JPMorgan Whale Report Spreads Blame as Dimon’s Pay HalvedDawn Kopecki and Hugh Son
JPMorgan Chase & Co., detailing lapses behind its biggest-ever trading loss, said employees were overwhelmed by the complexity of their bets, risk managers were ill-equipped and leaders including Chief Executive Officer Jamie Dimon weren’t aggressive enough in responding.
In a 129-page report issued yesterday, the bank described an “error prone” risk-modeling system that required employees to cut and paste electronic data to a spreadsheet. Workers inadvertently used the sum of two numbers instead of the average in calculating volatility. The firm also reiterated an assertion that London traders initially tried to hide losses that ballooned beyond $6.2 billion in last year’s first nine months.
The investigation, overseen by Dimon confidante Mike Cavanagh, is part of an effort to overhaul the bank and rebuild investor trust after the trading debacle helped cut shareholder value by as much as $51 billion last year. The report doesn’t explain why the chief investment office, a unit responsible for managing cash and mitigating risk, departed from more conservative strategies, eventually amassing a portfolio of complex credit derivatives. Dimon’s pay for last year was cut in half following the losses.
“The people who conduct these internal investigations walk a fine line,” said David Felt, a lawyer with Arnall Golden Gregory in Washington. “Their job is to find out what happened and prevent it from reoccurring, but not to provide evidence to prosecutors and other litigators.” Felt, who specializes in corporate inquiries, helped oversee the regulatory investigations into accounting fraud at Fannie Mae and Freddie Mac for the Federal Housing Finance Agency.
JPMorgan first disclosed losses on the trades in May, almost a month after Dimon dismissed initial news reports on the bets as a “tempest in a teapot.” Transactions were handled by London-based trader Bruno Iksil, nicknamed the London Whale because his positions were so big. Dimon, 56, said yesterday the bank is almost done with losses in the CIO and won’t disclose the size of future declines.
The board of directors cut the CEO’s compensation for 2012 to $11.5 million. The decision was announced as the firm reported a 53 percent jump in fourth-quarter profit to $5.69 billion, driven by earnings on mortgages.
“Mr. Dimon bears ultimate responsibility for the failures that led to the losses in CIO and has accepted responsibility,” the bank said.
Cavanagh, who has worked with or for Dimon since 1993, led the management task force that produced the report. Dimon promoted him from chief financial officer to run the treasury and security services division in June 2010, and again last July to co-head the corporate and investment bank.
“I would have much rather seen a more-independent report,” said Paul Miller, an analyst at FBR Capital Markets in Arlington, Virginia. “Let’s say that Cavanagh is a straight-up, straight-shooting guy who’s going to do this effectively. Nobody is going to believe it.”
Joe Evangelisti, a spokesman for the bank, said Cavanagh answered to the independent committee of the board, which also conducted its own review.
The loss at JPMorgan, considered one of the industry’s best-managed firms after remaining profitable during the credit crisis, has prompted lawsuits and probes in the U.S. and abroad. This week, it led to the first regulatory sanctions, as banking watchdogs found internal-control “deficiencies.” It also has pushed lawmakers to tighten trading curbs included in the 2010 Dodd-Frank Act.
The CIO unit used credit derivatives as part of a hedging strategy, and the trades became so large the bank couldn’t easily unwind them. The report blamed managers, many of whom were reassigned or left last year, for roles in failing to halt the loss. The executives include former Chief Investment Officer Ina Drew, Barry Zubrow, ex-head of companywide risk management, and former Chief Financial Officer Doug Braunstein.
Dimon was faulted for trusting information given him by senior managers, according to the task force.
“He could have better tested his reliance on what he was told,” the firm found. “More should have been done regarding the risks, risk controls and personnel associated with CIO’s activities, and Mr. Dimon bears some responsibility.”
Dimon, who is also chairman of the board, wasn’t included in deliberations on his compensation, he told reporters on a conference call. The bank said its decisions took into account his replacement of senior managers, efforts to claw back their pay and the formation of a team to examine what went wrong.
“Once Mr. Dimon became aware of the seriousness of the issues presented by CIO, he responded forcefully by directing a thorough review and an extensive program of remediation,” the company said.
“The board had to look at the positives, which I think are large, and the negatives,” Dimon said. “This is one huge embarrassing mistake and I respect their decision.”
Executives failed to ensure that the CIO’s risk controls kept pace with the increased complexity of the unit’s activities, the task force said. The leaders didn’t verify that the unit was well managed or had the same level of risk controls as elsewhere at the firm, according to the report.
“Significant risk-management weaknesses developed within CIO that allowed the traders to pursue their flawed and risky trading strategies,” the bank said. “Senior firm management’s view of CIO had not evolved to reflect the increasingly complex and risky strategies CIO was pursuing.”
Dimon ousted three London traders involved in the loss, shuffled senior managers and accepted resignations from executives including Drew. Matt Zames, the former co-head of fixed-income trading, was promoted twice last year and, after helping overhaul the CIO, is now co-chief operating officer with Frank Bisignano.
Drew retired four days after the loss was disclosed May 10. Iksil, his supervisor Javier Martin-Artajo and the former CIO head in Europe, Achilles Macris, also left.
Zubrow, who had overseen JPMorgan’s risk-management function while Iksil expanded his book, retired at the end of last year. Braunstein, 52, stepped down to become a vice chairman in the investment bank.
In the years before the trading losses, Dimon had pushed the CIO to generate more profit by boosting the size and risk of its bets to include higher-yielding assets, Bloomberg News reported in April, citing former executives. The shift had made the unit an increasingly important customer to Wall Street’s trading desks, with bets that could move markets.
The task force wrote in a footnote to its report that while it had reviewed “certain background information” on how the CIO expanded into credit derivatives, its focus “was on the events at the end of 2011 and the first several months of 2012 when the losses occurred.”
The report also highlighted blunders tied to measuring risk. Dimon had previously said switching models understated the chance of losses.
The CIO exceeded its so-called value-at-risk limit “at several points” during a period in January 2012, driven by the synthetic credit portfolio, JPMorgan said in the report. The office recommended a temporary increase in the risk limit, as the new model was expected to show a “substantially” reduced measure of the amount in danger of being lost.
On Jan. 23, a trader e-mailed the person who developed the new model to say he should “keep the pressure on our friends in model validation and [quantitative research],” the bank said.
“There is some evidence the Model Review Group accelerated its review as a result of this pressure, and in so doing it may have been more willing to overlook the operational flaws apparent during the approval process,” according to the bank.
The risk model was developed by a London-based quantitative expert who had not previously created or implemented such a model and wasn’t given the support he requested, JPMorgan said. The firm’s review of the model wasn’t “as rigorous as it should have been,” JPMorgan said.
JPMorgan also found the spreadsheet used the sum of two numbers, rather than their average, as part of a risk calculation.
“This error likely had the effect of muting volatility by a factor of two,” according to the report.
The Federal Reserve and Office of the Comptroller of the Currency on Jan. 14 took the first regulatory actions stemming from the trade, ordering the bank to strengthen risk and auditing controls. The board of directors also was told to consider control weaknesses and “adverse risk outcomes” while awarding compensation for Dimon and other top managers.