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More JP Morgan Whitewash

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Via e-mail, some updates from Michael Crimmins, a bank compliance expert and member of Occupy the SEC, on the continuing failure of the media to portray the real significance of the JP Morgan London Whale losses: that it revealed glaring deficiencies in internal controls that warrant prosecution of Jamie Dimon under Sarbanes Oxley (SOX). This section of a July post by Crimmins explains why the London Whale control failures are serious. JP Morgan’s kid gloves treatment by the press shows it pays to be a major advertiser:

JP Morgan’s jawdropping revelations in its Friday earnings call don’t seem to be attracting the attention they deserve. The market may have shrugged off the size of the losses and the corporate governance modifications plans, but the announcement opens the door wide for the next phase of this scandal. The biggest question is whether Jamie Dimon should keep his job.

The first stunner, that JP Morgan was restating the first quarter financials, should have caused a deafening ringing of alarm bells. For a company of JP Morgan’s stature to be compelled to restate prior period financials is a very clear signal of bigger problems with their overall financial reporting. In isolation we would normally expect to see a massive selloff with an event of that seriousness. Analysts and reporters may have missed the significance since it was dropped into a footnote and overshadowed by the other disclosures.

Add in the magnitude of the restatement which increased the CIO losses by a massive 90% over the previously reported losses and you’d expect to see further panic. The original 1Q12 results included a loss of $718 million. The restated results added another $660 million , bringing the total first quarter loss to $1.4 billion.

But the real cause for alarm is the reason for the restatement. JPM was forced to disclose that it relied on its traders to provide honest and accurate valuations for its financial statement disclosures. That’s like putting the foxes in charge of not just the henhouse, but the entire farm. Much to its chagrin that was a costly choice. Note that was not a mistake, but a conscious choice.

That Stone Age policy has been extinct for a generation at every financial institution that signs a SOX internal controls certification. Oops, I’m wrong there. AIG relied on their trader marks too, but their external auditors finally had had enough and forced them to disclose ‘material weaknesses’ in internal controls. The stock dropped like a stone with that revelation.

Every firm that I’ve worked at has an independent valuation unit that resides outside the business unit. In JP Morgan’s case it seems that unit reported to the business, which is a serious deviation from good practice. (There is a remarkable new story up at Bloomberg which has former JP Morgan executives acting as if there was nothing amiss about having traders mark their own positions or having the valuation unit for the CIO sit within the CIO. This is in fact a troubling sign about the acceptance at senior level in JP Morgan of deficient controls as “normal”). History has shown that staffers preparing the valuation will be subject to pressure from the unit leaders, particularly if the business has losses that the producers hope can be reversed. Additionally, most major trading operations have a valuation committee that includes the corporate CFO to challenge (and memorialize the analysis of) the valuations and the valuation process. The activity of this committee is generally reviewed by (and in many cases attended by) the external auditors, especially since the beginning of the crisis.

It appears that JPM is attempting to make the case that rogue traders, with criminal intent, mismarked the books. That may be so and relevant criminal charges against those traders should be pursued. But that strategy does not protect management. If there was mismarking, especially to the extent that occurred here, it is the responsibility of management to know or have procedures in place to alert them to the potential for fraud.

Yves here. Crimmins prediction, that JP Morgan would try to blame traders for the position marks, has proven to be correct. Tonight, the lead story in the New York Times business section is “At JPMorgan, an Inquiry Built on Tapes,” with this as the summary:

Investigators examining a multibillion-dollar trading loss at JPMorgan Chase are focusing on calls in which employees openly discussed how to value troubled bets in a favorable way.

So the press is taking the JP Morgan party line that that exculpates management, when it doesn’t, particularly when JP Morgan’s practice was so radically out of line with industry norms. As Crimmins writes:

Sorkin’s team is doing their job managing JP Morgan’s PR hoping to minimize the threat to Dimon as the bank’s third quarter earnings announcement approaches Friday.

I expect JP Morgan will have to disclose the progress of its own internal investigation, and summarize the civil and crimminal investigations underway. It will also be interesting to see what the external auditors have to say. The full court PR press beginning with the New York Times Ina Drew story last week, followed by the toss of chief risk officer Barry Zubrow under the bus is looking like a desperate media offensive. I’m expecting the Friday news will not fit that narrative. We’ll see.

JP Morgan hopes the fiasco will be blamed on those rouge mis-marking traders. Me too since it violates Control 101 and keeps Jamie on the hook. Sacrificing Zubrow shouldn’t be enough. The Times story follows the party line that the traders worked in isolation, hence senior management is off the hook:

The scope of the inquiry suggests that the problems were isolated to a handful of executives and traders in an overseas division, and did not reflect a fundamental weakness with the bank’s culture and leadership. The investigation does not appear to touch the upper echelons of the executive suite, notably Ina Drew who oversaw the chief investment office. The findings could insulate JPMorgan and its chief executive, Jamie Dimon, from further fallout.

But that’s not how it works. Management is responsible for the integrity of controls and they were inexcusably lax and were directly responsible for the losses. And so we also see:

JP Morgan is also under investigation by civil regulators, including the Securities and Exchange Commission, which is examining whether the bank misled investors about the severity of the losses. British authorities have also recently opened inquiries into the matter, according to the officials.

Jamie is getting increasingly cocky and unhinged, i.e., allying with Blankfein to lobby for a lame duck fiscal cliff solution, the day before Schumer cuts that effort off at the knees.

And in today’s appearance at the Council on Foreign Relations he reiterated that mistakes were made and that he is fully responsible. That blatant admission (again) shows he’s pretty confident that he’s immune from any SOX threat. But that’s an unnecessary, hubristic risk to take before this matter has been put to bed.

One of these days, Dimon’s lack of caution will catch up with him. He’s probably right that it won’t be the London Whale, but this was a closer call than he seems to realize, and there is also no sign that he’s correcting the underlying risk control deficiencies ex reinstating the older, more conservative Value at Risk model, when we suspect the higher risk levels allowed in the later version were no accident. Inability to learn from your mistakes is a serious flaw, particularly at Dimon’s level.

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26 comments

  1. mcc777c2

    With Obama in office, Dimon has nothing to fear. This administration’s policy has been to collude and conspire with the banking industry to aid and abet their coverup of prior and continuing theft and fraud on a massive scale.

    1. Guy Fawkes Lives

      Obama v. Romney = Wall Street v. Wall Street

      No matter who wins, we are screwed. What to do when you can’t “vote ‘em out”???

        1. SocraticGadfly

          I’ll be voting for Stein. And, if I wanted a real libertarian (which I don’t, because that would mean in all likelihood even more economic oppression) I’d vote for Gary Johnson rather than a fake libertarian and real-world Xn Rightist called Ron Paul.

      1. Carla

        In the 35 states where she’s on the ballot, you vote for Jill Stein. In the 15 where she isn’t, you write her in.

        WHY? 1. She’s an excellent candidate, highly qualified and she doesn’t owe anybody. 2. Doing the same thing over and over and expecting different results is the definition of insanity.

        Someone has to start the change. Why not you and me?

        1. Clark Thornton

          Thank you, Carla. I recently looked closely at Stein’s website. Unlike her third-party competitors, her positions on the issues that matter are clearly and specifically spelled out. Unlike Gary Johnson, she proposes solutions such as break up TBTF, reinstate Glass-Stegall, etc. I’ve become a fan. I believe she’s on the Tennessee ballot, too.

  2. Clive

    SOX, schmox… where I am, SOX compliance is a bad joke. Every change requires, in theory, a SOX compliance statement signed of by a senior executive, VP minimum. There is the world’s largest paper chase, form filling and tick boxing then hey-presto, abracadabra everything is deemed no impact.

    Where, I ask myself, are the auditors and the regulators ?

    In their usual place betwixt various revolving doors is the answer, alas…

  3. SubjectivObject

    My opinion is that the hubris of JPM in general and Dimon in particular has to do with private understandings with the Fed and Treasury to fund/backstop JPM to any extent and by any means necessary, so long as they are effective in their role executing the bankster/govt concensus toward consolidation of power. For me, the many years running, seemingly limitless, and openly cavalier paper shorting of the silver market appears to support this conspiracy theory. My expectation is that such high level conspiracy correspondence among the principles is exclusively verbal, so actionable evidence is near impossible to find, and the moral opposition has the Sisyphian task to weave a whole cloth from reading sodden tea leaves.

  4. chris m.

    Can someone please explain to me why Jon Corzine of MFGlobal has not been charge under Sarbanes–Oxley either?

    Is this legislation BS or is it because he is a well known Democratic Governor, Senator, Obama bundler?

    1. NotTimothyGeithner

      It has nothing to do with being a Democrat. Barack Obama doesn’t believe theft by rich people is a crime or doesn’t really care, and the Justice Department has responded accordingly. Corzine’s status as a Democrat is unrelated. Obama would protect a Republican too.

    2. amateur socialist

      I’m sure the GOP controlled house is going to get right on appointing a special prosecutor to investigate that…

      (crickets chirp)

  5. MichaelC

    Update:

    This morning comes news that it’s Braunstein (CFO) turn to be dealt with before third quarter results are announced. It was pretty odd that the previous shuffle involving the CFO merely interjected the COO between Braunstein and Dimon.
    That arrangement is unusual, and an apparently desperate stop gap till JPM figured out what to do with him. Now they are stuck with a lame duck CFO reporting to the COO, rather than to the CEO for the rest of the year. That’s strange.

    How can JPMs auditors or the Board be comfortable with that organizational weakness?

    http://www.ft.com/intl/cms/s/0/3ec2df94-1348-11e2-ac28-00144feabdc0.html#axzz2909YtnwY

    Dimon’s public defense has been:

    “I called Ina Drew, who ran the CIO. I had spoken to our risk officers, our CFO [Mr Braunstein]. I was assured by them, and I have the right to rely on them, that they thought this was an isolated small issue and that it wasn’t a big problem.”

    Dimon’s ‘right’ to rely on them is proscribed by SOX. He can exercise that right, so long as he has fulfilled his responsibility to ensure effective internal controls are in place in the shops of those executives he relies on. That appears not to be the case, as evidenced by the 2Q disclosure of material internal control weakness.

    Ina’s left the bank, Zubrow is retiring, and now Braunstein is being redeployed. That may satisfy JPM fans, but it doesn’t solve the underlying control issues that are still subject of SEC or the US attorney’s probe. We will also be hearing shortly from Levin’s Permanent Committee on Investigation into the incident, so these moves still look like window dressing rather than remediation of the underlying issues at JPM. It will be interesting to read the auditor’s comments.

    The WSJ broke the Braunstein story last night. They did a better job of focusing attention on the regulatory and crimminal risks the firm is facing.

    http://online.wsj.com/article/SB10000872396390444799904578048961507186872.html

    Federal investigators are examining whether executives including Messrs. Dimon and Braunstein misled investors with their comments, said people close to the probes.
    One area of interest in the civil probe by the Securities and Exchange Commission and a parallel criminal investigation by the Manhattan U.S. attorney’s office is the public comments by senior J.P. Morgan executives before the losses were disclosed, these people said.

    Perhaps Dimon will provide an update on those probes at the earnings call tomorrow.

  6. lambert strether

    The headline kinda pulls its punches, doesn’t it? Seems like “Why isn’t Jamie Dimon sharing a cell with Jon Corzine at Club Fed?” would seem fully justified by the content of the piece.

    1. Jane

      I want to see Jamie Dimon in an orange jumpsuit and handcuffs,
      I want to see John Corzine in an orange jumpsuit and handcuffs,
      I want to see Lloyd Blankfein in an orange jumpsuit and handcuffs,

      Lambert – anaphora???

      This one could be an endless list, but I don’t have the time and Yves doesn’t have the bandwidth!!!

    2. Crazy Horse

      Actually there is a reason why we should keep holding on to Guantanamo. All those cells with no tenants, just awaiting the Dimons and Geithners of the world. We need to hurry up the process before all the valuable knowledge about waterboarding technique perfected at Guantanamo becomes outdated.

      1. Crazy Horse

        I do believe that even the worst criminals can be rehabilitated. After confessing their crimes while being waterboarded 50 times there should be a place for Jamie and Timmy as lifetime servers in a soup kitchen for the homeless. If they are truly rehabilitated they too can enter the gates of heaven when they die.

  7. Breslow

    Both the New York Times and NPR are nothing but corporatist rags. NPR is now 100% dominated by corporate-speak, everybody knows type gibberish.

    I will never buy a copy of the New York Times again. Everything in it is suspect. The paper of record? No way.

    I suggest NC’s readers starve the beast and cancel their subscriptions.

  8. steelhead23

    But, but, but… Jamie is worth every dime of that $23 million compensation package. Every dime.
    http://www.businessweek.com/news/2012-10-04/dimon-s-pay-shouldn-t-be-cut-over-london-whale-harrison-says

    Can’t we cut to the chase here? I seem to recall a certain book arguing that these enormous payouts to investment managers should come with a clawback provision. “Gee, Mr. Dimon, your compensation package was based on estimated earnings to JPM of 100 billion. Following some unforeseen losses in your London operation, JPM actually lost $100 billion. Please make your $23 million dollar check payable to JPM. And oh, by the way, clean out your desk.”

  9. steelhead23

    Yves, Did you actually say this: “Inability to learn from your mistakes is a serious flaw, particularly at Dimon’s level.”? C’mon, you’re pulling our legs aren’t you? Dimon’s lax risk-management model is precisely what you rail against in Econned. It was NOT a mistake. Each person in the chain of command above the Whale likely got a benefit from his wild projected earnings. Remember it is not earnings per se, these clowns get paid for – it is ANTICIPATED EARNINGS. Having poor risk controls leads to exaggerated anticipated earnings. Hence, this was no mistake. Dimon is not stupid – he is clever – the stupid people are the owners of JPM – and half of them likely have Bernanke and Geithner on their speed-dial.

    1. Yves Smith Post author

      Dimon has claimed to be different/better than everyone else. Remember all the mythology he’s created about JPM’s fortress balance sheet and it being a better run bank with him involved in details (in Gillian Tett’s book, he’s ranting about the costs of telephones).

  10. Glenn Condell

    Taibbi on the embarrassing fealty to Dimon shown by most Senators on the Banking Committee:

    ‘It would be one thing if this had been a bunch of hick congressmen from the plains asking a panel of MIT professors about, say, ozone depletion, or the potential dangers of nuclear fallout. But these were members of the Senate Banking Committee, asking Dimon questions as though he were an alien from another world: “Tell us, Mr. CEO, what is this ‘derivative trading’ to which you refer? How long has it been in use on your planet?” The whole tenor of the proceeding was incredibly embarrassing, and showed just how unlikely it is that you’ll ever get anything like real questioning in a Senate hearing when a) the level of general expertise among the members is so shamefully low, and b) the witness is a man who controls millions of dollars of campaign contributions.’

    http://www.rollingstone.com/politics/blogs/taibblog/senators-grovel-embarrass-themselves-at-dimon-hearing-20120615

    This touches upon Yves’s comment yesterday about the impossibility of imagining any US pol being capable of Julia Gillard’s debating and oratorical expertise. It is likewise impossible to imagine any group of Australian senators grovelling at the feet of a top Aussie banker. Our politicians are not yet servants.

    1. Nathanael

      The political parties are vibrant, internally functioning organizations in Australia. This is partly possible because of a multi-party system at the Australian Senate level (allowing politicians to leave their party while remaining in politics). It is partly possible because of a fierce loyalty-to-platform requirement within each of the parties. It is partly possible becaue the platform is taken seriously. These are all aspects typical of a parliamentary system.

      This means the political parties constitute coherent counterweights to corporate power.

      The political parties in the US are sclerotic messes, and the structure of the Senate *discourages* loyalty to one’s party, while our media discourages actually abiding by the party platform, and I could list yet more structural problems….

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