J.P. Morgan’s Client ‘Steering’ Questioned
By Emily Glazer and Jean Eaglesham
Mr. Burk came to view his $5 million investment in the fund as an ugly stepchild, and regulators now are looking at whether his experience fits a pattern of J.P. Morgan inappropriately steering its private-banking clients to its own hedge-fund investment products, according to people close to the probe.
The Commodity Futures Trading Commission is investigating whether J.P. Morgan made proper disclosures when directing clients to such investments, the people said. The previously unreported inquiry is part of a broader probe by federal and state regulators into the same issue.
The CFTC probe includes an examination of Highbridge Capital Management LLC, an investment firm owned by J.P. Morgan, the people said.
The regulator is looking at why such a high proportion of Highbridge’s assets come from J.P. Morgan’s private-bank assets, and if that helped stabilize Highbridge during the financial crisis, said the people familiar with the probe.
At the end of 2012, private-bank client assets had grown to 71% of Highbridge’s flagship fund, up from 26% in 2007, according to one person briefed on the CFTC’s findings.
Navigating potential conflicts of interest is a major issue for banks, which often encourage their employees to leverage relationships with clients to sell additional products.
Regulators are increasingly monitoring this area, even if there is no clear line marking where effective selling crosses into abusive tactics. Banks are allowed to sell in-house investments, but their advisers must conform to rules requiring them to recommend only products that are in clients’ best interests or at least suitable for those individuals.
In addition, regulators increasingly want advisers to be up front with clients about fees and not bury such disclosures in the technical fine print.
Mr. Burk says he didn’t understand the fee structure for his fund, which resulted in an estimated $30,000 in charges for about a year, based on a breakdown he requested from the bank. The fund’s performance was roughly flat over that period.
“It was sitting there not making a dime and the fees were eating everything up,” Mr. Burk said.
Mr. Burk said he also lost hundreds of thousands of dollars investing in other J.P. Morgan proprietary products over the past two years. He said he is in the process of moving his roughly $40 million portfolio to another bank.
J.P. Morgan spokesman Darin Oduyoye declined to comment on Mr. Burk’s situation, but said the bank “puts all proprietary and third-party hedge funds through a due diligence process.”
He also declined to comment on the investigation, as did a spokesman for the CFTC.
The bank has said in regulatory filings that it has received information requests, subpoenas and other inquiries from government agencies regarding client disclosure and possible conflicts of interest in the bank’s sales of proprietary products. The bank has said it is responding to and cooperating with the relevant authorities.
J.P. Morgan owns a number of hedge funds and alternative-investment products, including its in-house multistrategy fund in which Mr. Burk invested and Highbridge, a $27 billion firm that runs multiple hedge funds and private-equity funds under its own branding.
J.P. Morgan first took a stake in Highbridge in 2004, and bought the rest in 2009.
Highbridge produced strong returns for years, and at one point was among the largest hedge-fund firms on Wall Street, but it stumbled badly during the financial crisis.
Investors asked to withdraw billions from its largest hedge fund, and to get investors to stay, Highbridge offered reduced fees and other incentives. Highbridge subsequently built out its private-equity business as a less-volatile complement to its hedge funds.
J.P. Morgan private-bank clients are still significantly invested in Highbridge funds today, though the percentage of Highbridge’s funds that come from private-bank client assets has decreased as performance has improved and outside investors have returned, according to a person familiar with the matter.
Mr. Oduyoye said 95% of all hedge-fund investments from J.P. Morgan’s private-banking clients go into funds not associated with Highbridge.
From part of 2009 through the end of August, Highbridge’s flagship multistrategy fund had annualized returns of 5.8%. That compares with the 5.3% average annualized return of rival funds on average, and the 4% return by hedge funds regardless of strategy from the start of 2010 through the end of August, according to industry research-firm HFR Inc.
The long-running CFTC probe won’t necessarily lead to enforcement action.
The CFTC, which oversees hedge funds that invest in commodities, has been sharing information with the Securities and Exchange Commission and Indiana State Securities division, which are investigating J.P. Morgan on similar topics, according to some of the people familiar with the probe. The Wall Street Journal reported in mid-August that the bank is expected to settle with the SEC in coming weeks for more than $150 million.
The latest scrutiny is also notable because banks are increasingly weighing whether to keep their stakes in hedge funds and private-equity firms, said Christopher Scarpati , who heads the “Volcker rule” practice for PricewaterhouseCoopers Advisory Services. The Volcker rule puts a cap on how much of their own capital banks can have in such investments in an effort to force banks away from risky bets that potentially can trigger large, destabilizing losses.
Banks have until 2017 to draw down investments in the funds under the Volcker rule.
J.P. Morgan client money in Highbridge doesn’t constitute the firm’s capital, and the bank is looking to keep Highbridge, a person familiar with the firms said.
The bank also has been in discussions about possibly selling part of Highbridge to its management team, people familiar with the matter have said.
—Juliet Chung contributed to this article.
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