On Feb. 13, 2012, the bank submitted an official comment letter to its regulators, including the OCC, expressing concern that the creditderivatives trading might be prohibited by the Volcker rule. In the letter, Barry Zubrow, a former risk officer who retired in December, wrote that under the proposed Volcker rule this activity “could have been deemed proprietary trading.”
Also, Ina Drew, former chief investment officer for the bank, told Braunstein the day before the April earnings call that the Volcker rule was a “poor fit” with the CIO’s credit derivatives trading; Braunstein said the opposite on the call the next day.
“Mr. Braunstein’s optimistic assessment during the April 13 earnings call may have reassured investors, but that is no justification for misinforming the public about the bank’s official position that the Volcker rule might prohibit the SCP as an example of high-risk proprietary trading,” the subcommittee report stated, referring to the bank’s synthetic credit portfolio.
The report said that Braunstein should have known that his comments contradicted the bank’s own 68-page Volcker rule comment letter.
In addition, the investigation found that the bank considered the unit a proprietary trading operation as early as 2007. In November of that year, the bank’s internal audit group issued a report characterizing the CIO’s credit-trading activities as “proprietary position strategies executed on credit- and asset-backed indices.” The report didn’t mention hedging as a purpose of the unit.
JPMorgan officials told the subcommittee that the trades were intended to function as insurance or to “hedge” against credit risks. Although the original document seeking approval for the synthetic credit portfolio outlined hedging as a goal, the bank was unable to produce documentation over the next five years detailing its hedging objectives, strategies, assets, risks or events it was supposed to hedge.
“The bank was also unable to explain why the SCP’s hedges were treated differently from other types of hedges within the CIO,” the subcommittee report.
Levin said the findings call for regulators to quickly complete the Volcker rule and strengthen it. Specifically, he said any allowance for banks to hedge should be documented and tied to a specific risk.
“We cannot allow the argument of the banks that they can hedge their entire inventory somehow where we get global hedges,” Levin said at the news conference. “If they are going to claim that trades are a hedge, they’ve got to be able to identify what is being hedged against, what are the assets being hedged and what is the proof that it is a hedge.”
JPMorgan’s loss re-ignited the debate in Congress over whether aggregate portfolio hedging is appropriate at all and how to define and spot these trades.
“It has made regulators take another look at hedging and what constitutes appropriate hedging and what may fit within the Volcker rule limits,” Satish Kini, co-chair of the Debevoise & Plimpton LLP’s Banking Group, said in advance of the report’s release.
After the bank disclosed its losses May 10, Levin and Merkley sent a letter to five federal regulators urging them to remove “ill-advised loopholes” from the Volcker draft; regulators have yet to finalize the rule.
Merkley said the PSI report is another reminder for regulators to complete a “strong, simple Volcker firewall.”
“JPMorgan’s huge losses continue to cast a whale-sized shadow over these extended delays, and remind us once again just how important it is to separate risky, hedge-fund-style trading from the banking system that Main Street depends on,” Merkley said in a statement.
Comptroller of the Currency Thomas Curry said in a June 2012 hearing that the JPMorgan incident was a “risk-management issue, regardless of whether or not the Volcker rule was in play.”
“I think our experience here, as it unfolds with JPMorgan Chase, would help inform our views in the final rule-making,” Curry said.
The subcommittee will hold a hearing on the findings today with witnesses from the bank, including Drew and Braunstein, and from the OCC, including Curry.
“The investigation of our Permanent Subcommittee on Investigations into the JPMorgan whale trades opens a window into the hidden world of high-stakes derivatives trading by a major bank,” Levin said. “We found a trading operation that piled on risk, ignored limits on risk taking, hid losses, dodged oversight and misinformed the public.”