JP Morgan Chase 2009 Annual Report Download - page 152

Notes to consolidated financial statements
JPMorgan Chase & Co./2009 Annual Report 150
Note 1 – Basis of presentation
JPMorgan Chase & Co. (“JPMorgan Chase” or the “Firm”), a finan-
cial holding company incorporated under Delaware law in 1968, is a
leading global financial services firm and one of the largest banking
institutions in the United States of America (“U.S.”), with operations
worldwide. The Firm is a leader in investment banking, financial
services for consumers and businesses, financial transaction process-
ing and asset management. For a discussion of the Firm’s business
segment information, see Note 34 on pages 245–247 of this Annual
Report.
The accounting and financial reporting policies of JPMorgan Chase and
its subsidiaries conform to accounting principles generally accepted in
the United States of America (“U.S. GAAP”). Additionally, where appli-
cable, the policies conform to the accounting and reporting guidelines
prescribed by bank regulatory authorities.
Certain amounts in prior periods have been reclassified to conform to the
current presentation.
Consolidation
The Consolidated Financial Statements include the accounts of
JPMorgan Chase and other entities in which the Firm has a control-
ling financial interest. All material intercompany balances and trans-
actions have been eliminated.
The usual condition for a controlling financial interest is ownership
of a majority of the voting interests of the entity. However, a
controlling financial interest also may be deemed to exist with
respect to entities, such as special purpose entities (“SPEs”), through
arrangements that do not involve controlling voting interests.
SPEs are an important part of the financial markets, providing mar-
ket liquidity by facilitating investors’ access to specific portfolios of
assets and risks. For example, they are critical to the functioning of
the mortgage- and asset-backed securities and commercial paper
markets. SPEs may be organized as trusts, partnerships or corpora-
tions and are typically established for a single, discrete purpose.
SPEs are not typically operating entities and usually have a limited
life and no employees. The basic SPE structure involves a company
selling assets to the SPE. The SPE funds the purchase of those assets
by issuing securities to investors. The legal documents that govern
the transaction specify how the cash earned on the assets must be
allocated to the SPE’s investors and other parties that have rights to
those cash flows. SPEs are generally structured to insulate investors
from claims on the SPE’s assets by creditors of other entities, includ-
ing the creditors of the seller of the assets.
There are two different accounting frameworks applicable to SPEs:
the qualifying SPE (“QSPE”) framework and the variable interest
entity (“VIE”) framework. The applicable framework depends on the
nature of the entity and the Firm’s relation to that entity. The QSPE
framework is applicable when an entity transfers (sells) financial
assets to an SPE meeting certain defined criteria. These criteria are
designed to ensure that the activities of the entity are essentially
predetermined at the inception of the vehicle and that the transferor
of the financial assets cannot exercise control over the entity and the
assets therein. Entities meeting these criteria are not consolidated by
the transferor or other counterparties as long as they do not have
the unilateral ability to liquidate or to cause the entity to no longer
meet the QSPE criteria. The Firm primarily follows the QSPE model
for securitizations of its residential and commercial mortgages, and
credit card, automobile and student loans. For further details, see
Note 15 on pages 206–213 of this Annual Report.
When an SPE does not meet the QSPE criteria, consolidation is
assessed pursuant to the VIE framework. A VIE is defined as an
entity that: (1) lacks enough equity investment at risk to permit the
entity to finance its activities without additional subordinated finan-
cial support from other parties; (2) has equity owners that lack the
right to make significant decisions affecting the entity’s operations;
and/or (3) has equity owners that do not have an obligation to
absorb the entity’s losses or the right to receive the entity’s returns.
U.S. GAAP requires a variable interest holder (i.e., a counterparty to
a VIE) to consolidate the VIE if that party will absorb a majority of
the expected losses of the VIE, receive the majority of the expected
residual returns of the VIE, or both. This party is considered the
primary beneficiary. In making this determination, the Firm thor-
oughly evaluates the VIE’s design, capital structure and relationships
among the variable interest holders. When the primary beneficiary
cannot be identified through a qualitative analysis, the Firm per-
forms a quantitative analysis, which computes and allocates ex-
pected losses or residual returns to variable interest holders. The
allocation of expected cash flows in this analysis is based on the
relative rights and preferences of each variable interest holder in the
VIE’s capital structure. The Firm reconsiders whether it is the primary
beneficiary of a VIE when certain events occur. For further details,
see Note 16 on pages 214–222 of this Annual Report.
All retained interests and significant transactions between the Firm,
QSPEs and nonconsolidated VIEs are reflected on JPMorgan Chase’s
Consolidated Balance Sheets and in the Notes to consolidated
financial statements.
Investments in companies that are considered to be voting-interest
entities in which the Firm has significant influence over operating
and financing decisions are either accounted for in accordance with
the equity method of accounting or at fair value if elected under fair
value option. These investments are generally included in other
assets, with income or loss included in other income.
Generally, Firm-sponsored asset management funds are considered
voting entities as the funds do not meet the conditions to be VIEs. In
instances where the Firm is the general partner or managing mem-
ber of limited partnerships or limited liability companies, the non-
affiliated partners or members have the substantive ability to remove
the Firm as the general partner or managing member without cause
(i.e., kick-out rights), based on a simple unaffiliated majority vote, or
have substantive participating rights. Accordingly, the Firm does not
consolidate these funds. In limited cases where the non-affiliated
partners or members do not have substantive kick-outs or participat-
ing right, the Firm consolidates the funds.