The series of errors and misjudgments that resulted in JPM’s announced $2 billion loss on 5/10/12 is as spectacular as it is predictable.  Among the points raised in today’s WSJournal article ["Inside J.P. Morgan's Blunder"] on the events leading up loss and the aftermath:

• The JPM operating committee gave the Chief Investment Office (CIO) a pass because of its continued profitability over the years.  At company meetings, other investment units typically subjected to harsh questioning.
• Risk controls in effect at JPM require traders to sell out of positions when a loss exceeds $20 million.  The Head of London’s trading group exempted the CIO from those limits – something that Jamie Dimon says he was unaware of.
• Jamie Dimon learned of the problem with the CIO’s holdings when he read an article about “Bruno Iksil, The London Whale” in the 4/6/12 edition of the WSJournal.  [C-I Note: So much for dotted line reporting, or disciplined internal management reporting.]

Playing ‘Follow the Leader’, Instead of Just Picking Up On His/Her Cues. The problem at JPM seems like a classic case of “follow the leader.” Jamie Dimon’s trusted lieutenants turned their attention away from the CIO group because he did.  They saw that Dimon had implicit faith in the CIO unit’s head, Ina Drew, so they adopted that same mentality.

The problem with following such a course of action, is that these bank managers – in London and/or elsewhere – abdicated their subordinate obligations to Dimon, their superior.  And they violated a fundamental tenet of every organization – which is to protect the leader at all times – which means look out for anything bad that can happen.  But, before we get too far, it’s important that we expose Jamie Dimon’s carelessness, and show how it contributed mightily to the series of errors and blunders.

Jamie Dimon was careless in the way he handled his implicit faith or confidence in Ms. Drew and her CIO staff – and not in possessing such a high esteem for this bank unit and its leader.  He made 2 “egregious” errors:

• he let down his guard, and allowed his instinctual tendencies of concern about potential risks to evaporate, like wisps of thin clouds – while risks can be abated, they can never be eliminated;  and,
• he expressed his beliefs about Ms. Drew in a way to others – i.e., his lieutenants – either implicitly or explicitly – that communicated to them that it was all right to treat Ms. Drew’s CIO unit in reverential terms.  Instead, he would have been better off explicitly reminding his lieutenants that they should do as he says, and not as he feels or acts.
  • Note: We could go on and on, expressing our opinions on what Mr. Dimon did and didn’t do, what he should or should not have done, but to what purpose?  We believe that its key to simply recognize that management and other errors were made, and nothing we say further will change what one takes away from this concept.

A Question of Competency. The above scenario also says that perhaps JPMorgan’s management team was not as strong as it should have been.  The CEO should be hearing both the good and the bad, not just what he wants to hear.  It appears that “Group Think” befelled JPMorgan, and it cost the bank dearly.  Not only did they lose billions, which caused a precipitous decline in shareholder value, but its reputation – previously held in such high esteem – has been blighted and soiled, which exposes a vulnerability in the bank.

As a result, the final version of the Volcker Rule will seriously reflect upon recent events – regardless of whether it is appropriate – and the beneficiaries will be those who seek to limit banks in the risks they take.

Now the positive for JPMorgan. The WSJournal noted that Jaime Dimon, upon fully understanding the scope of the problem, took great pains to get the information out into the public domain.  As soon as the amount was known, he announced it.  He further delayed the publication of the 10-Q to include the piece of information.  By doing this, he cost his bank untold billions as traders at competing firms made it increasingly difficult and costly to unwind the position. But in the end, JPM will survive and the integrity of the CEO will be of things that is remembered.

This should be a lesson to all of those firms that would rather accept a fine than create and honor their compliance controls.  Money can be made or lost, but your reputation is something that once lost, can never be salvaged.  Even after the trading fiasco, customers are not leaving the bank, JPM was still the lead underwriter in the Face Book IPO and the bank will continue to set the standard for large commercial banks in this country.  Bravo Jamie Dimon!

To access the referenced article, go to:  [WSJournal, 5/18/12].

A former UBS AG  trader was fired after the bank found he worked with a colleague to manipulate trading figures.  The trader worked on the bank’s corporate-credit desk in London.  So, now he’s suing for unfair dismissal.  Let’s see how strong of a case he’s got.

The trader is Ramon Braga, and he was fired for collusion in the alteration of “marked-to-market” values of credit default swaps by Denis Minayev, according to testimony by UBS staff at an employment tribunal yesterday.  Minayev, a proprietary trader, “re-marked” Braga’s trading book on 66 occasions, even though he shouldn’t have had the authority to do so, UBS investigator Richard Kennedy said.

The product being re-marked was a credit default swap (“CDS”) on European industrial-company bonds – illiquid and difficult to value because it was rarely traded.  This prompted employment judge Graeme Hodgson to say at the hearing, “If you shift one of those markers, it can give a completely false picture.”

Lawsuit Filed by Braga. Braga’s argument was presented by his lawyer, Amy Sander.  she portrayed him as an inexperienced trader “thrown in at the deep end.”  That he wasn’t aware of many of the changes Minayev made, and actually thought his actions were permitted by managers. Braga, Ms. Sander continued, also was unjustly accused by UBS of “procuring a false broker quote.”

Keep in mind that this case in London is being raised while UBS continues to deal with the enormous fallout from allegedly “unauthorized trades” by London-based UBS employee and “rogue trader,” Kweku Adoboli. Mr. Adoboli’s trades led to $2.3 billion in losses, regulatory probes and the resignation of CEO Oswald Gruebel.

Across the pond, though dealing with trades also executed in London, is JPMorgan Chase CEO Jamie Dimon, who attributed his bank’s recent $2 billion loss to a trading unit’s “egregious” failure to manage risks.

UBS Internal Probe. Kennedy, the UBS investigator, said the bank had uncovered the re-marking of Braga’s trades during an internal probe into him and Minayev, who also is no longer at the firm.  Asked why a proprietary trader had been able to access Braga’s trading book, Kennedy said Minayev’s role had changed and he was asked not to adjust positions any more.  [C-I Note: But at what point in time?  After the 25th remarking?  Hmmm.]   [Yet,] “Despite his change in role, he hadn’t had his marking privileges removed,” Kennedy said.

Braga “was a junior employee” in the bank’s fixed-income, currency and commodities unit, who “was dismissed for gross misconduct in October 2011 following an investigation into alleged mismarking,” according to a UBS spokesperson, who added, “UBS has zero tolerance for such behavior.”

Back to the Hearing. During cross-examination of Braga last week, UBS lawyer Bruce Carr said Braga had asked a broker friend to send him a quote that justified changes made to his valuation, after a colleague said the price was too high.  This led lawyer Carr to observe, “You get an entirely unsolicited e-mail that happens to fit” the valuation. “That’s quite a coincidence, isn’t it?”  Braga responded that his “dismissal shouldn’t be based on speculation or coincidences.”

Lawyers for Braga questioned Paolo Croce, UBS’s European head of rates, at the continuation of the hearing about the close relationship between proprietary traders such as Minayev, who trade with the bank’s money, and flow traders (“agency traders” in the U.S.) like Braga, who execute orders on behalf of clients.  “All the other flow traders followed the direction of Mr. Minayev,” Braga’s lawyer said.

Croce responded by stating that, while flow and proprietary traders exchanged information, they weren’t supposed to take instructions on pricing.  Minayev had told Braga, “I need this to move,” according to Croce. “He told him ‘I’m down $9 million today.’”  Minayev declined to comment when reached by phone. Braga’s lawyers declined to comment outside court or when contacted by e-mail.

[C-I Conclusion. First of all, this account by Bloomberg reads like a melodrama - interesting, somewhat out of sync, and apparently lacking continuity in recital of the facts and flow of the testimony.  Also, I'm frankly puzzled by the scenario - i.e., it would appear that Braga is a passive participant in the matter.  Nowhere is it stated or intimated that he asked Minyev to remark his prices.  Further, it makes no sense, whatsoever, to expect a junior trader to price complex and infrequently traded securities - particularly without having the valuation signed off by a superior.

Until we learn anything further, our impression at this point in time, is to rule in favor of Braga - he was unfairly dismissed and should be rehired and compensated for lost time and out-of-pocket expenses.]

WHAT’S YOUR CALL?

[Bloomberg, 5/11/12]

BELIEVE IT OR NOT, DAVID BLECH ONCE AGAIN IS GETTING INTO THE CROSS-HAIRS OF THE SEC.

The SEC recently charged a Manhattan resident with carrying out a complex market manipulation scheme in biopharmaceutical stocks after he was kicked out of the brokerage industry for fraud.  [C-I Note: Even without the headline, many financial veterans might have guessed the SEC is referring to D. Blech.]

The SEC filed a civil lawsuit against Blech and his wife.  In a parallel action, the U.S. Attorney’s Office for the Southern District of New York filed criminal charges against Blech.

SEC Findings And Allegations. David Blech allegedly established more than 50 brokerage accounts in the names of family members, friends, and even a private religious institution – which he then used to buy and sell significant amounts of stock in 2 biopharmaceutical companies.

He did this to create the artificial appearance of activity in their securities so he could maintain their market price and use it to his own financial advantage.  Blech, who was previously convicted of securities fraud, also solicited investments for biopharmaceutical companies – including the 2 companies whose stock he manipulated – despite being barred by the SEC from acting as a broker-dealer. [C-I Note: Hard to teach an old dog new tricks.]

It’s further alleged that Blech and wife Margaret Chassman, who also is charged in the case, flouted federal securities laws when they repeatedly made unregistered sales of securities and failed to disclose their transactions in the various brokerage accounts.

According to the SEC’s complaint filed in federal court in Manhattan, Blech engaged in his scheme at various points in 2007 and 2008, specifically manipulating the stocks of Pluristem Therapeutics Inc. and Intellect Neurosciences Inc. Blech first opened dozens of nominee accounts at several broker-dealers in the names of his wife, uncle, and sister-in law as well as a longtime friend and a company he controlled, and religious institution Central Yeshiva Beth Joseph that is managed by Blech’s cousin.

The accounts allegedly were then used in deceptive activities, with Blech carrying out matched trades in Pluristem’s and Intellect’s stocks. Blech’s activity in these thinly-traded securities artificially inflated the stock price of both companies and created the false impression of a liquid market for each company. Blech then used the artificially inflated stock price to sell off his holdings of Pluristem and Intellect through the nominee accounts, and as collateral for a line of credit he established in his wife’s name.

Prior Record. Blech is, what we call a “repeat-offender,” having committed prior violations of the securities laws.  He pled guilty in 1998 to 2 counts of securities fraud and was sentenced to 5 years of probation.  In 2000, he settled a related SEC enforcement action, accepting a permanent bar from associating with any broker-dealer.

[C-I Note: Just one question:  Did the B/D firms that opened the customer accounts used in this case by David Blech know who they were dealing with?  At any point in time, did Blech identify himself?  While Blech is entitled to open brokerage accounts and transact securities transactions, firms that are familiar with past - if they care to "do the right thing" - would likely subject his accounts to some sort of heightened supervision.  We'll did a little deeper and report what, if anything, we find.]

Charges and Sanctions Sought by Current SEC Complaint. The SEC charges Blech with violating Section 17(a)(1) and (3) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5(a) and (c), and for acting as an unregistered broker-dealer in violation of Section 15(b)(6)(B) of the Exchange Act.

Both Blech and Chassman are charged with violating Sections 5(a) and 5(c) of the Securities Act and for failing to make filings required by Sections 13(d) and 16(a) of the Exchange Act.

The SEC seeks to disgorge D. Blech and wife of their ill-gotten gains, collect prejudgment interest and financial penalties, and permanently enjoin both from future violations of the provisions of the federal securities laws they violated.

The case is: SEC v. David Blech and Margaret Chassman, Civil Action No. 12-Civ-3703 (AJN).

For further details, go to:  [Litigation Release 22363, 5/10/12].

FINRA proposes to amend its Rule 4210, Margin Requirements,  to:  (i) revise definitions and margin treatment of option spread strategies; (ii) clarify the maintenance margin requirement for non-margin eligible equity securities; (iii) clarify the maintenance margin requirements for non-equity securities; (iv) eliminate the current exemption from the free-riding prohibition for designated accounts; (v) conform the definition of “exempt
account”; and (vi) eliminate the requirement to stress test portfolio margin accounts in the
aggregate.  In addition, the proposed rule change would amend FINRA Rule 4210 to
make non-substantive technical and stylistic changes.

Option Spread Strategies. Basic option spreads can be paired in such ways that they offset each other in terms of risk. The total risk of the combined spreads is less than the sum of the risk of both spread positions if viewed as stand-alone strategies. FINRA Rule 4210(f)(2) currently recognizes several specific option spread strategies.  These strategies consist of either a “long” and a “short” option contract or two “long” and two “short” option contracts. The “long” and “short” option contracts have the same underlying security or instrument and the “long” option contracts must expire on or after the expiration of the “short” option contracts.

While the strategies recognized under FINRA Rule 4210 are the most common types of option spread strategies used by investors, there are other combinations of calls and/or puts that are similar in terms of their risk profile. Accordingly, FINRA proposes a broader definition of a spread in FINRA Rule 4210(f)(2)(A)(xxxii) to mean a “long” and “short” position in different call option series, different put option series, or a combination of call and put option series, that collectively have a limited risk/reward profile, and meet the following conditions:

• all options must have the same underlying security or instrument;
• all “long” and “short” option contracts must be either all American-style or all European-style;
• all “long” and “short” option contracts must be either all listed or all OTC;
• the aggregate underlying contract value of “long” versus “short” contracts within option type(s) must be equal; and,
• the “short” option(s) must expire on or before the expiration date of the “long” option(s).

The proposed revised margin requirements are set forth in FINRA Rule 4210(f)(2)(H) and would require that the “long” option contracts within such spreads calendar iron butterfly spread, “short” calendar iron condor spread, “short” iron butterfly spread and “short” iron condor spread.

Note to Reader: Given that the text goes on and on in this filing, we think it best if interested persons read the rule proposal for themselves, rather than read some paraphrased summary from C-I which would likely do little justice.  Thanks for your understanding.

Therefore, for further details, go to:   [FINRA Rule Filing 12-24, 5/8/12].

Effective  May  22,  2012,  CBOE  will  activate  a  new  “Opt  Out”  feature  for  Automated Improvement Mechanism (“AIM”) auctions.  The Details of the rule are as follows:

• “Opt Out” will allow the contra/match order paired against the AIM Agency order to forgo any participation guarantee, if others are willing to fill the Agency order at the contra/match order’s limit price or better.
• “Opt Out” is only available for contra/match orders with a limit price.

• “Opt Out” will be available for AIM simple and complex orders, including those with stock (pending activation), as well as for AIM ISO’s and Sweep and AIM.

Interested parties should contact the API Group at 312-786-7300 or via email at api@cboe.com for message specifications and requirements for use of the “Opt Out” feature.

Questions  regarding  this  functionality  may  be  directed  to  Anthony  Montesano  at
312-786-7365  or montesan@cboe.com or the Help Desk at 866-728-2263 or via email at helpdesk@cboe.com.

[For further details, go to:   [RegCirc 12-65, 5/16/12].

“Our due diligence has made it clear that the Banking Committee should hear directly from JPMorgan Chase’s CEO Jamie Dimon, and following our two Wall Street reform oversight hearings I plan to invite him to testify,” Johnson said in the statement.
[Business Insider, 5/17/12]

Here’s the full press release from the Committee:

CHAIRMAN JOHNSON TO INVITE JPMORGAN CHASE’S JAMIE DIMON TO TESTIFY

May 17, 2012

WASHINGTON — Senator Tim Johnson (D-SD), Chairman of the Senate Banking Committee, released the following statement regarding the Committee’s upcoming oversight hearings.

“Earlier this week, I announced the Senate Banking Committee would continue its oversight of the implementation of Wall Street reform by holding additional hearings with key financial regulators. The first of these hearings will be held next Tuesday, May 22 and it will provide Banking Committee members the opportunity to hear from the SEC and CFTC. The second hearing will be held on Wednesday, June 6 with the Federal Reserve, FDIC, CFPB, and OCC as well as the Treasury Department. As part of these hearings, I have asked the appropriate regulators to be prepared to update the Committee on the recently reported trading loss by JPMorgan Chase.

“Over the past week, my staff and Ranking Member Shelby’s staff have jointly held briefings with regulators regarding the JPMorgan Chase trading loss, as well a briefing with the company itself. Our due diligence has made it clear that the Banking Committee should hear directly from JPMorgan Chase’s CEO Jamie Dimon, and following our two Wall Street reform oversight hearings I plan to invite him to testify. I encourage all of my colleagues on the Banking Committee to participate in these three critically important and timely hearings, so we can all better understand the facts.”

CEO Jamie Dimon personally approved the strategy that led to the trades, then reportedly never monitored how they were executed, according to people familiar with the matter that the Journal didn’t identify.  Apparently, Mr. Dimon’s failure to closely regulate that activity caused resentment among executives whose departments face tighter oversight.

Last Week’s Report. It was just last week that JPMorgan announced that it had incurred a $2bn trading loss on synthetic credit products, or derivatives tied to credit performance.  Dimon referred to incident involving supposed hedge transactions as “egregious” failures by the bank’s chief investment office.

Earlier this week, at the company’s annual meeting, Dimon told shareholders that the company was trying to reposition a portfolio of corporate credit derivatives and used a trading strategy that was “flawed, complex, poorly conceived, poorly vetted and poorly executed.”

The “Or More” Clause. The bank also noted that the amount, initially estimated at $2bn, could increase by $1 billion or more as it winds down the positions.  A spokesperson for the bank declined to comment on the $5 billion estimate, although it is now widely known that JPMorgan had a serious gap within its management structure at the time the trades were executed – it didn’t have a treasurer for those 5 months, the Journal reported in a separate article.

All told, JPMorgan’s chief investment office oversees about $360 billion – the difference between deposits and what the bank lends.  Matt Zames, who was appointed to lead the division after the loss was reported, shook up leadership and announced a “renewed focus” on hedging risks.  The loss also has prompted several regulators to initiate investigations, including the Federal Reserve Bank of New York and the SEC.  The Fed is also examining how banks in its district are managing cash after receiving a flood of deposits since the credit crisis.   [Bloomberg, 5/18/12]

Sir Winfred Bischoff, who previously served as Chairman of the Citigroup Board of Directors from 2007 to 2009, apparently has relatively little esteem for simple internal controls and supervisory checks and balances.

[C-I Note: Perhaps some of the Pre-Pandit corporate culture at Citi rubbed off on Sir Winnie, and he still hasn't shaken it off.  'Tis a shame.]      [Business Insider, 5/17/12]

In his new position, he’ll be responsible for the administrative and operational aspects of the Division of Trading and Markets, including HR, budget, IT, and strategic planning.

Mr. McNamara previously worked in Trading and Markets from 2003 to 2005, serving as a Branch Chief for Administration.  He then moved to Financial Management and became a Branch Chief for Budget Formulation and Performance Management until 2006, when he left to work in the private sector, only to return in 2010 to the SEC’s Office of Financial Management.  He started his 2nd tour of duty by serving as the agency’s Budget Officer for a year before becoming an Assistant Director.

“I am honored to have been selected for this position. I look forward to returning to the Division and working with Robert and the talented staff in Trading and Markets,” Mr. McNamara said.  Mr. McNamara holds a bachelor’s degree in history from Brown.   [SEC PR 12-98, 5/18/12]

As we approach Monday’s start of the Rajat Gupta insider trading trial, cognoscenti on the Street are wondering:  Will the U.S. prosecutors bring the “bling?”  Can they stand up to the star quality that this trial is sure to offer?

Yes, the prosecution released an A-List of potential witnesses for the trial, which is expected to be “Prime Time” entertainment all the way.  For starters, the trial features the leading defense attorney, Gary Naftalis of Kramer Levin Naftalis & Frankel, who befriends all sides with his affable home-spun charm – that’s lace with lethal legal barbs.

The defendant, Rajat Gupta, ran preeminent consulting firm, McKinsey & Company, and served on the Boards of Goldman Sachs and Procter & Gamble.  He has relationships with top professionals throughout the world, and sported a close friendship (that will be debated in trial) and business relationship with top business people, including convicted insider trading manager Raj Rajaratnam.  This latter relationship is the one that got Mr. Gupta into ‘hot water’ with the feds.

And Then There Are the Prospective Witnesses. Topping the more than 50-person list submitted to U.S District Judge Jed Rakoff in Manhattan are sure to be Goldman Sachs Chairman and CEO Lloyd Blankfein, along with Goldman President Gary Cohn.

Gupta’s attorneys submitted a no fewer than 116 names, that included Blankfein and Cohn, Berkshire Hathaway Chief Warren Buffett, and best-selling author Deepak Chopra – who founded the Chopra Center for Wellbeing in Carlsbad, CA.  Both lists were made public on Thursday.

Rakoff has asked for 100 prospective jurors to be summoned to court for the first day of the trial and said opening arguments could be heard later the same day.

Jennifer Padovani, a Goldman Sachs director, is also on the government’s list, as is Steven Peikin, a lawyer at Sullivan & Cromwell who advises the New York-based bank.

Others on the list: Representatives from companies affected by the alleged insider-trading scheme, including Alan “A.G.” Lafley, retired chairman of Procter & Gamble, and Jon Moeller, P&G’s CFO.

Former Galleon executives are also on the government’s list, including Raj Rajaratnam and his younger brother, Rengan; Galleon co-founder Gary Rosenbach; Ian Horowitz, who was Raj Rajaratnam’s trader; and Michael Cardillo, a former Galleon portfolio manager.

Anil Kumar, a former McKinsey & Co. partner who pleaded guilty to insider trading and testified as a government witness at Rajaratnam’s trial last year is also the list. Gupta ran McKinsey from 1994 to 2003.

Among those on Gupta’s list are Goldman Sachs director Claes Dahlback and Berkshire Hathaway reinsurance chief Ajit Jain, a close friend of Gupta. The two were identified in a hearing before Rakoff in January as possible defense witnesses.

The case is U.S. v. Gupta, 11-cr-00907, U.S. District Court, Southern District of New York (Manhattan).

To continue reading and obtain further names/details, go to:   [Bloomberg, 5/17/12].