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The “Well-Known Cloud” over JP Morgan’s Head

If living in hindsight was a reality,  there are many of us who would have taken a different path at times during the road of life.  As reported in today’s New York Times, JP Morgan Chase executives reportedly “expressed serious doubts about the legitimacy of Bernie Madoff’s investment business more than 18 months before his Ponzi scheme collapsed, but continued to do business with him.” Unfortunately now for JP Morgan, the path they chose (which encompassed a “Google search with no follow-up”) may cost them $6.4 billion in civil claims.

According to several internal bank documents unsealed yesterday in connection with the Madoff Trustee liquidation proceeding, several high-ranking JP Morgan risk management executives shared communications in 2007 about Madoff’s “Oz-like signals” which were “too difficult to ignore.”

As described in the court filings:

For whatever its worth, I am sitting at lunch with [JPMC Employee 1] who just told me that there is a well-known cloud over the head of Madoff and that his returns are speculated to be part of a [P]onzi scheme-he said if we google the guy we can see the articles for ourselves-Pls do that and let us know what you find.”

[JPMC Employee 2] warned, “you will recall that Refco was also regulated by the same crowd [SEC, NYSE, NASD] and there was noise about them for years before it was discovered to be rotten to the core. Hopefully this is not the case here but given [JPMC Employee 1’s] view, I think we owe it to ourselves to investigate further.”

Nevertheless, Equity Exotics seemed eager to receive approval, and the further research on Madoff was limited to a Google search with no follow-up. REDACTED [JPMC Employee 8] asked one of her colleagues to “please have one of the juniors look into this rumor about Madoff that [JPMC Employee 2] refers to below.”

The analyst forwarded an article about a proposed change in SEC regulations that would eliminate a loophole in the regulations governing broker-dealers. He speculated the loophole allowed broker-dealers to run “a ‘[P]onzi’ scheme of sorts.” Even though the article made no mention of Ponzi schemes and provided no suggestion as to why Madoff in particular would have had a “well-known cloud” over his head, upon information and belief, no further investigation was conducted—even after [JPMC Employee 2] cautioned, “Mr. Madoff will not allow us to conduct any due diligence on him directly and we are forced to rely on the diligence of third parties. . .

Now getting back to the earlier point of living in hindsight; we are confident that many individual investors and business executives were unfortunately blinded by Madoff’s “well-known cloud” and possibly even ignorant to the subtle red-flags he may have waived.  However, when one of the largest financial institutions in the world considers proper due diligence as “googling the guy” or last “having one of the juniors look into this rumor about Madoff”…something is seriously wrong with the avenue JP Morgan chose to vet Mr. Madoff, possibly even now negligent.

What do you think about JP Morgan’s “due diligence”?  Let us know in the comments.

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