On January 27, 2022, the United States Court of Appeals for the Second Circuit issued a decision in United States v. Connolly, overturning the 2018 fraud convictions of two former traders at a large financial institution.¹ A panel of three judges reversed the judgments of conviction, citing insufficient evidence at trial to prove that the defendants, Matthew Connolly and Gavin Campbell Black, induced co-workers to submit to the British Bankers’ Association (BBA) false statements that could influence the London Interbank Offered Rate (LIBOR)—a benchmark used to set the market rate on interest rate derivatives—to benefit their positions. In 2015, the financial institution where the defendants worked agreed to pay the US Department of Justice (DOJ) $2.5 billion in fines for the same rate manipulations at issue on this appeal.

The Connolly decision underscores the high threshold prosecutors must overcome to show a defendant’s actions were false, fraudulent, or misleading within the meaning of the federal wire fraud and bank fraud statutes. The ruling is the latest blow in a series of opinions limiting prosecutors’ attempts to define fraudulent conduct in financial crime broadly, even as the DOJ publicly commits to aggressive enforcement.

The Second Circuit’s decision in Connolly

As the Second Circuit found in Connolly, LIBOR is governed by the BBA, and is a widely used benchmark for trading interest rate derivatives. During the relevant period, sixteen banks, including the defendants’ financial institution, sat on the LIBOR panel with regard to United States currency, submitting daily rates reflecting hypothetical interest rates at which one bank could borrow money from another. The BBA compiled the numbers to generate a LIBOR number. Alterations to LIBOR can affect not only what party owes money to another, but also the amount of such payment. The value of swaps and futures traded using the LIBOR benchmark is upwards of $300 trillion.

In this case, the employees responsible for submitting the financial institution’s LIBOR rates each had a “pricer,” a model that compiled real time market data to automatically generate LIBOR numbers. However, the employees often manually edited the number based on various factors, such as actual cash trading, cash levels at other banks, and other interest rate changes. The defendants, moreover, would sometimes ask their co-workers for higher or lower LIBOR submissions to benefit their trading positions. Their co-workers then altered the LIBOR submissions based on the defendants’ requests.

Based largely on testimony at trial confirming that the practice occurred, the defendants were convicted of wire fraud, in violation of 18 U.S.C. § 1343, and conspiracy to commit wire fraud and bank fraud, in violation of 18 U.S.C. § 1349. The government relied on the theory, which was adopted by the district court, that the automatically generated number from the pricer was the one “true” number for each day, and would not have been altered but for the defendant’s conduct. Following the jury verdict, the district court denied the defendant’s Rule 29 motion, stating, among other things, that the government was not required to prove the financial institution could not have borrowed funds at the submitted rate to establish the falsity of the LIBOR submissions.

The Second Circuit disagreed, taking a narrower view of practices qualifying as false, fraudulent, or misleading. The panel ruled that in order to show falsity, given the language of the BBA guidelines, the government had to prove the institution could not have borrowed at the rates submitted to the BBA. If the rate submitted was one the bank could hypothetically request, be offered, and accept, the submission would not be false. Since no evidence suggested the opposite, the statements were not false or misleading. The Second Circuit also disagreed with the assertion that there was one true LIBOR rate, generated by the pricer. The panel cited the employees’ testimony that multiple factors each day were employed to manually edit the pricer rate, and the rate was often edited despite no input from derivatives traders.

The Second Circuit concluded that while the defendants’ efforts to manipulate rates to benefit themselves financially may have “violated any reasonable notion of fairness,” the government’s failure to prove the conduct fell outside the BBA guidelines—and thus was false or misleading—left the conduct outside the scope of the statutes.

Other recent decisions

The DOJ has long employed a broad interpretation of the wire statute fraud and other similar fraud statutes. However, this ruling is the latest in a series of decisions that dial back the government’s efforts to construe these statutes broadly. For instance, in March of 2019, a federal judge in the Northern District of California granted a Rule 29 motion in favor of Robert Bogucki, the former head of Barclays' foreign exchange trading desk, immediately following the prosecution’s case-in-chief at trial. The government accused Bogucki of making false and materially misleading statements in connection with Hewlett-Packard’s attempt to sell back, or “unwind,” options purchased from Barclays in 2011. In ruling against the government, the district court reasoned there was no expectation of full disclosure between the parties, given their sophistication, the agreement underlying the transaction, and the well-known industry tendency to posture and exaggerate. It also emphasized the unregulated nature of the behavior the government called fraud. When handing down the decision, the judge went so far as to criticize the DOJ for “assum[ing] the role of nanny.” The district court’s ruling echoed the Second Circuit’s decision in its 2018 acquittal of Jesse Litvak for allegedly lying to clients about mortgage-backed securities, where it stated that the counterparty to the transaction’s belief that Litvak was a fiduciary was not relevant to materiality: materiality is based on the viewpoint of the reasonable investor, who would not have believed Litvak was a fiduciary despite his misleading statements. The opinions illustrate that where transacting parties are sophisticated, proving the materiality of false or misleading statements is a tough sell. 

As another example, in May of 2020, the Supreme Court overturned the convictions in the “Bridgegate” case, wherein the defendants were charged with conspiring to reduce the number of lanes on the George Washington Bridge to increase congestion, as political retribution for the local mayor refusing to support Governor Chris Christie’s reelection campaign. The Court reasoned that the wire fraud statute, utilized to convict the defendants, was designed to criminalize fraudulent schemes undertaken to obtain money or property: these must be the motivation for, not simply the byproduct of, the misconduct.  While the defendants’ behavior was corrupt, it was politically motivated, and therefore they could not be convicted under the statute.

Key takeaways

The rulings in these cases and in Connolly are a warning shot to the DOJ that it should consider cases through the context of party sophistication and common industry practice, closely examine the motives for the misconduct in question, and think twice before prosecuting unregulated corporate practices. Notwithstanding Deputy Attorney General Lisa Monaco’s recent urging of prosecutors “to be bold” and to not be dissuaded by “the fear of losing,² these rulings suggest that the government may need to reevaluate its ability to use fraud statutes as broadly as it has used them in the past.

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