There's a Whale in the Fish Tank!

While no one can put a number to the JP Morgan trading problem yet, in the vocabulary of auditors, the results likely will be material.  Using the word material in this context means that it would influence the decisions of folks relying on the financial statements.   Coming in the midst of efforts to improve both regulatory and financial controls for banks, it points out how much work remains to be done on the topic of appropriate risk management and reporting.

 It strains credibility that the bank’s CEO started to realize they had a problem when he read about the “London Whale” on the front page of the Wall Street Journal.  The trade was executed as part of what was supposed to be the bank’s risk management strategy.  If there’s a whale in your fish tank it shouldn’t take a third party to make you notice. 

While JP Morgan messed up in many ways here, you have to give them credit for keeping the conversation focused on how risky and complex the trade was.  No one can dispute that the speed and complexity of global financial transactions make them difficult to manage.  However, this focus misses the point that the bank is supposed to have internal control infrastructure that doesn’t allow them to get into a place where they make trades that have indeterminate impact.  

Anyone who has worked in a big organization knows that risk culture doesn’t change quickly in either direction.  There must be senior people at the bank today who didn’t have to read the Wall Street Journal to find out there was a problem.  Apparently the Treasurer’s position at the bank wasn’t filled during the time much of the controversial trading was going on.  However, before he left the bank, the person in the role apparently was concerned.  This is someone who was reporting the bank’s CFO.  GMI, an independent corporate ratings agency gave JP Morgan Chase an “F” for corporate governance policies in advance of the loss being made public.  This grade is typically given to less than 5% of the companies they rate.  GMI also ranked JP Morgan’s financial statements lower than 92% of comparable firms in terms of accounting and governance risk. 

Group On auditors’ found the company had a material weakness in its internal controls.  The tools are available today to highlight when controls don’t appear to be in good condition.  An error of the scale that occurred at JP Morgan Chase should not happen in an effective internal control environment.  It is hard to believe the deterioration of these controls happened suddenly since the last audit report.