Commodity Futures Trading Comm'n v. Gorman

587 F.Supp.3d 24

COMMODITY FUTURES TRADING COMMISSION, Plaintiff,

v.John Patrick GORMAN III, Defendant.

21 Civ. 870 (VM)

United States District Court, S.D. New York.

Signed February 28, 2022

Candice Aloisi, Devin Michael Cain, Roby Stephen Painter, Jr., James Gardner Wheaton, Gabriella Marie Geanuleas, U.S. Commodity Futures Trading Commission, New York, NY, for Plaintiff.

Sean Hecker, Alexandra Conlon, Justin Richard Horton, Michael Ferrara, Shawn Geovjian Crowley, Kaplan Hecker and Fink LLP, New York, NY, for Defendant.

DECISION AND ORDER

VICTOR MARRERO, United States District Judge.

Plaintiff Commodity Futures Trading Commission ("CFTC") brings this action asserting violations of the Commodity Exchange Act ("CEA") and the CFTC's regulations promulgated thereunder. (See "Complaint" or "Compl.," Dkt. No. 1.) Currently before the Court is defendant John Patrick Gorman III's ("Gorman") pre-motion letter, dated May 21, 2021, which the Court construes as a motion to dismiss the Complaint under Federal Rule of Civil Procedure 12(b)(6) (" Rule 12(b)(6)").¹ (See "Motion" or "Mot." Dkt. No. 14.) On June 3, 2021, the CFTC filed a letter opposing the Motion. (See "Opposition" or "Opp'n," Dkt. No. 16.) For the reasons stated below, the Motion is DENIED .

I. BACKGROUND

A. FACTS ²

From February 3, 2015, to present, Gorman worked as a managing director and U.S. dollar swaps trader on the swaps desk for a global investment bank ("Bank").³ In February 2015, Gorman worked for the Bank in Tokyo, Japan. The CFTC's claims against Gorman stem from an interest rate swap transaction ("Issuer Swap") between the Bank and a bond issuer ("Issuer"). The Issuer is an Asian public financial institution that issues bonds for lending and investment programs.

At its core, the Complaint alleges that Gorman manipulatively traded swaps to financially benefit the Bank in the Issuer Swap. As explained below, Gorman traded swaps that were used to assign a price to the Issuer Swap, and Gorman allegedly planned and timed his trades to push down the price of those swaps. And because the price of the swaps was depressed, Gorman's trades allowed the Bank to purchase the Issuer Swap for a lower price. In sum, the scheme was financially beneficial for the Bank in the Issuer Swap.

The CFTC also alleges that Gorman deleted messages on his personal phone regarding his trading when the CFTC began investigating Gorman's trading. By deleting those messages, Gorman violated the CFTC's subpoenas directing him to preserve information responsive to the subpoenas. Gorman then allegedly lied to the CFTC about deleting those messages in the first place.

1. Bond Issuance and Swap Transaction

The Bank and Issuer entered into the Issuer Swap in connection with a bond issuance ("Bond Issuance") by the Issuer. The Bond Issuance consisted of U.S. dollar-denominated bonds with a ten-year maturity and a notional value of $1 billion ("Bonds"). The Bonds paid investors a fixed interest rate ("Bond Coupon"). According to the CFTC, the Bond Issuance exposed the Issuer to interest rate risk because prevailing interest rates would fall over the ten-year life of the Bonds. The Issuer intended for the Issuer Swap to hedge its risk by having the Bank (through Gorman) "buy" a swap from the Issuer to offset the Bond Coupon.

According to the terms of the Issuer Swap, the Bank would pay the Issuer an amount equivalent to the Bond Coupon, which was a fixed interest rate. In exchange, the Issuer would pay the Bank an amount based on a floating (or variable) interest rate. Specifically, the Issuer would pay the Bank a floating interest rate of three-month U.S. dollar LIBOR⁴ plus an additional amount above this LIBOR rate. Since the Bond Issuance had a $1 billion notional value, the Issuer Swap had a commensurate notional value of $1 billion.

2. Pricing the Issuer Swap and Bond Issuance

The prices of the Issuer Swap and the Bond Issuance were derived from the prices of other U.S. dollar-denominated financial instruments. These other instruments included: (a) the price for ten-year U.S. Treasury securities, and (b) the price for U.S. dollar interest rate swap spreads with a ten-year maturity ("Ten-Year Swap Spreads"). A Ten-Year Swap Spread is a package transaction of (i) a ten-year U.S. dollar fixed-for-floating interest rate swap and (ii) ten-year U.S. Treasury securities. The price of a Ten-Year Swap Spread is based on the difference (i.e., the spread) in basis points ("BPS")⁵ between the ten-year U.S. Treasury yield and the prevailing interest rate on ten-year U.S. dollar fixed-for-floating interest rate swaps. Prices for the ten-year U.S. Treasury securities and Ten-Year Swap Spreads were displayed on a trading screen ("19901 Screen") operated by a swap execution facility broker firm ("SEF Firm"). The prices on the 19901 Screen reflected trading conducted at the SEF Firm, which had brokers located in the United Kingdom and the United States.

As addressed below, the CFTC alleges Gorman used information from the 19901 Screen to plan and time his trades of Ten-Year Swap Spreads for the purpose of depressing the price. Since the price of the Issuer Swap was based on Ten-Year Swap Spreads, Gorman's trading to depress the price of Ten-Year Swap Spreads would in turn push down the price of the Issuer Swap. This meant the Bank could pay the Issuer less for the Issuer Swap.

The Issuer Swap and the Bonds were priced during a conference call on February 4, 2015, at 1:15 a.m. Japanese Standard Time ("Pricing Call").⁶ The Pricing Call included a dry run during which participants practiced pricing the Issuer Swap and the Bonds before moving to live pricing. During the Pricing Call, the Bonds and the Issuer Swap would be priced using the current prices of ten-year U.S. Treasury securities and Ten-Year Swap Spreads quoted on the 19901 Screen. The Issuer and the Bond underwriters — one of whom was the Bank — would participate on the Pricing Call. And since the Bank was selected to provide the Issuer Swap, Gorman also participated by providing price quotes for Ten-Year Swap Spreads.

For the Pricing Call, Gorman arranged to trade through a broker ("Broker") at the SEF Firm's U.S. office. Although the 19901 Screen displayed prices for U.S. dollar interest rate products, the 19901 Screen did not display information about the demand at the SEF Firm for buying and selling these products. Information about the demand for these products could only be obtained by market participants, like the Bank, who traded through the SEF Firm. The CFTC alleges Gorman obtained information about the number of buyers and sellers of Ten-Year Swap Spreads during the Pricing by asking the Broker. The Issuer could not, however, obtain the same information because it did not trade through the SEF Firm.

3. Economics of the Issuer Swap

The prices quoted during the Pricing Call directly impacted whether the Issuer Swap was profitable for the Bank. As noted above, according to the Issuer Swap, the Issuer would pay the Bank a floating interest rate of three-month U.S. LIBOR plus an additional amount of interest. The price of this additional amount of interest incorporated the price of Ten-Year Swap Spreads displayed on the 19901 Screen. This meant price fluctuations in Ten-Year Swap Spreads displayed on the 19901 Screen made the Issuer Swap more or less profitable for the Bank. Put simply, the CFTC alleges that if the price of Ten-Year Swap Spreads declined on the 19901 Screen, then the Issuer would pay the Bank a higher interest rate, which makes the Issuer Swap more profitable for the Bank.

Although the Issuer Swap offset the Issuer's interest rate risk, that risk essentially shifted to the Bank when it bought the Issuer Swap. The Bank could, however, hedge its risk by selling up to $1 billion in Ten-Year Swap Spreads. The CFTC alleges the Bank planned on selling some Ten-Year Swap Spreads to purchasers of the Bonds, which would automatically offset a portion of the Issuer Swap. Before the Pricing Call, Gorman estimated the Bank could sell $750 million worth of Ten-Year Swap Spreads, and therefore offset $750 million of the Issuer Swap. Gorman ultimately sold hundreds of millions of dollars’ worth of Ten-Year Swap Spreads.

In sum, the CFTC alleges Gorman had two ways to generate profit for the Bank through the Issuer Swap. First, the Bank could buy the Issuer Swap at the lowest possible price. This could happen if a lower price for Ten-Year Swap Spreads was displayed on the 19901 Screen during the Pricing Call. The CFTC alleges Gorman engaged in a scheme to lower the price of Ten-Year Swap Spreads for this purpose. The second way Gorman could generate profit for the Bank is if counterparties bought Ten-Year Swap Spreads from the Bank for a greater price than the Bank paid for the Issuer Swap. In this second method, selling Ten-Year Swap Spreads at a higher price is profitable because counterparties would be obligated to pay the Bank a fixed interest rate that is higher than the Bond Coupon, which was also a fixed interest rate. In other words, counterparties would owe the Bank more than what it had to pay for the Bond Coupon.

4. The Pricing Call

Turning to the Pricing Call itself, the Complaint begins with Gorman's conduct and statements in the hours preceding the Pricing Call. During that time, Gorman communicated with several individuals to coordinate the pricing of the Issuer Swap and his trades of Ten-Year Swap Spreads.

a. Hours Before the Pricing Call

On February 3, 2015, at roughly 10:15 p.m., Gorman contacted the Broker to coordinate his trading through the SEF Firm's U.S. office. The CFTC alleges that Gorman almost never traded through U.S.-based brokers at the SEF Firm. But Gorman explained to another trader on the Bank's swaps desk ("Swap Trader 1") that Gorman wanted to trade through the SEF Firm's U.S. office because it "had the screen" and he "only care[d] who can move the screen the quickest." (Compl. ¶ 29 (alteration in original).)⁷...