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

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The bank told the Subcommittee that it did not terminate Julien Grout at the time, because it
wanted to consider whether, as a junior trader, he had been coerced into marking the SCP book
improperly. 855
F. Analysis
While JPMorgan Chase has essentially conceded that the CIO mismarked the SCP book
to hide losses, it has chosen to rest its analysis on the subjective intent of the traders involved
with the mismarking, rather than on the objective evidence. That evidence shows that the CIO
had changed its valuation practices over time, began using more favorable marks than the
midpoint prices in ways that consistently benefited the bank, and used those more favorable
prices to avoid reporting hundreds of millions of dollars in losses over a three-month period.
The CIO’s mismarking was also evident from the hundreds of millions of dollars in collateral
valuation disputes it had with its counterparties, including JPMorgan Chase Investment Bank.
Detecting the mismarking of derivatives does not require analysis of a person’s subjective
opinions; it requires analysis of the marks themselves to determine the extent to which they
deviate from the midpoint prices and the extent to which that deviation benefits the financial
institution marking the values. Calculating those two objective factors is not only possible, but
provides a cost-effective option for bank managers and regulators to exercise better oversight of
the derivative valuation process.
While JPMorgan Chase has admitted the misconduct of the CIO personnel engaged in the
mismarking, it has yet to acknowledge the deficiencies in the SCP pricing reviews conducted by
the VCG and Controller’s offices. These reviews failed to use the objective information at hand
to expose the SCP’s mismarking, to condemn the CIO’s use of overly favorable derivative prices
to minimize losses, and to prohibit other bank business lines from engaging in similar derivative
valuation practices. Instead, the bank expressed support for the two internal reviews that upheld
the CIO’s pricing practices. By failing to provide any criticism of those reviews, the bank has
essentially signaled that its businesses can continue to game derivative prices, as long as they
select prices from the daily bid-ask spread and disguise their motives. That troubling message
should be counteracted with a clear policy statement prohibiting the gaming of derivative values
to benefit the bank.
Given the ongoing importance of derivative holdings in large, federally insured financial
institutions, strengthening the derivative valuation process is essential, including through
improved oversight measures to detect and stop mismarking and stronger policies that prohibit
the gaming of derivative valuations.
855 Subcommittee interview of Michael Cavanagh, JPMorgan Chase (12/12/2012) (Harry Weiss).