Risk Management at JPMorganIn “JPMorgan Chase and the Problem With Self Regulation,” I wrote about  the vital role that regulatory compliance plays in keeping the economic sector strong and stable. Self regulation is problem-ridden, and strong regulatory oversight is required to keep the economy running.

More information is emerging about some of the problems that result from an internally-driven compliance mindset. According to ComplianceXDealbook reported that as early as 2007, top JPMorgan execs expressed their concerns over the activities of the bank’s chief investment office in London, which is said to have cause the $2 – $5 billion loss reported Thursday, May 10, 2o12.

Failure to Supervise

Apparently, a schism between the bank’s headquarters in New York and the London chief investment office may have been one of the causes of the lack of oversight that might have prevented massive loss. Part of the breakdown in supervision, current executives said, was a fundamental disconnect between the chief investment office in London and the rest of the bank. Even within the chief investment office there were heightening concerns that the bets being made in London were incredibly complex and not fully understood by management in New York.

Achilles Macris, head of the CIO, ignored concerns from the unit’s internal risk manager in 2009. Some said that Doug Braunstein, who became the bank’s chief financial officer in 2010, tolerated a too-high level of risk and was too cozy with Macris, as the pair had worked closely together in the past.  After concerns were raised about positions assembled by Bruno Iksil, now known as the London Whale, Macris brought in Braunstein, as risk officer. CIO Ina R. Drew has stepped down, and Mr. Macris, who failed to heed concerns as early as 2009, is also expected to resign.  Mr. Macris, is said to have had wide latitude as well as Ms. Drew’s support. Apparently, since risk officers are empowered to stop trades considered too risky, the coziness of the arrangement generated talk in New York as well.

Dealbook states:

In the years leading up to JPMorgan Chase’s $2 billion trading loss, risk managers and some senior investment bankers raised concerns that the bank was making increasingly large investments involving complex trades that were hard to understand. But even as the size of the bets climbed steadily, these former employees say, their concerns about the dangers were ignored or dismissed.

An increased appetite for such trades had the approval of the upper echelons of the bank, including Jamie Dimon, the chief executive, current and former employees said. Initially, this led to sharply higher investment profits, but they said it also contributed to the bank’s lowering its guard. “There was a lopsided situation, between really risky positions and relatively weaker risk managers,” said a former trader with the chief investment office.

Alarms Ignored

Several factors may explain why Mr. Dimon, who is known for his ability to sense risk failed in this instance and failed to heed the first alarm bells that were sounded in early April.

First,  the scope of the chief investment’s office’s trades are said to have increased sharply following the acquisition of Washington Mutual during the financial crisis in 2008. WaMu owned riskier securities that needed to be hedged against, which caused the business’s investment securities portfolio to quadruple to $356 billion in 2011, from $76.5 billion in 2007.  Mr. Dimon was also distracted by gigantic losses from bad mortgages, and new regulations threatening the profitability of traditional banking.

When erratic trading sessions in late March resulted in big gains one day, followed by bigger losses the next on the London trading desk of the bank’s chief investment office, Ms. Drew and her team persuaded Jamie Dimon that the turbulence was manageable. After first-quarter earnings were reported on April 13, the erratic trading pattern continued. Still, no one on the operating committee questioned Ms. Drew’s conclusion, or were even advised of the scope of the problem until days before Mr. Dimon went public with the loss.

Expect An Expanded Role for Compliance

While there is a lot of blame to go around, the Compliance failure is egregious.  Whatever the new regulations coming out of Washington will look like, it’s clear that Compliance will need to take a more active and empowered role in banking.

Thanks to Beth Connolly,s Editor-in-Chief of the Wall Street Job Report and the Compliance Exchange. She blogs creatively at When Nutmeg Met Basil. Connect with her on LinkedIn Twitter, andAbout.Me.