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Does JPMorgan Have a Culture of Fraud?

M. Joy Hayes
October 25, 2012

Federal investigators are currently building a criminal case against four key employees involved in JPMorgan Chase's (NYSE: JPM) notorious London Whale trade for allegedly failing to provide accurate valuations for their financial statement disclosures. In addition to investigating Bruno Iksil and Julien Grout for allegedly overvaluing their positions, investigators are following up on allegations that London's trading strategy manager Javier Martin-Artajo, and the international chief investment office's top executive, Achilles Macris, pressured Iksil and Grout to price their positions aggressively.

A recent New York Times story discussing the investigation opined that "[the] scope of the inquiry suggests that the problems were isolated to a handful of executives and traders in an overseas division, and did not reflect a fundamental weakness with the bank's culture and leadership."

To quote the phrase of the moment, I think that's a bunch of malarkey.

Even if JPMorgan's top leadership didn't directly encourage the alleged fraud, and wasn't aware it was occurring, that doesn't help them escape broad criticisms of their culture. A corporate culture is defined by the shared understanding of "how things really work" in the organization, and what types of behaviors are allowed and encouraged. And at JPMorgan, the internal controls system would play a major role in the formation of this shared understanding within the chief investment office (CIO), and have the potential to create a "culture of fraud" within the department.

Material weakness
If an organization doesn't have strong internal controls to detect and prevent fraud, that reflects a failure on the part of organizational leadership to take the steps necessary to foster a strong ethical culture. And as JPMorgan revealed in its own filings, it had material weaknesses in its internal controls that allowed traders to mismark the books undetected.

Sarbanes-Oxley expert Michael Crimmins has pointed out that JPMorgan's internal controls process deviates from widely followed practices in the financial industry, which require valuations to be determined by an independent valuations unit, existing outside of the CIO. In contrast, it seems that JPMorgan relied on traders to provide their own valuations, with an internal control group conducting regular checks of the traders' markings to ensure they were honest and accurate.

JPMorgan's CEO Jamie Dimon should have been well aware of these industry standards, and with the consequences faced by AIG(NYSE: AIG) for its failure to follow them. At the very least, he should have recognized these key shortcomings in JPMorgan's internal controls by May of this year, when the company acknowledged the inaccuracy of its first-quarter value-at-risk numbers. However, even at that point he still certified the effectiveness of the company's internal controls process.

These statements reflect a shameful oversight on the part of Dimon