JPMorgan London Whale Valuations and Controls Case: The Traders Helped Check Their Own Prices

JPMorgan agreed to pay a $200 million Securities and Exchange Commission penalty in the London Whale valuations and controls case after misstating financial results and failing to detect traders’ concealed losses. The order describes trading losses that later grew to nearly $6 billion as the bank tried to reduce the portfolio’s risk. The bank admitted the facts in the SEC’s settlement order and acknowledged that its conduct violated federal securities laws. For a trading controller or valuation employee, the telling detail is who supplied the independent check: the traders whose prices needed checking helped select the evidence used to check them.

This page follows the desk prices, internal reviews and management decisions behind JPMorgan’s first-quarter results in 2012. Our broader page on reserves, impairment and asset values follows how estimates can keep losses out of reported earnings across different businesses.

How Did the London Whale Portfolio Grow?

JPMorgan’s Chief Investment Office invested excess deposits from the bank and maintained offices in New York and London. Its Synthetic Credit Portfolio was designed to protect against adverse credit events, including widespread corporate defaults. It held credit derivative indices and portions of those indices, known as tranches, tied to credit default swaps on corporate debt.

In its admissions, JPMorgan described an instruction to reduce the portfolio’s use of regulatory capital. Instead of paying the costs of reducing existing positions, the office added offsetting investments, then expanded other positions too. The portfolio’s net notional amount tripled during the first quarter of 2012, and the bank had no risk limit restricting its notional size.

That expansion put more work on a thin valuation function. At quarter end, one London employee actively price-tested the portfolio’s 132 positions while also testing all the office’s other London portfolios. The Securities and Exchange Commission found that the valuation group was understaffed, insufficiently supervised and unequipped for the portfolio’s increased size and complexity.

How Did the Traders Hide the Losses?

The traders changed the prices they assigned to positions so that daily reports showed smaller losses. JPMorgan admitted that, by early March, the most senior trader had instructed the others to stop reporting losses unless a market-moving event could readily explain them. A junior trader moved away from prices near the middle of dealers’ bid-offer spreads toward the most advantageous prices, sometimes outside every dealer quote received that day.

A mark is the value assigned to a position before it is sold or settled. In this portfolio, the traders supplied daily marks to management and the middle office, where they entered JPMorgan’s books. The bank’s policy required good-faith estimates based on market information, with attention to prices at which the traders could reasonably expect to transact. Choosing a more flattering mark therefore changed the reported result without changing the investment.

The junior trader kept a separate spreadsheet comparing the assigned prices with the average midpoint of the best dealer bids and offers. JPMorgan admitted that the difference reached $432 million while daily reports to management showed substantially smaller losses. The larger loss stayed in the spreadsheet.

JPMorgan also admitted that the traders changed the valuation cutoff on March 30, 2012, the quarter’s last trading day. The senior trader told the junior trader to wait past the required London close until markets closed in New York, hoping for prices that would support higher valuations. The junior trader followed that instruction and used the most advantageous prices within the bid-offer spread.

At quarter end, the valuation group noticed that most marks had moved toward the aggressive end of the spread. When it asked one trader about the change, the response was:

JPMorgan admitted that the valuation group did not pass along its observation until questions arose about a collateral dispute. It also failed to share the details of that exchange. The price tester had noticed the change; the warning stopped there.

How Did the Independent Pricing Check Fail?

JPMorgan admitted that the valuation group allowed the traders to influence the evidence used to validate their marks. It consulted them about pricing tolerances and used dealer quotes they selected. We see a peculiar version of independence: the desk helped supply its own check.

Under the bank’s policy, the group was supposed to establish an independent benchmark using pricing services and dealer quotes. It then applied a tolerance around that price based on the bid-offer spread. Marks within the tolerance generally escaped adjustment, while marks outside it prompted a correction to reported profit or loss. The width of the tolerance determined how much disagreement the check would accept.

JPMorgan admitted that the group sometimes applied the entire bid-offer spread on each side of its independent price, producing a tolerance twice as wide as intended. Internal audit calculated that properly applied tolerances would have required a $307 million downward adjustment, compared with the approximately $17 million adjustment the group actually made. The control had given the marks extra room to pass.

Spreadsheet errors created a separate problem. Correcting one calculation increased the gap between trader marks and the valuation group’s independent prices from approximately $275 million to $512 million. The Investment Bank’s valuation team informed senior management of the correction and its effect.

The bank’s Investment Bank also tested the quarter-end positions using consensus prices from Markit and Totem. Its analysis put the traders’ marks approximately $767 million above those prices. Senior management reviewed the analysis, and the Investment Bank’s preliminary valuation was broadly consistent with the lower values used by trading counterparties.

What Did Management Know Before Reporting the Results?

Senior management knew about major pricing disagreements and weaknesses in the valuation process before filing the first-quarter report, according to JPMorgan’s admissions. Trading counterparties had made collateral calls, seeking payment or collateral because their valuations differed from the bank’s. The amount in dispute was approximately $520 million, prompting concern about the portfolio’s pricing and multiple internal reviews.

Those reviews did not reliably share what they found. Internal audit identified the overwide tolerances but did not circulate its draft memo to senior management or the audit committee before the filing. The controller’s staff accepted the traders’ market-volatility explanation without adequately assessing whether the bank could transact at the marked prices. It also failed to escalate unsupported marks after a trader agreed that they were too far from the midpoint.

JPMorgan admitted that senior management’s confidentiality instructions impeded the reviews’ exchange of information. The controller’s staff was told to limit discussion and exercise caution about committing findings to writing. Daily review meetings did not bring all the significant findings together.

Management did change the valuation policies before the report went out. The revisions tightened tolerances and required broker quotes obtained independently of traders. But the audit committee was not told the important findings behind those changes or included in the revisions. The Securities and Exchange Commission found that this deprived the committee of information it needed to oversee management and the financial statements investors would receive.

What Is an Accounting Restatement?

An accounting restatement corrects previously reported financial results. JPMorgan’s moved certain trading losses from the second quarter back into the first. The bank announced the correction and filed amended results. Its admissions state that the correction reduced first-quarter revenue in the Corporate/Private Equity reporting segment by $660 million.

JPMorgan also reversed its earlier conclusion that its disclosure controls were effective at quarter end. It disclosed a material weakness in the valuation controls over the portfolio.

What Evidence Is Needed for Whistleblowing?

For a valuation employee or trading controller, useful whistleblowing evidence connects a reported price to its inputs, the independent comparison and the decisions that followed. JPMorgan’s admissions show those connections in daily marks, dealer quotes, valuation spreadsheets, review memoranda and communications with management. Your knowledge of how those records were produced can explain a discrepancy that the published financial statements never reveal.

The admissions put daily marks beside dealer quotes, original spreadsheets beside corrected calculations, and internal warnings beside what reached management. We use those comparisons to connect the price, the decision and the public report.

The reporting chain runs from transactions and estimates through the accounting close, disclosure review and officer certifications. An employee may know one part of that chain particularly well: who selected a quote, why a tolerance widened, or which finding disappeared from an update.

A broader fraud study helps explain why that perspective matters. In The Significance of Whistleblowing as an Anti-Fraud Measure, published in the Journal of Forensic & Investigative Accounting in 2018, researchers examined occupational-fraud survey data and found that whistleblowers detected 35.9% of the frauds in their complete-data sample, compared with 21.4% detected through internal controls. The JPMorgan order shows how a pricing control can fail while employees see the discrepancy.

What Did the JPMorgan SEC Settlement Cover?

The Securities and Exchange Commission’s corporate action addressed inaccurate financial reports, accounting controls and disclosure controls. Its September 19, 2013 announcement placed the SEC penalty within approximately $920 million in coordinated penalties involving the U.K. Financial Conduct Authority, the Federal Reserve and the Office of the Comptroller of the Currency.

Infinity Q and the Manager Behind the Independent Price

The same weakness appears in allegations about Infinity Q’s fund valuations. In its civil complaint against the fund manager, the Securities and Exchange Commission alleged changes to pricing-service code, false inputs, unsuitable models and fabricated valuation-committee minutes. That account concerns alleged manipulation of the valuation machinery and the records purporting to review it.

At JPMorgan, the bank admitted that traders helped supply quotes used to test their own prices, while other reviewers’ findings failed to reach the right audience. Across the two accounts, the useful question is who controlled the information behind the independent check. Someone who knows the original input, the review actually performed or the message that went missing can explain much more than the final valuation.

Whistleblower Rewards and the Facts You Know

Eligible whistleblowers can receive 10% to 30% of sanctions collected in a qualifying SEC action with sanctions exceeding $1 million. For false claims involving government money, a whistleblower case under the False Claims Act can pay 15% to 30% of what the government recovers.

You Know What the Pricing Check Accepted

If you saw a trader-selected quote pass as independent evidence or a valuation finding disappear before it reached the audit committee, speak with our whistleblower experts. We turn your knowledge of the desk, the calculations and the reporting decisions into your strongest securities fraud whistleblower case. We bring in securities fraud whistleblower lawyers who understand valuation controls and stay beside you throughout the process.