The Trustee’s Complaint Against JP Morgan.

The Trustee’s Complaint Against JP Morgan Chase.

February 9, 2011


A few days ago, when I was just beginning to read the Trustee’s complaint against JP Morgan Chase, I posted the fairly dramatic introduction to the complaint. Having now read the entire complaint, I would like to add a few comments.

The factual allegations of the complaint are essentially divided into three parts: facts related to JPMC’s sale of so-called “structured products” that would put investors’ monies into Madoff, facts related to the 703 account, which was the account into which and from which purported investment monies flowed, and loans made by JPMC. There were different JPMC groups and persons dealing with differing aspects, but the complaint says, and illustrates, that they were in touch with each other. Information, it seems, was not rigidly compartmentalized, but shared.

Of course, due to the heavy redaction which still exists in the complaint, especially of names, it can sometimes be a bit challenging to track what is going on or who was talking to whom, but still it all seems fairly comprehensible.

I shall not discuss the question of what was known by the developers and sellers of structured investment products, whose knowledge, if I understand the complaint, was at appropriate times passed on to JPMC people in charge of the 703 account and of loans. This knowledge was pretty much, or even entirely, of the same kinds of red flags first publicly revealed by Harry Markopolos and subsequently revealed to have been known by lots of people on Wall Street, though not to us innocent dupes. I speak here of such matters as concern, or potential concern, over the identity and competence of Madoff’s auditor, over Madoff’s refusal to be interviewed thoroughly or to permit thorough due diligence, over the fact that he self custodied and there was no way to know whether purported trades actually took place, over Madoff’s refusal to name counterparties and funds’ consequent lack of knowledge as to who their alleged counterparties were, over the fact that the business was operated at every level by members of Madoff’s family, over the lack of knowledge of how Madoff secured his results and the inability of any experts on Wall Street to “reverse engineer” those results, and over a possible connection of feeders to Colombian drug gangs.

As well as the foregoing red flags that were widely known on Wall Street, there were some other points relating to Morgan’s structured investments business. A Morgan executive was specifically told at lunch that there was a large cloud over Madoff because he was suspected of a Ponzi scheme. There also was concern because other investment schemes -- Refco and Petters -- had been exposed as Ponzi schemes, and, as has been said elsewhere, JPMC got sufficiently concerned about Madoff that it redeemed the money from its structured investments, taking a loss that would not have made sense but for its concerns. It also sought secrecy for this redemption from funds involved with its structured products -- which cannot have been a good sign; notified a British regulatory agency about its suspicions that Madoff was a fraud; and warned off its private bank customers from Madoff -- while continuing to service and make gazillions off the 703 account into which and from which we dupes were putting money and withdrawing what we thought were legitimate profits.

There equally are a raft of allegations regarding the 703 account, which started at Chemical Bank (my first checks went to Chemical), became part of Chase when Chase and Chemical merged, and became part of JPMC when Chase merged with J.P. Morgan to form JPMC. As said by Picard’s lawyer, David Sheehan, the bank -- and therefore this account -- were critical to the fraud; without them, there could not have been a Ponzi scheme. The complaint’s allegations regarding the 703 account are especially interesting to me for two reasons. One is that, as written here on June 16, 2010, JPMC and its predecessors had to know that, although the 703 account was the one used for Madoff’s purported advisory business, no monies ever went out of it to pay brokers or others for securities or options bought by Madoff, and no money ever came into it from brokers or others to pay Madoff for securities or options sold by him. As was written on June 16th:

Chase and Morgan knew, in short, or assuredly should have known, that the account showed no transactions of the kind required by the investment advisory business that the account supposedly was servicing. They thus knew or certainly should have known -- probably since at least the mid or late 1980s -- that a fraud was in progress. Indeed, since there were no monies from securities dealers or options dealers being deposited in the account, yet investors were receiving monies from it, they certainly should have known, if they did not in fact know, that the exact nature of the fraud was that it was a Ponzi scheme. How else but through the operation of a Ponzi scheme, after all, could Madoff be paying billions of dollars to investors if he was not engaging in securities transactions from which he was making money that would have come into the account?

This point is made in Picard’s complaint: I noticed it at least twice. E.g.:

Billions of dollars flawed through BLMIS’ account at JPMC, the so-called ‘703 Account,’ but virtually none of it was used to buy or sell securities as it should have been had BLMIS been legitimate.” Para. 2.

* * * *

JPMC was aware that BLMIS was operating at least two businesses: a market making business and the IA Business. But the activity in the 703 Account did not match up with either of these enterprises. Para. 219.

If JPMC had believed Madoff was using the 703 Account for market making, the bank would have likely seen regular transactions with other brokerage firms with which BLMIS was trading. If Madoff had been using the 703 Account for the IA Business, JPMC would have seen billions of dollars leaving the 703 Account and going to purchase stocks and equities, and corresponding multi-billion dollar inflows as BLMIS sold those securities. In the interim, JPMC should have seen tens of billions of dollars -- nearly all of the IA Business’s assets under management -- moved into T-bills, as that was part of BLMIS’s purported investment strategy. Para. 220.

Instead, what JPMC saw was massive outflows of money that were in no way linked to customer accounts or stock and options trading. Money would come into the 703 Account as customers invested additional funds with BLMIS. An overwhelming majority of funds would then go directly back out to customers in the form of redemptions. Any balance that remained in the 703 Account was invested in short-term securities such as overnight sweeps, commercial paper, and certificates of deposit. Para. 221.

The complaint also cites a host of other reasons why, because of the 703 Account, JPMC (and its banking predecessors) should have known that Madoff was operating a fraud. Several of these other reasons shall be mentioned below, and one might even say the Trustee has an embarrassment of riches on this score. But to me, the lack of payments into or out of the account from brokers and others for Madoff to buy and/or receive payment for securities and options is the absolute and unmistakable key. Because of this, JPMC and its predecessors had to know, and certainly should have known, that something was very wrong.

The other reason why the allegations regarding the 703 Account are particularly interesting to me is that to a significant extent they flesh out how a bank’s oversight of accounts works or at least is supposed to work. This is particularly germane because we dupes sent money to and received money from the 703 Account; it was the vehicle through which JPMC and its predecessor banks directly dealt with us.

Early on after the fraud was exposed I was dimly aware, both from general knowledge and from talking to a major league banker who is a graduate of MSL, that specific persons in a bank are charged with overseeing specific accounts, at least large ones. How the oversight process works within a bank is amply discussed in the complaint. And though the complaint does not detail how or whether information got to the very top of the bank -- to Jamie Dimon, for example, who is discussed extensively in Gillian Tett’s highly regarded “Fool’s Gold” -- it does show relevant processes reaching to a very high level in the bank.

Let me, then, list some of the points made in the complaint in relation to the 703 Account (allegations which incorporate material reiterated in the section on loans).

1. Banks often assign a so-called “sponsor” to an account. The sponsor has the duty of learning enough about “the client’s business to identify suspicious activity.” (Para. 190.) The sponsor for the 703 Account was a person identified only as “JPMC Employee 9,” who retired in the Spring of 2008. Here is what the complaint says regarding old number 9 (emphasis in original):

The sponsor for the 703 Account through 2008 was [redacted] [JPMC Employee 9]. When asked about his duties as a client sponsor at his Rule 2004 bankruptcy examination, [redacted] [JPMC Employee 9] responded that he did not even know what a client sponsor was, much less that he was the sponsor for BLMIS’s accounts. He had received no training regarding his duties as a client sponsor and had taken no action to discharge those duties. When shown a document in which he had recertified that he had performed his duties as a client sponsor, [redacted] [JPMC Employee9] stated that he did not have any recollection of the duties of a sponsor or of the recertification process. (Para. 191.)

192. JPMC utterly failed to “know its customer” when it came to Madoff and BLMIS. Shockingly, after decades of hosting BLMIS’s checking account, [redacted] [JPMC Employee9], the client representative who had been in charge of the 703 Account for more than ten years, admitted, “I don’t know what the checking account was used for.” He did not know whether it was used for market making activities, investment advisory services, both, or neither.

193. [Redacted] [JPMC Employee 9] did receive financial statements from BLMIS on a regular basis. These statements included FOCUS Reports. A quick review of those reports by JPMC would have revealed irregularities that required further investigation.


2. As indicated, banks have a duty to ‘“know your customer’” (KYC) -- to understand the business in which a customer is engaged, so that they can tell whether account activity is suspicious. (Para. 185.) The KYC rule is standard industry practice, existed before the Patriot Act, was reinforced by the latter, and is a common rule of regulatory bodies. Under KYC a bank must determine what the customer’s “normal business activity would look like” (Para. 189), so that it could spot suspicious activity. Many banks, including JPMC, have an entire department devoted to KYC. The problem, however, was that, though it gave lip service to the KYC rule, that is all that JPMC gave it. It did not in fact know its customer and ignored deeply suspicious matters related to the 703 Account.

3. The 703 Account did “not look like a normal broker-dealer account -- customer funds would be coming in, but those funds would not be segregated or transferred to separate sub-accounts.” (Para. 174.)

4. Both before the Patriot Act and as reinforced by it, banks are to have monitoring systems in place to detect whether there may be money laundering. JPMC had such purported systems, but they did not work even though billions of dollars were being laundered -- they did not give a warning except once, when the warning was ignored.

5. JPMC had obtained thirteen quarterly so-called FOCUS Reports (the earliest stemming from October 2001) and annual audited reports; both types of reports are filed with the SEC. Often the FOCUS Reports, and sometimes the annual reports, failed to correctly show assets and liabilities JPMC knew of, and “consistently underreported the amount of cash” held by Madoff, “a fact to which JPMC was privy by virtue of its maintenance of BLMIS’s bank accounts.” (Paras. 201-202.) In addition, the FOCUS Reports did not show any bank loans outstanding owed by BLMIS, although JPMC itself had made large loans to it. The Reports also understated the collateral on the loans, and did not include customer receivables or payables, which would have been shown in the financial reports of a broker-dealer.

6. There were also a number of activities -- some of them distinctly odd -- that should have created suspicions of illegal activity. For example, a customer identified only as Customer 1 -- who almost surely was Norman Levy if one compares what is said in the complaint with what is said at pages 14-15 of SIPC’s January 24, 2011 answers to Congressman Garrett -- received nearly $76 billion from the 703 Account between December 1998 and September 2005; in 2002 Madoff sent 318 checks to Customer 1 for precisely $986,301 each, sometimes sending multiple checks on a given day; for over two years the monthly amount of money going into the 703 Account from Customer 1 was almost always equal to the amount going out to him from it, with no clear economic purpose for repetitive transactions that “had no net impact” on Customer 1’s account; in December 2001 Customer 1 sent the account checks for, “90 million, on a daily basis – a pattern of activity with no identifiably business purpose” (Para. 231 (emphasis added)); from 1998 to 2008 “BLMIS transferred $84 billion out of the 703 Account to just four customers,” representing “over 75% of the wires and checks that flawed out of the 703 Account.” (My bet would be that three of the four were Levy, Picower, and Shapiro. Who might the fourth be?); and there was repeated “wire activity with offshore banking customers or financial secrecy havens.” (Para. 222.)

From the above you can see why I say the Trustee has almost an embarrassment of riches vis-à-vis JPMorgan Chase. To many the evidence will bring up the question -- there has already been chatter on the websites regarding it -- of why JPMC does not become the object of private suits by victims for aiding and abetting a fraud and aiding in a breach of fiduciary duty by Madoff. (The Trustee is alleging these among numerous other causes of action.) As some readers may know, a small group of us has been working on obtaining counsel to sue JPMorgan on behalf of investors, who suffered enormous damages because of Morgan’s aiding and abetting of Madoff’s fraud. We believe JPMC is liable notwithstanding a silly decision in its favor delivered long before most of the facts were known by a federal judge who appeared to be ignorant of how banking works and how it worked in this case. We have moved very slowly in seeking counsel -- far too slowly to suit me personally -- because to some extent one had to see what the Trustee came up with and what he did, so that a suit could be brought on the basis of far more knowledge than existed before the complaint against Morgan was unsealed a few days ago. Now that the Trustee’s complaint is unsealed, and what Morgan did is known to a far greater extent -- and will be known yet more after discovery -- the effort to obtain counsel should be sped up.

There will be two interrelated problems, however, problems that arise from the Trustee’s past and expectable future actions. The Trustee opposes and has obtained injunctions stopping suits against persons and institutions whom he is suing or settling with. He says that only he can represent the claims of victims against defendants. Correlatively, although he of course offers no proof or even hints as to how it will be done, he now claims he may recover $45 billion, which is enough, I gather, to pay victims amounts of money approximating the sums shown as theirs on the final statements of November 30, 2008. On these interrelated grounds (for one of which he of course offers no evidence), the Trustee will ask Judge Lifland to enjoin any suit not filed before Lifland in the Bankruptcy Court.

The Trustee will win before Lifland. He has but to file a brief, or walk into court, before Lifland and he automatically will be the winner on any significant issue (at least against any little person or little people). One has known this for awhile, but it was strongly reinforced on me when I argued before Lifland two weeks ago. I have been a member of the bar for nearly 47 years, but never before in the 47 years was I insulted and assaulted like I was two weeks ago. Lifland lived up to his at least two decades old reputation. To believe anyone can defeat the Trustee before Lifland on any important point seems to me naïve. (The only question, really, is how did the Madoff case come to be heard by Lifland -- the Chief Judge -- out of all the judges in the Bankruptcy Court. Was it purely the result of random chance -- purely the result of the random “wheel” used in federal courts?*)

So, to bring a lawsuit against JPMC in a court other than Lifland’s is to accept at the very beginning that one will have to file and win an appeal from a Lifland decision barring the case, before the case can go forward. This will take time. And whether one could file a suit against JPMC in Lifland’s court, and ride the coattails of the Trustee in that court, is something I do not know.

There are highly competent lawyers who think that victims have causes of action that cannot be “taken over,” as it were, by Lifland in the Bankruptcy Court, and that accordingly can be filed elsewhere. There is, I believe, at least one appeal pending from a Lifland decision barring a suit alleging such causes of action. A decision in that case could alleviate much of the problem under discussion if the decision is in the plaintiff’s favor, or could make the problem nearly insuperable if it is in the Trustee’s favor. There also are highly competent lawyers who believe it possible to file a suit that rides the Trustee’s coattails in the Bankruptcy Court itself. Again, I don’t know the answers here, but one does know that these are matters which will have to be thought about when considering, as we must, a suit against JPMC.



*After completing but before posting this essay, I read an article on the Wilpon/Katz case, in the New York Times of February 8th, which quoted “George Newhouse, a partner at Brown, White & Newhouse, who is a white-collar litigator who has worked on many fraud cases.” The article said:

The stakes are steep for defendants who roll the dice in bankruptcy court because of the often close relationship between the trustees charged with recovering money and the judges who appoint them, Newhouse said. Judges tend to know the relatively small number of trustees, and they assign the biggest cases like the Madoff fraud to trustees that they have become comfortable with over many years.

As a result, ‘you’ll get a fair hearing, but it will be subjectively biased in favor of the trustee,’ he said. ‘Most bankruptcy judges tend to be as pro-trustee as federal judges tend to be pro-prosecutor.’

It is, I think, unusual for a lawyer to go on the record – in a newspaper read by hundreds of thousands or millions, no less -- saying that a court system is biased. That Newhouse publicly said what he did in the Times is, to me, a measure of the problem faced before Lifland by those of us who are small innocent victims being assailed by the Trustee in Lifland’s court. That the problem of inherent bias in favor of the Trustee exists here has been known from the beginning of the case, but lawyers have not commented on it -- out of general fear and fear of making things worse, I suppose. I myself do not know what to do about the problem, or even whether there is anything that can be done. But I equally think there can be no doubt that we have a most serious problem.