The U.S. Commodity Futures Trading Commission (CFTC) filed and settled charges yesterday against JPMorgan Chase for its unlawful handling of Lehman Brothers, Inc.’s customer segregated funds.
The CFTC order imposes a $20 million civil monetary penalty against JPMorgan and also requires that the bank implement measures to ensure the proper handling of customer segregated funds in the future. They must also release customer funds upon notice and instruction from the CFTC.
From November 2006 to September 2008, JPMorgan was a depository institution serving Lehman, a futures commission merchant registered with the CFTC. During this time, Lehman deposited its customers’ segregated funds with JPMorgan in large amounts, almost always more than $250 million at any one time.
During the same time period, JPMorgan extended intra-day credit to Lehman on a daily basis to facilitate the company’s proprietary transactions, including repurchase agreements, or “repos.” JPMorgan would extend credit to the extent that Lehman’s “net free equity” at JPMorgan was positive.
As of November 2006, JPMorgan included Lehman customer segregated funds in its calculation of Lehman’s net free equity, even though these funds belonged to Lehman’s customers and not the company.
The Commodity Exchange Act and CFTC regulations prohibit depository institutions from using or holding segregated customer funds and prohibit the extension of credit based on such funds to anyone other than that customer.
According to the order, JPMorgan violated these prohibitions in two ways.
First, JPMorgan extended intra-day credit to Lehman for approximately 22 months.
Second, when Lehman Brothers filed for bankruptcy in 2008, JPMorgan declined Lehman’s request that its customers’ segregated funds be released. Lehman no longer had positive net free equity held at JPMorgan, but the bank continued to refuse to release these funds for approximately two weeks.
“The laws applying to customer segregated accounts impose critical restrictions on how financial institutions can treat customer funds, and prohibit these institutions from standing in the way of immediate withdrawal,” said David Meister, director of division of enforcement at CFTC. “It’s crystal clear that these laws must be strictly observed at all times, whether the markets are calm or in crisis.”
JPMorgan didn’t admit or deny any wrongdoing, and only admitted it was happy to resolve the case and agreed to change practices in handling customer accounts. The firm claimed it had mistakenly included the customer funds in its calculations, and called the resulting loans “small relative to the overall relationship.”
This is second case launched against the bank in relation to the collapse of Lehman Bros.
JPMorgan’s futures broker paid $300,000 to settle CFTC allegations in 2009 that it co-mingled accounts and created a $750 million shortfall in customer funds. In addition, the bank’s transactions are being examined as part of the investigation into the $1.6 billion shortfall in the customer accounts at MF Global.