JPMorgan Misled Investors, Dodged Regulator, Report Shows

By Dawn Kopeck

JPMorgan Chase & Co. (JPM) Chief Executive Officer Jamie Dimon sought to hide escalating trading losses that surpassed $6.2 billion, misled investors and dodged regulators as a “monstrous” derivatives bet deteriorated last year, a Senate probe found.

The largest U.S. bank “mischaracterized high-risk trading as hedging,” and withheld key information from its primary regulator, sometimes at Dimon’s behest, according to a reportyesterday by the Senate Permanent Subcommittee on Investigations. The 301-page document also shows how managers manipulated internal risk models and pressured traders to overvalue their positions in an effort to hide growing losses in a credit derivatives portfolio in London. “We found a trading operation that piled on risk, ignored limits on risk taking, hid losses, dodged oversight and misinformed the public,” Chairman Carl Levin, a Michigan Democrat, told reporters yesterday after his investigators spent nine months combing through 90,000 documents and interviewing current and former executives.

Former Chief Investment Officer Ina Drew, 56, among Wall Street’s most powerful women until she resigned in May four days after the bank disclosed the initial trading losses, will testify today at a subcommittee hearing in her first public appearance since leaving the New York-based bank. Lawmakers have pushed banks to halt so-called proprietary trading, and regulators are weighing tightening exemptions for hedging.

‘High Risk’

“Mr. Dimon has not acknowledged that what the SCP morphed into was a high-risk proprietary trading operation,” according to the report, referring to the synthetic credit portfolio.

JPMorgan has “repeatedly acknowledged mistakes” in handling the loss, Mark Kornblau, a spokesman for the bank, said in an e-mail.

“Our senior management acted in good faith and never had any intent to mislead anyone,” Kornblau said. The bank cooperated with the investigation and has “already identified many of the issues cited in the report,” he said. “We have taken significant steps to remediate these issues and to learn from them.”

JPMorgan, regarded on Wall Street as one of the best- managed banks in the world, lost more than $6.2 billion over nine months last year in a derivatives bet on companies’ creditworthiness.

Synthetic Credit

Bloomberg News first reported on April 5 that the portfolio built by U.K. trader Bruno Iksil, known as the London Whale, had built an illiquid book of derivatives so large that it was distorting credit indexes. The Federal Reserve and Office of the Comptroller of the Currency sought additional information about the trades following media reports.

The Senate report cited Bloomberg stories published last year disclosing that Dimon had transformed the CIO in the past five years from a conservative investment operation into a much larger, high-risk trading profit center, and that he exempted the office from rigorous scrutiny.

JPMorgan’s communications officer met with reporters on April 10 to say that the activities were for hedging purposes and that regulators were fully aware of them, “neither of which was true,” according to the subcommittee’s report.

John McCain of Arizona, the ranking Republican on the subcommittee, said the report shows a “shameful demonstration” of what goes on at federally insured banks and said JPMorgan and other institutions are not “too big to fail” or “too big to jail.”

‘No Hope’

Iksil’s book more than tripled from a net notional size of $51 billion in late 2011 to $157 billion by the time trading was shut down in late March of last year, the report says. Iksil acquired more than $80 billion or about 50 percent of a thinly traded credit index, which made it difficult to find buyers, according to the subcommittee.

“There’s nothing that can be done, absolutely nothing that can be done. There is no hope,” Iksil said, according to a transcript of a March 16 call with junior trader Julien Grout. “The book continues to grow more and more monstrous.”

As losses ballooned, Iksil faced increasing pressure from manager Javier Martin-Artajo to report a higher value of his portfolio by marking it aggressively when compared with market prices, the report said.

‘Getting Idiotic’

“I can’t keep this going, we do a one-off at the end of the month to remain calm,” Iksil told Grout in discussing a price adjustment that the report said was apparently requested by Martin-Artajo.

The change would have valued the portfolio $400 million above market prices, the report said. “I don’t know where he wants to stop, but it’s getting idiotic,” Iksil said.

JPMorgan “dodged federal regulators and misled the public by hiding losses, by mismarkingcredit derivatives’ values,” McCain told reporters at a press briefing.

The OCC noticed that JPMorgan stopped sending the investment bank’s daily profit-and-loss report, which shows how much money the unit made or lost on a given trading day, in late January or early February of last year, according to the report. Dimon told executives to stop sending the data “because he believed it was too much information to provide to the OCC,” the report said, citing an interview with the OCC’s head JPMorgan examiner, Scott Waterhouse.

Risk Downplayed

The bank also said there was a data breach that prompted the company to limit the disclosures. When Dimon found out that then-Chief Financial Officer Douglas Braunstein agreed to resume the reports, the CEO “reportedly raised his voice in anger” the subcommittee said.

JPMorgan frequently pushed back on the OCC, according to the report. Waterhouse “recalled one instance in which bank executives even yelled at OCC examiners and called them ‘stupid,’” according to the report.

While JPMorgan has a reputation for best-in-class risk management, “the Whale trades exposed a bank culture in which risk limit breaches were routinely disregarded, risk metrics were frequently criticized or downplayed, and risk evaluation models were targeted by bank personnel seeking to produce artificially lower capital requirements,” according to the report.

Dimon and Drew were among bank managers who spoke with the panel’s investigators. Several ex-employees refused to be interviewed, including Iksil and Achilles Macris, who was chief investment officer of Europe, Middle East and Africa. The panel said it couldn’t require them to cooperate because they lived outside the U.S.

Pay Clawbacks

Iksil, Macris and Martin-Artajo were all forced out of their jobs. The bank told the panel it clawed back the maximum amount permitted under its employment policies with them, or about two years of compensation. The bank canceled outstanding incentive compensation and obtained repayment of previous awards. Drew forfeited about $21.5 million.

Dimon’s pay for 2012 was cut 50 percent by the board of directors after an internal review found him partly responsible for the botched trades on credit derivatives.

Senate investigators said they found little evidence showing what the bets would have protected against. Dimon told senators last year that the wagers were intended to cushion losses on other holdings in the event of a credit crisis.

Drew said the credit derivatives were intended to hedge JPMorgan’s entire balance sheet, while others at the bank said they protected against losses on investments held by the CIO, according to the report.

Voodoo Magic

Patrick Hagan, at one point the CIO’s senior quantitative analyst, told investigators that he was never asked to analyze the bank’s other assets, which would have been necessary to use the bets as a hedge, according to the report.

The credit bets were called a “make believe voodoo magic ‘composite hedge,’” by an examiner at the OCC, according to the report.

The CIO group e-mailed a presentation to Dimon and other executives on April 11 that showed the credit bets were no longer working to protect against losses, the Senate investigators said. It included a chart that showed the portfolio would lose money in a financial crisis.

Days later, Braunstein told investors and analysts on a call to discuss earnings that the credit bets were a hedge that lowered risk. Dimon that day dismissed accounts of the loss as a “tempest in a teapot.”

“None of those statements made on April 13 to the public, to investors, to analysts were true,” Levin said. “The bank also neglected to disclose on that day that the portfolio had massive positions that were hard to exit, that they were violating in massive numbers key risk limits.”

Braunstein, who stepped down in January as CFO and is still at the bank, will join Drew before the panel today. Ashley Bacon, JPMorgan’s acting chief risk officer, and Michael Cavanagh, who led the internal review of the losses and is now co-CEO for the corporate and investment bank, also are scheduled to testify.

To contact the reporter on this story: Dawn Kopecki in New York at dkopecki@bloomberg.net

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