JP Morgan Chase 2005 Annual Report Download - page 82

Management’s discussion and analysis
JPMorgan Chase & Co.
80 JPMorgan Chase & Co. /2005 Annual Report
A firm’s success depends not only on its prudent management of liquidity,
credit, market and operational risks that are part of its business risks, but
equally on the maintenance among many constituents – clients, investors,
regulators, as well as the general public – of a reputation for business practices
of the highest quality. Attention to reputation has always been a key aspect
of the Firm’s practices, and maintenance of reputation is the responsibility of
everyone at the Firm. JPMorgan Chase bolsters this individual responsibility
in many ways, including through the Firm’s Code of Conduct, training, main-
taining adherence to policies and procedures and oversight functions that
approve transactions. These oversight functions include a Conflicts Office,
which examines wholesale transactions with the potential to create conflicts
of interest for the Firm.
Policy review office
The Firm also has a specific structure to address certain transactions with
clients, especially complex derivatives and structured finance transactions, that
have the potential to adversely affect its reputation. This structure reinforces
the Firm’s procedures for examining transactions in terms of appropriateness,
ethical issues and reputational risk, and it intensifies the Firm’s scrutiny of the
purpose and effect of its transactions from the client’s point of view, with the
goal that these transactions are not used to mislead investors or others.
The structure operates at three levels: as part of every business’ transaction
approval process; through review by regional Reputation Risk Committees;
and through oversight by the Policy Review Office.
Primary responsibility for adherence to the policies and procedures designed to
address reputation risk lies with the business units conducting the transactions
in question. The Firm’s transaction approval process requires review from,
among others, internal legal/compliance, conflicts, tax and accounting groups.
Transactions involving an SPE established by the Firm receive particular scrutiny
intended to ensure that every such entity is properly approved, documented,
monitored and controlled.
Business units are also required to submit to regional Reputation Risk
Committees proposed transactions that may give rise to heightened reputation
risk – particularly a client’s motivation and its intended financial disclosure of the
transaction.The committees may approve, reject or require further clarification on
or changes to the transactions. The members of these committees are senior
representatives of the business and support units in the region. The committees
may escalate transaction review to the Policy Review Office.
The Policy Review Office is the most senior approval level for client transactions
involving reputation risk issues. The mandate of the Office is to opine
on specific transactions brought by the Regional Committees and consider
changes in policies or practices relating to reputation risk. The head of the
Office consults with the Firm’s most senior executives on specific topics and
provides regular updates. Aside from governance and guidance on specific
transactions, the objective of the policy review process is to reinforce a
culture, through a “case study”approach, that ensures that all employees,
regardless of seniority, understand the basic principles of reputation risk
control and can recognize and address issues as they arise.
In 2006, this structure, which until now has been focused primarily on
Investment Bank activities, will be expanded to include the activities of
Commercial Banking and the Private Bank.These lines of business will
implement training and review procedures similar to those in the Investment
Bank and their activities also will be subject to the oversight of the Policy
Review Office.
Fiduciary risk management
The risk management committees within each line of business include in
their mandate the oversight of the legal, reputational and, where appropriate,
fiduciary risks in their businesses that may produce significant losses or
reputational damage. The Fiduciary Risk Management function works with the
relevant line of business risk committees to ensure that businesses providing
investment or risk management products or services that give rise to fiduciary
duties to clients perform at the appropriate standard relative to their fiduciary
relationship with a client. Of particular focus are the policies and practices
that address a business’ responsibilities to a client, including client suitability
determination, disclosure obligations, disclosure communications and
performance expectations with respect to such of the investment and risk
management products or services being provided by the Firm that give rise to
such fiduciary duties. In this way, the relevant line-of-business risk committees,
together with the Fiduciary Risk Management function, provide oversight of
the Firm’s efforts to monitor, measure and control the risks that may arise in
the delivery of the products or services to clients that give rise to such duties,
as well as those stemming from any of the Firm’s fiduciary responsibilities to
employees under the Firm’s various employee benefit plans.
Reputation and fiduciary risk management
Private equity risk management
Risk management
The Firm makes direct principal investments in private equity. The illiquid nature
and long-term holding period associated with these investments differentiates
private equity risk from the risk of positions held in the trading portfolios.
The Firm’s approach to managing private equity risk is consistent with the
Firm’s general risk governance structure. Controls are in place establishing
target levels for total and annual investment in order to control the overall
size of the portfolio. Industry and geographic concentration limits are in place
intended to ensure diversification of the portfolio, and periodic reviews are
performed on the portfolio to substantiate the valuations of the investments.
The Valuation Control Group within the Finance area is responsible for
reviewing the accuracy of the carrying values of private equity investments
held by Private Equity. At December 31, 2005, the carrying value of the private
equity portfolios of JPMorgan Partners and ONE Equity Partners businesses
was $6.2 billion, of which $479 million represented positions traded in the
public market.