JP Morgan Business Issues and Analysis - Research Paper Example

JP Morgan – Business Research Issues and Analysis Executive Summary The purpose of this report is to identify the factors that led to the mis-sellingof financial products by JP Morgan and its impacts on the global financial crisis. The business research adopted a case study and the phenomenology approach to explore these issues and address the research objectives. The data collected from the interviews of some employees, customers and financial regulators associated to JP Morgan and the inferences from the literature review was used to draw the final conclusions and observations. The findings of the report suggest that the lack of adequate product knowledge and information contributed to the mis-selling of mortgages by JP Morgan and finally the mis-selling practices did not contribute to the financial crisis alone. It was one of the factors but the primary forces that contributed to the financial crisis were the economic policies and ineffective regulatory controls over banks and financial institutions. Introduction The Financial Conduct Authority (FCA) investigated a number of cases of mis-selling by banks and financial institutions. Faulty advices from banks in context to financial investments and purchase of financial products have been highlighted as one of the key aspects that triggered the recent financial crisis. A number of financial transactions were declared unprofitable and the principle reason behind this was mis-selling of financial products by banks and financial institutions. The evidences of the FCA’s investigations into this issue revealed that most of the time the banks provided little or mis-leading information relating to the financial products during the sales process. A number of research studies and official reports in this context have highlighted the role of mis-selling of financial products by banks in stimulating the global financial crisis situation (Loerwald and Retzmann, 2010; European Parliament’s Committee on Internal Market and Consumer Protection, 2014). The recent case of mis-selling by JP Morgan highlights the implications of poor accountability practices within banks and the extent to which such practices can impact the bank’s reputation. JP Morgan had to pay a penalty of nearly US$ 13 billion to institutional investors who accused the bank of mis-selling bad mortgage bonds (Yarker, 2013). These bonds were sold by JP Morgan and Bear Stearns between the period 2005 and 2008. Among the primary investors who invested in these bonds were Goldman Sachs, Fannie Mae and Freddie Mac. The housing market collapse during this period led millions of homeowners to default on mortgage payments and this resulted in the loss of billions of dollars for investors who had purchased these securities from JP Morgan. Some of these investors declared bankruptcy (Jivanda, 2013). JP Morgan is one of the leading banks having a global presence. It is one of the largest banks in United States and has its headquarters in New York City. The organization operates across 60 countries catering to the personal banking, investment banking, financial management and financial service needs of billions of customers. The research study explores the various factors that led to the mis-selling of financial products by JP Morgan and the role played by the mis-selling of products in the global financial crisis. The findings of the research will establish the linkages, if any, between mis-selling of products and the global financial crisis and the reasons why banks or financial institutions resort to mis-selling of financial products. It will also help in defining the efficacy of existing regulations that guide the selling of financial products and the need to implement additional measures that might help in overcoming the issues of bad selling practices adopted by banks and financial institutions. Critical Literature Review Factors that lead to mis-selling Numerous theories and frameworks have sought to explain the possible causes that lead to mis-selling practices. The term ‘mis-selling’ has been defined as “the ethically questionable practice of a salesperson misrepresenting or misleading an investor about the characteristics of a product or service” (investopedia, 2014). The practice refers to the deliberate leaving out of vital information while describing the features of a financial product or service with the intention of making a sale to the customer. Mis-selling relates to unethical selling practices by banks and the application of this term to the sale of financial products or services assumes new dimensions in the light of possible events and situations that guide the performance of these products or services in the near future (Global Solutions, 2010). Customers or investors often lack the expert knowledge and details of the financial products or services they choose to invest in. Most seek expert financial advice from banks or financial institutions before making the final decision to invest in the products. “But whenever a decision depends upon external advice, it bears the risk of being accidentally or even knowingly wrong advice from experts” (Loerwald and Retzmann, 2010, p51). Wrong or misleading information given to customers may be accounted to lack of adequate knowledge or qualification of the ‘experts’ in the defined sector. This involves a complete or inadequate understanding of market forces, its impact on the performance of financial products, ways of evaluating the risks and potentials of the financial products in question. The judgment is often based on the ratings provided by external agencies or bank analysis reports without a complete understanding of the product features or its risk assessment factors. Another dimension that prompts mis-selling of financial products and services is the motivation or incentives related to the sales of distinctive product categories to the financial advisors who act as sales agents for the banks. The sales agents receive commission on the sales of some products, and this acts as a motivating factor that prompts mis-selling practices. The advice provided by these sales agents is thus based on the bank’s recommendations for specific financial products to reach definite sales targets (Loerwald and Retzmann, 2010). The concept of mis-selling thus relates to the presence of inefficient marketing relationships that stems from the lack of complete knowledge of product information and understanding of financial market forces. A perfect marketing relationship between the buyer and the seller can only exist in perfect market environment, where both have a perfect understanding and knowledge of the products and market conditions. A perfect market condition thus rules out the need for any expert advice or information before making the purchase decision or before closing the sales process. However, such market conditions do not exist in reality and there is an imbalance in terms of knowledge and understanding that exists between the buyer and the seller (Adams, 2004). Financial products and services assume increased complexities in the global business environment where numerous forces influence the nature of risks associated to it and the extent to which it can withstand market forces. Complicated tax regulations, legal frameworks, compliance standards and risk assessment procedures guide the ratings and performance of financial products and services (King and Carey, 2014). Banks and financial institutions in order to retain profitable operations choose to highlight the product benefits rather than portray the details related to product risks. The situation is further worsened by the “plethora of small print required by financial regulators, which most investors do not have the time, inclination, or knowledge to read and understand, and it is, sadly, easy to generate a scenario in which mis-selling is likely to occur” (Adams, 2004, p208). Claims of misinterpreting financial advice or misleading statements by banks before selling the financial products have been debated on grounds of ineffective interaction that lead individual customers to incorrect assumptions or lack of understanding the key aspects related to the product features and its associated risks. The retail investors also face similar problems in terms of understanding the risks associated with the financial products or services they choose to invest in. The ethical dimension of selling financial products and services involve a commitment to make the customer aware of the potential threats, extent of risks, benefits and other product alternatives that may suit the investor’s needs. Thus, financial institutions are supposed to know the requirements of the investors, help them in making informed decisions, and provide them with alternative suggestions that can serve the investor’s purpose (Wong, 2011). Relationship between mis-selling and financial crisis The global financial crisis raised many debates on the role of bank’s misconduct and their adherence to regulatory procedures in instigating the global economic conditions. A research study report by the Directorate General for Internal Policies (2014) claimed that one of the primary reasons that contributed to the global economic crisis was the inappropriate or mis-selling of financial products and services to consumers. The financial sectors are highly volatile where mis-leading by the seller of a financial product can lead to catastrophic losses for the buyer. Mis-selling can occur where the seller knowingly sells a financial product which is of no utility to the buyer. The buyers have already specified their requirement of the financial product and their utility but despite knowing the same the seller misleads them in purchasing a different product to gain their short term targets. Singh (2002) emphasized this point by stating that this was an industry wide problem which needed a collective approach to rectify and compensate the buyers who incur shortfalls in their investment to cover their mortgage. This was exactly what happened with JP Morgan Chase & Co. where they sold mortgage backed securities to Fannie Mae and Freddie Mac. The decision by the state to induct penalty of net $13 billion including $9 billion penalty and $4 billion as relief to home investors who were undergoing financial difficulties were on the right direction as certain measures had to be taken to stop the mis-selling. However the financial crisis in the US and world market was not solely dependent on the mis-selling of the financial property. There were a host of other factors that had led to the economic turmoil. IMF (2010) stressed on this aspect that the USA and other advanced economies went through a crisis with direct exposures to subprime assets and the drying up of wholesale financial markets. According to the Wall Street Journal (2011) there were several complicating factors which included the use of subprime and adjustable rate of mortgages which had led to excessive risk taking. The mis-selling of the financial products had a minor part to play in the economic crisis as the purchaser of the financial mortgage backed securities could not utilize the products and it led to a big financial loss for the purchasing company Fannie Mae and Freddie Mac. The mis-selling can be attributed to the target based consumer market which has been created with financial institutions pressing the need for aggressive marketing. Commission based marketing strategy were followed with financial advisors of banks misleading consumers with poor advice and information on products (King and Carey, 2013). There were other factors also as the banks were mis-selling products like mortgages, loans, credit cards and credit agreements without any proper policy. It is always advisable for the banks to market their financial products under the purview of the financial regulatory framework. Customers need to be encouraged in knowing more about the financial products so that they are not misled by any of the banks. This is an important area where the regulatory authorities should also provide more and more information on the financial products so that banks cannot mislead them on any product. It has been the practice for the banks where they are paying penalties for mis-selling of products but still they are not stopping the menace as they think that more business can be procured in this manner. The penalty levied on JP Morgan Chase & Co. is justified as it sends a strong message to all banking and financial institutions that they cannot get away with mis-selling of products and provide wrong advice to the customers for their business targets. In the UK the Financial Services and Markets Act 2000 had increased the regulatory powers of the FSA significantly. The FSA had specific tasks which were to maintain market confidence, ensure the protection of consumer interests, protection and enhancement of the financial stability system in the UK, and reduce financial crimes (King and Carey, 2013). Emphasis must be laid on the fact that the mis-selling of the financial products was partly responsible for the financial crisis as other economic indicators also brought about the downturn. However the decision of the state to incorporate penalty action was justified and financial institutions must be extremely strict in restricting these practices so that customers benefit from the information derived from these institutions and the market sanctity is not compromised in any respect whatsoever. Methodology The key issues addressed in this study are the mis-selling practices adopted by JP Morgan and the role it played in triggering the global financial crisis. The study adopted a qualitative approach to address the following research objectives – To identify which factors lead to the mis-selling by JP Morgan To understand the relationship between mis-selling and the financial crisis Qualitative research method is highly suited for research studies that explore specific phenomenon, situations, instances, or events and its subsequent impact on other parameters. The qualitative research method follows distinctive approaches to exploring the topic and collecting vital information and data that can explain the research context. These approaches include case study, interpretive, and phenomenology among others (Thyer, 2010). The phenomenological approach is suited for this study as it involves the study of the phenomenon through the experience and perspectives of individuals associated to it. It adopts a non-quantitative approach where researchers develop their arguments on the basis of observations and inferences drawn from interpretations of others through their observations and personal insights. Interview is a common data collection method associated with phenomenological approaches (Smith et al., 2009). The findings of this report were based on the primary data collected from the interview of 15 research participants and the secondary data used to write the literature review. The literature review was based on findings and observations from existing studies, reports and journals that have developed their own arguments and their findings have shaped the perceptions related to the mis-selling practices by banks and the global financial crisis. The primary data was based on the interview of 15 research participants who were chosen randomly by the researcher. The participants belonged to 3 distinctive categories – 5 employees of JP Morgan, 5 customers of JP Morgan and 5 professionals working in financial regulatory bodies linked to JP Morgan. Direct interview was taken and the observations of each participant were recorded through a voice recorder. Prior to the interview the research participants were provided a consent form that stated the objectives of the research, the context in which the information provided by the participants will be used and the confidentiality of the information collected during the interview process. Once the participant consented to be a part of the research study, an appointment was fixed for the interview. The questionnaire (refer appendix) was used to obtain the participants’ views. The questionnaire used for this research study contained open ended questions that allowed the participant to respond in a more detailed manner to each question. The findings collected through this process were then used to frame the discussion and analysis report. Data Analysis and Results The findings from the interview responses of the 15 research participants revealed some interesting insights into the research study. Data analysis adopted the discourse analysis where the responses of the participants were analyzed for specific trends that highlighted the response pattern, the differences of opinions and the similarity of opinions presented in response to the given question (Taylor, 2013). The response patterns were weighed in terms of percentage of the participants who have distinctive perceptions about the whole phenomenon and others who believe differently. 86 percent of the research participants had a long association (nearly 5 to 10 years) with JP Morgan either as clients, employees or in their roles as financial regulators. Only 6 percent of the participants did not have any idea about the meaning of the term mis-selling. The remaining explained the meaning of the term as any kind of misleading or inaccurate information provided by the bank to the customers while selling financial products. The employees of the bank felt that their organization had not committed any crime while selling the bad mortgages to other investors. According to them, the investors were well aware of the risks associated with the products and had not anticipated the market swings that will convert these mortgages into bad debts. It was completely unforeseen that a large chunk of the homeowners will default on their mortgage payments and this is attributed to a wide range of economic factors that include interest rate hedging, ineffective financial regulations and policies that threatened the whole economic system. The financial regulators and clients however, felt that the Bank should have examined all aspects before selling the mortgages to the investors. This practice reflected the greed of the bankers to make more money and generate profits through unethical selling of financial products and services that in turn contributed to the global financial crisis. The participants in these two categories also reflected on the significance of the bank’s role as financial advisors. Since the banks are experts in their domains, it is assumed that they have the adequate financial knowledge and understanding of market risks associated with each of the products sold by them. The key aspects defining the quality of advice given by banks or financial institutions were identified as knowledge of sales agents or financial advisors, experience that contributes to improved understanding of market operations and regulatory guidelines that help in establishing effective sales of financial products and services. Almost all 96 percent of the participants highlighted these parameters as vital indicators for improving the advisory roles of banks and financial institutions. In response to the last question 46 percent of the participants felt that JP Morgan had realized its responsibility as financial advisors. It is significant to note that all the 5 employees of JP Morgan and 2 customers shared this belief. The remainder felt that the Bank had failed to recognize its social and ethical obligations when it came to giving accurate financial advice to the customers and investors. The findings suggest a mixed and biased view to the mis-selling practices by JP Morgan. While the bank employees feel that the mis-selling of financial product was not a deliberate action of the Bank, the other participants feel that the Bank should have adopted a more responsible stance in this case. These observations also project a different dimension to the exact causes that led to the financial crisis. The literature review has highlighted the role played by financial regulators in defining the efficacy of sales mechanism of financial products. Financial products and services operate in a highly competitive industry where innovative products make their entry on a regular basis. The role of financial advisors assumes new significance with the demand for investment advice growing in a market filled with numerous alternatives. Customers find it confusing to differentiate between various products and evaluate the products on its potential returns, benefits, and associated level of risks (Adams, 2004). The regulatory bodies and financial services guidelines also play an important role in maintaining transparency in financial operations and providing a base for an improved understanding of the role and scope of financial intermediaries and advisors. Financial institutions and banks seek profits through a number of channels that involve the mobilizing of funds through the market and driving investment strategies for effective returns. Regulation of financial services and sales of financial products aims to maintain clarity in operations, provide transparency in transactions and provide a platform for effective implementation of financial processes. The overall objective of these regulatory bodies is to maintain customer confidence through the reduction of fraudulent practices, financial crimes and mitigation of risks that the customer is exposed to in the uncertain economic conditions (Zinkin, 2013). It may be concluded from the discussion that the key factors associated with the mis-selling practices at JP Morgan were lack of adequate knowledge of financial products, lack of expertise in the bank while selling the mortgages to the investors, and ineffective governance mechanism that failed to see the existing flaws in the system and its subsequent implications on the economic environment. However, laying the onus of the global financial crisis on the mis-selling practices is not justified. While the role of mis-selling of bad mortgages cannot be overlooked, it was just a minor factor that contributed to the financial crisis. The vital force was contributed by the ineffective governance structure, poor economic policies and inadequate controls over banking transactions that led to such oversight. Conclusions Ethical obligations of banks and financial institutions cannot be ignored and the case study of JP Morgan in context of mis-selling practices has highlighted the significance of sales ethics in driving operational efficiency and maintaining market reputation. Customer confidence is the key to market success and hence banks and financial institutions need a clear focus on developing their expertise in advisory roles and promoting fair practices that do not camouflage the truth and relevant details from the customers. Transparency and trust are vital parameters that can help banks in overcoming these challenges. Bibliography Adams, A. (2004), The split capital investment trust crisis, Chichester: John Wiley & Sons. Directorate General for Internal Policies (2014), Consumer protection aspects of financial services, European Parliament report. Global Solutions (2010), Mis-selling of financial products, Research report, Linklaters LLP. Investopedia (2014), Definition of mis-selling, [online] available from http://www.investopedia.com/terms/m/misselling.asp (accessed 19 March 2014). Jivanda, T. (2013), JP Morgan agrees $4.5 billion payout over mortgage security mis-selling claims, [online], available from http://www.independent.co.uk/news/business/news/jpmorgan-agrees-45bn-payout-over-mortgage-security-misselling-claims-8944261.html (accessed 19 March 2014). King, J. and Carey, M. (2014), Personal finance: a practical approach, Oxford: Oxford University Press. Loerwald, D. and Retzmann, T. (2010), Mis-selling as a new topic of financial education? A didactic analysis of investment advice after the financial crisis, Journal of Social Science Education, 9(1), pp 49-58. Lumpkin, S. (2010), Consumer protection and financial innovation: a few basic propositions, OECD Journal: Financial Market Trends, 1(1), pp 1-23. Merrouche, O. and Nier, E. (2010), What caused the global financial crisis? – evidence on the drivers of financial imbalances 1999 – 2007, IMF Working Paper. Singh,D. (2002), Banking Regulations of UK and US Financial Markets, Ashgate Publishing. Smith, J.A., Flowers, P., and Larking, M. (2009), Interpretative phenomenological analysis: theory, method and research, London: Sage Publications. Taylor, S. (2013), What is discourse analysis?, London: Bloomsburg Academy. Thyer, B. (2010), The handbook of social work research methods, New York: Sage Publications. Yarker, J. (2013), JP Morgan faces $6 bn US mis-selling penalty, [online], available from http://www.fundweb.co.uk/jp-morgan-faces-6bn-us-misselling-penalty/1076415.article (accessed 19 March 2014). Wong, M. (2011), The risk of investment products: from product innovation to risk compliance, Singapore: World Scientific Publishing Co. WSJ (2011), What caused the financial crisis?, [online] available from http://online.wsj.com/news/articles/SB10001424052748704698004576104500524998280 (accessed 19 March 2014). Zinkin, J. (2013), Rebuilding trust in banks: the role of leadership and governance, John Wiley & Sons. Appendix 1 Questionnaire We are currently conducting a research study for our University project based on the sale of bad mortgages by JP Morgan. The research objectives are to identify the factors that led JP Morgan to mis-selling practices and find out the extent to which this mis-selling contributed to the global financial crisis. 5 minutes of your time will be highly appreciated to answer the questions given below. Your responses and information gathered from this questionnaire will be used solely for the purpose of this research study and treated as highly confidential. Gender - a) Male b) Female Age group – a) Under 20 b) 20 – 29 c) 30 – 39 d) 40 – 49 e) Above 50 Category – a) Employee of JP Morgan b) Customer of JP Morgan c) Working for regulatory bodies How long have you been associated with JP Morgan? a) Less than 5 years b) 5 – 10 years c) More than 10 years What according to you is the meaning of the term mis-selling? What are the reasons behind the mis-selling practices of JP Morgan? Do you feel the mis-selling of financial products and services contributed to the global financial crisis? Do you think the role of banks is vital as financial advisors? What according to you are the vital parameters that define the quality of financial advice given by banks or financial institutions? To what extent has JP Morgan realized its responsibility as financial advisors? Thank you for taking the time to respond to these questions and being a part of our research project. Your responses will help us analyze the research context better and provide the valuable insights for further evaluation. Appendix 2 Interview results – The responses of the interview is categorized below in terms of number of participants who agreed to or provided specific response pattern to each question. The percentage value for this was taken for reporting the findings and analysis of the interview data. Male – 9 Female – 6 Age group – f) Under 20 0 g) 20 – 29 1 h) 30 – 39 8 i) 40 – 49 4 j) Above 50 2 Category – d) Employee of JP Morgan - 5 e) Customer of JP Morgan - 5 f) Working for regulatory bodies - 5 How long have you been associated with JP Morgan? d) Less than 5 years 1 e) 5 – 10 years 13 f) More than 10 years 1 What according to you is the meaning of the term mis-selling? A clear and accurate idea - 11 A somewhat vague but good perception 3 No idea 1 What are the reasons behind the mis-selling practices of JP Morgan? Bank’s fault - 10 Other reasons cited 5 Do you feel the mis-selling of financial products and services contributed to the global financial crisis? Bank’s fault - 10 Other reasons cited 5 Do you think the role of banks is vital as financial advisors? Vital - 10 Supportive function 5 What according to you are the vital parameters that define the quality of financial advice given by banks or financial institutions? Vital parameters defined - 14 To what extent has JP Morgan realized its responsibility as financial advisors? Realized its responsibility 7 Not realized 8 Read More