By Heidi Soumerai, CFA
From the Winter 2013 Edition of Values

How can an investment manager who integrates environmental, social, and governance (ESG) factors in investment decision-making hold J.P. Morgan (JPM) stock? The extent of troubling revelations surrounding the firm’s basic business ethics and risk control practices is astonishing. In recent months alone, JPM has racked up nearly $2 billion in fines, settlements, or refunds for manipulation of energy markets, wrongful debt collection practices, and the “London Whale” trading fiasco that also tallied over $6 billion in losses for the bank. Most consequential, by far, however, is the landmark $13 billion settlement with the Justice Department on charges of fraudulent mortgage-backed securities and bad residential mortgages.

Setting aside several relatively positive environmental and social aspects of J.P. Morgan’s overall ESG profile to focus on core business ethics and risk control concerns, Walden’s decision process has emphasized two primary considerations: the sufficiency of JPM’s response and the effectiveness of investor engagement to encourage better corporate governance.

Walden is encouraged in both the substance and scope of J.P. Morgan’s response. Highlights include:

  • Enhanced board oversight by strengthening the role of the newly titled lead independent director and replacing two board members with new directors who have deeper risk management expertise.
  • Creation of a firm-wide Oversight & Control Group, separately staffed, with strong senior manager accountability structures centrally and in each business line.
  • 4,000 new employees since 2012 dedicated to control initiatives (Risk, Compliance, Legal, Finance, Technology, Oversight & Control, and Audit), and $1 billion in spending on controls in 2013.
  • 750,000 hours of regulatory and control-related training across the franchise along with a 27 percent increase in regulatory and control technology investment since 2011.
  • Simplifying and refocusing business priorities.
  • Working closely with regulators.

Since the 2008 financial crisis, Walden has voted proxies, engaged in dialogue, and filed shareholder resolutions addressing key areas of concern at J.P. Morgan—the lack of an independent board chair (Jamie Dimon serves as both CEO and chair), the need for better alignment of performance and executive compensation, and loan modification and mortgage servicing progress to stem foreclosures. There remains ample room for improvement, but positive momentum exists on all fronts. As described, JPM has taken steps to strengthen board oversight; risk control performance is a component of executive compensation (though still exorbitant, too discretionary, and insufficiently transparent); and substantial progress is being made on mortgage servicing, the area in which Walden has been most focused.

For now, Walden continues to hold J.P. Morgan stock in many client portfolios. In November, Walden and a small group of investors met with key JPM board members and executives to underscore the critical importance of strong internal risk controls and better transparency around its efforts to address concerns. We anticipate many discussions internally as we continue to monitor the bank’s performance and encourage progress.