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JPMorgan Chase & Co. (JPM, Financial) has been in the news quite a bit recently due to a couple of notable scandals. Though the stock price has barely moved in response, the issues that they present are very real.
One of the scandals revolves around how several JPMorgan employees siphoned off money from the Economic Injury Disaster Loan program to their own personal accounts. The company also faces a Commodity Futures Trading Commission fine of $920 million for market manipulation, which had significant impact on the trading of precious metals and Treasury securities. This represents the largest monetary fine that the CFTC has ever levied.
Investors may be puzzled as to why JPMorgan's stock is down only about 6% since the first of these scandals emerged in mid-September.
There could be several reasons for this. We will take a look at these scandals, why investors are barely reacting and what they could mean for the bank's stock in the future.
EIDL scandal
In mid-August, Bloomberg identified approximately $1.3 billion in suspicious funds tied to the EIDL program. In 52 congressional districts, Bloomberg noted that the number of loans granted was higher than the number of small businesses that were eligible for the program in the first place, meaning the money was going to someone it shouldn't.
Almost a month later, JPMorgan fired several employees that it said had applied for and received EIDL coronavirus relief funds meant for small businesses, depositing the money into their personal checking accounts. This came as the conclusion of an internal investigation conducted by the bank after it noticed some suspiciously high deposits made by the employees in question.
According to JPMorgan, the employees were not acting in their work capacity when they fraudulently obtained the loans. This was possible because, unlike the Paycheck Protection Program, the EIDL loans were given out by the Small Business Administration rather than being facilitated by the banks.
JPMorgan also reported that only a small percentage of the EIDL fraud cases were tied to its employees, and that it found no similar activity from employees regarding PPP loans. Questionable activity surrounding PPP loans occurred across the financial sector and centered more around duplicate loans, mismatched information and similar issues that are being attributed to the frantic rollout of these programs and the emphasis on speed. "We are doing all we can to identify those instances, and cooperate with law enforcement where appropriate," a JPMorgan spokesperson told CNBC.
All things considered, the EIDL scandal involves a specific group of employees rather than JPMorgan as a whole, so it comes as no surprise that it did not affect the stock price much, especially in a bull market.
Market manipulation
Unlike the EIDL issue, JPMorgan's market manipulation practices are tied intrinsically to the company's operations and structure. The company has admitted to its wrongdoing in the case and agreed to pay the $920 million fine to the commission.
The penalty will be the largest of its kind ever levied by the CFTC, and the charges consist of a $436.4 million fine for illegal activity, $311.7 million in restitution and $172 million in disgorgement.
So how exactly did JPMorgan manipulate the markets? The investigation found that over an eight-year period, the bank engaged in a practice called "spoofing," in which traders input large buy or sell orders that they have no plans of executing. This results in artificial demand or supply, allowing the bank to move asset prices in whatever direction it wanted. Commissioner Dan Berkovitz described the scam as follows:
"For eight years, a group of traders at JPMorgan systematically 'spoofed' precious metals and Treasury futures markets by entering hundreds of thousands of orders with the intent to cancel them before execution. The Commission's Order finds that JPMorgan manipulated these markets and failed to diligently supervise its traders."
Spoofing was made illegal after the 2008 financial crisis. The payment of the fine will put an official end to the criminal investigation of the bank, though the investigation of the employees involved is still ongoing.
No personal threat
Despite the two scandals, JPMorgan's stock is doing no worse than it has been since the pandemic began. This is in stark contrast to Wells Fargo (WFC, Financial), which is still facing regulatory restrictions and customer mistrust due to the fake account scandal a few years back.
One key difference here is that, unlike with the fake accounts scenario, individuals do not feel threatened on a personal level by JPMorgan's recent scandals. While market manipulation can harm profits for investors, not everyone is an investor, and any harm from market manipulation is 1) indirect and 2) will inevitably have unintended beneficiaries among the trading public (especially if they're bullish).
Too big to fail
Another potential reason for the bank major's resilience here could be the "too big to fail" logic – i.e., the theory that a company (especially a financial company) is so big and its operations form such an integral part of the capital structure of many companies and the economy in general that no matter what issues it encounters or what laws it breaks, it will survive and even thrive, as the government will basically have no choice but to bail it out.
"Too big to fail" was a prominent centerpiece of the 2008 financial crisis, and the basic idea is still very much alive and well today. There seems to be very little chance that, facing the collapse of a major bank, the U.S. government would not hesitate to commit to a bailout package. In 2018, with the economy in a strong growth period, the number of "too big to fail" banks was decreased to 13 from the previous 44, but of course, JPMorgan still makes the list as the largest U.S. bank by assets.
Conclusion
Given JPMorgan's sheer size, the "too big to fail" practice and the resilience of the share price even in the face of admitted illegal market manipulation, it seems almost that the bank's stock is being treated like an overall indicator for the banking industry at large.
GuruFocus gives the stock a "modestly undervalued" rating, which is typical for the current state of the financial sector at large. The price-earnings ratio stands at 12.87 as of Sept. 29, which is slightly over the company's 10-year median of 11.53 but higher than the industry median of 9.48.
Again keeping with most of its peers, analysts estimate that JPMorgan's earnings will remain relatively flat over the next few years, though we could see some pullback when that $920 million fine shows up on the bottom line. Given the stock's undervaluation and lack of near-term growth prospects, a pullback could be the only scenario where investors would gain a decent entry point.
Disclosure: Author owns no shares in any of the stocks mentioned. The mention of stocks in this article does not at any point constitute an investment recommendation. Investors should always conduct their own careful research and/or consult registered investment advisors before taking action in the stock market.
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