As part of its September 19, 2013 entry into a total of $920 million in regulatory settlements related to the “London Whale” trading loss debacle, and as part of the SEC’s new policy requiring admissions of wrongdoing in certain “egregious” cases, JP Morgan provided the SEC with an extensive set of factual admissions. The company’s provision of the admissions could have significant implications for the continuing regulatory and litigation proceedings against the company related to the London Whale losses. The company’s admissions also have important implications for other companies about the SEC’s new policy requiring admissions of wrongdoing.
The SEC’s September 19, 2012 press release about the company acceptance of a $200 million penalty can be found here. The September 19, 2013 Cease and Desist Order entered in the SEC administrative proceeding against the company – to which the Annex with the company’s admissions is attached – can be found here. A September 19, 2013 statement from George Canellos, the co-Director of the SEC enforcement division about the settlement can be found here.
The Office of the Comptroller of the Currency’s September 19, 2013 press release announcing the agency’s entry of a $300 million civil money penalty against the company for “unsafe and unsound practices related to derivatives trading activities” can be found here. The Federal Reserve’s September 19, 2013 press release announcing its entry of a $200 million penalty against the company for “deficiencies in the bank holding company’s oversight, management, and controls” can be found here. The U.K. Financial Conduct Authority’s September 19, 2013 press release announcing its entry of a $220 fine for “serious failings” can be found here. JP Morgan’s own September 19, 2013 press release about the settlements can be found here.
The settlements relate to extensive trading losses that the bank incurred losses at its London trading desk in early 2012. The London traders’ positions had previously been profitable but as the gains turned to losses, the traders sought to hide the magnitude of the losses by deviating from prior practices in “marking” the value of their positions. The changes hid the existence and size of the losses – for a time. The company ultimately reported losses of greater than $6 billion and was forced to restate its previous published financial statements for the first quarter of 2012.
The Company’s admissions in the Annex to the Cease and Desist Order make for interesting reading. Among other things, the Annex admits (in paragraph 10) that the London traders “intentionally understated mark-to-market losses.” The Annex also shows that the bank’s own internal control processes to evaluate traders marks was inadequate, built on flawed processes, and compromised by dependence on input from the traders themselves. Concerns about the processes and about the valuations became apparent as counterparties began demanding collateral.
The Annex details a sequence of events showing that the concerns about the valuations were not sufficiently elevated to senior management, and then once management became aware of the concerns and began putting remedial steps in place, were not sufficiently elevated to the Audit Committee of the company’s board of directors.
Among other things, in the Annex J.P. Morgan acknowledged “that its conduct violated the federal securities laws.” The Cease and Desist Order recites a finding that the company violated the books and records provisions under Section 13 of the ’34 Act.
In his statement about the settlement, the SEC enforcement co-director said:
In addition to failing to keep watch over how the traders valued a very complex portfolio, JP Morgan’s senior management broke a cardinal rule of corporate governance: inform your board of directors of matters that call into question the truth of what the company is disclosing to investors. Here at the very moment JP Morgan’s management was grappling with how to fix its internal control breakdowns and disclose the full scope of its trading disaster, the bank’s Audit Committee was in the dark about the extent of these problems.
By not sharing these troubling facts with its directors, JP Morgan deprived them of information they vitally needed to make proper judgments about how to address the company’s problems – including what information could be relied upon as accurate and what information needed to be disclosed to investors.
While the various regulatory settlements resolve a host of proceedings against the company, other proceedings continue. Among other things, the CFTC’s enforcement proceeding is continuing, as is the DoJ’s investigation and the criminal proceedings against London colleagues of the “London whale” trader who allegedly participated in efforts to cover up the losses. In additional, the shareholder class action lawsuit filed against the company and certain of its directors and officers is also ongoing.
Though the Annex to the Cease and Desist Order contain extensive admissions from the company, the document is as noteworthy for what it does not contain as for what it does contain. Thus, while the company acknowledges that its conduct “violated the federal securities laws,” the company itself does not specify which laws it violated. The Order does state the conclusion that the company violated the books and records provision of the federal securities laws, but as Wayne State Law Professor Peter Henning points out in a September 19, 2013 column on the New York Times Dealbook blog (here) , this conclusion is of limited value outside the context of the administrative proceeding, since there is no private right of action for a violation of the books and records provision.
While the Annex details various failings by a group of persons described generically as “Senior Management,” the document does not specify which specific individuals where responsible for which misconduct. By using the rather vague group description, the Annex avoids saying that any specifically identified individual acted improperly or failed to act properly. Simply put, the Annex – and by extension – the settlement, does not hold any one member of the company’s senior management responsible.
Perhaps even more significantly, while the Annex contains extensive factual admissions, the Annex does not contain any conclusive language; there are no admissions, for example, that the company and of its senior officials acted with an intent to deceive or that they acted fraudulently or even recklessly.
As a result, the Annex, while undoubtedly useful to the regulators and claimants in the ongoing proceedings against the company, may not prove to be all that helpful in the end. For example, the Annex will support the plaintiffs in the ongoing shareholder action, but there do not appear to be admissions in the Annex that would in and of themselves establish liability under Section 10(b). There do not appear to be admissions that establish that the company or its senior officials acted with scienter.
As Professor Henning noted in the Dealbook blog, the admissions “will be of very limited utility to private parties suing the bank for violating the federal securities laws.” Indeed, in a September 19, 2013 post on her On the Case blog entitled “Don’t Get Too Excited About JP Morgan’s Admissions to the SEC” (here), Alison Frankel says that “JP Morgan has shown that it is possible to give the SEC an admission that will permit the agency to look tough without conceding much, if anything, in private litigation.”
Now that we have the JP Morgan settlement, with it admissions of wrongdoing in hand, along with the prior settlement the SEC reached with Harbinger (about which refer here), we can begin to assess what the SEC’s new policy requiring admissions of wrongdoing may mean for other companies going forward. It appears it will be sufficient to satisfy the SEC’s admissions wrongdoing requirement to provide extensive factual admissions without accompanying descriptive admissions about the factual misconduct and even without specific admissions of what laws the misconduct violated. It apparently will also be sufficient – at least to settle an administrative proceeding – for the company to admit wrongdoing without any specific member of senior management admitting misconduct or responsibility.
The SEC’s new policy requiring admissions of wrongdoing in certain cases is still new and it will undoubtedly evolve. Just the same, other companies facing an SEC requirement of admissions wrongdoing will be studying the JP Morgan settlement to see what will be sufficient to satisfy the requirement. As Alison Frankel put it on her blog post, “I suspect that future SEC defendants are going to look the JP Morgan settlement as a model for how to quench regulators’ thirst for blood without spilling a drop in parallel shareholder litigation.”
Context matters here. In a civil enforcement proceeding, a federal district court judge’s approval would be required to finalize the settlement. A judge might require more specific admissions or more direct admissions of individual wrongdoing. Because JP Morgan negotiated the settlement in an administrative action rather than a civil enforcement proceeding, no court approval is required. Based on this important context consideration, I would say that other defendants in administrative proceedings might try to use the JP Morgan settlement as a model; defendants in civil enforcement actions may have to be prepared to make more extensive concessions.
In my prior post about the Harbinger SEC settlement, I expressed concerns that the SEC’s requirement of admissions of wrongdoing could create significant D&O coverage issues and potentially could trigger the conduct exclusion typically found in most D&O insurance policies. While that concern still remains, admissions of the type JP Morgan entered could prove to present less of n insurance coverage concern. The JP Morgan admissions arguably contain no specific admission of criminal or fraudulent misconduct. There would appear to be less of a basis for an insurer to contend in reliance on the conduct exclusion that coverage is precluded. So if the JP Morgan settlement were to become a “model” it at least would appear to present less a D&O insurance coverage concern.
Background regarding the securities class action lawsuit arising out of the London Whale disclosures can be found here.
A Disaster Full of Durable Images: Whales, Teapots and Hedges: One of the aspects that has always made this situation interesting to me is the colorful name given the London trader whose losses cause all of these losses. As early as April 6, 2012, the Wall Street Journal was reporting that trading markets were buzzing about the outsized positions that a London trader was taking; the article itself noted that others in the market were referring to the trader as the "London Whale" in reference to the size of the trader’s positions.
The invocation of the Leviathan is not only the only colorful and enduring image from this debacle. In an earniing confernce call on April 12, 2012, JP Morgan CEO Jamie Dimon tried to downplay the publicity surrounding the London trader’s positions by describing the controversy as a "complete tempest in a teapot."
Yet less than a month later, on May 10, 2012, when the company was forced to admit that the London trader’s positions had caused the company what it then thought was only $2 billion in losses, Dimon said that the trading strategy was "flawed, complex, poorly reviewed, poorly executed and poorly monitored. The portfolio has proven to be riskier, more volatile and less effective an economic hedge than we thought.”