Next Tuesday sees Mark Johnson’s bail application heard in New York and the documents filed by prosecution and defence are available online, which gives the wider world an opportunity to study both sides of the case through one prism, rather than the filtering out of reports on a daily basis as the trial proceeded.
Inevitably when one reads through these documents emotions swing as each argument is made to the best of the legal teams’ abilities, but the more I read about this case, the more I am convinced that certain important elements of what happened have been overlooked.
I have already bored you enough with my logic for pre-hedging such an order, if you want to read more about it, including the apparent agreement of Cairn Energy that it would accept the bank making money by buying ahead of the Fix, then click here. I would also, and I have never done this before, point you to Kevin Rodgers’ article on the Euromoneywebsite which discusses the case in some detail. In truth Kevin is not really saying much more than I have argued previously, but as an expert witness in the case he obviously had access to a lot more background information.
There is a lot of legal manoeuvring in the two documents which, frankly, is a little beyond me, but what surprised me in the prosecution document was how it states, when referencing the ISDA agreement between the parties, “Page 23 of that agreement stated that “the other party is not acting as a fiduciary for or as an adviser to it in respect of that Transaction.” Cairn’s Treasurer considered the ISDA to be an agreement on how the mechanics of trades are settled and did not recall seeing this language.
While the person concerned may not recall seeing the language, this doesn’t mean it wasn’t there, and it is things like this that have confused me.
My overriding interest in this case, as it has always been, is in the potential impact on the FX industry and it concerns me that the prosecution’s argument that Johnson provided advice during several conversations could lead to banks (and other service providers) refusing to have conversations with clients unless certain disclaimers or other legal paraphernalia are signed ahead of time.
I don’t know, frankly it is impossible for anyone outside Mark Johnson himself to know, whether, when he was chatting with the client about the order, he thought he was giving advice. He stated in evidence he was not and I tend to believe him because clients do get nervous about large trades and want a lot of reassuring, this leads to a lot of informal conversations, some of which the prosecution has chosen to take as evidence of advice.
If this argument wins out, who is going to want to talk to a client in the US (and I would point out Cairn is a UK company dealing with a UK bank in this instance)? The risks are just too great if something later goes wrong. Thus some clients, who are badly in need of advice when it comes to hedging currency exposures, could find themselves without access to the advice that has helped them so many times in the past.
If you want to go properly “doomsday” on this, why would anyone want to become, or remain, an FX salesperson to corporates or asset managers? The risks are clearly much greater than previously thought, especially if this conviction is upheld and could lead to a decline in both the numbers and skill levels of the sales and relationship force, as well as the strength of relationships between banks and clients (a cynic might suggest that this would also mean corporates and asset managers would have to execute their FX hedges on an exchange-like mechanism, which would suit certain US regulators).
I also think that the prosecution’s argument that HSBC was to trade “in a manner calculated to minimize market impact”, doesn’t sit well with the claim that the bank was front running. My aforementioned column on market impact deals with this, so there is no need for me to go into it again beyond reiterating that pre-hedging a large transaction minimises market impact – certainly it’s better than trying to buy it in one or five minutes!
It is hard to escape the notion that this is a case riddled with ambiguities and apparent contradictions, for example the prosecution case in the bail application states, “As Johnson knows well, his conviction was not the result of HSBC purchasing Pounds ahead of the fix on behalf of their client; instead, Johnson and other traders at HSBC under his direction defrauded Cairn by using its confidential information to buy currency in their HSBC proprietary trading accounts purely for their own gain and that of the bank, not to assist with filling Cairn’s order.”
Later on, the prosecution’s document states, “While [HSBC’s sterling trader Frank] Cahill did end up purchasing cable from these traders that went to fill Cairn’s order (and which allowed them to lock in the high fix price for their purchases), other traders also sold British Pounds on the open market – which never went to Cairn.”
So as I read that, the trades the prosecution is talking about in the first instance were for the Cairn order according to the second statement.
The language is also confusing. If other traders sold sterling, they surely cannot be accused on being part of a front running conspiracy, because the logical way to front run a buy order is to buy, not sell.
One could ask why those sales were not matched off against the Cairn order, but if there were Chinese Walls and other restrictions on the information (which I believe the prosecution claims there weren’t), then how would those selling sterling actually know about the large buy order. If they had knowledge and were looking to take advantage of it, they would have delayed their sales of sterling until after the order was complete.
An interesting question of the prosecution would be what it would have thought had just one trader bought the same amount, to the same pattern, that the multiple traders did? Would that also constitute front running under their definition, because I would argue it could just as easily be prudent risk management by pre-hedging to minimise market impact.
To someone who has been in FX for more than 40 years in a variety of guises, I find it hard to understand these arguments, conflicting as they are. They’re just not logical in terms of how the FX market works and fail to take into account the day-to-day tactics involved in managing a large order.
I take my independent stance seriously, so I have to point out that there are arguments in the prosecution’s case that make for uncomfortable reading, specifically some testimony attributed to Frank Cahill in his testimony (“Cahill testified that he traded in an aggressive manner calculated to increase the spot price.”) and the use of the word “ramp”.
Equally I am mystified why the client was apparently told (by Stuart Scott, not Johnson) that HSBC didn’t start buying until 2.55pm, just five minutes ahead of the Fix, when prudent risk management would have dictated an earlier start to the pre-hedging (as actually happened).
It will also be interesting to hear the court’s response to claims by the defense that the prosecution actually attributed statements to Johnson that were in fact made by Cairn’s advisor.
Overall though, I find myself looking at one or two points that don’t look good on paper, but which could be the result of a poor choice of words at the time, against the much more serious claim of front running. For it is the latter argument that has so many potential consequences for the industry – which is a point I have been making (repeatedly!) since September when the trial started.
It concerns me that this main plank of the prosecution’s case looks so flawed, you question how a jury came to a guilty verdict? It did, however, and next week’s application for bail presages an appeal that is important for all involved, especially those customers seeking help with their hedging requirements.
It may only be one plank of the prosecution’s case, but there has been, for whatever reason, a fundamental misunderstanding of how the FX market works when handling large risk. This lack of understanding is reinforced by some of the claims in the prosecution’s argument against bail. When it comes to the appeal – and the accusation of front running specifically – it is to be hoped that the appeal judges truly understand the critical difference between this practice and prudent risk management.