Sometimes a little inter-departmental tension can help keep people on their toes. At the Bank of Montreal (The Bank) the battle was fought between stressed out Traders who made and lost millions and number crunching analysts who tried (and failed) to protect it.
As the man in charge of the Traders it was Bob Moore’s (Bob) job to fight off any restrictions that Market Risk tried to impose. Even though they fought almost weekly, Market Risk’s Murray McIntosh (Murray) admitted that Bob was good at his job. According to what Murray told the FBI, Bob was always aggressively pushing for higher trading limits. Murray was also responsible for selecting the data sources that Market Risk used to track how the Traders were doing. Here again Bob steamrolled over Murray’s authority and insisted that that Market Risk use quotes from brokerages that Bob’s group traded with rather than consensus quotes from sources that were independent of The Bank.
Point/ counterpoint: Bob feared that sending his prices out for consensus quotes would expose them to the market. Bob argued successfully that this unnecessary exposure would hinder his team’s performance and profitability. Murray claimed that any broker’s view of the market was influenced by the trading that brokerage did with The Bank. Murray and fellow Market Risk analyst Patrick Cronin (Pat) found the notion that brokers were capable of providing quotes that were independent of The Bank laughable. Since The Bank’s trading was the very lens through which the brokerages saw the market, ‘independence’ from the bank simply was not possible (in the opinion of the Market Risk team).
From 2003 until 2006 Bob’s profits trumped Murray’s authority to select the data source. Murray later lamented to the FBI that every time he raised the issue with upper management they would just look at him and Bob and then shake their heads, not knowing who to believe.
Murray’s believability got a boost though when he told The Bank’s upper management that Bob’s group was losing money and that he suspected one of Bob’s Traders David Lee (Dave) of deliberately adjusting his prices to hide millions of dollars in trading losses. Murray suspected that Dave was “adjusting the skew" of his OTM options (out of the money options) while still reporting accurate prices for his ATM options (at the money options). ATM options are more widely traded than OTM options, so the fear was that Dave might be hiding losses in exactly the places where reliable market data was scarce.
In brief, here’s what happened next:
1) Market Risk brought in a lot of smart people who were sophisticated in the type of trading that Bob’s group did.
2) At the beginning of the investigation, it appears that Dave was given the benefit of the doubt. After all, given the risky nature of what The Bank employed Dave to do, the ebb and flow of millions in profits turning into millions in losses came with the territory.
3) As they became more certain that Dave was adjusting his prices they also began to wonder if Bob knew about the deception.
4) Something that surprised Market Risk was that as the investigation progressed and the tables began to turn on Bob, he became even more arrogant. He began demanding higher trading limits on a portfolio that was already (according to Market Risk) staggeringly huge. What’s more, rather than conceding to the use of consensus quotes Bob continued to insist that Market Risk use broker quotes that they openly and vocally mistrusted.
5) Bob’s swagger and bullying tactics stopped working. Upper management instructed Bob to lower the risk in the portfolio and Market Risk got authorization for their consensus quotes.
6) Bob and Dave did lower the risk in the portfolio, but they did it in a way that Market Risk felt was just gaming the system.
7) In what may have been a concession to Bob, upper management signed off on a new reporting service from brokerage firm Optionable called Real Marks. Real Marks was still broker based but according to Optionable’s CEO Kevin Cassidy (Kevin) it provided a wider lens into the market than Optionable had been able to provide previously. Murray questioned Kevin as to how many other brokerages Real Marks could see and Kevin replied that it could see all of the majors with the exception of Goldman Sachs.
8) In January 2007 when Market Risk compared quotes from Optionable’s Real Marks to the consensus quotes they had wanted for so long, both sources found similar discrepancies in Dave’s portfolio.
9) The investigation wrapped up. Market Risk wrote up a report that convinced everyone who read it, from upper management to Bob himself, that Trader David Lee had been hiding losses by adjusting the skew of his OTM options.
The Cover Up:
When it came time to explain all of this to their investors and Government Regulators The Bank hired a crisis management / public relations firm called DKC. The strategy DKC came up with was named “Blame Optionable”. The ‘Blame Optionable’ campaign linked The Bank’s trading losses to the ‘non-independent’ reports it received from Optionable. Even though Optionable's reports were consistent with the 'independent' reports, The Bank claimed that the auditors they hired were seeing 'the largest discrepancies that they had ever seen'. The next day Optionable’s partner NYMEX (now a part of CME group) announced that it was launching a service with Optionable’s competitor. And to seal the deal, Oops.... it was reported in the press that Optionable’s CEO had a criminal record. Optionable ceased generating revenue within days. When the smoke cleared, The Bank launched a lawsuit seeking monetary damages from Optionable.
Disclosure: I am an Optionable shareholder. (symbol OPBL.ob) This blog does not offer advice about buying or selling any security. A good portion of what I have written about in today's post was found on Pacer in exhibits to Defense's 9/17/12 letter opposing The Bank's request for restitution. Given my bias as an Optionable shareholder I encourage you to read the original documents for yourself here:
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