Authors: Charles Ferguson
The banks’ Iranian sanctions violations were particularly egregious, but far from isolated. JPMorgan Chase dipped its toes into similar territory at about the same time. In 2005 and 2006
the company processed $178.5 million in clearly illegal wire transfers from Cuban nationals. US Treasury officials also caught the bank processing illegal wire transfers to Sudan. At first the bank
denied it, but after being pressed, it
produced documents confirming the transactions. Although Treasury officials called JPMorgan Chase’s behaviour
“egregious”, the case was settled for an $88.3 million fine.
21
The single most notorious money-laundering episode related to political corruption was probably Citigroup’s assistance in smuggling about $100 million out of Mexico, mostly to Switzerland,
for Raúl Salinas and his wife in the 1990s. Raúl Salinas was the brother of Carlos Salinas de Gortari, Mexico’s president from 1988 to 1994, who was notorious for large-scale
corruption. The discovery of the smuggling, together with an enormous scandal in Mexico involving money laundering and political assassinations, resulted in Raúl Salinas’s arrest for
murder in 1995. Citigroup was never prosecuted. A GAO report prepared for Senator John Glenn of Ohio made it clear that Citigroup did not follow proper procedures, but left doubt as to whether the
smuggling was systematic policy or an arrangement made solely by local executives.
22
There have been other cases involving corrupt rulers. In 2004 and 2005 Riggs Bank, one of the oldest and most traditional banks in the US, paid two fines totalling $41 million, and pled guilty
to criminal charges related to money laundering for Saudi Arabian diplomats, the astonishingly corrupt dictator of Equatorial Guinea, and former Chilean military dictator Augusto Pinochet, who
turned out to have over $10 million in secret personal assets at Riggs. The bank received a suspended sentence and continues to operate; no executives were prosecuted.
23
But these cases, while striking, were actually small compared to the money-laundering activities that US banks allegedly allowed in support of the Latin American drug trade. The biggest recent
case—and it was pretty damned big—involved Wachovia. Wachovia was the sixth-largest lender in the US when it collapsed in 2008, having lost $30 billion as a result of its highly dubious
property lending during the bubble. Shortly afterwards, it was acquired by Wells Fargo. But Wachovia had another problem too.
Over the previous three years, US federal grand juries had served
Wachovia with 6,700 subpoenas related to its role in transferring a stunning
$378 billion
, most of
it in cash, between Mexican currency exchanges and the US—without reporting any transactions for suspicious behaviour, of which there was an awful lot. In fact, since 2004 Wachovia had
ignored or suppressed multiple internal warnings about highly suspicious funds transfers and had marginalized the compliance officers issuing the warnings. For example one compliance officer, a
former Scotland Yard investigator, had found numerous, supposedly separate, Mexican transfers made at the same location and the same time, involving sequentially numbered traveller’s cheques
totalling enormous sums of money. He was instructed by his management to stop examining American transactions, and Wachovia’s managing director for compliance sent him a letter warning him
that he was “failing to perform at an acceptable standard.” He sued Wachovia, which paid him an undisclosed amount for damages—on the condition that he leave the
bank.
24
The currency exchanges were ideal laundering facilities for drug cartels receiving proceeds from their American drug distributors. Funds
processed by Wachovia and also by Bank of America between 2004 and 2007 were traced to the purchase, among other things, of a dozen large commercial jets used for smuggling dozens of tons of
cocaine.
25
Wells Fargo, as the successor/owner of Wachovia, cooperated with the investigation and agreed to pay a $160 million fine and implement a robust money-laundering detection system. Similar
settlements for similar violations were reached with Bank of America and twice with subsidiaries of American Express. Amex paid a $55 million fine when its Edge Act subsidiary, AEBI, was caught
facilitating money laundering for Colombian drug lords in cooperation with the Black Market Peso Exchange from 1999 through 2004.
26
And then there is Bernie Madoff—or rather, the banks’ treatment of him.
Jumping on Board with Bernie
BERNARD L . MADOFF,
philanthropist, reliable friend, former chairman of the Nasdaq stock exchange, and creator of one of the first electronic trading platforms, also ran
the biggest pure Ponzi scheme in history, operating it for thirty years and causing cash losses of $19.5 billion.
27
Shortly after the scheme collapsed and Madoff confessed in late 2008, evidence began to surface that for years, major commercial and investment banks had strongly suspected that Madoff was a
fraud. None of them reported their suspicions to the authorities, and several banks and bankers decided to make money from him, without, of course, risking any of their own funds. Theories about
his fraud varied. Some thought he was “front-running”, examining the orders passing through his electronic trading business and then using this information to place his own trades in
front of them. Some thought he might have access to insider information. But quite a few thought that he was running a Ponzi scheme.
Madoff claimed to be tracking the S&P 500 stock index, while using options to slightly increase returns while reducing volatility in the value of his portfolio.
But there were just a few little problems. For instance:
• When others tried to replicate Madoff’s strategy or apply it retrospectively, they found that his results could only be achieved by always buying at or near the
market’s low and always selling at or near the market’s high—which is impossible. Madoff claimed to have had negative monthly returns only five times in fifteen years of
operation. In one period in 2002 in which the S&P 500 lost 30 percent, Madoff claimed that his fund was up 6 percent. Such performance was both inconsistent with his supposed strategy and
totally unprecedented in investment fund management.
• Although Madoff’s stated strategy entailed massive trading
volumes in both shares and options, no one knew who his trading counterparties
were, nor was there ever any visible sign of his moves in and out of the market. Actually pursuing his strategy would often have required trading more options than existed in the entire
market.
• Madoff simultaneously served as the broker executing the trades, the investment adviser, and the custodian of the assets. Such an arrangement obviously lacks checks
and balances and is conducive to fraud. It is unheard of for an operation on the scale of Madoff’s, and was repeatedly noted as a danger sign. Madoff also employed his brother, niece,
nephew, and both of his sons in his business.
• His auditing firm was a little known three-person firm in a suburban roadside “strip” shopping mall. One of the three was a secretary, and one was a
semiretired CPA who lived in Florida. The firm was not professionally qualified to perform audits and did not hold itself out as an auditor.
• Account statements were typed, not electronically printed, and the firm used only paper trading tickets, both of which were inconsistent with the required volume of
trading. Investors were never given real-time or remote electronic access to their account information; they only received paper statements in the mail.
• Despite his enormous purported success, Madoff did not charge any hedge fund management fees. He claimed that he made his money simply by having his own trading
platform process all of his trades, a highly implausible claim. The real reason that he did not charge the typical 20 percent of profits was that he needed to attract new money to keep the
scheme going as long as possible.
These problems and many others—we’ll get to those in a minute—were repeatedly cited as warning signs by banks and hedge funds that either dealt with Madoff or were considering
doing so. Goldman Sachs executives paid a visit to Madoff to see if they should recommend him
to clients. A partner later recalled, “Madoff refused to let them do any
due diligence on the funds and when they asked about the firm’s investment strategy they couldn’t understand it. Goldman not only blacklisted Madoff in the asset management division but
banned its brokerage from trading with the firm too.”
28
Risk managers at Merrill Lynch, Citigroup, UBS, JPMorgan Chase’s Private Banking,
and other firms had done the same. The Merrill parent company, for example, had expressly forbidden dealings with Madoff from the 1990s.
29
They all
suspected fraud of some kind.
As a result, most of the major banks declined to invest their own money with Madoff. However, they did sometimes allow
their clients
to invest. A number of banks, including Merrill Lynch,
Citigroup, ABN Amro, and Nomura, also created various tracking funds to replicate Madoff’s returns,
7
even though all suspected fraud.
But UBS and JPMorgan Chase were even more deeply involved. UBS created a new family of “feeder funds” to send assets to Madoff. (Madoff generally did not accept direct investments,
preferring to receive money via these “feeder funds”.) Most feeder funds acted as little more than drop boxes and made few, if any, investments except into Madoff’s fund. There is
strong evidence that several of them suspected Madoff was a fraud. But Madoff paid them about 4 percent per year for doing virtually nothing, so they were happy to look the other way.
UBS created or worked with several Madoff feeder funds, even though UBS headquarters forbade investing any bank or client money in Madoff accounts. The feeder funds were required by law to
conduct due diligence, and one of them hired a due diligence specialist named
Chris Cutler. After four days, he wrote to the feeder fund: “If this were a new investment
product, not only would it simply fail to meet due diligence standards: you would likely shove it out the door. EITHER extremely sloppy errors OR serious omissions in tickets.” Cutler found,
for example, that Madoff’s claimed strategy implied trading a number of options that was far higher than the total number actually traded on the Chicago Board Options Exchange.
30
The fund proceeded with its Madoff investments anyway.
31
UBS explicitly instructed its employees to avoid Madoff. A memo to one of the feeder funds in 2005 contained a section entitled “Not To Do”. In this section was the following, in
large boldface type: “ever enter into a direct contact with Bernard Madoff!!!” One of the UBS executives involved in creating the new funds received a headquarters inquiry on what he
was doing. He replied, “Business is business. We cannot permit ourselves to lose 300 million,” referring to anticipated fund management revenues.
32
UBS proceeded to issue fund prospectuses in which it represented that it would act as custodian, manager, and administrator of the feeder funds, when
in fact they had already agreed with Madoff to play no such role. Like all Madoff sponsors, UBS received no information except paper summaries of monthly results.
JPMorgan Chase was, if anything, even more dishonest. Like Merrill Lynch and Citigroup, they set up Madoff tracking funds despite explicit warnings from an executive in JPMorgan Chase’s
Private Bank unit that he “never had been able to reverse engineer how [Madoff ] made money.”
33
But JPMorgan Chase had even more evidence,
because they served as Madoff’s primary banker for more than twenty years.
8
Anyone with access to those accounts would know that something was
seriously wrong. For example:
• An investment company with thousands of individual customers should have credited incoming funds to segregated customer accounts or
directed them into multiple other subaccounts. Instead whatever came in was more or less tossed into a single pot.
• Know Your Customer (KYC) rules for business accounts were greatly strengthened after 9/11, and JPMorgan Chase insisted it took its KYC obligations very
seriously. A KYC department was attached to every line of business. But the identified KYC “sponsor” on the Madoff account, when interviewed by the Madoff bankruptcy trustee, was
unaware that he had been so designated and did not know what the job entailed.
• JPMorgan Chase received copies of the mandatory financial filings that Madoff made with the SEC. They were usually wrong, often wildly so. One
statement listed $5 million in bank cash accounts, when the actual amount at JPMorgan Chase was $295 million. Another listed no outstanding bank loans, when
there was a $95 million loan outstanding. For years, the statements showed no trading commission revenue, even though they were supposed to be the primary source of Madoff’s income (he
did not charge management or incentive fees). Then one year, the statements suddenly showed more than $100 million in commissions, although none were in the
product categories that were supposed to dominate his strategy. Madoff’s prospectuses represented that idle cash was always invested in US Treasury bills, when JPMorgan Chase knew
it was almost all in overnight deposits.
• Money-laundering regulations are quite strict and impose obligations on banks to report suspicious activity. JPMorgan Chase has an automated alert system that
is supposed to trigger a review and report whenever a “red flag” event occurs. How about a customer who received 318 transfers of exactly $986,310 each in a single year, often
several per day? No problem, no alert.
• Several of Madoff’s biggest customers were also JPMorgan Chase Private Banking customers, so the bank could see both sides of
the
transactions. And indeed they often saw hundreds of millions of dollars washing back and forth between client accounts and Madoff, sometimes billed as loans but often with no explanation at
all. In the entire history of the Madoff accounts, the automated money-laundering system generated only a single alert, which was not followed up.