The JPMorgan Settlement Is Too Small

It comes through loud and clear in the “London Whale” settlement by JPMorgan Chase & Co.: The bank thumbed its nose at its compact with shareholders to reveal how their money is being spent and how much they are owed in return.

Legal papers reveal misconduct involving a single trading strategy that is patently egregious. To its credit, the Securities and Exchange Commission required JPMorgan to admit to wrongdoing.

A few heads have rolled, including the chief investment officer’s, and some executive compensation has been clawed back. Still, for a bank that could earn $23 billion this year, $920 million in fines isn’t enough to ensure that shareholders won’t be deceived again.

The bank bypassed numerous internal controls, which all publicly traded companies must have to make sure shareholders get honest financial disclosures. The law requires multiple layers of oversight and strict rules for the disclosure of information to the lawyers and accountants who prepare a company’s quarterly filings. After the Enron Corp. scandal in 2001, Congress added yet another layer by requiring most large companies to regularly test the effectiveness of their controls.

JPMorgan and its auditor repeatedly told shareholders that its controls were airtight. Now we learn the truth. Federal prosecutors have criminally indicted two of the many bank employees who were involved. Yet Jamie Dimon, the chairman and chief executive officer, and a handful of other senior managers should also accept blame. They may not have known about the wrongdoing, but they didn’t make sure procedures were followed that might have prevented it, either. For a global bank with $2.4 trillion in assets, that’s asking for trouble.

Among management’s sins: Derivatives traders -- whose huge positions in an index that tracks corporate credit risk caused more than $6 billion in losses -- were allowed to run amok. For months, the traders covered their tracks by claiming higher values for their positions than market prices indicated. When their models told them they’d hit their risk limits, the traders created new models that let them bet even more.

A separate control group, which was supposed to monitor valuations independently of the trading desk, instead fell under its influence. The control unit was “understaffed, insufficiently supervised” and failed to “adequately document its actual price-testing policies,” according to the SEC.

The faults came to light in part because counterparties to the derivatives trades demanded $520 million in collateral that the bank disputed. Senior management then failed to tell the board’s audit committee -- violating what one SEC official called a cardinal rule of corporate governance -- or even to examine the reasons for the misvaluations. An order from top managers to keep all findings confidential hid essential details from internal and external review teams, and caused shareholders to be deceived.

These are only a few of the many failures “permeating all levels of the firm,” according to the U.K. regulator, the Financial Conduct Authority. The Office of the Comptroller of the Currency, JPMorgan’s lead bank regulator, was also misled about the trading strategy, the size of the positions and the failure of the controls.

Considering the extent of the wrongdoing, it’s hard to believe the bank’s executives didn’t smell trouble: The SEC says some “expressed reservations” about signing off on a first-quarter 2012 earnings statement. And Dimon, as CEO, knew things he should have reported to the board’s audit committee. He is, after all, the chairman of the board. Once there were news reports on the immensity of the derivatives trades, directors should have demanded quicker answers. And PricewaterhouseCoopers LLP, the auditor, should have detected weaknesses in the internal controls.

The bank’s legal woes aren’t over. Perhaps the Commodity Futures Trading Commission, which is investigating whether the bank manipulated trading in credit derivatives, and the Justice Department, which is conducting a criminal probe, can correct the settlement’s deficiencies.

This one shouldn’t just pinch; it should be painful, even if shareholders have to pay a steep price. Only then will they demand corrective actions to ensure they aren’t misled again. And only then will other public companies see that their controls are working.

To contact the senior editor responsible for Bloomberg View’s editorials: David Shipley at