(Bloomberg) --Glen Point Capital co-founder Neil Phillips is the one going on trial on charges that he manipulated the foreign-exchange market on Dec. 26, 2017, but the former hedge fund executive is hoping the jury pays more attention to his alleged victim: Morgan Stanley.
Phillips, whose trial begins Monday in Manhattan federal court, is accused of defrauding Morgan Stanley as the counterparty on a $20 million option pegged to a "barrier" exchange rate between the U.S. dollar and South African rand. A guilty verdict for Phillips, who allegedly directed $725 million in trades to hit that rate, could have a chilling effect on the trading practice known as barrier chasing or defending.
Prosecutors had unsuccessfully sought to keep Morgan Stanley's identity out of the trial, highlighting their concern that jurors would be distracted by the bank's own conduct and question whether it was actually hurt by Phillips. In a Friday court filing, Phillips said the government needed to show the $20 million option was material to Morgan Stanley.
"Fraudulent schemes are those that trick or deceive," the defense lawyers said. "For that to be possible, the alleged victim must care enough about what the defendant is doing or saying to consider changing their behavior."
'Standard Industry Practice'
Prosecutors contend that materiality is not an element of the offense and that the jury must only find that the scheme was capable of affecting another market participant, even if that participant didn't lose any money.
Morgan Stanley declined to comment on the case.
The bank may not be the only one drawn into the case. According to a defense filing over the weekend, the prosecution intends to call witnesses from Goldman Sachs Group Inc., Bank of America Corp. and Barclays Plc. The witnesses weren't identified and it's unclear what they would testify about, but lawyers for Phillips asked the judge to bar them because the government disclosed them too late.
The trial, which is scheduled to start with jury selection Monday followed by opening statements Tuesday, is expected to last two weeks. Phillips faces a maximum sentence of 10 years behind bars if found guilty of commodities fraud.
Phillips's defense got a boost last week when U.S. District Judge Lewis Liman, who will oversee the trial, ruled that the jury could hear about Morgan Stanley's own dollar-rand trades, which the defense claims were a barrier defense. The judge also said Phillips could present evidence that barrier chasing and defending are common practices among foreign-exchange traders and put former JPMorgan Chase & Co. trader Andrew Newman on the stand as an expert witness for the defense.
"If barrier chasing and barrier defense are standard industry practice, then it is less likely that defendant's trades would deceive or have the ability to deceive," Liman said in his Oct. 10 decision.
To be sure, the jury could convict Phillips even if it thinks Morgan Stanley engaged in similar conduct. And a famously hard-charging trader whose fund had backing by George Soros and owned a nine-bedroom London mansion may not be an ideal candidate for jury sympathy himself.
'Trial Within a Trial'
But in arguing to bar evidence on Morgan Stanley, prosecutors expressed concern about "a trial within a trial," with "jurors deciding the case based on their views of how Morgan Stanley's conduct compared to the defendant's, rather than the law."
Casting sophisticated financial institutions as fraud victims has also been a concern in New York Attorney General Letitia James's asset-valuation suit against former President Donald Trump and will be a major issue for federal prosecutors when they put Archegos Capital Management founder Bill Hwang on trial for market manipulation in February.
Trump, who is on trial now in James's civil case, argued that his financial statements inflating his properties' values didn't matter because his lenders, primarily Deutsche Bank AG, knew to take them with a grain of salt and conduct their own appraisals. That case will be decided not by a jury but a judge who has already found Trump liable for fraud.
Hwang and former Archegos Chief Financial Officer Patrick Halligan are accused of deceiving banks including Morgan Stanley, Credit Suisse AG and Nomura Holdings Inc. into taking stock positions that lost them more than $10 billion when Archegos collapsed. Defense lawyers have made clear that they plan to cast the banks not as victims but as sophisticated players who knew the game, comparing them in one 2022 hearing to "Shaq and LeBron."
The case against Phillips focuses on a frantic one-hour buying spree of the South African rand that began in the waning minutes of Christmas 2017 and ended an hour later on Dec. 26, which is known as Boxing Day in the U.K. Two months earlier, Phillips had purchased the option at issue, which would be triggered when the rate fell to 12.50 rand against the dollar.
He purchased the option through an intermediary and didn't know it was sold by Morgan Stanley. Prosecutors claim his actions were motivated in part by the option's Jan. 2, 2018, expiration date.
In its indictment, the government cited several Bloomberg chat messages Phillips allegedly sent during his trades. "My aim is to trade thru 50," he said in one. "Need to get it thru 50," he wrote in another. Prosecutors claim the messages show his intent to manipulate the market.
A London-based derivatives trader, who asked not to be identified, said Phillips's activities seemed to reside in a gray area. Traders don't typically trade huge amounts of money with the goal of piercing a barrier but may make a push if the market gets close to the trigger point, the trader said. That's especially the case in relatively illiquid markets like the rand/dollar.
Phillips's rand buying binge, executed largely by a Nomura trader in Singapore, succeeded in pushing the exchange rate to the barrier. Also through intermediaries, Glen Point and one of its clients collected the $20 million payout from Morgan Stanley.
According to defense lawyers, the bank, where Phillips was once a trader himself, would have known to hedge against the option. They claim Morgan Stanley's own Boxing Day trades showed it was trying to defend the barrier.
Big banks are no strangers themselves to accusations of misconduct in the currency markets. In 2015, JPMorgan, Citigroup Inc., Barclays Plc and the Royal Bank of Scotland Plc pleaded guilty to charges that they manipulated exchange rates and agreed to pay $2.5 billion in criminal penalties. Banks around the world have paid more than $10 billion in penalties for misconduct in the currency markets since regulators began cracking down more than a decade ago.
The case against Phillips and Glen Point is part of a larger push to take on questionable trading practices by U.S. prosecutors and regulators, said Andrew Verstein, a law professor at University of California, Los Angeles. "Commodities and FX used to be a place where defendants could stretch the law with a high degree of confidence and they'd be okay," he said.
Retail Investors
But Verstein pointed to the surfeit of cases in recent years charging traders over "spoofing" tactics. Five former precious-metals traders at JPMorgan and Bank of America Corp. have received prison sentences for spoofing since the beginning of 2023.
Though the defendants in trading cases typically try to argue that they are interacting with sophisticated parties who often engage in the same practices, London-based foreign-exchange consultant Thomas Stolper, the former head of global currency strategy at Goldman Sachs Group Inc., said the influx of retail investors into foreign exchange markets warrants government oversight and enforcement.
"I don't think the average retail investor is aware of the risk when they have a position on over Christmas and they get stopped out," Stolper said.
