Whale of Trade Shown at Biggest U.S. Bank With Best Control
Iksil, a Frenchman who would soon become known as the London Whale because of the size of his trades, had lost $44 million on corporate-credit bets three days earlier and was down more than $500 million for the year, Bloomberg Markets will report in its July issue. He and junior trader Julien Grout, under pressure from their manager, had tried to hide the extent of losses that would swell to more than $6.2 billion, the bank’s biggest trading blunder ever.
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“They are going to destroy us,” Iksil wrote to Grout that Friday in one of hundreds of e-mails, instant messages, transcripts of recorded conversations and other documents released in March by the U.S. Senate’s Permanent Subcommittee on Investigations after a nine-month probe.
In a 301-page report and at a hearing, the panel accused the largest and most profitable U.S. bank of hiding losses, deceiving regulators and misinforming investors.
The report, the bank’s own 129-page account and interviews with traders and current and former executives offer evidence of a widening spiral of panic as the losses became known beyond a small circle of traders and the extent of the damage reached top management, including Chief Executive Officer Jamie Dimon.
The saga of the London Whale provoked doubts about Dimon’s reputation as one of Wall Street’s savviest CEOs, even as JPMorgan reported a third consecutive year of record profit in January and Dimon survived a shareholder vote in May that could have forced him to give up his role as chairman.
A brash critic of regulation who sailed through the 2008 financial crisis without a loss, Dimon was seen as a manager who scrutinized every aspect of the bank’s business. He’s considered indispensable by some of JPMorgan’s most influential shareholders, including billionaire investor Warren Buffett and Home Depot Inc. co-founder Kenneth Langone, who called him “probably the finest CEO across any business in America.”
What the documents show is that Dimon presided over a company whose traders amassed growing positions in complex derivatives and whose executives offered rosy forecasts, withheld information from regulators and ignored risk limits that were breached 330 times in the first four months of 2012.
The records reveal how little has changed to prevent even the best-managed banks from speculating their way into trouble five years after the collapse of Lehman Brothers Holdings Inc. and three years after passage of the Dodd-Frank Act.
The Senate panel, led by Michigan Democrat Carl Levin, referred its report to the U.S. Securities and Exchange Commission and the Justice Department on April 12.
“There is reasonable cause to believe a violation of the law may have occurred,” Levin says.
The Federal Bureau of Investigation and the SEC are scrutinizing public statements, calls with investors and the April 13, 2012, earnings presentation by Dimon and then-Chief Financial Officer Douglas Braunstein, according to five people with knowledge of the probes.
The criminal investigation is focusing on, among other issues, whether traders painted the tape, a form of market manipulation that allows them to inflate the value of their positions, three of the people say.
Spokesmen for the Justice Department, the SEC and the FBI’s New York field office declined to comment.
“The Senate report arms the SEC and gives them a road map by which they could pursue the bank for failure to supervise its traders, maintaining inadequate risk controls and making misleading disclosures,” says John Coffee, a securities law professor at Columbia University Law School.
Joe Evangelisti, head of communications at the New York-based bank, wrote in an e-mail response to questions that statements made by Dimon and Braunstein “reflected what they believed at the time and were based on fact finding and analysis by a number of people investigating the situation. In hindsight, the information they received was wrong.”
After Bloomberg News first reported on April 5, 2012, that Iksil’s book had grown so large it was distorting markets, executives downplayed losses that by then had eclipsed $1 billion. Dimon, 57, dismissed the matter on an earnings call eight days later as “a complete tempest in a teapot.”
Dimon apologized for that remark and what he called in a letter to shareholders “the stupidest and most-embarrassing situation I have ever been a part of.”
The debacle led to clawbacks of more than $100 million in employee pay, a 50 percent cut in Dimon’s compensation and the departures of top executives, including Chief Investment Officer Ina Drew and Achilles Macris, who ran the London unit where Iksil worked. A nonbinding shareholder motion to strip Dimon of his role as chairman, which became a referendum on his leadership, received 32.2 percent of the votes cast, the bank said on May 21.
While JPMorgan dropped as much as 24 percent in the month after disclosing a $2 billion loss in the portfolio on May 10, 2012, the stock has rebounded and is up 34 percent since that date through yesterday. The Standard & Poor’s 500 Financials Index has risen 33 percent in that time.
JPMorgan’s stock would have suffered without Dimon at the helm, partly because there’s no clear successor, says Mike Mayo, an analyst at CLSA Ltd., who points to the departures of former investment-banking head James E. Staley, 56, and Co-Chief Operating Officer Frank Bisignano, 53, who left in April to run a credit-card-transaction processor in Atlanta.
“JPMorgan has had more management turnover than any of the other large U.S. global banks over the last two years as would-be successors have either been let go or moved on to other opportunities,” Mayo says.
From the outset, Dimon characterized the London Whale trades as a conventional hedge to balance risks on the bank’s balance sheet.
“We’re very conservative,” Dimon told journalists when JPMorgan reported earnings on April 13, 2012.
Braunstein, 52, said the portfolio “hedges against stress loss, meaning downturns in the credit market.” The trades were “just simply part of that structural credit book, which, by the way, we’ve been reducing over time,” he said.
What Dimon and Braunstein didn’t tell journalists and analysts on a later call was that they and other top executives had received a presentation two days earlier showing that the credit-derivatives portfolio managed by the London-based international chief investment office, or CIO, was three times bigger than at the start of the year. It also indicated that downturns in the credit market would produce losses, not gains, and cast doubt on the book’s conservative nature.
The April 11, 2012, presentation, included in the Senate report, forecast a range of outcomes from a gain of $1.7 billion to a loss of as much as $918 million. The portfolio already had a year-to-date loss of about $1 billion, according to e-mails Drew sent Dimon and Braunstein. Almost half, $412 million, came on April 10, the first day on which London markets were open after Bloomberg News and then the Wall Street Journal published articles about the trades.
Neither Dimon nor Braunstein said on the April 13 calls that JPMorgan’s first-quarter results included a $700 million loss on Iksil’s book, equal to about 10 percent of the bank’s pretax income. Dimon didn’t mention that he had approved raising a risk limit breached by Iksil’s trading and that he had been sent a presentation the night before showing some positions were so illiquid they could take months to unwind, even under the most-ideal circumstances.
Dimon and Braunstein also had been told by Drew in an April 12 report that losses could reverse in the second quarter. She said at an operating-committee meeting with Dimon that night that the bank couldn’t be forced to sell at a loss, according to an internal JPMorgan investigation made public in January.
Evangelisti told reporters on April 10 that the portfolio’s risks were “effectively balanced” and, according to the Senate report, set up a background briefing by Braunstein and Chief Risk Officer John Hogan for the Wall Street Journal. Sarah Youngwood, head of investor relations, had conversations with four analysts echoing Evangelisti’s message, the report shows.
Youngwood’s team also talked to Benjamin Hesse, a fund manager at Fidelity Investments, one of the world’s biggest asset managers and a top JPMorgan shareholder. Hesse called investor relations when the stories first appeared and was told there weren’t any losses related to the positions, according to a May 10 e-mail from Youngwood to Dimon summarizing the conversation.
While information given by Dimon and Braunstein turned out to be wrong, “they had a reasonable basis to believe it to be true,” Evangelisti says. The spokesman also says he and Youngwood “believed that the portfolio was balanced” when they spoke with reporters and analysts in April 2012. Dimon and Braunstein declined to comment.
The SEC probably would have a hard time making a case against Dimon because it would need to show he willfully intended to mislead investors, according to Coffee, the Columbia law professor.
“There were clear misstatements made, with the only question being whether New York-based officials were misled by people in London, who pulled the wool over their eyes,” Coffee says. “The CFO described the trades as part of a hedging policy, but this was wrong by 180 degrees.”
Statements made with knowledge that they are false are treated more harshly by regulators than those that turn out to be untrue, according to Tamar Frankel, a professor at the Boston University School of Law.
“Simply making a negligent statement in and of itself may not be enough to constitute a securities violation,” says Frankel, who reviewed the Senate’s findings.
At the least, the company could face enforcement action for failing to properly supervise the CIO and its team in London, as well as for downplaying the significance of the losses to the public, according to former SEC Chairman Harvey Pitt.
“Valuation issues are significant and require great care on the part of public companies, so imprecise statements about valuations can prove to be very detrimental,” Pitt says.
JPMorgan also faces scrutiny over its obligation under U.S. banking law to operate in a safe and sound manner, exposing it to possible sanctions and shareholder liabilities, Boston University’s Frankel says.
Jacob S. Frenkel, a partner at Shulman Rogers Gandal Pordy & Ecker PA in Potomac, Maryland, and a former federal prosecutor and senior SEC enforcement attorney, says there’s little chance of a criminal case against the bank or its top executives.
“What the company wants to avoid is expanding the scope or the effect of the allegation of fraud or material deficiencies” in its bookkeeping and supervision, Frenkel says.
A fraud violation could carry significant financial sanctions, while material weaknesses in controls or reporting could negate past audited earnings statements, Frenkel and two other former SEC enforcement attorneys say.
At first, it looked as if JPMorgan’s damage-control strategy was succeeding.
“The market is quiet today,” Javier Martin-Artajo, who oversaw Iksil’s trading, wrote to Drew in an April 11 e-mail. “The tension has stopped now. The bank’s communications yesterday are starting to work.”
Drew, 56, who was one of Wall Street’s most powerful women before being forced out last year, had won Dimon’s trust and confidence after helping steer the company through the financial crisis. By early 2012, her office was overseeing $375 billion. Dimon treated Drew’s unit differently than others at JPMorgan, exempting it from the persistent attention he applied to the investment bank, the CEO testified to Congress last year.
The CIO traditionally traded interest-rate, foreign-currency and other securities commonly used by banks to manage risk. Drew, who through her lawyer declined to comment, had little experience with credit derivatives when she and Dimon hired Macris in 2006 to start trading the riskier and potentially more profitable asset class, according to three people who worked with her at the CIO.
Macris, 51, a former co-head of capital markets at Dresdner Kleinwort Wasserstein, recruited Martin-Artajo, whom he had known at Dresdner, to oversee CIO trading in Europe as well as global equity and credit trading.
Iksil, who joined the CIO in 2005, became the chief trader for the credit-derivatives book in January 2007. He used his portfolio to hedge against corporate-bond defaults as the U.S. economy weakened, and it produced a profit of about $2.5 billion during the five years ended in 2011.
Iksil and Martin-Artajo were among the best-paid traders and managers at the bank, receiving $7.3 million and $12.8 million, respectively, for 2010. Macris was paid $17.3 million - - more than Drew, who received $15 million. Dimon was paid $23 million for that year.
As Iksil’s trades generated greater profit, Dimon encouraged Drew to take on more risk, former senior executives say. The portfolio expanded more than 10-fold in 2011 to $51 billion from $4 billion, according to JPMorgan data cited in the Senate report.
Iksil’s bets became riskier and weren’t directly hedging other investments on the bank’s balance sheet, according to the report. One was on an index that paid off only if at least two of 100 high-risk companies declared bankruptcy or defaulted on a debt payment before the position expired on Dec. 20, 2011.
The wager showed signs of being a losing one, and Iksil was headed for a loss for the year until AMR Corp., the parent of American Airlines, filed for bankruptcy on Nov. 29, resulting in a $453 million gain for the bank in 2011, according to the Senate report. JPMorgan was unable to link that gain to “any loan or credit loss suffered elsewhere in the bank,” the panel said in the report.
“The CIO mandate from the beginning was not just to hedge,” says John Parsons, senior lecturer at the Massachusetts Institute of Technology’s Sloan School of Management who has studied derivatives. “It was a profit center, and these strategies were strategies that were turned on and off according to management’s views on the direction of interest rates. When you take a view of interest rates, credit spreads and the like, you’re not hedging. You’re speculating.”
Dimon has said the trade changed into something he couldn’t defend. Macris didn’t respond to messages left at his home, and his attorney in London declined to comment. Lawyers for Martin-Artajo and Iksil didn’t return calls seeking comment.
In late 2011, as the European sovereign-debt crisis eased, Dimon came to believe that U.S. companies were on the mend, Braunstein told Senate investigators. That led the London team to embark on a strategy of slowly unwinding the portfolio as investments matured, which they called landing the plane, according to two former CIO executives. After generating an average of $500 million a year, Iksil was given a revenue target for 2012 near zero, one of them says.
During the next two months, e-mails show, Drew gave Macris what proved to be an impossible task: reduce the risk on Iksil’s book more quickly without losing money.
Regulators adopted global rules requiring banks to hold extra capital against risky trading, and Drew was under orders from Dimon to cut so-called risk-weighted assets, Braunstein told Senate investigators.
She informed Martin-Artajo in a Dec. 22, 2011, e-mail that the bank wanted to reduce the portfolio’s risk-weighting, which would increase capital ratios and improve chances that regulators would allow it to buy back more stock. Repurchasing stock would boost the share price, a good thing for investors -- and for executives paid largely in deferred stock and options.
The simplest and fastest way to cut risk is to sell positions. It also would have been costly: Unwinding 35 percent of the trades would produce losses of about $516 million, Martin-Artajo told Drew in an e-mail six days later.
Under Drew’s direction, the London traders embarked instead on a strategy to reduce the appearance of risk for regulatory purposes, a process known as optimization that involved adjusting internal models, according to e-mails released by the Senate and a former CIO executive. They also hedged investments with securities that moved in the opposite direction, increasing the size and complexity of the portfolio.
The net notional value of Iksil’s book swelled to $88.6 billion on Feb. 22, 2012, from $55.1 billion on Jan. 18, according to e-mails obtained by the Senate panel. That didn’t reflect the total amount of securities Iksil was trading, because accounting rules allow firms to net derivatives contracts that offset each other. The gross amount outstanding on Iksil’s book on Jan. 18 was $483 billion, the e-mails show.
As Iksil’s portfolio ballooned, the market for junk bonds he was betting against rallied on the easing of Europe’s debt crisis. That caused a spike in an internal measure called value-at-risk, or VaR, which estimates the maximum amount a trade can lose most days. The VaR for Iksil’s book jumped to $93 million on Jan. 10 from $76 million on Dec. 21, bumping against the CIO’s limit of $95 million.
Rather than alter its trading, the London office changed the model. In a Jan. 12 e-mail to CIO market-risk head Pete Weiland, Martin-Artajo said Patrick Hagan, a quantitative analyst for the CIO who has a doctorate in applied mathematics from the California Institute of Technology, was working on a new VaR model.
Hagan’s model, which the company later said had spreadsheet errors that produced volatility estimates about half of what they should have been, resulted in a VaR of about $70 million, well under the limit.
“Hopefully we get this approved as we speak,” Martin-Artajo told Weiland in the e-mail. Hagan declined to comment.
On Jan. 19, the day 133-year-old Eastman Kodak Co. filed for bankruptcy, Iksil’s portfolio lost $2.5 million. The loss came because Iksil had let protection on Kodak expire, in line with the plan to wind down the book. Iksil’s managers instructed him not to let such a loss happen again, which prompted him to increase bets protecting against credit risk, according to JPMorgan’s internal report and the Senate panel.
Dimon approved a temporary increase in the firmwide VaR limit in a Jan. 23 e-mail, and Hagan’s model was approved by the bank the next week. By then, year-to-date losses on Iksil’s book were approaching $100 million, according to an accounting statement obtained by the committee.
Dimon would tell reporters in April 2012 that the bank’s regulators “see everything and anything we do whenever they want.” What Senate investigators found is that JPMorgan temporarily cut the flow of information to the Office of the Comptroller of the Currency as Iksil increased his position.
The CIO stopped sending monthly executive-management reports to the OCC in January. The next month, it suspended delivery of reports from its valuation-control group, which verified Iksil’s daily profits and losses, according to the Senate report. Evangelisti, the JPMorgan spokesman, says the suspension was inadvertent and promptly corrected when found.
When John Wilmot, the CIO’s finance chief, met with the OCC on Jan. 31, 2012, he told examiner Jaymin Berg that the credit-derivatives portfolio was “decreasing in size” that year. Instead, the gross notional value soon topped $1 trillion. Wilmot, who has announced his resignation, declined to comment.
“One of the public statements they made was that this is all transparent to regulators,” says Levin, the Senate subcommittee chairman. “Well, this is about as murky and opaque as it gets.”
The extent of Iksil’s trading in credit indexes attracted attention. Boaz Weinstein, founder and managing partner of hedge-fund firm Saba Capital Management LP, said at a Feb. 2, 2012, conference in New York that his best investment idea was buying protection on the Markit CDX North America Investment Grade Index, which Iksil was selling protection against, the New York Times reported that May.
In mid-February, as the new VaR model showed that the portfolio had less risk than in January, another estimate called the comprehensive risk measure, or CRM, projected the portfolio could lose $6.3 billion during the next 12 months, double what it had predicted a month earlier.
Weiland, the CIO’s head of market risk, expressed doubt.
“We got some CRM numbers and they look like garbage as far as I can tell, 2-3x what we saw before,” he wrote in a March 2 e-mail to managers.
Weiland said in his Senate testimony that the response was an initial reaction to a number that had risen from previous estimates and was “not an appropriate word” given that the figure “turned out to be predictive.” He declined to comment.
By mid-March, Iksil and Martin-Artajo had more than $150 million in losses, according to a document later sent to the OCC. The loss was closer to $350 million, Senate investigators found. Although the CIO typically marked its derivatives books in line with the midpoint of market prices, Iksil and Martin-Artajo had started using more favorable prices in January. Their values, still within the range of prices offered by the market, were at the higher end, making Iksil’s losses look smaller.
As daily losses ballooned in March -- a rally in high-yield bonds Iksil was wagering against continued, and hedges didn’t keep pace -- the pressure from Martin-Artajo to report higher values mounted, according to the Senate report.
“I can’t keep this going; we do a one-off at the end of the month to remain calm,” Iksil told Grout, the junior trader, in discussing a month-end price adjustment requested by Martin-Artajo, according to a transcript of a March 16, 2012, call. “I don’t know where he wants to stop, but it’s getting idiotic.”
That same day, Iksil told Grout and fellow trader Luis Buraya that the difference between the prices he was marking the book at and market prices was $300 million and could be $1 billion by the end of the month at the pace they were going, according to the Senate report and the traders’ instant messages. Iksil reported a year-to-date loss of $161.1 million on March 16, when his losses were closer to $600 million, according to a separate spreadsheet Grout maintained.
“The new trade pnl is f*ck up because the prices are stupid,” Buraya said of the profit-and-loss estimate in an instant message that day.
A March 20 e-mail from Grout to Drew and other top CIO executives showed that the book lost about $40 million that day, the biggest one-day loss of the year, and was down by more than $275 million for 2012. Grout couldn’t be reached for comment.
Three days later, on March 23, Drew ordered Macris and his team to “put the phones down” and stop trading, she told Senate investigators. The losses snowballed from there: $32.4 million on March 26, $44.7 million on March 27, $50.7 million on March 28 and $50 million on March 29. On March 30, when prices were verified by an independent group within the bank, the portfolio had a loss of $319.2 million, the biggest yet.
An internal audit that same day showed deficiencies in the unit’s practices, particularly how it priced the credit book.
“There is also a lack of transparency and quantitative assessment of the considerable judgment used to price-test” Iksil’s book, the audit found.
Drew, who testified in March 2013 that she wasn’t aware of what she described as the “deceptive conduct” of her subordinates until after she left the bank, encouraged them on one occasion to be more aggressive in pricing Iksil’s book, according to a transcript of a call in late April 2012. Hedge funds and other banks had started trading against JPMorgan when Martin-Artajo told Drew he was having trouble marking the portfolio within market prices.
“Here’s my guidance,” Drew told him on the call. “It’s absolutely fine to stay conservative. But it would be helpful, if appropriate, to get, to start getting a little bit of that mark back.”
The “mark” Drew was referring to was the market value of the portfolio, according to Senate investigators. She recommended that Martin-Artajo “tweak” prices where he could find data to back up the changes.
“She should be telling people to tell the truth, not twisting the truth,” Levin says.
Drew said in testimony she “had been told for a long period of time that the marks were very conservative” and only asked traders to mark up positions when data justified the move. Senior JPMorgan executives, including Dimon, began raising questions about Iksil’s book in early April 2012. Drew asked Macris on April 3 to summarize its status for Dimon and Hogan, the bank’s chief risk officer. While Macris wrote in an e-mail that his team believed the trades were balanced for risk and profit, the portfolio was failing at Drew’s primary objectives: cutting risk-weighted assets and avoiding losses.
Macris told Drew in the e-mail that he could make up first-quarter losses if traders were allowed to keep the book “as is,” resulting in more than $45 billion of risk-weighted assets at the end of the year. That would be more than double what the group was supposed to have, according to targets in previous e-mails. His recommendation: Give up some profit and gradually reduce the book to $35 billion.
“I realize that this is higher than what we have all hoped for,” Macris wrote. “I am very concerned by over-acting in the market relative to our size and poor liquidity.”
The CIO underestimated the risk of future losses to top executives. On April 12, the day before the earnings call, Drew sent Dimon and Braunstein a report saying recent market moves made no “economic sense” and that losses would moderate. Drew also told Dimon at an operating-committee meeting that day that the bank could unwind the trades at its own pace, according to JPMorgan’s in-house investigation.
A separate report to Dimon from Irvin Goldman, the CIO’s chief risk officer, showed the portfolio was so big relative to the market that it owned an $80.9 billion position in one index that traded on average only $1.5 billion a day.
Less than an hour after Dimon finished the April 13 call on which he made his “tempest in a teapot” remark, he e-mailed Hogan with a question: “Why didn’t they just sell?”
That Dimon hadn’t asked the question earlier would come back to haunt him. On May 10, 2012, JPMorgan announced $2 billion of losses related to the portfolio and said it could easily lose another $1 billion. Dimon acknowledged “egregious mistakes” and called his bank “stupid” for taking on the strategy. The announcement sparked a $570 million loss in the CIO positions the next day.
Dimon gutted the CIO and replaced almost everyone in London involved with Iksil’s trade. The company conducted a review of risk management last year and created an oversight and control group with the authority to make changes across all divisions. It also added weekly CIO investment meetings and monthly companywide meetings to ensure continuity in valuing assets, as well as new risk parameters.
While the CIO still trades some credit derivatives, it’s sticking with less-complex investments such as sovereign debt and no longer trading the types of credit-default swaps that led to the loss, says a person with knowledge of the matter.
By the end of June 2012, JPMorgan had racked up losses of $5.8 billion on Iksil’s book and cut the net notional size of the positions to $39.5 billion, down 75 percent from the end of March. In July, the bank restated first-quarter profit and acknowledged a weakness in internal controls. Total losses as of the end of September were at least $6.2 billion -- almost exactly the same as the estimate that Weiland, the CIO’s market-risk officer, had called garbage six months earlier.
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Even with the loss, JPMorgan reported a record $21.3 billion in profit last year, more than any other U.S. lender. The bank, which has incorporated the remaining position into its investment bank’s results, still hasn’t disclosed the exact amount it lost on the trades.
To contact the editor responsible for this story: David Scheer at email@example.com