By PETER J. HENNING
JPMorgan Chase’s woes continue to grow after its disclosure of losses from a failed hedging strategy in its corporate bond portfolio. The bank is already the subject of an inquiry by the Securities and Exchange Commission, and now the Federal Bureau of Investigation has opened a preliminary criminal investigation.
But even though the F.B.I. is looking at the issue, it does not mean a criminal prosecution is likely. Under the F.B.I.’s investigations guide, a preliminary inquiry can be started “on the basis of any ‘allegation or information’ indicative of possible criminal activity.” That is a low threshold to open up an investigation, and there is a reasonable possibility it will not advance beyond that stage.
The F.B.I.’s interest in the transactions will affect how employees of JPMorgan respond to requests for interviews from the S.E.C., which is likely to take the lead in the case. Any statement to a government official can be the basis for a prosecution under the false statement statute.
One of the most famous cases prosecuted under that provision involved Martha Stewart‘s responses to questioning by the S.E.C. regarding her stock trades. She was never charged criminally with insider trading, but she was convicted of making false statements during her interview.
The preliminary criminal investigation of JPMorgan may lead defense lawyers to counsel clients not to respond voluntarily to information requests, and to assert the Fifth Amendment privilege against self-incrimination if subpoenaed. In fact, employees may refuse to respond to any inquiries by the bank’s lawyers conducting an internal investigation out of concern that the information will be turned over to the F.B.I.
This may have the effect of slowing the government investigations as the S.E.C. and prosecutors will have to decide whether to grant immunity to potential witnesses who refuse to cooperate. The MF Global investigation involving $1.6 billion in missing customer money has been hampered after a crucial witness asserted her Fifth Amendment rights, and the same could happen with a JPMorgan employee.
The possibility of criminal charges is also likely to lead employees to request independent lawyers rather than relying on JPMorgan’s. There is a potential conflict of interest between individuals and the bank, so there is a good chance a bevy of lawyers will be called into the case – all at the bank’s expense.
As I discussed in a previous post, the S.E.C. is looking into the timing of JPMorgan’s disclosure of the loss.
An S.E.C. investigation would probably not focus as much on the decision to use complex derivatives as it would on when its chief, Jamie Dimon, and the bank’s management knew about the losses and what they said to investors. Federal securities laws prohibit a company from making false or misleading statements that involve material information.
The transactions were not the work of a rogue trader, so the investigation may also look at the bank’s internal controls and financial reports to determine whether the bank adequately disclosed the risks on its books.
If securities laws were violated, prosecutors may take up a criminal case in tandem. In such a case, the Justice Department would have to prove that the violation was “willful,” meaning that the defendant was aware the conduct was wrongful.
An interesting question is whether the F.B.I. will focus on any specific employee at JPMorgan, or just the bank. Proving an individual violated the securities law can be difficult as the employee could argue that any disclosures made were not intended to be misleading.
Prosecutors may be reluctant to pursue a criminal charge against JPMorgan because of the potential risk it would pose to the bank’s operations. Under the banking laws, a finding that a bank engaged in “unsafe or unsound practices” could result in revocation of government insurance for its deposits, which would put it out of business.
While that action is unlikely, the government will be concerned about whether pursuing a criminal case could hurt JPMorgan’s operations beyond the losses already suffered by shareholders from the drop in the share price.
The F.B.I.’s preliminary investigation may simply be a means to give the agency a hand in the case if evidence comes to light showing serious misconduct inside the bank. If nothing significant develops, then the cost of starting an investigation is minimal — except to JPMorgan.