US Court Sentences FX Trader to Two Years

Mark Johnson, the former head of global FX cash trading at HSBC in London, has been sentenced to two years in prison following his conviction for eight counts of wire fraud and one conspiracy charge by a US court in October last year. Johnson was also fined $300,000.

Profit & Loss has reported extensively on the case, and just pulling out a few of the headlines provides a fairly decent timeline for how the case has developed since Johnson was arrested in New York almost two years ago.

Reports: HSBC Executive Arrested in Currency Investigation – June 2016
US Justice Department Brings Charges Against Two FX Traders – July 2016
FX Trader Arrest: Do Not Pass Go, Do Not Collect $8m – October 2016
Second Former HSBC FX Trader Arrested – June 2017
HSBC’s Execution of Cairn Order “Followed Standard Industry Practice” – August 2017
Former HSBC Exec Found Guilty in FX Fraud Case – October 2017
DOJ Hands HSBC $101.5m Fine for Front Running – January 2018

In addition, Profit & Loss managing editor, Colin Lambert, has been opining on the Johnson case, warning that not enough care has been taken by the FX industry regarding how people communicate, and that the case has illustrated some naïve assumptions about how FX liquidity operates.

But now that the sentence has been handed out, the question becomes: does the punishment fit the crime?

Prosecutors for the US government actually argued in favour of a much stiffer sentence for Johnson, stating that “no less than 84 months”, or seven years, would be sufficient.

Such a sentence, they argued, would be an accurate reflection of the serious nature of the offenses committed by Johnson.

“As a senior banker in one of the world’s largest and most prestigious financial institutions, he knowingly and intentionally betrayed his client in order to maximise profits for the bank, to the tune of millions of dollars…In order to adequately and justly punish this offense, a significant custodial term is warranted,” said the US prosecutors in the government’s sentencing memorandum.

In addition, the prosecutors claimed that a significant jail sentence was important to deter others from committing similar offenses to Johnson.

From the memorandum: “Recent events have shown that corruption and fraud is rampant in the FX market. In May 2015, four of the largest financial institutions in the world – Citicorp, JP Morgan Chase, Barclays, and the Royal Bank of Scotland – pled guilty to conspiring to manipulate the spot price of the euro/dollar currency pair. These settlements exposed a culture of cheating on the foreign exchange desks of many of the world’s largest financial institutions that can be checked only by the incarceration of wrongdoers. A custodial sentence for Johnson will make those traders think twice before doing so.”

Broader harm

Further, the prosecutors argued general deterrence is critically important in this case because fraud schemes that involve manipulating important benchmarks, such as the FX spot fixings, can do broader damage to society, beyond simply the loss of earnings for the victims of the scheme.

Firstly, the prosecutors stated that Johnson’s actions served to undermine the public’s confidence in the integrity of financial markets and have helped to fuel the perception that these markets are rigged against the average investor and in favor of elite financial institutions.

Secondly, the prosecutors said that schemes such as the one perpetrated by Johnson increase the transaction costs associated with merger and acquisition deals. They point out that Cairn Energy decided that the best use of its assets was to sell a subsidiary and distribute the proceeds to its shareholders, but that by moving the spot price in a direction that made the transaction more costly for Cairn, Johnson and others at the bank effectively discouraged Cairn from taking an action that its board of directors had deemed to be in the best interests of the company’s shareholders.

Another prong to the government’s argument that a significant prison sentence was necessary to deter other potential bad actors seems to be that proving FX malfeasance is hard to do, and therefore while someone has been found guilty, they need to come down hard on them.

“A significant custodial sentence is also necessary to achieve general deterrence because traders who are contemplating this sort of crime are capable of weighing the low likelihood of detection against the consequences of prosecution…Crimes accomplished through trading in the FX markets are extremely difficult to detect because there is a huge disparity of information between the victim and the offending bank concerning how the bankers executed the trade…Hence, substantial prison sentences are necessary to alter the calculus of traders like Johnson who know that they have an informational advantage over clients that makes detection of misconduct extremely unlikely,” say the prosecutors in the memorandum.

The response

Johnson’s lawyers issued their own court filing rebutting these arguments. In the court document, signed by Frank Wohl, a partner at Lankler Siffert & Wohl, initially takes issue with the fact that the government cites the cases of banks manipulating the spot price for EUR/USD as evidence that there was a culture of cheating on FX desks that “can be checked only by the incarceration of wrongdoers”.

Wohl points out that the guilty pleas from the banks in this case were issued because they had violated the Sherman Antitrust Act – a totally different offense and conduct issue to what Johnson was convicted of. There is also no evidence that Johnson was involved in any of the collusion amongst FX desks referenced in those cases.

“The government’s effort to imprison Mark for a ‘culture of cheating’ in which he did not participate is both irrational and barbaric. Mark is not a symbol to be punished for all manner of white collar crime committed by others in the FX industry; he is an individual whose punishment must fit his individual circumstances and conduct,” said Wohl in the reply to the sentencing memorandum.

He also pointed out that the fines issued to the banks already act as a deterrent to FX malpractice because it has forced these banks to strengthen their compliance programs and internal controls and re-assess how their FX desks operate and are supervised. With the bank themselves incentivised to make this top-down change, the lawyers argued, a prison sentence for Johnson was not needed in order to deter bank employees from engaging in fraudulent schemes.

Wohl also attacked the argument that his actions caused broader “societal harm”, stating that the prosecutors fundamentally mischaracterised both how the FX market operates and the nature of Johnson’s offense.

“Unlike the securities market and certain commodities markets, the wholesale FX market at issue in this case involves sophisticated participants, and the government offers no evidence of any impact on ‘average investors’…Cairn is the only alleged victim of the offense conduct, and there is no proof that Cairn suffered any tangible harm…the government’s suggestion that public perception of the financial markets has been meaningfully affected by the one transaction at issue here – involving merely speculative harm to one corporate victim – is not credible,” said Wohl.

No harm, no foul

He went on to make the case that the government prosecutors never alleged or offered any proof that HSBC’s alleged “front-running” or “ramping” conduct was inherently wrongful or prohibited or that it defrauded any victim other than Cairn.

The point being made here is that the government did not argue that HSBC’s execution varied from the industry standard, but rather that Johnson and other HSBC employees made a series of misrepresentations to Cairn about how they would execute FX transactions on its behalf. In a nutshell, Johnson’s lawyer argued that he was convicted for a disclosure issue rather than actually doing anything illegal when trading, and therefore the argument that his actions undermined faith in financial markets was invalid.

Further on, Wohl refuted the argument that Johnson’s actions discouraged Cairn from taking actions deemed to be in the best interests of its shareholders, pointing out that the government failed to identify any specific action from which the firm was actually discouraged.

“To the contrary, the evidence at trial showed that Cairn’s directors decided to engage in the fix transaction, in large part to achieve transparency and avoid shareholder complaints and criticism, more than a month before HSBC and Mark were advised of that decision. Further, as previously explained, the government has failed to prove that Cairn actually suffered any tangible harm, including any increased ‘transaction costs’, [Gov’t Mem. at 30], let alone the kind of harm that would prevent companies from making efficient transaction decisions,” stated Wohl in the court document.

Countering the argument that a custodial sentence is necessary to deter malpractice by traders because the chances of detection and prosecution in these cases are low, Wohl again refers to the steps taken by the banks following their 2015 antitrust plea agreements to improve their compliance and internal controls so that they could more effectively detect bad behaviour.

Additionally, he pointed out that Johnson did not profit personally from his actions, has lost his career and livelihood, suffered financial consequences and been separated from his family for 13 months now.

Wohl stated in the document that, “regardless of the sentence imposed on Mark, no rational person weighing the benefits of the offense conduct against the likelihood and consequences of prosecution would conclude that the benefits outweighed the risks”.

Aberrant conduct?

There were other arguments on each side of the debate regarding Johnson’s sentencing. For example, Johnson’s defense pointed out that he did not personally profit from his conduct, while the prosecutors said that he was motivated to maximise the performance of his group at the bank, profiting indirectly in the form of increased compensation and potential career advancement.

Similarly, the prosecutors were not impressed by efforts to highlight Johnson’s history as a law-abiding and morally upright citizen.

“The defendant devotes much of his submission to Johnson’s personal characteristics and career performance, ranging from his conduct in rescuing pets as a child, [Def.’s Mem. at 4], to sponsoring the advancement of women at HSBC. The government does not dispute that Johnson is a devoted family man, or that he has had a long career filled with success. These circumstances, however, are not so unusual in white collar cases and do not mean that a non-custodial sentence can be viewed as appropriate,” they said in the sentencing memorandum.

Meanwhile, Wohl contended that Johnson’s behaviour was “an extreme aberration from his nearly 30 years of exemplary conduct in the financial industry”, whereas the government said the fact that this conduct occurred over a period of weeks undermines this argument and, moreover, “the type of conduct described here was not unusual for Johnson or his team at HSBC”.

Aside from the deterrence piece, perhaps the most interesting argument regarding whether or not Johnson should receive a prison sentence revolved around the punishments that have been handed out in similar cases.

Essentially, Johnson’s defense and the government prosecutors disagreed on which other cases are suitably analogous to Johnson’s, and therefore draw very different conclusions.

Wohl cited eight cases, stating that they are “simply a few examples”, where defendants were given non-custodial sentences for what he argued are comparable fraudulent schemes. The government memorandum countered that these are “cherry picked” cases, and then cited five different cases where the defendants did get custodial sentences for what it said were comparable fraudulent schemes.

Conflicting views

The government memorandum said that the case, United States Vs. Dial, is a fairly similar case in which a commodities broker received an 18-month sentence for front-running clients on orders for silver futures.

However, in the memorandum the prosecutors argued that Johnson’s conduct was more egregious than Dial’s because, while the latter’s conduct deprived his clients of profits that they would have made if their orders had been placed sooner, there is no indication that he attempted to manipulate the entire market in a way that harmed the client. They said that Johnson, on the other hand, schemed to “ramp” the entire spot price.

Wohl obviously disagreed with this conclusion, stating that the conduct at issue in the Dial case was far more serious than in Johnson’s.

Firstly, he pointed out that Dial was acting as an agent of his customers, whereas HSBC was acting as a dealer, a principal counterparty, and therefore was required to buy currency ahead of the Fix and sell it to the customer, and was permitted to profit from doing so. Therefore, he argued the “trading ahead” in Johnson’s case did not have deception or harm involved in the Dial case.

Secondly, Wohl said that Dial aggressively solicited the customer orders at issue, for the specific purpose of enabling him to benefit his own personal accounts, at the customer’s expense. This is in direct contrast to the Johnson case.

Thirdly, the fraud scheme perpetrated in the Dial case caused tangible loss to customers, whereas Wohl contended that the government has failed to prove any tangible harm to Cairn from Johnson’s behaviour.

Fourthly, in the Dial case, it was not just customers that were defrauded. In that case, the defendants traded without margin – thereby subjecting their employer to the risk of $25 million in potential trading losses – and actively concealed their conduct from their employer, in breach of their fiduciary duties to their employer.

And in that case the defendants lied under oath repeatedly during the course of the investigation.

Another case particularly highlighted by the prosecutors is United States v. Coscia, in which a commodities trader named Michael Coscia, received a 36-month sentence for his practice of artificially manipulating the price of precious metals futures by placing buy and sell orders that he never intended to fill, a practice known as “spoofing”.

Again, they argued that “Johnson acted with a higher degree of culpability because, although Coscia manipulated a market, he did not abuse the trust of a client who relied on his advice”.

In his rebuttal, Wohl claimed that the Coscia case cited by the government is, in fact, “unhelpful to its position” and said that the conduct involved was far more serious, extensive and harmful to financial markets than in Johnson’s case.

“Coscia’s spoofing scheme basically boiled down to a high-tech, high-frequency pump-and-dump scheme, through which Coscia sought to accomplish “artificial movement” of commodities by, inter alia, “placing large and small orders on opposite sides of the market,” he said.

Wohl argued this victimised multiple parties with whom he traded, and the market itself, by sending a false pricing signal to the market, for the purpose of his own gain

“Mark’s conduct, in marked contrast, involved only one transaction, one alleged victim, no tangible harm to anyone, no false pricing signal, and no profit to Mark,” Wohl concluded.

These are essentially the condensed arguments for and against incarcerating Johnson for his part in defrauding Cairn during a $3.5 billion currency trade in 2011. Ultimately, the US District judge, Nicholas Garaufis, decided that the government’s case for a custodial sentence was more compelling than the defense provided by Johnson’s lawyers.

All eyes will now turn to Johnson’s former colleague at HSBC, Stuart Scott, who has also been charged in connection with this case. A London judge ruled last October that Scott should be extradited to the United States to face these charges, although Scott indicated at the time that he would be appealing the decision.

Galen Stops

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