United States v Connolly and Black

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The counterpoint to Hayes and Palombo v R.

On 27 January 2022, the Second Circuit quashed the convictions of Matthew Connolly and Gavin Black, traders at Deutsche Bank, one of the 16 US dollar LIBOR panel banks for bank fraud and wire fraud in connection with US dollar LIBOR submissions by inducing co-workers to submit to false statements that could influence LIBOR rates, to increase their employer’s profits on existing derivatives contracts.

Those embarrassing emails

There are formal and informal interactions between individuals in any institution. JC has written elsewhere that, however much it might pain bank executives to acknowledge it, it is the informal ones that matter. These are the ones by which the bank engages its gears. These are subtle, nuanced, context-dependent, and require judgment, presence of mind and a holistic assessment of the situation as it presents itself, necessarily inchoate, still unfolding, with not all implications known. These communications are made in the absence of knowledge, in the face of uncertainty, in an attempt to get better clarity but, most importantly, prospectively: they deal with the unknown future.

It is the human dilemma that should they ever subsequently come to be scrutinised, these informal communications will be stuck fast in the ossified past. The causal chain is now known, the prevailing contingencies at the time of those communications have now crystallised, and we can review them with 20:20 hindsight.

There is a survivor bias at play here, too, in that if it bleeds, it leads: in that fossil record we will ignore the vast preponderance of dull, quotidian exchanges about workaday, businesslike things, but anything fruity will stick in the mind and bring closer scrutiny.

In this way are modern financial services employees short an ugly option: the compliance department is unlikely to dwell on your occasional acts of selfless humanitarian virtue.

There is in any case, a lesson here: Be careful what you put on the formal record. Seeing as you won’t always know what will outrage future generations, your best bet is to put as little as you can on the formal record. Financial crises have a habit of ignoring this rule. The LIBOR scandal is no exception.

Connolly and Black traded LIBOR-based products and were not responsible for LIBOR submissions. That was handled by two other employees: Curtler and King, who both also traded LIBOR derivatives, but who were responsible for Deutsche Bank’s treasury operation: borrowing cash from the interbank market and lending that money to DB’s other desks.

For a long time, the cash desk used its own internal offered rate to the trading desks, plus a spread, as DB’s LIBOR submission.

But, if the cash desk mispriced these internal loans, the DB trading desks would arbitrage the cash desk function, by over- or under-borrowing and hedging in the market. Therefore the cash desk would manually change items and spreads in their pricer, changing their internal rates and DB’s LIBOR submissions.

There were other inputs to the LIBOR process: as well as making manual adjustments King would also consult interbank cash brokers whom he believed had a view of where DB could borrow money.

Additionally, Connolly and Black would ask them to make submissions that would benefit DB’s derivative positions. They would say things like:

“WE WOULD PREFER IT HIGHER...WE HAVE ABOUT 15 BB 1MO RECEIVES”

“if possible, we need in NY 1mo libor as low as possible next few days....tons of pays coming up overall”

“Send an email to the cash guys in London, let them know which way around and how much you have, and then just let them do whatever they do.”

Finding

as set out in the Appeals Court judgment:

The court stated that “whether Deutsche Bank could have borrowed funds at a submitted rate is not dispositive of the falsity of its LIBOR submissions.” (emphasis in original). It ruled that the government was not required to prove “that Deutsche Bank could not have borrowed funds at a rate submitted to the BBA” in order “to establish the falsity of its LIBOR submissions,” and that “[a]s a factual matter, even if Deutsche Bank could have borrowed funds at a submitted rate, that would not prevent the submission from being false and misleading.” (emphasis in original). The court stated that even “evidence that Deutsche Bank could have borrowed funds at a submitted rate would not have rendered the Defendants’ statements truthful.” (emphasis in original).

Appeal

Connolly and Black argued that there was insufficient evidence to establish the elements of the counts of which they were convicted. The principal evidence adduced by the prosecution was expert testimony from one economist and three co-operating alleged co-conspirators.

In allowing the appeals, the court found the evidence was insufficient as a matter of law to permit a finding of falsity:

“Because we conclude, for the reasons which follow, that the evidence was insufficient to prove that the defendants caused DB to make LIBOR submissions which were false or deceptive i.e. to prove that they engaged in conduct that was within the scope of para 1343, we reverse defendants’ convictions.”

The Government had failed to adduce sufficient evidence that there was “one true interest rate” or that DB’s submissions took into account only the inputs to DB’s official LIBOR pricer. DB’s LIBOR submission had differed from the pricer even where there was no request from a trader.

The US Court’s interpretation of the LIBOR definition is starkly different from the UK Court of Appeal’s:

And in the [US] district court’s view, evidence that DB Bank “could have borrowed funds at a submitted rate would not have rendered the Defendants’ statements truthful.” … (emphasis in original). We disagree. The precise hypothetical question to which the LIBOR submitters were responding was at what interest rate “could” DB borrow a typical amount of cash if it were to seek interbank offers and were to accept. If the rate submitted is one that the bank could request, be offered, and accept, the submission, irrespective of its motivation, would not be false.

A series of hypotheticals

the government’s three cooperating witnesses ... testified that they knew it was “wrong”, “intuitively wrong”, for LIBOR submissions to take into account the DB derivatives traders’ existing positions. ... “because it would give Deutsche Bank an unfair advantage over its trading counterparties.” Yet none of the witnesses testified that DB could not have borrowed a typical amount of cash at the rate stated in any of DB’s LIBOR submissions. And contrary to the district court’s Rule 29 Opinion, whether DB “could” do so was the precise question to which the LIBOR submissions were to respond, and was thus the key to whether a given submission was false.

Later:

“Here, the government failed to show that trader-induced LIBOR submissions did not reflect rates at which DB could have borrowed. If the submissions did reflect rates at which DB could have borrowed, they complied with the BBA LIBOR Instruction, and the LIBOR submissions were not false.”

LIBOR “was created in the ’80s,” and LIBOR’s use as a reference point in interest-rate-based derivatives contracts became so popular that “trillions and trillions of dollars of contracts in notional value [have come to] depend on it.” (Tr. 128-29.) There can thus be no doubt that the BBA as an industry organization well knew that traders in interest-rate-sensitive derivatives are intently attuned to and concerned about LIBOR. Indeed, the BBA LIBOR Instruction expressly required submitters to use maturity dates calculated in conformity with “the ISDA Modified Following Business Day convention”.

See also

• United States v Connolly and Black judgment
• LIBOR rigging