Recent regulatory actions:
JPMorgan admits to reckless conduct in London Whale case; hit with $100 million penalty
The U.S. Commodity Futures Trading Commission (CFTC) issued an order against JPMorgan Chase Bank, N.A. after a 17-month investigation, bringing and settling charges for employing a manipulative device in connection with the Bank’s trading of certain credit default swaps (CDS), in violation of the new Dodd-Frank prohibition against manipulative conduct. By selling a staggering volume of these swaps in a concentrated period, the Bank, acting through its traders, recklessly disregarded the fundamental precept on which market participants rely, that prices are established based on legitimate forces of supply and demand, the CFTC stated. JPMorgan, which admits the specified factual findings in the order including that its traders acted recklessly, is directed, among other things, to pay a $100 million civil monetary penalty.
“In Dodd-Frank, Congress provided a powerful new tool enabling the CFTC for the first time to prohibit reckless manipulative conduct,” said David Meister, the CFTC’s director of enforcement. “As this case demonstrates, the Commission is now better armed than ever to protect the market from traders, like those here, who try to ‘defend’ their position by dumping a gargantuan, record-setting, volume of swaps virtually all at once, recklessly ignoring the
From approximately 2007 through 2011, JPMorgan’s Chief Investment Office (“CIO”), operating through a trading desk in the Bank’s London branch, traded and held various credit default indices, including CDX, in a Synthetic Credit Portfolio (“SCP”). Each day the SCP traders marked their positions to market, assigning a value to the positions using market prices and other factors. That value was used to calculate the CIO’s profits and losses. At the end of each month an “independent” group at JPMorgan tested the validity of the traders’ month-end marks.
Since the end of 2011, the portfolio held $51 billion net notional of these credit instruments, the outsized amount spurring press reports referring to one CIO trader as the “London Whale.” Although previously quite profitable, the portfolio had taken a serious turn for the worse at least by late January 2012, with year-to-date mark-to-market losses of $100 million. In February 2012, daily losses were large and growing.
The violation charged in the CFTC’s order concerns the Bank’s trading of one particular credit default index -- “CDX NA.IG9 10 year index” (“IG9 10Y”). As the end of February 2012 approached, the SCP’s net short position in the IG9 10Y grew to $65 billion, which meant that relatively small favorable or adverse movements in market prices produced significant mark-to-market profits or losses for the CIO. Because the SCP was short IG9 10Y, the mark-to-market value of the position increased as the market price decreased.
On Feb. 29, just ahead of the month-end testing of their marks, the traders believed the portfolio’s situation was grave. That day, desperate to avoid further losses, the traders developed a resolve, as they put it, to “defend the position.” Recognizing that the sheer size of their position in IG9 10Y had the potential to affect or influence the market, the traders recklessly sold massive amounts of protection on the IG9 10Y. They were short protection and they sold more protection.
Specifically, with the portfolio standing to benefit as the IG9 10Y market price dropped, on February 29 the CIO sold on net more than $7 billion of IG9 10Y, a staggering volume -- far and away the largest amount the CIO ever traded in one day -- $4.6 billion of which was sold during a three-hour period as the day drew to a close.
The CFTC provides comparative measures that demonstrate large size and concentration of these Feb. 29 sales of IG9 10Y. For example, these sales alone accounted for more than 90% of the day’s net volume traded by the entire market, were 15% of the month’s net volume traded by the entire market, and were nearly 11 times the SCP’s average daily volume in February. The Feb. 29 trading followed more than $3 billion in sales of the IG9 10Y during the prior two days. The net volume the CIO sold February 27-29 amounted to roughly one-third of the total volume traded for the entire month of February by all other market participants.
During this same period at month-end, the IG9 10Y market price dropped substantially. While the CIO was selling at generally declining prices, the value of the short position that the CIO held in the SCP benefited on a mark-to-market basis from the declining market prices.
The trading strategy to “defend the position” - selling $7.17 billion of the IG9 10Y on Feb. 29 in a concentrated period - constituted a manipulative device employed by the traders in reckless disregard of the possible consequences of their conduct, including obvious dangers to legitimate market forces, the CFTC stated.
In addition to paying a $100 million penalty, JPMorgan must continue to implement written enhancements to its supervision and control system in connection with swaps trading activity, including trading and risk management controls reasonably designed to prevent and promptly detect mis-marking of its books, enhanced communications among risk, control and supervisory functions, and the development of additional surveillance tools to assist supervisors with monitoring trading activity in connection with swaps.