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

186
“[T]he model was approved despite operational problems. The Model Review
Group noted that the VaR computation was being done on spreadsheets using a
manual process and it was therefore ‘error prone’ and ‘not easily scalable.’
Although the Model Review Group included an action plan requiring CIO to
upgrade its infrastructure to enable the VaR calculation to be automated
contemporaneously with the model’s approval, the Model Review Group had no
basis for concluding that the contemplated automation would be possible on such
a timetable. Moreover, neither the Model Review Group nor CIO Risk followed
up to determine whether the automation had in fact taken place. …
CIO’s implementation of the model was flawed. CIO relied on the model creator
[Patrick Hagan], who reported to the front office, to operate the model. Data were
uploaded manually without sufficient quality control. Spreadsheet-based
calculations were conducted with insufficient controls and frequent formula and
code changes were made. Inadequate information technology resources were
devoted to the process. Contrary to the action plan contained in the model
approval, the process was never automated.” 1046
Still another problem was that the new VaR model included an unapproved model
component designed by Mr. Hagan, but never tested or approved by the Model Risk
Group, 1047 as well as calculation errors involving hazard rates and correlation estimates
that improperly lowered the VaR results. 1048
In other words, a critical risk model for a portfolio containing hundreds of billions
of dollars of financial instruments, operated by the man who developed the model at the
behest of the portfolio manager, included flawed and untested components, and depended
upon manual uploads of key trading data daily for its calculations. This untested,
unautomated, error prone VaR model was nevertheless put into place at a bank renowned
for its risk management.
At the time it was implemented, the new VaR model produced no objections from
the bank’s regulators. Later, however, after the agency conducted an intensive review of
the VaR model and learned of the operational problems, the OCC head capital markets
examiner told the Subcommittee that the bank’s poor implementation efforts were
“shocking” and “absolutely unacceptable.” 1049
In May 2012, four months after activating it, JPMorgan Chase revoked the CIO’s
new VaR model and replaced it with the prior model. Four months after that, JPMorgan
Chase revised the VaR model used for the Synthetic Credit Portfolio for a third time. 1050
1046
2013 JPMorgan Chase Task Force Report, at 105.
1047
See 2013 JPMorgan Chase Task Force Report, at 125, 128.
1048
Id. at 128 (explaining that this error “likely had the effect of muting volatility by a factor of two and of lowering
the VaR”).
1049
Subcommittee briefing by OCC (3/4/2013) (Fred Crumlish).
1050
See JPMorgan Chase & Co. Form 10-Q for period ending 9/30/2012, filed with the SEC (11/08/2012), at 22,
http://files.shareholder.com/downloads/ONE/2252595197x0xS19617-12-308/19617/filing.pdf.