* Altered risk model likely to be a focus for regulator
* Undisclosed change masked spike in JPMorgan risk
* SEC would have to prove materiality of risk model change
By Sarah N. Lynch and David Henry
WASHINGTON/NEW YORK, June 12 JPMorgan Chase's
failure to timely disclose a major change in how it
measured risk could become the centerpiece for an enforcement
action by U.S. securities regulators as they probe the bank in
connection with its multibillion dollar trading loss.
By omitting the change from its earnings release in April,
the bank disguised a spike in the riskiness of a particular
trading portfolio by cutting in half its value-at-risk number.
JPMorgan did not tell investors that the model for its Chief
Investment Office had been changed until May 10, the same day it
revealed the failed hedging strategy had produced a loss of at
least $2 billion.
Securities and Exchange Commission Chairman Mary Schapiro
said last month that her agency is probing the bank's financial
reporting and made a vague reference to banks' obligation to
publicly disclose changes to their risk model.
Experts say that regulators' strongest potential case is one
focusing on whether JPMorgan should have disclosed the risk
model change earlier.
But at the same time, they say it may be difficult to prove
that the change in the risk model in January was material to
shareholders' interests, which could limit the SEC's ability to
use the JPMorgan investigation to appear tough on big banks
playing fast and loose after the financial crisis.
"I would think this is a case that gets down to questions
about just how aggressive the SEC wants to be," said Jim Cox, a
professor at the Duke University School of Law.
JPMorgan chief Jamie Dimon, 56, is expected to be questioned
over the change in the risk model on Wednesday when he is called
before the Senate Banking Committee to testify.
Dimon has not said exactly when or why the model was
changed, nor has he said who knew about it. He has said that the
portfolio not only took on too much risk, but "was badly
The model was changed in Jaunary by a committee, according
to a person familiar with the matter.
Typically, changes in value-at-risk models at banks are made
by committees composed of managers who monitor risks and
business heads who take them, according to risk management
JPMorgan representatives declined to comment.
Banks in the United States are required to give investors
periodic counts of their value-at-risk. The numbers are
calculated and presented differently across companies, but in
general are supposed to show a minimum amount that a portfolio
could be expected to lose in each of a few days during a
What's most useful to investors is not so much the actual
numbers, but how much they change, experts say.
JPMorgan first told investors on April 13 that the reading
of risk at its CIO unit as of the end of March showed that the
unit could lose at least $67 million in a single trading day,
slightly less than the $69 million from the previous reading in
The report indicated steady risk management in the CIO's
office, which was in contrast to press reports at the time that
a London-based trader for JPMorgan was taking whale-sized
But on May 10 when the bank suddenly disclosed the $2
billion-plus loss, it also revealed for the first time that the
$67 million reading had been calculated with a new model. The
prior model showed risk had actually spiked as the value-at-risk
nearly doubled to $129 million.
Had the higher number been reported, said analyst Jason
Goldberg of Barclays, "certainly, they would have been asked why
the VaR doubled."
To bring a potential case against JPMorgan over its
value-at-risk model change, the SEC will need to decide if the
failure to disclose the model change was "material." In other
words, would a reasonable investor see the information as
Experts are divided on whether the understatement of risk by
the bank will meet the SEC's legal test. It is unclear if
investors would have seen the hike in risk-taking as something
that could lead to a big trading loss.
"It may look bad and it may smell rotten, but it is not
obvious that switch would have greatly misled the market or
greatly influenced the stock price," said Lawrence Cunningham, a
law professor at George Washington University. "That is a
But some experts say that the threshold for materiality of
risk-taking is lower in current market conditions.
Elizabeth Nowicki, a professor at Tulane University Law
School, said the failure by the bank to timely tell investors
about changes to its risk valuation methodologies is significant
- especially because investors are still spooked by the
financial crisis of 2008.
"When disclosure was a huge, huge issue leading to the
debacle of 2008, it is important to the SEC to show no mercy on
the issues of disclosure in the financial industry," said
JPMorgan and Dimon have a legal powerhouse to argue the
understatement was not significant. The team includes two former
SEC enforcement directors: Stephen Cutler, the bank's general
counsel, and William McLucas, a partner at Wilmer Hale Pickering
Hale and Dorr LLP who has been retained in connection with the
Since the financial crisis, the SEC has faced a barrage of
criticism for what some say is a failure to go after the top
executives at the country's major banks.
Several legal experts say that the failure of JPMorgan to
disclose changes to its value-at-risk modeling could actually
present a prime opportunity to do just that.
The SEC could investigate whether the episode reveals
failures by Dimon and Chief Financial Officer Doug Braunstein to
adequately control the bank's internal financial reporting and
disclosure procedures to investors.
Even if the SEC did not charge executives under internal
control provisions, digging into the area could prove fruitful
in other ways. It might turn up email chains that give insight
into how the model was changed, and who at the company knew
It could also put pressure on the company and its executives
to agree to settle and pay a fine.
"To make management sweat a little bit, the SEC's focus
might well be on internal controls," said Charles Whitehead, a
professor at Cornell Law School and former Wall Street