One of the key tests in court would be whether investors could show that they were harmed by anything the bank did or failed to do last fall, or whether any other course of action would have simply made things worse, said Charles Mooney Jr., a law professor at the University of Pennsylvania. “If I were the bank’s lawyer, those are the questions I’d ask — and the answers are far from clear,” he said.
Investors say the bank should have done a better job of investigating the Fairfield funds before it issued the notes. Another European investment manager, who also declined to be identified because of potential litigation, says he decided to purchase the notes for his clients partly on the strength of the bank’s reputation.
He said that when he saw JPMorgan Chase “put its brand name” on the Fairfield notes, “I thought that there was no more reason to remain cautious.” He added, “For me, the JPMorgan notes were the final imprimatur of Sentry’s financial soundness.”
What has upset him and other investors interviewed about their stake in the notes is that they did not know that JPMorgan Chase had already exited from Fairfield, almost unscathed, without notifying them.
“We looked at the prospectus and concluded that they had no obligation to do that,” the Italian asset manager said. “But I certainly expected it, after such an unusual move.”
After JPMorgan started pulling out of Fairfield, with credit markets in disarray everywhere, the quoted price of the notes fell by about 12 cents on the dollar, a discount that discouraged some investors from selling because the price seemed at such odds with the Fairfield Sentry fund’s continued good performance.
An executive with a Swiss financial advisory firm said that he had placed an order to redeem some notes at the end of October. But when he found out how low the quotes were, he said, “I immediately placed a stop to the withdrawal — a decision that, after Madoff’s arrest, I haven’t stopped regretting.”
His regrets seem to be justified. Some buyers of the notes face the loss of their entire investment.
In a letter dated Dec. 31, 2008, Timothy R. Hailes, a managing director and associate general counsel for the bank in London, notified investors that Mr. Madoff had been arrested and that his firm was being liquidated by regulators. These events activated provisions in the terms of the notes that allowed the bank to substitute some other asset for the Fairfield funds, which “may have a considerable impact on the value and the amount payable” to investors, according to those contracts.
Investors said that the bank had not provided any further information about their potential losses, even when asked for updates. “As of today, I still do not know if JPMorgan attributes any value to those notes,” said one European money manager.
About two-thirds of the Fairfield-linked notes the bank issued were guaranteed against principal loss, according to the bank. But the bank said the owners of the remaining notes, like all the investors cited here, had probably lost their entire stake. That would mean a loss the bank puts at about $30 million but that investors say could be much larger.
“We believe the notes that are not guaranteed are now valued at zero,” said Ms. Lemkau, although investors “could reach some recovery through bankruptcy proceedings.” In any case, she added, “The risks were fully explained to clients in the purchase agreements.”
If the bank had withdrawn almost $250 million directly from Mr. Madoff’s firm, Bernard L. Madoff Investment Securities, the bank would be subject to federal bankruptcy rules that give the court-appointed trustee leeway to recover money paid out over the previous year and use it to repay creditors. It is less likely that a similar withdrawal from Fairfield Greenwich would be within the trustee’s reach, but the question is certain to be posed in litigation, several lawyers said.
“I would consider it a probable development,” said the source close to JPMorgan Chase. “Especially with a redemption so close in time to Madoff’s arrest.”
This article was a joint investigation by The New York Times and the Italian business daily Il Sole 24 Ore. Claudio Gatti is an investigative reporter for the Italian paper, based in New York.