What Risk Management process did the Bank of Montreal think was in place?

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You might think that it would be difficult to write a blog about a single legal matter for six years without repeating yourself. And in my case, you’d be right.  It is difficult and I do repeat myself – a lot. Worse, there is one particular question that I just keep coming back to: What Risk Management process did the Bank of Montreal (The Bank) think was in place?  Like a pit bull snarling and slobbering over a half eaten bone, I have latched onto the idea that The Bank lied to us all when they claimed that their 2007 trading losses were the result of a conspiracy aimed at subverting their risk management controls.  I didn't buy it back in 2007, I don’t buy it now, and so help me God, I feel like a stray dog that's had a bone ripped away and muzzle slapped over its face, because I just haven't been able to find the right words to put into this blog that will convince you (yes, Y.O.U.) not to buy it either.

Here's how it happened.  The Bank’s Risk Management department followed a process called the Independent Price Verification Process (IPV)  IPV is an internal proprietary process within The Bank and as such they’re not obligated to make the steps of the process public, (and so they haven’t).  Kevin Cassidy (of Optionable - a company I am invested in) however, is currently sitting in Federal prison for supposedly conspiring with David Lee (of The Bank) to subvert The Bank’s IPV process.  Oh sure, a person can conspire with another person to subvert a process without actually ever seeing the guidelines for it - no problem there.  But I still find it frustrating however that a person accused of conspiring to subvert a process can go through the legal system for 6+ years without the nuts and bolts of the process they are accused of conspiring to subvert being laid bare for legal review and analysis.  This is why I keep coming back to the question: What Risk Management process did the Bank of Montreal (The Bank) think was in place? Just like to the accused has a right to confront their accuser; we should be given the opportunity to know exactly what the process was that we’re being accused of conspiring to subvert.)  

I got a bit of a shock the other day when I downloaded the transcript of Kevin Cassidy’s sentencing hearing, although I completely enjoyed the first part.  In the first part, Cassidy’s lawyer Douglas Jensen engaged Judge Griesa in a dialog about the RealMarks service that Optionable performed for The Bank.  The verbal exchange read like a symphony to someone like me who has hungered for this type of detail.  It is my impression that the Judge was right there with Jensen too, based on the number of light bulbs that seemed to be igniting for him.

As you might expect, Prosecutor Michael Levy wasn’t enjoying Jensen’s information exchange with the Judge as much as I was (and the Judge seemed to be)  When Levy’s turn came to speak, he said that he had had to figuratively ‘bolt himself to his chair’ for the previous 45 minutes in order to keep from making objections.  I bring up Mr. Levy’s discomfort to highlight one point.  Neither Mr. Jensen’s statements (which I loved) nor Mr. Levy’s statements (which angered me) were put to the rigors of being proven in a court trial.  Yes, the statements were being made in a court of law, and yes, they were being spoken directly to a Judge. But at the end of the day, the statements were only statements, not trial proven facts. And let me tell you, one of Mr. Levy's statements really bothered me, and not just because I believe it is untrue. It bothered me because I believe it is untrue AND its aim was an attempt to falsely fill a gaping hole in the Bank's narrative regarding my most nagging question: What Risk Management process did the Bank of Montreal think was in place?  Are you curious to know what Mr. Levy said? (hint: it's about the process The Bank thought was in place)

Please allow me to take a step back before telling you.

Although The Bank’s IPV process is a proprietary secret which the Bank is within their rights to prevent us from evaluating, the RealMarks contract that The Bank entered into with Optionable is not a secret.  While we can't know for sure what's in the IPV, we can know for sure what Optionable agreed with The Bank to deliver through the RealMarks service.  Remember, the RealMarks contract was drawn up by lawyers at Optionable, vetted by lawyers at The Bank and signed into effect by The Bank’s Executive Managing Director of Commodity Markets (Robert Moore).  While the contract is filled with legal jargon that is hard to understand in the Terms and Conditions as well as the Disclaimers and Limitations of Liability sections, (including amusingly enough an agreement not to sue each other over the results of the RealMarks service, ha!), it does make one thing crystal clear.  The first sentence of the contract says:  “RealMarks provides specific market information based on actual market quotes obtained by Optionable.”  

Think of RealMarks as a basic input/output device.  You put actual market quotes into RealMarks and the specific market information you get out is the market reaction to those actual market quotes.  Are you with me on this? (this is important)

So in their role as a brokerage firm, Optionable took actual market quotes from The Bank, market tested them by entering real buy and sell orders into Optionable's trading platform for those options, at those prices, and then reported the response those orders generated back to The Bank. This wasn’t a hypothetical exercise.  These were real orders that real traders could and did trade on. This is what Optionable did, and it is exactly what The Bank contracted with them to do, and so help me God, there isn't a single thing illegal about it.

OK... now I’m ready to tell you what Mr. Levy said.  Mr. Levy said that the process The Bank thought was in effect went like this: a Risk Manager from The Bank sent a broker at Optionable a list of options to market test through RealMarks, and this list was sent without including prices at which to place the market testing orders.  The reason I find this so disturbing is: a) I don’t believe it happened and b) simply supplying the names of the options without the prices for them would not have given Optionable enough information to place the market testing orders c) it paints a picture that makes what David Lee did (supply Optionable the prices at which to place the market testing orders) look like some conspiratorial breach in The Bank’s process, when it fact, it was a key basic requirement in order for Optionable to perform the service that the Bank asked them to do. If The Bank wanted to only send the names of the options to be market tested, without the prices to test them at, then they didn't want the RealMarks service.  That doesn't make RealMarks 'bad', and it doesn't make the RealMarks requirement for actual market quotes into a 'conspiracy'.  Likewise, not wanting to provide actual market quotes doesn't make The Bank 'evil'.  What makes The Bank 'evil' is putting the company I invested in out of business 6 years ago, and worse, allowing the man who ran that company to go to jail over some imaginary conspiracy theory.   

Do you get it?  Do you see it? Am I making any sense? Do you see how The Bank is flat out wrong when they claim that the transmission of quotes from David Lee to Optionable was some type of conspiracy?  Lee's participation wasn't a conspiracy; it was a basic requirement for the service The Bank wanted.  I don't know if I can say it any clearer than that.  

In closing I'd like to say that back in 2007 The Bank lost a lot of money trading exotic options for natural gas derivatives, and they lost that money fair and square. When it came time to admit it, rather than accepting responsibility, they came up with a conspiracy theory instead, and they did it with the full knowledge and authorization of The Bank's CEO Bill Downe.  We still don't know what Risk Management process The Bank thought they had in place, but we do know that there was no other way for The Bank to have received output from RealMarks other than by The Bank providing prices to Optionable, so that Optionable could test The Bank's prices in the market.  I hope I've given you enough information to see how The Bank's conspiracy theory is contradicted by the practical reality of how the RealMarks system worked.  If I have, I like to ask you to take action against the Bank of Montreal by sharing links to this blog in your social media networks.  Let's get the word out!

This blogging platform does accept comments, so if you have any questions about any part of what I've written, please feel free to ask.  Thanks for taking the time to read this, whether you agree with me or not.   Peace.

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