In the summer of 2007, as the first tremors of the coming financial crisis were being felt on Wall Street, top executives of JPMorgan Chase were raising red flags about a troubled investment vehicle called Sigma, which was based in London. But the bank chose not to move out $500 million in client assets that it had put into Sigma two months earlier.
Sigma collapsed a year later. Now, new documents unsealed late last month as part of a lawsuit by bank clients against JPMorgan show for the first time just how high the warnings about Sigma went — all the way to the office of the bank’s chief executive, Jamie Dimon.
While the clients lost nearly all their money, JPMorgan collected nearly $1.9 billion from Sigma’s demise, according to the suit. That’s because as Sigma’s troubles worsened, JPMorgan lent the vehicle billions of dollars and received valuable assets in the form of a security deposit.
After Sigma came undone in September 2008, many of those assets ultimately became JPMorgan’s and eventually appreciated in value, giving the bank a large profit, the suit says.
The case, which is filed as a class action and includes several pension funds as named plaintiffs, accuses JPMorgan of breaching its responsibility to keep its clients in safe investments, and it sheds new light on one of Wall Street’s oldest problems — whether banks treat their clients’ money with the same care that they treat their own.
Joseph Evangelisti, a spokesman for JPMorgan, called some of the suit’s accusations “ludicrous” and said the bank lent more than $8 billion to Sigma to try to help the vehicle survive, not to profit from its failure. He said the bank did its best to protect its clients’ money and that its dealings with Sigma were to the clients’ benefit.
The suit, however, asserts that JPMorgan workers developed a “grand scheme” to profit from Sigma in the event of a collapse, even though employees at another part of the bank left client money invested in the vehicle.
One internal e-mail between top executives, for instance, states that the firm needed to protect its own interests in its dealings with Sigma, without taking into account the clients’ position. The suit also contends that the bank’s loans to Sigma gave it access to the vehicle’s best assets, at a discount, which proved to be a profitable trade for the bank.
JPMorgan has said in a court filing that no such scheme existed and that it acted properly in the way it managed client money.
The bank argues that by law, different units of the company that dealt with Sigma could not share information, because of so-called Chinese walls, which are meant to prevent the spread of nonpublic information within the firm. According to this argument, the unit that invested client money in Sigma could not confer with the arm that lent the vehicle money.
But because the information rose to executives who oversee the entire company and were in a position to intervene, analysts say the issue is trickier.
“In one sense, I don’t think it’s good enough to say, ‘We’re a large organization, we can’t relay information.’ That, in many respects, is a cop-out,” said William Fitzpatrick, a banking analyst at Manulife Asset Management, a Canadian insurance company that is not party to the case. “Does Jamie Dimon have some sort of veto power where he can overrule it? That gets very gray.”
But he added, “I can see where the banks would come back and say, ‘The Chinese walls are there for a reason. We don’t want to put in manual overrides.’ ”
In many cases, the rules and practices banks follow are based on nonpublic information they receive.
It’s not as clear what a bank’s obligations are with insights that are based on public information, like some of the information related to Sigma.
Within the financial services industry, the case is being closely watched. A victory by JPMorgan’s clients may mean that banks will have to be more careful about deciding whether to share — or silo — information that affects their clients’ investments. The Securities Industry and Financial Markets Association, a prominent trade group, wrote a brief in support of JPMorgan last month saying that the pension funds that are suing had an “unprecedented and novel theory” that “contradicts decades of Congressional and regulatory guidance.” The trade group said that if the plaintiffs won, it would impose greater costs on banks.
Whatever the legal outcome, the new documents paint a picture of how one of Wall Street’s strongest players profited in its deals with the weak.
The events described in the suit, which was filed in Federal District Court for the Southern District in New York, began in the summer of 2007. That June, JPMorgan’s unit put about $500 million from pension funds and other clients into notes issued by Sigma, meaning those clients would be repaid based on how Sigma’s financial bets performed.
The investments were made by the bank’s securities lending unit, which stood to share in profits if the bet was successful but would not share in losses if it wasn’t.
According to the new documents, by that August, JPMorgan executives elsewhere in the bank began to worry about Sigma and other similar entities called structured investment vehicles, or SIVs.
Mr. Dimon is named in several documents related to these vehicles.
One e-mail in August 2007 said Mr. Dimon was interested in hearing about “the systemic risk of a complete unwind of all SIVs,” according to the suit. Another e-mail told a bank worker to prepare “a very real picture of the assets that will be unwound with particular focus on Sigma.” At the end of August, Mr. Dimon received a memo on the SIV market, with a note about Sigma in the cover sheet, according to the lawsuit.
That same month, a fixed-income executive, John Kodweis, wrote in an e-mail that he believed it was probable the entire sector would run into trouble.
If that were to happen, the SIVs might have to unload $400 billion in valuable assets at fire-sale prices, he wrote. He suggested the bank create a team, which the suit says it did, to take advantage of the forced selling.
In the same e-mail, Mr. Kodweis noted that the block of SIV investments that JPMorgan had made on behalf of its clients was among the top 12 investors in all SIVs.
Other top officials at the bank were also aware of the conflict. In September that year, as the bank’s top brass considered lending money to Sigma, the bank’s chief credit officer, Andrew Cox, wrote that “I have heard JPM Asset Mgmt are large buyers of SIV and Sigma CP,” referring to short-term debt called commercial paper. “Do we need to consider the firmwide position?”
The bank’s chief risk officer, John Hogan, wrote back that JPMorgan needed to protect its own position and not worry about what its clients were invested in.
By February 2008, credit continued to tighten, and Sigma was desperate for cash to finance its operations. An executive in JPMorgan’s London office, Mark Crawley, wrote that it was “unlikely” that Sigma would survive. He also said there could be risks to the bank’s reputation if it went ahead with the loan. Still, JPMorgan proceeded.
As time passed in 2008, bank executives did more trades with Sigma.
Mr. Crawley e-mailed Mr. Cox to say that the bank was treating its loans to Sigma as a “trade,” rather than as support for Sigma and that there were “very big moneymaking opportunities as the market deteriorates” because Sigma had what he called high-quality assets.
Mr. Cox described Sigma’s health as “a race against time” in a note to Bill Winters, then co-head of the investment bank, and Mr. Crawley.
By September 2008, when Sigma defaulted, JPMorgan had lent it a total of $8.4 billion and had received $9.3 billion of assets as a security deposit, according to the suit. The value of the collateral was dubious at that point, given the panic of the financial crisis, and it was unknown if the assets would decrease in value.
But a year later, many investments had risen in value, the suit says. JPMorgan made over $470 million in profit within a year of the default by selling off some of the collateral and had recorded a paper gain of $1.2 billion on assets it still held, according to the suit. The bank had also made $228 million in fees from Sigma in exchange for the loans. The total gain was nearly $1.9 billion, the suit says.
The pension funds whose money JPMorgan had put into Sigma lost nearly all of their investment. The suit said their $500 million became worth 6 cents on the dollar.
Mr. Evangelisti, the JPMorgan spokesman, said the bank disputed the profit figures but he would not say how much the bank believed it made on the Sigma transactions.
He also said the unit that put the client money in Sigma “closely monitored” the investment and did its best to decide whether to sell it early. He said a different client investment in Sigma was repaid in full to JPMorgan clients just weeks before Sigma collapsed.
The bank also said in a court filing that it would have been irrational for its executives and traders to try to obtain Sigma’s assets by lending money to the vehicle. The bank could have instead just purchased some of those assets, though they might have come at a higher price.
In addition, Mr. Evangelisti said it was Sigma that approached JPMorgan about the loans, and Sigma executives told the bank the loans would help the JPMorgan clients who were Sigma investors.
He added that in the fall of 2008, when it came time for the bank to auction off some of the assets JPMorgan had received from the failed vehicles, “in many cases there were no takers.”