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JPMorgan Blaming Marks on Traders Baffles Ex-Employees

JPMorgan Chase & Co. (JPM)’s assertion that traders at its London chief investment office may have intentionally mismarked trades, masking losses that total at least $5.8 billion, makes little sense, according to former executives with direct knowledge of the unit’s operation.

The bank restated first-quarter results, paring profit by $459 million, in part because an internal review revealed that U.K. traders had priced their books “aggressively,” Mike Cavanagh, head of Treasury & Securities Services, said in a July 13 meeting with analysts. The mispricing made losses on a portfolio of credit derivatives look smaller than they were, and executives concluded that traders may have sought to hide the “full amount of losses,” JPMorgan said in a presentation.

JPMorgan requires traders to mark their positions daily so the firm can track their profits, losses and risk. An internal control group double-checks the marks against market prices monthly and at the end of each quarter, said three former executives from the CIO and a senior executive in market risk. The firm uses the control group’s prices, not what individual traders submit, to calculate earnings, making it difficult for one trader or trading desk to rig prices, the people said.

“We just have questions about whether the traders were doing what they need to do for accounting, which is put a mark on their positions where they think they can exit,” Cavanagh, who led the internal review, said on a conference call with reporters. “Instead, it felt more like they were pricing their marks a little bit more aggressively, but generally inside the bid-ask spread.”

London Whale

The spread is the difference between what an investor would pay to buy a security and the price at which someone is willing to sell the same asset.

Bruno Iksil, known as the London Whale because his positions became so large, ran the credit derivatives book that generated the losses. He personally apologized in recent weeks to almost everyone in the London unit for causing turbulence within the group, according to one of the former CIO executives who had been told about it by two people in the unit.

Iksil and Raymond Silverstein, his attorney, didn’t return phone and e-mail messages seeking comment. The New York Times quoted Silverstein saying that Iksil is innocent of wrongdoing.

Deciding to Restate

The decision to restate results for the first three months of 2012 was made one day before New York-based JPMorgan reported second-quarter net income of $4.96 billion, and after executives and lawyers interviewed employees, and reviewed thousands of hours of calls and about 1 million e-mails, said Cavanagh, 46.

The firm didn’t elaborate on the content of those e-mails and Joe Evangelisti, a spokesman for the bank, declined to comment on the doubts expressed by the former executives.

JPMorgan’s shares fell 2.7 percent to $35.09 in New York. The KBW Bank Index of 24 U.S. lenders dropped 0.1 percent.

JPMorgan, led by Chief Executive Officer Jamie Dimon, has seen its market value plunge $36 billion since April 5, when Bloomberg News first reported the London unit’s illiquid bets on credit derivatives were big enough to move markets. The trade, a wrong-way bet on credit derivatives, cost the bank $5.8 billion in the first six months of this year and the tab could climb by $1.7 billion, the bank said.

Price Verification

Chief Investment Officer Ina Drew, 55, who retired four days after the initial losses were disclosed on May 10, voluntarily forfeited as much as two years of compensation. JPMorgan said it ousted the three London executives responsible for the loss and that it will claw back as much as two years of their bonuses, without naming the individuals.

Iksil’s boss, Javier Martin-Artajo, and former Europe CIO head Achilles Macris were among executives who also oversaw the trades.

Some securities, such as interest-rate derivatives or foreign-exchange contracts, are easier to price because they’re generally traded on exchanges, making them more transparent to investors. Credit derivatives and other securities traded by Iksil were more difficult to price because they traded less frequently, and not on open exchanges.

Even then, traders have to submit documentation verifying their pricing and the internal control group generally would solicit prices from about two dozen outside firms to verify the marks, the people said. Executives including Dimon had said previously that Iksil’s positions were “marked-to-market,” indicating that they were available market prices that confirmed his valuations.

The CIO also valued some trades at prices that differed from those of JPMorgan’s investment bank, people familiar with the matter said in May.

Short Position

JPMorgan, the largest U.S. lender by assets, shut down all synthetic trading at the chief investment office and transferred the rest of the position to the investment bank. The CIO has retained an $11 billion short position in “basically liquid indexes” to hedge other credit assets, Dimon, 56, said during the meeting with analysts. Positions in Series 9 of the Markit CDX North America Investment Grade Index, a credit-swaps benchmark known as IG9 that’s at the heart of much of the loss, were cut by 70 percent, he said.

The investment bank has the expertise to manage it, Dimon said. The bank transferred about $30 billion of risk-weighted assets to the investment bank, an amount that is “down substantially” from an earlier peak and back to levels at the end of 2011, he said.

Federal Investigations

The stock jumped 6 percent on July 13 as investors expressed “relief that it wasn’t worse,” said Gary Townsend, head of Hill-Townsend Capital LLC, said of the trading loss. It was “substantially better than many of the estimates that I was hearing,” he said.

Agencies scrutinizing the bank’s handling of the loss include the Securities and Exchange Commission, U.S. Justice Department and Federal Bureau of Investigation.

Ohio Attorney General Mike DeWine said July 14 that he is seeking to lead a proposed class-action lawsuit against JPMorgan after state pension funds lost more than $27.5 million due to the “alleged fraud.” Two funds for state employees held about 10.2 million JPMorgan shares as of March 31, data compiled by Bloomberg show.

“Pension-fund managers acting on behalf of Ohio retirees were given false and misleading information by JPMorgan Chase that hid the true nature of the bank’s risky trades, causing Ohio teachers, school employees and public employees to lose tens of millions of hard-earned retirement dollars,” DeWine said in a statement.

Dimon transformed the unit in recent years to boost profit by buying higher-yielding assets such as structured credit, equities and derivatives, Bloomberg News reported on April 13, citing former employees.

Dimon dismissed initial news reports about the London operation as a “tempest in a teapot” when the bank reported first-quarter earnings April 13. He reversed course less than four weeks later, disclosing a $2 billion loss that he said could grow to $3 billion or more during the quarter.

To contact the reporters on this story: Dawn Kopecki in New York at dkopecki@bloomberg.net;

To contact the editor responsible for this story: David Scheer at dscheer@bloomberg.net

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