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From Securities Regulation Daily, December 18, 2015

JPMorgan out $307M for disclosure failures following joint enforcement effort

By Amy Leisinger, J.D.

JPMorgan has agreed to pay just shy of $307 million to settle CFTC and SEC charges that two subsidiaries repeatedly failed to disclose conflicts of interest to investing clients. Specifically, the CFTC found that JPMorgan Chase Bank, N.A. (JPMCB) failed to disclose conflicts to clients concerning its preference for investing client assets in funds managed by an JPMorgan affiliate and third-party-managed hedge funds that shared fees with the firm’s affiliates. The SEC found similar violations and also concluded that another subsidiary engaged in an investment advisory business failed to disclose its preferences to retail investors and did not tell them about less-expensive share classes. Admitting to the facts set forth in the agencies’ orders, the entities agreed to cease and desist from further violations and to pay disgorgement totaling $127.5 million, plus prejudgment interest, and civil penalties of $40 million to the CFTC and $127.5 million to the SEC (In the Matter of JPMorgan Chase Bank, N.A.CFTC Docket No. 16-05, December 18, 2015; In the Matter of JPMorgan Chase Bank, N.A. and J.P. Morgan Securities LLCRelease No. 33-9992, December 18, 2015).

CFTC action. According to the CFTC, JPMCB serves as the investment manager for certain of its clients’ investment management accounts and private funds offered to clients. Since 2008, JPMCB has had a preference for investing these accounts and private fund assets in proprietary funds associated with JPMorgan. Although JPMCB had made some disclosures regarding preferences in the past, the company did not continue to do so, up until January 2014. Moreover, the Commission stated, until August 2015, JPMCB did not disclose its preference to invest in (and actively seek out) third-party hedge funds for which JPMCB or an affiliate would earn fees for placement and other services (“retrocession” fees)

JPMCB failed to disclose conflicts of interest to clients of its wealth-management business concerning its preferences for investing its client funds in certain commodity pools or exempt pools in violation of Commodity Exchange Act Section 4o(1)(B) and CFTC Regulation 4.41(a)(2), the CFTC found. JPMCB admitted to the violations and agreed to settle the charges. In addition to a cease-and-desist order, the company consented to pay a $40-million civil penalty and disgorgement in the amount of $60 million (offset by disgorgement payments made pursuant to the SEC’s order in the related action, discussed below).

“Investors are entitled to know if a bank managing their money favors placing investments in its own proprietary funds or other vehicles that generate fees for the bank,” said CFTC Enforcement Director Aitan Goelman.

SEC action. The SEC also found that JPMCB preferred to invest clients in the firm’s own proprietary investment products and third-party-managed hedge funds that shared retrocession fees with JPMCB affiliates without properly disclosing the preference or attendant conflicts of interests to clients. However, the Commission investigation additionally discovered that the firm’s investment advisory business, J.P. Morgan Securities LLC (JPMS), also failed to disclose other conflicts to clients from 2008 to 2013, including a preference for firm-managed mutual funds for retail investors in a unified managed account program sold through Chase Bank branches. JPMS also failed to disclose that certain mutual funds purchased for these clients offered a less expensive share class that would generate less revenue for a JPMS affiliate. The conflicts of interest were also not disclosed in the company’s Forms ADV, the SEC stated.

By this conduct, the SEC stated, JPMCB and JPMS willfully violated the antifraud provisions of Securities Act Section 17 and Advisers Act Sections 206 and 207 and Rule 206(4)-7, respectively, and failed to implement written policies and procedures reasonably designed to prevent the violations. Both parties admitted the facts set forth in the SEC’s order and acknowledged that the conduct violated the federal securities laws. They jointly agreed to cease and desist from further violations and to pay $127.5 million in disgorgement, plus over $11 million in prejudgment interest, and a $127.5 million penalty. JPMS also agreed to be censured for its conduct.

In determining to accept respondents’ offers, the Commission considered their remedial acts, including the retention of an independent compliance consultant to make recommendations on their policies and procedures concerning disclosures of conflicts of interest and the implementation of the recommendations.

“Firms have an obligation to communicate all conflicts so a client can fairly judge the investment advice they are receiving,” said SEC Enforcement Director Andrew J. Ceresney. According to the director, this action should send an “unambiguous message” to advisers that the SEC will take action when investors are deprived of the information necessary to make a fully informed decision.

The CFTC proceeding is No. 16-05. The SEC release is No. 33-9992.

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