Why JPMorgan's Regulatory Fixes May Fall Short

JPMorgan Chase (JPM) came out of the financial crisis as the most revered bank in America. It was JPMorgan Chase that the government turned to in its moment of need in the spring of 2008 to rescue Bear Stearns. That September Fortune magazine featured on its cover Chief Executive Jamie Dimon and his team — keepers of the "fortress balance sheet" — with the heading "The Survivors."

A comedown was perhaps inevitable, but by any measure it's been a precipitous one. Since 2009, regulators have cracked down on the bank over everything from derivatives sales to its mishandling of a giant trading loss to credit card debt collections.

With Jefferson County, Ala., the Securities and Exchange Commission in 2009 accused JPMorgan Chase's securities unit and two managing directors of "an unlawful payment scheme [aka, bribery] that enabled them to win business" underwriting sewer bonds. The scandal ultimately sent several public officials to prison and led to the largest municipal bankruptcy in history. The bank agreed to nearly $1.6 billion in settlements and forgone fees to dispose of the matter. It neither confirmed or denied wrongdoing. "Lucifer spells his name J.P. Morgan," is how Birmingham News columnist John Archibald summed up the episode.

Then came the London Whale trading loss. The risk management failures alone were highly embarrassing and costly. The Senate Permanent Subcommittee on Investigations concluded that within JPMorgan Chase "risk evaluation models were manipulated to downplay risk; inadequate regulatory oversight was too easily dodged or stonewalled; and derivative trading and financial results were misrepresented to investors, regulators, policymakers and the taxpaying public."

The latest word is that two former bank employees will soon be indicted for criminal wrongdoing.

Even if no criminal proceedings are forthcoming, regulators may break with precedent and require the bank to acknowledge wrongdoing as part of a settlement.

Separately, JPMorgan Chase agreed late last month to pay $410 million to settle charges that it deliberately misled public officials and rigged energy markets in California and the Midwest after the financial crisis. The bank accepted the facts in that settlement agreement without admitting or denying wrongdoing.

The past week also brought word that the bank is under federal criminal investigation for practices tied to sales of mortgage-backed bonds that the Justice Department has already concluded broke civil laws. 

With this litany of wrongdoing brewing, government officials appear to have concluded this spring that letting JPMorgan Chase carry on business as usual was no longer an option. On the same day in April, the New York Times and the Wall Street Journal reported meetings in which the Office of the Comptroller of the Currency and the Federal Reserve Bank of New York read Dimon & Co. the riot act. They reportedly told him, his fellow directors and operating committee members that regulators no longer trust the bank's management, according to the reports, which cited "people familiar with the meeting."

JPMorgan Chase's once-vaunted management team (which has seen its share of churn but kept profits at record levels) appears to have gotten the message. On the surface, at least. Bank spokesman Mark Kornblau noted late last week that in his annual letter to shareholders Dimon emphasized that the bank is committed to doing "all the work necessary to complete the needed improvements identified by our regulators." That includes messaging from senior management about the importance of putting its regulatory troubles behind it and redeploying a few hundred people to work through a backlog of legal entanglements and internal controls problems. What the revamp does not include is any change in financial incentives inside the bank.

"If you see something that doesn't seem right, you raise your hand and get it fixed," says spokesman Kornblau. "That's the ultimate incentive. It's a culture that's not accepting of transgressions in compliance and controls."

I have my doubts about how far the satisfaction of doing the right thing will go inside a giant Wall Street firm to staunch the flow of trouble. And as Dimon himself has acknowledged, JPMorgan Chase has a lot more of it on the horizon.

One emerging headache involves what appear to have been unsupported demands for payments from thousands of delinquent credit card customers. As American Banker has reported, those demands appear to have involved the robo-signing of documents that were supposed to have been carefully reviewed, as well as payment demands by the bank and third-party debt collectors based on faulty or nonexistent records.

A probe by the OCC prompted the bank to quietly cease filing lawsuits to collect consumer debts in 2011, dismiss in-house attorneys and virtually shut down a collections machine that had been bringing in hundreds of millions of dollars a year. The bank has already said that it expects the OCC to take enforcement action in the matter. California Attorney General Kamala Harris also sued JPMorgan Chase in May over alleged shortfalls in its debt collection operations.

Another, possibly far more costly issue involves JPMorgan Chase's massive asset management unit. The OCC privately warned JPMorgan Chase early last year that it had concluded the bank had wrongfully steered clients into in-house investment products.

The financial stakes for JPMorgan in this dustup are big. Asset management has been a major growth engine for the bank. Last year it brought in $9.9 billion in revenue, which the company has set a goal of increasing to $13 billion over the next three years.

The question JPMorgan Chase shareholders should be asking is whether management is doing enough to minimize the financial fallout of its regulatory and legal troubles. The bank paid more than $8.5 billion in related settlements between 2009 and 2012, representing almost 12% of the net income, Graham Fisher & Co. analyst Joshua Rosner estimated in March.

For their part, big bank managers have not spent much time fretting about regulatory troubles in the past. You can't blame them. For decades regulators have allowed them to dispense with allegations of wrongdoing by writing checks that were easily dismissed as a cost of doing business and move on without admitting anything at all.

But political winds and times change. Even if a handful of banks remain too big to fail, or indict, their subsidiaries and employees may no longer be.