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.

Where is BMO's "Mountain of Data"?

Last December, BMO's lawyer Anne Beaumont told Judge Daniels that she expected BMO to complete their 'document production' by the end of February. Yet Team BMO arrived at the conference today without having completed this task.

“Who cares?”, you might wonder.

Since last December I’ve done some thinking about the relevance of the trading data that BMO fought to prevent the Defense from seeing. I've also thought about why BMO might drag their heels producing it. (NOTE: there is still a battle to be fought over whether or not this data could be used at trial, but BMO lost the fight to withhold it from the defense)

Here’s what I’m thinking:

If BMO is fighting so hard to hide this data, it must be pretty damning, right? It must expose two things: 1) The weakness of BMO's complaint against Optionable and 2) The strength of Optionable’s counter claims against BMO.

“Remind me”, I hear you ask, “What was BMO’s complaint again?”

My understanding of BMO’s position is that they claim to have relied on reports that Cassidy/ Optionable provided to their Back Office on a twice-monthly basis as their only available double check of the valuations that their own trader (David Lee) provided to them on a daily basis. Their complaint is that while it was fine for Lee to send his valuations to the Back Office as the basis for their daily review of his valuations, it was a violation of Federal Law for Lee to send his valuations to Optionable as the basis for their twice monthly review. At his allocution in the Federal Criminal case against him, Cassidy acknowledged that Lee did send him valuations to use as the basis of his twice monthly reports, although Cassidy also stated that he believed the reports he sent to BMO were accurate, despite Lee's involvement. The data that BMO hasn't produced yet will help validate Cassidy's "belief".

This is probably also a good point at which to mention that I have a vested interest in this case as I am an Optionable shareholder. My interpretation of events is most likely not shared by BMO or the Federal Prosecutors. Given my bias, here is my highly opinionated and only slightly educated view of BMO’s “struggle” to produce this data:

1) There must be a lot of data. It seems like BMO is working through a “Mountain of Data”. If I were to see samples of this data I probably wouldn't know how to interpret it. What I do know is that the sheer volume of it suggests to me that BMO had *A LOT* of their own data about the value of the portfolio that Lee traded on their behalf.

2) I believe that the twice monthly reports from Optionable consisted of a single page that someone at Optionable faxed over to someone at BMO’s Back Office. For the sake of argument, lets err on the side of caution and say the reports were a few pages long. They were still at best an overview - a snapshot - an estimation.

3) So…. what we’re looking at is BMO with a “Mountain" of their own proprietary data and they are asking us to believe that instead of climbing this "Mountain of Data" they safeguarded their multi-hundred-million dollar High-Risk investment with a brief twice monthly report from a tiny brokerage firm that they knew received a huge portion of their annual revenue from the very same BMO trader whose valuations were supposed to be under scrutiny here.

4) Now, I can get behind the concept that a brief report is more manageable to digest than a "Mountain of Data". And I can even give a little ground and say that it seems like BMO didn't have a good grasp of their "Mountain of Data". So, perhaps there could be some truth to their claim that they were somewhat dependent on reports from Optionable as a high level overview. But..... ummm…. BMO is a huge multi-national bank, right? They had hundreds of millions of dollars in sketchy high risk investments in play here, right? They had been involved in this specific high risk market for over a decade and they've had problems with previous trader's valuations too, right? So, when they got hit with a huge trading loss in 2007, rather than facing the music with their shareholders, they ran off and blamed some easily scapegoated tiny brokerage rather than admit that their own Controls and Risk Management had failed. To spare themselves some bad publicity, BMO detonated a nuclear bomb on Optionable's business, poisoned their marriage with NYMEX and triggered a Federal Criminal investigation against some poor schmuck with an unrelated prior criminal record. Optionable's business is dead, they're fighting a messy "divorce" and Kevin Cassidy is looking at jail time, all for the "crime" of sending BMO what may well prove to be ACCURATE reports. Well...... I can’t get behind that.

Side note:

Despite CMEG/ NYMEX getting a pass on the Oral Arguments scheduled with Judge Daniels today, CMEG/NYMEX will be back for a May 16th appearance. The next conference with Judge Daniels and the Bank of Montreal will be on May 31.

Sentencing Delay Stalls Cassidy Deposition

(photo: Justice takes a breather. Statue outside the Federal Courthouse in NYC.)

December 20 Civil case conference with Judge Daniels

Note: audio recordings are not permitted in the court house, so I am relying on my own handwritten notes. I am not a lawyer and may have misunderstood some statements made during the conference. Corrections to these notes by any persons who attended this conference are welcome. Send comments to traderelvis@gmail.com

Cassidy Status:
Kevin Cassidy was scheduled to be sentenced on December 15th. Cassidy's lawyer Lawrence Gelber told the court that sentencing will now be on January 31st. Gelber said that the new date was set by the government and was not at the request of Cassidy.

The expectation is that there will be a 30 to 60 day window between when Cassidy is sentenced and when he goes to jail. During this time Cassidy will be deposed (asked questions under oath) and allowed to speak, for the first time, about the business rules that existed between Optionable and the Bank of Montreal defining how pricing information was to be shared between Optionable and BMO's back office. Judge Daniels expressed his personal doubt that Cassidy would have anything game-changing to say but supported the process by which Cassidy would be sentenced first and deposed later.

[Personal note: I have always doubted BMO's version of events as presented to BMO's Shareholders and Industry Analysts at their 2007 press conference and have been waiting for four years to hear Cassidy's version of events. Unlike Judge Daniels I'm thinking that Cassidy's deposition will reveal a credible alternate interpretation of the admitted actions taken by Lee, Cassidy and BMO's back office that will poke holes in BMO's publicized interpretation that scapegoated Cassidy to mask their own massive losses on excessive risky investments.]

First Up: CFTC
Eugene Smith of the CFTC reported that the CFTC recently finalized a Consent Order with Optionable and O’Connor and that the CFTC expects to reach a similar outcome with Cassidy. Lawrence Gelber said that he needs to wait until after Cassidy is sentenced, before having further discussions with either the CFTC or the SEC. No one from the SEC attended the conference. Marni Rae Robin stated that O’Connor has not settled with the SEC.

Next Up: CMEG / NYMEX
Daniel Pollack said that CMEG filed a motion for Summary Judgment and anticipates an answer from Nordlicht and Cassidy by January 18th. Pollack's position is that when Nordlicht, Cassidy and O'Connor sold NYMEX a 19% stake in Optionable, a warantee was broken because Optionable did not disclose certain alleged criminal acts in their SEC filings, even though the acts had not yet been alleged when the documents were filed. Several Defense lawyers jumped up simultaneously, outraged, to respond while Pollack was talking.

Judge Daniels told both Gottlieb/Nordlicht and Gelber/Cassidy to submit documents to him as to why CMEG’s request for a Summary Judgment is premature – otherwise he expects them to file an answer by January 18th. The problem here is that CMEG wants their motion answered BEFORE Cassidy is deposed.

And Then: BMO
Anne Beaumont's update covered 1) Pleadings 2) Discovery and 3) Document Production. Beaumont said that document production should be done by the end of February. She suggested that Cassidy’s deposition should happen after document production is completed. [personal note: document production seems to be putting a strain on BMO and it was not clear to me why this is the case, or what its relevance is going forward. I feel like I did not fully grasp parts of Beaumont's update]

Norton (for Optionable) asserted that he wants BMO trader David Lee deposed during this time as well. Beaumont clarified that she is not representing Lee and was not sure when Lee will be sentenced. Judge Daniels said that he would expect Lee’s deposition to happen within 30 to 60 days of Lee’s sentencing.

Regarding Joseph Saab of MF Global
Owen Pell wants Saab’s portion of the case stayed (halted) while MF Global’s bankruptcy is figured out. Pell is waiting to see if MF Global’s insurance will pay Saab’s legal fees, because if it doesn’t Saab may need to find another lawyer. Judge Daniels said that he will not halt this case himself, but he would honor such a request from the Judge handling the MF bankruptcy if such a request were made.

Next conference March 1, 2012

Plaintiffs Present: CFTC, Bank of Montreal, CMEG / NYMEX
Plaintiffs Absent: SEC
Defendants Represented: Optionable, Ed O’Connor, Mark Nordlicht, Kevin Cassidy and Joseph Saab

Plaintiffs:
CFTC: Eugene Smith
BMO: Anne Beaumont
CMEG: Daniel Pollack

Defense:
Nordlicht: Jason Gottlieb
Cassidy: Lawrence Gelber
O’Connor: Marni Rae Robin
Optionable: Michael Norton
Saab: Owen Pell

Hook.Line.Sinker

The following story is fiction. Any resemblance to any persons either living or dead is purely coincidental.

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So let’s say there is this company in Japan called the Bank of Marine Organisms (BMO for short). They are the 4th largest fish processing company in Japan. They buy fish, they sell fish, they warehouse fish and they mortgage fish inventories.

The Bank of Marine Organisms also trades Fugu. Fugu is a tasty fish that if cooked incorrectly will kill you. The Japanese government strongly regulates Fugu and only allows carefully trained chefs to prepare it. The livers of the Fugu fish are the most lethal part of the fish, but are also reported to be the tastiest. Like any natural product, Fugu has an expiration date past which it can not be sold.

The Bank of Marine Organisms is a publically traded company. They don’t hide the fact that they deal in Fugu, but they downplay it. Instead, they present themselves to their shareholders as a cut and dried fish operation. Even though Fugu represents less than 1% of the fish BMO sells by volume, it generates a much larger percent of their total profits.

Fugu traders get special treatment at BMO, but nothing compared to the elite traders who trade Fugu livers near their expiration date. These traders ‘swim’ in highly profitable, yet highly toxic waters where a highly regulated precious commodity is on the brink of becoming worthless.

David Eel was one such trader and he was good at his job. The market for near expiration Fugu livers is so small, and Eel’s influence in it was so large, that Eel was able to set the market prices. Things went on this way for a number of years, David Eel made a lot of money for BMO and in turn BMO rewarded David Eel with a huge salary and bonuses.

But nothing so risky runs smoothly forever. A large Fugu hedge fund, aMerInch, collapsed and the market still hadn't fully recovered from the stench caused by EnRoe. The Securities and Exchange Commission was sniffing around fish trader's financial reports, and it was just a bad time to be trading Fugu.... let alone near expiration Fugu liver. David Eel's influence weakened and he was no longer able to make his prices stick in the marketplace.

BMO was worried because they were looking at Eel's huge inventory of near expiration Fugu liver – and over a million dollars worth of the stuff was expiring daily.

Without David Eel’s ability to set and enforce prices, BMO had to dump a lot of their near expiration Fugu livers at a loss. They had some explaining to do. They knew that with the amount of blood they were spilling into the waters Government sharks were gonna be circling.

In an attempt to distract the Government and their own shareholders, BMO fired David Eel and repackaged his diminished influence in the market instead as a fraud. BMO's spin was that Eel had been lying to them when he reported the value of his near expiration Fugu livers inventory rather than saying that Eel had previously been able to set market market prices and now he wasn't. After all, this strategy had worked for them several years earlier when they fired Eel's predecessor under similar circumstances.

Luckily it turned out that David Eel traded a lot of his near expiration Fugu livers through a small brokerage firm called Oceanable. Oceanable was also a publically traded company and its CEO had a public, but not commonly known criminal record. This made Oceanable an easy scapegoat. BMO held a press conference and spun their conspiracy theory which blamed reports from Oceanable based on Eel's valuations as a cause of their losses on near expiration Fugu livers.

When the criminal record of Oceanable’s CEO, Kevin Bassidy was reported, the press, shareholders and even Government agencies swallowed BMO’s story: Hook, Line and Sinker. "Oh, I get it now", came the collective sigh of relief, "there was a Criminal involved - that explains everything". Oceanable’s CEO was arrested and eventually, years later, took a plea deal.

The irony is that Oceanable's reports actually brought more transparency to the near expiration Fugu liver trading market than was previously possible. The toxicity levels were accurately reported and expiration dates were accurately tracked. The only ‘crime’ that happened was that Oceanable accurately reported the valuation of David Eel’s near expiration Fugu livers during the period of time that Eel controlled the market.

What Would Mark Nordlicht Do?

The underlying premise of this blog is that I stink at picking stocks. See those birds flying away in the upper right hand corner of this page? You can think of those birds as your investment dollars flying away if you invest the way I do.

But recently, someone with a better track record than me proclaimed to the world (as well as to the SEC) that he thought Optionable shares were undervalued. That someone is Mark Nordlicht.

Who is Mark Nordlicht?

* One of the founders of Optionable

* Operates a hedge fund known for seizing opportunities others miss.

* Is represented by lawyers who have studied the BMO and NYMEX lawsuits

* In June put $1.5 million on the table in a Tender Offer to buy Optionable outright

* As a result of the Tender Offer Nordlicht is once again an Optionable Insider (owns more than 10% of the company)

* Unlike fellow Optionable founder Kevin Cassidy, Nordlicht does not have to “bite his lip” out of concern for a criminal indictment

* Has the money needed to defend Optionable at trial

Here is a link to a more complete bio of Mark Nordlicht

Here is a link Mark Nordlicht's portfolio performance with Platinum Management

On August 15th Kevin Cassidy took a plea on one count in the criminal case against him. So far, everyone is keeping very quiet about what happens now. What WILL Mark Nordlicht do?

Pssst..... The Ex-Con Did it.

He did what? Kevin Cassidy pleaded guilty today (8/15) to one count in the criminal case against him. Statute 18 U.S.C. § 371 - which is the general conspiracy statute.

In my mind there are still a lot of open, unanswered questions - but - I think it is also important to admit that the game is different now. I have no insight into what contingency plans have been put in place for this outcome - but it would be my assumption that the lawyers on both sides are figuring out what to do next in the civil cases.

Federal guidelines calls for a 30 to 37 month prison term. An interesting coincidence is that by the time Cassidy appears for sentencing, by my count, it will have been 37 months since he was indicted. (November 13, 2008 to December 15, 2011 = 37 months) (in effect doubling the time Cassidy's life will be impacted by taking this plea - if you add his house arrest time to the maximum sentence. )

Links to some press clips:

Reuters:

http://www.reuters.com/article/2011/08/15/us-bankofmontreal-optionable-plea-idUSTRE77E4JL20110815

Bloomberg:

http://www.bloomberg.com/news/2011-08-15/ex-optionable-chief-kevin-cassidy-pleads-guilty-to-conspiracy-in-new-york.html

Worth Noting: It is true that Cassidy had a previous criminal record, and it is true that he did not disclose it in SEC filings. What some reporters keep missing is that back in 2008 Judge Kaplan ruled that Cassidy's criminal past did not need to be disclosed in SEC filings.

Here are some press clips that avoid dredging up Cassidy's previous criminal record.

The Terra News quoted Chad Bray of the Wall Street Journal as saying that Cassidy admitted in court that he failed to provide independent quotes regarding the value of Bank of Montreal's natural-gas options positions and that he knew this was wrong at the time.

http://www.theterranews.com/content/?p=46090

The Globe and Mail (Canadian)

http://www.theglobeandmail.com/globe-investor/guilty-plea-in-bmo-trading-scandal/article2130042/

Forbes:

http://www.forbes.com/sites/billsinger/2011/08/19/guilty-pleas-in-bank-of-montreal-natural-gas-portfolio-pricing-scam/

A Brief Description of the Case: USA vs. Kevin Cassidy

To date in this blog I have been offering my opinions about a wide range of topics involving the company called Optionable. My opinions are also influenced by my ownership of common stock of Optionable. Today I am going to share a brief description of the case as seen by Kevin Cassidy's Defense team. This description is what the Defense proposes be told to prospective jurors as a part of the Jury Selection process.

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BRIEF DESCRIPTION OF THE CASE

Kevin Cassidy (the “Defendant”) is the former chief executive officer of a company called Optionable Inc. (“Optionable”), which was based in New York. Optionable was a commodities brokerage firm, which means that it brokered – or acted as the “middle man” – between traders who wanted to buy and sell commodities contracts. Commodities are goods like gold, coffee, natural gas and other forms of energy. Optionable focused on energy commodities, and received a commission for each transaction it brokered. Optionable often acted as a broker for a type of energy contract called an “option.” An option in the commodities market is a contract granting its owner the right to buy or sell a commodity at a certain price on a later date.

One of Optionable’s largest clients was the Bank of Montreal (“BMO”). BMO is a Canadian bank that has a division in New York which trades, among other things, natural gas options. BMO paid Optionable to act as “middle man” for these options. Until mid-2007, the head energy trader at BMO’s New York Office – that is, the person in charge of deciding which natural gas options to buy or sell – was a man named David Lee. As part of his job, David Lee was required to provide daily valuations for every investment he was making for BMO, including the options in his natural gas portfolio. At least once a month, a separate department at BMO conducted an independent verification of the valuations Lee provided. For part of this independent verification, BMO claims it relied on pricing data provided to it by Optionable.

The Government has charged the defendant, Mr. Cassidy with three things arising out of Optionable’s relationship with BMO. David Lee is not a defendant in this case. First, the Government has charged Mr. Cassidy with conspiring with David Lee to subvert BMO’s independent verification of Lee’s valuations. Under the Government’s theory, Lee and Mr. Cassidy agreed that Lee would send Mr. Cassidy pricing data for natural gas options, and that Mr. Cassidy’s company, Optionable, would then send this data back to BMO, without telling BMO that the data originated with its employee, David Lee.

Second, as the Chief Executive Officer of Optionable, Mr. Cassidy was responsible for signing each of Optionable’s public filings submitted to the U.S. Securities and Exchange Commission (the “S.E.C.”). The S.E.C. is the government regulatory agency whose job it is to regulate the securities industry, which includes commodities traders and brokers. The Government asserts that Optionable should have revealed in those public filings that Mr. Cassidy was conspiring with David Lee to defraud BMO. So the Government has also charged Mr. Cassidy for having failed to disclose his alleged conspiracy with Mr. Lee in the reports Optionable filed with the S.E.C.

And third, the Government alleges that Mr. Cassidy failed to reveal the alleged conspiracy with David Lee in negotiations with a company called NYMEX, when NYMEX purchased an ownership interest in Optionable.

Have any of you here heard about this case or know anything about it based on this short description? If so, please raise your hand now.

This trial is about to begin because Mr. Cassidy denies that he committed any crimes. Mr. Cassidy has pleaded not guilty to the charges against him and has asked for a trial by jury. He is presumed to be innocent of all these charges until and unless the government proves the charges beyond a reasonable doubt.