I understand that it is the job of legal representatives to make as strong a case as possible and that this in turn might lead to exaggerations – it is often noted that great actors could make great lawyers – but even allowing for the odd dramatic flourish, reading the appeal brief delivered to the US Second Circuit Court of Appeal this week by Mark Johnson’s defence team made my jaw drop.

I find it astounding that the US Government has reversed its stance on notable and critical aspects of its original charges, but also that it has decided to introduce new arguments at appeal. Surely if it was confident in its case it would need to neither back track nor make new arguments that it didn’t see fit to present to the original jury?

The upshot of reading this document is the reinforcement of my belief – as I have stated in several columns about this case – that the prosecution knows nothing about how FX markets work and is desperately trying to fulfil some political mandate that “someone” is held to account for what are perceived as the banking industry’s shortcomings. 

Make no mistake, there were serious shortcomings at the banks in the first decade of this century, but they had little or nothing to do with foreign exchange, and nothing to do with Mark Johnson. One pretty well executed FX trade did not bring on a financial crisis (which had already happened of course), so why was this case brought if it wasn’t in desperation? Anyone with a real understanding of how the FX market works could have explained why, but too many in our industry chose not to.

I may be wrong – it has been known – but changing one’s arguments and metaphorically whispering that actually some of the original claims were wrong smacks of desperation to me and I honestly think the prosecution should do the right thing and say to the Court that having reviewed its position it no longer feels confident in progressing.

Sadly, there is little chance of that, so apart from the facts laid out in our article this week on the appeal, which can be read here, why else am I thinking the whole sorry episode should be brought to a close?

Mostly it revolves around further evidence that the prosecution has no understanding of how OTC markets work and best practices around reducing market impact and preserving confidential information.

I have to say that few of these arguments are new to this column, I have made most in the past year or two, but to reiterate, the Government is now apparently claiming that by sharing the trade with other HSBC traders Johnson broke confidence. It also, however, still infers (without any actual proof) that the use of code words was to help the “fraudulent scheme”. Those claims are contradictory – he simply can’t be guilty of both misdemeanours, so is the prosecution just trying to throw sufficient mud that something sticks? 

By using code words Johnson was helping keep the information on the trade to a strict “need-to-know” basis. Only those traders executing the deal and those involved in the agreement with Cairn were party to information, nothing went outside – there was no chat room, no sharing of information, only prudent internal discussions.

During the original trial and post-conviction, I have argued until I am blue in the face that there was nothing wrong with the execution (assuming, unlike me, you think the Fix is fine). The prosecution’s argument was that by buying ahead of the Fix, HSBC was seeking to profit from the deal. Not only does the appeal document from the Government now accept that Johnson made the appropriate disclosure that this was how HSBC would make money, it now seems to argue that – quite correctly – the best way to execute the trade was in tranches in a period leading up to the Fix. I can’t stress this enough but that is exactly how the deal was executed! It’s another contradiction!

Remember if you will, the Prosecution’s expert witness who suggested perhaps the bank should have held the risk until after the rate was set – and I will happily be corrected on this but I am sure at one stage the prosecution argued that the execution should take place in the window itself. Hence my repeated assertions that this physically cannot be done, or it would destroy the market and create a flash event that would cost Cairn a huge amount in lost income from the dollars.

The Government now also argues that HSBC acted illegally by selling 3% of the sterling it was buying to third parties. It would have done this through its normal market making activities, something the prosecution seems ignorant of. If it did understand the role of market maker or liquidity provider then perhaps it might want to consult with certain regulators in the US who have sounded warning bells about liquidity levels in markets? After all, if an LP has to stop pricing while it executes an order not only would that denigrate market quality, it would also be a huge signal to the world that it was doing something – and that something is likely to be big. This would lead to information leakage, or signalling risk if you prefer, and a much worse outcome for the client.

And if I find that argument nonsensical, what to make of the assertion that statements by HSBC personnel induced Cairn to settle transaction two days later? Is the DoJ seriously suggesting that a party to a trade, if they are a little unhappy with how the execution went, can withhold payment? Can you imagine the chaos in financial markets if that was allowed to stand as a point of law?

On the execution front I was interested to read that the Government case is now that HSBC tried to ramp the market by buying the bulk of the order in the last 10 minutes before the Fix. Aside from the fact that this has been proven incorrect by the trade logs, surely this flies in the face of the original argument that the bank front ran the order?

You cannot on one hand suggest that the order be filled at or after the window because do so beforehand represents some sort of fraudulent activity – and then calmly change your argument to say that some buying before the window is acceptable?

After all, when is front running not front running? Is there a difference if you start buying 10 minutes in front of the Fix rather than 30? (Actually there is, the latter would generally speaking have less market impact). 

I wasn’t convinced by the Government’s first argument in front of the jury – the latter clearly was – but I am even less disposed to what borders on the irrational arguments being put forward now apparently. I have long argued that this case has potentially serious repercussions for the foreign exchange industry if the DoJ prevails, I believe that even more now – which makes the inaction on the part of some industry associations even more scandalous.

As things stand, if the DoJ wins this latest argument it will be establishing that making money out of a customer trade is OK, but it can’t be too much. Exactly how much is “too much” is unknown, therefore every time a bank trades with a customer there will be uncertainty (and where there is uncertainty there is a compliance department that will err on the side of caution).

Furthermore, a large ticket can be pre-hedged but only to certain, again unknown, parameters that appear to be in the heads of the prosecution team in this case. Pre-hedge a minute too early and you could be going through the type of hell that Mark Johnson has for much of the past three years. In those circumstances, who is going to take the risk? The only result will be more random volatility, easier identification of Fix orders and worse outcomes for clients – significantly worse outcomes.

It bothers me that too many people at senior levels in the industry, or at those bodies meant to represent the FX industry (ACI FMA is the honourable exception here), have sat around and metaphorically averted their gaze from this issue. At ground level I can assure readers that there are a lot of people worried about the outcome of this case, even those – like me – who don’t know Mark Johnson.

As I noted early, the stakes for the FX industry appear to have been raised even further thanks to the prosecution introducing new – and even more illogical in terms of how the FX market works – arguments. I don’t know if it is too late in the appeal process to educate the US legal system about some realities of OTC markets but if it is then those that sat silent should hang their heads in shame for they stood by and did nothing while their industry was hung out to dry on a string of ill-conceived, illogical and, frankly, ignorant claims.


Twitter @lamboPnL

Twitter @Profit_and_Loss

Colin Lambert

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