The bank's Chief Investment Office made big bets now known as "the London Whale trades" on corporate debt using derivatives. JPMorgan said in the worst-case scenario those trades will lose another $1.7 billion, and it has fixed the problems in the CIO's office.
Even with the bank's trading losses, it earned nearly $5 billion overall in the second quarter, thanks to strong performance in areas like mortgage lending.
But JPMorgan's disclosure that CIO traders may have lied about their positions could bring even more intense regulatory scrutiny to the bank, analysts said. It is already under investigation by agencies ranging from the FBI to the UK's Financial Services Authority.
An internal review found that some of the CIO traders appear to have deliberately ignored the massive size of their trades -- and the difficulty in liquidating them -- when valuing their positions. The result was not reporting the full declines in the value of positions.
A person familiar with the matter said a criminal investigation into people at JPMorgan is focusing on employees based in London.
"I see little doubt that someone is going to get charged with fraud," said Bill Singer, a lawyer at Herskovits in New York who provides legal counsel to securities industries firms, and publishes the BrokerandBroker website. Criminal charges are possible, he added.
The trading losses and possible deception from traders are a black eye for JPMorgan Chief Executive Officer Jamie Dimon, who was respected for keeping his bank consistently profitable during the financial crisis.
"(Dimon) has a lot of explaining to do about how this could happen," said Kim Forrest, senior equity research analyst at Fort Pitt Capital Group in Pittsburgh.
The Chief Investment Office became infamous in May when JPMorgan said bad derivatives bets had triggered about $2 billion of paper losses, a figure that turned into $4.4 billion of actual losses in the second quarter.
One trader in the CIO, Bruno Iksil, took big enough positions in the credit derivatives markets to earn the nickname "The London Whale." He executed at least some of the big bets that caused trouble for the bank, and has since left JPMorgan, a source said on Friday.
Ina Drew, who headed the CIO, has also left, and offered to give back as much as the bank could claw back, said Dimon, whose pay could be taken back as well. A spokesman for the bank said JPMorgan had accepted Drew's offer.
The bank said it had moved the bad trades from the CIO, which invests some of the company's excess funds, to its investment bank. JPMorgan was one of the inventors of credit derivatives, and its investment bank is one of the biggest traders of the product on Wall Street.
The CIO will now focus on conservative investments, JPMorgan said.
"We have put most of this problem behind us and we can now focus our full energy on what we do best," Dimon said in a statement.
JPMorgan said later on Friday that its former CIO risk officer, Irvin Goldman, had resigned. Goldman "behaved with integrity and we wish him well," JPMorgan said.
Many investors and analysts believe the company has done a good job of working through this difficulty, at least from a business standpoint. The bank said it hopes to resume buying back shares in the fourth quarter.
"People feel good that the loss is largely contained at this point," said Nancy Bush, a banking analyst at independent research firm NAB Research.
JPMorgan's shares rose 5.8 percent to $35.99 in afternoon trading.
But from a legal and regulatory standpoint, the difficulty with the CIO's office may only just be beginning. Lawyers said the bank's finding will likely add fuel to the multiple probes the company is facing now.
THE TEMPEST LEAVES THE TEAPOT
The bank posted second-quarter net income of $4.96 billion, or $1.21 a share, compared with $5.43 billion, or $1.27 a share, a year earlier.
The derivative loss after taxes reduced earnings per share by 69 cents, the company said.
JPMorgan said it expected to file new, restated first-quarter results in the coming weeks, reflecting a $459 million reduction of income because of bad valuations on some of its trading positions. The bank found material problems with its financial controls during the period.
Friday's financial report came three months to the day after Dimon, 56, told stock analysts that news reports about Iksil and looming losses in London were a "tempest in a teapot."
That remark, which Dimon told Congress last month was "dead wrong," added to the damage the loss has done to his reputation and his argument that his bank is not too big to be managed safely.
A host of international regulators and agencies are probing the trading mishap. Besides the FBI and FSA, they include the U.S. Securities and Exchange Commission, the Federal Deposit Insurance Corp, the U.S. Commodity Futures Trading Commission, the U.S. Treasury's Office for the Comptroller of the Currency, and the Federal Reserve Bank of New York.
(Reporting by David Henry and Jed Horowitz in New York, additional reporting by Chuck Mikolajczak; Editing by Lisa Von Ahn and Phil Berlowitz)