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How to Deter Misbehavior by Bankers

Bank Regulation
Photo: Peter Foley/Bloomberg

Sept. 15 (Bloomberg) -- Six U.S. agencies, a congressional committee and four state regulators, not to mention Canada, three European countries and the European Commission, are investigating JPMorgan Chase & Co. The bank’s litigation expenses hit $1 billion in the first half of this year, and the bank says its legal losses could reach $6.8 billion.

So shareholders are furious, right? Nope. JPMorgan’s shares have risen 35 percent in the past year, more than twice the 17 percent increase in the Standard & Poor’s 500 Index. Part of the reason has to be that $6.8 billion isn’t much for a bank that’s on track to make $23 billion this year.

Which leads to two questions: Five years after the global economy was sucker-punched by the bankruptcy of Lehman Brothers Holdings Inc., has the U.S. done enough to prevent financial companies from breaking the law? If not, what else can it do to deter misconduct -- and motivate shareholders to demand changes?

For years, the Justice Department has been reluctant to punish large corporations for fear of driving them out of business. (Remember Arthur Andersen LLP?) The department has instead relied on so-called deferred prosecutions, which usually involve signed promises not to misbehave and the acceptance of on-site monitors to check on compliance.

The Securities and Exchange Commission’s view has been that hitting public companies with large penalties only hurts shareholders. When companies are willing to settle allegations of wrongdoing, the SEC’s default position has been to let them do so without admitting guilt.

This approach doesn’t protect investors or the economy. Instead, it contributes to market dysfunction by allowing companies to treat litigation as just a cost of doing business.

Shareholders, moreover, have little incentive to provide market discipline because they, too, benefit if companies can earn bigger profits by crossing legal lines with impunity. If hefty penalties damped earnings, shareholders would suffer -- and might then have reason to hold banks to account.

At JPMorgan specifically, shareholders can freely ignore the possibility that the U.S.’s largest bank -- with $2.4 trillion in assets, it’s about the size of France’s economy -- may simply be too big to manage. It recently hired 3,000 people just to deal with compliance and controls.

The good news is that regulators and prosecutors have the tools they need, including the securities laws and various other statutes against fraud and conspiracy, to discourage miscreants. Plus, there is the anti-racketeering statute, which allows prosecutors to seek triple penalties if a company keeps violating the same laws.

SEC Chairman Mary Jo White, a former prosecutor, can demand only civil reparations, yet she holds a trump card: She can refuse to let JPMorgan settle cases without admitting or denying guilt. Then private litigants can piggyback off any SEC settlement, adding to the penalties.

Prosecutors are not always correct, of course: JPMorgan units involved in such diverse businesses as electric-power trading and consumer credit-card services may not have engaged in all the bad practices they are accused of. Nor should the bank be tarred with the misconduct of former employees of Bear Stearns & Co. and Washington Mutual Corp., which JPMorgan bought at the U.S.’s behest in 2008 and must defend now.

At the same time, it’s not fair to say that prosecutors are retaliating for the bank’s criticism of federal regulators. The sheriffs aren’t overreaching; they’re merely late. If, in judiciously applying the law, the government sends a clear message that no bank gets a pass, then the financial system will be stronger -- and more trustworthy -- for everyone.

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