JPMorgan Chase & Co.'s claim that it found possible employeeintent to misprice trades in a unit that lost $5.8 billion may putdistance between management and any wrongdoers while providing aroad map for U.S. investigators.

“E-mails, voice tapes and other documents, supplemented byinterviews” were “suggestive of trader intent not to mark positionswhere they believed they could execute,” the bank said in apresentation July 13 as it reported net income fell 9 percent to$4.96 billion. “Traders may have been seeking to avoid showing fullamount of losses,” the bank said, noting management had concernsabout the integrity of the prices used. The bank didn't provideevidence to support the allegations.

The U.S. Department of Justice and the Federal Bureau ofInvestigation in New York in May began a probe of the bank'strading losses, a person familiar with the matter said. TheSecurities and Exchange Commission and the Commodity FuturesTrading Commission, which regulates derivatives trading, are alsoexamining New York-based JPMorgan's trading activities, accordingto people familiar with those probes.

The largest U.S. bank by assets restated first-quarter resultsto reduce net income by $459 million after a review of the pricesused in the unit. Yet multibillion-dollar losses and an internalreport by the bank are just the beginning of any federal case, saidSam Buell, a former U.S. prosecutor in New York who worked on theEnron Corp. Task Force and is now a professor at Duke UniversitySchool of Law.

“You can't just say, 'hey, this is bad, there are billions ofdollars in losses, let's prosecute someone,”' Buell said. Eightweeks after Enron collapsed, the company's board of directorsproduced a report about what transpired at the energy trader.Prosecutors, however, weren't able to bring charges for two moreyears, he said.

JPMorgan's statement “suggests they are trying to isolate thisas a problem that occurred below the management level,” Buell said.Any attempt to reach beyond traders to management would bedifficult for prosecutors, he said.

“In U.S. criminal law, we very rarely do hold people criminallyresponsible for failure to supervise,” he said. “You need to shownot only outright knowledge but also willful blindness — having astrong suspicion that there is wrongdoing and then taking steps toavoid it.”

Ellen Davis, a spokeswoman for Manhattan U.S. Attorney PreetBharara, and Jim Margolin, a spokesman for the FBI's New Yorkoffice, declined to comment on JPMorgan's statements.

Suggesting Traders

Jennifer Zuccarelli, a spokeswoman for JPMorgan, declined tocomment on whether the bank was suggesting traders had broken thelaw. JPMorgan didn't name any employees involved in the potentialmismarking of positions.

The discrepancy between prices used by the chief investmentoffice and JPMorgan's credit-swaps dealer, the biggest in the U.S.,was first reported May 30. The trades in question, made by a ChiefInvestment Office group that included Bruno Iksil, nicknamed theLondon Whale because his positions grew so large, were on so-calledtranches of credit-swap indexes, people familiar with the mattersaid at the time. All declined to be identified because theyweren't authorized to speak publicly.

Tranches allow investors to wager on varying degrees of riskamong a pool of companies. Credit swaps pay the buyer face value ifa borrower fails to meet its obligations, less the value of thedefaulted debt. Because JPMorgan had amassed such large positions,even a small change in how the prices were marked may havegenerated a big difference in the value of the trades, one of thepeople said.

Banks use internal or external groups to independently verifythat prices used by traders to value their investments areaccurate, and firms typically use one price for an asset that maybe traded in different parts of the bank, according to Brad Hintz,a brokerage firm analyst with Sanford C. Bernstein & Co. in NewYork who is the former chief financial officer of Lehman BrothersHoldings Inc.

JPMorgan shut down synthetic trading in its CIO unit with theexception of an $11 billion short position in “basically liquidindexes” to hedge other credit assets, Chief Executive OfficerJamie Dimon said last week. Positions in Series 9 of the Markit CDXNorth America Investment Grade Index, a credit-swaps benchmarkknown as IG9 that's at the heart of much of the loss, were cut by70 percent, Dimon said.

The residual portfolio, largely in so-called tranches of indexesthat wager on the degree to which companies will default together,was transferred to the investment bank, where they have “theexpertise” to manage it, Dimon said.

The bank transferred about $30 billion of risk-weighted assetsto the investment bank, an amount that is “down substantially” fromthe peak and back to levels at the end of 2011, he said.

Voice Recordings

The e-mails and voice recordings that JPMorgan claims to havewould be particularly important to proving securities fraud, saidPeter Henning, a professor at Wayne State University Law School inDetroit and a former enforcement attorney for the SEC between 1987and 1991.

“That's all very helpful to prosecutors,” he said. “It's whatthe person had in their mind at the time. Their own words are thebest way” to show intent, he said.

Henning agreed with Buell that JPMorgan is seeking to distanceitself from the traders in the unit.

“This seems to point the finger at individuals in the bank whomisled the bank,” he said.

JPMorgan restated in a regulatory filing its first-quarter netincome to $4.92 billion, rather than the $5.38 billion previouslyreported. The CIO was responsible for trading losses that the bankestimated at $2 billion in May.

“Restatement is significant, too, because it says what we did iswrong because it's no longer defensible, here's what went wrong. Wewere lied to,” Henning said. “That was a way of mitigating Dimon'scomment about a 'tempest in a teapot.' It really was atempest.”

Dimon dismissed initial reports about the loss as a “tempest ina teapot” when the bank reported first-quarter earnings on April13. He reversed course less than four weeks later, disclosing a $2billion loss that he said could grow to $3 billion or more duringthe quarter.

The release of the details last week may also be a way forJPMorgan to dissuade employees from fighting the bank as it seeksto take back salary and bonus payments to the traders andexecutives in the CIO unit, Henning said.

CIO Unit

Ina Drew, the former head of the unit, will forfeit her pay andother managers were ousted following the bank's internal inquiry.The bank accepted Drew's offer to return about two years ofcompensation, the maximum clawback allowable under employmentterms, said Joe Evangelisti, a company spokesman. Drew didn'trespond to a request for comment.

Other London-based managers of the CIO's synthetic-credit betsleft without severance and will be required to forfeit as much astwo years of pay, including restricted stock and options, the banksaid in a presentation.

“JPMorgan is sending a message,” Henning said. “You have muchbigger issues to face than a clawback suit. The employees willcertainly be looked at by the SEC and DOJ.”

John Moscow, a former prosecutor in the office of ManhattanDistrict Attorney Robert Morgenthau, said the statement by the bankabout “intent” was unusual.

“They are tripping over themselves to suggest the possibilitythe conduct may have been criminal,” Moscow, now with BakerHostetler LLP in New York, said. “This is quite strong for acorporation that is not formally accusing its people ofcrimes.”

As for the speed of the federal investigation, it's too soon toknow how prosecutors will proceed, said Daniel Richman, a formerU.S. prosecutor in New York who now teaches at Columbia LawSchool.

“Here you have an interested party making a not-so-veiledallegation of improper behavior by subordinates. It serves thebank's interest to identify them as rogues,” he said. “While theyin fact may be rogues, the most important thing for the governmenthas to be sort out what's in this report and the bank's statementsand determine for themselves what the facts were and whatinferences of criminal intent can be made.”

To bring a criminal case, “the burden is heavy,” Richman said,and requires evidence someone knowingly and willfully intended tobreak the law.

“What is required is to look into the mind of the person who isbeing charged,” Richman said. “The fact that mistakes were made iscertainly nowhere near enough for a crime or even civil fraud.”

Prosecutors can use a bank's internal investigation as atentative road-map, he said, but they will want to hear thetraders' side of the story if at all possible. And the governmentmay also have to get access to people and information that thebanks don't have at this point, said Richman.

“There's no way to make this happen fast,” said Buell. “Justbecause there is a report there is still a criminal investigationthat must be done,” he said. “There's this mosaic; it's not asmoking gun. You can't put all the pieces together until you gatherup all the millions of pieces.”

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