JPMorgan's risky client approach: Cut them off before they cut us down
JP Morgan has always thrown its weight around but should clients be wary of this new trend?
“Once is happenstance. Twice is coincidence. Three times is enemy action.” Ian Fleming, Goldfinger
Is JPM deliberately throwing clients under the bus?
Is Jamie Dimon telling his bankers to point out the bad behavior of others, no matter the cost? Or is it bankers’ self-interested risk calculations that drive them to point the SEC and Department of Justice towards clients who may already be under heavy scrutiny?
JPMorgan snitches on entertainment industry royalty
On March 8, Jeffrey Trachtenberg and Dave Michaels at the Wall Street Journal hugely scooped that the Justice Department is investigating options trades by Barry Diller, David Geffen and Alexander von Furstenburg to determine if they violated insider-trading laws. The SEC is also conducting its own investigation.
Messrs. Diller, von Furstenberg and Geffen bought options to purchase Activision shares at $40 each on Jan. 14 in privately arranged transactions through JPMorgan Chase, the people said. Activision shares were trading around $63 at the time, meaning the options were already profitable to exercise, or "in the money." Option holders could reap more if Activision's stock price rose.
Apparently, the three amigos — actually, von Furstenburg is Diller’s stepson with Diane von Furstenburg — purchased the options just days before the merger between Microsoft and Activision was announced.
The Wall Street Journal says Diller and Geffen are longtime friends, having worked together in the mail room at the William Morris agency back in the day. Diller has served on the board of directors of Coca-Cola Co. with besieged Activision Chief Executive Bobby Kotick. Kotick has now stepped down from the Coca-Cola board amidst multiple federal and state regulatory investigations into how he handled workplace misconduct claims. The Activision acquisition may help to bury those allegations and the impact of any settlements in the belly of a beast as big as Microsoft.
Diller described Kotick, according to the WSJ, as "a long-time friend,” but said that that their perfect timing was, “simply a lucky bet. We acted on no information of any kind from anyone. It is one of those coincidences."
The options were not purchased on an exchange but were bespoke, arranged privately by JPMorgan. The WSJ says that after the deal between Microsoft and Activision became public, JPMorgan reported the trades to law enforcement.
JPMorgan’s report is an aggressive approach to risk managing clients whose business may come back to bite the bank, but it’s not wrong.
JPMorgan may be watching its p’s and q’s because it remains under scrutiny for, amongst other activities, its own toe-dip into market-manipulation of metals futures and Treasury securities. Under the terms of a $920 million multi-agency criminal settlement it reached in September 2020, the bank is required during the term of a deferred prosecution agreement with the Department of Justice — it also settled charges with the SEC and CFTC — to disclose any evidence or concerns about its own or clients’ misconduct to law enforcement. JPMorgan untypically admitted its guilt when it agreed to the settlements.
We see now what happens when a bank doesn’t report a whistleblower’s concerns to DOJ while under multiple settlement agreements. I wrote 10 years ago that Deutsche Bank is a serial recidivist and I am still not wrong.
WSJ: Deutsche Bank Violates DOJ Settlement, Agrees to Extend Outside Monitor Violation is related to internal complaint in its asset-management arm’s sustainable-investing business
The bank had ongoing disclosure and compliance obligations as part of a 2021 criminal settlement related to Deutsche Bank's involvement in overseas corruption and market manipulation by futures traders. That deal required Deutsche Bank to pay $130 million, but the settlement allowed it to avoid indictment in exchange for staying out of trouble for three years and flagging future potential problems to prosecutors.
The Wall Street Journal reported in December that the DOJ had informed Deutsche Bank of the possible violation, although it hadn't made a final decision.
As a result of the violation, Deutsche Bank agreed to extend the term of an outside compliance monitor that dates to a different settlement with the DOJ reached in 2015 over manipulation of benchmark interest rates. The monitor will now be in place until February 2023.
Activision doesn’t like to follow SEC accounting/disclosure rules, either. I wrote in August of 2017 that after receiving a letter from the SEC in 2016 that said it had to drop revenue deferral figures from its non-GAAP numbers — the earnings-report figures that do not comply with Generally Accepted Accounting Principles, or GAAP — Activision instead asked journalists to calculate the figures from info it provided in an email and publish the regulator-prohibited adjusted revenue numbers that Activision was prohibited from providing.
These option trades seem too good to be true to me, too. The scenario is similar to the lucky bets Dean Food Chairman Tom Davis, gambler Billy Walters, and golfer Phil Mickelson made based on Davis’s inside information back in 2017. I wrote:
Sara Kropf, an attorney who defends white collar defendants, says the SEC sometimes gets tips about insider trading, but it looks like this time it used market surveillance tools to investigate Walters.
“Unfortunately for Walters, it appears that he engaged in large, successful trades with respect to a single company’s stock. If he had a limited history trading that company or others over the period, then that can raise suspicions,” said Kropf.
Walters’ trades were very large compared to the average daily trading volume in Dean Foods and Darden. They were also consistently successful on the up- and downside over more than six years.
The WSJ reported in 2017 that Davis was sentenced to two years in prison in 2017. He also pleaded guilty to perjury because he lied to the SEC by denying his involvement in the conspiracy. Walters invoked his Fifth Amendment rights, declined to testify, was convicted and sentenced to five years in prison.
Mr. Davis cooperated with prosecutors and testified for five days at Mr. Walters's trial as the star government witness… Mr. Davis has said he started cooperating with the government after a series of health scares in late 2015 gave him perspective and made him want to take responsibility for his conduct.
At trial, the defense tried to undermine Mr. Davis by portraying him as a liar. Mr. Walters's lawyers produced phone records that showed frequent calls from Mr. Davis to escort services, saying this conflicted with Mr. Walters's statements to the government that he had not paid for sex while he was with his third wife. She has since filed for divorce.
One of the most valuable parts of Mr. Davis's cooperation was the details he shared about a burner phone that Mr. Walters gave him to share tips. Mr. Walters allegedly called it the "bat phone" and told Mr. Davis to refer to Dean Foods as the Dallas Cowboys.
JPMorgan sues Tesla
It came as a surprise to most Tesla watchers, if not all, that JPMorgan would sue Tesla over a measly $162 million. Well, maybe not everyone was surprised. The WSJ’s David Benoit reported in November that, “Elon Musk and Jamie Dimon don't get along.”
Benoit explained back when the lawsuit was filed that it’s rare in the self-serving world of banking to cut off a hand just because it spasmodically slaps your face.
Typically, bankers seek to avoid public fights with big clients and even potential clients, anxious about winning fees and worried the slightest insult could cost them access.
But this is a battle of bigger-than-life personalities.
Both chief executives are commanding presences inside their companies and industries. And both have had public fights with rivals or sharp words for critics and regulators, though Mr. Dimon has often wound up expressing regret over what he admits are uncareful slips while Mr. Musk has rarely backed down.
On March 2, Alison Frankel of Reuters provided a status for the dispute.
JPMorgan advised U.S. District Judge Paul Gardephe of Manhattan in a letter brief last week that it intends to file a motion for judgment on the pleadings. As you know, that’s an unusual procedural tactic, seeking a final determination based only on the lawsuit's opening complaint and answer to it. But JPMorgan’s lawyers at Davis Polk & Wardwell told the judge that this is the rare case that can be decided on admitted facts and long-established contract law precedent.
Not so fast, says Tesla.
But Tesla’s lawyers at Quinn Emanuel Urquhart & Sullivan, in a vivid and accusatory response filed on Tuesday, said it’s anything but. The Quinn filing talks about a “brazenly self-serving” scheme by JPMorgan to wrest an “improper windfall” from Tesla, on top of the billions of dollars of shares the automaker delivered to the bank when the 2014 warrants expired.
Frankel goes on to say that Tesla “posits a baroque theory of the case, in which high-ranking JPMorgan executives saw the warrants deal as an opportunity to exact revenge against Tesla and Musk for icing JPMorgan out of profitable finance and underwriting assignments,” according to earlier reporting by Jonathan Stempel in January.
Benoit at the WSJ described the tension in November:
Mr. Musk has spurned Mr. Dimon's JPMorgan Chase & Co. for years, turning to other banks while expanding Tesla Inc. and his broader empire. Conversations over the years between the two companies have often upset one side or the other, according to people familiar with the matter.
JPMorgan's investment bankers haven't worked on any Tesla offering or transaction since 2016, according to public records.
When JPMorgan worked on Tesla's 2010 initial public offering of stock and several capital-markets transactions in the following years, it was usually ranked behind rivals such as Goldman Sachs Group and Morgan Stanley.
JPMorgan has been paid about $15 million by Tesla for advice and capital-markets work in the past decade, while Goldman Sachs has made about $90 million, according to Dealogic.
What isn’t described by the WSJ or Reuters is that PwC, as their auditor, has been making billions off all three — Tesla, JPMorgan, and Goldman Sachs — for years, and years. And now PwC is presiding over a mismatch in valuation and significant litigation over a transaction — one Goldman Sachs advised on— between two of its clients.
I wrote about it shortly after the lawsuit was filed in November.
The kicker here, and the most interesting part for me, is that it appears that Tesla and JPM were recording this transaction at different valuations since August 2018, when the First Adjustment occurred. PwC is the external auditor for both Tesla and JPM.
But that’s not all… [Matt] Levine writes:
It’s worth saying that JPMorgan was one of four banks that acted as Tesla’s counterparties on the warrant transactions for this convertible bond deal. Did the other banks [fm note: such as Goldman Sachs] adjust their warrants to give themselves more shares for Musk’s pretend going-private deal? Apparently not.
Here’s a grudging footnote in JPMorgan’s complaint:
“Tesla also claimed that none of its three other warrant dealers had made similar adjustments. But Tesla has never substantiated that claim.”
On August 13, Musk tweeted, “I’m excited to work with Silver Lake and Goldman Sachs as financial advisors, plus Wachtell, Lipton, Rosen & Katz and Munger, Tolles & Olson as legal advisors, on the proposal to take Tesla private.”
In a footnote to its complaint, JPM says that, according to a Tesla August 24 blog post, two of Tesla’s other warrant dealers, including Goldman Sachs, were advising Musk on his going-private proposal.
After I wrote about PwC presiding over mismatched books books and litigation between its two clients, Tesla and JPMorgan, I got this comment from a former SEC official, a veteran expert in financial accounting and reporting:
[Here’s] why the accounting might not match up. It isn’t all that surprising that JPM would mark its purchased option to market while Tesla would not need to remeasure the written option, as these options often qualify for equity classification for the issuer, while the holder must do derivative accounting.
What I can’t explain is how they wound up disagreeing over the settlement requirements. These things are common transactions and I can’t imagine that it would actually be unclear whether the option was in the money or not.
GE’s Biggest Bear - Stephen Tusa, JPMorgan sell-side analyst
Stephen Tusa asks the questions no one else will.
In their book, Lights Out: Pride, Delusion, and The Fall of General Electric, The Wall Street Journal’s Thomas Gryta and Ted Mann open Chapter 17, “Enter the Bear,” with this:
Like any modern bank, JPMorgan Chase had to juggle its interests.
Gryta and Mann go on to remind us that “inherent conflicts of interest embedded in the Wall Street research models employed by massive banks had supposedly been corrected by a $1.4 billion settlement with regulators in 2003.” That’s the settlement where ten Wall Street investment banks, including JPMorgan, agreed to stop issuing biased stock ratings to attract investment banking business. It’s also the one where Henry Blodget, then of Merrill Lynch, and Jack Grubman, then of Citigroup's brokerage business Salomon Smith Barney, agreed to pay $19 million in fines and penalties and be banned permanently from the securities industry, but not admit nor deny any wrongdoing, to settle fraud charges.
When Tusa developed doubts about GE’s financial disclosures in 2008, before the breadth of the problems it would encounter during the financial crisis period were fully known, he ran up against JPMorgan’s significant banking relationship with GE led by James Bainbridge “Jimmy” Lee.
Tusa gets a lot of credit in my book for following his heart all these years on GE. He had an “overweight” rating on the stock in the early days of the financial crisis but when GE missed its earnings target he dropped it to “neutral”.
“It would appear as though accountability for hitting targets is the top priority, and some managers may be chasing earnings,” Tusa wrote to clients in a note.
Fast forward to 2016, Tusa issued the first “sell” rating on GE by a major bank analyst in recent memory.
Over the next two years GE would lose more than $200 billion in market value.
In May of 2017, GE CEO Jeff Immelt spoke to an industry group in Sarasota, Florida and said that a $2 per share earning target for 2018 was a reach and that significant cost cutting would have to occur for the company to have a chance to achieve it. The analysts in attendance, in particular JPMorgan’s Steve Tusa, were shook, according to an account in Gryta’s and Mann’s book. Tusa had been telling his clients to sell GE and he asked Immelt about his succession plans, a hugely taboo subject to discuss openly.
On a conference call in Jan. 2018, after GE announced the life-threatening fourth quarter after-tax charge of $6.2 billion and a $3 billion cash capital contribution to its insurance subsidiary that was expected to grow to $15 billion by 2024, Tusa even asked about the auditors!
Tusa posed the question to then-CFO Jamie Miller of whether the company was happy with KPMG, given the huge charge related to aggressive accounting estimates.
If these guys reviewed this stuff every year for the last several years and this is kind of a result of that, doesn’t that kind of raise questions?
John Flannery, who replaced Immelt in June 2017, told the attendees that he was not planning an auditor change.
In September of 2018 GE announced it had issues with its turbine business. A couple of weeks later, on October 1, CEO Flannery was fired. Flannery had admitted to the board the prior week that GE would miss its year-end targets and have to take a $23 billion charge related to write-downs of acquisitions by the power business, including Alstom.
Larry Culp was now CEO.
In February of 2019, Tusa told CNBC GE “stock could go up based on narrative and sentiment,” because no one was reading the 10-K which suggested much weaker fundamentals. The remark starts at the 6:15 mark.
Tusa was on a roll.
In April of 2020 he said GE’s first quarter results were bad but the second quarter would be even worse.
On June 18, 2020, GE announced that after “an extensive evaluation process,” it had finally dumped KPMG after more than 100 years, and selected Deloitte & Touche LLP as its new independent registered public accounting firm beginning with the fiscal year ending December 31, 2021.
On September 30, 2020, General Electric announced that the US Securities and Exchange Commission had issued a “Wells Notice” advising GE that it was “considering recommending to the SEC that it bring a civil injunctive action against GE for possible violations of the securities laws.”
On December 9, 2020 GE agreed to pay a $200 million penalty to settle SEC charges that it misled investors. The action was prompted in part by a whistleblower report from Harry Markopolos, of Madoff fame.
The case against GE was a textbook example of a fraudulent scheme to inflate revenue, earnings, and share price to create the false appearance of meeting or exceeding analyst estimates and financial projections.
SEC: GE misled investors by describing its GE Power profits without explaining that one-quarter of profits in 2016 and nearly half in the first three quarters of 2017 stemmed from reductions in its prior cost estimates.
SEC: GE failed to tell investors that its reported increase in current industrial cash collections was coming at the expense of cash in future years and came primarily from internal receivable sales between GE Power and GE’s financial services business, GE Capital.
SEC: GE lowered projected costs for claims against its long-term care insurance portfolio from 2015 to 2017, and failed to inform investors of the corresponding uncertainties resulting from lower estimates of future insurance liabilities at a time of rising costs from long-term health insurance claims.
GE was also charged with violations of Rule 100(b) of Regulation G, “which prohibits a registrant, or person acting on its behalf, from making public a non-GAAP financial measure that, taken together with the information accompanying that measure and any other accompanying discussion 15 of that measure, contains an untrue statement of a material fact or omits to state a material fact necessary in order to make the presentation of the non-GAAP financial measure, in light of the circumstances under which it is presented, not misleading.”
The phrase “pull forward” appears in both the GE and Under Armour SEC complaints. GE pulled forward cash by factoring receivables, including unbilled receivables. That is a super-aggressive form of accelerating revenue recognition. The SEC’s GE settlement called it “deferred monetization”. I wrote:
Deferred monetization was different from GE’s past factoring practices in two key respects: (1) GE previously sold receivables due in one year or less, but deferred monetization involved the sale of unbilled receivables with due dates up to five years out…
GE’s new deferred monetization practice pulled forward future years’ cash collections into the present year, decreasing cash flows in later periods. Deferred monetization was described internally as a “drug” because the company needed to continue to do more deferred monetization to achieve equivalent effects period after period.
(Was GE factoring these unbilled receivables through Greensill? Seems quite possible.)
Shareholders began suing the company and, just like Flannery, the stock sank almost every time Culp spoke, maybe because his message of the need for a massive turnaround was the same.
JPMorgan’s Tusa saw what he thought was a light at the end of the tunnel, according to Gryta and Mann. He temporarily removed his sell rating, arguing that, “GE’s businesses were broken, but the risks were now mostly known.” However, a few months later he realized the light was another oncoming train and reestablished an underweight/sell rating.
Last November Culp announced GE would break-up, something I signaled back in 2018 at the Grant’s Interest Rate Observer Conference.
Tusa has been pessimistic about GE’s prospects ever since and rates GE “neutral”.
A spokeswoman for JP Morgan declined comment.
© Francine McKenna, The Digging Company LLC, 2022
Full disclosure: I have written quite a bit about JP Morgan and Jamie Dimon over the years but it is informed by close association. I worked for JP Morgan as a consultant and then as a Vice President, running its Y2K readiness project in Latin America — Mexico, Brazil, and Argentina — from August 1997 until the end 1999.