Developments in FX and US Treasuries Litigation

An interesting week. Two developments emerged concerning possible behind-the-scenes activities in two of the largest markets – foreign exchange (FX) and U.S. Treasuries (bills, notes and bonds). 

The New York Department of Financial Services (NY DFS) fined Credit Suisse $135 million for FX wrongdoing. And plaintiffs in a class action alleging manipulation in the U.S. Treasuries market filed a new complaint with additional allegations.

ForEx

The NY DFS consent order presents its findings that Credit Suisse engaged in a myriad of transgressions in the FX market – including: 

• Efforts to manipulate prices around the “fix” and improper sharing of customer information with traders at other banks, e.g.: 
• "... Trader 1 discussed with Trader 4 an effort to “unload” ammunition. Trader 1 stated “get ready unload on nzd,” to which Trader 4 replied, “I am. Nearly hit it last time.” As the fix drew near, Trader 1, referring to an unidentified co-conspirator, remarked “if he can’t get it lower we may be in trouble.” After apparent success, Trader 1 remarked “come to poppa,” while Trader 4 retorted, “phew.” "
• Attempts to front-run customer orders, e.g.: 
• " In one instance in February 2013, a Credit Suisse trader, Trader 1, disclosed potentially confidential information obtained from the Credit Suisse sales desk about FX trading associated with a pending merger and acquisition: “I think there’s some lhs2 action today at the fix on the back of tht massive m+a . . . massive caveat, info is from sales desk . . . but 4 o clock. . . . 16 yrds . . . something to do with the equity leg is going thru today . . . that’s the reason they saying the spot will be done.” "
• Collusion with other banks to maintain wide bid-offer spreads
• Price manipulation on behalf of certain customers, e.g.: 
• " On September 7, 2012, a Credit Suisse customer (“Customer 1”) enlisted the assistance of a Credit Suisse trader, Trader 18, in seeking to push down the price of the U.S. dollar/Turkish lira pairing. Customer 1 asked Trader 18, “can you walk down usdtry for me pls.” Trader 18 replied, “Yeah, no problem.” Customer 1 then stated, “just offer 1 at like 72 . . . just walk it brotha,” to which Trader 18 replied, “No sweat.” Customer 1 cheered on Trader 18, saying “come on . . . just walk it,” to which Trader 18 replied, “Collapsado.” Apparently upon achieving success, Customer 1 stated, “thks [Trader 18] for walking it down . . . great job . . . you really shellacked it.” Trader 18 quickly replied, “pleasure.” "
• Abuse of last look via its electronic platform
• Deliberately triggering (and front-running) customer stop-loss orders

This last item is particularly noteworthy – not because Credit Suisse is the first to be accused of intentionally triggering stop-loss orders (it’s not), but because the bank apparently wrote an algorithm to calculate the likelihood of successfully triggering stop-loss orders that were potentially ripe for targeting.  In so doing, the bank seems to have systematically developed a system for deciding which stop-loss orders to target.

The penalty imposed by the NY DFS is the first FX-related regulatory fine imposed against Credit Suisse. In contrast, Swiss competitor UBS has settled with the CFTC, Federal Reserve, FINMA (Swiss regulator) and FCA (UK regulator), as well as class action plaintiffs in the U.S. and Canada, for a total of nearly $1.3 billion. 

U.S. Treasuries 

In the consolidated complaint, styled In Re Treasuries Securities Auction Antitrust Litigation (1:15-md-02673), plaintiffs indicate that they have evidence in hand, such as chats and emails, which shows bank traders sharing customer order information with traders at other banks (but by our reading they don't seem to have produced said evidence). 

According to the complaint: 

“Plaintiffs have obtained documents relating to the DOJ’s ongoing investigation, which confirm that such trader communications occurred. These materials include online chat transcripts in which the Auction Defendants shared the identities (often using code phrases) of their indirect bidder customers, the details of those customers’ order flow, and other private customer information.” 

Interestingly, plaintiffs have broadened the scope of the complaint, to include wrongdoing in the secondary market.  Plaintiffs allege, anew, that dealer banks have conspired to boycott trading platforms that would enable market participants to trade with each other on anonymous all-to-all platforms, such as eSpeed and Direct Match: the theory being that all-to-all trading platforms could be a threat to the status quo of dealer dominance of the secondary trading market, potentially putting dealer trading revenues at risk. 

The boycotting allegations are similar to those made against interest rate swap and credit default swap dealers in cases such as In Re Interest Rate Swaps Antitrust Litigation (1:16-md-02704) and Tera Group, Inc. et al v. Citigroup, Inc. et al (1:17-cv-04302).


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For more detailed coverage of these matters, visit our piece here.

Defending the Barrier

It’s been almost two years since the Federal Reserve fined six banks a total of $1.85 billion for misconduct in the FX markets.  Last week, Deutsche Bank joined the list, with the Fed fining DB $137 million. 

In this latest order, the Fed added a new form of misconduct, by DB, to its prior summaries of transgressions by the other banks – barrier running.  

Barrier running had never been part of the Fed's previous settlements, but the OCC did cite barrier in its settlements.  Here though, the Fed's language includes a new detail: not just the triggering of barriers, but also the defending of FX barriers.

Thus, not only might DB have regularly acted to trigger a market level that would hurt its trade counterparty (or client), but it may have actively worked to stop a level being hit to the degree that a movement in the FX pair would be harmful to the bank's pre-existing contractual exposures.

Barrier-running (and defending) by dealers is problematic: akin in some ways to front-running, dealers here would be taking advantage of their knowledge of (confidential) customer information, generally pursuant to private contracts the customer would have entered with the dealer: with barrier-running, dealers attempt to “knock out” customers from their FX exotic options positions; or in defending barriers, dealers would “knock in” and activate customers’ options.  

Importantly, dealers would be engaging in a form of market manipulation, steering the market for their peripheral benefit (here to take advantage of derivative contract exposures) as distinct from, say, simply trying to profit from a specific underlying instrument being mispriced. 

“Deutsche Bank’s deficient policies and procedures prevented it from detecting and addressing unsafe and unsound conduct by certain of its FX traders, including in communications by traders in multibank chatrooms, consisting of: ... discussions on trading in a manner to trigger or defend certain FX barrier options within Deutsche Bank, in order to benefit Deutsche Bank….” (per the Fed's C&D order, with emphasis added) 

The following table updates fines and settlements for FX misconduct pertaining to benchmark fixings (i.e. excluding “Standing Instruction” and “Last Look” settlements).  The total now exceeds $12.3 billion.

FX Settlements — New Admissions on Bank Misconduct

Another day, another FX settlement. What’s new? Well, actually a lot. The recent settlements, when you dig into them, provide a whole new array of material. First we will explore the background, and then we’ll get you to the new… 

The latest settlements between FX banks and regulators were filed on May 20. Five banks agreed to pay approximately $5.6 billion in fines to US and UK regulators relating to the rigging of FX rates, including several fix benchmark rates. JPMorgan, Citi, Barclays and RBS plead guilty to criminal charges for having “entered into and engaged in a combination and conspiracy to fix, stabilize, maintain, increase or decrease the price of, and rig bids and offers … in the foreign currency exchange spot market.” UBS avoided a guilty plea, and was only fined for breaking a prior non-prosecution agreement relating to LIBOR misconduct, as a reward for being the first to inform regulators of these FX activities. 

A Bloomberg news story in June 2013 provided the initial public information that there was a potential problem with FX benchmark fixes, particularly the WM Reuters London Fix. Since then numerous news stories and the November 2014 settlements with the CFTC, OCC, FCA (UK regulator) and FINMA (Swiss regulator) have described the communications between bankers at several major banks, conniving to rig FX benchmark rates -- including their use of group chats to share information on the fix trades that they would need to execute. These traders would communicate each other’s currency positions and customer orders for the upcoming fix and then determine the means to trade off of this information so that the banks could make profits at the expense of their customers. Some of the settlements provide examples of chat room conversations in which traders from multiple banks collude to manipulate the fix. 

This collusion at the London Fix is the focus of news reports and the regulators’ settlements with banks for good reason: fix trading constitutes a major portion of daily FX spot trading; fix rates are used world-wide to price many widely-held assets including mutual and pension funds; collusion is illegal and easily shown to have occurred based upon chat room communications; and the names of the chatrooms (e.g., the Cartel, the Mafia), and the lingo used within, make for entertaining media. 

New Revelations 

New areas of misbehavior are revealed in the new set of settlements and pleas. There is much less awareness of these than the fix-specific misconduct, so we’d like to underscore some of the more egregious patterns of behavior. 

This time around, the New York State Department of Financial Services (NY DFS) gets in on the act as well, tagging Barclays with a Consent Order. The NY DFS sheds light on some areas that are not covered in other plea agreements or settlements. For example, it stipulates that “Barclays conspired with other banks in order to coordinate trading … coordinate bid/ask spreads charged.” [1] 

The DFS also highlights Barclays’ “misleading sales practices”[2] , as well as the fact that “The misconduct described in this Order was not confined to a small group of individuals; it involved more than a dozen employees, who acted with the knowledge and oversight of some senior desk managers, and spanned geographically across numerous countries.”[3]  Moreover, the DoJ and DFS agreements include broader time ranges of misconduct than some of the earlier settlements, such as the CFTC’s.[4] 

So…what other wrongdoings were these FX trading engaged in? 

Manipulation of Spot Market to Profit from Client Orders 

Clients leave orders with their FX banks to execute FX spot trades, in order to manage their risks from future spot moves. 

Banks have admitted to manipulating FX rates when near the order levels, in order to increase the banks’ profit at the customer’s expense. For example, banks admitted to “accepting limit orders from customers and then informing those customers that their orders could not be filled … when in fact the defendant was able to fill the order but decided not to do so because the defendant expected it would be more profitable not to do so….”[5]

Likewise, NY DFS notes that Barclays told “clients that their orders had been only partially filled, when in fact the FX Sales employees were holding back a portion of the fill as the market moved in Barclays’ favor….”[6]  

Providing Quotes with Dealer Markup to Clients Expecting to Hear “Direct Trader Quotes” 

On large trades, some clients insist on hearing quotes not from their salesperson (who might add a spread to a trader quote), but directly from the bank trader over a phone line. Clients would expect these to be market-based -- and not shaded in one direction based upon the direction of the client’s intended trade. However, bank traders shaded the quotes either based upon hand signals from the salesperson indicating the direction and the size of the markup to include, or based upon earlier agreements made between the two bank employees. 

On this count, banks admitted to “including sales markup, through the use of live hand signals or undisclosed prior internal arrangements or communications, to prices given to customers that communicated with sales staff on open phone lines….”[7]  

Disclosure of (Confidential) Customer Identities and Trade Activity to Other Market Participants 

Banks provided this information to other banks and even other customers, on both large fix and non-fix trades. According to the plea agreements, the banks disclosed “non-public information regarding the identity and trading activity of the defendant’s customers to other banks or other market participants….”[8]  

Trade Platform Provided Altered Rates to Certain Customers 

The settlements were unclear on the relationship between the platforms and the bank, but platform rates provided to certain customers were systematically favorable to the bank versus the unaltered rates. RBS engaged in “intentionally altering the rates provided to certain of its customers transacting FX over a trading platform disclosed to the United States in order to generate rates that were systematically more favorable to the defendant and less favorable to customers….”[9]  

Trading Ahead of a Corporate Transaction 

We find a new anecdote of RBS trying to move the currency rate ahead of a corporate transaction so as to favor the bank at the client’s expense. This is commonly known as front running. 

From the plea agreement: “… in connection with the FX component of a single corporate transaction, trading ahead of a client transaction so as to artificially affect the price of a currency pair and generate revenue for the defendant, and to affect or attempt to affect FX rates, and in addition misrepresenting market conditions and trading to the client….”[10]  

Manipulation of Emerging Markets Currency Pricing 

 “Barclays FX traders exchanged information about customer orders with FX traders at other banks…”[11]  For example, “a Barclays FX trader explicitly discussed with a JP Morgan trader coordinating the prices offered for USD/South African Rand to a particular customer, stating, … ‘if you win this we should coordinate you can show a real low one and will still mark it little lower haha.’”[12]  

Conclusion 

These regulatory investigations have uncovered several different means used by traders to increase bank profits to the detriment of their customers, including by “providing false and misleading information to customers and markets.”[13]  

As opposed to the FX market convention of adding a spread on each trade to generate bank profit (controllable by customer scrutiny of the rates), these investigations opened the window to the various layers of deceptive practices prevalent in the FX market, and the abuse of client confidentiality and trust. While the FX market has begun adjusting to the misconduct around the 4pm WM/R London fix, it is not yet clear whether banks have begun (internally) investigating some of the newly highlighted misbehavior. 

One additional feature of these settlements is the demand by regulators for additional compliance scrutiny of FX trading which will hopefully limit potential future misconduct. May we return all the stronger for it, and more robust! 

About the Author 

Jonathan Wetreich has spent 20 years in the foreign exchange markets, beginning on the buy side with the Treasury Group at Honeywell International. There he was responsible for managing the foreign exchange risk to this multinational firm, which included trading in spot, forwards and options. At Brown Brothers Harriman, a private bank, his sell side positions included consulting with the senior management of corporations to improve their foreign exchange risk management and execution. Jonathan also spent several years there on the foreign exchange trading desk, working primarily with asset management firms, as well as spending time as an FX strategist. Jonathan also assisted asset management firms in managing their passive hedge programs. Since 2012 Jonathan has been an independent consultant, primarily to corporations on matters of foreign exchange risk management. In addition, he has consulted on FX litigation and to organizations attempting to further their understanding of corporate hedge programs. Jonathan received an MBA from Columbia Business School.

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[1] NY DFS Consent Order, In the Matter of: Barclays Bank PLC, p.1

[2] NY DFS Consent Order, In the Matter of: Barclays Bank PLC, p.2

[3] NY DFS Consent Order, In the Matter of: Barclays Bank PLC, p.6 ¶14

[4] FCA “Relevant Period”: 1/1/2008 – 10/15/2013; CFTC “Relevant Period”: 2009 – 2012; FINMA “Period under Investigation”: 1/1/2008 – 9/30/2013; OCC “Relevant Period”: 2008 – 2013; Fed “Review Period”: 2008 – 2013; DoJ: 1/1/2008 and 1/1/2009 – 5/20/2015

[5] See for example: Plea Agreement USA vs JPMorgan Chase & Co. p.17 ¶13

[6] NY DFS Consent Order, In the Matter of: Barclays Bank PLC, p.16 ¶ 56

[7] See for example: Plea Agreement USA vs Citicorp p.16 ¶13

[8] See for example: Plea Agreement USA vs Barclays PLC p.18 ¶16

[9] Plea Agreement USA vs The Royal Bank of Scotland PLC p.17 ¶13

[10] Plea Agreement USA vs The Royal Bank of Scotland PLC p.17 ¶13

[11] NY DFS Consent Order, In the Matter of: Barclays Bank PLC, p.11¶33

[12] NY DFS Consent Order, In the Matter of: Barclays Bank PLC, p.11 ¶34

[13] NY DFS Consent Order, In the Matter of: Barclays Bank PLC, p.2