JPMorgan Chase & Co. (JPM)’s efforts to hide trading losses, outlined in a Senate report yesterday, probably will ignite debate over whether the largest U.S. bank is too big to manage and ratchet up pressure on Chief Executive Officer Jamie Dimon to surrender his role as chairman.
Dimon misled investors and dodged regulators as losses escalated on a “monstrous” derivatives bet, according to a 301-page report by the Senate Permanent Subcommittee on Investigations. The bank “mischaracterized high-risk trading as hedging,” and withheld key information from its primary regulator, sometimes at Dimon’s behest, investigators found. Managers manipulated risk models and pressured traders to overvalue their positions in an effort to hide growing losses.
“Too big to fail has been put back on the table -- not providing risk data, misleading shareholders -- this suggests that breaking up the banks is a viable idea,” said Mark T. Williams, a former Federal Reserve bank examiner who teaches risk management at Boston University. “This big trading loss reinforces the need for independence. It’s kind of hard to argue at this point that JPM would’ve been worse off if they had a separate chairman.”
JPMorgan fell 2.8 percent to $49.57 at 9:48 a.m. in New York. The company has advanced 13 percent since Dec. 31.
After nine months of investigation, the panel concluded that JPMorgan had “a trading operation that piled on risk, ignored limits on risk taking, hid losses, dodged oversight and misinformed the public,” Chairman Carl Levin, a Michigan Democrat, told reporters yesterday. His team combed through 90,000 documents and interviewed dozens of current and former executives.
Former Chief Investment Officer Ina Drew, 56, among Wall Street’s most powerful women until she resigned in May four days after the bank disclosed the initial trading losses, will testify today at Levin’s hearing in her first public appearance since leaving the New York-based bank.
“Since my departure, I have learned of the deceptive conduct by members of the London team, and I was, and remain, deeply disappointed and saddened to learn of such conduct and the extent to which the London team let me, and the company, down,” she said in prepared remarks.
U.S. lawmakers have pushed banks to halt so-called proprietary trading, and regulators are weighing tightening exemptions for hedging. A panel of British lawmakers today urged regulators to “bear down” on prop trading and renew the case for an outright ban within three years.
JPMorgan, regarded on Wall Street as one of the best- managed banks in the world, lost more than $6.2 billion over nine months last year in a derivatives bet on companies’ creditworthiness.
The bank has “repeatedly acknowledged mistakes” in handling the loss, Mark Kornblau, a spokesman for the bank, said in an e-mail.
“Our senior management acted in good faith and never had any intent to mislead anyone,” Kornblau said. The bank cooperated with the investigation and has “already identified many of the issues cited in the report,” he said. “We have taken significant steps to remediate these issues and to learn from them.”
While JPMorgan won approval yesterday to raise its dividend 27 percent to 38 cents a share and buy back $6 billion in shares, as part of a review of top U.S. banks, the Fed ordered the company to address weaknesses in its capital plan and resubmit a proposal by the end of the third quarter.
The derivative bets “caused regulators to rethink capital needs” for banks with large trading operations, said Charles Peabody, an analyst with Portales Partners LLC in New York. “Much more broadly, are we going to get more heat on the too- big-to fail, too-big-to jail, too-big-to-manage theme?”
Bloomberg News first reported on April 5 that U.K. trader Bruno Iksil, known as the London Whale, had built an illiquid book of derivatives in the chief investment office so large that it was distorting credit indexes.
The Senate report cited Bloomberg stories published last year disclosing that Dimon, 57, had transformed the CIO in the past five years from a conservative investment operation into a much larger, high-risk trading profit center, and that he exempted the office from rigorous scrutiny.
The report and its recommendations, issued jointly by the committee’s Democrats and Republicans, may increase pressure on regulators to tighten exemptions in the draft Volcker rule, which would restrict the kinds of trades permitted by banks holding deposits insured by taxpayers. Banks have lobbied against the Volcker rule, arguing that it will restrict market- making and other standard practices.
“We’re going to continue to work very hard for a final rule that does not allow the kind of manipulation, the kind of concoctions that were created here by the bank to be accepted in the name of hedging,” Levin said.
John McCain of Arizona, the ranking Republican on the subcommittee, said the report offers a “shameful demonstration” of what goes on at federally insured banks and said JPMorgan and other institutions are not “too big to fail” or “too big to jail.”
JPMorgan’s credit portfolio more than tripled from a net notional size of $51 billion in late 2011 to $157 billion by the time trading was shut down in late March of last year, the report says. Iksil acquired more than $80 billion, or about 50 percent, of a thinly traded credit index, which made it difficult to find buyers, according to the subcommittee.
“There’s nothing that can be done, absolutely nothing that can be done. There is no hope,” Iksil said, according to a transcript of a March 16 call with junior trader Julien Grout. “The book continues to grow more and more monstrous.”
As losses ballooned, Iksil faced increasing pressure from manager Javier Martin-Artajo to report a higher value of his portfolio by marking it aggressively when compared with market prices, the report said.
“I can’t keep this going, we do a one-off at the end of the month to remain calm,” Iksil told Grout in discussing a price adjustment that the report said was apparently requested by Martin-Artajo.
The change would have valued the portfolio $400 million above market prices, the report said. “I don’t know where he wants to stop, but it’s getting idiotic,” Iksil said.
Iksil’s book breached all five of the CIO’s internal risk measures, and with increasing frequency from January through April, totaling more than 330 violations, the report said. Instead of investigating the cause or reducing its danger, traders, risk managers and executives criticized the metrics as inaccurate and “pushed for model changes that would portray credit derivative trading activities as less risky,” the report said.
On Jan. 30, 2012, the bank began using a new formula for so-called value at risk that cut Iksil’s estimated possible losses by about half. He had breached the limit under the prior model.
“The new VaR model not only ended the SCP’s breach, but also freed the CIO traders to add tens of billions of dollars in new credit derivatives to the SCP which, despite the supposedly lowered risk, led to additional massive losses,” the report said, referring to the synthetic credit portfolio. That model was later scrapped.
That wasn’t the only risk measure executives ignored. An internal report in February 2012 projected that Iksil’s portfolio could incur a yearly loss of $6.3 billion, an analysis that the CIO’s chief market risk officer at the time, Pete Weiland, dismissed as “garbage.” Drew also doubted the accuracy of the report, the investigation found. By the time she believed it, “it was too late,” the report said.
JPMorgan misled the public by hiding losses, mismarking trades, withholding information from the Office of the Comptroller of the Currency and “lying to investigators by saying that JPMorgan was fully transparent to regulators regarding the mounting losses when it was not,” McCain told reporters at a press briefing.
The CIO group e-mailed a presentation to Dimon and other executives on April 11 that showed the credit bets were no longer working to protect against losses, the Senate investigators said. It included a chart that showed the portfolio would lose money in a financial crisis.
JPMorgan executives made no mention of the presentation on an April 13 earnings call or that Iksil had already lost more than $1 billion. Dimon and then Chief Financial Officer Douglas Braunstein both knew some of his positions would take weeks or months to exit, the report said.
Dimon that day dismissed early press accounts of possible losses in Iksil’s book as a “tempest in a teapot” while Braunstein told investors the company was “very comfortable” with the positions.
“None of those statements made on April 13 to the public, to investors, to analysts were true,” Levin said. “The bank also neglected to disclose on that day that the portfolio had massive positions that were hard to exit, that they were violating in massive numbers key risk limits.”
Dimon “clearly can’t be both chairman and CEO,” said Josh Rosner, an analyst with independent research firm Graham Fisher & Co. in New York. Bank of America Corp., the second-largest U.S. bank, splits the roles of chairman and CEO. Lloyd Blankfein holds both posts at Goldman Sachs Group Inc. (GS)
“I don’t see how it’s feasibly possible for the executive to be expected to effectively oversee himself at the board level” at JPMorgan, Rosner said.
JPMorgan has an “open kimono” with regulators, Dimon told House lawmakers in June 2012. “We don’t hide reports from them,” he said at the time.
At one point, the Office of the Comptroller of the Currency noticed that JPMorgan stopped sending the investment bank’s daily profit-and-loss report, according to the report. Dimon told executives to halt the data “because he believed it was too much information to provide to the OCC,” the report said, citing an interview with the OCC’s head JPMorgan examiner, Scott Waterhouse. While the report said the incident occurred in late January or early February of last year, Waterhouse said in testimony today it happened in August 2011.
The bank also said there was a data breach that prompted the company to limit the disclosures. When Dimon found out that Braunstein agreed to resume the reports, the CEO “reportedly raised his voice in anger” the subcommittee said.
JPMorgan frequently pushed back on the OCC, according to the report. Waterhouse “recalled one instance in which bank executives even yelled at OCC examiners and called them ‘stupid,’” according to the report.
While JPMorgan has a reputation for best-in-class risk management, “the Whale trades exposed a bank culture in which risk limit breaches were routinely disregarded, risk metrics were frequently criticized or downplayed, and risk evaluation models were targeted by bank personnel seeking to produce artificially lower capital requirements,” according to the report.
JPMorgan resisted OCC oversight as far back as 2010, when Drew spent 45 minutes “sternly” discussing with an examiner the regulator’s recommendation that her office needed to manage risk better and document changes in the portfolio, the report said.
Drew said the OCC was trying to “destroy” JPMorgan’s business and that investment decisions were made with Dimon’s full understanding, according to the regulator.
Drew was seeking to “invoke Dimon’s authority and reputation in order to avoid implementing formal documentation requirements,” the report said, citing Waterhouse.
Senate investigators said they found little evidence showing what the bets would have protected against. Dimon told senators last year that the wagers were intended to cushion losses on other holdings in the event of a credit crisis.
Drew said the credit derivatives were intended to hedge JPMorgan’s entire balance sheet, while others at the bank said they protected against losses on investments held by the CIO, according to the report.
Patrick Hagan, at one point the CIO’s senior quantitative analyst, told investigators that he was never asked to analyze the bank’s other assets, which would have been necessary to use the bets as a hedge, according to the report.
The credit bets were called a “make believe voodoo magic ‘composite hedge’” by an examiner at the OCC, according to the report.
Statements and regulatory filings by the bank “raise questions about the timeliness, completeness and accuracy of information” given to investors, the committee said in a section on securities laws and their requirements about disclosing information. The Securities and Exchange Commission has been conducting its own investigation of the bank’s losses.
The evidence suggests the bank “initially mischaracterized or omitted mention” of the portfolio’s problems partly because it “likely understood the market would move against it if even more of those facts were known,” the report says.
Dimon and Drew were among bank managers who spoke with the panel’s investigators. Several ex-employees declined to be interviewed, including Iksil and Achilles Macris, who was chief investment officer of Europe, Middle East and Africa. The panel said it couldn’t require them to cooperate because they lived outside the U.S.
The lender awarded Macris, the trader behind the expansion into credit trading at the office, $31.8 million in the two years before the firm racked up the losses, more than his boss, Drew, and among the most at the bank.
Macris’s total compensation was $14.5 million for 2011 and about $17.3 million for 2010, according to a presentation in the report. Drew, the former chief investment officer who lost her job because of the bad trades, got $29 million for those two years.
“They were compensated at levels that were at the top range of, or better than, the best investment-bank employees,” the committee wrote.
Iksil, Macris and Martin-Artajo were all forced out of their jobs. The bank told the panel it clawed back the maximum amount permitted under its employment policies with them, or about two years of compensation. The bank canceled outstanding incentive compensation and obtained repayment of previous awards. Drew forfeited about two years’ pay.
Dimon’s pay for 2012 was cut 50 percent by the board of directors after an internal review found him partly responsible for the botched trades on credit derivatives.
Braunstein, who stepped down in January as CFO and is still at the bank, will join Drew before the panel today. Ashley Bacon, JPMorgan’s acting chief risk officer, and Michael Cavanagh, who led the internal review of the losses and is now co-CEO for the corporate and investment bank, also are scheduled to testify.
The report showed that on April 5, in responding to early press inquiries about Iksil’s trades, Joe Evangelisti, JPMorgan’s top spokesman, sent Dimon and other executives a list of talking points he wanted to make.
A revised list that took into account their feedback changed the statement, “we cooperate closely with our regulators, who are fully aware of our hedging activities” by removing the word “fully,” the report said.