It’s unusual to see anyone from the financial industry held accountable for misconduct in the post-crisis era. Criminal charges are even rarer. So it was a big deal yesterday when Javier Martin-Artajo and Julien Grout, two former traders in the Chief Investment Office of JPMorgan Chase in London, were indicted for their role in the 2012 “London Whale” trade, a $6 billion derivatives loss. According to the Justice Department’s criminal complaint, the duo hid the losses from federal regulators and falsified records in accounting books. But their indictments is another example of what Better Markets' Dennis Keheller called “chasing minnows while letting the whales of Wall Street go free.”
In the haphazard and sometimes random world of financial fraud enforcement, the actual “London Whale” who placed the trades, Bruno Iskil, reached an immunity deal with prosecutors. But instead of flipping on senior executives, he gave up Martin-Artajo and Grout. Based on the evidence, it would appear that Martin-Artajo, the day-to-day manager of this particular portfolio, orchestrated the specific scheme to hide the losses, and Grout and Iskil carried it out.
The Whale trades were a series of complicated credit default swaps that were essentially bets on whether major U.S. corporations would default on debt. According to JPMorgan Chase's internal rules, as well as federal regulations, traders are supposed to set the daily value of such securities using the most reasonable prices at which they could sell them. Traders are supposed to consult dealers and check recent transaction prices, and set the value somewhere in the middle, a process known as “mid-marking.” Grout initially marked the losses in the Whale trade properly when it went sour in early 2012, but after facing pressure from supervisors (one email said “the financial performance is worrisome”), Martin-Artajo allegedly persuaded Grout to inflate the value of the trades, setting them further and further away from the mid-mark. “What they don’t want is for us to be down,” Iskil told Grout in early March, after receiving instructions from Martin-Artajo.
These fake valuations, hiding hundreds of millions and eventually billions of dollars in losses, were used in forms filed by JPMorgan Chase with the SEC, misrepresenting the financial position of the company to regulators and investors. JPMorgan Chase eventually restated its first quarter 2012 earnings, reflecting $660 million in additional losses from the Whale trades.
Grout had specific responsibility for marking the positions on a daily basis, and Martin-Artajo, as supervisor, allegedly directed Grout (and Iskil) to hide losses. As a result, it’s proper that they get punished for the scheme. But it’s clear from the complaint that Martin-Artajo was taking cues from an unnamed supervisor. “I told (my boss), he told me that he didn’t want to show the loss until we know what we are going to do tomorrow,” Martin-Artajo says on a recorded phone call. At another point, Martin-Artajo claims that hiding the losses was “what New York wanted,” referring to JPM’s headquarters.
This is the bigger scandal revealed in the London Whale debacle: the implicit pressure to cheat coming from above, and the deliberate lack of control from senior management that enabled the cheating. Clearly the supervisors of Martin-Artajo and Grout were pressuring the traders to always show positive results. As an executive you never have to tell your traders specifically to cheat, just to “focus on the metrics” and “defend the positions,” as Martin-Artajo’s supervisor did. Traders then get the message to do what they must to show profits.
Moreover, the internal controls—the key fraud prevention device inside the company—were a joke. The Chief Investment Office in London had a Valuation Control Group that was supposed to act as a check on mismarking or other violations. But it had only one employee for a large trading desk. And the employee would get price quotes from the traders themselves, like asking the fox for statistics on the hen house. The Valuation Control Group even set prices within “thresholds,” allowing for variance between what is supposed to be a rigid mid-mark and whatever the traders decided to dream up.
This was a license to cheat, and the VCG guidelines could only have come from the risk management officers at the bank. Traders “took full advantage” of the VCG’s laissez-faire approach to valuations, the complaint says, and would lobby successfully for even more leeway. Essentially, there was no risk management at the Chief Investment Office, and senior executives were all too happy to not be apprised of the details.
JPMorgan Chase is in settlement talks with the SEC over the Whale trades, and they are trying to pay a fine without admitting wrongdoing. Top executives won’t face charges that they lied to the public or federal regulators. Javier Martin-Artajo and Julien Grout never signed the 8-K and 10-Q forms with the SEC, showing false 2012 first-quarter financial results; the ultimate responsibility for that form, and the fake valuations on it, lies with CEO Jamie Dimon. Lying on a federal financial statement is an actual crime, a violation of Sarbanes-Oxley requirements. But Dimon is not featured in any criminal complaint.
Preet Bharara, the U.S. Attorney for the Southern District of New York, gave Dimon and his fellow executives a stern lecture in his press conference announcing the charges yesterday. “The difficulty inherent in precisely valuing certain kinds of financial positions does not give people a license to mislead or cover up losses," Bharara said. "That goes double for handsomely paid executives at public companies whose actions can roil markets and upend an economy.” But no handsomely paid executive was named in the suit; they are all shadowy “superiors” and “supervisors” on the fringes of the complaint.
Ina Drew, the lead executive at the Chief Investment Office during the Whale fiasco, testified before Congress that she didn’t know about the losses in the portfolio, but the criminal complaint suggests otherwise. When losses were reported in January 2012, according to the charges, “the direct supervisor of Javier Martin-Artajo, as well as the Chief Investment Officer became increasingly concerned, and inquired more regularly about the losses.” And certainly, Senator Carl Levin’s report from the Senate Permanent Subcommittee on Investigations pointed the finger at top executives for a failure to control risk management and an evasion of oversight from their chief regulator. But instead, the lawsuit picks the mid-level traders who carried out the scheme, not the executives who, through implicit and explicit pressure, caused it to occur.
In essence, the indictment frames Martin-Artajo and Grout as “rogue traders,” similar to UBS’ rogue trader Kweku Adoboli, who was convicted to seven years in prison after a multi-billion-dollar trading loss. The deals were called “secret,” but Adoboli insisted that his superiors knew about and encouraged his trades. Nevertheless, Adoboli went off to jail, and UBS paid a $47 million fine.
Faking valuations and covering up losses is a crime worth prosecuting. But it’s also worth looking at the culture of Wall Street that virtually ensures such crimes happen. Risk management is a core responsibility of senior financial executives, and the obviously lax controls put the entire economy at risk. It’s hard to wage war on Wall Street without waging war on that.
David Dayen is a contributing writer at Salon.