An old tale tells the story about a scorpion who wanted to cross a river. Unable to swim, the scorpion asks a
frog, who was sitting on a nearby rock, if he could ferry him across the river on his back.
“I would do that for you, but how do I know you will not sting me and that I would not die?”
Perplexed, the scorpion replied: “I would not sting you since you are doing me a favor. And if I stung you, I would also drown in the middle of the river. I also consider you my friend, so I would not harm you for doing me this great favor.”
Convinced by this logic and sincerity, the frog agrees. The scorpion climbs on the frog’s back and they start across the raging river. As they approach the far bank, the scorpion lifts his long tail and stings the frog. As the frog gasps for air, he asks the scorpion why he killed him, despite all of his assurances that all would be well.
The scorpion looks the frog in the eyes and says: “It is my nature and nothing I do can change it.”
Like the scorpion, the nation’s largest investment and trading banks have it in their nature to be repeat offenders of U.S. securities regulation. Despite the fines imposed by the SEC, the same globally-known names keep getting cited by regulators for many of the same offenses.
It is a given that these banks operate with the most highly-paid and educated talent available in their compliance departments. They know the securities laws and regulations and have the best available trade tracking technology and millions in their compliance budgets.
So why does this happen? Why would a global investment bank continue to repeat the same mistakes and risk their public reputation to run afoul of federal regulators?
The reason is that violating securities laws is good business. And like the scorpion, abusing unsuspecting and less sophisticated customers, their own employees, board of directors and shareholders is profitable and penalty free at the individual level for the perpetrators of securities frauds inside of global banks.
Take the latest case against JP Morgan Chase, the nation’s largest bank with $1.7 trillion in assets (as of December 31, 2014). The firm was cited in the Bloomberg report about how it settled SEC allegations that it didn’t inform clients about numerous conflicts-of-interest about how it managed customers’ money over a half decade. The SEC fined JP Morgan a mere $300 million, a sum that accounts for a little more than 1% of the company’s annual operating profits, or about a month of profits generated from its asset-management division, Bloomberg said.
The core of the charges was conflicts-of-interest in the information Morgan provided its unsuspecting institutional and retail clients.
In its charges, according to the Bloomberg news report, “firms have an obligation to communicate all conflicts so a client can fairly judge the investment advice they are receiving,” Andrew J. Ceresney, director of the SEC Enforcement Division, said in a statement. “These JPMorgan subsidiaries failed to disclose that they preferred to invest client money in firm-managed mutual funds and hedge funds, and clients were denied all the facts to determine why investment decisions were being made by their investment advisers.”
Regarding this same case, the SEC’s co-chief of the SEC Enforcement Division’s Asset Management Unit, Julie M. Riewe, said, “In addition to proprietary product conflicts, JPMS breached its fiduciary duty to certain clients when it did not inform them that they were being invested in a more expensive share class of proprietary mutual funds, and JPMCB did not disclose that it preferred third-party-managed hedge funds that made payments to a J.P. Morgan affiliate. Clients are entitled to know whether their adviser has competing interests that might cause it to render self-interested investment advice.”
The problem here is that JPMorgan is a repeat offender.
In another instance in September 2013, the SEC said JPMorgan misstated financial results and lacked effective internal controls to detect and prevent its traders from “fraudulently overvaluing investments to conceal hundreds of millions of dollars in trading losses” in what the SEC said was a “complex portfolio.” Yet anyone who has seen a trading operation knows this is like forgetting to add sugar to a brownie mix, but somehow JPMorgan’s well-paid trading management team did not know the real value of the securities being traded.
Even worse, JPMorgan hid the extent of the problem from its own board of directors. “While grappling with how to fix its internal control breakdowns, JPMorgan’s senior management broke a cardinal rule of corporate governance and deprived its board of critical information it needed to fully assess the company’s problems and determine whether accurate and reliable information was being disclosed to investors and regulators,” George S. Canellos, co-director of the SEC’s Division of Enforcement, said.
In this instance, JP Morgan violated “a cardinal rule of corporate governance.” In the earlier example from December 2015, Morgan knew it was deceptively selling more expensive proprietary funds to unsuspecting clients, but continued to do so.
In these two cases alone, JP Morgan paid $507 million in fines, but like the Energizer Bunny, the firm got right back up and will continue to repeat these trading violations again in 2016. That’s a given since, like the scorpion, it’s in JPMorgan’s corporate culture to victimize the unsuspecting, including its own clients, shareholders and employees.
Glass-Steagall Would Improve Chances for Adopting the Fiduciary Standard
This observation also helps explain why JPMorgan and many other investment banks oppose the fiduciary standard. Creating full conflict-of-interest disclosure to the unsuspecting will devastate their bottom lines because trading is always about getting the edge on the opponent. This means large banks are in a constant adversarial relationship with their own customers. Of course it’s about the extraordinary amounts of money paid in salaries, bonuses and perks to the employees who commit the violations, but it’s also about a culture where there is no accountability for individual violations.
That why advocates for the fiduciary standard should realize that enacting a fiduciary standard will only happen if large banks are broken up.
Re-establishing Glass-Steagall (which was repealed in 1999 by Bill Clinton) would accelerate the adoption of the fiduciary standard. Maintaining the current system, which bailed out the too-big-to-fail banks, only made them less accountable to everyone except their own inner circles.
In the current 2016 presidential campaign, no Republican is in favor of re-establishing Glass-Steagall and they are joined by Democrat Hillary Clinton. However, Bernie Sanders and Martin O’Malley favor its re-introduction.
So the next time we see another big bank cited for SEC violations, we can rest assured that nothing has changed. The perpetrators will be familiar names, but there will always be new victims.