USD swaps trader says CFTC complaint against him is deficient
More than three months after the United States Commodity Futures Trading Commission (CFTC) filed a complaint against John Patrick Gorman III, accusing him of manipulation of the price of U.S. dollar interest rate swap spreads, the trader has responded to the complaint.
According to a letter filed by Mr Gorman’s counsel on May 24, 2021, the defense claims that the CFTC’s complaint is deficient.
“If the CFTC declines to amend or withdraw its Complaint, we will seek leave of court to move to dismiss it”, the defense lawyer says.
As FX News Group has reported, the CFTC complaint alleges that on February 3, 2015, Gorman III, a U.S. dollar swaps trader and managing director of a global investment bank (the bank is unnamed in the complaint), trading from Tokyo, Japan for a U.S. affiliate of the Bank, engaged in a scheme to deceive and to manipulate the price of U.S. dollar interest rate swap spreads published on a screen displaying prices from a swap execution facility broker firm (SEF Broker Firm) in the United States. Gorman engaged in this scheme in order to benefit the Bank in a separate interest rate swap transaction with a bond issuer, the CFTC says.
The Issuer entered into the interest rate swap transaction with a Japanese affiliate of the Bank in connection with a U.S. dollar-denominated bond issuance with a ten-year maturity. Both the Bond Issuance and Issuer Swap were priced on February 3, 2015, using a specific screen which displayed prices from the SEF Broker Firm (19901), including prices for U.S. dollar interest rate swap spreads with a ten-year maturity.
Gorman allegedly knew that the Issuer Swap would be more profitable to the Bank if lower prices for Ten-Year Swap Spreads were displayed on the 19901 screen during the pricing of the Bond Issuance and Issuer Swap. Thus, Gorman engaged in a scheme to deceive and to manipulate the price of Ten-Year Swap Spreads on a swap execution facility to maximize the Bank’s profit on the Issuer Swap, at the expense of the Issuer.
Under the terms of the Issuer Swap, the Bank, through Gorman, would be “buying” a swap from the Issuer (that is, paying a fixed interest rate to the Issuer) based on terms set during the pricing call. As a result, Gorman could generate profit for the Bank by “selling” swaps (that is, receiving a fixed interest rate) for more than the price the Bank was “buying” them from the Issuer.
Another way Gorman could increase profits for the Bank on the Issuer Swap was to “buy” the Issuer Swap at a lower price—which the Bank could do if a lower price for Ten-Year Swap Spreads was displayed on the 19901 screen during the pricing.
On February 3, 2015 Gorman arranged to trade through a broker who worked at the SEF Broker Firm’s U.S. office. As he explained to another trader at the Bank in a text message on his personal cell phone, Gorman traded through the Broker because at the time the Issuer Swap was pricing, the prices displayed on the 19901 screen were controlled by the SEF Broker Firm in the United States and Gorman wanted to trade through a broker who could “move the screen the quickest.”
Before and during the pricing of the Bond Issuance and Issuer Swap, Gorman knew that there was more buying than selling interest in Ten-Year Swap Spreads and knew that as a result, market prices for Ten-Year Swap Spreads had risen and were positioned to continue to rise. Due to the rising prices, Gorman’s supervisor, the head of the Bank’s U.S. Dollar swaps desk, advised Gorman to sell fewer Ten-Year Swap Spreads at the time of the pricing, because he thought they could sell more Ten-Year Swap Spreads at increasing profits after the time of pricing.
Gorman timed his trading through the Broker during the pricing to move the price of Ten-Year Swap Spreads down on the 19901 screen, in the opposite direction of where the market was moving. When Gorman stopped trading to move the price of Ten-Year Swap Spreads down on the 19901 screen, the price on the screen immediately rose and, for over 18 hours, did not return to the level to which Gorman’s trading had moved it for the pricing.
Gorman did not disclose to the Issuer that there were more bidders than sellers at the SEF Broker Firm, that market prices had been rising as a result of the heavy buying interest, or that the only reason a lower price was displayed on 19901 during the pricing call was because Gorman had sold Ten-Year Swap Spreads in order to move the price down. Gorman also did not disclose to the Issuer that he sold Ten-Year Swap Spreads during the pricing not because he legitimately wanted to sell at that price level at that time, but so the Bank could “buy” the Issuer Swap at a lower price, or that he was trading through the Broker in the United States because the 19901 screen was being controlled in the United States and thus his trading through the Broker would move the screen “the quickest.”
Gorman’s trading had the effect of moving the price of the Ten-Year Swap Spread down on the 19901 screen, and the manipulated price was used to price the Issuer Swap with the Issuer, resulting in a more profitable transaction for the Bank and a less profitable transaction for the Issuer.
The Complaint alleges that Gorman violated both the fraud and manipulation prohibitions of the Commodity Exchange Act by trading to hedge the risks of a contemporaneous swap.
According to Gorman’s response, the CFTC allegations do not satisfy Rule 9(b)’s heightened pleading requirements, and the Complaint fails to state a claim. The fraud allegations fail, the defense says, because Gorman had no duty to make any allegedly omitted disclosures to either his swap counterparty, JBIC, or his open-market trading counterparties. And the manipulation allegations fail because Gorman’s open-market hedging trades, which served a legitimate economic purpose, do not constitute manipulation as a matter of law.
Also, the defendant notes that the Complaint stands on weak ground where it alleges that he made material omissions “to other market participants” in the brokered voice markets for swap spreads. The CFTC does not allege that Gorman owed a duty to all “other market participants” trading Ten-Year Swap Spreads to disclose “the reason” for a global market price or his purpose in accepting another trader’s bid.
The Complaint alleges that Mr. Gorman manipulated the price of U.S. dollar interest rate swap spreads by accepting open-market bids for Ten-Year Swap Spreads to offset the risk of the issuer swap. The defense argues that the Complaint does not allege that Mr. Gorman’s open-market trades created an artificial price. And, according to the defendant, the complaint defeats its own claims by acknowledging the legitimate economic purpose of Mr. Gorman’s trades.
The defense further argues that the Complaint fails to sustain Count Two’s claim for attempted manipulation, which similarly requires allegations “that the accused acted (or failed to act) with the purpose or conscious object of causing or effecting a price or price trend in the market that did not reflect the legitimate forces of supply and demand.” Because the Complaint acknowledges that Mr. Gorman’s trades had the legitimate economic motive of “offsetting, in part, the $1 billion Issuer Swap,” they cannot constitute attempted manipulation, the defense concludes.
The lawsuit continues at the New York Southern District Court.