The recent US Appeals Court decision in USA v Connolly and Black (decided January 27, 2022), has after careful review- but then without hesitation, acquitted 2 former Deutsche Bank (DB) traders on all counts, who had previously been convicted of “wire fraud” in breach of United States Code U.S.C 1343 and attempted fraud and conspiracy under U.S.C. 1349, in connection with their Libor Panel Interest Rate Submissions, in the period up to 2011.The US Code wire fraud section provides that: “Whoever, having devised or intending to devise any scheme or artifice to defraud, or for obtaining money or property by means of false or fraudulent pretences, representations, or promises, transmits or causes to be transmitted by means of wire, radio, or television communication in interstate or foreign commerce, any writings, signs, signals, pictures, or sounds for the purpose of executing such scheme or artifice, shall be fined under this title or imprisoned not more than 20 years, or both”.Meanwhile the “Instructions to BBA Contributor Banks”, including DB, at the relevant time stated that: “An individual BBA Libor Contributor Panel Bank will contribute the rate at which it COULD borrow funds, were it to do so by asking for and then accepting inter-bank offers in REASONABLE MARKET SIZE just prior to 1100” London time. N.B. There was no explicit reference to or prohibition at that point in the BBA Libor Panel instructions against any panel bank discussing rate fixings with its own traders or taking note of its own trading positions.At the original trial in 2018, a US jury had considered a small number of occasions where either Connelly or Black had asked for trading desk information to be fed into DB’s Libor rate submissions (for particular tenors in USD Libor) to reflect, accommodate and benefit their own traders’ positions, and the jury duly convicted them of “wire fraud” and conspiracy and attempt. The prosecution expert had testified that: “There was always an understanding that the panel banks would submit the one best estimate of the true borrowing cost they had.” Furthermore the prosecution had argued that: “You borrow at the lowest rate. There’s no range” i.e. postulating a One True Rate Theory for each Libor submission by each bank. The government summarized the charges against the traders in simple slam-dunk terms for the jury as follows: “They took what would otherwise have been an honest submission, they changed it and they dishonestly sent the rates that benefitted the trading positions.”However subsequent analysis by the US Court of Appeals for the 2nd Circuit, of the actual Libor pricing practices and context at DB showed a totally different picture. Rather than one system producing one automatic Libor rate per tenor and currency, each trader working with interest rates and interest rate derivatives had their own customised interest rate analysis and prediction systems, some highly complex. Different bespoke and evolving spreadsheet models were being used with automatic and volatile live market data feeds (no doubt including traded Libor indexes changing second by second) plus a range of manual inputs reflecting additional information, internal ALM asset and liability management type order flow and pricing signals to and from other desks at the same bank, and additional daily market information from c.5 external interest rate brokers. Qualitative judgment was routinely used by DB’s Libor submitters on each day to blend together all this information to get a reasonable result, for each tenor relative to that currency’s Libor yield curve and previous fixings and published panel submissions. In fact the Appeals Court analysis shows just how much useful market information and data was actually being considered and blended together by banks on a daily basis in their Libor panel submissions. Other DB traders with NPA Non Prosecution Agreements and giving evidence for the government testified that different rates would be available from different counterparties in the same tenor and currency for different sized deals within the broad Reasonable Size range. By implication there were always a range of rates for any tenor and currency at which a bank like DB could hypothetically trade and so “The government’s [failure] to produce any evidence that any DB Libor submissions that were influenced by the bank’s derivatives traders were not rates at which DB could request, received offers, and accept loans in DB’s typical loan amounts” meant that the government had “failed to show that any of the trader-influenced submissions were false, fraudulent or misleading.” Furthermore the government’s attempts to get the jury to consider or substitute in the words: “would”, “should” or “should not” instead of the operative word “could” in the BBA Libor Panel instructions were not relevant.This ruling should come as no surprise to any financial markets practitioner who has watched the real time flow of market data and orders in financial markets or indeed to any statisticians or financial econometricians who observe the volatility and distribution and time series behaviour of interest rates. The idea that a typical sub-basis point change in a Libor quotation, at a trader’s request, would move the rate from one that a bank could borrow at to one that a bank could not borrow at is ridiculous and should have been dismissed with appropriate independent expert evidence immediately. Moreover the whole Libor panel rate fixing estimation process itself only made logical sense on the basis that there was a broader trading range and range of uncertainty and volatility about the rates at which very similar banks could borrow at any point from the broader market. Additionally the Libor panel data truncation process, meant that any extreme outliers were automatically excluded from having any direct effect at all on the fixing rate calculations.What the Connolly and Black Appeal Decision implies and confirms is that the fact alone that any Libor panel submission included adjustments or tweaks for that bank’s own trading positions, is not prima facie evidence at all that the submission rate was factually incorrect or false within the Libor panel submission rules. The same argument could also be extended to some lesser degree to cases based on Libor and interbank collusion. Ironically, this belated decision and vindication for Connolly and Black, also comes too late to help save Libor itself, which is being systematically decommissioned post 2021, because of its purported panel fixing problems, and just at the time of a secular increasing global interest rate business cycle, and now the Russian sanctions shocks, when the forward looking nature of Libor fixings and interest rates would be most economically helpful for global floating rate lenders and borrowers
