The following editorial appeared on Bloomberg View:
JPMorgan Chase’s chief executive officer, Jamie Dimon, initially called the bank’s “London whale” trading debacle a “tempest in a teapot.” Some teapot. Wednesday the bank agreed to pay $100 million to settle an action brought by the Commodity Futures Trading Commission. But more important than that relatively modest sum is the bank’s admission that its traders were “recklessly aggressive.”
The new settlement brings to more than $1 billion the penalties the bank has had to pay for the London whale and, with more cases to come, that figure could grow. The real news, though, is that after decades of allowing companies to “neither admit nor deny” wrongdoing when settling cases, regulators are insisting that they admit guilt.
JPMorgan’s concessions in Wednesday’s CFTC case and last month’s Securities and Exchange Commission settlement signal that Wall Street firms no longer can flout the law and then, if caught, dismiss the resulting penalties as a cost of doing business. This is a sea change in U.S. law enforcement, one with far-reaching consequences.
A mea culpa in the CFTC case exposes JPMorgan to client and shareholder lawsuits for having built, then unloaded, huge trading positions that distorted the normal supply and demand signposts in the market. The bank’s London investment office, operating much like a hedge fund, accumulated a $157 billion position in credit-derivative indexes, which track the default risk of baskets of corporate debt.
On one day in February 2012, the bank’s traders dumped more than $7 billion of swaps – more than 90 percent of the volume in the market that day. In doing so, the bank disregarded the distorting effect on the broader market, the CFTC said, potentially harming investors and others who relied on the indexes to hedge. The positions ultimately blew up, costing JPMorgan more than $6 billion in 2012.
The admission to the CFTC goes further than the admission in the SEC case, so it sets a more potent precedent. At issue in the SEC action were managerial lapses. The SEC said JPMorgan violated securities laws that require companies to have adequate controls and governance standards. Admitting to poor management is weaker than conceding that credit derivatives were used with reckless aggression.
The CFTC is also signaling a willingness to make maximum use of the 2010 Dodd-Frank Act. The law lets the agency sue banks that use instruments, including derivatives, as a “manipulative device.” This doesn’t require regulators to prove intent to manipulate, so cases are easier to bring and to press to a successful conclusion.
This easier standard is two-edged: It may limit JPMorgan’s civil liability. Admitting to reckless use of a credit derivative as a manipulative device lacks the clarity and punch of an admission of deliberate market manipulation. Civil liability can play an important reinforcing role in law enforcement if it makes managers pay closer attention to the actions of employees.
Still, the new precedents are good news for investors at risk in markets that can be swamped by the actions of Wall Street’s giants. Best of all is curbing the practice of settling cases without an admission of wrongdoing. That will make the markets safer for all.