An ice storm, an email suggesting regime change and the mechanics of thinly traded futures markets have emerged as central points of contention in the market manipulation trial of one of the world’s biggest traders in financial derivatives.
Donald Wilson and DRW, the trading group he leads from Chicago, are fighting civil charges they distorted the price of an interest rate futures contract. They went on trial in a New York federal courtroom this week.
The proceedings are a rarity, as most charges of market manipulation are settled with the Commodity Futures Trading Commission, the main US derivatives regulator. Mr Wilson pushed back and this week found himself being questioned in a wooden witness box by a CFTC attorney and a judge. If he loses he faces fines and a potential trading ban.
Mr Wilson is a luminary in derivatives markets, having risen from a young trader in the Chicago Mercantile Exchange options pits to the head of one of the top proprietary trading firms, which bet their own capital and have widened their influence as banks take fewer risks in financial markets.
Wearing a conservative suit and blue tie, Mr Wilson at times sounded more like a professor than a trader as he tried to explain why DRW for months posted bids for an interest-rate futures product that no one else would hit. The CFTC alleges that DRW only entered the bids to artificially inflate the value of a large futures position it already owned.
“To my mind, that’s just Trading 101,” Mr Wilson said, referring to the number customarily given to introductory classes in US universities.
US District Judge Richard Sullivan became impatient. “This is not a tutorial. This is court,” he said on Thursday. As Mr Wilson was explaining how the Dodd-Frank financial reform of 2010 was changing futures markets, Judge Sullivan said, “I don’t want a lecture on Dodd-Frank.”
In a courthouse that has hosted some of the most famous trials in finance, the trial has attracted only modest attention. A scattering of reporters stretched out in the long benches reserved for press.
The lack of splash testifies to the unseen nature of derivatives markets even though their notional volumes surpass $1,000tn a year. Most ordinary investors do not trade futures and options, though the funds in which they entrust their savings might.
The futures contract at issue in the DRW trial was called Idex USD Three-month Interest Rate Swap Futures, a fledgling product listed by an exchange owned by Nasdaq. DRW spotted what it viewed to be a flaw in the contract’s design that made it trade at a cheaper price than fair value.
In the summer of 2010 it bought $350m worth of the futures from Jefferies, the New York investment bank, and MF Global, the futures broker that subsequently failed in late 2011. Jonathan Cogan, an attorney for DRW, said in court the two counterparties “apparently hadn’t done their homework” when they sold the mispriced futures.
Throughout autumn 2010, DRW waited for the price of its position to rise to true value, the CFTC said. It later started to inject bids electronically on to the exchange, which moved settlement prices higher and boosted the value of its $350m position.
The CFTC argues that DRW never intended for the bids to attract a seller. “It’s like they’re yelling into an empty trading pit,” said Daniel Ullman, a CFTC attorney.
CFTC lawyers repeatedly pointed to an email from a DRW researcher to Mr Wilson and colleagues that mentioned a shift from an “old regime,” in which a parallel swaps market determined settlement prices, to the “new regime” in which the price would be “DRW defined”.
DRW officials testified that they made the electronic bids because the exchange asked them to. As proof of DRW’s eagerness to trade, its lawyers cited a day in February 2011 when MF Global struck a deal to sell $250m worth more Idex futures to DRW.
But a massive ice storm had just paralysed Chicago to New York, preventing the paperwork from getting completed. Mr Wilson said MF Global, itself later sued by the CFTC over $1bn in customer funds that went missing after its collapse, reneged on the deal.
MF Global’s behaviour, Mr Wilson testified, “to me was insane”.
