On 23rd October, Mark Johnson, the former head of global cash foreign exchange trading at HSBC, was found guilty by a New York jury. The former British banker is the first person to be prosecuted and found guilty of fraud in relation to London-based foreign exchange manipulation.

His former employer, HSBC, is in settlement talks with US regulators and the Department of Justice (DoJ) over the issue, while former employees of Barclays, Citigroup and JP Morgan are awaiting trial in New York on similar charges concerning other alleged instances of FX manipulation in the London market.

After a month long trial, Johnson was convicted of nine charges of wire fraud and conspiracy, each carrying a maximum potential prison sentence of 20 years. Specifically, the charges related to him fraudulently profiting from a $3.5bn (£2.7bn) foreign exchange trade for UK-based Cairn Energy by front-running the deal.

Cairn had hired HSBC to convert the proceeds of an Indian asset sale from US dollars into sterling. Johnson was accused of devising a scheme to ramp up the price of a $3.5bn currency trade for Cairn. The DoJ alleged that the scheme involved exploiting confidential information supplied by Cairn to front run the deal in the currency markets - co-ordinating other traders to buy sterling before the trade - thereby making an $8m profit for HSBC at the expense of its client.

Jurors in the trial were played a tape recording of Johnson saying "Oh, f***ing Christmas" when he learned that Cairn had decided to go ahead with the trade. The defence case was that Johnson’s trading strategy was legitimate risk management designed to help fulfil the client’s order. Probably it would have been unassailable, save for the contemporaneous recordings and emails.

The use of pre-hedging is a common method to reduce risk when trading in the volatile US Dollar-Sterling currency pair (known as “Cable” to FX traders). Being able to differentiate this benign measure from front running, which takes improper advantage of a client’s forthcoming unexecuted FX order and is designed to  enrich the bank, is usually extremely difficult except for flagrant examples. Pre-hedging and front running appear very similar trades if one only has the raw transaction data.

Johnson’s downfall was that by revealing to his HSBC colleagues a malign intention, to front-run the client order, he effectively confessed to the crime. Moreover, he unwisely disclosed this on an HSBC’s internal communications network which of course would store his self-congratulatory messages and be found by HSBC’s compliance department when Cairn unexpectedly complained that it had been ripped off. Perhaps Johnson was carefree because  he thought his real strategy was  so ingenious that no one would ever detect it.

This prosecution shows the benefit of FCA rules which compel banks to monitor their traders’ communications and emphasises the need for ongoing  training as to which trading strategies are legitimate and ethical. The legal distinction between pre-hedging and front running is vast, yet for a naïve trader they might appear as two sides of the same coin.

The training shouldn’t simply focus on the do’s and don’ts in terms of best execution of orders it is as much about ethics. This training should insist that any trading which exploits client confidential information and prejudices the client  is impermissible.

Training by the compliance department alone is insufficient. The FCA post the LIBOR and FX scandals expects senior management to be involved in promoting good conduct and deterring poor. The expression “ tone from the top” is apposite. Johnson’s conduct, especially because of his relative seniority, should have stimulated a broad review by HSBC compliance and senior management as to what the root-causes of it were. Possibly the bank has also been subjected to searching FCA supervision visits. It is certain that the FCA will expect HSBC to have proactively read across from what Johnson did and to be able to demonstrate that internal procedures have been tightened.  

This case involved a single transaction and was therefore relatively easy to prosecute. Next June, the much more ambitious DoJ prosecution of three London-based FX traders is due to commence. The chief allegation is that they were part of a cartel: proving that may be a much tougher task.