The so-called “London Whale,†whose trading in credit default swaps ended up costing JPMorgan Chase more than $6 billion in losses, appears to have a new role as the linchpin of the government’s criminal case against two employees of the bank. His cooperation shows that the Justice Department has learned an important lesson about putting on cases involving complex Wall Street financial machinations that are said to have involved fraud.
Federal prosecutors unsealed criminal complaints against Javier Martin-Artajo, a former head of trading in JPMorgan’s chief investment office, and Julien Grout, one of the bank’s traders. The charges accuse the two men of conspiracy, wire fraud, falsifying corporate records and making false filings with the Securities and Exchange Commission related to the valuation of swaps in March 2012 that led the bank to understate its losses.
A lawyer for Mr. Martin-Artajo said his client “is confident that when a complete and fair reconstruction of these complex events is completed, he will be cleared of any wrongdoing.â€
When JPMorgan’s trades first came to light, Bruno Iksil, another trader at the bank, was pinned with the “London Whale†moniker because his bets on the direction of corporate bonds indices were so large that other firms began taking opposite positions to squeeze the bank. The criminal charges lay out an effort to minimize the losses by using aggressive valuations of the swaps to prop up the portfolio. E-mails, chat sessions and recorded phone conversations in March 2012 show increasing pressure from Mr. Martin-Artajo to come up with prices that were further from middle range that the bank normally used to value its holdings.
Once viewed as one of the rogue traders, Mr. Iksil entered into a nonprosecution agreement with the Justice Department that will make him the key witness in any trial that might take place. This is a step the Justice Department rarely takes, more commonly having an individual plead guilty in exchange for an agreement to cooperate.
The criminal complaints paint Mr. Iksil in a sympathetic light, trying to show that he resisted Mr. Martin-Artajo’s efforts and told Mr. Grout to keep records of the proper valuation of the swaps to track the disparity between the reported losses and a truer picture of what was going on in the portfolio. That portrayal will be important because the government will use him to be the face of its prosecution, avoiding what happened in other cases that relied almost entirely on documents without a witness to point the finger at the defendants.
In 2009, the Justice Department pursued securities fraud charges against two former Bear Stearns hedge fund managers, accusing them of making false statements to investors about the value of the fund’s holdings. The jury acquitted them, accepting the defense argument that various e-mails were misinterpreted and did not provide a complete picture of the defendants’ intent.
The S.E.C. had a similar problem when a jury found in favor of a low-level executive at Citigroup accused of deceiving investors about a collateralized debt obligation the bank sold. The S.E.C. did not have witnesses who testified that they were misled by him, which allowed the defense to argue that more senior officials were truly responsible for any violations.
The recent trial of Fabrice Tourre for his role in the sale of a C.D.O. by Goldman Sachs shows the important role witnesses can play in explaining how a transaction unfolds and what should be disclosed. Among those testifying for the government were two witnesses, one of whom once worked at Goldman, who said that Mr. Tourre deceived them by not disclosing who selected the mortgage securities packaged in the C.D.O.
In most cases, the Justice Department has significant leverage over a potential defendant because of the possible sentence in the event of a conviction. In a fraud case like this one, the defendants could be looking at recommended prison terms of more than 15 years if even a portion of JPMorgan’s losses on the swaps were attributed to their violations.
Without Mr. Iksil, however, prosecutors would have had to make the case on the documents and recordings alone, without anyone to explain what was meant or what other conversations took place in connection with the valuations. This case is already difficult because pegging the price of the swaps is an inexact art, so proving fraud or knowledge that the information was false might be too high a hurdle without a cooperating witness.
This is not the first time the Justice Department has used this type of agreement with a crucial witness in a prominent securities fraud case. In the insider trading prosecution of Mathew Martoma and SAC Capital Advisors, the government agreed not to pursue charges against Dr. Sidney Gilman, a former University of Michigan doctor who admitted to tipping off Mr. Martoma about the poor results of a drug trial before the firm traded. It is unlikely a criminal insider trading case could have been pursued without his cooperation.
Like Dr. Gilman, Mr. Iksil was in a much stronger position because the government needed him to build its case. Thus, he was able to secure the holy grail in a criminal investigation by receiving a complete pass on any criminal charges rather than a plea bargain.
In addition to the nonprosecution agreement, Mr. Iksil was not named as a defendant in the S.E.C.’s parallel civil enforcement action against Mr. Martin-Artajo and Mr. Grout. He is only identified as “CW-1,†which is also how he is identified in the criminal complaints. He will emerge from this case without any legal taint from the mismarking at JPMorgan.
The defense is sure to seize on the favorable arrangements with Mr. Iksil as a basis for arguing to a jury that it should not accept his version of how the swaps were valued. Of course, that assumes the case ever gets to trial.
Mr. Grout is living in France, which usually does not extradite its citizens to face criminal charges. Mr. Martin-Artajo is traveling on vacation, so there is a chance he will not return England, which is likely to send him to the United States to face the charges.
To build their case, prosecutors needed a witness who could explain how the complex process of valuing JPMorgan’s holdings tokk place, and more importantly why Mr. Martin-Artajo and Mr. Grout flouted the bank’s internal rules to hide what was happening in the portfolio. The Justice Department did not want to face a situation in which defendants could play on the ambiguity of their words to argue that no crime took place.
Making a favorable deal with Mr. Iksil appears to have been the price for getting the type of testimony that can support charges of fraud and making false statements.
