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Stanley Epstein
Stanley Epstein

Stanley Epstein

Stanley Epstein - Citadel Advantage Ltd

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Operational risk management is NOT a joke

08 January 2014  |  3238 views  |  0

If you have been following the news these past few days you will have seen that JP Morgan is to pay a further $1.7 billion in fines under a deferred criminal prosecution agreement.

JP Morgan’s problem this time is for failing to catch Bernie Madoff’s Ponzi scheme as it managed his accounts.  It wasn’t that Madoff was smarter than the bank – there were dozens of warning signs or “red flags”. The bank folk involved just didn’t take heed of what was before their eyes.

The bank has had to admit that it didn't have the risk management systems in place to catch Madoff and implement them. For the bank’s management this case is a catastrophe worse than the London Whale.

More damming though is the litany of alleged failures at JP Morgan over a period of about 20 years. JPMorgan Chase was Madoff's main banker and was responsible for knowing the business of its customers – and Madoff was a very large customer indeed.

In an earlier lawsuit Irving Picard (the court-appointed trustee tasked with recovering Madoff's clients' funds) it was alleged that JPMorgan "had everything it needed to unmask and stop the fraud - it had unique information from which it could have reached only one plausible conclusion: Madoff was a fraud."

These failures include;

  1. The bank ignored years of red flags in Madoff's Chase bank account that he used for money laundering and Ponzi scheme payouts.
  2. JPMorgan seems to have violated basic account monitoring and "know your customer" principles.
  3. JPMorgan knew at least as far back as 2006 that the Bernie Madoff funds were suspicious.
  4. Despite its suspicions, JPMorgan went ahead and sold, to its customers, financial products based on Bernie Madoff feeder funds.
  5. JPMorgan sold more Madoff-based products to customers after ignoring internal warnings that Madoff was running a Ponzi scheme.
  6. JPMorgan neglected to report Madoff to US law enforcement ... even after it told a British financial authority that the bank was retrieving its own Madoff investments because he was a fraud.
  7. Following Madoff's confession, the JPMorgan employees responsible for due diligence weren't exactly surprised he had been a fraud.

Which brings us back to the question: “How seriously do banks take the question of managing operational risk?”

Regrettably, from the evidence that emerges out of almost every recent major banking disaster, the answer is exactly the same. Banks in their mad dash for greater and greater profits throw caution to the winds and ignore not only common sense operational risk practices, but those mandated by law as well.  

TagsRisk & regulation

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Stanley is a Director and co-founder of Citadel Advantage Ltd., an international consultancy to the financial services industry that provides specialist services and training in the areas of operation...

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