SEC Charges Banker, Brokerage Execs. With Fraud

Nov 19 2008 | 10:58am ET

The Securities and Exchange Commission yesterday charged four individuals for overvaluing the commodity derivatives trading portfolio at Bank of Montreal and inflating BMO's publicly reported financial results. 

The defendants include a former senior derivatives trader at BMO and the top two senior executive officers of Optionable, a publicly traded commodities brokerage firm. The SEC alleges that David Lee, formerly the managing director of BMO's Commodity Derivatives Group, fraudulently overvalued BMO's portfolio of natural gas options by deliberately “mismarking” trading positions for which market prices were unavailable.

Lee recorded inflated values that were then validated by Optionable, which held itself out to BMO and the public as a legitimate provider of independent derivatives valuation services. Lee also allegedly schemed with Optionable's CEO Kevin Cassidy, its president Edward O'Connor, and Optionable broker Connor to have the firm simply rubber-stamp whatever inflated values Lee recorded.

After the scheme was discovered, BMO restated its financial results by reducing net income for the first quarter of its 2007 fiscal year by approximately C$237 million (US$204 million), which reflects a 68% overstatement of BMO's net income for that quarter.

Whatever It Takes

According to the SEC, BMO was Optionable's largest customer, and BMO trades accounted for as much as 60% of Optionable's commodity brokerage business. Lee's trading accounted for virtually all of BMO's business with Optionable. As a result, Optionable's management, led by Cassidy, allegedly was willing to do whatever it took to keep Lee satisfied. When market prices were unavailable, BMO's risk management personnel sought to verify the accuracy of BMO's commodity derivatives traders' valuations by obtaining supposedly independent valuations for those positions from one or more third parties.

As it turned out, Optionable was the primary source of the third-party quotes that BMO used to validate Lee's marks. Lee allegedly provided his marks directly to Cassidy or Connor, who then simply forwarded his marks virtually unchanged to BMO's risk management department as if they were Optionable's independent quotes. At first, Lee allegedly used this "u-turn" scheme to boost his trading profits and incentive compensation, but in 2006, the market turned against Lee and he used the scheme to hide substantial trading losses.

In May 2007, BMO concluded that due to the Optionable scheme and other positions that Lee had also mismarked, Lee's trading book was overvalued by an aggregate total of C$680 million (US$553 million) since the beginning of BMO's fiscal year ended Oct. 31, 2006.

On May 9, 2007, one day after BMO announced that it had placed Lee on leave and suspended its business relationship with Optionable, Optionable's stock price fell almost 40% from $4.64 to $2.81 per share, and dropped to below 50 cents per share one week later after Cassidy's prior criminal record was disclosed in press reports.

In connection with his guilty plea, Lee agreed to pay a total of $4.41 million in forfeiture.

The SEC is seeking a permanent injunction against future violations, disgorgement of ill-gotten gains plus prejudgment interest, and civil monetary penalties for the other defendants. The complaint also seeks an order barring Cassidy and O'Connor from acting as officers or directors of a public company.

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