Regulators Fault JPMorgan’s Senior Management in ‘Whale’ Case

JPMorgan Chase’s wayward traders caused the big losses that led to the London Whale debacle last year, but two new inquiries indicate that the bank’s most senior executives made things worse.

The Securities and Exchange Commission and the Financial Conduct Authority, a British regulator, both issued reports on Thursday that laid out their reasoning for fining JPMorgan for the trading missteps.

Providing important new details, the reports home in on the role played by a small group of executives known collectively as “Senior Management.” Without naming anyone, the S.E.C’s report said this group included JPMorgan’s chief executive, who is Jamie Dimon, and its chief financial officer, who at the time was Douglas Braunstein. It also listed the titles of chief risk officer, controller and general auditor.

In early 2012, a large unit of JPMorgan known as the chief investment office had started to suffer growing losses because of enormous wagers made out of its London operations. The losses were on credit derivatives, which allow traders to bet on the perceived creditworthiness of corporations. The trades in the investment office appear to have been recorded to make their losses seem smaller than they really were. Yet the traders kept adding positions. Their activity caused enough of a stir in the markets that the trades began to attract media attention on April 6.

When signs of trouble surfaced, JPMorgan arguably needed leaders who would decisively intervene â€" to find out what was really going on and work out what the true losses were. Ideally, they then needed to communicate to the public an accurate depiction of the troubled investment office in the bank’s next securities filing.

But almost the opposite happened, according to the details in the reports.

As a result, when the bank’s next filing came out on May 10, it did not give shareholders a full picture of what was going on. The filing had to be revised later. Investors expect such filings to provide accurate information, and regulators sanction companies when their filings contain material errors and omissions.

The new regulatory reports are valuable because they reveal how senior management operated in the crucial days before the filing.

The executives started to ask questions about the trading positions after the media reports. The British report says that senior executives asked the investment office for a “full diagnostic” on the positions, by April 9.

A few days later, the bank was outwardly communicating that it wasn’t overly concerned.

On April 13, JPMorgan released its first quarter results and, on a public conference call the same day, Mr. Dimon referred to the coverage of the trades as “a complete tempest in a teapot.”

He may have arrived at that opinion after the investment office sent an estimate of what it expected to make on the credit derivatives in the second quarter. The estimates didn’t point to large losses. The British report says this may have prompted “firm senior management” to send an e-mail to another manager that described the media coverage as “a tempest in [a] teapot driven by sour grape hedge funds and some former baby employees.”

By the end of that April, senior management had another big reason to look more closely at the investment office’s positions.

When a bank is losing money on a trade that hasn’t yet run its course, it hands over risk-free assets to the entity on the other side of trade that has a paper profit on the trade.

“Collateral” is transferred like this to ensure that the entity that is up on the trade can still collect if the losing entity doesn’t pay when the trade closes. In the second half of April, JPMorgan was getting into major collateral disputes with its trading partners over investment office trades. The disputes suggested big differences between the values that the investment office was ascribing to the derivatives positions and the values seen by the entities on the other side of the trades.

The commission’s report says that a member of senior management sent an e-mail on April 20, noting that the collateral disputes were not “a good sign on our valuation process.”

These disputes did motivate senior management to do more to understand what was going on in the investment office. But the executives again fell short, according to the reports.

On April 28, JPMorgan’s own investment bank, which also traded credit derivatives, submitted an analysis to senior management that showed that the investment office appeared to underestimating its losses. Using the investment bank’s approach, the positions would effectively be valued lower by $767 million, the analysis concluded.

After that analysis, and before the filing came out on May 10, senior management assigned a lot more people to look at the situation at the investment office. They included internal auditors and controllers, as well as internal and external lawyers.

As these efforts progressed, senior management discovered other warning signs. On May 8, senior management learned that the investment bank had found errors in the investment office’s spreadsheets, leading to a potential overvaluation of the troubled trades.

Senior management also learned of big problems with the methodology used by a group that valued the at-risk trades, the reports found. Improvements were discussed, and introduced in the first days of May.

Despite all of this, senior management did not give the bank’s audit committee, part of its board of directors, a comprehensive description of the problems it had identified, according to the S.E.C.

“Because the Audit Committee was not apprised of the initiation of the reviews or facts learned as a result of those reviews, it was unable to provide input on the issues before the filing of JPMorgan’s first quarter report,” the S.E.C. said, “and was unable to engage with those doing the work to ensure that it was sufficient from the perspective of the Audit Committee.”

Senior management saw plenty of red flags and, according to the reports, the executives often acted as their own worst enemies. The S.E.C. noted, in particular, their insistence on secrecy. The people in the investment bank working on valuing the credit derivatives were told to keep it to a “relatively tight group.” The controllers were told not to discuss their work “outside the immediate group.” The internal audit team was also instructed to keep strict confidentiality.

“These instructions affected the ability of those conducting the reviews to share, learn from, and build upon each other’s work,” the S.E.C. concluded.