Examining coverage of JPMorgan trader charges

As if losing more than $6 billion wasn’t enough, traders at JPMorgan were charged Wednesday with trying to hide the losses, marking another round of press over the botched trading position.

Here’s the story from the Wall Street Journal:

U. S. prosecutors filed criminal charges against two former J.P. Morgan & Co. traders on Wednesday, alleging they sought to hide mounting losses on the bets that eventually cost the nation’s largest bank more than $6 billion.

Prosecutors charged Javier Martin-Artajo, a Spaniard in charge of the team that made the giant wagers in corporate-credit investments that piled up losses early in 2012, and Julien Grout, a Frenchman responsible for recording daily values on the positions.

The Securities and Exchange Commission also filed a related civil complaint against the two men.

Lawyers for Messrs. Martin-Artajo and Grout couldn’t immediately be reached for comment. A lawyer representing Mr. Martin-Artajo said Tuesday that his client was confident he would be exonerated once a “complete and fair reconstruction of these complex events is completed.”

Prosecutors also reached an agreement with former J.P. Morgan trader Bruno Iksil, a Frenchman who executed the trades and who was known as the “London whale,” in which he would not be criminally prosecuted for his conduct. Mr. Iksil has agreed to cooperate with the investigation by U.S. authorities as part of the agreement, according to documents filed Wednesday by the U.S. attorney’s office. A lawyer for Mr. Iksil, Jonathan New of BakerHostetler, said his client “has been cooperating with U.S. authorities and will continue to do so as needed.”

At the heart of the case is how to come up with values for the derivatives, the New York Times wrote in a sidebar:

Their trading didn’t take place in a market where very large numbers of transactions produced transparent and public prices through the day, like the stock market. Instead, the traders made bets with derivatives, financial contracts that often trade sporadically and in the shadows of Wall Street. The traders focused on so-called credit derivatives, including one named CDX.NA.IG9, which allow traders to bet on the creditworthiness of a basket of companies.

In its lawsuits, the government says that the traders deliberately valued their huge derivatives bets to make their losses look lower than they actually were in the early months of 2012.

One way that traders value their holdings is to use pricing data from a range of banks.

If Wall Street brokers are offering to buy a derivative contract at 100 and sell it at 104, the trader might value that contract on his own books at 102, the midpoint between the two numbers.

Prosecutors say that the JPMorgan traders did two things when using this so-called bid-offer spread to value trades. They stopped using using the midprice, and opted instead to use values closer to the edge of the pricing range when it suited them. In one case, the government says the traders even marked a big derivatives position outside of the range. Traders also use data from third-party companies that survey a range of price quotes across a range of banks.

The problem with using these approaches is that they may not be fully based on prices that occurred in actual transactions. Instead, they may rely heavily on indicative prices, which is the term Wall Street gives to the price quotes that a broker puts out to the market but isn’t obligated to make transactions at the value.

The Financial Times outlined the details of the charges brought against the two traders:

Prosecutors allege that in 2012, from March until May, the traders artificially inflated the value of positions “to achieve specific profit daily and month-end profit and loss objectives”. As a result of the mismarking, JPMorgan restated its first-quarter results for net revenue by $660m.

As the trading losses mounted, prosecutors allege, Mr Martin-Artajo put pressure on Mr Iksil and Mr Grout to stop reporting losses in the portfolio. According to one complaint, Mr Grout shifted from valuing the portfolio at the midpoint of the bid-ask range, to a price that would reflect a better valuation.

On March 15 2012, prosecutors allege, the traders hid $292m in losses that should have been taken on the portfolio.

The following day, Mr Iksil said, “I don’t know where [Mr Martin-Artajo] wants to stop, but it’s getting idiotic.”

Days later, after Mr Iksil recorded a $40m loss in the portfolio and said the “lag” or loss could grow to $880m, the complaint says Mr Martin-Artajo asked him on a recorded call, “Why did you do that?” and added: “This is just what we explain tomorrow. You don’t need to explain in an email, man.”

While that’s just one side of the story, exchanges like these definitely help make prosecutors’ case that something was awry with the trades. It will be interesting to see if the charges cause any changes in the way that values for derivatives are determined or if it changes the policies for setting those values at any institution.