Warren Buffett, always good for a pithy quote, once said: “Only when the tide goes out do you discover who’s been swimming naked.”

He was talking about bear markets. High water—i.e., economic boom times—can hide unpleasant sights. We don’t notice them until the surrounding water recedes.

Bernie Madoff, for instance, had a scheme that worked really well until 2008, when some of his distressed clients tried to redeem cash that wasn’t actually there. They were swimming naked and didn’t even know it.

But it’s not always fraud. Sometimes low tide exposes simple foolishness and incompetence. That seems to be what happened at Silicon Valley Bank and Signature Bank, which failed last month after Federal Reserve rate hikes sent the tide out.

If history is any guide, more examples are coming. Today I’ll tell you about one that, quite frankly, makes everyone look bad.

Source: pxhere

A $175 Million “Mistake”

In 2021 JPMorgan Chase (JPM) paid $175 million to acquire a startup company called Frank. The founder, a young woman named Charlie Javice, had developed an online platform to help prospective college students and their families apply for financial aid.

That much is confirmed. The rest is still in dispute.

JPM says Javice claimed to have a database of more than 4 million college-age customers—an attractive audience for other bank products—that was mostly fictional. Only about 300,000 were real, says the bank.

But according to Javice’s attorney, “After JPM rushed to acquire Charlie’s rocketship business, JPM realized they couldn’t work around existing student privacy laws, committed misconduct and then tried to retrade the deal.”

JPM filed a civil suit against Javice and another Frank executive in December. This month the Justice Department issued criminal charges against Javice, claiming she defrauded JPM.

Defrauding a bank is serious. But it’s not the same as swindling widows and orphans.

JPM is a giant institution with well-paid, talented executives who should know how to evaluate acquisitions. Part of the due diligence process is verifying the asset you are acquiring (in this case, a list of customer leads) is actually real.

Evaluating risk is core to being a banker. That’s why they make loan applicants provide proof of income, etc. The fact JPM’s leaders were so easily duped should raise red flags for both shareholders and regulators.

CEO Jamie Dimon called the Frank acquisition a “huge mistake.”

To most people and businesses, $175 million is a staggering amount of money. To JPM, it’s a rounding error.

Source: Wikimedia

Felony Charges

Another reason JPMorgan Chase should have been more wary of financial fraud is because JPMorgan Chase has experience committing financial fraud.

In 2015 JPM, along with four other large banks, pled guilty to felony charges for conspiring to manipulate foreign currency prices, for which it paid a $550 million fine.

This wasn’t just a civil lawsuit. JPMorgan Chase, as an institution, admitted to criminal acts.

Under normal circumstances, felons are barred from underwriting securities offerings. That would have put JPM and the others out of business. These banks exist today only because the Securities and Exchange Commission gave them a special exemption (to which then-SEC commissioner Kara Stein vigorously objected but was outvoted). Compared to that possibility, a $550 million fine was a small penalty.

You might think JPM would have learned its lesson and avoided additional fraud. Nope.

In 2020, JPM agreed to settle more criminal charges for two different fraud schemes in the precious metals and US Treasury bond markets. This time the fine was $920 million.

So, the same bank that alleges someone duped it into losing $175 million was itself caught repeatedly duping others of much larger amounts, for which it paid almost $1.5 billion in fines.

This isn’t a partisan political thing. The 2015 case came under the Obama administration and the Trump administration prosecuted the other one.

Worse still, fraud charges like this against major banks aren’t particularly rare. They pay some fines, DOJ issues a harsh press release, then the bank goes back to business as usual. A few traders might get prosecuted. The CEO, who should establish compliance systems that prevent such things from happening, keeps their job.

Which is really weird when you think about it… because right now billions in deposits are fleeing from smaller, non-felon banks into big banks like JPMorgan Chase, which are known to have defrauded their own customers.

Depositors trust the megabanks anyway because their size makes them “too big to fail.” And if by some chance one did fail, people are sure FDIC will cover even uninsured deposits.

Those are probably good assumptions but they’re not 100%. So be careful where you bank.

See you at the top,

Patrick Watson
@PatrickW

P.S. If you like my letters, you’ll love reading Over My Shoulder with serious economic analysis from my global network, at a surprisingly affordable price. Click here to learn more.

• banks
• fdic
• fraud
• jpm