Published with permission

Joshua Rosner
646/652-6207
jrosner@graham-fisher.com

JPMorgan Chase: Out of Control – Executive Summary

In this report we will focus on the risk management and internal control environment at JPMorgan Chase, a bank whose balance sheet is almost one-ninth the size of the United States economy. JPMorgan’s financial filings, its “Task Force” investigation of losses in the CIO’s office and its recent history of significant regulatory failures demonstrate that shareholders are continuing to be called upon to pay for the firm’s inability to ensure an acceptable control environment.

We have intentionally chosen not to detail all of the many private or public actions settled
or outstanding (which have driven almost $16 billion in litigation expenses since 2009)
or, other than the multistate settlement and foreclosure review settlement, the agreed to or
unresolved costs of actions related to mortgage putback demands, including those of
institutional investors, insurers, the GSEs, FHA, or the costs of foreclosure-related
actions. Moreover, the impunity with which the firm is seeking to transfer billions of
dollars of Washington Mutual (WaMu) related losses to the FDIC demonstrates their
unwillingness to accept the responsibilities for their own management failures.

Even without the inclusion of these items, since 2009, the Company has paid more than
$8.5 billion in settlements for the various regulatory and legal problems discussed in
this report. These settlement costs, which include a small number of recent settlements
of older issues, represent almost 12% of the net income generated between 2009-2012.
Banking regulations and laws are intended to protect stakeholders and the public but
some portion of these costs may be tax deductible to the company allowing management
to transfer to the public the costs of and future risks of these violations.

In addition, JPM’s ability to retain its reputation, its political power and support of
investors in the face of financials that lack the details necessary for a proper analysis are
reminiscent of another too-big-to-fail institution: Fannie Mae.

We are not suggesting that JPM will meet the fate that Fannie did, nor that its actions will
result in accounting problems. But there are notable similarities in the actions taken by
these institutions. JPM appears to have taken a page out of the Fannie Mae playbook in
which the company perfected the art of cozying up to elected officials, dominating trade
associations, employing political heavyweights and their former staffers and creating the
image of American Flag-waving, apple-pie-eating, good corporate-citizen, all of which
supported an “implied government guarantee” and seemingly lowered their cost of
funding. Additionally, rather than being driven by the strength of its operations and
management, many of the JPM’s returns appear to be supported by an implied guarantee
it receives as a too-big-to-fail institution.

JPM has a reputation of being the best managed of the biggest banks. In our reviews we
could not find another “systemically important” domestic bank that has recently been
subject to as many public, non-mortgage related, regulatory actions or consent orders.
The firm’s pride in a disputable “fortress balance sheet” – which underestimates their offbalance
sheet risks – appears to have given investors false comfort, after all poor risk
management and control failures are almost always the major drivers of capital
destruction.

Key areas of focus in this report include:

London Calling: The Whale p. 2

In the wake of at least $6.2 billion in losses and an earnings restatement in the CIO’s
office, which manages JPM’s excess cash and should therefore be run by top talent, the
regulatory response has been surprisingly muted. The two reports issued by JPM in early
January were unrevealing and illustrate the current state of regulatory capture where large
financial institutions are concerned.

Internal Control Problems are Pervasive p. 7

JPMorgan’s list of regulatory violations over the past five years is long, diverse and
crosses legal and regulatory jurisdictions. Many of these infractions are for repeated
violations of specific control failures, which the Company had previously agreed to
remedy.

Anti-Money Laundering and Bank Secrecy Act issues p. 7

Segregation of Client Funds p. 8

Commodities Violations p. 9

Fictitious Trade/Wash Sale p. 11

Consumer Abuses p. 13

Muni Market Manipulations p. 15

Energy Regulatory Problems p. 17

International Actions p. 18

Refusal to Cooperate with Authorities p. 19

Some Outstanding Issues p. 20

Consistent with the purpose of this report we felt it important to consider
outstanding internal control, headline and other extraordinary items that could
materially impact JPMs profitability and potentially highlight further breakdowns in
controls.

These include:

Washington Mutual: a Story of Opacity and Impunity p. 20

After several years of agreeing with the FDIC’s position and acknowledging that it
acquired the mortgage liabilities of Washington Mutual, JPMorgan appears to have
changed its mind when it realized the enormity the industry’s mortgage putback risks .
JPMorgan is now boldly demanding FDIC Insurance Fund indemnification for between
$3 and $6 billion dollars of WaMu related liabilities. While the firm’s reserving policies
are relatively opaque it reasonablt to expect that if JPM loses in this effort they could
require significant additions to reserves.

New Mortgage Suits p. 24

In the past few months, a new round of mortgage-related suits were filed against the firm.
Investors, regulators, prosecutors, and insurers have filed a new round of claims against
the bank related to billions of dollars’ worth of securities backed by residential
mortgages.

On February 5, 2013, in the matter of Assured Guaranty v. Flagstar, U.S. Southern
District Court Judge Jed Rakoff appears to have created precedent by handing down a
decision to allow staistical analysis provided by Assured’s independent auditor, rather
than loan-by-loan analysis, to be a basis for findings of breaches to PSAs and Reps and
Warranties in pooled mortgage loans. The auditor found that 606 of the sample of 800
loans across the trusts were found to have material breaches. While the ruling will likely
be appealed, the reality is that it significantly heightens the risks to JPM and other
defendants in putback litigations. It may also lead JPM to determine that they need to
increase reserves.

The Whale – Heading Toward Land p. 25

While the Federal Reserve and OCC have issued Consent Orders relating to the trading
failures in the firm’s CIO office, there are ongoing investigations by various U.S.
regulators as well as legislative committees which could result in fines, further legal and
enforcement issues and an increasing number of shareholder suits.

LIBOR – A Global Settlement? p. 26

Currently, the New York Attorney General and the “DOJ, CFTC, SEC, European
Commission, UK Financial Services Authority, Canadian Competition Bureau, Swiss
Competition Commission and other regulatory authorities and banking associations
around the world” have subpoenaed documents, made requests and embarked on
investigations of the firm’s involvement. To date, RBS, Barclays and UBS have been
fined a total of $2.6 billion and it appears likely that JPM shareholders will again be
called on to pay a substantial amount for the management’s oversight failures.

Department of Labor p. 27

Buying Political Protection p. 27

JPMorgan may be without peer in its spending on direct and indirect lobbying and PR. Its
effort to capture legislators, neuter regulators and influence policymakers are reminiscent
of Fannie Mae before it as the firm has retained, employed or had revolving door
relationships with more former legislators, legislative staff and executive branch
employees than perhaps any other financial firm in history. As of mid-2012 the firm had
the second largest corporate political action committed and employed at least 48 lobbyists
including at least 14 in-house lobbyists who are former congressional and federal staffers
or legislators. Its lobbying power is not only direct but also the result of domination of
several of the largest industry trade associations.

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