Long seen as one of the most careful banks on Wall Street, JPMorgan Chase on Wednesday drew back a curtain on a rare breakdown, showing traders acting on their own and concealing losses while managers seemingly turned a blind eye.
In a 129-page internal report dissecting a bad bet on credit derivatives that cost the bank more than $6 billion, the bank confessed, in painstaking detail, to widespread “failures.”
Yet the report, written by a JPMorgan management task force, is not the final word on the trading blunder. Federal investigators are examining whether fraud was committed and are planning to use the report as a guide for pursuing their inquiries, say officials briefed on the matter.
The report describes traders making overly optimistic estimates of their losses, but stops short of claiming outright fraud. Showing that traders crossed a legal line presents a challenge for investigators. In some derivatives markets, traders are afforded flexibility to estimate the value of their positions.
But the F.B.I., suspecting that some employees intentionally hid the losses last year, is using taped phone conversations to build criminal cases against London-based traders involved in the debacle, according to the officials briefed on the matter. And the report could help that effort, the officials said. Authorities expect to interview one of the junior traders in the coming weeks, one official said.
Congress is exploring potential wrongdoing, as well. The Permanent Subcommittee on Investigations has taken testimony, people close to the inquiry said, from Jamie Dimon, the bank’s chief executive, and Ina R. Drew, the former leader of the chief investment office,where the trading losses occurred.
The subcommittee’s investigation has already complicated things for the bank. It is rare for a bank to expose its missteps so publicly, but JPMorgan knew that the subcommittee would have eventually received the document from regulators and made it public.
The regulators at the Office of the Comptroller of the Currency, the people close to the inquiry said, are required to turn over such documents under a subpoena they received from the subcommittee. So last fall, a person close to JP Morgan said, the bank decided to release the report on its own terms.
“This was getting out there anyway,” another person close to the situation said. This person and others interviewed for this article spoke on the condition of anonymity because the details of the case are not public.
Federal authorities responded positively to the internal report. One Congressional official privately told JPMorgan that the bank was wise to release such a detailed document, one person briefed on the matter said, while some regulators at the comptroller’s office praised it as an “important step” for corporate governance.
The report centered on a breakdown at the chief investment office in London, a group created to invest JPMorgan’s own money and offset potential losses across the bank’s disparate businesses.
JPMorgan’s troubles began in January 2012, when the investment office ignored the basic rules of trading. On a well-functioning Wall Street desk, traders are told to end a deeply vulnerable position early, even if it means sustaining some minor losses.
But under Ms. Drew, the report said, JPMorgan traders did the opposite. In response to adverse moves in the markets and regulatory changes, the group made a series of aggressive derivatives trades. As these bets began to sour, the London team increased their trades rather than exiting. The traders thought that reducing the assets was too costly, the report says.
Some questioned the strategy. By the end of January, one trader became deeply unnerved. In an e-mail to a more senior trader, he said the size of the trades were becoming “scary” and advised that the unit take the “full pain” now.
But the traders “continued to build the notional size of the positions through late March,” according to the report, which was led by Michael J. Cavanagh, the bank’s co-head of corporate and investment banking.
In an April e-mail, Mr. Dimon asked JPMorgan’s chief risk officer, John Hogan, why the chief investment office hadn’t simply cut some of its positions to reduce risk. The office, Mr. Hogan replied, indicated that adding positions was the “most ‘efficient’ way to do it.”
The report does not name the architects of the trade; British privacy laws prevented it from doing so. But they are known to be 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; and Achilles Macris, the executive in charge of the international chief investment office. None of the employees have been accused of any wrongdoing. They have all since departed the bank.
The JPMorgan report, while taking aim at the London office’s strategy, also exposes major gaps in oversight that allowed this headstrong team of traders to carry out their wager. Ms. Drew, who helped steer the bank through the financial crisis, received the brunt of the blame.
“Ina Drew failed in three critical areas,” the report said, pointing to lax controls and a failure to ensure that her team “understood and vetted” the trade.
The management missteps also ensnared Barry L. Zubrow, a former chief risk officer, and Douglas L. Braunstein, formerly the bank’s chief financial officer but now a vice chairman at the bank. While the report acknowledged that Mr. Dimon could “appropriately rely upon” senior managers who oversaw the trading strategy, it also concluded that he “could have better tested his reliance on what he was told.”
This slipshod culture magnified the impact of simple human errors across the bank. At one point, the mathematical mistakes of an employee in London prevented others in the bank from seeing the potential losses accumulating beneath the surface.
Still, the problems lurking in the investment office should have set off alarms for executives outside the office. The report reveals, however, that the bank dismantled its early-warning system.
The investment office’s alarm system, based on a computer model, showed risk limits were exceeded in late January, according to the report. Senior executives made a temporary exemption for the investment office, which was approved by Mr. Dimon and others. But then, the bank introduced a new model that underestimated the losses building in the investment office, and allowed the traders to fly below the bank’s internal risk radar.
The flawed model, the report says, was built by a London-based mathematician who also provided analysis to the investment office’s traders. It appears the employee, who built the model with a simple spreadsheet, was out of his depth. The model wasn’t properly back-tested and contained errors, the report said.
JPMorgan’s report raises the possibility that the investment office pressured the managers to approve the new model. The model-builder received an e-mail on Jan. 23 from the trader to whom he reported, saying that he should “keep the pressure on our friends” in a group that validated models.
The public disclosures by the bank also came under scrutiny in the report. Failure to properly report trading losses could make JPMorgan vulnerable to lawsuits from investors. The bank’s disclosures are the subject of the Congressional investigation and an inquiry from the Securities and Exchange Commission.
The problem stems in part from the London traders, who underestimated the size of their losses, a misstep that has drawn the scrutiny of the F.B.I. and federal prosecutors. The bank restated its first-quarter results to reflect that the traders may have masked their losses by $459 million.
“In the course of the task force’s ensuing work, it became aware of evidence — primarily in the form of electronic communications and taped conversations — that raised questions about the integrity of the marks,” the report said.
Still, obstacles remain for a criminal prosecution. Authorities planned to interview Mr. Macris in his native Greece, but the talks have broken down. Instead, officials said, they now expect to interview a lower-level employee.
Some people close to the investigation also note that traders have some leeway when marking the value of trades. And the internal report shows how JPMorgan, after consulting its auditor, PricewaterhouseCoopers, approved the investment office’s valuations of its trades.
The report highlighted an episode that, in theory, might have made JPMorgan think twice before initially signing off on the first-quarter results. An “internal audit group” identified deficiencies in the unit that double-checked its traders’ valuations, calling out the group last March with a simple concern: it “needs improvement.”
DealBook: Report Details Missteps in Trading at JPMorgan
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DealBook: Report Details Missteps in Trading at JPMorgan
