A Risk Manager’s Impossibility?

Reconsidering the London Whale, JPMorgan’s risk management, Jamie Dimon’s oversight -- and their implications for other financial institutions

Monday, September 23, 2013 , By Janet Tavakoli

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If you are a risk manager at a U.S. bank, you will be faced with difficult decisions. You've probably already run into one or more of what I think of as the three major problems for risk managers. The first is the lip service paid to risk management by people in leadership positions who are unfit to lead; the second is ignoring or covering up oversized risky positions; and the third is not effectively managing short positions.

Jamie Dimon, chairman and CEO of JPMorgan Chase, is still lauded as the best bank manager in America. That's a leading indicator of how difficult your job will be if you actually try to perform your role in the way it should be done. Yet, if you go-along-to-get-along, you will probably be safe only temporarily.

Dimon was a busy man at the end of 2011 and the beginning of 2012. Apparently, he was so busy courting the media in his campaign against the Volcker Rule (which would prevent taxpayer-insured banks from engaging in proprietary trading) that he didn't do his job overseeing the proprietary trading in the Chief Investment Office (CIO) unit that reported directly to him.

Janet Tavakoli is the president of
Tavakoli Structured Finance in

Despite concrete evidence to the contrary -- including a massive wrong-way coal short for JPMorgan's own book -- Dimon's PR spin was that JPMorgan Chase didn't engage in proprietary trading. Similar to Goldman Sachs' ludicrous claim before Congress, Dimon claimed the bank only traded on behalf of customers.

Meanwhile, Dimon's CIO unit was in serious trouble. In March 2012, the Wall Street Journal and Bloomberg News reported a huge position in credit default swaps taken by JPMorgan's London-based Bruno Iksil. His positions were so huge that other traders called him the London Whale.

Dimon reportedly was a hands-on risk manager capable of handling the enormous responsibility of managing the largest and most systemically dangerous bank in the United States. If that were true, he should have known about the oversized risky derivatives position in the unit that actually reported directly to him.

The trade was so large and risky that before it was done bleeding, it would wipe out years of the unit's earnings. Oswald Gruebel resigned as CEO of UBS in September 2011, after "rogue trader" Kweku Adoboli lost $2.3 billion. Dimon claimed he took responsibility, yet, unlike Gruebel, he didn't step down. Even worse, Dimon reportedly exempted the CIO unit from rigorous scrutiny, and brushed off concerns about the unit's lack of transparency.

The CIO unit was a poster child for rotten risk management and disclosure practices. By May 2012, losses were $2.2 billion and rising rapidly. The Wall Street Journal reported that losses could be as high as $5 billion, more than 25% of JPMorgan's total profits in 2011. Losses ultimately rose to more than $6 billion -- at least, that is the official number.

All of JPMorgan Chase's problems came to a head on Sept. 19, when, in an effort to resolve regulatory investigations into its $6.2 billion trading loss, the bank admitted to violating federal securities laws. As part of a settlement, it agreed to pay a $920 million fine to resolve claims by the Federal Reserve, the Securities and Exchange Commission (SEC), the U.S. Comptroller of the Currency (OCC) and the U.K. Financial Conduct Authority (FCA, which gets a $220 million payout). But the Justice Department and the Commodity Futures Trading Commission (CFTC) are still on the case. The CFTC informed JPMorgan that it recommends enforcement action.

In April 2012, senior management already knew the CIO unit used aggressive valuations that obscured $750 million in losses. The SEC, in its Sept. 19 statement, said that JPMorgan admitted that those losses occurred "against a backdrop of woefully deficient accounting controls" (including spreadsheet miscalculations that caused large violation errors) in Dimon's CIO unit. Moreover, the commission said that the bank was also guilty of "misstating" its financial results in its public filings for the first quarter of 2012.

"JPMorgan failed to keep watch over its traders as they overvalued a very complex portfolio to hide massive losses," George S. Canellos, co-director of the SEC's Division of Enforcement, said in the statement. "While grappling with how to fix its internal control breakdowns, JPMorgan's senior management broke a cardinal rule of corporate governance and deprived its board of critical information it needed to fully assess the company's problems and determine whether accurate and reliable information was being disclosed to investors and regulators."

Though the SEC did not name individuals in its release, it did state that "senior management" applies to the people who held the titles of CEO, CFO, CRO, Controller and General Auditor at JPMorgan as of May 10, 2012.

Dimon Compounded His Credibility Problem

On April 13, 2012, Dimon had knowledge that losses were already as high as $1 billion. That was not publicly disclosed. Instead, Dimon told shareholders it was "a complete tempest in a teapot." He said it was the bank's job to invest "wisely and intelligently."

It was Dimon's job to understand the risks that unit was taking, and by now the time to do his job has long passed. When Dimon misled the public and his shareholders about the magnitude of the problem, he should have known otherwise.

As rumors of the actual position circulated, losses soared, and loss reports were estimated at $100 million or more per day by outsiders. Dimon delayed the 10-Q's scheduled April 27 release.

"Sources" at JPMorgan sounded suspiciously like PR flacks. They told the Wall Street Journal that Dimon didn't ask to see the positions until April 30. Even though the 10-Q was delayed, first quarter earnings had to be restated later.

Shareholders got some of the bad news on Thursday, May 10 -- only five days before the shareholders' annual meeting. Since there was a weekend wedged between, they barely had three days' notice. Dimon admitted: "In hindsight, the new strategy was flawed, complex, poorly reviewed, poorly executed and poorly monitored."

I'll add that, with foresight, it was fully knowable too.

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