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

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In November 2007, JPMorgan Chase’s internal audit group conducted an audit of “CIO
Global Credit Trading,” characterizing it as a “First Time Review of New Business, Product or
Service.” 201 The audit report stated: “Chief Investment Office (CIO) credit trading activities
commenced in 2006 and are proprietary position strategies executed on credit and asset backed
indices.” The audit made no mention of hedging or credit stress loss protection, and contained
no analysis of the credit trading activity in terms of lowering bank risk. It also did not identify
any assets or portfolios that were being hedged by the credit derivatives. The audit rated the
CIO’s “control environment” as “Satisfactory,” but noted, among other matters, that the CIO’s
Valuation Control Group committed multiple “calculation errors” when testing the prices of the
credit derivatives. 202
In July 2008, the CIO started a credit derivative trading program intended to “benefit
203
from large defaults on High Yield names.” “High Yield names” referred to individual
corporations perceived to be at higher risk of default, often signaled by carrying a junk bond
rather than investment grade bond rating. 204 Credit default swaps or “High Yield” credit indices
naming these non-investment grade corporations generally required the payment of higher
premiums by the short parties, but also promised large payoffs if the named corporations
defaulted. 205 Each of these derivatives, under generally accepted accounting principles, was
subject to mark-to-market accounting, which meant their value had to be calculated and booked
on a daily basis. 206
Despite credit trades and a formal approval document dating from 2006, it is difficult to
establish when the credit trading program actually coalesced into the Synthetic Credit Portfolio
(SCP). The 2007 internal bank audit stated that the credit trading commenced in 2006, although
207
Ms. Drew told the Subcommittee that the SCP was established in June 2007. The OCC
determined that the SCP acquired its current name in 2008. 208
The timing is somewhat unclear due to a lack of documentation regarding the SCP during
its first five years of operation. Even though the Synthetic Credit Portfolio involved higher risk
instruments that were unusual for an asset-liability management function, the Subcommittee has
uncovered no evidence that the CIO alerted the OCC to the establishment of the SCP or briefed
the OCC about SCP trading activities. The OCC told the Subcommittee that it expects banks to
201 11/29/2007 “CIO Global Credit Trading,” JPMorgan Chase & Co. Audit Department Report, JPM-CIO-PSI-H
0006022-023.
202 Id.
203 4/12/2012 email from Ina Drew, CIO, to Jamie Dimon and others, “Synthetic Credit Materials,” JPM-CIO-PSI
0001101.
204 See “Junk Bond,” OCC February 2008 Comptroller’s Handbook: Leveraged Lending – Appendix B, at 63,
http://www.occ.gov/publications/publications-by-type/comptrollers-handbook/_pdf/leveragedlending.pdf.
205 For more information on the HY credit index, see Chapter 2.
206 See 5/22/2008 “Chief Investment Office New Business Initiative Approval,” prepared by CIO, on “Credit and
Equity Capability,” OCC-SPI-00081631, at 11.
207 Subcommittee interview of Ina Drew, CIO (9/7/2012); see also 5/13/2012 email exchange with Jamie Dimon,
JPMorgan Chase ,”Synthetic Credit QA_2,” JPM-CIO-PSI 0017385 (“The Chief Investment Office has utilized the
‘synthetic credit portfolio,’ which is a portfolio of credit derivatives, to construct a hedge against other risks on
JPMC’s balance sheet. This activity has been part of the CIO portfolio construction and risk management since
2007.”).
208 See Subcommittee interview of Doug McLaughlin and Mike Sullivan, OCC (8/30/2012).