Not Much Illumination: JP Morgan, MF Global & Man in the Middle, Jamie Dimon

The more I write about banks, auditors, legislators, regulators and the big money that passes amongst them, the easier it is to see the connections between them all.

Jonathan Safran Foer wrote a book in 2002 called Everything is Illuminated. According to Wikipedia, the novel tells the story of…

“…a young American Jew who journeys to Ukraine in search of Augustine, the woman who saved his grandfather’s life during the Nazi liquidation of Trachimbrod, his family shtetl. Armed with maps, cigarettes and many copies of an old photograph of Augustine and his grandfather, Jonathan begins his adventure with Ukrainian native and soon-to-be good friend, Alexander “Alex” Perchov, who is Foer’s age and very fond of American pop culture, albeit culture that is already out of date in the United States. Alex studied English at his university, and even though his knowledge of the language is not “first-rate”, he becomes the translator. Alex’s “blind” grandfather and his “deranged seeing-eye bitch,” Sammy Davis, Jr., Jr., accompany them on their journey. Throughout the book, the meaning of love is deeply examined.”

It’s widely believed that the title of the book comes from a line in one of my all time favorite novels The Unbearable Lightness of Being by Milan Kundera:

“In the sunset of dissolution, everything is illuminated by the aura of nostalgia.”

I’m sure MF Global customers are waxing nostalgic for their missing money, but not much light has been officially shed yet on the mystery of its whereabouts. A preliminary “investigation” report from MF Global SIPA proceeding trustee (that’s the bankruptcy process for the broker/dealer), James Giddens, comes up short. I use quotes for the word “investigation” because this is not a bankruptcy examiner’s report in the grand tradition of Tony Valukas’ Lehman Report, or Michael Missal’s New Century Report or even Josh Hochberg’s Refco Report. Giddens is no investigator and we get very few answers, especially to the fundamental question, “Where is the $1.6 billion of missing customer money?”

(Louis Freeh, the MF Global Holding Company trustee also published a report but it is nearly worthless given its lack of candor and sniping at Giddens. I’m looking forward to meeting Freeh at the Stanford Law School Directors’ College in Palo Alto, June 24-26.)

Giddens is using Ernst & Young as his forensic investigation firm. In addition to all the other conflicts Giddens – and Freeh – have with JP Morgan and MF Global auditor PwC, the use of Ernst & Young in this context should not have been allowed.  Ernst & Young is the same firm, according to sources, that designed and implemented MF Global’s internal controls in time for its first Sarbanes-Oxley review and same firm that Randy McDonald, the MF Global CFO prior to current CFO and PwC alumni Henri Steenkamp, worked for.

I wrote about MF Global again this week for my column at Forbes. The focus was on some revelations about the repo-to-maturity transactions that caused a momentary stir – the issue is a tempest in a teapot – but I also criticized Giddens for what the “investigation” report does not say:

More important than the debate over the accounting treatment, which appears moot, is the fact that the trustee’s report, for all its depth and breadth and fingers pointed at executives with threats of litigation, still does not tell us who, specifically, was on the receiving end of the $1.6 billion of stolen customer funds. The trustee admits he may not have all the facts.

“This Report reflects the Trustee’s best judgment based on information currently available to the Trustee, which is less than the amount of information available to law enforcement and regulators…”

What is known is that Henri Steenkamp, CFO, appears, based on the trustee’s report, to have been much more involved in managing the “shell game” that developed to fund Corzine’s trades than he admitted to Congress. What is also known is Steenkamp, an accountant’s accountant who likely worked with Corzine to design a structure that met all the requirements for accounting rules, is an alumni of PwC, MF Global’s auditor.

Giddens, the trustee, doesn’t tell us whether PwC, the shareholders’ watchdog, ever barked.

There is nothing in the Gidden’s report which precludes my theory of where some if not most of the customer assets went.  In fact, major investor and backstage actor Chris Flowers has been curiously silent about his own loss. He’s moved to London, according to The Financial Times, and moved on.

According to people close to the financier, he moved from New York to London last month and is about to move into a new home in Belgravia. Mr Flowers has never lived outside the US before.

Who is Chris Flowers?

He’s the guy who gave Jon Corzine the job at MF Global.

Jon Corzine got the chief executive job at MF Global in early 2010 for one reason: Chris Flowers bailed the firm out in 2008 after a wheat trader’s shenanigans cost it $140 million. Flowers was growing impatient with constant losses  – MF Global’s core business was losing money, squeezed by a low interest rate environment and declining trading volumes for futures customers – and Corzine was brought in to return the firm to profitability.

Maybe Flowers got his money out in the last days of MF Global. Did he or one of his many portfolio firms lend against MF Global customer securities and then cash in the excess collateral when the firm filed for bankruptcy?  That would have made him whole. The trustee will have to go to London to get those T-Bills back. Or was one of Flower’s firms a counterparty to the RTMs backed by sovereign debt and a recipient of customer funds masquerading as margin? Is he still holding Italian or Spanish bonds?  Is that why he believes a default by one of those countries would be “catastrophic”, per the FT?

Speaking of London it’s where the cool firms go to make risky trades beyond the reach of US regulators and the ken of UK watchdogs.

My American Banker column this week draws the parallels between some recent arbitrageurs of the regulatory variety and what almost all of them have in common – PwC.

Pop quiz time. Which U.S.-based financial services firm used the U.K. to make losing trades that caused embarrassment, regulatory scrutiny and much worse: MF Global, AIG, Lehman Brothers, or JPMorgan?

Answer: All of the above.

The inimitable FT Alphaville does a smashing job of explaining the rationale for going to London for the JPM “whale” trades in this post.

I’v explained previously why I think the JP Morgan “hedge” was not a hedge and why the Volcker rule doesn’t address the discrepancy between accounting standards and the media’s repetition of a trader’s perspective on what to call such trades. Which brings us finally to Jamie Dimon, CEO and Chairman of JP Morgan Chase, who testified before the Senate this week about the “whale”, the bank’s money losing bet on synthetic creit derivatives, and also answered a few softball questions about the bank’s role in MF Global.

Two good summaries of “the inquisition that was not” come from Yves Smith at Naked Capitalism and Alexis Goldstein at The Nation.

First Naked Capitalism:

In Senate testimony, Dimon revealed his idea of “portfolio hedging” to be even more egregious than the harshest critics thought. Dimon presented the job of the CIO to be to make modest amounts of money in good times and to make a lot of money when there’s a crisis. (That does not appear to be narrowly true, since in the last couple of years, during which there was no crisis, the CIO’s staff were among the best paid in the bank and produced significant profits for the bank. That is a bald faced admission that the CIO’s mandate had nothing to do with hedging. A hedge is a position taken to mitigate losses on an underlying exposure should they occur. Instead, Dimon has admitted that the mission of the CIO is to place bets on tail risks that are unrelated to JP Morgan’s exposures…

Not surprisingly, Dimon was good at giving irrelevant responses. When Jeff Merkeley tried to pin the JP Morgan CEO on the hedge fund-like nature of the CIO, Dimon talked about the low-yielding/low risk nature of the underlying assets. That may be true, but what about the derivative positions taken on top of that? Dimon only described one part of the CIO’s operations. Similarly, Jon Tester went after MF Global, trying to argue that Dimon withheld customer monies and Dimon batted that back, saying he had waited for instructions from the trustee while omitting the fact that he was fighting tooth and nail in court…

Since Dimon has admitted in Congressional testimony that he was responsible for the internal control failures in the CIO portfolio SOX should now be a slam dunk for the SEC. (fm note: Sox 302 certification violations, which are criminal.) But of course, that will never happen.

It was instructive to see how effective confident misrepresentation can be. Most of the Republican senators fawned over Dimon after the ritual scolding at the top of the hearings, and I suspect most of the media will simply replay his lines uncritically. There were a few that will work against him, like his reluctant admission that the Volcker rule might have prevented the failed London trade. But in general, reducing complex situations to soundbites allows for obfuscation and misdirection, which is exactly what Dimon and his ilk are keen to have happen.

And The Nation:

The hearing revealed that JPMorgan appears to have found a solution to the pesky problem of the Volcker Rule. No, it’s notbuying off members of the Senate Banking committee, though given what passed for “questions” in the hearing, that is certainly Plan B. JPMorgan’s solution is far simpler. It has relabeled proprietary trading: it’s now called “portfolio hedging.” This is a convenient rebranding, because portfolio hedging is explicitly allowed in the current draft of the Volcker Rule.

The Volcker Rule (which was part of the Dodd-Frank Wall Street Reform bill) has a noble goal: create a firewall that bars banks that enjoy FDIC insurance from risky, speculative gambling. On Wall Street, gambling with the firm’s funds is known as proprietary or “prop” trading.

The banks hate the Volcker Rule because prop trading is very profitable when you’re on the right side of a bet. And when you’re a “too big to fail” bank on the wrong side of a bet, the government will bail you out, and the Fed will secretly give you billions of dollars in emergency loans. The Volcker Rule aims to prevent the need for these bailouts by prohibiting banks that enjoy customer deposits and FDIC insurance from making these risky prop trades.

I think the most damning admission by Dimon for JP Morgan’s external auditors, PwC, was the following:

“In the rest of the company we had those controls in place. We didn’t have them here.”

  • Was the Chief Investment Office in scope for PwC’s internal controls testing for Sarbanes-Oxley at year end?
  • Did PwC ever raise concerns for level of trading in CIO, for loss of key personnel, for lack of, disdain for, and relaxation of controls?
  • Were there any internal control exceptions, significant deficiencies or material weaknesses cited by PwC for  either financial or IT controls?
  • Did PwC review and have any concerns about the change in the VAR model – a key risk management tool – for the CIO?
  • Did PwC perform a subsequent events review related to a change in trading strategy, increased risks, and reduction in monitoring and controls between December 31 and the date of their audit opinion?

I ask, as I always do:

Where were the auditors?

Last week when I was in Washington DC, I appeared live on Lauren Lyster’s TV show, Capital Account, talking about MF Global and JP Morgan. Here you go:

Main page photo source

7 replies
  1. Richard_A
    Richard_A says:

    Nice segue on the lead to this posting. I was wondering where you were going with the literary references, but you got there quickly.

    The literary references were very appropriate, considering that the investigations of MF Global and JP Morgan Chase are nothing more than comedic political theater intended to deluded as much of the voting population as possible into thinking that the people in Congress and the current Presidential administration are doing something to look out for investors and taxpayers. In reality, absolutely nothing will be done. In the end, the Volcker Rule won’t actually have teeth and be enforced; Dodd-Frank will be further eviscerated before final regs are published; and the execs of companies such as JP Morgan Chase, Goldman Sachs, and the CPA firms will continue to get a free pass on everything that might have been done improperly or illegally at their firms, even through the next financial crisis and bailout of the phony capitalists with public money.

    The conviction of Rajat Gupta being an exception to the political theater (or perhaps being just another act in the play to distract the masses). However, his case has nothing to do with the kinds of accounting manipulations and “re-branding” and misrepresentation of high risk investment vehicles and “hedging” strategies as being safe that seem to have been common practices in companies such as Chase, Goldman Sachs, et al. Insider trading, while sometimes difficult to prove, is much easier for most people to understand and doesn’t require the kind of attention span necessary to get even a basic understanding of how much manipulation of the investment markets, credit markets and financial reporting was, and apparently still is, being done.

    Thanks to you, Yves Smith, Alexis Goldstein, and a few others for continuing to provide information and analysis. It is up to the rest of us to read, investigate, understand, and do what we can to try to force politicians into actually doing something to address the problems instead of just fawning over every high profile CEO who shows up for one of their “investigative” farces.

  2. David
    David says:

    Another important article. … I am happy to “see” you in action on TV – nice.
    But – the heart of the matter seems to be that these sophisticated firms are doing what they can to use a great deal of intelligence and discernment to go around the heart of the law. The strategy is how can they get something done and not make it illegal.
    The Spirit of the law is not an issue. Some of the smartest guys and gals around are working at MFGlobal and at PwC. Yet, PwC missed this huge bet. I maintain that they did not miss it, rather, the conversation became can we avoid prosecution if we model it “thus and so.”
    Now, they scream – Where were the regulators!! The regulators are not making these huge dollars, they are not as heavily trained, and we rely on them?
    They system seems to have been broken because the spirit of equitable behavior has vanished – in these firms.

  3. Charlie Quinn
    Charlie Quinn says:

    You are the single best investigative reporter since Scott Pelley went to the FRONT DESK at CBS-TV nightly news.
    Keep up the superb work. Now that I know your favorite literary work, I am going to read it. Great quote and hope that the “read” is as good
    Charlie Quinn

Trackbacks & Pingbacks

  1. […] 2008, resulting in its bailout by investor J.C. Flowers. Flowers quickly installed a new CEO, Jon Corzine, a partner in Flower’s […]

  2. […] But I’m talking about something more than money. What’s still missing from this sordid affair is an accounting of the whereabouts of the financial auditor, PricewaterhouseCoopers.  The global audit firm would rather come off as stupid than complicit in the actions of whomever broke the law and stole MF Global customer funds. PwC prefers you believe they were “duped” and given false or no information when executives took on inordinate risk with little or no oversight, and took advantage of lax or relaxed internal controls to double down with other people’s money in the noble hope he could “save the company” for investors including his true boss, Chris Flowers. […]

  3. […] Not Much Illumination: JP Morgan, MF Global & Man in the Middle, Jamie Dimon( This entry was posted in Uncategorized and tagged Federal Bureau of Investigation, J. P. Morgan, JPMorgan, MF Global, United States Department of Justice, Wall Street by Glenn Olnick. Bookmark the permalink. […]

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