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

C. Whale Trade Case History
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By digging into the details of the whale trades, the Subcommittee investigation has
uncovered systemic problems in how synthetic derivatives are traded, recorded, and managed for
risk, as well as evidence that the whale trades were not the acts of rogue traders, but involved
some of the bank’s most senior managers.
Previously undisclosed emails and memoranda showed that the CIO traders kept their
superiors informed of their trading strategies. Detailing the Synthetic Credit Portfolio showed
how credit derivatives, when purchased in massive quantities, with multiple maturities and
reference entities, produced a high risk portfolio that even experts couldn’t manage. Internal
bank documents revealed that the SCP was not managed as a hedge and, by March 2012, was not
providing credit loss protection to the bank. Systemic weaknesses in how some hedges are
documented and managed also came to light. In addition, the investigation exposed systemic
problems in the derivative valuation process, showing how easily the SCP books were
manipulated to hide massive losses. Recorded telephone calls, instant messages, and the Grout
spreadsheet disclosed how the traders booking the derivative values felt pressured and were
upset about mismarking the book to minimize losses. Yet an internal assessment conducted by
the bank upheld the obviously mismarked prices, declaring them to be “consistent with industry
practices.”
While the bank claimed that the whale trade losses were due, in part, to a failure to have
the right risk limits in place, the Subcommittee investigation showed that the five risk limits
already in effect were all breached for sustained periods of time during the first quarter of 2012.
Bank managers knew about the breaches, but allowed them to continue, lifted the limits, or
altered the risk measures after being told that the risk results were “too conservative,” not
“sensible,” or “garbage.” Previously undisclosed evidence also showed that CIO personnel
deliberately tried to lower the CIO’s risk results and, as a result, lower its capital requirements,
not by reducing its risky assets, but by manipulating the mathematical models used to calculate
its VaR, CRM, and RWA results. Equally disturbing is evidence that the OCC was regularly
informed of the risk limit breaches and was notified in advance of the CIO VaR model change
projected to drop the CIO’s VaR results by 44%, yet raised no concerns at the time.
Still another set of previously undisclosed facts showed how JPMorgan Chase
outmaneuvered its regulator, keeping the high risk Synthetic Credit Portfolio off the OCC’s radar
despite its massive size and three months of escalating losses, until media reports pulled back the
curtain on the whale trades. In a quarterly meeting in late January 2012, the bank told the OCC
that it planned to reduce the size of the SCP, but then increased the portfolio and its attendant
risks. Routine bank reports that might have drawn attention to the SCP were delayed, detailed
data was omitted, blanket assurances were offered when they should not have been, and
requested information was late or not provided at all. Dodging OCC oversight went to the head
of the CIO, Ina Drew, a member of the bank’s Operating Committee, who criticized the OCC for
being overly intrusive.