized.
"We take our fiduciary responsibility to our clients very seriously, and our reporting lines are aligned to meet that responsibility," he says.
