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Agencies Push JPMorgan to Improve Risk Controls

Tuesday, 15 Jan 2013 | 3:18 AM ET
Jamie Dimon
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Jamie Dimon

Federal banking regulators hit JPMorgan Chase with two enforcement actions on Monday for failures in risk management that led to a multibillion-dollar trading loss, the first formal sanctions in a case that damaged the bank's reputation and brought heightened scrutiny to its trading operations. The regulators also ordered the bank to fix breakdowns in money-laundering controls that threatened to allow tainted money to move through its network..

The dual cease-and-desist orders from the Office of the Comptroller of the Currency and the Federal Reserve came just as the nation's largest bank is poised to report earnings on Wednesday and potentially issue its own report publicly on the trading debacle.

The regulators identified deficiencies in several layers of the bank, from flaws in assessing potential losses due to complex trades to failures by bank executives to fully inform the board about the increasingly risky wagers.

The chief investment office, the once little-known unit at the center of the trade, was making large bets on credit derivatives from its London offices. In its order, the Comptroller of the Currency's office, one of the bank's top regulators, said the unit was "able to increase its positions and risk, and ultimately losses, without sufficiently effective intervention by the bank's control groups."

Separately, a British regulator, the Financial Services Authority, announced it was continuing to conduct "a formal enforcement investigation into the trading losses." The Securities and Exchange Commission and law enforcement agencies are also investigating the trades.

The trading loss, now estimated at more than $6 billion, was first disclosed in May 2012 and has claimed the jobs of several senior executives and forced the bank's chief executive, Jamie Dimon, once highly regarded for his risk prowess, to appear before Congress to explain the fiasco.

The moves against JPMorgan Chase point to the changing stance of the regulatory agencies, which are working to crack down on outsize risk taking by the nation's biggest banks after being faulted in the depths of the financial crisis for failing to police Wall Street.

Even as the chief investment office took increasingly large and complex bets, for example, the regulators did not station any examiners in the unit's offices in London or New York, according to current and former regulators.

Under the terms of the Federal Reserve's order on Monday, JPMorgan's board has to outline a plan to bolster its risk management along with other critical functions. The bank also has to alter how it rewards senior executives, factoring in poor "risk outcomes and control deficiencies," according to the order.

Neither of Monday's actions, also known as consent orders, requires JPMorgan to pay any fine, and the bank did not admit or deny wrongdoing.

"We've been working hard to fully remediate the issues identified," said Joe Evangelisti, a spokesman for JPMorgan Chase.

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Since announcing the botched trade, which Mr. Dimon acknowledged was "egregious," the bank has shuffled senior management and commissioned an internal investigation into the trades, which was led by Mike Cavanagh, JPMorgan's former chief financial officer.

JPMorgan's board will review the findings of that investigation in a meeting Tuesday ahead of the company's earnings announcement, according to several people close to the bank. At the meeting Tuesday, the board is also expected to vote on whether to make the report public and whether to reduce the bonuses of Mr. Dimon and Douglas Braunstein, formerly the bank's chief financial officer. Mr. Dimon's bonus could be reduced by up to 20 percent, according to two people familiar with the matter.

Among the six largest banks in the United States, Mr. Dimon was the highest-paid chief executive, receiving $23.1 million in 2011. That year, his total pay package was made up of stock and option awards along with a $4.5 million cash bonus.

The report is expected to outline concerns that were privately expressed throughout the upper echelons of the bank. Among the chief problems discussed, according to these people, were critical gulfs in how the bank managed the increasingly complex bets made by the chief investment office.

The report is expected to be especially critical of Mr. Braunstein, who stepped down as chief financial officer in November 2012 and no longer directly reports to Mr. Dimon. Mr. Braunstein, these people said, is faulted in the internal report for not exercising stricter oversight of traders in the London office.

Some within the bank said Mr. Braunstein's credibility was undercut because he assured analysts just weeks before the trading errors were unearthed that he was "very comfortable with the positions we have."

In July, Mr. Cavanagh disclosed initial findings of the internal investigation, which unearthed troubling questions about how traders were valuing their bets. Attempting to mask the size of their losses, traders at the bank may have mismarked their trades, senior executives said during the bank's quarterly earnings call.

The orders issued on Monday also focus on weak money-laundering safeguards, requiring the bank to fortify its monitoring of transactions and its filing of suspicious-activity reports. The Comptroller of the Currency's office faulted the bank for "an inadequate system of internal controls and independent testing."

Mr. Evangelisti, JPMorgan's spokesman, said compliance with controls against money laundering "is a top priority for us."

"We have already made progress addressing the issues cited in the consent orders, which contain no allegations of intentional misconduct by the firm or any of its employees," he said.

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