Bank of Montreal Sees Square Peg - Round Hole Mismatch as Fraud

Part 1: Two Sides to Every Story

What happened, the series of events, who sent what to whom, can all be clearly documented.  Still there are two sides to every story when it comes to interpreting those events.  In this case, both sides feel that they are the victim, which I guess given human nature isn’t that unusual.   What’s different in this case is that all we’ve ever heard is the Bank of Montreal’s (the Bank) side of the story, painted, as you might expect, with themselves as victims and us as perpetrators.  This has forced us into the unenviable position of trying to defend ourselves against the Bank’s vision, without ever once getting a turn at the easel of perception, and being allowed to paint the picture as seen through our eyes, in which we are the victim and the Bank is the perpetrator.   That was about to change, and so the Bank hastily shut the case down.

Victim no more
Our chance at the easel was going to come during the depositions of the Bank’s employees.  I was in the courtroom when Judge Cott discussed the possibility of including the Bank’s CEO Bill Downe on the list of Bank employees ordered to testify.  While I’m duly cautious of summarizing the Judge’s remarks, I believe the following statements are accurate:  1) The Judge was not going to order Downe to testify first, before other employees of the Bank.    2)  Bill Downe wrote a letter to the court asking to be completely exempted from having to give testimony.  Judge Cott found Downe’s argument to be insufficient, and kept him on the list of people that he could potentially order to testify.   I didn’t leave the court room with the impression that a Downe deposition order was guaranteed, but I did think it was likely.  Given the Bank’s sudden interest in settling the case, it seems that Bill Downe himself shared my opinion.

Not surprisingly, a few days later the Bank and Optionable negotiated a settlement price so low that Optionable chose to accept it.  While I’m sure it is a relief, this settlement leaves the canvas painted with the Bank as the victim and us as the perpetrator.  There are two sides to every story – but in the courtroom anyway - ours will remain unheard.

Part 2: Telling the Untold Story 

The Bank tried to put a square peg in a round hole.  Then they sued us for fraud when it didn’t fit. 

Square – the Bank’s point of view

The Bank claims that there were defrauded by market tests conducted by Optionable that were based on trader quotes, rather than what they wanted, which was a consensus survey of the marketplace.  You see, the Bank already evaluated its trader’s quotes on a daily basis, so twice a month they wanted to see something else, an evaluation that was ‘independent’ of the Bank’s traders.

What the Bank wanted sounds perfectly reasonable to me.  Fortunately there were a few companies in the market that conducted the type of consensus surveys that the Bank wanted.  One such company was called Totem and from 2003 until 2007 the Bank’s Risk managers asked for, and were denied the use of Totem.  (Irony alert: The Bank’s own records confirm that Kevin Cassidy of Optionable actually played a role in convincing the Bank’s upper management to begin purchasing the Totem surveys the Risk managers had been asking for. )

Round – Our point of view

The Bank employed a Natural Gas trader named David Lee.  Lee’s portfolio was huge, as it contained several million derivatives contracts.  Just to bring in an outside point of reference, in 2001 Warren Buffet admitted to a New York Times reporter that he chose to take a $400 million loss unwinding 23,000 contracts held by a company he acquired rather than trying to assemble a team qualified to manage it.  (In a court filing, Defense attorney Lawrence Gelber estimates that Lee held 7.6 million contracts, which is 330 times more than the amount Warren Buffet deemed too large to manage)

To protect their investment the Bank’s Risk Managers selected a handful of contracts from Lee’s portfolio twice a month which they asked Lee to get market tested.  Lee reviewed the list and assigned prices at which he was willing to either buy or sell each one.  Per the terms of the service agreement the Bank signed with Optionable, brokers at Optionable market tested Lee’s prices by placing orders to trade the contracts the Risk managers had chosen and they entered them at the Bid and Ask prices Lee had indicated.  At the end of the trading day, Optionable sent the Risk managers the results of those orders.  True, Lee provided the prices, but neither he nor Optionable had any control over the market’s response to them. The service Optionable performed was accurate, legal and performed per the terms of the service contract (called Real Marks) that the Banks lawyers had vetted and the Bank's management approved.

In summary:  The Bank wanted consensus surveys such as Totem could provide, (square pegs) but that’s not what they signed up for when they requested reports from Optionable (round holes).  When the Bank finally bought consensus surveys from Totem, they found them to be consistent with the information they received from Optionable.  Could communications between the Bank and Optionable have been better?  Were there perception gaps? Apparently.  In my view, the none of the misunderstandings were the result of fraud.  Here’s what does seem fraudulent to me:  the Bank’s claim that any misunderstandings between themselves and Optionable were the result of a conspiracy against them.  The Bank’s litigation which is based on this theory of conspiracy despite ultimately realizing that both Optionable and Totem were accurately reflecting the Bank portfolio, despite their different methodologies, is what makes the Bank, in my opinion, the perpetrators here.

Disclosure:  I am an investor in Optionable.  This blog does not offer advice on buying or selling any security.  

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