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Thursday, December 12, 2013

What's another billion (or two) between friends?

If Jamie Dimon's intention was to make 2013 the Year of Settling and Paying, then he's doing a fabulous job.  On the heels of a $13 billion dollar settlement relating to mortgage backed securities (including conduct engaged in by Bear Stearns and Washington Mutual employees), Dimon seems poised to agree to either a $1 or $2 Billion Deferred Prosecution Agreement (DPA) with the Department of Justice. (Is it me or is this starting to sound like Monopoly money?)

The agreement - and massive (can you still say that about a mere 1-2 billion?) penalty stem from the bank's alleged failure to alert American authorities regarding its employee's concerns that Bernard Madoff's investment advisory business was ... sending off "Oz-like signals."   Why would the bank fail to pass along these concerns?  Possibly because Madoff reportedly had done business with JP Morgan for two decades.  (Then again, so have I, if you count my hum-drum bank account).  Or perhaps the employee's concerns were discounted, or ignored, or forgotten.  There are lots of possibilities; perhaps we will learn what happened when the government and the bank announce their settlement agreement.  Or not. 

Under the Bank Secrecy Act, institutions such as JP Morgan must file "SAR's" or suspicious activity reports whenever they suspect a customer's account is being used to further criminal activity or includes funds obtained through criminal activity.  Had JP Morgan filed a SAR when it first suspected Madoff's "oz-like" returns, the SAR would have been received by the Financial Crimes Enforcement Network (FINCEN), which is an investigatory arm of the Department of Treasury.  In FINCEN's hands, the case that languished at the SEC might have been better developed by some of FINCEN's investigators. In other words, Madoff's scheme might have been caught and fewer people would have been hurt.     

Regardless of the actual penalty, some observers will surely lament the bank's avoidance of a corporate-wide criminal indictment, particularly if no individual prosecutions emerge from the government's investigation.

I'll leave my thoughts about the DPA process, which I have criticized elsewhere, for a separate post. However one might feel about DPA's and corporate criminal indictments in general, it may be, as Greg Gilchrist nicely suggests in this recent essay, that banks present a special case, warranting a regulatory response that implies "punishment" but is nevertheless based in civil and not criminal liability.  I have already voiced my own concerns regarding society's relative preference for punishment over regulation, but Gilchrist responds that at least in the banking context, we are far from the tipping point.  I don't know yet whether I agree with Greg's interesting paper, but I do know that by the end of this year, JP Morgan will have shelled out an awful lot of money in connection with a bevy of criminal and civil investigations.  If this hasn't already inspired a major change in practices (and the bank claims it has), Jamie Dimon isn't doing his job.  

Posted by Miriam Baer on December 12, 2013 at 05:13 PM | Permalink

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Hi Miriam,

Please excuse the long post. I thought another interesting aspect of the $1-$2 billion deal, according to the New York Times, is that the government will use a "sizable portion" of the money to compensate victims, even though a separate bankruptcy proceeding already exists to do the same. (http://dealbook.nytimes.com/2013/12/11/criminal-action-is-expected-for-jpmorgan-in-madoff-case/). While this form of victim compensation is increasingly common in these large deals, extremely little guidance exists for prosecutors to determine which "victims" receive restitution, or how, if at all, both overlapping proceedings should be coordinated.

By way of background, two separate "funds" exist to compensate Madoff's victims--one rooted in a civil process of bankruptcy, the other rooted in criminal law. The first fund, "The Madoff Recovery Initiative," is headed by Irving Picard, the court-appointed bankruptcy (technically, he is a "SIPA" Trustee), who, to date, has collected over $9.5 billion and paid out almost $5 billion. The second is a $2.2 billion criminal restitution fund managed by Richard Breeden, a former SEC chairman, who recently oversaw the distribution a criminal restitution fund for approximately 8,500 Adelphia victims. The use of parallel private and government proceedings to compensate large groups of people from the same set of wrongdoers has become increasingly common -- in cases ranging from state attorney general suits and SEC/FTC actions to criminal cases. (For those interested, I talk about these trends in Adam S. Zimmerman & David M. Jaros, The Criminal Class Action, 159 U. Pa. L. Rev. 1385 (2011); Adam S. Zimmerman, Distributing Justice, 86 N.Y.U. L. Rev. 500 (2011); Adam S. Zimmerman, Mass Settlement Rivals (forthcoming 2014)). But overlapping proceedings in bankruptcy and criminal law are even more complicated because, among other things: (a) the creditors entitled to receive money in a bankruptcy may be very different than the "victims" defined in criminal law; (b) the government may not be able to share information about how to locate assets or victims with the trustee in a parallel civil proceeding without jeopardizing a criminal investigation; and (c) the dueling compensation systems may produce fights over how to distribute limited assets without any formal process for handling those disputes. For one famous recent example, see In re Rothstein, 2013 WL 2494980 (11th Cir. June 12, 2013).

This is a live issue in the Madoff distribution, where Breeden now complains that many of the beneficiaries in the bankruptcy are not true "victims," but rather, include large feeder funds and sophisticated "claims traders" -- hedge funds and other strategic investors who bought the right to pursue bankruptcy claims at a discount from small investors caught up in Madoff's fraud who otherwise could not afford to wait years for a recovery. (Claims trading isn't new for financial calamities; it was also used in Enron and Lehman.) Breeden has expressly touted the benefits of his criminal restitution fund over Picard's Fund, claiming "[t]here are literally widows and orphans" who will not get "one thin dime" from the bankruptcy process, but who will from the restitution fund because criminal law can define "victim" more broadly than the claimants to a bankruptcy. http://dealbook.nytimes.com/2013/11/18/compensation-fund-set-for-feeder-fund-victims-in-madoff-scheme/.

On the other hand, criminal restitution funds like this may disrupt the more comprehensive “priority” scheme that exists in bankruptcy law. Commercial creditors, left unpaid when a criminal conspiracy collapses, are ordinarily entitled to at least a pro rata distribution on the same priority as the direct victims of a fraud. But they receive no distribution in a criminal proceeding when they are not considered "victims" under criminal law.

Few guidelines exist for whether the proceeds from JP Morgan should go to Picard's fund, Breeden's fund, or both. In many recent cases, the answer actually has been "both," and the DOJ and bankruptcy trustees have been able to negotiate "coordination agreements." See Coordination Agreements in U.S. v. Marc Drier, 09-CR-85 (2009) and In re Marc Drier, 08 BR 15051 (2009) (Dec. 12, 2009); Coordination Agreements in United States v. Petters, 2010 WL 4736795 (D. Minn. Nov. 16, 2010); Coordination Agreements in Picard v. Picower (S.D.N.Y. Case No. 09-1197, Docket Nos. 25 (Dec. 17, 2010) & 43 (Jan. 13, 2011)). These agreements, which may involve courts in different jurisdictions, with different stakeholders and different legal entitlements, recognize that coordination of the parallel proceedings may better serve the victims and creditors of a criminal scheme than overlapping litigation. In the Madoff case, the bulk of the assets distributed by Picard and Breeden grew out of a landmark coordination agreement involving the estate of Jeffery Picower, a secretive investor who took more than $7 billion from his Madoff accounts over the life of the Fraud. Pursuant to the agreement, the government and Picard split the baby -- $5 billion went to the fund administered through bankruptcy, while the other $2.2 billion went to the Justice Department. But that was almost three years ago. How, if at all, to divide JP Morgan's money among these rival funds remains very unclear.

One final note. Some suggest that "claims trading" may also create new conflicts and incentives for such large settlements. A number of large financial institutions are trading in Madoff claims--which has fluctuated from a low of 30 to 77 cents on the dollar--betting on the success of Picard and the US Attorney in collecting funds from third parties, like Picower and JP Morgan. And some institutions holding those claims are also targets of Picard and the DOJ. According to Picard's lawyer, David Sheehan, the higher the trading price of Madoff's claims go, the more likely the institutions are to settle lawsuits: "They have a real financial incentive to sit down, and many of them are, talking to us about the notion of settling those claims." (http://www.cnbc.com/id/100454360).

Posted by: Adam Zimmerman | Dec 13, 2013 3:49:54 PM

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