J.P. Morgan 'Whale' Report Signals Deeper Problem

J.P. Morgan Chase JPM +5.96% & Co. said traders appear to have hidden problems in a portfolio whose losses have ballooned to $5.8 billion, the latest twist in an episode that has tested the reputation of Chief Executive James Dimon as one of Wall Street's soundest risk managers. A review of roughly 1 million e-mails and tens of thousands of voice tapes suggests traders within the once-obscure Chief Investment Office "may have been seeking to avoid showing the full amount of losses" during the first quarter by placing inaccurate prices on their positions, the bank said Friday. One trader, nicknamed the "London whale," may have been pressured by a boss to mark positions more aggressively, people close to the investigation said. WSJ's David Reilly pulls up a chair on Mean Street and discusses the idea that despite J.P. Morgan's Q2 loss announced on Friday, should CEO Jamie Dimon be seen as a hero? Photo: Getty Images. The discovery, made in recent days, prompted the company to restate earnings for the first quarter and admit to a "material weakness" within a unit that manages the bank's excess cash—embarrassments for J.P. Morgan, long considered one of the best-managed U.S. banks. Timeline: Tracking Trading at CIO View Interactive "This has shaken our company to the core," Mr. Dimon told analysts and investors Friday. Recap: The J.P. Morgan Call 'Maximum' Clawbacks Sought Deal Journal: Three Key Results Tracking the Trade: New 'Whale' Revelations Heard on the Street: J.P. Morgan's Cookie-Jar Quarter The largest U.S. bank tried to demonstrate Friday that the worst of the problem was in the rear-view mirror, reporting a $4.96 billion profit for the second quarter, down 8.7% from a year ago. The New York company said the results reflect solid performances in its retail, investment-banking and mortgage units. Second-quarter mortgage-loan originations jumped 29% from a year ago to $43.9 billion, while credit-card sales volume rose 12% from a year earlier to $96 billion. The company's investment bank was ranked first globally in fees. Enlarge Image Associated Press J.P. Morgan Chase CEO James Dimon enters the company headquarters Friday. The bank also cited an overhaul in personnel and risk controls within the Chief Investment Office, and announced that compensation would be clawed back from former CIO head Ina Drew and three London managers involved in the bad bets, without giving a total. Ms. Drew declined to comment. "It's time to move forward," Matt Zames, the new head of the CIO, said in a memo to employees. Investors reacted positively, pushing up shares of the bank $2.03, or 6%, to $36.07. Following J.P. Morgan's earnings call and details of their $5.8 billion loss, will investors be too jittery to invest in the stock in the long term? David Benoit reports on Markets Hub. (Photo: Mark Wilson/Getty Images) But it could take longer for J.P. Morgan Chase to lastingly convince investors that any risk-management weaknesses have been fixed and the losses are under control. The trading losses are far larger than the $2 billion to $3 billion of losses that the company two months ago said could result from the bungled trades; the $5.8 billion total is through Thursday. Chief Financial Officer Doug Braunstein said Friday that the troubled positions could still lead to additional losses of $700 million to $1.7 billion. Eight agencies are conducting probes into the losses, including the Justice Department and the Securities and Exchange Commission. Now Reporting Track the performances of 150 companies as they report and compare their results with analysts' estimates. Sort by date and industry. More photos and interactive graphics In addition, the second-quarter profit was boosted by one-time gains that won't likely recur in coming quarters, and revenue tumbled 17% from a year earlier. Overall, J.P. Morgan has lost $18 billion in market value since it shocked Wall Street on May 10 with the existence of trading losses. J.P. Morgan's assurances on Friday don't "eliminate the concern that this accident could be a predictor of future accidents," said Mike Mayo, a banking analyst with CLSA. "Maybe they are higher risk than we thought before. There is a nagging overhang that we might not know everything that we should know." The bank has been probing the losses for two months. But it was only in recent days that the bank became convinced that traders may have done more than make trading mistakes, according to two people close to the investigation. The company's report didn't name the traders, but one of the turning points came in an interview with one of them, Bruno Iksil, known as the London whale for his large trades, the people said. As part of its investigation, the bank said it "has recently identified concerns around the integrity of traders' marks," or the values placed on the traders' positions. The bank said "emails, voice tapes and other documents, supplemented by interviews, [are] suggestive of trader intent not to mark positions where they believed they could execute." The London Whale Claw Is Out for 'Whale' Officials July 11, 2012 J.P. Morgan plans to reclaim millions of dollars in stock from executives who were at the center of the bank's costly trading blunder. Dimon on the Hill: Cool and Contrite June 13, 2012 J.P. Morgan's chief, tarnished by trading losses, remains steadfast before Senate Banking Committee J.P. Morgan Knew of Risks June 12, 2012 Warning flags were raised two years ago about the trading desk that lost $2 billion. Inside J.P. Morgan's Blunder May 18, 2012 A behind-the-scenes account reveals that CEO Dimon blessed the concept behind the trads that cost the bank billions and stunned Wall Street. Bruno Iksil: From 'Caveman' to Whale May 17, 2012 Last year, J.P. Morgan's Iksil wagered large and won, but in 2012, his bets soured. J.P. Morgan's $2 Billion Blunder May 11, 2012 The nation's second-largest bank by assets admits losses on a massive trading bet gone wrong, a mistake CEO James Dimon calls "egregious" and "self-inflicted." The Original WSJ Article: 'London Whale' Rattles Debt Market April 6, 2012 The credit markets have been buzzing about the identity of a deep-pocketed trader dubbed 'the London Whale,' and some investors are placing heavy bets against him. How the London Whale story unfolded The two people close to the investigation say investigators didn't find a smoking gun suggesting potential malfeasance. But the evidence "painted a picture that made us uncomfortable," one of them said. Mr. Iksil received pressure from a boss to be more aggressive about certain valuations within an accepted range, one of the people said. Mr. Iksil's lawyer said his client "has done nothing wrong and will be exonerated." On Friday, executives offered the most detailed account to date of how the losses happened, attributing the fiasco to a combination of complacency, poor judgment and faulty risk controls. The portfolio—which featured outsize bets on certain corporate credit indexes—generated about $2 billion of profit from 2007 to 2011. Traders were asked in late 2011 to reduce the positions and instead put on other trades that increased the size of overall portfolio. The bank also singled out risk management within the Chief Investment Office for being "ineffective" and having "failed to meet expectations." Risk managers should have addressed the office's inadequate risk limits more quickly, challenged the office's leaders more forcefully and escalated more problems to management. The person who was named chief risk officer for the unit in late Janaury, Irv Goldman, has resigned from the bank, said a person familiar with the situation. Mr. Goldman couldn't be reached for comment. In January, certain risk limits within the office were breached, and yet in February Ms. Drew said in a presentation to Mr. Dimon and other senior officers that the reduction plan was on track. The office breached certain risk limits again in March, losses increased and Ms. Drew asked her traders to stop trading on March 23. After The Wall Street Journal reported the existence of the trades on April 5, Mr. Dimon asked for a review of the troubled portfolio. Ms. Drew told Mr. Dimon that the positions were likely to lose as much as $250 million in the second quarter and possibly even gain $350 million. A more extreme scenario called for losses two or three times as large as $250 million, said a person close to the investigation, but Messrs. Dimon and Braunstein were given "multiple assurances" that the position was manageable. On April 13 Mr. Dimon told investors that concerns about the trades were a "complete tempest in a teapot." On Friday, Mr. Dimon admitted that "we shot ourselves in the foot."