░░░ INSOLVENCY INTERFACE

Details were released today of the $US6 billion lawsuit brought in December 2010 against JPMorgan Chase (JPMC) by the Trustee for the Liquidation of Bernard L. Madoff Investment Securities LLC  (BLMIS).

The lawsuit, brought under the US Bankruptcy Code, the Securities Investor Protection Act (SIPA) and other laws, seeks to recover fees, profits and damages.  JPMorgan Chase was the primary banker of Mr. Madoff’s firm.  The Trustee further alleges that the bank aided and abetted his fraud.

The Trustee, Irving H. Picard, has sued J P Morgan Chase & Co., J P Morgan Chase Bank NA, J P Morgan Securites LLC, and J P Morgan Securities Ltd.

Many of the words, phrases and concepts contained in the Causes of Action – of which there are 21 – will be familiar to Australian insolvency practitioners.

For example, claims are made for Preference Period Initial Transfers (“a preferential transfer avoidable by the Trustee”); Two Year Initial Transfers (“a fraudulent transfer avoidable by the Trustee”);  and Six Year Initial Transfers (“made by BLMIS with the intention to hinder, delay, or defraud the creditors”). 

Also, it is alleged that “BLMIS did not receive fair consideration for the Six Year Initial Transfers. BLMIS was insolvent at the time it made each of the Six Year Initial Transfers or, in the alternative, BLMIS became insolvent as a result of each of the Six Year Initial Transfers”.

JPMorgan Chase strenuously denied the allegations, calling the suit meritless and “based on distortions of both the relevant facts and the governing law.”

“J.P. Morgan did not know about or in any way become a party to the fraud orchestrated by Bernard Madoff,” the bank said in a statement. “Madoff’s firm was not an important or significant customer in the context of J.P. Morgan’s commercial banking business.”

JPMorgan Chase says it will “defend itself vigorously against the unfounded claims brought by the trustee.”

In the Nature of the Action, the Trustee uses strong language and is severely critical of JPMC (see below). 

Full details of the lawsuit may be found at http://documents.nytimes.com/madoff-trustees-lawsuit-against-jpmorgan-chase?ref=business

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Irving H. Picard (“Trustee”), as trustee for the substantively consolidated liquidation of the business of Bernard L. Madoff Investment Securities LLC (“BLMIS”) under the Securities Investor Protection Act, 15 U.S.C. §§ 78aaa, et seq. (“SIPA”), and the estate of Bernard L. Madoff, by and through his undersigned counsel, as and for his Complaint against JPMorgan Chase & Co., JPMorgan Chase Bank, N.A., J.P. Morgan Securities LLC, and J.P. Morgan Securities Ltd. (collectively, “JPMC” or “Defendants”), states as follows:

NATURE OF THE ACTION

1.            The story has been told time and time again how Madoff duped the best and the brightest in the investment community. The Trustee’s investigation reveals a very different story—the story of financial institutions worldwide that were keen to the likely fraud, and decidedly turned a blind eye to it. While numerous financial institutions enabled Madoff’s fraud, JPMC was at the very center of that fraud, and thoroughly complicit in it.

2.            JPMC was BLMIS’s primary banker for over 20 years, and was responsible for knowing the business of its customers—in this case, a very large customer. JPMC is a sophisticated financial institution, and it was uniquely situated to see the likely fraud. Billions of dollars flowed through BLMIS’s 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. But if those large transactions that did not jibe with any legitimate business purpose triggered any warnings, they were suppressed as the drive for fees and profits became a substitute for common sense, ethics and legal obligations. It is estimated that JPMC made at least half a billion dollars in fees and profits off the backs of BLMIS’s victims, and is responsible for at least $5.4 billion in damages for its role in allowing the Ponzi scheme to continue unabated for years, with an exact amount to be determined at trial.

3.            In addition to being BLMIS’s banker, JPMC also profited from the Ponzi scheme by selling structured products related to BLMIS feeder funds to its clients. Its due diligence revealed the likelihood of fraud at BLMIS, but JPMC was not concerned with the devastating effect of fraud on investors. Rather, it was concerned only with its own bottom line, and did nothing but a cost-benefit analysis in deciding to become part of Madoff’s fraud: “Based on overall estimated size of BLM strategy, . . . it would take [a] . . . fraud in the order of $3bn or more . . . for JPMC to be affected.” JPMC also relied on the Securities Investor Protection Corporation (“SIPC”) to protect its profits: “JPMorgan’s investment in BLM . . . is treated as customer money . . . and therefore [is] covered by SIPC.” By the Fall of 2008, in the midst of a worldwide economic downturn, the cost-benefit analysis had changed. JPMC, no longer comfortable with the risk of fraud, decided to redeem its $276 million in investments in BLMIS feeder funds. JPMC also received an additional $145 million in fraudulent transfers from BLMIS in June 2006. The Trustee seeks the return of this money in this Action.

4.            JPMC allowed BLMIS to funnel billions of dollars through the 703 Account by disregarding its own anti-money laundering duties. From 1986 on, all of the money that Madoff stole from his customers passed through the 703 Account, where it was commingled and ultimately washed. JPMC had everything it needed to unmask the fraud. Not only did it have a clear view of suspicious 703 Account activity, but JPMC was provided with Financial and Operational Combined Uniform Single Reports (“FOCUS Reports”) from BLMIS. The FOCUS Reports contained glaring irregularities that should have been probed by JPMC. For example, not only did BLMIS fail to report its loans from JPMC, it also failed to report any commission revenue. JPMC ignored these issues in BLMIS’s financial statements. Instead, JPMC lent legitimacy and cover to BLMIS’s operations, and allowed BLMIS to thrive as JPMC collected hundreds of millions of dollars in fees and profits and facilitated the largest financial fraud in history.

5.            In addition to the information JPMC obtained as BLMIS’s long-time banker, JPMC also performed due diligence on BLMIS beginning in 2006, using information it obtained from those responsible at JPMC for the 703 Account, as well as information provided by various BLMIS feeder funds. At some point between 2006 and the Fall of 2008, if not before, JPMC unquestionably knew that:

               a. BLMIS’s returns were consistently too good—even in down markets—to be true;

               b. Madoff would not allow transparency into his strategy;

               c. JPMC could not identify, and Madoff would not provide information on, his purported over-the-counter (“OTC”) counterparties;

               d. BLMIS’s auditor was a small, unknown firm;

               e. BLMIS had a conflict of interest as it was the clearing broker, sub-custodian, and sub-investment adviser;

               f. feeder fund administrators could not reconcile the numbers they got from BLMIS with any third party source to confirm their accuracy; and

               g. there was public speculation that Madoff operated a Ponzi scheme, or was engaged in other illegal activity, such as front-running.

6.            JPMC looked the other way, ignoring the warning signs, even in the aftermath of other well-known frauds. In response to those who, prior to Madoff’s arrest, found it “[h]ard to believe that [fraud] would be going on over years with regulators [sic] blessing,” REDACTED Risk Officer of JPMC’s Investment Bank responded, “you will recall that Refco was also regulated by the same crowd you refer to below and there was noise about them for years before it was discovered to be rotten to the core.”

7.            JPMC’s due diligence team was further concerned about fraud at BLMIS in the wake of another well-known fraud, the Petters fraud. Some of these concerns centered on BLMIS’s small, unknown auditor, Friehling & Horowitz (“Friehling”):

The “DD” [due diligence] done by all counterparties seems suspect. Given the scale and duration of the Petters fraud it cannot be sufficient that there’s simply trust in an individual and there’s been a long operating history . . . . Let’s go see Friehling and Horowitz the next time we’re in NY . . . to see that the address isn’t a car wash at least.

8.            In or about September 2008, as JPMC was re-evaluating its hedge fund investments in the midst of the worldwide financial crisis, REDACTED [JPMC Employee 3], of JPMC’s London office, had a telephone call with individuals at Aurelia Finance, S.A. (“Aurelia Finance”), a Swiss company that purchased and distributed JPMC’s structured products. During the course of that call, the individuals at Aurelia Finance made references to “Colombian friends” and insisted that JPMC maintain its BLMIS-related hedge. That conversation triggered a concern that Colombian drug money was somehow involved in the BLMIS-Aurelia Finance relationship, which led to an internal investigation at JPMC of BLMIS and Aurelia Finance for money laundering. Significantly, it was only when its own money was at stake that JPMC decided to report BLMIS to a government authority.

9.            As reported in the French press, by the end of October 2008, JPMC admitted in a filing of suspicious activity made to the United Kingdom’s Serious Organised Crime Agency (“SOCA”) that it knew that Madoff was “too good to be true,” and a likely fraud:

(1) . . . [T]he investment performance achieved by [BLMIS’s] funds . . . is so consistently and significantly ahead of its peers year-on-year, even in the prevailing market conditions, as to appear too good to be true—meaning that it probably is; and

(2) the lack of transparency around Madoff Securities trading techniques, the implementation of its investment strategy, and the identity of its OTC option counterparties; and

(3) its unwillingness to provide helpful information.

None of this information was new to JPMC—it had known it for years. It was only in an effort to protect its own investments that JPMC finally decided to inform a government authority about BLMIS. JPMC further sought permission from SOCA to redeem its Aurelia Finance-related investments and admitted that “as a result [of these issues with BLMIS] JPMC[] has sent out redemption notices in respect of one fund, and is preparing similar notices for two more funds.”

10.          Incredibly, even when it admitted knowing that BLMIS was a likely fraud in October 2008, JPMC still did nothing to stop the fraud. It did not even put a restriction on the 703 Account. It was Madoff himself who ultimately proclaimed his fraud to the world in December 2008, and the thread of the relationships allowing the fraud to exist and fester began to be revealed as well. JPMC’s complicity in Madoff’s fraud, however, remained disguised, cloaked in the myth that Madoff acted alone and fooled JPMC. But that is the fable. What follows is the true story.