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Janet Tavakoli

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JPMorgan Raises Fraud Questions: Rising Trading Losses Top $5.8 Billion (Update)

Posted: 07/16/2012 5:53 pm

In the first half of 2012, losses due to the derivatives trading scandal in JPMorgan Chase's Chief Investment Office (CIO) climbed to $5.8 billion and are still rising.

On Friday's conference call, Jamie Dimon, Chairman and CEO of JPMorgan Chase, resorted to PR spin referring to the trading losses as an "accident." But the bank's financial filings belie his words. JPMorgan's disclosures reveal its investigation has uncovered a likely cover-up that could lead to criminal charges:

"Recently discovered information raises questions about the integrity of the trader marks, and suggests that certain individuals may have been seeking to avoid showing the full amount of the losses being incurred in the portfolio during the first quarter."

JPMorgan also announced it restated its first quarter earnings. That's odd, because Jamie Dimon delayed filing JPMorgan's 10Q (a required financial statement) for the first quarter, and the firm missed the deadline.

Michael J. Moore and Dawn Kopecki at Bloomberg lobbed a grenade at Dimon over his April 13, 2012 disclosures in response to an analyst's question about media reports that JPMorgan Chase had engaged in enormous derivatives trades and that huge trading losses were imminent.

While JPMorgan booked a $718 million loss on the positions held by its chief investment office in the first quarter, it didn't publicly specify the loss when releasing the results April 13. When an analyst asked Dimon that day about media coverage of the trades, he dismissed them as a ["tempest in a teapot."]. ("Dimon Saw $1 Billion Potential Loss When He Made 'Teapot' Remark," July 13, 2012.)

Intensified Criminal Investigation

The losses have led to a criminal investigation. So far the focus is on traders, but given that the control operations at JPMorgan should have checked the traders' marks and given the perceived flaws in Dimon's disclosures, the criminal investigation may broaden. Matt Goldstein and Jennifer Ablan at Reuters broke the story of how the criminal investigation has intensified following last week's disclosures:

Before last week's disclosure, the criminal probe largely had focused on the personal trading of some CIO traders, two of those sources said. The authorities were looking for evidence that some in London may have sold shares of JPMorgan in advance of the firm's May 10 disclosure that it could lose a minimum of $2 billion on the derivatives trades gone awry.


Now the investigation is focused on whether three JPMorgan employees in London committed fraud in reporting on their transactions. The bank is cooperating with authorities.
"JPMorgan Disclosed Possible Misconduct to Feds Ahead of Earnings," July 16, 2012.


Materially Misleading?

Questions swirl around the character and timing of Dimon's disclosures to shareholders. Given the widespread speculation about JPMorgan's potential losses, which proved to be accurate, it raises the question of why people outside of JPMorgan were more aware of JPMorgan's risk and potential losses than Jamie Dimon claims to have been. His public estimates of losses have been a fraction of reality, and it raises the issue of whether he has materially misled stockholders.

This would be enough for European regulators to remove the Chairman and CEO of a bank. Moreover, JPMorgan has other serious issues. One additional example is in JPMorgan's commodities unit, which lost hundreds of millions of dollars in a 2010 coal bet that was outsized relative to the global market. The same commodities division is now being investigated for alleged abusive bidding practices that manipulated energy process in California and the Midwest. A judge gave JPMorgan a deadline to turn over emails it withheld in the investigation.

Dimon signed off on statements that his accounting controls and risk controls were adequate. Yet they were very far from adequate. (In an earlier post, I discussed Jamie Dimon's failure to provide reasonable corporate governance for the CIO unit: "Jamie Dimon: JPMorgan's Chief is the World's Funniest Financier." - May 19, 2012.) Under Sarbanes Oxley rules, he should be held accountable.

Accounting Gimmicks

Through a variety of accounting gimmicks, JPMorgan was able to report second quarter net income of $5 billion, or $1.21 per share, exactly what analysts' projections said it would. Stephen Gandel, senior editor of Fortune saved me the trouble of providing examples of how JPMorgan moved money around to dress up its second quarter earnings. It would have been nice if JPMorgan could have made up its trading losses through business revenues instead of resorting to several games including this one:

Banks have to put money away for loans they believe are going to go bad. But banks can lower their expenses by putting away less money for future loan losses. In the second quarter, the bank put away just over $200 million for future loan losses. That was not only the lowest amount the bank had set aside in any three month period since the start of the financial crisis, it was the lowest by far. A year ago, the loan loss provision was $1.8 billion. ("How Jamie Dimon Hid the $6 Billion Loss," CNN Money, July 13, 2012.)

I discussed the CIO's trading issue with Tom Hudson on Nightly Business Report on Friday:



Excerpt from Transcript

HUDSON: This strategy generated $2 billion in profits over the previous four years before this year. Deposit money wasn't lost, and you know this. Critics, defenders say this trading loss was just not all that material, considering the bank still is able to report a profit today.

TAVAKOLI: Well, that's ridiculous. Now look at what you just said, that this unit reported 2 billion in profit over several years. Now they have $5.8 billion in losses [for the first half of 2012]. The losses are climbing. The losses swamp the profits they reported previously, which shows you how outsized this trade was relative to the size of this unit, and this unit itself is a large bank within a tremendously big bank. Now this is one silo, one unit that blew up at JPMorgan and JPMorgan has trouble elsewhere. The way to look at this isn't in the context of the size of JPMorgan but the size of this unit. Now in terms of the profits that JPMorgan reports, it should be reporting profits. It has a $2.3 trillion balance sheet. The profits it's reporting relative to the size of their balance sheet are not big.

Disclosure: I do not have a position (long or short) in JPMorgan.

Endnote:
Jane Wollman Rusoff interviewed me for Research Magazine's May cover story, "Finding the Culprits of the Crisis," about the deep monetary connections of Wall Street and Washington and the corrosive effect it has had on the economy and the Republic. We discussed risks at JPMorgan and control fraud in the banking system. The interview was conducted in March. I responded to a question about how banks lose money in a control fraud wherein perpetrators within the bank enrich themselves at the expense of shareholders:

The fact that a bank lost money isn't an indication that they were a victim as opposed to being a perpetrator. A classic problem with control fraud is that the parasites destroy the host -- in this case, the host being the bank and the parasites being the bank employees. If you were the victim of a control fraud by the people who worked in your own bank but meanwhile, you were collecting huge bonuses, you overlooked the control fraud within your own institution.
 
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