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From Banking and Finance Law Daily, October 23, 2014

OIG evaluates Fed’s actions in London Whale story

By Katalina M. Bianco, J.D.

The Office of Inspector General for the Federal Reserve Board and Consumer Financial Protection Bureau has released a summary report on its findings stemming from an assessment of the Fed’s and Federal Reserve Bank of New York’s consolidated and other supervisory activities related to losses incurred by JPMorgan Chase & Company’s (JPMC) Chief Investment Office (CIO) in what is referred to as the London Whale story. The OIG said that by focusing on consolidated supervision, its evaluation addressed aspects of the story not covered in prior reviews released to the public.

London Whale. The report comes in the wake of a loss of more than $6 billion incurred by JPMC’s CIO in 2012 due to a complex trading strategy involving credit derivatives. The CIO employee who initiated the relevant trades became known as the “London Whale.” Bank holding company JPMC and its bank subsidiary, JPMorgan Chase Bank, N.A., agreed to pay penalties totaling approximately $920 million dollars regarding losses incurred by JPMC in connection with the trades.

Summary report. The OIG’s summary report contains four findings and a number of recommendations. The complete report has been issued to Fed and New York Fed officials but is not publicly available because it contains a substantial amount of privileged and confidential supervisory information related to an open financial institution, according to the OIG. The OIG initiated the evaluation in July 2012, assessing supervisory activities from July 2004 through April 2012. In July 2004, JPMC merged with Bank One Corporation, and JPMC created the CIO in 2005. April 2012 marked the publication of media articles describing the CIO's derivative positions.

Findings. The OIG found that the New York Fed effectively identified risks related to the CIO's trading activities and planned two examinations of the CIO. However, the New York Fed did not discuss the risks that resulted in the planned or recommended activities with the Office of the Comptroller of the Currency as outlined in SR Letter 08-9, thereby missing the opportunity for the Fed, as consolidated supervisor, and the OCC, as primary supervisor, to discuss risks related to the CIO and how to use agency resources most effectively.

As noted in the report, the New York Fed did not conduct the examinations because of competing supervisory demands and lack of resources. The OIG acknowledges these reasons but said “these practical limitations should have increased FRB New York's urgency to initiate conversations with the OCC concerning the purpose and rationale for the planned or recommended examinations related to the CIO.”

The OIG also found that:

  • Fed and OCC staff lacked a common understanding of the Fed's approach for examining Edge Act corporations which could lead to gaps in supervisory efforts;

  • New York Fed staff members were unclear about what to expect from continuous monitoring activities; and

  • New York Fed JPMC supervisory teams appeared to exhibit “key-person dependencies,” which heightened the bank’s vulnerability to the loss of institutional knowledge.

Recommendations. The report includes 10 recommendations intended to encourage the Fed’s Division of Banking Supervision and Regulation to bolster its supervisory processes and approach to consolidated supervision of large, complex banking organizations. Among these recommendations was the suggestion to issue guidance: reinforcing the importance of effective collaboration; reassessing the supervisory planning process; outlining how Fed staff should document and track supervisory activities; and detailing best practices. Fed guidance also should address expectations for documenting and approving the deliverables of continuous monitoring activities, tracking identified issues, and performing follow-up activities and outline preferred methods for mitigating key-person dependency risk.

Finally, the OIG recommends that the New York Fed assess whether it needs to hire additional supervisory personnel with market risk and modeling expertise.

Companies: Bank One Corporation; JPMorgan Chase & Company; JPMorgan Chase Bank, N.A.

MainStory: TopStory BankingOperations CFPB EnforcementActions FederalReserveSystem NewYorkNews SecuritiesDerivatives

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