Longboat Retirement Solutions LLC

Truthiness Is Next To Lawlessness: Its Time To Enforce Sarbanes Oxley In The JP Morgan CIO Scandal May 30, 2012

By Michael Crimmins, who has worked on risk management and Sarbanes Oxley compliance for major banks

As more news comes to light about JPMorgan’s inadequate supervision of its CIO desk, the source of its multi-billion-dollar losses, it’s clear an investigation of violations of Sarbanes Oxley (SOX) is warranted.  At a minimum, Congressmen and the public should demand that the SEC and/or the DOJ owe it to us to pursue a SOX-related enforcement action. SOX was passed in the wake of Enron to end the all-too-common “I’m the CEO and I know nothing” defense, and the CIO operation is looking more and more Enron-like with every passing day.

By way of background, here’s the certification that’s at the heart of Sarbanes-Oxley. A false certification carries civil penalties against the signators and criminal penalties if the certification is fraudulent.

JPMorgan’s SOX Certification for 2011.

Management has completed an assessment of the effectiveness of the Firm’s internal control over financial reporting as of December 31, 2011. In making the assessment, management used the framework in “Internal Control — Integrated Framework” promulgated by the Committee of Sponsoring Organizations of the Treadway Commission, commonly referred to as the “COSO” criteria.

Based upon the assessment performed, management concluded that as of December 31, 2011, JPMorgan Chase’s internal control over financial reporting was effective based upon the COSO criteria. Additionally, based upon management’s assessment, the Firm determined that there were no material weaknesses in its internal control over financial reporting as of December 31, 2011.

The effectiveness of the Firm’s internal control over financial reporting as of December 31, 2011, has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein.

Signed Jamie Dimon, CEO and Douglas Braunstrein CFO

The certification also contains this qualifier.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

At first glance the qualifier looks like fair warning that the inherent limitations in designing an internal control framework may not work perfectly. But JPM has designed its internal control system to meet the COSO standards, which are pretty comprehensive, There shouldn’t be much risk  that internal control inadequacies can be attributed to poor design (or they would not have met the COSO criteria, making the certification invalid) so the disclaimer should be considered boilerplate.

What Risk Management Failures Should the SEC Investigate?

People Risks

One key element of an effectively operating internal control system is having the people and systems in place to operate the controls. There were some critical staffing gaps in the CIO group at the time the 2011 certification was signed, which should make the SEC skeptical that the internal control processes dependent on these people were operating effectively.

The head of the CIO group was working from home, the CIO treasurer’s office was vacant (a fact which hadn’t been publically disclosed), limits procedures and controls were reportedly revised by staff that normally wouldn’t have that authority. The unit was apparently exposed to the classic ‘Key man risk’ problem we witnessed with Jon Corzine at MFGlobal. If the risk committee didn’t acknowledge this particular risk and design a process to mitigate it then the risk committee’s role in the internal control framework is also up for review. The fact that the former AIG risk head was a member of JPM’s risk oversight committee raises some eyebrows. Given that in 2011 the CIO contributed over 20% of the bank’s profit, that meant it was a significant operation and warranted close monitoring.  It would constitute an egregious internal control breakdown, NOT an egregious ‘mistake’ if any of these people risks were not adequately mitigated.

Modeling Risks

There has been a lot of reporting regarding the replacement of the Value at Risk model after the disclosure of the London Whale’s position in March 2012. I’d like to focus on two areas where the VaR restatement impacts SOX.

If the model was replaced in 2011, then the adequacy of the model review process impacts  the 2011 internal controls certification. The pricing and risk model review process is a key internal control. If it turns out that the replacement model was implemented before December 31, 2011, then the controls certification will need to be reviewed in light of the events of April. Note that JPM may try to point to the disclaimer, but I’d doubt they could successfully argue that the VaR models inadequacy only came to light as a result of subsequent events, without looking incompetent.

The second issue is that VaR by design does not measure tail risk. Yet  JPM Morgan has said that the CIO’s role was hedging tail risk. Thus VaR would be incapable of measuring the riskiness of the bets the CIO was taking.  Any references to the Var for this portfolio by JPM are misleading and disingenuous. As a result it is hard to accept that publishing a VaR for the portfolio would satisfy the SEC’s risk disclosure requirements.

If JPM’s explanation that the CIO portfolio was designed to hedge tail risk is true, then the hedges against those risks would presumably be way out of the money, low volatility hedges. The risk estimation of a portfolio like that would not be captured in the VaR. The likelihood of a significant price change on the hedge would be a rare occurrence. VaR only captures the risk expected under normal market conditions.

Since the loss was announced and JPM reinstated the original model JPM has made reassuring comments that even though the old model produced a risk figure that was twice the size of the new model, none of the losses it experienced in the first quarter exceeded the VaR. However they also announced that in the first 13 days of April they experienced $2 billion of losses. If by some miracle those losses are distributed in such a way that they fall below the VaR on each day they experienced a loss, JPM may be able to avoid explaining to its investors that VaR is inherently incapable of measuring the risk of tail hedges in the CIO portfolio.

The SEC should immediately demand that JPM publicly disclose a risk estimate of the underlying tail risks these ‘hedges’ are designed to offset. Presumably these estimates are provided to the risk oversight committees, so they should be available to the regulators.

Truthiness  Risks

The overarching key control SOX imposes on corporations is honest disclosure.

Since the CIO losses were disclosed Dimon has taken a lot of liberties with the English language. He has repeatedly described these positions as hedges, yet the accounting rules JPM is obliged to use for their public reporting and disclosures emphatically define the transactions as NOT hedges. The accountants at JPM have to report these transactions as trading positions, in spite of their chief’s mischaracterizations in his public comments. Dimon’s gotten around this conflict by coining a fictional financial term, an economic hedge. I haven’t seen anyone call him on the use of this bogus term, but the SEC should be pointing out that no such term exists in their vocabulary. Doubly so since Dimon apparently interprets the Volcker rule’s hedging exemption to apply to these undefined ‘economic hedges’.

He also avoids labeling these transactions as trading positions by referring to them as ‘economic hedges’ to

manage structural and other risks including interest rate, credit and mortgage risks arising from the Firm’s ongoing business activities. ( Per the March 30, 2012. 10Q)

Yet there is no definition of ‘structural risks” anywhere in the 10Q. Again the SEC seems strangely incurious about the definition of the term even though everyone is dying to know just what risks he’s talking about.

The poor language choice that I think is going to give JPM the most trouble is Dimon’s reassuring statements to the markets that the reserves that have built up in the Investment portfolio have been and will continue to be mined to cover the losses in the CIO trading portfolio. These positions are reported in the financial statements as Investments and receive favorable accounting treatment because they are meant to provide liquidity protection for depositors in the event of a market shock.

From a SOX perspective the financials have been misstated for the entire period the firm viewed these as part of the CIO trading portfolio. From a depositor’s or regulator’s perspective the intended use of that portfolio is alarming.


What is a Self Directed IRA LLC? May 26, 2012

Filed under: Real Estate Investing,Uncategorized — larsfforsberg @ 5:45 pm
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Many Wall Street brokerage firms and custodians use the term Self Directed IRA to describe  their programs that limit your investment choices to products that they sell. When Longboat Retirement Solutions uses the same term, it means you can invest into any asset allowed by the Internal Revenue Code. The only investments not allowed are collectibles and life insurance.

This structure allows an account holder to completely control investments with increased flexibility and reduced operational costs compared with operating out of a custodial account.

The LLC Formation

Longboat assists clients with creating Articles of Organization for an LLC with the state in which the LLC is to be operated. It is considered a business entity structure which is a hybrid combining aspects of both a partnership and a corporation.

After the IRA is moved into the LLC, it authorizes the Manager (generally the IRA account holder) to set up a checking account that will be utilized for making investments. The Manager of the LLC can enter into contracts and agreements on behalf of the LLC.


You can rollover funds from Traditional IRAs, Roth IRAs, 401k Plans, 403b Plans, Money Purchase plans, Profit Sharing plans, Keogh plans, Government Eligible Deferred Compensation Plans, ESA Plans, HSA Plans, Qualified Annuities and more to initially fund your IRA LLC. You do this by setting up a account for the IRA LLC and directly transferring the funds from the Custodian to the newly created IRA LLC bank account.

Investing in Real Estate

The Longboat client can now make an offer, negotiate a deal, and acquire real estate. Once real estate is acquired, the client can handle administrative duties or appoint a property manager.

Income-producing properties can provide your plan with monthly income as well as long-term gains through appreciation. There are no limitations on the types of properties that can be held within your Real Estate IRA.

Real Estate has always been permitted inside IRA retirement accounts under the Employee Retirement Income Security Act of 1974 (ERISA). As your IRA LLC funds grow, you can continue to invest.

Contributions are made to the Self Directed IRA Custodian and invested into the IRA LLC. Distributions are initiated via sales of LLC shares to the Custodian.

Income to an IRA associated with the financed portion of a property purchased using a non-recourse loan is subject to the Unrelated Debt Financed Income (UDFI) tax. UDFI is a type of unrelated business taxable income.


What is a Solo 401k?

A Solo 401k is a retirement savings plan designed for self employed individuals.

Solo 401k Advantages

A Solo 401k plan possesses most of the characteristics of the Self Directed IRA LLC, including having the ability to invest in anything the law allows, but without the need to establish an LLC. It’s the most tax-advantaged, self employed plan available with very high annual contribution limits. You can set up this plan even if you’re employed at a full-time job. And, you can borrow funds from the account.

3 Simple Steps

Is setting up a Solo 401k a difficult?  No.  Longboat has made the process simple and quick.

  • STEP 1: Solo 401k documents are produced by Longboat and delivered to you.
  • STEP 2: You establish a local bank account to receive existing funds or contributions.
  • STEP 3: As Trustee, you determine best investment options and execute transactions.

Self Trustee

With a Solo 401k, you act as your own Trustee and are charged with investing trust assets prudently and productively. The Trustee cannot co-mingle personal funds with the trust and cannot enter into a transaction with the trust.


You can rollover funds from Traditional IRAs, SEP Plans, previous employer 401k plans, Money Purchase plans, Profit Sharing plans, Keogh plans, Defined Benefit plans, 403(b) plans and Rollover IRAs to initially fund your Solo 401k. You do this by setting up a Trust account for the Solo 401k and directly transferring the funds from the Custodian to the trust bank account.

Making Contributions

For the salary deferral portion in 2011, you can contribute the regular 401k maximum of $16,500 (with an an additional $5,500 if over the age of 50 at year end). And, you can add up to 25% of compensation for the profit-sharing portion. The combined maximum of these contributions can’t exceed $49,000, plus catch-up additions, if applicable. You could also set up a “designated Roth component”, if you desired.

Taking Out A Loan

Our Solo 401k plan document has a loan provision enabling you to take out a loan from your 401k. You can borrow up to 50% of the total 401k value up to a maximum of $50,000, tax free. Repayment of the loan is according to a loan amortization schedule created when the loan is initiated and must be paid back into the account (including interest). It is a simple process with no cost to you, through Longboat software, to create the loan documents.  Failure to make the loan payments may cause a loan default causing taxes and IRS penalties.

A Solo 401k is Not Subject to UDFI Tax

Income to an IRA associated with the financed portion of a property purchased using a non-recourse loan is subject to the Unrelated Debt Financed Income (UDFI) tax. UDFI is a type of unrelated business taxable income.  Solo 401k plans are exempt from this tax.


Beware of Promoters of ROBS

Filed under: Corporate Malfeasance,Uncategorized — larsfforsberg @ 4:45 pm
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The IRS and Rollovers as Business Startups (ROBS)

Why should you use Longboat Retirement Solutions to setup a Self-Directed IRA LLC, or Solo 401k instead of some of the other companies out there?

Many of the other companies promote a strategy of ROBS.  If you are a client of a company promoting ROBS, you may be a target for IRS audits.

Best case audit scenario: After months or years of being audited, you are finally cleared. Your assets might be frozen during that time, and you may incur tens of thousands of dollars in attorney fees to defend yourself.

Worst case scenario: If you used the ROBS strategy yourself with, say a couple hundred thousand dollars, you could incur MILLIONS of dollars in taxes.  The tax penalties are severe.

What is ROBS?

ROBS is a strategy involving a C-Corp, a 401k, and you using your retirement funds to start, purchase or grow a business. The government says ROBS is not legal.  They aren’t going after ROBS promoters or ROBS users…..yet.

So basically, if you become a client of a company that pushes ROBS strategies, you are associated with the promoters of a strategy that the government deems illegal and could eventually pursue.

The IRS notes that it has identified 9 promoters of these programs. Here are the main legal deficiencies being identified in the programs, according to the Memorandum:

We have examined a number of these plans – having opened a specific examination project on them based off referrals from our determination letter program – and found significant disqualifying operational defects in most. For example, employees in some arrangements have not been notified of the existence of the plan, do not enter the plan or receive contributions or allocable shares of employer stock. Additionally, we have identified that plan assets are either not valued or are valued with threadbare appraisals. Required annual reports for some plans have not been filed. In several situations, we have also found that the business entity created from the ROBS exchange has either not survived, or used the resultant assets on personal, nonbusiness purchases.

The IRS states that there are “two primary issues raised by ROBS arrangements”: (1) violations of nondiscrimination requirements, in that benefits may not satisfy the benefits, rights and features test of Treas. Reg. § 1.401 (a)(4 )-4. and (2) prohibited transactions, due to deficient valuations of stock.

Many promoters will claim that they have IRS approval for their program, when in fact the IRS has only approved the form of the Plan document. The Memorandum notes that the violations that occur are typically operational and not document failures.

On November 5, 2008, the IRS issued the following warning to all business owners contemplating the implementation of a ROBS arrangement:For these reasons, we intend to scrutinize ROBS arrangements. Our guidelines will serve as instructions to our technical specialists to resolve issues they encounter when evaluating these plans. We believe that ROBS arrangements may endanger the qualified status of otherwise tax-qualified employee plans and may be prohibited transactions, requiring complete undoing of the transaction, and imposition of excise taxes.

Again in 2010 the IRS Looked at ROBS:


Tread carefully with your retirement savings.

Longboat Retirement Solutions does not promote ROBS.


Thanks to all those who gave all

Filed under: Uncategorized — larsfforsberg @ 2:53 pm

I’d like to take a moment to thank all of the men and women who died for our country.  Too often this weekend is celebrated as the beginning of summer.  Many people get together and have barbecues or go to the beach or visit with friends, while spending little time to think about the lives lost in service to our country.  This shouldn’t be a day of celebration.  This is a day of remembrance, and should be a day of thanks for what we have, and to those who gave us what we have.


Quantitative Easing Explained


The Curious Case of John Corzine

Filed under: Corporate Malfeasance,Uncategorized — larsfforsberg @ 12:03 am
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