JPMorgan hid trades banned by Volcker Rule, Senate probe claims

Trades vs. hedges is at crux of Volcker Rule

JPMorgan Chase & Co. engaged in high-risk proprietary trading under the guise of ordinary hedging, said Senate investigators, who urged U.S. regulators to strengthen the proposed ban on such trades known as the Volcker rule.

Regulators should require banks that hold federally insured deposits to explicitly link positions in derivatives to the underlying risk they are hedging, the Senate’s Permanent Subcommittee on Investigations recommended in a 300-page report released yesterday.

The issue of which trades are hedges and which are risky bets that could destabilize a bank is the crux of a stalemate over the Volcker rule, which was adopted as part of the 2010 Dodd-Frank Act designed to rein in systemic risks. The rule, which is in the final stage of drafting by five U.S. regulators, would restrict the kinds of trades permitted by banks holding deposits insured by taxpayers.

Banks have lobbied heavily against the Volcker rule, arguing that it will restrict market-making and other standard banking practices.

The report and its recommendations, issued jointly by the committee’s Democrats and Republicans, is expected to increase pressure on regulators to tighten exemptions in the draft Volcker rule. The Volcker rule was one of the most controversial provisions of the Dodd-Frank Act, generating more than 18,000 comment letters from the industry.

Bank officials and regulators are scheduled to be questioned on the report’s findings in a hearing today.

‘Increased Risk’

“JPMorgan’s chief investment office increased risk by mislabeling the synthetic portfolio as a risk-reducing hedge when it was really involved in proprietary trading,” said Senator John McCain of Arizona, the panel’s top Republican.

Subcommittee Chairman Carl Levin, a Democrat from Michigan who sponsored the Volcker rule, said regulators should close a loophole in an early draft of the rule that would permit broad “portfolio” hedges.

“We’re going to continue to work very hard for a final rule that does not allow the kind of manipulation, the kind of concoctions that were created here by the bank to be accepted in the name of hedging,” Levin said in a news conference.

The subcommittee released the panel’s findings after a nine-month probe into JPMorgan’s record trading losses that came to light when Bloomberg News first reported them on April 5. The flawed bet on credit derivatives by a trader in London eventually cost the company more than $6.2 billion and stained Chief Executive Officer Jamie Dimon’s 31-year Wall Street career. The trader was dubbed the “London Whale” because the derivatives positions were so large they moved credit markets.

‘Significant Mistakes’

“While we have repeatedly acknowledged significant mistakes, our senior management acted in good faith and never had any intent to mislead anyone,” Mark Kornblau, a spokesman for JPMorgan, said in an e-mail.

Levin and Senator Jeff Merkley, a Democrat from Oregon, sponsored the measure that eventually became known as the Volcker rule in honor of its original proponent, former Federal Reserve Chairman Paul Volcker, and was included in the Dodd- Frank Act. The law bars federally insured banks from proprietary trading, or trading for their own account, while allowing regulators to make exemptions for market-making and hedging.

The subcommittee found that officials at the bank’s main regulator, the Office of the Comptroller of the Currency, expressed skepticism that the trades were a hedge. In a May 2012 internal e-mail, an OCC examiner referred to synthetic credit portfolio as a “make believe voodoo magic ‘composite hedge’.”

OCC ‘Misinformed’

Bryan Hubbard, a spokesman for the OCC, said the agency continues to investigate the matter. As a result of the report’s findings on regulators’ shortcomings, the OCC has taken steps to improve its supervision, he said.

“We are very disappointed that the bank misinformed the OCC which hampered our supervisory efforts,” Hubbard said in an e-mailed statement. “We will take additional action as appropriate.”

The subcommittee said the investigation uncovered evidence that bank officials portrayed the losing trades as a hedge when internal communications suggested otherwise.

For instance, in an April 13, 2012, earnings call, former Chief Financial Officer Douglas Braunstein called the positions “consistent” with the Volcker rule. However, two months earlier, the bank made the opposite assessment, the report said.

Next page: Proprietary Trading

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