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Introduction
Jamie Dimon, CEO of Bank One Corporation, sipped his coffee in the boardroom of J.P.
Morgan Chase & Co. while he waited for William B. Harrison, Jr. to arrive. Although the
merger between their two banks wouldnt be finalized for a few more days, he felt at home in
the World Headquarters building at 270 Park Avenue in midtown Manhattan. It was good to
be back in New York. Hed left the city and number two position at Citibank after a falling
out with its CEO, Sandy Weil, in 1999. A year later, Dimon became CEO of Bank One and
moved to Chicago.

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The merger of Bank One and J.P. Morgan Chase would be finalized on July 1, 2004, creating
the second largest financial institution in the world. Mr. Harrison, CEO of J.P. Morgan Chase,
had called the meeting today with Mr. Dimon to discuss the final settlement of the charges
brought by the Securities and Exchange Commission (SEC) and New York State Attorney
General Eliot Spitzer against Banc One Investment Advisors Corporation. As he waited for
Harrison, Dimon went over the events of the last ten months that had rocked the pristine
mutual fund industry. The widespread probe into trading practices could have tarnished Bank
Ones reputation in the financial community. Dimon was relieved that the situation would be
resolved shortly. He was ready to brief Harrison on the final details of the settlement before it
became public.

Background of the Investigation

In September 2003, the mutual fund scandal started when Bank One, Bank of America, Janus,
and Strong Capital came under investigation for improper and/or illegal trading practices.
They were named in a complaint brought by the SEC and Eliot Spitzers office against
Canary Capital Partners. Bank One was the last of the four companies to reach a settlement
with the SEC. Under pressure to reach an agreement before the merger with J.P. Morgan
Chase took place, Bank One agreed to a $90 million settlement. Although the company
neither admitted nor denied wrongdoing, it agreed to pay $50 million in fines and restitution,
and reduce fees charged to investors in its mutual funds by $40 million over the next five
years.
In addition, Mark Beeson, former head of Bank Ones mutual fund division, agreed to pay a
$100,000 fine. He was also banned from the industry for two years. Bank Ones $90 million
settlement was considerably less than the $675 million in fines and restitution that Bank of
America/Fleet Boston paid for its role in the scandal. Like Bank One, Bank of America
reached an agreement with the SEC just before its merger with Fleet Boston took place. Bank
of America paid a higher price because of a broader case in which one of its brokers faced
criminal charges. The scandal spread far beyond the four companies named in the complaint
against Canary Capital. Less than a year after the original charges were brought, dozens of
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mutual fund companies had paid over $2.5 billion in fines, restitution, and fee cuts (Brewster,
2004).
Long known in the financial community for his integrity, Dimon addressed the allegations of
improper trading as soon as they became public in September 2003. Quickly, he developed a
strategy that involved cooperation, transparency, and communication to lead the bank out of
the crisis. He focused on doing the right thing, a value he consistently emphasized at the
bank. In a message to employees, Dimon (September 9, 2003) wrote, At Bank One we talk a
lot about doing the right thing, and I promise we will do the right thing in this situation. In
the same message, Dimon outlined the steps that Bank One would take to respond to the
mutual fund scandal. Echoing the theme of doing the right thing, Dimon wrote, Nothing is
more important to us than maintaining the highest ethical standards. He also emphasized that
the bank took its responsibility to shareholders very seriously. He mentioned that the bank
shared the interest of the New York Attorney General and regulators to safeguard the integrity
of the mutual fund industry. Dimons message to employees established the major
components of his strategy that were followed throughout the crisis:

Do the right thing

Maintain the highest ethical standards
Take the banks responsibility to mutual fund shareholders seriously
Cooperate fully with the New York Attorney General and regulators
Review and evaluate policies and procedures quickly and thoroughly
Take disciplinary action as needed against employees
Make restitution to shareholders
Communicate and promote transparency

Dimon promised a swift and thorough gathering of the facts. In the interest of transparency
and communication, Dimon pledged to communicate with bank employees and mutual fund
shareholders as appropriate, and encouraged bank employees to share his letter with any
Bank One customers who were interested.
However, Dimon requested employees to withhold comment or speculation until the
investigation uncovered the facts. He also asked for their patience, since it would clearly take
some time before the investigation was completed. Throughout the crisis, the bank adhered to
the basic strategy outlined in that letter to employees.
How well did his strategy pay off? Did his leadership, commitment to doing the right thing,
transparent action, and communication help Bank One to regain customer trust and move
beyond the mutual fund scandal?

About Bank One and J.P. Morgan Chase & Co.

Bank One Corporations wholly owned indirect subsidiary, Banc One Investment Advisors
(BOIA), came under investigation in the mutual fund probe. BOIA offered investment
management services, including One Group Mutual Funds, to individuals and companies.
One Group Mutual Funds manage over $100 billion in assets. BOIA, whose headquarters
were in Columbus, OH, registered with the SEC as an investment adviser on November 22,
1991.

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BOIA was a wholly owned subsidiary of Bank One, National Association (Ohio), which in
turn was a wholly owned subsidiary of Bank One Corporation. Before its merger with J.P.
Morgan Chase & Co. on July 1, 2004, Bank One was the sixth largest bank in the United
States, with assets of around $320 billion. Bank One served about 20,000 middle market
clients and approximately seven million retail households. The bank issued over 51 million
credit cards and managed investment assets of about $188 billion.
On July 1, 2004, Bank One merged with J.P. Morgan Chase & Co. The combined financial
services firm had assets of about $1.12 trillion. Operating in over 50 countries, the company
provided financial services for consumers and businesses, investment banking, asset and
wealth management, financial transaction processing, and private equity. With corporate
headquarters in New York, J.P. Morgan Chase would maintain headquarters for U.S. retail
financial services and commercial banking in Chicago (Wall Street Journal Online, 2004).

Situation Leading Up to the Scandal

On September 3, 2003, New York State Attorney General Eliot L. Spitzer and the SEC
brought charges against Canary Capital Partners, a hedge fund, for illegal after-hours trading
and improper market timing.

In this complaint, Bank One and three other mutual fund firms were named for making
special deals with Canary to conduct the improper mutual fund trades. Probes into mutual
fund trading focused on late trading and market timing. Late trading, an illegal practice,
occurs when mutual fund orders that are placed after 4 p.m. are processed at the same day
price rather than the price set on the following day. Law requires that late trades be placed at
the following days price. Although market timing, also known as timing, is not illegal, many
mutual fund prospectuses discourage investors from doing it. Timing involves the rapid
buying and selling of mutual fund shares by short-term investors who try to take advantage of
inefficiencies in the pricing of mutual funds. Timers hope to profit from fund share prices that
lag behind the value of the underlying securities.
Share prices of mutual funds are set at 4 p.m. Eastern Standard Time (EST) based on the
values of their portfolio holdings. Any trades placed after 4 p.m. EST are supposed to be
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charged at the next days prices to keep investors from taking advantage of news that happens
after the close of trading (Carey, 2003).

Like many other funds, One Group Mutual Funds had policies that discouraged market
timing, because it skimmed profits from the accounts of other shareholders. By giving special
permission to certain large investors to market time, BOIA earned higher management fees
from those investors accounts (Lauricella, 2004). Market timing could hurt long-term
investors by driving up costs and reducing their profits (Johnson, 2003).
The rapid in-and-out trading can cause an increase in transaction costs since the portfolio
manager may have to buy and sell securities in response to the hedge funds trades. These
costs are normally borne by the mutual fund. In addition, the dilution effect occurs when the
fund has to pay for the timers profits out of its own finite pool of assets (Carey, 2003).
The profits usually are paid from the funds cash holdings or a sale of securities to cover the
payment. In either case, shareholders are hurt because the total amount of assets available in
the mutual fund is diminished. Some blame the practice of market timing on stale pricing.
Since mutual fund prices are only adjusted once a day, they frequently go out of date, hence
stale. The funds underlying securities change value throughout the day, and may be spread
across different time zones.
Large investors can use sophisticated technology to take advantage of the differences
between the prices of the funds shares and the funds assets (Arizona Republic, 2003). The
effects of Canarys market timing apparently took a toll on Bank One mutual fund managers.
According to the Canary settlement document, the managers complained to One Group
President Mark Beeson about the impact of Canarys timing activity on their funds (Atlas,
2003). In April 2003, Canary stopped trading in Bank Ones mutual funds when Beeson no
longer felt comfortable waiving penalties for their frequent trading.

One Group Restrictions against Timing

Mark A. Beeson held the positions of President and CEO of One Group from January 2000
until his resignation in October 2003. In 1994 Beeson began working at BOIA as the chief
financial officer. After two years he was promoted to chief administrative officer.

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From June 2002 until May 2003, Mark A. Beeson and One Group allowed Canary Capital to
make 300 buy-and-sell transactions in several domestic and international stock funds. Canary
earned a profit of around $5.2 million from this market timing. In addition, Canary was not
charged around $4 million in penalties that it should have paid for market timing (SEC Order,
2004). Prospectuses in the One Group put restrictions on excessive exchange activity in all
the One Group mutual funds. Exchange of any investment in the funds was limited to two
substantive exchange redemptions within 30 days of each other. In November 2001, One
Group set a 2% early redemption fee for any international fund redemption made within 90
days of purchase. It also reserved the right to refuse any exchange request that would
negatively affect shareholders. In fact, over 300 exchange privilege violations were identified
by Beeson and BOIA between January 2002 and September 2003 (SEC Order, 2004). Late in
2001, Edward Stern, head of Canary Capital, made a proposal through Security Trust
Corporation to BOIA.
He offered to borrow $25 million from Bank One and match it with $25 million of his own
funds if he were allowed to trade in certain mutual funds. Beeson refused the proposal several
times. But after talking it over with Security Trust Corporation and Bank One employees,
Beeson decided to consider letting Stern trade in certain Bank One funds in March 2002.
Although Bank Ones chief operating officer advised against it, Beeson allowed Edward
Stern to trade in several domestic and two international funds for up to half of one percent of
the funds value. For trading purposes, Bank One loaned $15 million to Stern, who matched it
with his own $15 million. Stern agreed that the entire amount would stay within Bank One as
security for the loan.
BOIA did not charge Stern the 2% redemption fee normally required for any trade made less
than 90 days after an initial purchase. This would have amounted to around $4.2 million in
redemption fees. In January 2003, Stern received a second Bank One loan of $15 million,
which he again matched with $15 million of his own funds.
He also used this money to trade in One Group funds. Between June 2002 and April 2003,
Stern earned a net profit of about $5.2 million from approximately 300 in-andout trades.
From this arrangement, Bank One gained the interest on the loans and BOIA increased
mutual fund sales and associated fees. According to the SEC settlement document (2004), the
agreements with Canary Capital were never discussed with the One Group Board of Trustees.
Another possible reason why Beeson agreed to the arrangement was the hope of doing future
business with Stern. On several occasions, he discussed Sterns possible investment in a Bank
One hedge fund, but that investment never took place (SEC Order, 2004).
Other customers besides Canary Capital received special treatment from BOIA. Apparently
without Beesons knowledge, a Texas hedge fund was excused from paying the 2%
redemption fee in March 2003. Although the Texas Company invested $43 million in two
international funds and redeemed the investment three days later, it did not have to pay about
$840,000 in redemption fees. BOIA did not reimburse the two international funds for the fees
that it didnt collect. As standard procedure, the portfolio holdings of One Group mutual
funds were considered confidential information that was published only as required by law.
Nonetheless, Stern asked for and received monthly updates on the eight funds in which he
had investments from July 2002 until April 2003 when the relationship ended. Beeson
provided him with this information without any confidentiality agreement. The investigation
also found that BOIA provided One Groups portfolio holdings to other special clients over a
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period of ten years. This information was given out as often as once a week to seven clients,
eight prospective clients, and several dozen consultants from pension funds or fund advisers.
The special trading arrangements for Stern and others began to unravel in July 2003. Noreen
Harrington, a former Hartz investments officer, blew the whistle on improper trading
practices at Canary Capital. She quoted Eddie Stern as saying, If I ever get in trouble,
theyre not going to want me, theyre going to want the mutual funds (Vickers, 2004). New
York Attorney General Eliot Spitzer subpoenaed Stern and named him in a complaint for
having engaged in fraudulent schemes of late trading and market timing of mutual funds.
Two months later, Canary Capital settled with the SEC and
Attorney Generals office for $40 million. Canary agreed to pay $30 million in restitution for
profits gained by improper trading, as well as a $10 million penalty. Canary neither admitted
nor denied wrongdoing.

The Mutual Fund Industry

Shock waves hit Wall Street when Spitzers investigations began into trading abuses in the
mutual fund industry. Few outside the financial community expected to see a scandal occur
there. As the probe continued, it uncovered improper trading practices at dozens of mutual
fund companies. New York Attorney General Eliot Spitzer called the industry a cesspool
(Waggoner, Dugas & Fogarty, 2003).

Half of the 88 largest mutual fund groups had permitted favored investors to buy mutual fund
shares at stale prices, skimming profits from long-term shareholders (Quinn, 2003). Pricing
had been an issue in the mutual fund industry for a long time. In the 1930s, mutual funds
often had two prices: a public price, as well as a more up-to-date price that a few big
investors could access just before the price became public. The privileged investors who
knew where mutual fund prices were going could make fast profits. In response, Congress
passed the Investment Company Act of 1940 in an attempt to make mutual fund pricing
policies fairer. Among other rules, it required funds to have just one public price.

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According to Mr. Spitzer, mutual fund companies made over $50 billion in management fees
in 2002. He was the first to suggest that the widespread practice of preferential trading for big
investors could be channeling billions of dollars away from everyday long-term investors in
mutual funds. Mr. Spitzer commented on ways that companies could make amends. If
theyre expecting to get settlements (with regulators), theyre going to have to give much
more back than just (investors) losses.
Theyre going to be paying stiff fines and giving back their management fees. They violated
their trust with the American investor (Gordon, 2003). Spitzer also expressed dissatisfaction
with the SECs oversight of the industry. Paul Roye headed the mutual fund division of the
SEC. Heads should roll at the SEC. There is a whole division at the SEC that is supposed to
be looking at mutual funds. Where have they been?
According to SEC Chairman William Donaldson, the SEC was considering new curbs on
fund trading (Gordon, 2003). The question remained how the scandal would affect the mutual
fund industry. Arthur Levitt, former SEC chair, said, This seems to be the most egregious
violation of the public trust of any of the events of recent years. Investors may realize they
cant trust the bond market or they cant trust a stock broker or analysts, but mutual funds
have been havens of security and integrity (Lauricella, 10/20/03). How many of the 95
million customers would cash in their shares?
Investors apparently didnt lose faith in all mutual funds. John C. Bogle, founder of the
Vanguard Group, believed that money was flowing out of companies that had lost investor
confidence and into companies that had kept their good reputations for being well managed
or holding down costs and fees (Lauricella, 10/20/03).

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