The U.S. Senate probe into JPMorgan Chase & Co. did more than conclude the bank hid the full damage of last year’s trading losses from investors and regulators. It also delivered 900 pages of evidence that could help the Securities and Exchange Commission make the case that bank executives broke the law.
Former SEC Chairman Mary Schapiro said last year that her agency was investigating whether JPMorgan adequately disclosed the losses on a derivatives portfolio that eventually swelled to more than $6.2 billion.
The case may become an early test for SEC chairman nominee Mary Jo White, a former prosecutor picked to help the agency shed a reputation for failing to prosecute Wall Street wrongdoing. White may have to avoid personal involvement in the case because her law firm has represented JPMorgan.
SEC officials weighing charges of improper disclosures will be able to draw on the 300-page report by the Senate’s Permanent Subcommittee on Investigations released on March 14, as well as over 90,000 e-mails and other documents, 200 transcribed telephone calls and 25 interviews with bank officials compiled by the committee.
“The report puts tremendous pressure on the SEC to address the responsibilities of JPMorgan and its top officers for what is happening in the trenches,” Robert W. Hillman, a securities law professor at the University of California at Davis School of Law, said in an e-mail. “This gives the SEC a chance to respond to the many questions that have been raised as to whether the agency can be an effective regulator or will continue to be a potted plant.”
Senate investigators found that JPMorgan’s portfolio of credit derivatives began to lose money in the first quarter of 2012 while tripling over the three-month period to a net notional value of $157 billion. The positions were so large they swayed international credit markets and earned the U.K.-based trader the nickname ‘London Whale.’
The portfolio lost $415 million on a single day three days before JPMorgan Chief Executive Officer Jamie Dimon told investors on an April earnings call that stories about the losses were a “tempest in a teapot,” according to the Senate findings.
The bank’s communications and securities filings about the trades “were incomplete, contained numerous inaccuracies, and misinformed investors, regulators and the public” about the losses, said Senator Carl Levin, a Michigan Democrat and the subcommittee’s chairman.
The SEC enforces laws that require public companies to tell investors about information that affects a person’s willingness to buy, sell or hold securities. Courts have held that such material information includes information about earnings estimates or events likely to change the company’s share price, the Senate report says.
SEC spokesman John Nester declined to comment about the regulator’s investigation.
The Senate report accused bank officials of taking actions to lower loss estimates as well as improperly changing risk models that gauge potential losses. John Coffee, a securities law professor at Columbia University, said the report could provide a road map for prosecuting bank officials over such failures and said he expects the bank to settle a case soon with the SEC. Mark Kornblau, a JPMorgan spokesman, declined to comment.
“The SEC can say, in doing those things without full disclosure, you misled investors,” Coffee said in a phone interview. “That would be the natural conclusion.”
Levin also faulted Douglas L. Braunstein, then the bank’s chief financial officer, for saying on the earnings call that the bank was “very comfortable with our positions as they are held today, and I would add that all of those positions are fully transparent to the regulators.”
“You give this very glowing call,” Levin said at a Senate hearing. “You thought it was a balanced presentation? Not disclosing that it was losing money? Not disclosing that it violated all five risk limits regularly, in some cases for months?”
Braunstein said he made his “best, good-faith effort” to disclose the portfolio’s losses to investors.
The subcommittee’s report also raised questions about whether JPMorgan’s disclosures accurately described the involvement of risk managers and bank regulators, the nature of the London unit’s trades as a hedge and whether they would be allowed under the Volcker rule banning proprietary trading by federally-insured banks.
The SEC, which began its investigation under Schapiro, could have a new chairman as soon as next week. The Senate Banking Committee has scheduled a vote on White’s nomination for March 19; she would next need to be approved by a vote of the full Senate.
White could have to recuse herself from any commission action on an enforcement case against JPMorgan. She has pledged to abstain for one year from any SEC matter that involves a former client of her law firm, Debevoise & Plimpton LLP. White listed JPMorgan as a Debevoise client on her financial disclosure form last month.
Jacob S. Frenkel, a securities lawyer and former SEC enforcement attorney, said the SEC’s investigation would probably focus on the “accuracy and timeliness of disclosures and possible omissions.” The Senate’s findings may be useful as a “road map, but not as gospel” as the SEC combs through the bank’s justification for its disclosures, he said.
If there is a violation, the SEC “is well positioned and capable of bringing a case,” Frenkel said in a phone interview. “If there is no violation, then it should not respond to congressional or public pressure and simply do so for the sake of extracting a settlement.”
Senate investigative reports have sometimes foreshadowed lawsuits by regulators and prosecutors.
In July the subcommittee issued a report detailing a decade of lax controls against money laundering and terrorist financing at HSBC Holdings Plc. In December, the bank agreed to pay $1.92 billion to settle the Department of Justice’s claims that it laundered funds of sanctions nations including Iran and Sudan.
The SEC isn’t the only regulator that could seek to penalize JPMorgan over its disclosures.
The Office of the Comptroller of the Currency, which oversees JPMorgan because it is a bank holding company, last month ordered JPMorgan to strengthen its risk and auditing controls in connection with the botched derivatives trades. Thomas Curry, the OCC’s chief, told Levin’s subcommittee that his agency could take further action based on the Senate findings.
“We will continue to investigate this matter,” Curry said. “Be assured that I will not hesitate to take additional action if warranted in response to any new information we learn from the report.”