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From Banking and Finance Law Daily, September 19, 2013

JPMorgan fined $920 million for London whale; publicly acknowledges securities violations

By John M. Pachkowski, J.D.

The bank holding company, JPMorgan Chase & Co. (JPMC), and its bank subsidiary, JPMorgan Chase Bank, N.A. (Bank), have agreed to pay penalties totaling approximately $920 million dollars regarding losses incurred by JPMC in connection with its 2012 London whale trades. The penalties will settle a number of actions taken by the Office of the Comptroller of the Currency and the Financial Conduct Authority (FCA) of the United Kingdom against the Bank, and the Federal Reserve Board and Securities and Exchange Commission against the bank holding company.

The London whale trades were undertaken by JMPC’s Chief Investment Office (CIO) as part of its Synthetic Credit Portfolio (SPC) which invested $350 billion in excess deposits of the Bank. Following a number of “bets” on a complex set of synthetic credit derivatives, in early 2012, JMPC eventually reported a total loss of $6.2 billion on the London whale trades. A March 2013 report issued by the Senate Permanent Subcommittee on Investigations noted that JMPC indicated that the SCP “was not intended to function as a proprietary trading desk, but as insurance or a ‘hedge’ against credit risks confronting the bank.”

JMPC and JPMorgan Chase Bank agreed to pay penalties as follows: $300 million to the OCC, $200 million to the Fed, $200 million to the SEC, and £137,610,000, or approximately $220 million to the FCA. By settling with the FCA, JPMorgan Chase Bank received a 30 percent discount under the FCA’s settlement discount scheme. Without the discount the fine would have been £196,586,000 or $315 million.

Prior to the monetary penalties being levied against JMPC and the Bank, criminal charges were filed against two traders d involved in the London whale. The indictments alleged that the traders conspired to hide more than $500 million in losses in the SPC (see story in Banking and Finance Daily, Aug. 14, 2013).

OCC/Fed. The action taken by the OCC and FCA against JPMorgan Chase Bank related to unsafe and unsound practices, found by the OCC, and breaches of Principles 2, 3, 5 and 11 of the FCA’s Principles for Businesses.

The OCC based its civil money penalties on the findings of several targeted exams which discovered the following deficiencies related to CIO’s credit derivatives trading practices: inadequate oversight and governance to protect the Bank from material risk; inadequate risk management processes and procedures; inadequate control over pricing of trades; inadequate development and implementation of models used by the Bank; and inadequate internal audit processes.

The FCA based its penalty on a finding that JPMorgan Bank’s trading activities “undermined trust and confidence in UK financial markets.” Specifically, the FCA found that the Bank breached: Principle 2 of the Principles for Businesses, which requires a firm to conduct its business with due skill, care and diligence, by, among other things, failing to appropriately manage the trading strategy for the SCP in the first quarter of 2012. Principle 3 was breached by the bank’s failure to have adequate and effective systems to monitor risk within the SCP. Principle 5 was breached since the actions taken by the Bank to “limit the damage” indicated that the Bank “failed to observe proper standards of market conduct.” Finally, the Bank breached Principle 11 by failing to deal with the FCA in “an open and co-operative way” during the time losses to the SCP were escalating. The FCA added that the Bank’s breach was aggravated by the fact that the Bank was subject to a more detailed supervisory relationship with the FCA during that period of time.

Prior to it being fined by the OCC, the Bank was operating under a cease and desist order issued in January 2013 that directed the Bank to correct deficiencies in its derivatives trading activity.

Fed/SEC action. The civil money penalty action taken against JMPC by the Fed was to resolve deficiencies in the JMPC’s oversight, management, and controls governing its Chief Investment Office. The Fed’s penalty follows a cease and desist order issued against JMPC, in January 2013, which required the holding company to take corrective action and to continue ongoing enhancements to its risk-management program and its finance and internal audit functions particularly in regard to its Chief Investment Office.

The enforcement action taken by the SEC addressed agency charges that JMPC misstated financial results and lacked effective internal controls to detect and prevent its traders in the CIO from fraudulently overvaluing investments to conceal hundreds of millions of dollars in trading losses.

In a press release announcing the SEC’s enforcement action, it was specifically noted that JMPC “admitt[ed] the facts underlying the SEC’s charges, and publicly acknowledg[ed] that it violated the federal securities laws” which is a departure from standard procedures where a party neither admits or denies the SEC’s findings.

Agency comments. Following news of the agencies’ action, the Comptroller of the Currency Thomas J. Curry stated, “Today’s actions by the OCC, the Board of Governors of the Federal Reserve System, the Securities and Exchange Commission, and the Financial Conduct Authority in the United Kingdom represent extraordinary work and international cooperation to help ensure our financial system operates in a safe and sound manner and in accordance with applicable laws domestically and abroad. The nearly $1 billion in combined penalties and the more than $6 billion in losses resulting from the failures in controls over derivatives trading serve as important reminders to all bankers of the importance of prudent controls, strong governance, and effective risk management. The OCC will continue to use the remedial measures at its disposal, including civil money penalties and cease and desist orders, to deter unsafe and unsound practices.”

Tracey McDermott, the FCA’s Director of Enforcement and Financial Crime said, “This is yet another example of a firm failing to get a proper grip on the risks its business poses to the market.” She added, “Firms must learn the lessons from this incident and ensure that they have business practices, values and culture to control the risks in their businesses.”

George Canellos, Co-Director of the SEC's Division of Enforcement noted, “JPMorgan failed to keep watch over its traders as they overvalued a very complex portfolio to hide massive losses. 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.”

Congressional and industry reaction. The Ranking Member of the House Financial Services Committee, Maxine Waters (D-Calif) said the fines “validate[d] Congress’ decision to provide our regulators with broad authority to regulate derivatives trading whenever it affects the US economy, including overseas. These actions, as well as those expected by the CFTC, send a powerful message to Wall Street that when it engages in irresponsible behavior, it will be held accountable.” She added, “JP Morgan’s admission of guilt should be instructive to our nation’s legislators, regulators and financial institutions. Perhaps now, those of us fighting to end such reckless behavior will no longer have to struggle against the significant resources these institutions have devoted to continuing the dangerous practices that caused the near depression, from which our country is just now beginning to emerge.”

Senator Jeff Merkley (D-Ore), a member of the Senate Banking Committee, said the settlement by JPMC and the Bank was “only half the story.” He added the “SEC failed to hold the company accountable for what appear to be deeply misleading statements made to investors” and concluded if regulators refuse to impose accountability and transparency, we will keep repeating the failures of the past.”

Senator Carl Levin (D-Mich), Chairman of the Senate Permanent Subcommittee on Investigations, said, “The size of the penalties is testimony to the great damage risky derivatives bets can do, and that’s important. However, the whole issue of misinforming investors and the public is conspicuously absent from the SEC findings and settlement. Our PSI investigation showed that senior bank executives made a series of inaccurate statements that misinformed investors and the public as the London Whale disaster unfolded. Other civil and criminal proceedings apart from this settlement are continuing, so there is still time to determine any accountability on that matter.”

Merkley and Levin are co-authors of the Volcker Rule amendment to the Dodd-Frank Act.

Dennis Kelleher, President of Better Markets, a nonprofit organization that promotes the public interest in the financial markets, issued a statement noting, “JP Morgan’s admission of certain facts and acknowledgment that it violated the law is an important step in the right direction. But, using shareholder money to pay headline-grabbing fines to buy a get-out-of-jail-free card for its executives will not end the Wall Street crime spree.” He added, “The behavior and culture on Wall Street must change and that will only happen when CEOs and other senior executives are personally charged and held responsible. Buildings and banks don’t break laws. People do. CEOs and executives do. They need to pay big fines from their own pockets. They need to be censured and barred from the industry. They need to see the inside of prison cells. Then, and only then, will the culture and behavior of Wall Street change.”

JPMC response. In a press statement, JMPC said, “The settlements are a major step in the firm's ongoing efforts to put these issues behind it.” Jamie Dimon, Chairman and Chief Executive Officer, said, “We have accepted responsibility and acknowledged our mistakes from the start, and we have learned from them and worked to fix them. We will continue to strive towards being considered the best bank—across all measures—not only by our shareholders and customers, but also by our regulators.” Lee R. Raymond, Lead Director of the Company's Board of Directors, added, “The Company has been engaged in a comprehensive program of remediation to address, among other things, the deficiencies reflected in the regulators' findings. ... Our Company has learned from its mistakes, and our Board is confident that our management team is fully committed to ensuring they don’t recur.”

Companies: Better Markets; JPMorgan Chase & Co.; JPMorgan Chase Bank, N.A.

BankHolding BankingOperations DoddFrankAct FederalReserveSystem FinancialStability SecuritiesDerivatives VolckerRule

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