'London whale' fiasco begs question: When do investments become bets and approach fraud borders?

By Richard Hurley, Ph.D., J.D., CFE, CPA;Tim Harvey, CFE, JP

richard-hurley-80x80.jpg   tim-harvey-80x80.jpg   Global Fraud Focus: Examining cross-border issues



"Call me Ishmael." That's the identifiable opening line for Herman Melville's 1851 novel "Moby Dick." In fact, the American Book Review listed it as No. 1 in its list of 100 best first lines from a novel. Flash forward about 160 years, and you have a French-born trader named Bruno Michel Iksil trying to harpoon one more whale of a trading deal for his firm, JPMorgan Chase & Co. 

Gregory Zuckerman in The Wall Street Journal May 17 article, "From 'Caveman' to 'Whale,' " writes that Iksil, a London-based trader in the chief investment office of JPMorgan Chase & Co., had bet $1 billion that companies like Eastman Kodak, Dynegy and American Airlines would default on their debts. 

Supposedly, Iksil gained the "caveman" moniker because of his steadfast belief that his overly aggressive and risky trades would reap financial benefits. Dynegy filed bankruptcy on Nov. 7, and, shockingly, only a few weeks before the trades were set to expire AMR Corp. (American Airlines' parent company) filed bankruptcy on Nov. 29.1  

To the dismay of his rivals who took the opposite positions, "Mr. Iskil's positions brought a windfall of about $450 million to J.P. Morgan, saddling hedge funds and other rivals with similar-size losses," according to Zuckerman. Millions of dollars in success sometimes bring riskier investments, higher dollar amounts and lesser oversights. Zuckerman reported that J.P. Morgan's Chief Investment Office was "part of a group that posted net income of $5.09 billion over the past three years, according to regulatory filings, over 10% of J.P. Morgan's $48.08 billion of profits over that period." 

One has to wonder if Iksil was given greater longitude and latitude in navigating the high seas of investing or betting. In 2012, he took a large position for JPMorgan Chase on credit default swaps. From the view of opposing traders, the position was so massive that they knew Iskil as "the London Whale." The trouble is when you're the largest mammal in the ocean you might have a hard time unloading your position to minimize your losses. 

As the European bank worries subsided, Iskil's large position in the credit default swaps lost value. Total losses aren't official but the majority of news releases indicate they're in excess of $2 billion. The Wall Street Journal May 21 article, "Rivals Go to Lunch on J.P. Morgan's Losses," also written by Gregory Zuckerman with Liz Rapport, reveal that while losses mounted at JPMorgan Chase, "A group of about a dozen banks, including Goldman Sachs Group Inc. and Bank of America Corp., have scored profits that collectively could total $500 million to $1 billion on trades that sometimes pit them directly against" the London Whale. 

The Financial Times on May 16 reported in the article, "How JPMorgan's storm in a teapot grew," by Tracy Alloway and Sam Jones that during a first-quarter results conference call, Jamie Dimon, chief executive of JPMorgan Chase & Co., told listeners that the trade was "a complete tempest in a teapot." Talk about a captain not being able to gauge the magnitude of the impending storm brewing in the financial ocean. Speaking of oceans, The Financial Times reported that one trader said, "It wasn't just a giant whale. It was the size of the Atlantic Ocean." The Atlantic Ocean is some teapot. So what we have is a trade position where one side wins and one side loses. Sounds like betting on football matches (or soccer, if you're in the states) — not investing in business plans. 

Have you noticed the financial press using the words bet or betting instead of invest or investing in describing business ventures or investment activities? Example in point is a headline, "Hedge or Bet? Parsing the J.P. Morgan Trade," by Katy Burne, Aaron Lucchetti and Zuckerman in the May 16 edition of The Wall Street Journal. The article highlights the questionable strategies of JPMorgan Chase & Co. and its trading losses in excess of $2 billion. Was it a hedging strategy to manage risk, or as the article implies, a banking bet to earn revenue?   

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