JPMorgan (NYSE:JPM) may be facing its nemesis in the form of the SEC and the Justice Department. Initially, the Justice Department investigated the bank's actions in the United States, but this revealed a paper trail that led further down the rabbit hole. Now it is expanding its investigating to the company's practice of hiring the sons and daughters of prominent Chinese officials to secure financial benefits for JPM in Asia.
This investigation is now getting very interesting for shareholders of the mega banks because it may include other prominent and widely held mega bank stocks and may ultimately involved serious fines for JPM and other banks. These fines and related legal fees may lead to continued limited dividends for shareholders of these stocks.
The company's penetration into the Asian financial and business scene is not new-and, in fact, it's something of a historical tradition. JPMorgan has been active in Australia, Bangladesh, China, India, South Korea and Thailand for more than 140 years. However, as the Tiger Economies rose to impact world economics, JPM has been observed to significantly leverage familial relationships to increase profits.
The Foreign Corrupt Practices Act
The banks increased level of aggressive liaisons in Asia's political and economic affairs has led to suspicions by the SEC and the United States Department of Justice about the possible misuse of JPM's financial power to violate laws, ethics, and national interests. The core of this concern is the possible violations of the 1977 Foreign Corrupt Practices Act, a law enacted to prevent U.S. companies from bribing foreign officials.
Ironically, despite the sensitivity of the issue, there is even a name for JPM's strategy to gain an unfair economic advantage in Asia. It's called the "Sons and Daughters" program. Initiated in 2006, it was set up to prevent suspicion about the mechanics behind forging key business relationships in China. In essence, it was designed to deflect any trace of suspicion of bribery or hint of impropriety.
What federal officials want to know is whether the money offered to relatives of political and industrial leaders is based on legitimate hiring practices. After hiring relatives of key influencers, JPM appears to be able to fast-track its business projects, needing fewer interviews and jumping through less bureaucratic hurdles. In fact, the bank appears to gain entry into lucrative deals while meeting lower standards.
Is JPM hiring people for real jobs or to win favors for business? Is JPM really creating jobs or is it actually forging powerful alliances? These are the questions that the SEC and our Department of Justice is trying to answer for the mega banks' shareholders.
The N.Y.T. and SeekingAlpha.com is also reporting today that other mega banks that were bailed out by the United States taxpayers might also be involved in these types of questionable hiring practices. These banks include Goldman Sachs (NYSE:GS), Morgan Stanley (NYSE:MS) and Citigroup (NYSE:C). See here and here.
A String of Coincidences?
In 2007, for instance, JPM enjoyed a range of significant involvement in a number of Chinese railway businesses after they hired the daughter of the chief engineer of the Ministry of Railways. Recently, relationships between JPM and China Everbright Group picked up after JPM hired Tang Shuangning's son. Yet while these stories are dramatic, they are just a few of many stories; and rather than isolated incidents, they may indicate an apparent trend.
While hiring the relatives of important officials does do away with the idea of overt bribery, the level of power and influence gained by JPM suggests that they could possibly be violating the Foreign Corrupt Practices Act.
Following a Paper Trail
However, Federal authorities are not merely working on rumors and causal inference, but on actual documentation. Emails and spreadsheets suggest that hiring sons and daughters of important Chinese officials has led to direct benefits.
This wealth of uncovered documents not only reveals the original intention of JPM to create a way to throw off the scent of impropriety, but it also spells out a direct correlation between hiring relatives and participating in profitable ventures with China's state-owned companies. Since Wall Street mega banks help these companies issue stocks, there are numerous advantages for all parties.
An Open Secret?
Besides documents indicating the original plan and showing a linear relationship between hiring practices leading to handpicked business deals, federal authorities are also following another line of inquiry--interviewing whistle blowers. According to documents reviewed by The New York Times, JPM's hiring practices are an open secret at its Hong Kong bank. But despite this fact, not all employees or affiliates are pleased with the practice. In fact, as far back as 2011, two employees filed an official complaint with the Hong Kong Stock Exchange.
Summary and What Should Investors Consider
Federal officials are tracking the relationship between the bank's Asia hiring practices and the bank's profitable connection to China's political elite and economic influencers. Besides observing a causal link between hiring a relative and the bank's fast track results, federal officials are reviewing candid emails, spreadsheets showing a correlation between hiring practices and business favors, and witness testimonials.
While JPM, GS, MS and C have not been officially accused of unlawful activity, the accumulating evidence from multiple sources will make it much more difficult to deny wrongdoing.
We believe that investors should continue to take some profits in the mega banks and reallocate the money to banks like U.S. Bancorp (NYSE:USB) which Goldman Sachs just added to their conviction list this week and Berkshire Bank (NASDAQ:BHLB) which we have written about recently here.
Both of these financial institutions have good management and they pay their shareholders a solid dividend.
Disclosure: I am long BHLB. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.