TheChek News Flow

Thinking of Buying Nike Shares? Just Don’t

As Adidas picks up the pace, Nike is losing ground in the sneaker race. Its stumbling stock could fall another 10%.

Nike had a great run for much of its storied history. An investor who bought $1,000 worth of stock in 1980, when the company went public, would have had more than $700,000 at the end of 2015. Since then, however, the footwear giant has been losing traction with buyers of both its sneakers and shares, and there is little sign these trends will reverse soon.

Nike shares (ticker: NKE) have skidded 16% since the end of 2015, to a recent $52, and could fall another 10% or more in the coming year. The problem is twofold: The growth of e-commerce has rattled Nike’s retail partners, including Foot Locker (FL). And Germany’s Adidas (ADS.Germany), which finally figured out how to sell sneakers in the U.S., has become a formidable foe. Adidas, whose shell-toed Superstar was the best-selling sneaker of 2016, saw its market share more than double since 2015 at Nike’s expense. The German company looks likely to continue its U.S. climb for years.

That poses problems for Nike shareholders, especially with the stock selling for 22 times estimated earnings for the current fiscal year ending in May 2018, a premium of 15% or so to the broad U.S. market. A lofty price/earnings ratio was an appropriate fit for Nike’s peppy earnings growth in recent years, but it now looks excessive relative to this year’s projection for an earnings decline.

For the next fiscal year Wall Street is looking for earnings to rebound, but the consensus, now $2.78 a share, has been sliding all year. That suggests there will be a better time to own the shares, possibly in a year or two, either when Nike has proven it can better defend itself against Adidas, or when its stock carries a humbler price. Long-term Nike investors should lock in profits, and short-term investors should take losses.

ONE CHALLENGE facing Nike is the company’s relatively high exposure to performance basketball shoes, which sold well in the three years that ended around mid-2015. They have since fallen out of favor as retro styles and sports-inspired shoes for casual wear have taken off. In Foot Locker’s latest earnings call, second-quarter revenue and earnings missed estimates by enough to send the shares 28% lower in a day—and the retailer cited Nike’s Jordan shoes as an example of a line for which demand had suddenly slowed. But Foot Locker Chief Executive Richard Johnson also spoke more broadly about “the limited availability of innovative new products in the market.” That’s telling, considering that 68% of Foot Locker’s merchandise last year came from Nike.

Fashion brands that miss a trend can get back on track, and Nike has had some successes. A new line of running shoes called VaporMax has been well-received. Direct sales through Nike’s website and app have been growing, and Nike, based in Beaverton, Ore., has undertaken what it calls a manufacturing revolution designed to get fresh designs to market faster. Two months ago, Barron’s recommended shares of Flex (FLEX), an electronics manufacturer which has expanded into new goods, including Nike sneakers. Flex has already produced a million pairs of sneakers, and in two or three years, supply-chain improvements could help Nike respond to changing trends more quickly.

For now, though, Nike faces an uphill path. Adidas’ North American sales jumped 45% in the latest quarter; Nike’s were flat. Healthier markets for Nike, such as China, aren’t yet large enough to compensate for challenges in North America, which accounts for 44% of Nike’s revenue. Analysts are forecasting a 6.6% drop in earnings this year, to $3.96 billion, or $2.41 a share, and a 4.7% increase in revenue, to $36 billion.

Nike executives didn’t respond to a request for comment.

FOR BRANDS, A SALES slump can set off a dangerous cycle as retailers cut back on shelf space to favor more popular products. But that can put retailers, such as Foot Locker, in a bind, too. The footwear chain has long had a symbiotic relationship with Nike; it receives plenty of exclusive models, giving it some protection against discount competition, and Nike in turn maintains a willing buyer. If Foot Locker shifts its mix toward Adidas, it risks damaging its relationship with Nike. Those challenges are partly reflected in its humble stock valuation of nine times earnings. To reignite sales growth, Nike could make more models for casual wear, but if it does so too quickly, it could alienate the jocks on which its business still relies.

In many ways, though, Nike’s sales problems are less about fashion missteps than about what Adidas is suddenly doing right. When Jefferies analyst Randal Konik lowered his rating on Nike stock last month to Hold from Buy, he cited a raft of odd statistics that together explain the issue. Mentions of Adidas have soared on the earnings calls of sporting-goods retailers. So have online search queries focused on Adidas. Plus, Adidas prices have ballooned on secondary sneaker markets.

JUST WHAT ARE secondary sneaker markets? They are websites like StockX.com where sneaker enthusiasts, who sometimes call themselves sneakerheads, list popular models for sale. Sometimes, these are models that shoe brands have released in limited quantities for the purpose of generating price spikes and buzz. Konik notes that Adidas Yeezy shoes, part of a collaboration with rapper Kanye West, recently fetched a 220% premium to their retail price at StockX, while Nike’s KD sneakers, backed by basketball player Kevin Durant, recently sold for a 140% premium.

A precise gauge it isn’t, but what is telling is that Adidas premiums and market share have been rising. In January 2015, Adidas was nearly absent from secondary markets. Suddenly, it makes up 45% of sales there.

Adidas had a false start in the U.S. market back in 2005, when it arguably paid a sneakerhead premium of its own, scooping up Reebok for $3.8 billion, 34% above Reebok’s stock price before the deal was announced. The move combined Adidas’ 10% U.S. market share with Reebok’s 8%, providing the heft to take on Nike in its home market. Or at least, that was the idea. By 2014, Under Armour (UAA) had passed Adidas to become the No. 2 U.S. sportswear brand. By 2015, Adidas’ U.S. sneaker share had collapsed to 4%, and Reebok’s to 1%. But changes were afoot.

One was the 2014 appointment of Mark King as president of Adidas Group North America. King came from TaylorMade-Adidas Golf, where he had doubled sales since 2003 by besting rival Callaway Golf (ELY) on product development and marketing. Adidas also moved its design operations away from its corporate base of Herzogenaurach, Germany, where in 1920 founder Adolf “Adi” Dassler had designed his first sports shoe in his mother’s laundry room. Charming it may be, but the sleepy Bavarian town was an odd fit when recruiting young designers, so Adidas opened a global design headquarters in Portland, Ore.—a half-hour drive from Nike’s headquarters. It also made an American, Paul Gaudio, global creative director. Gaudio has focused on moving beyond performance to create sneakers that serve as fashion statements, too, thereby expanding Ahassle didas’ reach from athletes to students, hipsters, techies, and others.

“Adidas finally did what everyone had been asking them to do and made products appropriate to the U.S. market,” says Matt Powell, a sports-industry analyst at NPD Group, a market researcher. “At the same time, Nike made products that weren’t appropriate.”

AT THIS POINT, IT is difficult to tell whether Adidas helped set off a fashion shift from sneakers built for dishing and dunking to footwear that wears well at the local latte house, or simply anticipated the trend. But it has benefited from less exposure than Nike to the athletic market and more exposure to shoes like the retro Superstar, once worn by L.A. Lakers big man Kareem Abdul-Jabbar, and the NMD, a street sneaker with performance cushioning. Adidas’ U.S. market share has jumped to 11.3% from 6.3% in the past year, while Nike’s has slipped to 46.5% from 50.7%. What has to concern Nike about those numbers isn’t just the speed of the shift, but the fact that Nike is still four times the size of Adidas in the U.S., potentially leaving plenty more share for Adidas to gain as it makes simple changes, such as entering more stores.

Meanwhile, Adidas is taking more substantial steps. It has quadrupled its deals with National Football League players and tripled those with Major League Baseball stars, while signing up college partners such as Arizona State University and the University of Louisville. Long term, the presence of another big bidder besides Nike could help to push up the price of endorsement deals.

To keep a close watch on fashion trends, Adidas opened a new design hub in Brooklyn, N.Y., last year.

“We intentionally put the Brooklyn Creator Farm in the heart of one of our key cities, at the ground level of culture, so we can better connect with the U.S. consumer,” explained Adidas Chief Executive Kasper Rorsted in an email exchange with Barron’s last week.

Adidas also has expanded its Portland footprint and doubled its head count there in the past three years. “There has never been more focus on the U.S. throughout the company,” writes Rorsted.

Reebok isn’t enjoying the same star turn as Adidas, and investors want Adidas to sell it. The company says it can turn the brand around. In the meantime, it is getting more focused on core businesses. In May, it announced the sale of TaylorMade, including the Adams Golf and Ashworth Golf brands, to New York–based private-equity firm KPS Capital Partners, for $425 million.

Across the apparel and footwear industry, Amazon.com (AMZN) looms large. It captured 7.4% of the U.S. apparel market last year, second only to Wal-Mart Stores (WMT), according to Morgan Stanley. Online shopping for clothing and footwear is a mixed bag. Customers can search for sizes, styles, and markdowns with ease, but they risk the of return shipping because they can’t try things on.

Amazon offers free two-day shipping for Prime customers and free returns on many garments and shoes. This summer Amazon launched Prime Wardrobe, “the fitting room that fits into your life.” Customers select three or more items across clothing, shoes, and accessories, try them on at home, leave what they want at their doorstep in the return-ready box, and pay for what they keep, minus 10% if they keep three or four items, and 20% for five or more.

Nike announced this summer that it will begin dabbling in direct sales through Amazon. A recent search for men’s athletic shoes offered on Prime Wardrobe turned up 19 Nike models out of more than 3,000, including hundreds apiece for Adidas, New Balance, and Puma (PUM.Germany). Ultimately, Nike would like to grow its direct sales on its home turf, at Nike.com. But long term, it could have a difficult time matching Amazon’s shipping might. Nike.com orders ship free for those who spend $150 or sign up for a free NikePlus membership, but delivery typically takes two to four days, according to Nike.

There are other risks that could affect all sneaker players. One is a price war. On an Aug. 15 earnings call, Dick’s Sporting Goods (DKS) discussed fierce price competition that started around June among both retailers and footwear brands selling directly. “If we’re going to get into a price war, we’re going to get into a price war, and that’s what’s happening,” said Chief Executive Edward Stack.

Investors didn’t love it; Dick’s shares plunged 23% in a day. Under Armour could be one culprit. It has struggled to extend its past strength in snug workout clothes into a foothold in athletic shoes. In the latest quarter, it reported a 2% footwear sales decline on the heels of a 58% jump the year before, and wrote down inventory. Under Armour shares dropped 9% in a day. A Dick’s circular last week touted hefty markdowns on Under Armour apparel and shoes.

THEN THERE’S THE possibility that some sales tactics have gone cold. To drum up enthusiasm for its LeBron 14 shoes this year, Nike bundled a limited number for auction on StockX, with replica championship rings and boxes made from floorboards taken from the Quicken Loans Arena home court in Cleveland that LeBron James played on last year. The packages fetched thousands of dollars. But when Nike released the model more widely, it did so at $175, down from $200 for the LeBron 13.

Adidas’ Rorsted calls limited releases “terrific drivers for our brands,” but notes that they don’t contribute much to growth. In its latest earnings call, Foot Locker, which in past years attracted launch-day lines like Apple (AAPL) after an iPhone refresh, described a shift in sentiment. “The old multiseason seed, ignite, and rollout of key footwear platforms just doesn’t work as effectively anymore,” said Foot Locker CEO Richard Johnson.

But then, Adidas doesn’t seem to be struggling. Its shares trade at an ambitious 29 times earnings. Wall Street reckons the company’s earnings per share could double in four years. The stock isn’t an obvious bargain, but if we had to choose, we’d rather lace up with Adidas’ pricier shares than bet on a quick turnaround at Nike.

What a Correction Will Look Like

While a bear market might not be imminent, would anyone be surprised if the market took a sudden sharp drop?

Maybe it’s the lingering effects of last week’s cover story on bear markets (“How This Bull Market Will End,” Sept. 1), but I have corrections on the mind.

While a bear market, defined as a drop of 20% or more, might not be imminent, would anyone be surprised if the market took a sudden sharp drop—the kind we saw in August 2015, when the S&P 500 dropped 12% on concerns about China’s currency devaluation, or the 12% decline that greeted the start of 2016?

We’re certainly overdue for something. Since the start of 2010, the S&P 500 suffered drops of at least 10% in every year except 2013 and 2014, according to Strategas Research Partners, and even in those years it had drops of 6% and 7%, respectively. This year, the biggest peak-to-trough decline has been about 3%. No wonder I feel the need to look over my shoulder.

The good news: When a correction comes—and it will come—it’s likely to be a buying opportunity as long as the economy continues to hold up.

It isn’t just the market’s lack of progress—the S&P 500 has gained just 1% over the past three months—or the headlines that have us worried that a setback could be in the offing. Technical indicators used by some of our favorite investors are also pointing to a potential setback. For instance, the Leuthold Group’s Major Trend Index registered a neutral reading on Aug. 11 after a 13-month bullish streak. “We believe this bull market still has legs,” Leuthold’s Doug Ramsey wrote to clients last week. “But so too might the minicorrection that’s hit mainly the secondary stocks thus far.”

What will a correction look like? To state the obvious: It will start with something smaller, like a drop below the S&P 500’s 200-day moving average. It has traded above that trend indicator for 303 days, only the 15th streak of at least 300 days since 1937, according to Bespoke Investment Group data. Some streaks last far longer—the S&P 500 traded above its 200-day moving average for 627 days in a streak that ended in May 1956—but others ended shortly after hitting the 300-day mark. 2004’s streak ended at 313 days. And it wouldn’t even take a correction to get the S&P 500 to drop below its 200-day moving average, as the S&P 500 closed on Friday just 4% above the metric.

Such a break, however, doesn’t usually signal the end for a bull market. While the S&P 500 has dropped 0.9% on average during the week following such a fall, it has gained 1.1% on average during the following month. “A break below the 200-day will likely be accompanied by weakness in the very near term, but nothing more than that,” says Bespoke Investment Group co-founder Paul Hickey.

And if the selloff morphs into a correction? Since 1989, the S&P 500 has suffered drops of 10% or more 11 times without a recession or bear market, with an average tumble of 14.2% lasting 2.4 months, according to Strategas Research Partners’ Nicholas Bohnsack. Yet it didn’t take the market too long to make back those losses once a bottom was reached. The S&P 500 followed those declines by rallying 16.5% during the following three months, Bohnsack says.

Stocks with high shareholder yields, strong profit margins, and high returns on invested capital or equity have outperformed during corrections, Bohnsack notes, while the market’s more volatile and heavily shorted names have underperformed. He created a list of companies that meet characteristics that should outperform during a pullback, one that’s heavy on tech names like Apple (ticker: AAPL) and Microsoft (MSFT), as well as health-care companies like Johnson & Johnson (JNJ) and Amgen (AMGN).

Amgen in particular looks interesting. Last Thursday, it released positive results from a Phase 2 study on its antimigraine treatment Aimovig, data that helped send the stock up 1.3% that day. But it isn’t just the fundamentals that make Amgen look interesting. It trades at just 14.5 times 12-month forward earnings, well below the S&P 500’s 18 times. And last week it closed at $180.64, the third time this year it has closed near its all-time high of $182.66. The last two times, Amgen was rebuffed. Could the third time be a charm?

Swatting the Activists

Not only are activists being snubbed, but some are even being greeted with a little mockery to boot.

Activist investors are on the verge of becoming the punchline of their own joke.

It wasn’t that long ago—just two years ago, in fact—that just the very hint that an activist investor was sniffing around could be enough to send management scurrying off to do their bidding—or act on the activist playbook before they arrived.

No longer. Now, not only are activists being snubbed, but some are even being greeted with a little mockery to boot. Shareholders, though, can relax and enjoy the entertainment, knowing that just the activists’ existence could help support a stock.

It was only three months ago that we marveled at how activists were running into roadblocks. Greenlight Capital’s David Einhorn had been brushed off by General Motors ( GM ), and Buffalo Wild Wings (BWLD) had tumbled after Mercato Capital successfully agitated to add four board members. Since then, Procter & Gamble (PG) has pushed back—hard—against Nelson Peltz’s Trian Partners’ plan to reorganize the company, while Ackman has targeted Automatic Data Processing (ADP), only to get called a “spoiled brat” by its CEO. “Companies don’t care,” says Ian Winer, head of equities at Wedbush Securities. “They’re willing to wait it out.”

And time may be on their side. For Peltz and Ackman to have any chance of getting their board seats, they need to get shareholder buy-in. But there’s one group of shareholders who won’t side with them no matter what—the index funds that hold large positions in both companies. Vanguard, BlackRock, and State Street own nearly 18% of Procter & Gamble and 19% of ADP. These investments are largely passive, which means by definition that they will side with current management, making it much harder to get the votes needed for change. “Where do you think you get a board seat if you aren’t going to be able to get the votes?” Winer says.

It’s also fair to ask if either company needs the help that Ackman and Peltz are offering. ADP, for instance, has returned 59% during the past three years, nearly twice the S&P 500’s 31% return—and better than Ackman’s hedge fund, which ADP’s management was quick to point out. Just last week, it thanked Ackman for his time but refused to budge on adding him to its board.

Procter & Gamble is more complicated. Its stock has certainly underperformed—returning just 22% over the past three years—but it is also in the process of making many of the changes Peltz would like it to make. Nor does Peltz appear to be trying to break the company up or oust its CEO. But that doesn’t mean that his agitation won’t benefit P&G, says Jefferies analyst Kevin Grundy.

How is that possible? In a note to clients last week, Grundy noted that Peltz’s presence might be a distraction, but it will also force Procter’s management to be more accountable in its plans to drive cost savings, and also get it more focused on executing. That’s “the proverbial ‘win-win’ for shareholders,” Grundy says. Peltz’s activism might place a floor under Procter’s stock, as any missteps would probably draw calls for more change. Put that all together, and Grundy expects the shares to hit $103, up 11% from Friday’s close of $92.84.

Says Grundy: “P&G remains a good place to be.”

The Trader: Even Hurricanes Can’t Kill Off This Rally

ASML and SAP: Euro Tech Stocks in the FANG Class

The chip-equipment leader and software powerhouse are technology pacesetters with room to grow. There aren’t many in Europe.

A frequent complaint is that the run-up by the FANG stocks appears overdone.

Whether that’s true or not, investors still want to hold big tech names showing solid growth. As a result, there are all sorts of efforts to identify such companies, while steering clear of the usual U.S. suspects— Facebook (ticker: FB), Amazon.com (AMZN), Netflix (NFLX), Google parent Alphabet (GOOGL), plus Apple (AAPL), and Microsoft (MSFT).

Dutch chip-making equipment provider ASML Holding (ASML.Netherlands) and German software giant SAP (SAP.Germany) just might fit the bill. They are pacesetters with room to run, according to Benjamin Segal, portfolio manager for the Neuberger Berman International Equity fund, which counts those two stocks among its largest holdings. “When you come to Europe, you’ve got essentially those two companies that are leaders in their industry,” he says, in discussing stocks on par with the FANG gang. “The rest of European technology is basically consulting firms.”

Scandinavia’s Nokia (NOKIA.Finland) and LM Ericsson (ERICB.Sweden) are big tech names, but Segal advises avoiding them, saying they’re essentially suppliers to the telecom industry, which isn’t inclined to spend lavishly these days. They also face stiff competition from Chinese rivals that are state-influenced, have low costs of capital, and don’t share the same profit motive.

“When you’ve got a big competitor that isn’t looking at profits, and you’ve got a very price-sensitive set of customers, that isn’t a particularly appetizing recipe for sustainable returns,” says the portfolio manager.

Neuberger Berman prefers to buy dominant players in the higher-margin software industry, such as SAP. It’s also bullish on ASML, even though the company sells hardware, producing lithography equipment for semiconductor manufacturers. That’s because ASML has a lead in its sector thanks to its innovative extreme ultraviolet (EUV) technology, he says. Plus, demand for chips looks set to remain strong thanks to an expected boom in connected devices, the so-called Internet of Things.

“There is such ongoing demand and investment for semiconductors as we move into an IoT world, where we’re going to have chips in the toaster, the refrigerator, the car, our cattle, the supply chain, and everywhere,” he says.

He isn’t alone in highlighting European players benefiting from the IoT. Chip companies like Austria’s ams (AMS. Switzerland) and Switzerland’s STMicroelectronics (STM) “tend to fly beneath the radar,” but they’re “playing a pivotal role in this technological revolution,” says Anis Lahlou-Abid, co-manager of JPMorgan Asset Management’s Europe Technology Fund, in a recent commentary for Financial News.

ASML shares have appreciated from 107 euros to €133, a year-to-date gain of more than 40%, so they’re no steal. The company trades around 30 times earnings and 26 times forecasted forward-year earnings, well above Japanese rival Canon’s (CAJ) 21 and 19, respectively. Yet Neuberger’s Segal isn’t fazed by the price. He says it will take time for ASML to step up deliveries for its EUV systems, and investors are anticipating the ramp-up.

“It’s 30 times this year, but it’s 24 times next year, and it’s 19 times the next year. So your multiple compresses by 40% in two years, and that’s because of the growth you’re getting,” he says. Investors are betting the company “is going to deliver two, three, or four pieces of equipment in the next couple of years, but in 2019 or 2020, it’s going to be 10, 15, or 20 pieces of equipment.”

RISKS FOR ASML, which also trades on the Nasdaq through American depositary receipts, include the possibility that major customers such as Intel could slash their spending on equipment because of a financial crisis or other shock. The company could also stumble from manufacturing problems or a competitive breakthrough product.

Neuberger Berman likes SAP due in part to its broad suite of enterprise resource-planning software, as well as a migration to the cloud that has made it easier for smaller companies to use SAP and Oracle’s (ORCL) offering, broadening that market. “The enterprise software market is growing, and SAP’s share within that market is, too,” Segal says.

SAP shares trade at €90, or 20 times forecasted forward-year earnings, above Oracle’s P/E of 17. That valuation is “more than reasonable” for a business “growing organically and sustainably at close to 10% in a low-growth world,” Segal says. The stock is up roughly 9% in 2017, after pulling back since June as investors expressed disappointment about SAP’s profit margins. “The one caveat that we have with SAP is that margins haven’t expanded to the extent that you would expect,” Segal says. It should happen soon, but it’s a big problem if it doesn’t, since it’s been a key expectation among bulls, he adds.

IN EUROPEAN MARKETS LAST WEEK, the major benchmarks were mixed, with the pan-European Stoxx Europe 600 index edging lower by 0.18%. The European Central Bank made no change to interest rates or its bond-buying program, as expected, but it hinted at an update in October.

Four years ago, JPMorgan Chase reached a then-record settlement with the Department of Justice after, among other things, the bank received a copy of a U.S. attorney’s draft complaint documenting its alleged role in underwriting fraudulent securities in the years leading up to the 2008 financial crisis. Following the bank’s $13 billion financial agreement, the draft complaint was never filed. Then the bank paid another settlement to prevent a separate legal case from potentially unearthing it. The contents of the draft complaint have long been a financial-crisis mystery, a Great White Whale of a document. At least until now.

In November 2013, JPMorgan Chase, the nation’s largest bank, agreed to pay a then-record $13 billion fine to federal and state authorities in order to settle claims that it had misled investors in the years leading up to the financial crisis. JPMorgan Chase’s settlement raised many eyebrows on Wall Street. The huge settlement appeared inconsistent with the oft-repeated narrative of the bank’s heroism during the crisis. JPMorgan Chase and its C.E.O., Jamie Dimon, after all, were appropriately lauded for swooping in to save both Bear Stearns and Washington Mutual, acts of financial patriotism that certainly helped prevent the U.S. economy from further doubling over upon itself.

But people wondered why one of Wall Street’s ostensible white knights would pay $13 billion—$9 billion of its shareholders’ cash, plus another $4 billion in mortgage relief—in a government case. During a conference call on the morning that the settlement was announced, Mike Mayo, a veteran Wall Street analyst, asked Dimon and bank C.F.O. Marianne Lake the question that appeared to be on the minds of everyone in the financial-services industry: “How is it that JPMorgan got front and center with this issue? That it’s the Department of Justice working out an agreement with JPMorgan when JPMorgan performed so well during the crisis, yet here’s the one bank that’s paying a $13 billion fine?” Without missing a beat, Dimon retorted, “Mike, you’ve got to ask them, O.K.?” In other words, Dimon seemed to be saying to Mayo, as he later put it in Davos, that the whole thing was “unfair.”

A number of clues about what had forced Dimon’s hand, however, began emerging soon after the conference call. As I reported in The Nation in 2014, JPMorgan Chase’s settlement came at the end of an intense series of negotiations with a wide range of government officials. Perhaps the most pivotal moment in the conversations occurred in September 2013 when D.O.J. lawyers shared with Dimon and his attorneys a draft of a 92-page civil complaint that Benjamin B. Wagner, the then U.S. attorney in the Eastern District of California, and his colleagues were prepared to file in federal court. The draft complaint—based upon hundreds of thousands of subpoenaed internal JPMorgan documents; and interviews with its bankers, employees in its mortgage-backed securities division, and third-party mortgage originator—alleged that the bank’s due-diligence process had been subverted, and ignored, during the years before the crisis. In Wagner’s narrative, the bank was not nearly the white knight of Wall Street.

No one knew precisely what Wagner’s investigation had uncovered about JPMorgan Chase, however, because his brief was never filed publicly. Within weeks of Wagner sharing a draft copy of the complaint with Dimon—and following a tense face-to-face meeting at the Department of Justice between Dimon and Eric Holder, then the U.S. attorney general—the two sides agreed to the $13 billion settlement, at the time the largest ever. (It has since been surpassed by Bank of America’s $16.65 billion fine, settling similar claims.) In return, the Department of Justice agreed with Dimon and JPMorgan Chase that, among other things, it would not file Wagner’s complaint. Instead, an anodyne 11-page “Statement of Facts” was released. But it didn’t offer a tremendous amount of insight. “Much of it was the same-old-same-old, a not-very-lively description of a corrupted Wall Street mortgage factory,” wrote Gretchen Morgenson in The New York Times, “based largely on some facts that have been in the public domain for years.”

Wall Street C.E.O.s have many reasons for using their shareholders’ money to settle nettlesome lawsuits—from “optics” and brand preservation, to boosting their stock price and keeping embarrassing facts out of the public’s hands. And in the wake of his bank’s $13 billion settlement, Dimon made clear that he was frustrated that the bank had to settle. At a Microsoft C.E.O. summit, Dimon confessed that he “had to control his rage” regarding the topic.

To keen observers, though, it also seemed that he and JPMorgan Chase appeared intent on keeping Wagner’s unfiled complaint out of the public record. The specter of the document becoming public was again raised in a separate court case, when, a few weeks after the Department of Justice announced the settlement with JPMorgan Chase, lawyers for the Federal Home Loan Bank of Pittsburgh, which had sued JPMorgan Chase’s investment bank, along with other defendants, alleging it had sold the bank more than $1.7 billion in squirrelly mortgage-backed securities, wanted a copy of Wagner’s complaint. In fact, a state judge in Allegheny County, Pennsylvania, ordered the bank to turn over the draft complaint. But JPMorgan Chase settled the litigation after the judge’s ruling—a settlement that, among other things, included a provision that the draft complaint was to remain private. (Disclosure: after JPMorgan Chase fired me as a managing director in January 2004, I brought—and lost—an arbitration claim against the bank. I also remain in litigation with the bank as the result of a soured investment I made in 1999.)

Now, nearly four years later, as part of a Freedom of Information Act lawsuit initiated by Daniel Novack, an enterprising First Amendment attorney in New York City, the D.O.J. sent Novack a partially redacted copy of Wagner’s curiosity-stoking draft complaint against JPMorgan Chase. Novack provided a copy of the partially redacted complaint to me. “By this action,” the draft complaint begins, “the United States seeks to recover civil penalties” against JPMorgan Chase and its investment banking arm “for a fraudulent and deceptive scheme to package and sell residential mortgage-backed securities” that the bank “knew contained a material amount of materially defective loans.” As the unfiled complaint continued, “JPMorgan knowingly securitized and sold billions of dollars of mortgage loans that were originated in material violation of underwriting guidelines and law.” (When reached for comments and responses to the various allegations in Wagner’s unfiled brief, a spokesperson for JPMorgan Chase told me, “These allegations have been addressed, resolved, or refuted years ago.”)

Wagner’s unfiled brief catalogs behavior rather at odds with the public narrative about the bank in the years preceding the crisis. It further asserts that JPMorgan Chase knew that “many of these loans were tainted with fraud” and “knowingly misrepresented” that the loans met its underwriting guidelines, even though they clearly did not, and that the loans had sufficient equity value to collateralize the mortgages even though they did not. Notably, Wagner’s complaint argues that “these fraudulent misrepresentations” cost investors “to suffer billions of dollars in losses.”

Wagner wrote in the unfiled complaint that, according to his investigation, Christine Cole and Bill King, managing directors at JPMorgan Securities, ran the Securitized Products Group inside the investment bank that manufactured and sold the tainted mortgaged-backed securities in hopes of generating fees that would lead to large end-of-year bonuses for them and other members of the group. The bonuses ranged into the millions of dollars, and could be many times the size of the bankers’ and traders’ salaries. Between 2005 and 2007, Wagner wrote, “the year-end bonuses of the traders and salespeople rose significantly, in correlation with the spike in volume of [residential mortgage-backed securities] issuances at JPMorgan.”

The unfiled complaint also alleges that the JPMorgan Chase bankers and traders acquired mortgages from third-party originators with the sole intention of packaging up the mortgages into securities and selling them off quickly to investors in exchange for large fees. Wagner wrote that the bankers, traders, and employees responsible for carefully scrutinizing the mortgages being packaged up and sold knew they were acquiring loans with material defects that would be securitized and sold to investors. The bank, the unfiled brief continues, “ignored its due diligence findings and securitized materially defective loans” and “knowingly purchased and securitized loans with material credit and compliance defects.” The document further alleges that the bank, and its employees, knowingly sold mortgage-related securities with “inflated appraisals” and that “ignored internal controls” and that it “intentionally misrepresented” to investors “the quality of the loans” in offering documents, filed with the Securities and Exchange Commission, for the securities.

Worse, the unfiled brief notes, the bank continued to sell mortgage-backed securities even though Dimon himself was worried that the residential mortgage-backed securities market was about to crash. According to Wagner, during the second week of October 2006, Dimon allegedly told King, the co-head of the Securitized Products Group, that he needed to “watch out for subprime”—a reference to low-quality mortgage-backed securities—because he feared that the market “could go up in smoke.” The document also notes that Dimon wanted King to reduce the bank’s exposure to that market. The “impetus” for Dimon’s concern, Wagner continues, was his review of reports from the mortgage-servicing arm of the bank that showed that delinquencies on such mortgages “were rising at an alarming rate.” At Dimon’s “insistence,” the unfiled complaint asserts, “JPMorgan formulated an exit strategy to divest itself” of the riskiest pieces of mortgage-backed securities that had been accumulating on its balance sheet. But, Wagner writes in the draft complaint, “despite knowledge at the highest levels that underwriting had deteriorated across the industry and early payment defaults were spiking, JPMorgan continued to purchase and securitize subprime loans without addressing the known breakdown of its due diligence practices and without disclosing its knowledge to investors.” This is pretty much the exact same thing that Goldman Sachs did leading up to the financial crisis, a practice for which the bank was roundly criticized.

Wagner’s unfiled complaint provided details on 10 allegedly fraudulent mortgage-backed securities that JPMorgan Chase underwrote and sold to investors. (Four of the 10 examples were redacted in the copy the D.O.J. provided to Novack and that Novack provided to me, because “the D.O.J. contends that these paragraphs contain information pertaining to an ongoing investigation,” according to a recent ruling in Novack’s case.)

The draft complaint further stated that the 10 examples “do not encompass the full extent of JPMorgan’s fraudulent scheme.” In one un-redacted example, the U.S. attorney’s office in the Eastern District of California described what happened to a $1 billion security that JPMorgan underwrote in August 2006 that contained more than 5,500 mortgages issued by Countrywide Financial, then an independent public company (and now part of Bank of America). Prior to purchasing the Countrywide pool, one-quarter of the loans were tested by an independent third-party consultant hired by JPMorgan. The third-party evaluator’s report, received by JPMorgan in May 2006, showed that up to 17 percent of the mortgages contained “material” defects, including “excessive” loan-to-value ratios, “incomplete or defective” appraisals, and missing verifications of income, employment, or assets at closing, among other problems.

According to Wagner’s draft complaint, after JPMorgan received the third-party report showing the defects in the mortgages, the company’s bankers “manipulated” the results by re-categorizing the defective mortgages because of “missing documents,” which lowered their risk assessment and made them appear to comply with the bank’s underwriting standards. But, according to Wagner’s unfiled complaint, “these missing documents were not delivered” and despite “knowledge of the material defects in the Countrywide pool,” JPMorgan Chase nevertheless bought 99 percent of the mortgages, and securitized all but seven of them into what became known as JPMAC 2006-CW2. Furthermore, the bank “did not inform investors of material amount of materially defective loans” that created the security. Wagner’s complaint, drafted seven years after the security was issued, noted that JPMAC 2006-CW2 “has suffered hundreds of millions of dollars in cumulative lost principal balance, and more losses are projected.” The complaint noted that although the top tranches of the security were once rated AAA, they had since been downgraded to “junk bond” status or below. And some had defaulted.

In another un-redacted example from Wagner’s complaint, a mortgage-backed security that JPMorgan Chase underwrote in February 2007—relatively late in the cycle—for some $980 million contained around 35 percent of mortgages originated by GreenPoint Mortgage Funding, Inc. The mortgages, which were drawn from two pools with unpaid principal balances of $459 million and $300 million, respectively, had many of the same underwriting flaws as found in the Countrywide mortgages. Once again, JPMorgan hired a third-party consultant to look at a sample of them and to report back to it about their quality. Approximately 25 percent of the sample evaluated came back as containing unacceptable risks because of the low quality of the initial underwriting. According to Wagner’s draft complaint, “JPMorgan had knowledge that a substantial portion of the loans did not comply with the originator’s underwriting guidelines and had a substantial risk of default.” The bank packaged up the GreenPoint mortgages and sold them anyway. In the end, investors suffered “hundreds of millions of dollars” of losses on that one security. In all, the unfiled document concludes, JPMorgan Chase and its investment bank “reaped substantial profits from their fraudulent scheme, having sold over $25 billion in nonprime RMBS”—residential mortgage-backed securities—“certificates backed by toxic loans.”

Mythmaking is a blood sport on Wall Street, and few are better at the game than Dimon. While Dimon has not been shy about criticizing Donald Trump and his many offensive policy proposals, it is worth recalling that he was considered a leading candidate to be Trump’s Treasury secretary and served on the president’s Strategy and Policy Forum (until he resigned last month in protest of the president’s response to Charlottesville). One of Dimon’s main jobs as C.E.O. is to find his successor, but so far one top executive after another has left the firm, with many of them becoming C.E.O.s at other financial institutions. (Matt Zames, the bank’s 46-year-old chief operating officer, became the latest Dimon heir apparent to leave JPMorgan Chase when he departed unexpectedly in June. “We have huge success and great people for succession of the bank,” Dimon told CNBC in August.)

Dimon had harsh words, of course, for the Obama administration over his belief that his bank was treated unfairly by the Department of Justice in the $13 billion settlement. Instead of penalizing the bank for its bad behavior, Dimon argued, it should be celebrated for helping to save the financial system from its further free fall. That may be true to some degree, but Wagner’s 92-page draft complaint puts the wood to Dimon’s spin machine and shows that he and his colleagues at the bank were no different than the rest of the Wall Street banksters who received big bonuses for packaging up mortgages they knew would not be repaid into securities that they could sell to investors for big fees. Dimon’s pay package for 2013, the year of the big government settlement, was $20 million—a raise of 74 percent from the year before.