The JPMorgan Chase CEO deserves every dollar of his recent pay raise.  That statement places us at odds with most commentators. Marketwatch’s David Weidner just published a piece whose headline uses the phrase “mocks accountability” to describe the raise. Forbes bashed not only the CEO but also an “ineffective board” in its article a few days prior to Weidner’s. Other negative opinions were expressed in such disparate places as The Wall Street Journal and The New York Times.

Few of these headlines point out that the board had previously, almost a year ago, halved Mr. Dimon’s compensation to $11.5 million from about $22 million in the “London Whale’s” wake. So while his recent raise looks enormous, he is still making less than he was before. But whether we call it a pay raise or a smaller pay cut from his highest compensation, I believe this current increase was deserved for the following reasons.

First, as noted in a post on this blog at the time the “Whale” surfaced, Mr. Dimon tackled the problem of his rogue London trader within days. He very quickly dismissed both the individual trader and the head of the London hedging operation, went public without excuses on the $6 Billion loss, and tightened the reins of that operation.

Other problems that faced JPMorgan Chase were problems that crossed multiple banks: Libor rate setting, foreign currency exchange rates and mortgage packages. You can be sure that the Libor and foreign exchange rate fixing, the collusion of personnel across multiple banks in multiple countries, was not out in the open for their respective CEOs to observe. As for the mortgage securities, we have all too easily forgotten that at the peak of the financial meltdown in September 2008, the federal government seized Washington Mutual and sold it to JPMorgan Chase. These were not securities that Dimon’s operation created.

Following the exposure of the “Whale,” Mr. Dimon acted swiftly on each of these problems, cooperated fully with all investigations, worked to settle with the government and initiated programs to develop and implement additional controls. The same was true when one of his department’s involvement in the Madoff scandal came to light.

As for the board, they acted quickly and publicly to slam Mr. Dimon’s compensation last year. They reportedly argued strongly over this most recent compensation adjustment. I find those to be healthy signs of an involved board.

Contrast this with Aubrey McClendon and the board of Chesapeake Energy, the company who gave us fracking. Mr. McClendon treated the company as his own fiefdom long after it went public. He leveraged his operation as much as he could and when gas prices came down he was caught short. The board did nothing until it was too late, primarily because the board had been filled with McClendon’s friends.

Over a ten month period Mr. Dimon has settled each of the issues for the bank, while still making healthy profits and delivering shareholders a strong improvement in share price. In every case Dimon has directed his team to examine internal processes and strengthen them. He has not hesitated to remove personnel, which is a key to strengthening internal corporate culture.

In short, Mr. Dimon is exactly what you want in a professional executive and he deserves every dollar. His board also deserves more credit than they have been getting.


A year ago we posted a number of predictions for 2013 and many proved accurate. One area in particular may be taking a significant turn for the better.

Our predictions for 2013 were:

Rebekah Brooks will go to trial. JPMorgan will further increase its reserve for bad trades by “The Whale.” No one in the investment banking industry will go to jail for anything other than insider trading. Goldman Sachs will continue to be bad. The global economy will continue to improve. Slowly. More dirt will come out regarding Walmart’s non-US operations. Somewhere in the US a bank will go under.

And there will be at least one big sex scandal.

What Did We See In 2013?

Ms. Brooks is on trial, JPMorgan did have greater Whale damage (along with several other huge financial settlements related to its business practices and flawed oversight), and several people are going to jail or being strongly pursued over insider trading. I won’t comment on the moral state of GS. The global economy has survived and is improving. Slowly. And without doing the research I am quite certain that at least one US bank somewhere was taken over by the FDIC.

I missed on Walmart’s non-US operations and a big sex scandal.

Yet the most significant change by far in terms of the financial industry is that the SEC, under new leadership, appears to have become more dedicated to putting some people in jail.

At the end of November 2012, SEC chairwoman Mary Schapiro left that office and was replaced in mid December 2012 by Elisse Walter, an SEC commissioner. Walter was an appointment by the president, who then nominated Mary Jo White as the chair. White was confirmed by the Senate and was sworn in on April 10, 2013.

Chairwoman White lost no time in tackling the challenge of prosecuting people in the financial industry. On April 22nd she named George Canellos and Andrew Ceresney Co-Directors of the agency’s Division of Enforcement. Canellos had been Deputy Director and then Acting Director of the division. Per the agency’s press release, Ceresney “served as a Deputy Chief Appellate Attorney in the United States Attorney’s Office for the Southern District of New York, where he was a member of the Securities and Commodities Fraud Task Force and the Major Crimes Unit. As a prosecutor, Mr. Ceresney handled numerous white collar criminal investigations, trials and appeals, including matters relating to securities fraud, mail and wire fraud, and money laundering.”

In particular White appears not interested in settlements that involve a fine with no admission of wrong doing. On her way in the door she got the board of the SEC to overturn a settlement with a hedge fund manager that included a no admission of wrong doing. Soon after, the individual involved signed a new settlement in which he admitted to most of the agency’s charges.  Later in the year, JPMorgan Chase reached its first settlement under the new leadership and it too included an admission of violating certain securities laws.

An article by Sheelah Kolhatkar in Bloomberg’s Business Week in mid October recaps this sea change and quotes Mr. Dennis Kelleher, president of Better Markets. “Mary Jo White has clearly changed the tone, and what she’s had to say is encouraging to anybody who wants the SEC to not only be successful, but be restored to its storied place as a protector of investors and markets.”

That’s the real story for investors coming out of 2013 and we look forward to more significantly stronger settlements in the year ahead.

Why this is important

Readers of this blog know that when it comes to ethical business behavior there is one key element that so often is overlooked to our detriment: the impact of corporate and industry culture on individual behavior. In the investment banking industry we have seen a cross company, industry level trading culture that has not only violated any sense of fair play and decency but has had tremendous real dollar impact on the global economy and investors’ trust. Alleged collusion on Libor rates was topped by collusion on foreign currency exchanges. Highly risky collateralized debt obligations were packaged and sold while the bankers made mockery of their  clients and customers. Massive bets were placed on global interest rates in a game of “top gun” between traders in different organizations.

This environment at an industry level makes it difficult for a CEO such as Jamie Dimon to totally manage his organization’s (and shareholders’ and customers’) risk. Mr. Dimon is doing all the right things in coming to relatively quick settlements and pledging to install new processes and oversight within his bank. I respect what he is doing. Yet until the industry as a whole changes its macho/top gun culture we global citizens are  not safe.

If there is one way to change that macho/top gun culture it is to prosecute, convict and sentence to jail a sufficient number of egregious individuals that the investment banking and trading community sobers up.


The head of the New York Fed said in a speech yesterday that there is an “important problem evident within some large financial institutions—the apparent lack of respect for law, regulation and the public trust.  There is evidence of deep-seated cultural and ethical failures at many large financial institutions.”  The remarks came in  this speech given by William C. Dudley, the President and CEO of the Federal Reserve Bank of New York.

His topic was “Ending Too Big to Fail.” Dudley first discussed various regulatory efforts to prevent another international banking disaster and how to reduce the risk of failure. Near the end of this speech he honed in on the ethical tone and business culture that is all to prevalent on the Street, in our opinion. Readers of this blog know that we often focus on the ethical issues of the banking industry and the need for both organizational and industry culture improvement.

Mr. Dudley’s statement in context said:

“Some argue that what I have proposed—higher capital requirements and better incentives that reduce the probability of failure combined with a resolution regime that makes the prospect of failure fully credible—are insufficient.  Perhaps, this is correct.  After all, collectively these enhancements to our current regime may not solve another important problem evident within some large financial institutions—the apparent lack of respect for law, regulation and the public trust.  There is evidence of deep-seated cultural and ethical failures at many large financial institutions.  Whether this is due to size and complexity, bad incentives or some other issues is difficult to judge, but it is another critical problem that needs to be addressed.  Tough enforcement and high penalties will certainly help focus management’s attention on this issue.  But I am also hopeful that ending too big to fail and shifting the emphasis to longer-term sustainability will encourage the needed cultural shift necessary to restore public trust in the industry.”

Good points, Mr. Dudley.

Jamie’s New Whales

Jamie Dimon, CEO and Chairman of JPMorgan Chase, may be facing three whales instead of two.

For much of 2012, Mr. Dimon was a financial media star. While other big banks were embroiled with the fall-out of the mortgage loan / CDO disaster, Jamie was heralded as the one banker who focused closely on risk management and had managed risk successfully.

Then came the first Whale. The so-called London Whale was at the trading desk inside the bank’s Chief Investment Office, the very office whose responsibility it was to manage the risk of the bank’s investments. The trading loss incurred by that one trader ended up a bit north of $6 Billion-with-a-B dollars.

Now Jamie is facing a second Whale as the CEO is negotiating a $13 Billion-with-a-B settlement with the US government related to mortgage fraud. Reports out this past week have indicated that Mr. Dimon personally negotiated this deal with the Attorney General and was attempting to get a settlement that closed the door on any criminal investigation of the bank. The fact that he eventually elected to pay such a high price in the settlement while not obtaining release from potential criminal charges is significant.

Mr. Dimon is an accomplished CEO and experienced risk manager. The reported settlement would lead one to surmise that Mr. Dimon believed there was a measurable risk that failure to settle would lead to even greater cost, greater than $13 Billion. The continued attempt to close the door on criminal investigations by the US government may be more than just an attempt to close the case so the bank can move on.

My bet is that there is one more whale of size. Stay tuned.

Bloomberg: Standard & Poor’s, facing charges that it defrauded investors, will defend itself by claiming that no one should have paid attention to its claims of independence. Why else would a ratings agency exist?

Per Bloomberg’s article, S&P will claim that “the government can’t base its fraud claims on S&P’s assertions that its ratings were independent, objective and free of conflicts of interest because U.S. courts have found that such vague and generalized statements are the kind of “puffery” that a reasonable investor wouldn’t rely on.”

This, of course, is resorting to the fine print of our legal system in an attempt to destroy the government’s case against the once well respected, and trusted, ratings agency. Far be it from us to complain about reliance on the decisions of prior cases. That reliance is the principle that supports consistency in the application of the law and is an essential component of “blind justice.”

However, if this is the best S&P has to offer in its defense, they may as well close the place down after the case is over. The whole point of ratings agencies such as S&P is precisely to provide an independent and objective opinion on the risk of an investment instrument. The very words “independence and objectivity,” which frequently appear in the codes of ethics of many professions, mean that there is no conflict of interest – that the competent opinion being rendered is untainted by any relationship the professional has with the organization on which an opinion is rendered.

If reasonable investors can’t rely upon that independence and objectivity, then there is no purpose served by a Standard & Poor’s. Close them down.

The fertilizer plant explosion in West, Texas was tragic and unnecessary. It may also have been unethical.

Regulation of chemical plants in general has been hobbled. Nationally, congress has resisted more stringent regulation, a successful result of industry lobbying. Texas in particular has long resisted regulation, indeed prided itself on its hands-off business philosophy. It is very possible that no one, corporation or executive, will be charged with a violation of the law.

However, there is a profession, the engineering profession, whose members are bound by a professional code of ethics and are subject to state level regulation via boards of engineering that oversee the licensing process and activities of professional engineers.

Similar to CPAs, certain activities cannot be performed without an engineering license.  The supervision of the work of non-licensed personnel with an engineering degree is one such activity. Only a licensed engineer can certify the structural integrity of buildings and bridges. A firm that holds itself out to be an engineering firm must have a licensed engineer in order to make that assertion.

Licensed engineers in particular and professional engineers in general are called upon to uphold a code of ethics. In most states that code of ethics is closely based upon or actually is the code of ethics adopted by the National Society of Professional Engineers® (NSPE).

The Preamble to the NSPE Code of Ethics states in part:

“Engineering has a direct and vital impact on the quality of life for all people. Accordingly, the services provided by engineers require honesty, impartiality, fairness, and equity, and must be dedicated to the protection of the public health, safety, and welfare.”

The Code goes on to state its “Fundamental Canons.” The very first Fundamental Canon is “Hold paramount the safety, health and welfare of the public.”

We await further investigation to determine the last time an engineer signed off on plant maintenance, what was examined, what was observed and what records were kept.

This week has been filled with tragedy and bravery. Once again, as they do without hesitation, our first responders and ordinary fellow citizens led by example. The Boston bombs were unexpected and events moved quickly. With many people wounded and the shock of two explosions still ringing in their ears, first responders, marathoners and people in the crowd aided the victims. Who can forget the scenes of people being raced to ambulances on gurneys and in wheelchairs, some with bleeding arteries held tight by another spectator.

The explosion at a fertilizer plant in the small town of West, Texas looked like a miniature nuclear bomb in the film clips I saw. A fire at the facility had already been burning, the town’s small fire department, a volunteer fire department, had raced to the scene. The ensuing explosion that leveled five city blocks hit them without warning. The evacuation of a nearby senior living facility, damaged by the explosion, took place with every vehicle that could be found. First responders arrived from nearby towns and cities. The wounded were transported as far away as Temple and Fort Worth.

In every tragedy our nation faces it is our fellow citizens, ordinary men and women who work for a living to support their families, who show us what ethical leadership really is. They don’t need corporate placards or SEC regulations to tell them what to do.

Last week the U.S Senate conducted hearings on JPMorgan’s $6.2 billion 2012 trading loss in its London office. This was the amount of a trading loss attributed to the “London Whale,” an individual trader in the bank’s Chief Investment Office (CIO), an office whose responsibility is risk management. That individual and the executive in charge of the CIO were let go and the damage now seems to be contained. So why should the Senate be investigating? Why should we care?

Critics might argue that this is the business loss of a defined corporate entity, JPMorgan Chase, and therefore a matter for the company and its shareholders, not the general public and the Congress. In most cases I would agree.

However, this is not just any company and the causes of the loss have significance beyond its corporate and national bounds. An important point to make here is that while the bank was successful in holding the loss at $ 6 billion, it could have been more extensive and had greater consequences.  More importantly, the nature of the loss is indicative of a systemic problem that continues to threaten the nation’s economy, which is the reason it is definitely the public’s business.

When the Banks Fall It Hurts Us All

JPMorgan Chase is a global financial entity, the largest global bank according to an editorial in Bloomberg. As the editorial points out, the bank’s equity is only between 3 and 4 percent of its total value. A sufficient drop in stock price could potentially wipe out that underlying equity and set events in motion that would cause the American taxpayer to bail them out.

How much would that bail out be? JPMorgan has a total value of around $4 trillion.   As someone argued soon after the first bail out, “too big to fail will one day be too big to save.”

The area that should be our greatest concern is this: if Mr. Dimon is the best risk manager in the industry, then can the industry as a whole really be counted on to be a partner with the people (via regulation) in ensuring we do not have another global calamity? The Bloomberg editorial re-opens the discussion on capping the size of the largest banks.

It’s Not Their Money

There are people who believe the $6 billion loss is an issue for JPMorgan management and its shareholders and should be left there. But it is not just the bank’s direct shareholders that may be hurt in these situations. This bank’s stock prices impact many other investors and non-investors. Indirect investors in JPMorgan include those who buy ETFs including ETFs that track the S&P, the Dow and other metrics. People who do not directly invest but have pension and other retirement plans can be affected. A major bank failure, as we saw in 2008 and 2009 can impact the economy as a whole costing the jobs of people who have no investments of any kind.

We need to address bank size to protect us all. We need to understand that complex investments aimed at managing risk can introduce new risks. And we need to realize that the importance of fiduciary responsibility must be re-established in the industry.

Each of these firms had achieved the highest reputation for integrity and quality by placing their responsibility to the investing public ahead of all else. Then their corporate cultures changed.

For those of us who were a part of Arthur Andersen in the 1960s and 1970s, there was no question that the firm considered its reputation to be its principal asset. An asset to be safeguarded at all cost. Reputation was everything and reputation brought in the revenue. The foundations of that reputation were competence, independence and objectivity, all found by no coincidence in the ethical standards for CPAs. The people we served were not our clients; they were the investing public who relied upon competent and independent audit opinions; opinions that were signed “Arthur Andersen & Company.”

The firm invested greatly in achieving and maintaining those qualities throughout its organization. We were masters at training our personnel, developing and enforcing firm wide standards of practice across the globe and maintaining discipline in the use of those standards through a mechanism of internal quality assurance reviews of every audit, tax and consulting engagement combined with frequent and specific personnel reviews at all levels.

But we overlooked one key and fundamental element of maintaining a corporate culture that applies to all organizations, one that Standard & Poor’s may also have missed. We altered the values that generated real rewards and recognition for upward movement in the organization. Over time we collectively allowed the importance of independence and objectivity to slip and the importance of revenue generation by individuals to rise. Serving the investing public remained in our literature, but generating more revenue for the partners became the most important value within the partnership.

Had the partners ever sat down at an annual meeting and openly proposed that this be done it most likely would have been booed down. It was not really a conscious decision, nor do I believe that we ever actually viewed rewarding individual revenue production as something likely to be in conflict with our reputation and our integrity. (A prior generation of partners most definitely did.) But slowly over time the focus on admission to and advancement within the partnership shifted. Reputation did not drive revenue; individuals did. Service to investors was not the primary overriding importance; renewing audit contracts and deriving consulting and tax opportunities was.

So when a Chicago Headquarters partner with a well established reputation for audit and accounting expertise came down to Houston to provide the quality assurance review for the Enron audit, his disagreements with the treatment of certain off balance sheet partnerships resulted in his quick dismissal by the firm’s client. The client had no say in the selection of quality assurance partners in the old days. The firm’s top management would not have acquiesced to a clean opinion after such client actions. The threat of loss of consulting revenue from the client would not have swayed the objections presented in the audit opinion. This time they did.

Floyd Norris’s story in The New York Times draws potential parallels between the corporate culture issues underlying Andersen’s demise and those that are appearing to surface as the government brings its civil case against Standard & Poor’s. In the case of Andersen, damage to our economy was contained. In the case of the CDO s of the type that S&P and others rated, the damage was global and a near worldwide meltdown.

Corporate culture is the key to ethical behavior in any organization. But can a company of such importance police itself? Enron led to the Sarbanes-Oxley Act, which among other things established a new oversight agency, the Public Company Accounting Oversight Board (PCAOB), for a profession that had previously been proudly self-regulating. It is time to do the same for the ratings industry.  They are there to serve the public and the public should have the oversight.

As I read John Carney’s piece on CNBC.com (“In Defense of Morgan Stanley’s ‘Nuclear Holocaust'”) I decided a rebuttal of his opinion should be a post on this blog.

Among the news items this week was the release, in a civil trial, of the text of certain emails that were sent among staff at Morgan Stanley pertaining to the internally perceived quality of a mortgage backed CDO that they were preparing for the market. The emails speculated on an appropriate name for the CDO and included such labels as “Subprime Meltdown.” The emails were brought to light in a lawsuit by a Taiwanese bank that had invested in part of that CDO.

The original story was written by Jesse Eisinger in ProPublica on January 23rd and was also published by the New York Times’ DealBook that same day.

While there is a lot to ‘bite’ on, ethically speaking, in the story itself, I was particularly amazed by the defense of Morgan Stanley written by John Carney, Senior Editor at CNBC.com. Mr. Carney’s article attempts to defend Morgan Stanley from having done anything wrong. The core of his argument can be found in this statement: “There’s a big difference between selling a product to a retail investor and a bank, even a Taiwanese bank.”

Setting aside the obvious disrespectful phrase “even a Taiwanese bank” (implying that a Taiwanese bank is inherently not as competent as its Western counterparts), I find it incredible that anyone could hold out a distinction of this sort as a basis of a defense. At its foundation, this defense is the inevitable result of the caveat emptor (“buyer beware”) attitude that has permeated the financial industry for so long.

Carney goes on to say that it was no secret in the industry that Morgan Stanley was bearish on mortgage debt and that the bank had published articles on the approaching bubble as early as August of 2006. Evidently none of those articles reached the desk of then Federal Reserve chief Alan Greenspan. We all know that there were many contrary opinions within expert economic circles at that time.

Carney then points out that it is common practice, even today, for a bank to sell products to its customers that it does not itself believe to be good investments. In other words, everyone does this so therefore it is OK.

This defense of the bank’s actions is filled with flaws. I want to discuss those using my model for ethical standards, the Seven Layers of Integrity®. Quotations below are from his article, referenced above, and I encourage you to read his entire article.

The Law and Contracts and Agreements

We have laws and regulations governing the selling of securities to investors. A key focus of those rules is the attempt to ensure that the buyer is fully aware of the risks of the securities. That risk discussion is to be found in the prospectus or offering documents, not in “notes” from one of the company’s analysts appearing in an overall market assessment or industry hearsay that the bank was a bear on mortgages in general. The risks of the specific security being offered, not just the broad market or industry risks, should have been highlighted. The fact that fully $415 million of the $500 million package ended up being worthless and that this apparently came as a surprise to the buyer would raise the question of what was and was not revealed. The fact, via the emails in question, that the bank’s own staff who were putting the offering together believed it to be highly likely to default is tantamount to the bank itself knowing that the product being offered on the market was completely speculative and extremely risky. Is that how they categorized it?

The argument that these securities were not being sold to retail investors implies that for “sophisticated financial institutions” an investment bank can be less scrupulous, less transparent, in presenting the risks involved. I am not a registered financial broker or the like, and would invite the perspective of someone who is, but I am highly skeptical that an appropriate discussion of risk can be bypassed when the bank presenting the offering believes the securities to be highly risky. If that is actually acceptable, it should not be.

Professional Standards

I would like to think that people in the banking industry who hold certain securities licenses have professional ethical standards that they should adhere to just as CPA s and attorneys do. I would like to think that independence and objectivity would be part of those standards, along with placing your clients’ interests above your own. I don’t see any of that being observed in this case, nor does Mr. Carney’s defense even attempt to address those issues, other than pointing to an industry standard.

Industry Standards

The argument that “the investment banks have typically allowed clients to take the opposite sides of trades, even when they regard one side of the trade as misguided” states a current industry standard of expected behavior.  As I point out in our book, industry standards can and do violate the standards found in the Law, Contracts, Professional Standards and the other layers in my model. When they do, and this is one case where I believe strongly that they are in conflict, the industry standard will ultimately be changed.  I look forward to that day.

Community Standards – The Investing Public

Neither Mr. Carney nor anyone else can state without qualification that there were no retail investors involved. The odds are high that some were involved, albeit indirectly. For example, there could well have been retail investors holding shares of the purchasing bank that saw their investment in those shares hit when this CDO and others like it proved to be worth so much less on the bank’s books. And in general the losses on mortgage backed CDOs that were bought by municipalities, pension funds and other entities have affected retail investors and the non-investing public alike.

Interpersonal Standards and Spiritual Values

Not even raised by Mr. Carney as something to be defended, so the only flaw is that he doesn’t even mention them. Interpersonally, no one buys a second time from someone they had to sue. Spiritually, as I have said before, there is no spiritual value I am aware of that justifies what the banking industry has done to the global economy and millions of individuals in the name of greater profits for its own pockets.


Mr. Carney’s defense makes it clear that in his mind Morgan Stanley did little wrong, save for failing to teach their staff to not send emails of this sort. I don’t consider hiding bad actions to be a virtue.

For my part, and likely a large percentage of the retail investor market, the revelations coming from this lawsuit are of little surprise and may simply confirm our worst suspicions. There are so many instances of ethical failures and deception in this real world example that a reasonable person can only conclude that what the bank did in this case was simply wrong.  It is one more reason why so many of us are reluctant to return to the market even now as it is clearing the decks for new highs.

Wall Street has tarnished itself mightily, doesn’t even realize it and most likely doesn’t even care.

Other Assessments

Two other interesting opinions on the ethics of the investment banking industry are

“Wall Street Ethics Codes Make Me Want to Inhale” by Susan Antilla of Bloomberg News

“The Market Has Spoken, and It Is Rigged” by Simon Johnson, Professor of Entrepreneurship, M.I.T. Sloan School