NEW YORK (Reuters) - In a matter of days, the two-month-old criminal investigation into a $5.8 billion trading loss at JPMorgan Chase & Co. -- known as the "London Whale" blunder -- was transformed from dormant to potentially explosive.
Last Thursday, the day before JPMorgan reported its highly anticipated second-quarter earnings, the bank informed U.S. authorities that an internal investigation had found evidence that three London traders may have tried to hide the losses in some of their positions, said people familiar with the matter.
Late on Thursday evening, JPMorgan also decided it needed to restate its first-quarter earnings as a result.
The bank's disclosure has breathed new life into the criminal investigation that up until last week lacked evidence of a smoking gun pointing to wrongdoing in the bank's Chief Investment Office, said three people familiar with the matter.
Before last week's disclosure, the criminal probe largely had focused on the personal trading of some CIO traders, two of those sources said. The authorities were looking for evidence that some in London may have sold shares of JPMorgan in advance of the firm's May 10 disclosure that it could lose a minimum of $2 billion on the derivatives trades gone awry.
Now the investigation is focused on whether three JPMorgan employees in London committed fraud in reporting on their transactions. The bank is cooperating with authorities.
JPMorgan's chief executive, Jamie Dimon, and some of his top lieutenants did not learn about the potential misconduct by some CIO employees until early last week, said these sources, who were not authorized to speak publicly on the matter.
A federal prosecutor assigned to the investigation did not return calls seeking comment. A U.S. Securities and Exchange Commission attorney overseeing the matter also did not return phone calls.
The bank learned of the potential wrongdoing from lawyers with WilmerHale, the outside counsel hired by JPMorgan to investigate the matter. The law firm has reviewed thousands of emails and tens of thousands of recorded conversations between the traders and also interviewed some of the traders.
The WilmerHale internal review found that "traders may have been seeking to avoid showing the full amount of losses," according to a presentation the bank released on Friday. The presentation also said the internal review found "a material weakness" in the valuations the CIO office had used for some of the more esoteric derivatives it had traded in London.
Assisting WilmerHale in the investigation are lawyers from Shearman & Sterling, which has been retained by JPMorgan's board to advise them on the internal investigation.
In a Friday conference call with investors and analysts, Dimon said the trading loss had "shaken our company to the core." He also said the problems that led to the big trading loss had been fixed.
The CIO trading losses haves been an embarrassing affair for Dimon, long praised on Wall Street for running a tight ship when it comes to managing risk. In June, Dimon appeared before two Congressional panels on Capitol Hill to testify about the trading debacle.
Asked why Dimon testified on the Hill before the investigation was done, bank spokeswoman Kristin Lemkau said: "The timing of the hearings was the decision of Congress."
So far, the trading loss has cost a number of people their jobs, including Ina Drew, the former head of the CIO, who resigned in May. Also gone from the bank are three traders in London, Bruno Iksil -- who gained fame as the "London Whale" for his large trades -- Achilles Macris and Javier Martin-Artajo.
Lawyers in London for Iksil and Martin-Artajo did not return phone calls or email seeking comment. A lawyer in New York for Macris declined to comment.
A lawyer in New York for Drew did not return request for comment. A family member who answered the phone at Drew's home said she was not available for comment.
On Friday, JPMorgan said Drew had offered to return some of her pay to the bank.
JPMorgan has lost about $20 billion in market capitalization since May 10.
In its conversations on Thursday with securities regulators and federal criminal investigators, JPMorgan first disclosed its concerns about losses being hidden. Later in the day it said it would likely need to restate first-quarter earnings. The bank intends to reduce its income by $459 million in light of the bad valuations and potentially misleading valuations placed on some derivatives trades.
On Friday JPMorgan publicly disclosed to investors the potential wrongdoing by the London traders and the decision to restate first-quarter earnings, which it said it was doing because it had "recently identified concerns around the integrity of traders' markets."
(Additional reporting by Emily Flitter and David Henry; Editing by Leslie Adler)
Updated Date: Jul 17, 2012 05:45 AM