[ by Larry Goldfarb]

The Board of JPMorgan Chase elected to release a report on the bank's internal investigation into the now-notorious $6.2 billion 'London Whale' trading loss.  The report addresses the mismanagement by bank senior officials, detailing the steps and missteps involved throughout the episodic trading in JPMorgan's London-based chief investment office (CIO).  Some surprising developments and disclosures are sure to make even the most knowledgeable of Wall Street veterans shake their heads.  For instance:

• When the manager's trading strategy ran into head winds and, for a time, was in a small loss position, traders opted to add to the notional value of the bank's positions rather than follow conventional wisdom which dictates that a trader cut his or her losses and sell out of a position - and live to fight another day.
• The bank's risk management system detected that the CIO had exceeded its prescribed risk limits.  Yet, senior executives issued a temporary exemption for the CIO that Jamie Dimon approved. 
• At the same time, the bank rolled out a new risk model that the CIO urged the bank to adopt.  As it turned out, the new model was flawed and it underestimated the actual risk. 
• The report identifies several procedural lapses in the develop and the implementation of this risk model:
  • the model was based on a simple spreadsheet prepared by an employee who appears to have been operating out of his depths. 
  • The model was not properly back-tested and it was flawed.

The report further notes 2 areas where the firm may be at risk of criminal prosecution:

• The integrity of marking the positions by certain traders.  If it's determined that they falsified their marks, they would then be directly responsible for causing the firm to misstate its earnings
• There is reason to believe that senior management, including Ina Drew (who ran the CIO), knew that the quarterly numbers being reported were incorrect.  An “internal audit group” identified deficiencies in the unit that double-checked its traders’ valuations, calling out the group last March with a simple concern: it “needs improvement.”

For more information, please read [NYT Dealbook, 1/16/13]