Included in the SEC’s civil complaint against Frank DiPascali, a key figure in Bernard Madoff’s mega Ponzi, was an allegation that BMIS maintained a sizable “slush fund” at JPMorgan.
As the FT reported earlier this month:
This account – known as the 703 account – was used to fund the overall operations of Bernard Madoff Investment Securities [BMIS] and was also the main receptacle for the funds sent to Mr Madoff by investors lured by his promise of steady returns.
Every day, Mr DiPascali’s staff prepared reports for Mr Madoff showing how much money had been deposited or withdrawn from the 703 account, the SEC claimed.
When Mr Madoff’s operation was running at full steam in the summer of 2008, the affiliated account contained more than $5.5bn, according to the regulators.
JPMorgan declined to comment on the accounts but has denied allegations made in some of the lawsuits.
But just how much money did JPM make by hosting the so-called slush fund?
According to research by Linus Wilson, assistant professor of finance at the University of Louisiana at Lafayette, about $483m in after-tax profits over the course of 16 years.
Mr Wilson assumes “the deposits returned the bank’s net interest margin and grew at a random geometric rate”, but notes “without detailed account records, these estimates should be treated with some caution.”
From the paper:
This paper estimates the after-tax cash flows to JP Morgan Chase, given that the Madoff bank account was opened at the start of 1993 with a balance of $100 million. The starting balance was arbitrary[a larger beginning balance would generate higher estimated profits for JP Morgan Chase] but the ending balance of $5.5 billion is based on the August 12, 2009, complaint filed by the SEC. This account was nearly zero for most of the last quarter of 2008. The author assumes that the Chase bank account led to annual before tax profits equal to the average annual balance times net interest margin (NIM). (Because this account was reportedly so large, administrative overheads were likely to be an insignificant percentage of the account balance.) Using a Monte Carlo simulation, author estimates that the account added shareholder value of $483 million based on closing prices on August 21, 2009.
The rest of Mr Wilson’s paper sets out the methodology as well as the maths behind the calculations, and is worth reading in full.
Of course, as he takes pains to point out:
Just because JP Morgan Chase may have profited greatly from the bank account, which was so closely associated with Mr. Madoff’s $65 billion fraud, does not mean that JP Morgan Chase engaged in any illicit or illegal activity. Few would say that the vendor who sold Mr. Madoff a hotdog on the street was doing anything wrong.