J.P. Morgan Chase Faces Arising Issues
Taylor A. Akinmoladun
National American University

Abstract
J.P. Morgan Chase Bank has found their way into a lot of turmoil in recent years. Each having its own affect of the bank’s reputation. The famous Enron scandal is hard to forget, and some of J.P. Morgan’s executives are still being sued over the bank’s relationship with them, even over a decade later. Back in 2005 the bank made an interest rate swap with the city of Milan in which criminal charges are still pending with hearing occurring weekly. J.P. Morgan also made its way into the news over their mortgage foreclosures and mortgage backed securities. There have also been several lawsuits accusing the bank of aiding and abetting Bernie Madoff’s Ponzi scheme, the bank has been sued to get back some of Madoff’s clients’ money. Though all of these things are bad for business, a few things have topped the charts recently.
Over the past year J.P. Morgan Chase has been wrapped up in three major issues. The first of which is the bank’s chief investment office’s $5 billion loss. The loss came from gambling on credit derivatives made by Bruno Iksil, “the London Whale”. In addition, traders tried hiding the losses from the home office. The second major issue I will address is the unethical push of their mutual funds. Being one of the country’s largest mutual fund managers, the bank was able to falsely promote and push their own mutual funds over those of better performing competitors. J.P. Morgan decided to emphasize sales over clients’ needs. The last major issue I’d like to address is the manipulation of the energy market. J.P. Morgan faces charges from the Federal Energy Regulatory Commission about their manipulation of power markets in California and the Midwest. These manipulations significantly raised consumer costs.

J.P. Morgan Chase has been facing scrutiny on several fronts and can’t seem to stay out of the news. Recently they’ve been found to be manipulating how they market mutual funds for profit and have been revealing multibillion-dollar trading losses related to the “London Whale”. In addition, J.P. Morgan Chase has been declining to share emails related to its power- trading operations; these emails may prove whether J.P. Morgan extracted artificially high payments from wholesale energy markets, in turn, driving up prices for consumers. The bank has been under investigation by a number of federal regulatory agencies that are subpoenaing these internal documents relating to whether the firm manipulated energy markets in California and the Midwest as alleged.
J.P. Morgan’s chief investment office in London has recently taken the spotlight, but not for doing well. The CIO invests excess deposits for the bank and is intended to reduce interest rate risk by making offsetting investments. The CIO made more than $4 billion in profits over the last three years; this was approximately 10 percent of the bank’s profit over that period (Silver- Greenberg & Craig, 2012). In recent news, the CIO has made some decisions that have consequences of large losses. CEO James Dimon testified before the House Financial Services Committee saying that the CIO attempted a complex strategy exposing the bank to great risks, even though it was their job to minimize them.
One trader in the CIO, Bruno Iksil, accumulated positions in credit derivatives so large and market moving that he received the nickname the “London Whale”. These outsized wagers in the credit markets were illiquid, meaning they are not easily converted into cash taking the bank more time to get out of them. Some of his bets on credit-default swaps backfired this year resulting in major losses to the bank. Back in 2010 a senior executive at the CIO created a report estimating how much money the bank could lose if Iksil’s trades had to be turned within 30 days. The warning was given that reserves should be put aside to handle any losses that may arise from Iksil’s trades; CEO Dimon did not take the advice.
In CEO Dimon’s defense, J.P. Morgan Chief Executive Officer of Treasury and Securities Services Business Michael Cavanaugh, who oversaw the review of the London Whale, stated that both Dimon and Chief Financial Officer Doug Braunstein did not know much about the potential losses back before they began to spiral downhill. Dimon, Braunstein, and other senior executives were informed by the CIO traders and managers that the derivatives bets ranged anywhere from a profit of $350 million to a loss of $250 million (Farrell, 2012). Bank executives currently believe that traders were avoiding showing losses, hoping for an upswing.
The question may be raised as to how Bruno Iksil, AKA 'The London Whale', was able to create such a large loss; the simple answer is his solid reputation. Iksil went to a prestigious French engineering school, École Centrale Paris, and made some treacherous trades the ABX subprime mortgage index netting the bank roughly $1 billion back in 2008. So when he began to dig into trading trouble again, he has credibility. With that, trading executive Achilles Macris approved his trades.
Iksil’s trading positions didn’t come to anyone’s attention at first because he was moving credit default swaps, complex instruments that are used as a type of insurance against companies defaulting. After theses “London Whale” losses, J.P. Morgan announced that all traders involved have also been separated from the bank without severance. In addition, Achilles Macris, chief investment officer in Europe and Asia, Javier Martin-Artajo, director of the office of chief investment officer, and Iksil have left the bank; these departures came just after the resignation of Ina Drew. Drew was based in New York but ran the chief investment office that was headquartered in London where all the major trading losses took place. Drew offered to return two years of compensation, the three other former employees could also lose as much as the past two years pay without forfeiture because of the claw back clause. (Treanor, 2012)
Throughout the unveiling trading losses numbers kept changing. As of mid July numbers seemed to be balancing out and becoming measurable. From what started out as estimations in the millions quickly grew to over $5 billion in losses by the chief investment office. In addition, J.P. Morgan has found documents suggesting that traders were hiding the losses, bank executives were not confident with the figures reported by the CIO and decided to restate their first quarter earnings. The restated first quarter results reduced profits by $459 million, or 8.5%. The second quarter results from J.P. Morgan reported an 8.7% decline in their net income to $5 billion on revenue of $22.9 billion. This was down from $5.4 billion during the second quarter of 2011. Earnings per share were at $1.21 second quarter of 2012 compared to the $1.27 it was second quarter of 2011. (Schlesinger, 2012) In search of a bright spot, commercial lending was up increasing 24% year over year. Unfortunately mortgage loans and home equity loans declined by more than $11 billion from the prior year’s quarter. (Farrell, 2012) Slowing mergers and initial public offering activity pushed the company's investment banking profits and related fees down during the second quarter. In addition, investment banking fees dropped roughly 35% to $1.2 billion and net revenue from investment banking fell from 7% to $.6.8 billion. (Farrell, 2012) The investment-banking arm reported a revenue of $1.91 billion; this is down 7% from a year ago but up 14% from the first quarter. Additionally, the bank's retail services business, which serves consumer and small-business clients, reported a profit of $2.27 billion; this is a huge increase from the $383 million a year ago and up 29% from the first quarter. (Farrell, 2012)
J.P. Morgan Chase bank is now digging out of the hole made from the losses and planning it’s next move. Dimon said J.P. Morgan hopes to restart buying back stock in the fourth quarter, if the Federal Reserve approves the bank's new capital plan. CEO Dimon also stated that the CIO would no longer be trading derivatives; instead the investment bank will be unwinding the original trades. The bank has already reduced its position in an obscure index, IG-9, buy 70%; this is where the CIO’s bets were made.
In addition, prior to the trading losses when our countries financial crisis was occurring, many banks found themselves in a slump, including J.P. Morgan. To help J.P. Morgan turned to ordinary investors to make up for the lost profit. Regulators, including the Securities and Exchange Commission and the Financial Industry Regulatory Authority, have opened inquires into J.P. Morgan's mutual funds sales practices. The regulators are concerned that J.P. Morgan has created a conflict of interest favoring the bank’s profit over the clients’ best interest by marketing and promoting its own mutual funds to customers over many better performing mutual funds offered by its competitors. Many former brokers and financial advisors of J.P. Morgan admit to having sold some weakly performing funds merely to enrich the company; the advisors say that J.P. Morgan encouraged them to promote their own products despite the competitors’ better-performing and cheaper options. In addition, the bank exaggerated the returns of the mutual funds they were selling in their marketing materials. These exaggerations were uncovered by The New York Times in J.P. Morgan documents they reviewed.
One of the main mutual fund products that J.P. Morgan pushed on its clients was the Chase Strategic Portfolio. The Chase Strategic Portfolio has six main models, each with a variance of risk level. This investment has a combination of approximately 15 mutual funds and is meant to allow regular investors to have holdings in both stocks and bonds. This product was started four years ago and has gained about $20 million in assets since then. Marketing documents for the Chase Strategic Portfolio highlights theoretical returns that are much higher than their true performance. The hypothetical annual return shown is 15.39 percent; the actual return was 13.87 percent per year. The bank states that it did not provide actual results per standard practice in the industry, standard is to wait until all the parts of the portfolio had a three year return prior to citing its performance in any marketing materials. However, The Chase Strategic Portfolio is not the only poor performing fund, according to a Morningstar researcher, over the past three years roughly 42 percent of J.P. Morgan’s mutual funds performance was lower than the average performance of funds that make similar investments.
The benefit to J.P. Morgan is apparent, the more money investors bring into the bank’s mutual funds, the more fees and profit the bank collects for managing them. With the Chase Strategic Portfolio J.P. Morgan receives two layers of fees; in addition to the management fee that can be as much as 1.6 percent of annual assets, J.P. Morgan also collects fees for the J.P. Morgan underlying proprietary mutual funds that are bundled inside the product. To compare these fees, when Neuberger Berman bundles funds, it typically waives expenses on its own funds and most independent financial planners who work with ordinary investors typically charge 1 percent to manage the assets.
J.P. Morgan’s response to the mutual fund attention is defensive; they insist that customers want access to proprietary funds and that financial advisors from other companies also accounted for the sales of J.P. Morgan mutual funds. Based on J.P. Morgan former brokers’ comments however, their response holds little value. In addition, J.P. Morgan has been in trouble for pushing its own mutual funds in the past. In a 2011 arbitration case J.P. Morgan was ordered to pay $373 million because they were favoring their own products even though they had an agreement to sell alternative funds from American Century.
J.P. Morgan Chase Bank has also recently been facing accusations in the alleged energy market manipulation news. Energy market manipulation has been an issue more than once in the past, but for J.P. Morgan to find themselves in the middle of it doesn’t help their declining reputation. The Federal Energy Regulatory Commission (FERC) has cracked down on energy policy enforcement since the 2005 collapse of energy trader Enron Corp., since January of 2011 the FERC has announced 11 probes of alleged manipulation in electricity and natural gas markets, including J.P. Morgan. According to the FERC’s initial court filing the FERC opened the probe into J.P. Morgan in August after receiving complaints from California and Midwest grid operators reporting that J.P. Morgan’s bidding practices were abusive. The case is Federal Energy Regulatory Commission v. J.P. Morgan Ventures Energy Corp., 12-mc-352, U.S. District Court, District of Columbia (Washington).
The investigation allegations toward J.P. Morgan Chase are that they manipulated the market in 2010 to 2011 for millions of dollars in windfall profits. The accused scheme being investigated is that J.P. Morgan would submit preliminary low bids for energy, possibly even negative amounts, qualifying them for a bid cost recovery payment even if the bid isn’t accepted. The low bids would lose J.P. Morgan lots of money if accepted, but the bank then submits actual bids too high to be accepted the next day profiting the windfall. The bank allegedly made these bids resulting in at least $73 million in improper payments to the generators according to the FERC.
Against these allegations J.P. Morgan says that they have done nothing illegal and are cooperating with the investigation. Unfortunately lack of cooperation has forced FERC to sue J.P. Morgan for refusing to give them 25 emails, the bank insists that the emails have no information about the bidding practices that are under investigation; they are said to contain privileged attorney client information and legal advice. The FERC stated that J.P. Morgan had made the same attorney client privilege claim for 28 prior emails that were eventually turned over to regulators. These previous emails were said to contain no legal advice, according to the filing in U.S. District Court in Washington. The bank and the agency came together and agreed to let a magistrate judge settle the dispute of the release of the emails.
Nora Mead Brownell, a FERC commissioner from 2001 to 2006 did inject that the FERC probe into J.P. Morgan’s bidding activities does not mean that wrongdoing has necessarily occurred. Since Enron, the agency has worked hard to keep up with the quickly developing financial markets; they are investigating J.P. Morgan just as they would any other corporation. The investigation has made news because of the refusal of turning over the emails to the agency. Some of the emails being requested are between commodities chief Blythe Masters and head of principal commodity investments Francis Dunleavy.
In conclusion, J.P. Morgan Chase Bank has been found in hot water many times in the news recently and working to dig out. Without being able to change what has already been done, all the bank can do is learn from its recent mistakes. The “London Whale” loss was a major hurdle for J.P. Morgan Chase, ceasing the trade of derivatives and eliminating the people involved in the loss will hopefully prevent future events from happening. The mutual fund issue that the bank faced resulted from having poor management in place; having the scandal picked up by media and brought to the public’s attention will help consumers to be careful of what they are getting into. Unfortunately, companies as large as J.P. Morgan are always going to have some employees who do not act ethically in sales. Having all of the negative publicity will hopefully help the company to monitor bad business more closely. As far as the energy market scandal is concerned, with as many things J.P. Morgan has struggled with in the past, it doesn’t look good for them, but until more concrete evidence is unveiled, it’s hard to point the finger in the investigation. Overall, CEO Dimon is handling the situation well and replacing employees that need to be replaced. Hopefully once this is all settled, we won’t be seeing J.P. Morgan in the news anymore.

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