Few Possibilities for Prosecution at JPMorgan The internal report released by JPMorgan Chase this week related to a disastrous bet on a hedging strategy may not be a good guidebook for federal prosecutors. As DealBook reported last October, the Federal Bureau of Investigation has been examining whether four traders in the London office of JPMorgan's chief investment office may have broken laws by improperly valuing the securities that led to the trading loss, which has topped $6 billion. Prosecutors have been given access to recordings of the traders and notes of meetings, which could be used to build a criminal case. But JPMorgan's management report does not provide much support for pursuing charges. The tone of the report makes is sound as if the trading blunder were the product of a series of bad - or even stupid -- bets; it does not provide any guidance on whether any traders tried to deceive management by making false entries in the bank's records. When JPMorgan made a presentation about the flawed trades last July, one entry said there were "Emails, voice tapes and other documents, supplemented by interviews, suggestive of trader intent not to mark positions where they believed they could execute." That seemed to indicate that the bank had found evidence of a conscious effort to make false entries in the bank's records. As a publicly traded company, JPMorgan is required to maintain accurate books and records, and any attempt to falsify information can be the basis for a criminal prosecution. The internal report from this week, however, does not include similar language about "trader intent." Instead, it concludes that traders in London were aggressive in choosing prices for the securities, but that ultimately the company's own internal estimates did not initially raise any issues regarding the valuation. According to the report, in March 2012, at the direction of a manager, one trader "assigned values to certain of the positions in the Synthetic Credit Portfolio that were more beneficial to C.I.O. than the values being indicated by the market." That certainly sounds questionable, but the report goes on to state that the traders also believed that others trading in the market "were engaging in strategic pricing behavior and intentionally providing prices that did not accurately reflect market values." In other words, counterparties were trying to take advantage of JPMorgan's position in order to profit from the bank's distress by posting inaccurate quotes. While that would not excuse making false entries in the bank's records, a trader could argue that it was not intended to falsify information because the person thought the prices were in fact accurate. When it comes to a criminal case, a subjective belief that one is being truthful can undermine proving intend to mislead. The most damning statement in the report about the traders involved accounting rules. Traders were required to make a good faith estimate of the value of the securities, but the report stated that that "at the direction of a more senior trader, however, the relevant trader may not have always done so." The wording leaves much open to interpretation. Note that JPMorgan used the word "may" rather than a more definitive statement that would suggest misconduct. Whether JPMorgan intended to or not, that kind of soft language suggests there is not evidence to support a criminal charge for making false entries or trying to mislead senior management. Making things even more problematic for a criminal case is that JPMorgan's own internal assessment of the valuations, which found that they were within an acceptable price range. At the end of the first quarter of 2012, as the issue of the size of the losses was being scrutinized, the valuation control group in the bank's chief investment office determined that the prices of the securities were usually on the high side, but that "the trader marks were acceptable." The report also points out shortcomings in the bank's methodology for assessing the values of its holdings, but that does not change the fact that JPMorgan's own evaluation found the pricing was proper. If criminal charges were pursued against any of the traders, their first line of defense would be that JPMorgan did not find any flaws in valuations, so how can the government show that they knew the entries were false or that they intended to mislead anyone at the bank? The government would have a hard time going after only junior employees, especially when a corporate review that found nothing improper in their pricing. Last year, the Securities and Exchange Commission ran afoul of the "Where's Waldo?" defense in a civil enforcement action against a mid-level manager at Citigroup over the structuring of a collateralized debt obligation who pointed the finger at management as responsible for any violations. The London traders could advance the same argument if accused of a violation. Such a defense may well resonate with a jury when the victim is a bank that has achieved record earnings despite the flawed investment strategy. If JPMorgan's internal investigation had found more damaging evidence of misconduct by traders over the pricing of the securities, that would be strong evidence it could use to exonerate management. Instead, it looks as if the bank found little indication of intentional misconduct. The London traders are not citizens of the United States and currently reside abroad, so bringing them to this country would be difficult even if prosecutors had a strong case. The difficulties in proving intent makes it even less likely that the Justice Department will pursue a criminal prosecution.