Infighting at the Bank of Montreal

4/20/12 Updated:

Last week Kevin Cassidy signed Consent Orders in the SEC and CFTC cases. Cassidy's admissions from  the criminal case are brought into these cases as fact. There are some implications for Cassidy from each Consent Order, but monetary penalties, if there will be any, were not specified.

Optionable investors (like me) tend to overlook the SEC case since neither Optionable nor the Bank of Montreal are named as defendants in it. However the SEC made some statements in their complaint (filed November 2008) that reflect poorly on the Bank of Montreal’s internal controls. (in my opinion)

Under the theory that any critic of BMO is a potential friend of mine, let’s take a closer look at the SEC’s complaint. (text marked with an * indicates text found in the SEC complaint) Did you know that:

* A multi-contributor independent valuation service was available since 1997 and a second became available in 2004, but BMO did not even subscribe to, let alone rely upon, such a service until the latter part of 2006.

* BMO’s market risk unit (“Market Risk”) supervised an internal control system that was intended to obtain independent price verification. Market Risk personnel were required to select third parties to serve as a source for independent quotes. (emphasis added)

However……
* David Lee’s unit, the Commodity Products Group (CPG) successfully resisted efforts by Market Risk to transition to available multi-contributor independent valuation services until shortly before the “fraud” unraveled. (quotes around the word fraud added)

What this means to me:
1) There was an internal power struggle between BMO’s Market Risk group and BMO’s Commodity Products Group. Lee was the Managing Director of CPG.

2) BMO had a documented process requiring BMO’s Market Risk group to select the source of the third party independent verification of the CPG group’s valuations. In my opinion, if BMO had met this requirement, Optionable would still be in business and Kevin Cassidy would not be heading towards jail. Why do I say that? I say it because I think it was the appearance of impropriety that damned Optionable more than any discrepancy between the reported valuations.

3) For whatever reason, (certainly beyond the influence of Optionable), this requirement went undelivered and David Lee was able to “bully” the Market Risk group into using his source of verification (which may well have been accurate) while his trades were profitable and then lost the ability to “bully” the Market Risk group when his trades became unprofitable.

4) Because the Market Risk group had been denied the opportunity to select the validation source themselves, as they were required to do, Cassidy and Optionable looked guilty, if for no other reason than Lee had chosen them against Market Risk’s objections.

Bottom Line:

BMO has successfully been able to present their inability to police their internal requirements as “a conspiracy” between Lee and Cassidy, rather than what it really was: a power struggle between their own competing divisions. I think Lee openly prevented the Market Risk Group from fulfilling their requirement to select the verification source themselves. Lee got away with rubbing the Market Risk group’s face in it while he was up, but he found himself under criminal indictment when he was down.

At his allocution, Cassidy acknowledged that he knew that BMO’s Market Risk group wanted valuations that were independent of Lee, and that they didn’t get it. But Cassidy went on to say that he believed the reports were accurate despite Lee’s involvement. The power struggle between BMO’s Market Risk group and BMO’s CPG team wasn’t Cassidy’s fight, but still Cassidy and Optionable become easy scapegoats when BMO’s star trader slipped.

Disclosure: 1) I am an Optionable shareholder. 2) I have repeatedly underlined the word requirement because to me a requirement carries the same meaning as a “contract” or a mutually agreed upon course of action.