Why Investigators Need to Look Into Jamie Dimon's Role in the London Whale Case

The London Whale has surfaced again. The lingering question is whether the investigations will prove that whales, like fish, rot from the head.

In the early months of 2012, JP Morgan Chase’s Chief Investment Office in London racked up $6.2 billion or so in losses as a complex strategy for trading credit default swaps spun out of control. The CIO was originally tasked with investing excess deposit funds and reducing bank risk by hedging, but along the way it started making profits and management allowed it to morph into a trading operation. An investigation by the Senate Permanent Subcommittee on Investigations found, among many other things, that employees changed the procedure for valuing holdings so as to to mask losses. It has been widely reported that the US authorities are seeking the arrest of two employees involved in the valuation change, Javier Martin-Artajo and Julien Grout, in London. Bruno Iskil, the London Whale himself, may be assisting the investigation.

Far more importantly, the report says that JP Morgan Chase may be negotiating a settlement with the SEC that admits its fault in the episode. The admission of fault by a major Wall Street bank in such a proceeding would be a breakthrough in the post financial crisis world.

The question is how far the fault admission goes. The London Whale caper is remarkable because motive is somewhat elusive. The losses were significant, but in no way materially threatened the underlying health of JP Morgan Chase. That lower level employees, like Iskil, Martin-Artajo and Grout, would fiddle the numbers to hide losses to attempt to protect themselves is an understandable narrative. But if the fault is limited to failure in oversight of these employees, the process would fall far short of its potential.

The news reports speak of a third government process, a possible investigation by the FBI and federal prosecutors of misrepresentations to investors by JP Morgan Chase in a 2012 teleconference meeting, during the period that Jamie Dimon was referring to the London Whale as a “tempest in a teapot.” This is potentially the most important thread of the investigation, but it is also the most complex. The participants in the call included Dimon and then-CFO Douglas Braunstein. The language used in the teleconference was studied, with clear input from the legal team. The question is what the JP Morgan Chase leadership team knew of the effort to minimize the consequences of the London Whale in the months prior and why would they have risked so much for a problem that could be solved by writing a check from available funds.

The Senate Permanent Subcommittee on Investigation's report clearly depicts a senior management that had contempt for regulators and rules. I have suggested in previous postings that this culture of contempt was the real reason for the recent shareholder initiative to strip Dimon of one of his two titles, Chairman and CEO. And the flood of government investigations of the bank, everything from electricity market price manipulation to mortgage practices, underscores this terrible flaw.

Inspired by Dimon, JP Morgan Chase has for years been in a titanic struggle with the government and reformers, resisting the rules that could curb its risky behavior in the quest for super profits (and bonuses). A centerpiece of the bank’s argument is that it can handle the risks of its business internally, having an unparalleled risk management system. Dimon has been in the vanguard of industry resistance to regulation largely because his bank remained relatively strong in the financial crisis. He claimed credit for his risk management systems and skills. And the quality of these systems and skills was important to JP Morgan Chase share value.

The skyrocketing risks associated with the London Whale trades in early 2012 were uncomfortably inconsistent with this public image. The risk was causing the amount of capital to be set aside as a firewall against bank failure under new rules to spiral higher. It was evidence of failed risk management.

The bank then took a very telling step. Instead of reducing the risk, it put in place new software that calculated the risk to be lower. Nothing changed but the assumptions and algorithm, but miraculously the risk figure reported to the authorities and the public in early 2012 was virtually identical to the risk figure in late 2011. No one was told that the figures were not comparable, and this hid that the risk of the huge trades had doubled.

The Committee reports that while the software switch was implemented, Dimon personally signed off on a waiver of risk limits for the Chief Investment Office. Did he know the circumstances behind this waiver? Very likely, yes.

Why would someone of the stature of Dimon or Braunstein risk a cover up of the London Whale fiasco.  It was not the loss. It was the damage to image and the implications for regulation, an intervention by the government that they believed to be a threat to their way of doing business. It turns out that the risk was real, but not in the way they had planned.