March 25, 2023

Common Sense: When Trying to Follow Rules Isn’t Enough

In a speech in 2004 to the General Counsel Roundtable, he said: “You’ve got to talk the talk; and you’ve got to walk the walk. Both are critical to maintaining a good tone at the top.” And he called for more accountability: “Hold all of your managers accountable for setting the right tone. That means disciplining or even firing them when they have failed to create a culture of compliance. Human nature being what it is, there will be those who break the rules. But if managers don’t do enough to prevent those violations, or let them go unaddressed for too long, then they should be held responsible — even in the absence of direct involvement in those violations.”

How times have changed.

As general counsel of JPMorgan Chase Company, Mr. Cutler is now on the receiving end of the lectures, which this week came from George S. Canellos, a successor to Mr. Cutler and currently the co-chief of enforcement at the S.E.C. On Thursday, the S.E.C. and other regulators announced that JPMorgan had agreed to admit wrongdoing and pay nearly $1 billion in fines for its conduct in the “London Whale” matter, in which the bank’s chief investment office lost more than $6 billion and bank officials misled regulators about the losses. The S.E.C. faulted JPMorgan’s “egregious breakdowns in controls” and said that “senior management broke a cardinal rule of corporate management” by failing to alert the board to the full extent of the problem.

The S.E.C. didn’t name any of those senior managers, but made reference to the “chief executive,” who is Jamie Dimon. Mr. Cutler oversaw both the legal and compliance departments during those events. (Mr. Cutler no longer oversees compliance.)

And the London Whale affair isn’t JPMorgan’s only regulatory problem. The bank faces multiple other regulatory actions and investigations, ranging from manipulating energy markets, to mortgage-backed securities fraud, to failing to disclose suspicions about the Ponzi scheme operator Bernard Madoff, to conspiring to fix rates in the setting of the global benchmark interest rate informally known as Libor. As the allegations have mushroomed, JPMorgan has gone with almost dizzying speed from one of the world’s most admired banks to one tainted by scandal.

And all of this happened on Mr. Cutler’s watch. “You have to say, he didn’t run a tight enough ship,” said John C. Coffee Jr., a professor of law and expert in corporate governance at Columbia University. “It’s not just the London Whale episode. I wouldn’t call that the crime of the century. But taken with everything else, the energy manipulation, the mortgage fraud cases, the Libor rigging, it suggests that there was not enough investment in compliance and the general counsel was not proactive enough. He’s done a very good job at defending the firm but not enough at preventing it in the first place.”

A lawyer whose company was an S.E.C. target during Mr. Cutler’s tenure said this week, “I have to admit to a certain amount of schadenfreude,” adding: “At the time, he did a lot of grandstanding about lawyers being gatekeepers and the moral compass for the organization and how we should have prevented all this. He sounded great on the soapbox. Now I’ve been following JPMorgan and it’s pretty ironic.”

This lawyer was among the many I contacted who didn’t want to be named. I quickly realized that I was wasting my time trying to get people to offer unconflicted comments about Mr. Cutler or anyone else at the bank, since a) their firm represents JPMorgan; b) they represent someone for whom JPMorgan is paying the legal bills; or c) they’re trying to get into category a or b. James Cramer joked on CNBC’s “Mad Money” this week that JPMorgan should just buy the Manhattan law firm Paul, Weiss, Rifkind, Wharton Garrison, famed for its high-stakes litigation practice.

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Deal Professor: Reports Reveal Financial Challenges, but Few Solutions

Harry Campbell

The important and self-important of global finance are again gathering at the annual World Economic Forum in Davos, Switzerland. This year, the mandatory reading should be two recent reminders from JPMorgan Chase and the Federal Reserve that we are light years from understanding or preventing financial crises.

The reminders come in the form of JPMorgan’s management task force report on the bank’s billions in losses from the “London whale” trade and the released transcripts of the 2007 Federal Reserve meetings. The report and the transcripts provide a sobering lesson that the people who run our financial system not only have a lot of work to do, they still aren’t sure what that work is.

Let’s start with JPMorgan’s $6.2 billion trading loss.

JPMorgan is a huge institution with more than $2 trillion in assets. Banks typically lend their deposits, but for the tens of billions that JPMorgan cannot lend, this remainder is turned over to its chief investment office. This unit is charged with earning returns on this money and also using these billions to hedge the enormous financial institution against bad events.

What happened next was that a number of C.I.O. traders got stuck.

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The traders made a complex financial bet that was intended in part to hedge the bank from another big credit disruption. But the trading position became so large — more than $50 billion in notional value — that the JPMorgan traders couldn’t liquidate it without hundreds of millions of dollars in losses. Instead of liquidation, they went in the other direction, adding some $30 billion more in notional value to the portfolio, hoping this would save them. But that trade still didn’t work, and JPMorgan lost an estimated $169 million in the first two months of 2012. It was then that the traders added another $40 billion to the portfolio.

The trade went really bad after that.

In early April, reports emerged of an outsize bet by a JPMorgan trader in London — the “whale.” Hedge funds went on the attack as they took offsetting positions in anticipation that the bank couldn’t hold the trade. The funds were right. JPMorgan lost $412 million on the first trading day after Bloomberg News and The Wall Street Journal reported about the London whale, and the losses would subsequently mount.

The internal report details what went wrong, and it is head-scratching. In the middle of a meltdown, JPMorgan traders fudge numbers, ignore orders, try to evade pesky regulations and in general scramble as they try to salvage their trade. Management races to understand what is going on at the subsidiary while markets go haywire in ways that no one ever expected or that JPMorgan’s models predicted. After the first-day loss of $412 million, Ina R. Drew, then the head of the chief investment office, wrote in an e-mail that it was an “eight sigma event,” according to the report. The Reuters columnist Felix Salmon calculated that the chances of it happening was one in 800 trillion.

Unfortunately, the bank’s trading debacle was just history repeating itself.

You could substitute the names, but this story of self-interest, unexpected market events and huge losses is similar to almost every other financial blowup of the last two decades.

In every instance, the question is: Where were the regulators? Well, one answer comes from the recent release of the transcripts from the 2007 meetings of the Federal Reserve. The transcripts portray a regulator that not only failed to appreciate the risk that had built up in the financial system and the coming storm, but also seemed to misunderstand fundamentally the subprime mortgage market.

For example, in the Federal Reserve’s August 2007 meeting, the mortgage lender Countrywide Financial was described as having a “strong franchise.” Countrywide has since saddled its acquirer, Bank of America, with tens of billions of dollars in losses.

In this meeting, the Federal Reserve governors went on to discuss the economy and noted that despite the recent market turmoil, it had a “reasonably good” chance of returning to its trend growth. The gem from this meeting was a remark by Frederic S. Mishkin, who stated that since “subprime market is really a very small percentage of the total credit markets,” the fact that the markets were now turning a critical eye to this sector was a “good thing.”

It’s all sobering. Not only are financial trading losses hard to predict and manage from the inside, but regulators with a farther view often do not appreciate the risk, the markets or the prospect of the losses. It happened with subprime mortgages and again after the financial crisis with JPMorgan’s trading loss, a loss that even the firm’s chief executive, Jamie Dimon, who had a vaunted reputation as a risk manager, could not prevent.

The JPMorgan report in particular is disheartening. One is struck that nothing we have really done so far in terms of financial reform would have prevented JPMorgan’s loss. Certainly the requirement that boards have systemic-risk committees wouldn’t have done anything. If the traders and JP Morgan’s management can’t monitor things, how could the boards? In fact, how can anyone anticipate a one-in-800-trillion event?

This all adds strength to those who argue to break up the banks or limit their financial activity through the Volcker Rule.

Which brings us to the World Economic Forum.

Flipping through the forum’s program, it is once again filled with events that are Davos-like, like a panel on “Connected Transportation — Hype or Reality.” But nowhere do the words “financial crisis” even appear in the preliminary program, though there is a worthwhile discussion of the crisis in Mali. And flipping through its 80-odd pages, I counted only two panels on big systemic risk issues even tangentially related to financial institutions. Instead, the panels are the same old Davos big think and global stuff, except now instead of about China dominating the world, it is about whether China will make it.

This is a problem. We are five years past the beginnings of the financial crisis, and there is still no real explanation for what happened, let alone a solution. Was it a unique event that should have been foreseen and prevented? How can we regulate these institutions when smart people like Federal Reserve governors can miss so much? And is breaking up banks even feasible in a global economy?

Here, JPMorgan has admirably provided its own self-analysis, and its task force prescribes more risk analysis, better risk models and management — all of the comforting things you would want — as a remedy. But would it really prevent a one-in-800-trillion event, or even just an event its traders didn’t model?

The World Economic Forum and its leaders appear to be moving on, but if the financial titans gathered there are really going to fight off the small but growing number of critics who are calling for the breakup of the big banks or even more likely a stronger Volcker Rule, they should put forth an alternative or an explanation for why these blowups keep occurring. The forum would seem to be an ideal place to do it.

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DealBook: At JPMorgan, an Inquiry Built on Tapes

Offices of JPMorgan Chase in London. The trade losses were associated with London workers.Carl Court/Agence France-Presse — Getty ImagesOffices of JPMorgan Chase in London. The trade losses were associated with London workers.

Federal authorities are using taped phone conversations to build criminal cases related to the multibillion-dollar trading loss at JPMorgan Chase, focusing on calls in which employees openly discussed how to value the troubled bets in a favorable way.

Investigators are looking into the actions of four people who previously worked for the team based in London responsible for the $6 billion loss, according to officials briefed on the case. The Federal Bureau of Investigation could make some arrests in the next several months, said one person who spoke on the condition of anonymity because the inquiry was ongoing.

The phone recordings, which were turned over to authorities by JPMorgan, have helped focus the investigation, the officials said. Authorities are poring over thousands of conversations, in English and French. They are also relying on notes that employees took during staff meetings, instant messages circulated among traders and e-mails sent within the group.

Authorities are examining how some traders in the chief investment office influenced market prices as their bets began to sour. Investigators are also looking into whether records were falsified to hide the problems from executives in New York. Based on those records, JPMorgan submitted inaccurate financial statements to regulators, another area of focus for investigators.

The scope of the inquiry suggests that the problems were isolated to a handful of executives and traders in an overseas division, and did not reflect a fundamental weakness with the bank’s culture and leadership. The investigation does not appear to touch the upper echelons of the executive suite, notably Ina Drew who oversaw the chief investment office. The findings could insulate JPMorgan and its chief executive, Jamie Dimon, from further fallout.

Timeline: JPMorgan Trading Loss

Five months into the investigation, attention is centered on four people: Javier Martin-Artajo, a manager who oversaw the trading strategy from the bank’s London offices; Bruno Iksil, the trader known as the London Whale for placing the outsize bet; Achilles Macris, the executive in charge of the international chief investment office; and a low-level trader, Julien Grout, who worked for Mr. Iksil and was responsible for marking the trading book.

The people briefed on the matter said the investigation was in the early stages, and federal prosecutors in Manhattan had not made a decision about whether to file charges. None of the current or former employees have been accused of wrongdoing.

Jamie Dimon, the chief of JPMorgan Chase.Yuri Gripas/ReutersJamie Dimon, the chief of JPMorgan Chase.

If they decide to bring charges, prosecutors will face significant challenges. Financial cases are notoriously difficult to prove in court. The intricacies of Wall Street, which are often central to such matters, can be difficult to explain to jurors. In the aftermath of the financial crisis, authorities have brought few cases against individual employees.

Complicating matters, some of the JPMorgan employees are from France, which does not extradite its citizens. Mr. Iksil has already returned home to France after leaving the bank, according to a person with knowledge of the matter. Mr. Grout, also a French citizen, has been suspended from the bank but remains in London, said another person briefed on the situation.

Prosecutors would also have to prove that employees intentionally masked losses by mispricing the positions. It is a high bar. In some derivatives markets, traders are allowed to estimate the value of their positions because actual prices may not be readily available.

Some people close to the investigation say the significance of the mismarked positions may be overstated since they represented a tiny fraction of the overall trades. They also cautioned that authorities could easily take an incriminating sentence from a single phone call out of context, and that many conversations took place in person at the London office.

“Mr. Martin-Artajo is confident that when a complete and fair reconstruction of these complex events is completed, he will be cleared of any wrongdoing,” his lawyer, Greg Campbell, said in a statement. “There was no direct or indirect attempt by him at any time to conceal losses.”

Lawyers for Mr. Macris and Mr. Grout declined to comment. A lawyer for Mr. Iksil did not respond to requests for comment. Spokesmen for the United States attorney’s office in New York, the F.B.I. in Manhattan and JPMorgan declined to comment.

The trading loss could get further scrutiny on Friday when JPMorgan is set to report third-quarter earnings. Since the blowup was first disclosed in May, the losses have increased to about $6 billion, from $2 billion.

As the bank continues to unwind the bet, investigators have held multiple meetings with lawyers representing people involved in the matter. Authorities plan to interview Mr. Macris this month in his native Greece, according to people briefed on the matter. Such discussions could provide a more detailed account of the employees’ actions and alter the course of the investigation. Some of the former employees could also cooperate with authorities.

While authorities are narrowing the focus of the criminal investigations, JPMorgan and its executives still face scrutiny from civil regulators, including the Securities and Exchange Commission, which is examining whether the bank misled investors about the severity of the losses. British authorities have also recently opened inquiries into the matter, according to the officials.

The trading losses have already prompted a broader management shuffle. Ms. Drew resigned in May. Douglas L. Braunstein, the bank’s chief financial officer, is expected to step down from his post later this year, according to two people with knowledge of the situation.

The investigations center on the chief investment office in London.

The group was created to invest JPMorgan’s own money and offset potential losses across the bank’s disparate businesses. For example, Mr. Iksil bought and sold derivative contracts — financial instruments tied to the value of corporate bonds and other investments — in an effort to protect the bank from market fluctuations.

By early 2012, the London team increased its risk. In response to adverse moves in the markets and regulatory changes, the group made a series of aggressive derivatives trades, betting on the strength of companies like American Airlines.

As these bets started to sour, the London team decided to double down instead of getting out, according to the bank. From late 2011 to March 2012, the bank’s net exposure to such contracts more than doubled to nearly $150 billion. Authorities are examining whether the large positions improperly influenced market prices.

The phone calls, which are taped as a part of JPMorgan’s routine practices, suggest that traders tried to limit the losses, according to people briefed on the matter. In some phone recordings, Mr. Martin-Artajo encouraged Mr. Iksil to record the value of certain trades in an optimistic fashion, the people said. Their boss, Mr. Macris, was also involved in valuation discussions, according to two people with knowledge of the matter.

The chief investment office was also trying to play down the potential risk. Some employees told top JPMorgan executives that the situation was “manageable” and that the position might even produce a slight gain in the second quarter of 2012.

But the estimates proved inaccurate. This summer, JPMorgan restated its first-quarter earnings downward by $459 million, conceding errors in the valuations.

At the time, the bank said that the traders in the chief investment office “generally” valued the holdings within a reasonable range. But JPMorgan also pointed to the potential for deeper problems.

“The restatement is really based upon recent facts that we’ve uncovered regarding the C.I.O. traders’ intent as they were marking the book,” Mr. Braunstein, the bank’s chief financial officer, said at the time, according to a transcript. “As a result, we questioned the integrity of those trader marks.”

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DealBook: JPMorgan Shakes Up Management

Matthew Zames was promoted to co-chief operating officer of JPMorgan Chase.Matthew Zames was promoted to co-chief operating officer of JPMorgan Chase.

As JPMorgan Chase works to move beyond its multibillion-dollar trading blunder, it reshuffled some of its highest ranks Friday.

JPMorgan Chase, the nation’s largest bank by assets, promoted Matthew Zames and Frank Bisignano to co-chief operating officers in a broad management reshuffling. In May, Mr. Zames was tapped to take over the reins of the bank’s chief investment office, which was at center of the botched trade. At the time, Mr. Zames was seen by many industry observers as a kind of fix-it man, who could come into the unit that had been taking on outsize risks and straighten things out. He succeeded Ina Drew, who was one of the closest lieutenants of Jamie Dimon, the bank’s chief executive. Ms. Drew left the bank in the wake of the trading blowup, which has now totaled $5.8 billion in losses.

One little noticed element of the reorganization is its impact on Doug Braunstein, the bank’s chief financial officer. Although Mr. Braunstein will keep his position, he will no longer report to Mr. Dimon, but instead to Mr. Zames.

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Executives in the bank are split on how they interpret the moves. Some see the change as simply a promotion for Mr. Zames. But other senior executives at the bank, who didn’t want to be named because of the sensitivity of the issues, said that Mr. Braunstein lost some favor with Mr. Dimon after the trading losses.

“He lost some credibility with Jamie,” a senior executive said.

Frank Bisignano was promoted to co-chief operating officer of JPMorgan Chase.Frank Bisignano was promoted to co-chief operating officer of JPMorgan Chase.
Jes Staley will become chairman of JPMorgan Chase's corporate and investment bank.Scott Eells/Bloomberg NewsJes Staley will become chairman of JPMorgan Chase’s corporate and investment bank.
Michael Cavanagh will become co-chief executive of JPMorgan Chase's corporate and investment bank.Michael Cavanagh will become co-chief executive of JPMorgan Chase’s corporate and investment bank.

Just weeks before the trading mishap, Mr. Braunstein dismissed concerns about the trading that would later blow up in the bank’s chief investment office. In an interview, Mr. Braunstein said he was “very comfortable with the positions we have.”

Under the realignment announced on Friday, Mr. Zames will still oversee the chief investment office and mortgage capital markets. Mr. Bisignano was part of an earlier transformation at the bank when he was picked to lead JPMorgan’s mortgage banking group in 2011.

Jes Staley, the chief executive of the investment banking business, will become chairman of the corporate and investment bank, a new position. “In this role, he will head a group of senior executives who will work together to develop a view of what global banking will look like in the years ahead,” the bank said in a statement. He will continue to serve on the bank’s operating committee.

Michael Cavanagh, the head of treasury and securities services, and Daniel Pinto, head of the European, Middle East and Africa business and global fixed income, will become co-chief executives of the corporate and investment bank

In an interview on Friday, Mr. Dimon, the bank’s chief executive, said that the reshuffling within JPMorgan had “no relationship to the trading losses at all,” adding that “this was already under way and is a natural progression.”

Mr. Cavanagh has been discussed as a possible successor to Mr. Dimon, although there are no rumblings that Mr. Dimon will leave the firm anytime soon.

The moves come as the bank tries to reassure investors that its risk management practices are strong and that the losses are contained. Since disclosing the trading losses in May, the bank has been under close scrutiny. The Justice Department and the Securities and Exchange Commission are investigating the trading loss. In Washington, some lawmakers have seized upon the losses as further evidence that banks need to scale back their riskiest activities.

In a memo circulated to staff on Friday, Mr. Dimon said: “Periodically, all businesses need to reorganize to set themselves up for continued success.”

Shares of JPMorgan were up 0.8 percent in late morning trading on Friday, at $36.08.

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