By Peter Schroeder - 03/14/13 09:00 PM EDT
JPMorgan skirted regulators, ignored mounting risk and misled investors on the way to losing billions of dollars on complex derivatives trades, according to a Senate investigation.
The report from the Senate Permanent Subcommittee on Investigations details the disastrous “London Whale” trades that put a major blemish on the nation’s biggest bank and renewed calls for stricter regulation of Wall Street.
The findings cast significant blame on the bank and its regulator, the Office of the Comptroller of the Currency (OCC), for either failing to notice or deliberately downplaying warning signs about the complex trades, which resulted in at least $6.2 billion in losses.
But the 300-page report, which took nine months to produce, does not accuse the bank or any executives of breaking the law. And while it recommends regulators take steps to beef up oversight of the trading of derivatives, it does not call for new legislation.
JPMorgan acknowledged it made mistakes ahead of the trading losses, but denied misleading investors.
"While we have repeatedly acknowledged mistakes, our senior management acted in good faith and never had any intent to mislead anyone," a spokesman said. "We cooperated fully with the subcommittee's staff and welcome the opportunity to respond to the Senate's questions."
The spokesman also noted that JPMorgan identified many of the same shortcomings in its own report issued in July and is taking "significant steps" to address them.
The report provides the most detailed account yet of the trading losses suffered at JPMorgan. Senators will continue to look into the case on Friday when they hear testimony from bank employees and top regulators.
Levin seized on the JPMorgan findings to press for strict implementation the “Volcker Rule,” which seeks to ban risky proprietary trading by banks. While regulators are still crafting the rule, banks have pushed for a definition that allows for broad exemptions for hedging activity.
The senator said the report should slam the door on that request.
“If they’re going to claim that trades are a hedge, they’ve got to be able to identify what is being hedged against,” he said.
Levin also suggested that the headline-grabbing losses at JPMorgan support the case that many banks remain “too big to fail.”
“There’s evidence that this is simply too big to manage, or it was mismanaged, one or the other,” he said.
The report received a bipartisan blessing, as the top Republican on the panel, Sen. John McCain (R-Ariz.), signed off on its findings.
McCain said the report revealed a “shameful demonstration” by the bank, but he also placed significant blame on regulators.
“It’s important that the American people understand that this was a massive failure not just by JPMorgan but the public servants,” he said. “They failed to notice or stop these reckless investments even though they had 65 regulators physically located at JPMorgan sites."
The report details how JPMorgan, through its Chief Investment Office (CIO), dramatically increased its investment in synthetic credit default swaps, climbing from $4 billion in 2008 up to $157 billion in the first quarter of 2012.
Once losses began to accumulate, JPMorgan began to alter how it valued its derivatives in an effort to hide or minimize the losses, the report claimed. Emails from Bruno Iksil, the head trader behind the strategy dubbed the “London Whale” described the increasing push for rosier valuations as “getting idiotic.”
A bank spreadsheet from March stated that under the new valuation methods, losses stood at $161 million year to date. If the CIO had continued using prior methods, the losses would have totaled $593 million. The report also claims that a confrontation between two traders ensued after the CIO reported an estimated daily loss of $6 million on April 10. Ninety minutes later, that number was revised to $400 million.
While JPMorgan had been viewed after the financial crisis as the best in the business at managing risk, the report found that the bank “routinely disregarded” breaches in existing risk limits in building up its position. If a trader’s activity ran afoul of the risk model, they pushed for a new model rather than changing the trades.
After the CIO breached one key risk assessment tool, it adopted an alternative model that immediately lowered the risk measurement by 50 percent. In another case, a lead analyst for the CIO pressed to set up a system that would produce the “optimal” measure of Risk Weighted Assets — and was later discouraged from discussing such issues via email.
As losses mounted, JPMorgan’s chief regulator, the OCC, was frequently kept in the dark, according to the report. In January, the CIO told the OCC that it planned to reduce the size of the portfolio in question, and then went on to triple it in size over the following quarter. The bank also began to omit performance data of the portfolio from regular reports sent to the regulator.
At the same time, the OCC missed key signals or ignored missing information in the build-up to the losses. The OCC did not notice missing reports until press articles discussed the risky trades, and repeated breaches of risk limits failed to spur OCC action.
The report also found that while that trading activity was originally described as a hedge against risk, JPMorgan never provided any documentation detailing exactly how the hedging would work, suggesting the true motive may have been profit-hunting and proprietary trading that could be banned under the Volcker Rule.
In an internal OCC email, one examiner described the trades as “make believe voodoo magic ‘composite hedge.’ ”
As the losses mounted, the report claims that JPMorgan misled investors about the severity of the situation and the extent of the investments. JPMorgan officials reassured investors that the trading activities were part of a long-term investment strategy, were risk-reducing hedges, and had been overseen by the firm’s risk managers and regulators. JPMorgan Chief Executive Jamie Dimon famously dismissed stories about the trades as a “tempest in a teapot.”
The Senate report claims that none of that was true, and that the bank’s claims before the losses were fully disclosed were “incomplete, contained numerous inaccuracies, and misinformed investors, regulators, and the public.”
The OCC said it appreciated the Senate panel's efforts to produce "such a thorough report" and is reviewing the findings.
An OCC spokesman said the regulator takes the matter "very seriously," and noted that it had previously issued a cease and desist order against JPMorgan, requiring it to address deficiencies uncovered by examiners.
He added that the OCC was "very disappointed" that JPMorgan misinformed regulators and would take further action "as appropriate."
"We also recognize that there were shortcomings in the OCC supervision leading up to and responding to the unfolding events with JPMC’s CIO office," the spokesman said. "We have taken specific steps to improve our supervisory process across the large complex financial institutions we supervise."
While several current and former bank employees are scheduled to testify Friday before the Senate subpanel, Dimon was not asked to appear alongside them. Levin did not rule out calling him to testify at a later date but said he first wanted to hear from people directly involved in the trades.
Dimon previously testified before both the House and the Senate on the losses, calling the trades indefensible but defending the bank from claims of wrongdoing.
The report states that the bank fully cooperated with the investigation but that some former London-based traders refused to testify and could not be compelled to do so.