By Michael Crimmins, who has worked on risk management and Sarbanes Oxley compliance for major banks
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. Step one in that control process: Don’t let your traders mark their own books. If you do you have no excuse. Your controls are worthless and as CEO, you are responsible for ignoring that fundamental control gap. Full stop.
Which leads to the second underreported stunner.
It is a very big deal when a firm is compelled to disclose a material weakness in internal controls. That’s the worst level of internal control failure a going conern can report. In JP Morgan’s case its more damning since Dimon, as recently as May 10, 2012, certified that all was well with internal controls as of the end of 1Q2012.
That assessment means that it is impossible for the firm’s external auditor to sign off on the financial statements until and unless the control breakdowns are remediated sufficiently for the auditor to provide assurance. The description of the control weaknesses at JP Morgan appear to be design flaws, so it’s likely the weaknesses existed in periods earlier than the first quarter of 2012, when it was ‘discovered’. The fact that the unit with the weaknesses by all accounts was under the direct control of the CEO throws doubt on the validity of his prior certifications about the quality of the internal controls. The external auditors will be under extreme pressure to either support or refute the earlier certifications. Falsifying the certification is the worst Sarbanes Oxley violation there is, so Dimon is going to have to come up with an airtight rebuttal.
JP Morgan has apparently reassured the market that it will take the appropriate steps to mediate the control gaps, but they do not speak for the external auditors. They may not be as sanguine as the market that JP Morgan’s proposed remediations will be sufficient, and the fixes won’t resolve pre-existing conditions. The very real possibility that JP Morgan will not be able to produce adequately certified financial statements in the future should focus JP Morgan’s Board on the adequacy of the remediations and Jamie Dimon’s continuing role as CEO.
JP Morgan’s control weaknesses, like AIG’s, leave us all guessing to the true value of the CIO portfolio today, as well as the true value of the portfolio in the past. If the 1Q 2012 restatement is a guide, it seems plausible that the earlier reported valuations from the CIO group are unreliable.
Which leads us to the clawback issue.
It appears that JP Morgan is in the middle of a perfect storm from the standpoint of Sarbanes Oxley violations. They have material weaknesses, the prior certifications are suspect, and the reliability of the financials going forward is uncertain. The size of the losses and the extent of the control shortcomings at JP Morgan far exceed anything that has been previously disclosed. Their auditors should be about ready to throw them under the bus, even if just to protect their reputation and limit their liability. The SEC should be under enormous pressure to finally do something, and this looks like a slam dunk case of a false Sarbanes Oxley certification.
Congress has been demanding clawbacks. JP Morgan has announced that they will apply clawback provisions dictated by their corporate policies. They have floated a few clawback trial balloons, most notably against Ina Drew, but the details are still being negotiated internally at JP Morgan.
The SEC can demand clawbacks under Sarbanes Oxley, so JP Morgan’s clawback posturing may be moot if the SEC steps in and excercizes its authority. That authority extends to the CEO, so Jamie Dimon is facing an external as well as internal claims against his compensation. The SEC may be satisfied with self-imposed clawbacks that conform with the clawbacks it could demand, but they should intercede at this point and remind JP Morgan, and the rest of us, how much they could demand and from whom if they were to use their Sarbanes Oxley authority. Even the editors at Bloomberg agree.
Sarbanes Oxley is a sledgehammer, by design. Properly enforced it is meant to strip C-suite executives of immunity from frauds taking place in their firms under their watch. It’s clear there were many frauds that occurred and are continuing to occur at many financial institutions. Hopefully the various abuses will be prosecuted under the relevant statutes they violated. In the meantime it becomes clearer each day that the CEOs and CFOs were aware, and are required to be aware, of the potential frauds taking place in their institutions. To certify that there are adequate controls in place even as the frauds continue strains credulity.
Dimon’s “fortress balance sheet” claims are empty when the accuracy of JP Morgan’s financial statements and the integrity of its controls are in doubt. The time is past due for regulators and the JP Morgan board to hold him accountable for the abject failures that have occurred on his watch.
The problems are:
1) that the investor community — and perhaps society, auditors, the political establishment plus the institutions themselves — have become “inculturalated” (to use one of Yves’ words !) to such low standards.
2) that the same parties above have bought into the well spun (but nonetheless completely false notion) that the CEOs of the TBTFs are indeed a small, esoteric and virtually impossible to replicate or replace “Atlases” who keep these behemoths aloft. Quite how this bizzare illusion not only took hold in the first place but was then propagated and finally accepted as a fact by so many otherwise intelligent people is a complete mystery to me. But that is certainly the perception.
3) regardless of the imposition of fines, restatement of phantom “profits” and very uncertain inherent profitability in the medium to long term the view seems to be that, from these entities, there will always be gravy available. This sentiment isn’t entirely illogical — after all, what is the point of being a TBTF if you can’t still extract unearned rents no matter what ? If your business model is effectively a licence to extort more-or-less consequence free — with only the most outrageous excesses subject to token claw backs — then there’s no reason why that won’t continue to pay off. It’s just a case of “by how much” rather than “if”.
So where, then, are the imperatives to change ?
No, it’ll take another crisis to finally drive a stake though the hearts of this lot. It will come in time, but to quote “just because something is inevitable doesn’t make it imminent”. In the meantime, why wouldn’t you keep on grabbing ? Only good conscience prevents it and that is one commodity which is in short supply.
“Sarbanes Oxley is a sledgehammer, by design. Properly enforced…”
SOX one of many powerful regulations and laws on the books. they may as all be thrown down some well. If they are not enforced what good are they? As I recall Liberia has a constitution modeled on the U.S. constitution. What good has it done for them? Indeed what good does it do for us to have all sorts of things codified when no action is compelled?
Very true. Laws are like muscles. They can only be effective if they’re regularly flexed.
A sledgehammer? I thought is was a nerfhammer myself. But as a $34,000/year bi-weekly wage-earner, what could I possibly know about such things?
I know this: if the law repealing Glass Steagall were itself repealed, and Glass-Steagall were default restored exactly as originally written and passed, and all the relevant “banks” were thrown off a cliff to shatter into their Glass-Steagall-enforced-separation pieces on the rocks below . . . we wouldn’t need such silly gestures and diversionary non-law laws as Sarbanes Oxley.
Why WOULD the board dump him? He’s doing a stellar job, depending on your perspective and perception. In terms of corporate management intersecting ecological models: which coyote that has been groomed as a successor do you imagine would fill the territorial void?
From the oil patch
Jefemt is right, of course, which is the weak point of this blog post, obscuring the important facts of reality:
1. Dimon is continuing on the tradition of JPMC. Just do a quick review of the SEC’s litigation releases for JPMC over the decade.
2. The firing of the CEO, with the financial organization or bankster continuing as before is all part of the theater. Again and again those of us who know history say: who owns JPMorgan Chase? That should be the primary question of the day.
Let me repeat your question/statement:
“Who owns JPMorgan Chase? That should be the primary question of the day.”
Why hasn’t he been fired? Because these fellas have fewer skills than formerly required of a stenographer. At best, they’re suits for show.
On LIBOR manipulations from this mornings HuffPo
“proposed by .. forwarded on ”
Boards of director are hirlings of management, selected for cosmetic reasons related to gender, race, previous condition of importance. Their job is to apply the rubber stamp and collect their emoluments, sit through a monthly lunch without noticeable gastric embarrassment. Boards of directors are a fiction. When was the last time one of them actually did anything? You think these clowns worry about media outrage? They worry only about losing these profitable gigs on multiple Boards, which is what happens when they stop toeing the management line.
Good points and great explanation of that LIBOR stuff here:
Wasn’t there recently an article on iterated Prisoner’s Dilemma, which showed that extortion tactic works, as long as the “mark” will not throw in an ultimatum. Or walk away, in some literal or figurative way. So this is pretty much what there’s on offer: Shut up and pay up, just say no, or find something more interesting to do.
“Control weaknesses” it would appear JPM internal control process were deliberately designed–you call them weak they call them “effective. As you say–a feature not a bug. Indeed–control fraud. Boards firing CEO’s in U.S. is much like an eclipse or the occassional show trial…..
‘Forgive me, [says Dimon] for being at the center of such circles while a NY Fed boardmember.’
“JPMorgan Chase & Co. (JPM)’s assertion that traders at its London chief investment office may have intentionally mismarked trades, ..”
“the New York Times .. quoted Silverstein saying that Iksil is innocent of wrongdoing. ”
“Agencies reviewing the matter include the [Circling of the ‘Regulators’ Wagons to nestle this FraudFest inside the Olympic ‘Celebrations’, of FRAUD, that is] ”
London, where AIGFP’s Cassano lives, where LIBOR shareholders trump all, where Corzine’s modus fled to safety ..
“Sarbanes Oxley .. Properly enforced …”, that sounds like a fantasy of Olympic Village, lol,
center Circle, of the wagons, lol,
‘Discretion’ thrown to the wind, and, of course ?, ‘Found Out’
[I take it that poster on the right is their statement of intent, to ‘fight’ ??]
[ http://www.nakedcapitalism.com/2012/07/links-bastille-day.html#comment-758431 ]
forgot the lol-link,
‘Found OUT !!’
“Advising”, with vacuum,
Tempests, tea, fraudfests ..
Re: Olympic Village: “you’re meeting like-minded people” — cross between a DKE rush party and:
“OLYMPIA: The Complete Original Version” – Written, Produced, and Directed by Leni Riefenstahl, 1938 (A Pathfinder Home Entertainment Release 2-Disc Set, Pathfinder Home Entertainment, 2006).
As the linked piece avers: “Everybody’s beautiful” — Uberbonding perfected.
Why hasn’t Dimon been fired? Well-run criminal enterprises close their ranks when outsiders get a whiff of what is really going on. They don’t fire one of their caporegimes who probably can rat out the whole gang. Dimon is more likely to die in a plane crash than get fired…..
The CIO group reported directly to dimon and the integrity of the marks where therefore his responsibility for oversite – yet he said the affair was a “tempest in a teapot”
he was minimizing the affair because of his direct involvement – he knew more than he disclosed at that time -im sure there are associated communications and reports which would show the ability to get to the real marks that he intentionally avoided because he thought he could minimize the losses with some more time and the market got worse
Yes–Onerta! Onerta rules in Wall Street–another neat thing learned from our thing….
I’m sure you mean o “m” erta. Omerta with an “m”.
JPM is also conducting a full scale advertising campaign to bolster its public image. I had the pleasure to hear this nauseating piece of propaganda on the radio yesterday as well.
Secretary of Treasury in Obama’s second term thats the exit strategy regardless of whats transpired
He is obama’s favorite banker
so that wouldn’t surprise me remember his presidential cuff links :)
Obama himself has never challenged the kind of rapacious capitalism he is desperate to associate with his opponent
The board members probably believe that canning Dimon will result in the stock price deteriorating significantly in the short term. Sadly that is all these idiots care about.
A Few Good Men (Parody)
JD: You want answers?
SEC: I think I’m entitled to them.
JD: You want answers?
SEC: I want the truth!
JD: You can’t handle the truth! Son, we live in a world that has Banks. And those Banks have to be guarded by men with Derivatives. Who’s gonna do it? You? You, Michael Crimmins? I have a greater responsibility than you can possibly fathom. You weep for accountability and you curse crony capitalism. You have that luxury.
You have the luxury of not knowing what I know: that Government backstops and inept regulation, while tragic, probably saves jobs. And my existence, while grotesque and incomprehensible to taxpayers, saves jobs …You don’t want the truth. Because deep down, in places you don’t talk about at parties, you want me at that Bank. You need me at that Bank.
We use words like bonus, muppet, SuperPAC …we use these words as the backbone to a life spent accruing power. The public uses ’em as a punchline. I have neither the time nor the inclination to explain myself to a man who rises and sleeps under the blanket of the very profits I provide, then questions the manner in which I provide it! I’d rather you just said ‘thank you’ and went on your way. Otherwise, I suggest you open a Hedge Fund and get your own Presidential cufflinks. Either way, I don’t give a damn what you think you’re entitled to!
SEC: Did you certify JPM’s internal controls?
JD: (quietly) I did my job as CEO.
SEC: Did the CIO office report to you?
JD: You’re goddamn right it did!!
SEC: Well OK then, you’re free to go.
For your viewing pleasure:
A Few Good Men: Courtroom scene (1min 51sec)
Thank you for this exact comparison: “Bureaucracy R Us.” We were warned:
“THE BUREAUCRATIZATION OF THE WORLD” by Henry Jacoby, translated from the German by Eveline L. Kanes (Berkeley, Los Angeles, London; University of California Press, 1976, 1973; orig. published by Hermann Luchterhand Verlag GmbH, Neuwied and Berlin, 1969, as No. 64 in the seies “Soziologische Texte, edited by Heinz Maus and Friedrich Fuerstenberg).
This is the Universal “Leviathan” – the .99% Agency for the .01% Master Class.
What changes in corporate organization would be needed to enforce compliance with the law? And, what political movement could bring about those changes? How about a False Claims Act built into the legal definition of a corporation? That would send a lot of people sniffing out fraud. I’m sure this group could come up with good suggestions.
just keep borrowing short to lend long on downhill negative relative interest rates, and park the losses in pension account “assets” right?
Oh btw speaking of AIG
Spitzer lets it slip in this interview. It was the Oligarch from Omaha, Warren Buffett, who caused Spitzer to go after AIG, a major competitor of Buffett’s in the insurance business.
also of interest
CONFIRMED: The attempted cover-up of how JP Morgan torpedoed Lehman Brothers
When customer futures account money disappears … all roads lead to J.P. Morgan
“Advancing cash to keep the markets stable is simply double-talk bollocks: many observers are sure this was the Lehman trades money withheld by JPM. ”
I remember this at the time, it wasn’t a loan it was owed, Paulson made no attempt to step in.
OMAHA: The Franklin Cover-up still is in place.
Peter Brandt expects “the average turn-around commission rate” to double! What kind of inflation is that to be “externalized?”
Strong writing in this piece. Nice balance of outrage and analysis.
Absent real pressure from relevant outside authorities, however, Dimon is likely to stay where he is. So long as it is optional, or dictated by mere convention (or moral?), Dimon’s the type to thumb his nose.
[The entire notion of accountability is cosmically tragicomic. The only time you can get it is when you don’t need it. And when you need it, you don’t get it.]
Similar to Canada’s PM Stephen Harper and his cabinet: no matter how collossally they screw things up, no Minister shall take the once-traditional Olde Walk of Shame!
Stephen Harper remains Bush Dynasty co-conspirator, subject to QEII per forza.
So at the top of our Government we have a person who has decided to selectively in force some immigration laws, why would anyone think that same Government might want to in force SOX?
Yves, very long but dense, intelligent, complete, worth your while, on the evolution of CapitalismNOT:
VOLTAIRE’S BASTARDS–THE DICTATORSHIP OF REASON IN THE WEST
16.The Hijacking of Capitalism
Oh yes. I’m on the edge of my seat waiting to see if Jamie Dimon KEEPS HIS JOB at JPM. That is definitely the “biggest question.”
Let’s discuss it around the water cooler!!
Take this will-the-CEO-of-our-crime-syndicate-keep-his-title BS and shove it deep.
If 50 million bitter blue people each took some kind of tiny little economic action, could those tiny little economic actions be co-ordinated in some way to have the effect of drying up JPMorgan’s revenue streams and etc. just enough to destabilise JPMorgan enough to render it vulnerable to well placed “head shots” with the intention of exterminating JPMorgan from existence and wiping JPMorgan off the face of the earth? As a company?
If so in theory, what sort of economic action multiplied by 50 million would be required of 50 million bitter blue people to exterminate JPMorgan from existence and wipe JPMorgan off the face of the earth? Jamie Dimon is just an interchangeable part. If they fired “this” Jamie Dimon they would just replace him with “another” Jamie Dimon. Jamie Dimon is not the enemy. Neither is any other Jamie Dimon which the board might bring in to replace him. JPMorgan is the enemy and it is JPMorgan which requires extermination from existence and enwipement from the face of the earth. What does it take to get 50 million bitter blue people to Think Big?
Rope and a tree. Jamie’s just for starters.