The Securities and Exchange Commission charged JPMorgan Chase & Co. Thursday with misstating financial results and lacking effective internal controls to detect and prevent its traders from fraudulently overvaluing investments to conceal hundreds of millions of dollars in trading losses.
This action follows the SEC previously charging two JPMorgan traders with committing fraud to hide the massive losses in one of the trading portfolios in the firm’s chief investment office. The SEC’s latest charge faults both JPMorgan’s internal controls for failing to ensure traders were properly valuing the portfolio and its senior management for failing to communicate the severe breakdowns in the CIO’s internal controls to the firm’s audit committee.
JPMorgan agreed to settle the SEC’s charges by paying a $200 million penalty, admitting the facts underlying the SEC’s charges, and publicly acknowledging is violated the federal securities laws. As part of a coordinated global settlement with three other agencies, the U.K. Financial Conduct Authority, the Federal Reserve, and the Office of the Comptroller of the Currency, JPMorgan will pay a total of approximately $920 million in penalties.
"JPMorgan failed to keep watch over its traders as they overvalued a very complex portfolio to hide massive losses,” said George S. Canellos, co-director of the SEC’s Division of Enforcement, in a statement. "While grappling with how to fix its internal control breakdowns, JPMorgan’s senior management broke a cardinal rule of corporate governance and deprived its board of critical information it needed to fully assess the company’s problems and determine whether accurate and reliable information was being disclosed to investors and regulators."
According to the SEC’s order instituting a settled administrative proceeding against JPMorgan, the Sarbanes-Oxley Act of 2002 established important requirements for public companies and their management regarding corporate governance and disclosure. JPMorgan failed to follow these requirements for public companies, which are to create and maintain internal controls that provide investors with reasonable assurances that their financial statements are reliable, and ensure that senior management shares important information with key internal decision makers such as the board of directors. As a result, according to the order, JPMorgan misstated its financial results in public filings for the first quarter of 2012.
Specifically, after the portfolio began to significantly decline in value in late April 2012, JPMorgan commissioned several internal reviews that in part assessed the effectiveness of the CIO’s internal controls. From these reviews, senior management learned that the valuation control group within the CIO was "woefully ineffective and insufficiently independent from the traders it was supposed to police," according to the order, along with additional "troubling" facts about the CIO’s state of affairs, which senior management failed to timely escalate and share with the firm’s audit committee.
In settling with the SEC’s enforcement action, JPMorgan has also admitted:
• The trading losses occurred against a backdrop of woefully deficient accounting controls in the CIO, including spreadsheet miscalculations that caused large valuation errors and the use of subjective valuation techniques that made it easier for the traders to mismark the CIO portfolio.
• JPMorgan senior management personally rewrote the CIO’s valuation control policies before the firm filed with the SEC its first quarter report for 2012 in order to address the many deficiencies in existing policies.
• By late April 2012, JPMorgan senior management knew that the firm’s Investment Banking unit used far more conservative prices when valuing the same kind of derivatives held in the CIO portfolio, and that applying the Investment Bank valuations would have led to approximately $750 million in additional losses for the CIO in the first quarter of 2012.
• External counterparties who traded with CIO had valued certain positions in the CIO book at $500 million less than the CIO traders did, precipitating large collateral calls against JPMorgan.
• As a result of the findings of certain internal reviews of the CIO, some executives expressed reservations about signing sub-certifications supporting the CEO and CFO certifications required under the Sarbanes-Oxley Act.
• Senior management failed to adequately update the audit committee on these and other important facts concerning the CIO before the firm filed its first quarter report for 2012.
• Deprived of access to these facts, the audit committee was hindered in its ability to discharge its obligations to oversee management on behalf of shareholders and to ensure the accuracy of the firm’s financial statements.
The SEC’s order requires JPMorgan to cease and desist from causing any violations and any future violations of Sections 13(a), 13(b)(2)(A), and 13(b)(2)(B) of the Securities Exchange Act of 1934 and Rules 13a-11, 13a-13, and 13a-15, and to pay a $200 million penalty that may be distributed to harmed investors in a Fair Fund distribution.
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