Leadership lessons of the "London Whale"

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(MoneyWatch) Federal authorities investigating the massive trading losses JPMorgan Chase (JPM) suffered last year in its London office have for now trained their fire on former traders Javier Martin-Artajo and Julien Grout. Bruno Aksil, who was dubbed the "London Whale" for the outsized bets he placed that led to the $6 billion loss, has already reached an agreement to avoid prosecution.

But while Martin-Artajo and Grout are the focus of the criminal probe, some people suspect that they are not solely to blame for the debacle. The big question, and one that the case may never address, is why JPMorgan CEO Jamie Dimon was so unaware of what was going on inside his institution that his first instinct was to trivialize the losses as a "tempest in a teapot."

What most concerns investors is not so much that the losses occurred but that nothing in the bank's systems set off any kind of alarm. How could such huge losses occur without someone knowing? It's easy to say that this is a systems problem, but systems are built by people -- and people are where the risks lie. But the hard truth is that most CEOs have very little idea of what goes on inside their companies.

The legal concept of "willful blindness" argues that if there is information you could and should have known, but somehow managed not to know, then you should be treated as though you had the information you needed. For Dimon, ignorance may be an alibi, but it isn't an excuse. The fundamental error isn't about detail -- it's about understanding power. Here's what Dimon could have known and should have known about what was happening at JPMorgan that likely played a role in "Whale" affair:

1. When you reward people for big returns, you encourage big risks. Everyone knows this is how the game is played.

2. In highly competitive environments like JPMorgan Chase, everyone will go out on longer and longer limbs to be the super-achiever.

3. Public reward for public success guarantees that failure will be kept private because no one wants public humiliation.

4. People in power will always be told what they want to hear unless they strive egregiously to be brought news about errors, near misses and failures. If you are hearing nothing negative, you can be quite sure no one around you is telling you the truth. This problem is exacerbated if you depend on elites. That is the biggest problem you have.

Within the banking industry, Dimon is often held up as the smartest CEO around. If this can happen to him, it can and will happen to anyone. Which suggests that there are two problems: The banks are too big and the leaders are too insulated. What's worrying is the lack of appetite or will to solve either of them.

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    Margaret Heffernan has been CEO of five businesses in the United States and United Kingdom. A speaker and writer, her most recent book Willful Blindness was shortlisted for the Financial Times Best Business Book 2011. Visit her on www.MHeffernan.com.