The Justice Department said today that financial fraud charges were filed against two derivatives traders in connection with a multi-billion dollar trading loss at JPMorgan Chase & Company. The defendants allegedly hid more than half-a-billion dollars in losses resulting from derivatives trading in JPMorgan’s Chief Investment Office.
U.S. Attorney General Eric Holder announced the unsealing of criminal complaints against Javier Martin-Artajo and Julien Grout for their alleged participation in a conspiracy to hide the true extent of losses in a credit derivatives trading portfolio maintained JPMorgan. Martin-Artajo served as a Managing Director and Head of Credit and Equity Trading for the CIO, and Grout was a Vice President and derivatives trader in the CIO.
“Our financial system has been hurt in recent years not just by risky bets gone bad, but also, in some cases, by criminal wrongdoing,” opined Attorney General Holder. Critics maintain Holder has done little to prosecute financial fraud at the ratings agencies and on Wall Street that led to the collapse of the U.S. economy, cut American wealth in half, and created the highest rates of unemployment since the Great Depression that is still hurting the American middle class.
Allegedly, the defendants, Javier Martin-Artajo and Julien Grout, deliberately and repeatedly lied about the fair value of billions of dollars in assets on JPMorgan’s books in order to cover up massive losses that mounted month after month at the beginning of 2012.
Subsequently JPMorgan restated its losses by $660 million. The defendants’ alleged lies misled investors, regulators, and the public, and they constituted federal crimes, according to the Department of Justice, which remains under heavy criticism for its lack of Wall Street prosecutions.
“The complaints tell a story of a group of traders who got in over their heads, and to get out, doubled down on a series of risky positions,” said FBI Assistant Director-in-Charge George Venizelos. “In the first quarter of 2012, boom turned to bust, as the defendants, concerned about losing control to other traders at the bank, fudged the numbers on their daily book, and in some cases completely made them up. It brought a whole new meaning to cooking the books.”
In a separate action, the hapless and demonstrably infective U.S. Securities and Exchange Commission (SEC) announced civil charges against Martin-Artajo and Grout.
According to the allegations in the criminal complaints unsealed today in Manhattan federal court:
- JPMorgan’s CIO, is a component of the bank’s Corporate/Private Equity line of business, which, according to the bank, exists to manage the bank’s excess deposits – approximately $350 billion in 2012.
- Since approximately 2007, the CIO’s investments have included a so-called Synthetic Credit Portfolio (SCP), which consists of indices and tranches of indices of credit default swaps (CDS).
- A credit default swap is essentially an insurance contract on an underlying credit risk, such as corporate bonds. CDS indices are collections of CDSs that are traded as one unit, while CDS tranches are portions of those indices, usually sliced up by riskiness.
- Under U.S. Generally Accepted Accounting Principles (GAAP) and according to JPMorgan policy, CDS traders were required to value the securities in their portfolios on a daily basis. Those values, or “marks,” became part of the bank’s daily books and records. Because CDS indices and tranches are not traded over an exchange, traders are required to look to various data points in order to value their securities, such as actual transaction prices, price quotations from market makers, and values provided by independent services (such as Totem and MarkIT).
- JPMorgan’s accounting policy, which used the same methodology employed by the independent services, provided that the “starting point for the valuation of a derivatives portfolio is mid-market,” meaning the mid-point between the price at which market makers were willing to buy or sell a security.
- Through about January 2012, CIO traders generally marked the securities in the SCP approximately to this mid-point, which they sometimes referred to as the “crude mid.”
- The SCP was extremely profitable for JPMorgan – it produced approximately $2 billion in gross revenues since its inception – but in the first quarter of 2012, the SCP began to sustain consistent and considerable losses.
- From at least March 2012, Martin-Artajo and Grout conspired to manipulate the SCP marks to disguise those losses. They did so, among other reasons, to avoid losing control of the SCP to other traders at JPMorgan.
- Although Martin-Artajo pressured his traders, including Grout, to “defend the positions” in early 2012 by executing trades at favorable prices, the SCP lost approximately $130 million in January 2012 and approximately $88 million in February 2012.
- In March 2012, when the market moved even more aggressively against the CIO’s positions, Martin-Artajo specifically instructed Grout and the head SCP trader, Bruno Iksil (who has copped a plea by ratting out his fellow employees by entering a non-prosecution agreement), not to report losses in the SCP unless they were tied to some identifiable market event, such as a bankruptcy filing by a company whose bonds were in the CDS index.
- Martin-Artajo explained that “New York” – meaning, among others, JPMorgan’s Chief Investment Officer – did not want to see losses attributable to market volatility.
- By mid-March 2012, Grout was explicitly and admittedly “not marking at mids.” He maintained a spreadsheet that kept track of the difference between the price that Grout recorded in JPMorgan’s books and records, on the one hand, and the “crude mids,” on the other.
- By March 15, 2012, according to Grout’s spreadsheet, the difference had grown to approximately $292 million. In a recorded on-line chat the same day, Grout explained that he was trying to keep the marks for most of the SCP’s positions “relatively realistic,” with the marks for one particular security “put aside.” That is,
- DOJ claims that Grout mispriced that one particular security, of which the SCP held billions of dollars’ worth, by the full $292 million.
- The following day, Iksil told Martin-Artajo that the difference had grown to $300 million, and “I reckon we get to 400 [million] difference very soon.”
- In a separate conversation, Iksil remarked to Grout “I don’t know where he [Martin-Artajo] wants to stop, but it’s getting idiotic.”
- In the days that followed, Grout at times ignored Iksil’s instructions on how to mark the positions, and instead, followed Martin-Artajo’s mandate to continue to hide the losses. By March 20, 2012, Iksil insisted that Grout show a significant loss: $40 million for the day. In a recorded call, Martin-Aartajo excoriated Iksil, finally emphasizing, “I didn’t want to show the P&L [the profit and loss].”
- Throughout the remainder of March 2012, while Iksil continued to try to insist that Martin-Artajo acknowledge the reality of the losses, Grout, at Martin-Artajo’s instructions, continued to hide them.
- As of March 30, 2012 – the last day of the first quarter of 2012 – Grout continued to understate George Venizelos the SCP’s losses. These incorrect figures in the SCP were not only integrated into JPMorgan’s books and records, but also – as Martin-Artajo and Grout were well aware – into the bank’s quarterly financial filing for the first quarter of 2012 with the SEC.
- During the course of the mis-marking scheme carried out by Martin-Artajo and Grout, the CIO’s Valuation Control Group (VCG) was supposed to serve as an independent check on the valuations assigned by traders to the securities that the traders were marking at month-end. The VCG, however, was effectively only staffed by one person and did not perform any independent review of the valuations. Instead, the VCG tolerated valuations outside of the bid-offer spread as presented by Martin-Artajo and other CIO traders.
- In Aug. 2012, after Martin-Artajo and Grout were stripped of their responsibilities over the SCP and their scheme was discovered, JPMorgan restated its first quarter 2012 earnings, and recognized an additional loss of $660 million in net revenue attributable to the mis-marking of the SCP.
- JPMorgan announced that it was restating its earnings because it had lost confidence in the “integrity” of the marks submitted by Grout, at Martin-Artajo’s direction.
