By PETER J. HENNING
Daniel Rosenbaum for The New York TimesDouglas Braunstein, a top JPMorgan executive, testified at the Senate hearing on Friday.
The Senate report and hearing on JPMorgan Chase’s multibillion-dollar trading loss provides a portrait of a bank that went right to the edge of acceptable practices, and may have even stepped over the line. The questions now are what type of enforcement action the bank could face, and whether any individuals will be ensnared by the case.
The bar for any criminal case will be high. The report shows JPMorgan employees playing fast and loose with the rules for valuing securities and making proper disclosures, but bringing a criminal case against any individuals would be difficult because of the standard of proof required in prosecutions. Nor is this the type of misconduct that would normally lead to criminal charges against the bank because – at least if the “too big to jail” approach persists – the harm was largely self-inflicted.
Focus Back on JPMorgan's Chief (March 17, 2013)
The Securities and Exchange Commission may have a better chance in its efforts. There are two probable strands the S.E.C. can pursue: the improper valuation of derivatives that led JPMorgan to underreport growing losses, and statements made by senior managers in April 2012 reassuring investors that the portfolio presented no significant risks.
The report, released last week by the Senate’s Permanent Subcommittee on Investigations, highlights how JPMorgan shifted to a flawed risk model that permitted the derivatives portfolio managed by its chief investment office to increase substantially. Its traders also changed how they valued the securities to keep the losses from growing too large, helping to mask the problems even further, according to the report.
There is even the closest thing we will see to a smoking gun in this type of case: a trader maintained a spreadsheet for a few days to track losses using the more common valuation method. Yet the chief investment office reported a lower figure to senior management based on more favorable prices, effectively hiding the growing danger from its derivatives bets, the report found.
E-mails and recorded conversations will, as usual, provide the crucial evidence to show that some inside JPMorgan were aware that its losses were growing yet failed to disclose that information in a timely manner to the public or the bank’s chief regulator, the Office of the Comptroller of the Currency. When the bank restated its financial statement a few months later, it effectively conceded that its valuations had been off.
What is interesting about the e-mails and recordings is the absence of the kinds of hyperbolic statements seen in other cases that can be used to embarrass a company. There are no parodies of song lyrics or boastful claims about misconduct. But that may be traceable more to the situation JPMorgan faced as panic seemed to grip the chief investment office, giving the communications more of a funereal tone.
The lack of incendiary evidence does not diminish the fact that the bank is likely to face civil charges over the valuation of the derivatives or timely reports about its growing problems. Securities laws require a company to maintain accurate records and report them properly, which does not seem to have been the case with the bad bet.
The S.E.C. could pursue cases against individuals for their role in valuing the investments. Traders in the chief investment office could be charged because they were required to record accurate information. If so, the S.E.C. may scrutinize the actions of the group’s former head, Ina R. Drew, who was in regular communication with the traders.
The S.E.C. is also likely to look at statements last April by the chief executive, Jamie Dimon, and a former chief financial officer, Douglas L. Braunstein, playing down problems in the derivatives portfolio. While Mr. Dimon’s now-famous dismissal of concerns as a “tempest in a teapot” garnered the headlines, Mr. Braunstein made much more detailed statements that could have violated disclosure rules.
Senator Carl Levin, chairman of the Senate subcommittee, pressed Mr. Braunstein at the hearing over a statement about his “comfort” with the investments and that “all of those positions are fully transparent to the regulators.” Mr. Braunstein eventually conceded that the government received only summary information from the bank, not a detailed report on the portfolio, although he maintained his statement was accurate based on the information at the time.
To make matters worse, in August 2011 JPMorgan temporarily suspended providing daily information to the Office of the Comptroller of the Currency, its primary regulator, about its investment bank because of concerns about security breaches. Regardless of the reason, it certainly was a questionable decision, and it made Mr. Braunstein’s statement about transparency with regulators look even less defensible.
But proving a violation of the disclosure rules, or that the comptroller’s office was misled, is not necessarily a slam dunk despite the language of the Senate subcommittee report. How much information a bank is required to disclose to its regulator is not always clear, so a phrase like “fully transparent” is subject to differing interpretations. And JPMorgan can always try to fall back on the excuse offered by anyone caught not disclosing bad news – “you never asked for it.”
The S.E.C. has taken a harder line recently on the failure to adequately disclose risks to investors. For example, it recently settled a case with Illinois over misleading disclosure about how it was funding its pension obligations.
It took JPMorgan a month to disavow its earlier statements and reveal the losses from its derivatives trading. Although the prior statement did not contain any blatantly false information, the S.E.C. could pursue a case for giving misleading statements that did not adequately inform investors of the potential losses the bank faced.
Mr. Braunstein may also face a charge for violating the securities laws for his statement. A chief financial officer is usually held to a higher standard for disclosures to investors because of the importance of that position for providing investors with details about a company’s accounting and the risks it faces.
If charges are filed, this is not the type of case JPMorgan would want to litigate because of the potential that even more embarrassing information might come out. So a settlement with the S.E.C. is likely.
An interesting question would be how the payment of any monetary penalty would be handled. In the S.E.C.’s settlement with Bank of America over inadequate disclosure in soliciting proxies to approve its acquisition of Merrill Lynch, Judge Jed S. Rakoff of Federal District Court in Manhattan objected to a penalty that effectively required shareholders to bear the costs when they were the victims.
It would be a similar situation if JPMorgan were required to pay a fine for making misleading statements to its own investors. If it hopes to gain approval from the court, the S.E.C. may need to structure any settlement so the shareholders are its beneficiaries, not the ones responsible for paying all of the costs.