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

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In its January 2013 report on the CIO whale trades, the JPMorgan Chase Task Force summarized
the bank’s derivatives valuation approach as follows: “[B]oth U.S. GAAP and Firm policy
required that CIO make a good-faith estimate of the exit price for a reasonably sized lot of each
position, and assign values reflecting those estimates.” 621
Since at least 2007, JPMorgan Chase policy has been to use midpoint prices as the
“starting point” for valuing its derivatives:
“The Firm makes markets in derivative contracts, transacting with retail and
institutional clients as well as other dealers. … In general, the dealer market is
the Firm’s principal market for derivative transactions as the greatest volume of
the Firm’s derivatives activities occur in the dealer market. In addition the dealer
market is the most advantageous exit market for the Firm. … The starting point
for the valuation of a derivatives portfolio is mid market. As a dealer, the Firm
can execute at or close to mid market thereby profiting from the difference
between the retail and dealer markets. If the Firm cannot exit a position at mid
market certain adjustments are taken to arrive at exit price.” 622
Investment Bank. Within JPMorgan Chase, the Investment Bank is one of the largest
holders of derivatives. JPMorgan Chase told the Subcommittee that the Investment Bank’s
standard practice was to value its derivatives using the midpoint price in the relevant price
range. 623 To identify the mid-price, the Investment Bank employed an independent pricing
valuation service which provided pricing information on a number of derivatives for trading
book valuations. 624
This service typically provided the bank with the midpoints of the bid-ask
spreads for specified derivatives.
Chief Investment Office. The CIO began actively investing in credit derivatives and
assembling a Synthetic Credit Portfolio beginning in 2006. The internal document authorizing
the CIO to conduct credit derivatives trading contained this paragraph on valuing credit
derivatives:
“Valuation Control
CIO is not a market maker and uses the Investment Bank’s risk and valuation
systems to transact its products. As such CIO is a price taker using prices and
valuation inputs controlled and determined by the market making businesses of
the bank. CIO’s Valuation Control Group coordinator will ensure that where
pricing adjustments are identified from the month end price test process for
621 2013 JPMorgan Chase Task Force Report, at 48-49.
622 11/8/2007 Controllers Corporate Accounting Policies, “Fair Value Measurements,” prepared by JPMorgan
Chase, OCC-SPI-00056794 at 11. See also 5/10/2012 Controllers Corporate Accounting Policies, “Fair Value
Measurements,” prepared by JPMorgan Chase, JPM-CIO 0003424-442.
623 Subcommittee briefing by JPMorgan Chase (8/15/2012) (Olivier Vigneron).
624 Subcommittee briefing by JPMorgan Chase legal counsel (2/4/2013). For example, Markit provides price data
for credit derivative indices, while Totem, a related company, provides price data for credit index tranches. See
5/10/2012 JPMorgan Chase Controllers special assessment of CIO’s marks, January through April 2012, at 6, JPM-
CIO 0003637-654, at 642.