JPMORGAN CHASE WHALE TRADES: A CASE HISTORY OF DERIVATIVES RISKS AND ABUSES

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Source: JPMorgan Chase & Co. 2012 SEC filings; OCC spreadsheet, OCC-PSI-00000298. G. Analysis 94 CIO Synthetic Credit Portfolio Reported Mark-To-Market Losses January - December 2012 Month or Quarter End Monthly or Quarterly Losses Cumulative Losses YTD January $ 100 million $ 100 million 599 February $ 69 million $ 169 million March $ 550 million $ 719 million April $ 1.413 billion $ 2.132 billion As of May 15 $ 1.563 billion $ 3.695 billion June Not available $ 4.4 billion 600 July restatement of first quarter losses $ 660 million 601 Not available September $ 449 million 602 $ 6.2 billion December Not available $ 6.2 billion 603 JPMorgan Chase is the largest derivatives dealer in the United States, with years of experience in trading credit derivatives. At times, bank representatives told the Subcommittee that the synthetic credit derivatives traded by the CIO should be viewed as an effective risk management tool designed to lower the bank’s overall credit risk. The facts associated with the whale trades, however, prove otherwise. They show how credit derivatives, when purchased in massive quantities, with multiple maturities and reference entities, produce a high risk portfolio that even experts can’t manage. Step by step, the bank’s high paid credit derivative experts built a derivatives portfolio that encompassed hundreds of billions of dollars in notional holdings and generated billions of dollars in losses that no one predicted or could stop. Far from reducing or hedging the bank’s risk, the CIO’s Synthetic Credit Portfolio functioned instead as a high risk proprietary trading operation that had no place at a federally insured bank. The whale trades also demonstrate how risk can be misunderstood, manipulated, and mishandled when a bank claims to have been using derivative trades to lower its overall risk, but has no contemporaneous records detailing the risk reduction strategy or the assets being hedged, no analysis showing how the size and nature of the hedge were determined, and no tests gauging the hedge’s effectiveness. Hedging claims require those types of contemporaneous records in 599 For losses from January through May 15, 2012, see OCC spreadsheet, OCC-PSI-00000298. 600 JPMorgan Chase & Co. Form 10-Q for quarterly period ending 6/30/2012, at 6, 11. 601 JPMorgan Chase & Co. Form 8-K, (7/13/2012), at 2. 602 JPMorgan Chase & Co. Form 10-Q for quarterly period ending 9/30/2012, at 10, 12. 603 12/12/2012 OCC Supervisory Letter, JPM-2012-66, PSI-OCC-18-000001 [Sealed Exhibit]. The $6.2 billion did not change from September, apparently because, by then, the SCP had been largely dismantled and most of its positions transferred to the Investment Bank.
95 order to be substantiated. In addition, the fact that the OCC was not fully aware of the Synthetic Credit Portfolio for years, because it was not explicitly named in any bank report and because its performance data was subsumed within a larger investment portfolio, highlights the need for improved derivatives data to ensure the OCC can detect and oversee all substantial derivatives portfolios being traded by a bank through a U.S. or foreign office.
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United States Senate PERMANENT SUBC
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JPMORGAN CHASE WHALE TRADES: A CASE
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(a) Background ....................
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JPMORGAN CHASE WHALE TRADES: A CASE
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materials and reports on the whale
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(2) Hiding Losses 5 In its first fo
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7 The ability of CIO personnel to h
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9 incorrect information, and at oth
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11 “fully aware” of its activit
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13 activities to continue, includin
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15 Senior bank management was also
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17 specified level; and requiring d
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19 principal bank subsidiaries are
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to assuming that post in February 2
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consisted of stressed or distressed
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25 commuted to his job in London. 8
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27 banks’ deposits, the OCC is th
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29 holding down interest rates, the
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31 combine them into a single dolla
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33 index known as the “XO” inde
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III. INCREASING RISK 35 In 2005, JP
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37 derivatives was unusual for a CI
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39 provide information to the agenc
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Source: Replication of Subcommittee
Page 49 and 50: 43 costly if they do occur. 234 JPM
Page 51 and 52: 45 the SCP was expected to gain $1
Page 53 and 54: 47 bank in those scenarios. 275 Tha
Page 55 and 56: 49 would not function as a hedge at
Page 57 and 58: earish. 308 According to Mr. Macris
Page 59 and 60: 53 Subcommittee for more complete R
Page 61 and 62: 55 until after the OCC began examin
Page 63 and 64: 57 (5) SCP Trader Compensation SCP
Page 65 and 66: The compensation data for both Mr.
Page 67 and 68: the CIO to protect its $350 billion
Page 69 and 70: 63 that CIO would exit the syntheti
Page 71 and 72: 2012, Mr. Iksil reported internally
Page 73 and 74: 67 Martin-Artajo, Mr. Macris did no
Page 75 and 76: 69 20.5 Bln but the current model u
Page 77 and 78: 71 Of the four scenarios laid out i
Page 79 and 80: 73 during a market rally so, accord
Page 81 and 82: 75 Buy protection on the tightening
Page 83 and 84: 77 asked the OCC about those losses
Page 85 and 86: 79 derivatives and incurring even m
Page 87 and 88: 81 Drew he wanted to wait until the
Page 89 and 90: 83 2012, Mr. Iksil warned his super
Page 91 and 92: poor the SCP recordkeeping was, but
Page 93 and 94: 87 The order to stop trading preven
Page 95 and 96: Source: See 07/16/2012 FDIC present
Page 97 and 98: positions in newly issued credit in
Page 99: 93 In another context, Mr. Dimon wa
Page 103 and 104: 97 agitation over underreporting SC
Page 105 and 106: A. Background 99 (1) Valuing Deriva
Page 107 and 108: which it holds a concentrated block
Page 109 and 110: 103 market making groups in the Inv
Page 111 and 112: 105 provide his judgment and estima
Page 113 and 114: 107 of the last 16 business days --
Page 115 and 116: 109 The SCP had never before experi
Page 117 and 118: 111 Evidence indicates that the CIO
Page 119 and 120: 113 showed that the unreported loss
Page 121 and 122: 115 that the bank’s internal inve
Page 123 and 124: 117 daily loss of $43 million and a
Page 125 and 126: 119 On the same call, Mr. Martin-Ar
Page 127 and 128: 121 Mr. Martin-Artajo: “No, no, n
Page 129 and 130: 123 showing the losses, Ms. Drew to
Page 131 and 132: 125 trades using the Investment Ban
Page 133 and 134: 127 Mr. Macris: “… Javier has,
Page 135 and 136: 129 Mr. Pinto: “Ok. And you think
Page 137 and 138: 131 to the portfolio’s enormous s
Page 139 and 140: 133 “In terms of the worse case s
Page 141 and 142: 135 point in the year. The cumulati
Page 143 and 144: 137 Subcommittee that the CIO did n
Page 145 and 146: 139 Chief Investment Office Collate
Page 147 and 148: sources, and inadequate procedures
Page 149 and 150: 143 CDX.NA.IG 0-3% S09 10Y 60.750 6
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145 million before adjustment to th
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147 “The Firm believes that its v
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149 That the bank’s Controller fo
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E. Admitting the Mismarking 151 Som
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153 The bank told the Subcommittee
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155 In the case of the bank’s CRM
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157 The bank’s reliance on Ms. Dr
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159 For both the bank and its busin
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161 breaches, bank documents indica
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163 “[Mr. Zubrow] bears significa
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usiness. 922 165 As a result, bank
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167 period of time to a certain deg
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169 management team in London. 941
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171 Assets (RWA) results for the CI
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173 Portfolio “maintained its ups
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175 On January 16, 2012, the CIO’
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177 The Subcommittee could identify
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chief market risk officer in London
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181 In addition, the Subcommittee w
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Value-at-Risk 183 Value-at-Risk for
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185 At the end of 2011, the SCP con
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187 The newest VaR model “resulte
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189 As discussed earlier and as out
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191 Irvin Goldman, and Peter Weilan
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“Hoping that the model is somehow
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Mr. Bangia: Um hum. 195 Mr. Hagan:
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197 allowed to categorize them in o
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199 derivatives have to be marked-t
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201 The email included a chart, exc
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203 According to the JPMorgan Chase
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205 of several months, exceeding th
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207 CIO Mark-to-Market CSW10% Breac
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209 In early December 2011 these st
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211 advisories, or simply not doing
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213 have in the IB [Investment Bank
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management. 1195 215 While each of
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217 Beginning in January and contin
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219 experts. 1201 During the period
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221 (1) 2006-2009: Minimizing OCC O
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223 CIO management needed to “doc
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225 risk personnel criticized the O
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227 bank reportedly spent $1 billio
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229 understanding: “We were infor
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231 basic reports on a timely basis
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233 report provided the OCC with we
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235 apparent in contemporaneous ban
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237 (1) Providing OCC with Limited
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239 Subcommittee that the bank’s
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241 breaching its risk limits. In a
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243 that the CIO may have been over
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245 On May 9, 2012, the OCC held a
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247 losses, litigation etc).” 140
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249 Secondly, the OCC examination t
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F. Analysis 251 The whale trades pr
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y the bank were incomplete, contain
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255 When asked in a May 10 call wit
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257 of the Volcker Rule, quoting le
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259 reporting. All of those positio
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261 that bank executives were evalu
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(1) Rule 10b-5 263 Materiality. Dis
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265 (2) Section 17(a) of the Securi
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267 At the same time, as described
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269 (2) Mischaracterizing SCP as
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Synthetic Credit Portfolio was in
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273 had increased in size since Jan
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275 respond to regulators’ questi
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277 Scenario Analysis Showed SCP Wa
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279 Source: 2/2012 “CIO February
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281 Source: 4/11/2012 email from Jo
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283 During his interview, the Subco
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285 “The synthetic credit book, a
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mitigating hedging activities,” m
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289 (6) Omitting VaR Model Change A
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291 recast the CIO’s VaR-95 total
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293 and accompanying earnings call
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295 Source: 2/2012 presentation sli
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297 The May 10 10-Q reported that a
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299 was not, included in the bank
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301 When the SCP’s massive trades
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JPMORGAN CHASE WHALE TRADES: A CASE HISTORY OF DERIVATIVES RISKS AND ABUSES

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