Kathy Bazoian Phelps
Senior Counsel in Ponzi Scheme Litigation
and Bankruptcy Matters

Kathy is a senior business trial attorney with more than 30 years experience prosecuting and defending claims for high net worth clients involved in Ponzi scheme matters and in bankruptcy proceedings. Kathy’s practice includes recovering assets for clients in complex fraud cases under standard fee and alternative fee arrangements. She also handles SEC and CFTC whistleblower claims. Kathy also serves as a mediator in bankruptcy matters, in complex business disputes, and in matters requiring detailed knowledge about fraud or Ponzi schemes.

Kathy’s Clients in Ponzi Scheme Cases and Bankruptcy Matters
Equity Receivers
Bankruptcy Trustees
High Net Worth Investors
Debtors in Bankruptcy
Secured and Unsecured Creditors

Sunday, February 2, 2014

How to Calculate Penalties for Financial Institutions in Ponzi Scheme Cases

Posted by Kathy Bazoian Phelps

The Ponzi Scheme Blog’s JANUARY POLL asked how fines should be calculated for financial institutions engaged in wrongful conduct in Ponzi schemes. While much has been written recently about banks being “too big to jail,” they are clearly not too big to fine. But how do government agencies calculate the dollar amount of the fines they impose when a bank fails to comply with existing regulations?

Bank fines and Ponzi schemes are in the news a lot these days. And some of the dollar amounts are extraordinary. In connection with the Bernard Madoff Ponzi scheme, JP Morgan reached agreements with various governmental agencies and others to pay $2.6 billion in fines and settlements to resolve criminal and civil allegations that it failed to stop Madoff’s Ponzi scheme and that it failed to comply with the Bank Secrecy Act. In a deferred prosecution agreement, JPMorgan agreed that it ignored red flags in the Madoff banking arrangement for about 15 years. JPMorgan will pay $1.7 billion to settle the government’s charges, $350 million to the Office of the Comptroller of the Currency, $325 million to the Madoff trustee, and $218 million to settle class action claims.

So how did the Department of Justice arrive at the figure of $1.7 billion and the OCC arrive at the figure of $350 million?  What are the variables that the government considers in assessing fines and what objectives does the government hope to accomplish?
  • To punish?
  • To deter the wrongdoing institution?
  • To deter financial institutions generally?
  • To reimburse victims?
In the case of JPMorgan, is $2 billion – a number that seems exorbitant to the non-behemoth bank – sufficient to provide a specific deterrent to JPMorgan? Is that number a general deterrent to the players in the financial industry? While that number would put many banks out of business, did it even make a dent in JPMorgan’s bottom line?
The Ponzi Scheme Blog’s JANUARY POLL asked readers to vote on how to calculate fines in circumstances like these.  The choices and responses in terms of percentages were:
     a.     The percentage of the bank's profits from the scheme?    (42%)
     b.     A percentage of the bank’s annual net profits?   (7%)
     c.     An amount sufficient to pay all victim losses?   (35%)
     d.     Other (14%)
For the “Other” category, here are some of the comments received:
“I would vote for at least B. A percentage of annual profits. My history is in banks less than $2 billion in size. Even in larger institutions management should know what is going on and take action to stop these greedy practices. Everyone loves a positive bottom line and if regulators do not take appropriate actions to effect that, then nothing will change.” Rob Whitesides
“I'm in favor of B or C, with criminal prosecutions of both the institution, and complicit Bank officers.” Evan Smith
“There is an assumption here that fining is the right form of punishment for e.g. JPM and the Madoff scam. I'm not sure I fully agree with that. Yes, the amounts are absolutely large, but a fraction of earnings for a large bank like JPM. That makes them akin to just a cost of doing business! Why are there no criminal prosecutions against individuals and/or the bank, even from the Justice Department? I suspect the reasons could be (a) that a criminal prosecution against the bank could result in the bank endangering its banking license and (b) that it would provide a prima facie case for civil lawsuits. If that results in justice being done and being seen to be done, why are we protecting these banks in this way? So, now that means that large banks are not only too big to fail and too big to manage but now, also, too big to jail! JPM must be having a field-day laughing at the regulators and the Justice Department!” Nicholas Warren
“A contribution sufficient to make victims whole taking into consideration all other recoveries from other defendants plus the costs of recoveries, including the fees and costs of the trustee, legal counsel, and other professionals retained to assist in those recoveries.” Susan
The poll results reflect opinions ranging from a hurt-the-bank-financially viewpoint to a compensate-the-victims viewpoint. A look at the facts in the case of JPMorgan’s failures in the Madoff scheme reveal that neither one of those objectives was met. To assist in trying to quantify the impact of the fines in the JPMorgan case, some benchmark numbers are as follows:
  • JPMorgan’s earnings were $17.92 billion in 2013.
  • Jamie Dimon, chairman and chief executive of JPMorgan, got a 74% pay increase for 2013.
  • Most employees at JPMorgan did not get pay increases for 2013 because profits declined due to legal bills and settlements.
  • The $2 billion in fines assessed in connection with the Madoff case are about 1 week of revenue for JPMorgan.
  • The net investment losses for customers in the Madoff scheme are about $17.5 billion (and that’s not counting lost expected profits which would bring that number closer to $60 billion).
  • The balance maintained by Madoff at JPMorgan peaked at $5.6 billion in August 2008.
  • JPMorgan continued to provide banking services until Madoff’s arrest, at which time the balance in the account had fallen to $550 million.
  • The Government’s Complaint to forfeit $1.7 billion of proceeds from JPMorgan pursuant to the deferred prosecution agreement states: “The Defendant Funds [the $1.7 billion] represent proceeds of Madoff’s fraud, and constitute some of the billions of dollars that flowed through the Madoff Securities accounts at JPMC during the course of the Ponzi scheme, including from the point in October 2008 that JPMC reported to regulators in the United Kingdom that JPMC had suspicions about the legitimacy of Madoff Securities.” (emphasis added).
  • The Complaint further states that “The $1.7 billion that JPMC has agreed to forfeit to the United States pursuant to the Deferred Prosecution Agreement represents a portion of the funds leaving the Madoff Securities accounts at JPMC from October 29, 2008 (i.e., the date of JPMC’s report to SOCA) until Madoff’s arrest on December 11, 2008, and is in an amount substantially greater than the value of all funds redeemed by JPMC from the Madoff-linked feeder funds.” (emphasis added).
These facts reveal that the $2 billion in fines are not at all related to: JPMorgan’s profits; the amount of money that it handled for Madoff; the amount of losses of the victims, or any other relevant data point. Looking at these figures, one is left with the distinct feeling that the $2 billion fine may be of no consequence to JPMorgan at all. Here is what the $2 billion fines failed to do:
The fines do not compensate the victims whose money was lost on JPMorgan’s watch – this would have required about $17 billion in fines.
The fines did not have a real financial impact on JPMorgan – this would have required more than one week of revenue. How about 9 or 10 weeks of revenue, or $17 billion so the victims could be made whole?
The fines probably won’t have a general deterrent effect on other banks – any bank can absorb fines of one week’s revenues, right?
If banks are “too big to jail,” why at least can’t we hold them financially responsible in a meaningful and impactful way for their wrongful conduct?

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