If a federal regulator wants to make a point by shaming a bank, JP Morgan is the obvious one to put in the stocks as a warning to others – and that is what the US Federal Regulatory Commission has done with a dramatic and unusual penalty on the bank.
As a result of a legal dispute, Ferc is forcing JP Morgan to take lower profits in its electricity-trading division, known as JP Morgan Ventures Energy Corp. The division sells electricity by taking bids, similar to the way that stock traders take bids on stocks.
Ferc is hitting a bank where it is most likely to hurt: in its wallet. The JP Morgan energy-trading division won't be able to set prices for electricity starting in April 2013. The bank will only be able to sell electricity at prices that other people want to pay, which means it will lose the upper hand entirely when setting prices. The penalty will last for six months.
The penalty won't completely wipe out JP Morgan's profits from trading electricity, but it will hurt it, particularly as rivals will be able to charge what they like. For JP Morgan, which, like other banks, is challenged to find ways to maintain profits, the penalty is a setback, although not a devastating one. JP Morgan does not reveal what its profits from energy trading are, which indicates that they are probably not significant compared to the bank's other businesses. JP Morgan can still trade energy derivatives with no interruption.
The dispute between Ferc and JP Morgan arises from a wider investigation into manipulation of the power markets, an investigation that has included Barclays, Deutsche Bank and Constellation Energy.
California's regulatory authority that oversees electricity, the California Independent System Operator, or Caiso, started investigating JP Morgan and other banks this year with the suspicion that they may be manipulating power markets.
JP Morgan maintained that it did not manipulate the markets, and the matter won't be resolved likely until next year. Ferc indicates that this week's penalty is not an enforcement action, meaning that the agency is not accusing JP Morgan of fraud.
But what annoyed Caiso – and the US Federal Energy Regulatory Commission – was the idea that JP Morgan was not playing it straight with them. Ferc determined Wednesday that JP Morgan had "submitted false information" about bidding for electricity in California.
The dispute that caused the penalty comes down to just two emails. Caiso asked JP Morgan for documents and information. JP Morgan failed to provide two emails, sent in 2011, that Caiso thought could have been relevant to the case. Caiso insisted on receiving the documents. JP Morgan realized its mistake and issued a public apology – but that couple of months of work by Caiso's lawyers to convince JP Morgan to hand over the papers had the effect of ticking off the regulator and Ferc, and JP Morgan is now paying the penalty. JP Morgan maintained that the staff that scanned the firm's emails were different from the staff working with regulators, so they did not recall the two emails.
Ferc doesn't want to encourage any bank or electricity-trading firm to hold back information, and it called JP Morgan's violations "critically important". The agency explained that it expects electricity traders to be immediately co-operative with regulators.
"The Commission grants market-based rate authority to companies on the presumption that they will not engage in fraud, deception or misrepresentation," Ferc said in a statement. "The provision of false, misleading or inaccurate information undermines the integrity of the Ferc decision-making process, the smooth operation of markets and Ferc's ability to ensure just and reasonable rates for customers."
In short, Ferc doesn't want to do the work of hounding banks and other electricity-trading firms for information.
JP Morgan responded feistily to Ferc. The bank said in a statement that it would fight the penalty and downplayed the dispute.
"As the dissenting commissioner stated, this is a novel use of Ferc's authority over market-based rates and is unsupported by Ferc's own regulations – particularly given that the issue in this proceeding was not JP Morgan's conduct in the market, but rather a dispute over document productions. We are reviewing the opinion and will determine our next steps, prior to the proposed April 2013 effective date."
It's rare for a regulator – any regulator – to come after JP Morgan so dramatically. If you picture Wall Street banks as a classroom, JP Morgan is mostly the teacher's pet; despite the fiery anti-regulatory rhetoric of its chief executive, Jamie Dimon, JP Morgan still stands out as the bank to come through the US financial crisis in a position of financial strength and with a strong reputation.
Even the London Whale debacle earlier this year – in which the bank allowed a bad set of trades to wipe out billions of dollars – registered to many people as an anomaly at JP Morgan. Several regulators are currently pressing JP Morgan for more information on the Whale debacle.
Still, Ferc's penalty, and the remaining guts of the Whale trade, show that JP Morgan does not have a free pass in Washington. On Wall Street, traders bring each other down to earth with the saying that there's no such thing as a track record to save you when times get tough; the saying is "you're only as good as your last trade". That is true when it comes to dealing with regulators too.
After years of ruling the roost in Washington, JP Morgan, it seems, may have to humble itself and step up its charm offensive.
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