GATA (Gold Anti-trust Action)Lawsuit... Page 2
Statement of Facts
The principal factual allegations of the complaint are presented in three parts: Development of Today's Gold Market (C. 17-33); Manipulation of Gold Prices (C. 34-66); and BIS's Proposed Freeze-Out of Private Shareholders (67-78). For purposes of the motions to dismiss, they must be taken as true, drawing all reasonable inferences in favor of the plaintiff. Nicholson v. Moran, 961 F.2d 996, 997-998 (CA1 1992). Implementation of the freeze-out since the date of the complaint has revealed additional evidence regarding its true purpose, and thus will be addressed first here.
1. The Freeze-Out: Withdrawing the BIS's American Issue for the Fed.
The BIS was established under a Convention among Germany, Belgium, France, Great Britain, Italy, Japan and Switzerland (P.A. Ex. A) in 1930 to promote cooperation among central banks and to administer the Young Plan, established by a treaty signed three days earlier (P.A. Ex. B), for final settlement of Germany's World War I reparations. By a public statement issued in 1929 (P.A. 2), then Secretary of State Henry L. Stimson declared that the United States would not be a party to either treaty, and "will not permit any officials of the Federal Reserve system either to themselves serve or to select American representatives as members of the [BIS]."
To deal with this situation and preserve a certain level of American participation, the Convention established a Constituent Charter for the BIS that gave it a unique corporate structure. Fifteen percent of the original issue of partially paid shares -- the American issue -- was allocated to Morgan and two other private American financial institutions in return for their guarantee of its public subscription in the United States. The remaining shares were allocated to the founding central banks to be taken up by them or subscribed publicly in their respective countries, as was done with parts of the French and Belgian issues. No voting rights attached to any of the shares, which all carried equal rights to participate in the profits of the bank or any distribution of assets. Voting rights were assigned exclusively to the member central banks in proportion to their respective issues. The Constituent Charter also assigned certain seats on the BIS's board to governors of the founding central banks or their designees.
Two board seats were allocated to the United States, but Federal Reserve officials did not assume these seats until 1994. Then, as described by Mr. Greenspan in the transcript of the Federal Open Market Committee's conference call on July 20, 1994 (P.A. Ex. I):
Up until the Maastrich Treaty, our relationships with the BIS seemed to be appropriately constrained to our periodic visits over there to deal with the G-10 on a consultative basis and to be involved with a number of their committees, but to have no involvement at all with the actual management of the BIS. With the advent of the Maastrich Treaty and the development of the European Monetary Institute, the potential of the BIS being effectively neutered because of the overlap in jurisdictions of the EMI and the BIS has led the BIS to move toward a much more global role, one that anticipates inviting a significant number of non-European members, 10 to 25 as I recall the range, to become members of the BIS. That would significantly alter its character from a largely though not exclusively European managed operation to one which is far more global in nature. It is possible, perhaps probable, that the BIS as a consequence will become a much larger player on the world scene. It was our judgment that it would be advisable for us to be involved in the managerial changes that are about to be initiated rather than to stay on the sidelines, as we chose to do through all those decades when we did not want to get involved with a European-type international organization. In contradistinction to that, we think it is important to be an active player in the development of this institution to make certain that we as the principal international financial player have a significant amount to say in the evolution of the institution. That's the basis upon which this decision has been made here at the Board, and it was one which we probably would not have addressed in any meaningful way had not the altered nature of the BIS itself become imminent.
The DOJ has attached to its memorandum on behalf of Mr. Greenspan previously non-public letters to him from Secretary of State Warren Christopher dated June 15, 1994, and Secretary of the Treasury Lloyd Bentsen dated May 25, 1994 (DOJ Ex. C), authorizing Messrs. Greenspan and McDonough to assume the two BIS board seats allocated to the Federal Reserve. The DOJ has also produced extracts from the minutes of the Federal Reserve Board meeting on June 6, 1994, showing a vote to approve this action (DOJ Ex. B). This document further indicates that "appropriate members of the Congress" were informed of the decision on June 20, 1994, but copies of these letters were not provided.
Finally, the DOJ has produced a 1997 letter by a deputy assistant attorney general (DOJ Ex. D) (www.usdoj.gov/olc/fed208.htm) opining that the conflict-in -interest statute (28 U.S.C. s. 208(a)) does not prevent Messrs. Greenspan and McDonough from serving in their official capacities as BIS directors. Noting that the BIS is "a profit-making institution and declares an annual dividend," the opinion rests heavily on the President's broad authority to conduct foreign affairs and Secretary of State Christopher's letter declaring that "active participation of the Federal Reserve on the BIS board will serve U.S. foreign policy interests."
On September 15, 2000, the BIS issued a press release (P.A. Ex. L) followed by a Note to private shareholders (BIS.A. Ex. K) announcing that on January 8, 2001, it would hold an extraordinary general meeting to vote on a proposal to compel private holders of its American, French and Belgian issues to surrender their shares against a payment per share of CHF 16,000 (approximately US$ 9300). The stated reason for the transaction was "to enable the BIS better to pursue its objectives" and "to employ its resources in support of its public interest functions" (P.A. Ex. K, p. 3, part C). Noting that neither the World Bank nor the International Monetary Fund has private shareholders, the BIS declared that such shareholders were "no longer seen to be in line with" its future development.
Citing a valuation opinion by Morgan's wholly-owned French subsidiary which placed the net asset value per share at US$ 19,099, the BIS asserted lack of voting rights as the principal justification for discounting this NAV figure by over 50% in reaching the freeze-out price. As already noted, no BIS shares carry voting rights, which prior to the freeze-out were assigned to each member central bank based on the number of shares subscribed under that bank's non-fungible issue without regard to whether ownership of the shares rested with the central bank or in private hands (C. 71). All original shareholders, whether private persons or central banks, paid in exactly the same amount of gold per issued share. The right to vote was not then or ever assigned a monetary value, let alone one in derogation of the full property value of the shares (C. 71).
Except for the Federal Reserve, all member banks of the BIS are shareholders. The privately held American issue provided the sole basis for Messrs. Greenspan and McDonough to take the two U.S. seats on the BIS board in 1994. The September 15 press release and Note left unclear on what basis or authority they proposed to retain these seats, or even to participate in the affairs of the BIS, after the freeze-out. This issue received some clarification in the amendments to the Statutes of the BIS, passed by unanimous vote of its central bank members on January 8, 2001, implementing the freeze-out (P.A. Ex. N).
These amendments included a transitional Article 18A, which provides that the board may redistribute as it deems appropriate the shares purchased from private shareholders by "offering them for sale to central bank shareholders against payment of an amount equal to that of the compensation paid to the private shareholders." In other words, the American issue is destined for purchase by the Fed at the freeze-out price.
2. Gold Lending and Gold Derivatives: The Dangerous Short Position.
Gold is traded internationally on a 24-hour basis in both physical and paper forms, with major markets in London, New York, Hong Kong, Tokyo, Zurich and Dubai (C. 25). However, from the perspective of price discovery, the most important markets are the London Bullion Market Association ("LBMA") and the Commodities Exchange ("COMEX") in New York. The London market is the largest in terms of volume or turnover, doing significant business in both bullion and paper instruments, but lacks transparency. The COMEX does relatively little business in physical gold, being principally a futures and options market.
Gold derivatives are instruments such as forward contracts, futures, options and swaps whose value is tied to -- or derived from -- the price of gold (C. 2). Some gold derivatives are traded in standardized form as futures or options on exchanges such as the COMEX. However, most are traded over-the-counter in the form of specially-tailored private contracts between or among bullion banks, other financial institutions, gold mining companies, hedge funds, speculators and others (C. 25). Like other over-the-counter derivatives, gold derivatives are generally measured by their notional values, which are the face or reference amounts from which derivative payments are determined (C. 31). Notional value is similar in concept to open interest, but measures it by face value of contracts instead of their number. Although a tiny portion of all derivatives, gold derivatives are very large in relation to physical gold supplies.
Part III of the complaint summarizes the major characteristics of today's gold market (C. 17-33), including: (1) the continued use of gold as an international monetary reserve by central banks, who claim to hold some 32,000 metric tonnes of the approximately 120,000 tonnes of above-ground supplies (C. 21); (2) the loaning or leasing of gold by central banks to bullion banks at interest rates known as "lease rates" (C. 27); (3) the continuing and growing gap between annual new mine supply of around 2500 tonnes and annual demand for physical bullion now reliably estimated to exceed 4000 tonnes (C. 26); (4) the filling of this gap by official gold sales, scrap recovery and especially leased gold, mostly from central banks (C. 26); (5) declining gold prices from 1994 through 2000, putting the gold mining industry into a general condition of distress not experienced since the 1960's (C. 26); and (6) a huge build up of gold derivatives in certain bullion banks, especially the five that are defendants (C. 31-32, 57).
The fundamental point about leased gold is that it represents a short physical position. That is, when bullion banks borrow gold, they nearly always immediately sell it into the spot market for physical delivery, thereby receiving cash for the use of themselves or their clients (C. 27). Since lease rates typically run at 2% or less, borrowed gold represents a cheap source of financing provided that gold prices remain stable or decline (C. 29). On the other hand, a sharp rise in gold prices can cause painful or even catastrophic losses to borrowers who must repurchase gold at higher prices when their loans become due (C. 28). Gold derivatives, particularly forward contracts or call options, are frequently used to hedge this risk (C. 28).
While gold derivatives may be an effective means of hedging price risk under ordinary circumstances, they cannot guarantee immediately available supplies of physical gold, particularly in a sharply rising or illiquid market (C. 33). The Achilles' heel of today's gold market is the total short physical position, which informed estimates place at from 5000 to over 10,000 tonnes, or several years of annual new mine production (C. 30). This figure represents the total amount of loaned or leased gold that has been borrowed and sold into the market. Existing as gold receivables on the books of central banks and other lessors, it is gold that has left their vaults and can only be restored to them by physical repayment (C. 27).
3. Use of Gold Lending and Gold Derivatives To Suppress Gold Prices.
Part IV of the complaint alleges that from 1994 to the date of filing, the defendants engaged in a scheme to manipulate gold prices (C. 34), probably patterned on the London Gold Pool, which operated without formal agreement under the auspices of the BIS from 1961 to 1968 in support of the then official gold price of US$ 35/ounce under the Bretton Woods Agreements (C. 36). The modern scheme appears directed at three objectives: (1) to prevent rising gold prices from sounding a warning on U.S. inflation; (2) to prevent rising gold prices from signaling weakness in the international value of the dollar; and (3) to prevent banks and others who have funded themselves by borrowing gold at low interest rates and are thus short physical gold from suffering huge losses as a consequence of rising gold prices (C. 34).
Sources for the price fixing allegations include: (1) official data on gold derivatives published by the BIS and the U.S. Controller of the Currency ("OCC") and on gold accounts at the Fed and the U.S. Treasury, including those for foreign custodial gold at the N.Y. Fed and gold held by the ESF; (2) analyses of market data, particularly with respect to anomalous gold price movements on the COMEX and between it and overseas markets; and (3) statements by participants in, or others with knowledge of, the manipulative scheme (C. 35).
The manipulative scheme utilizes leasing rather than outright sales as the preferred method of bringing central bank gold to market, and uses gold derivatives not only to hedge price risk but also to force down gold prices, particularly on the COMEX, where the leverage of gold futures contracts and options thereon can be employed to great effect. But while gold derivatives can be used to suppress prices, the manipulators must also coax or coerce sufficient supplies of gold bullion to meet strong physical demand, particularly from Asia, responding in part to low prices caused by their manipulative activities (C. 37).
In July 1998, Fed Chairman Alan Greenspan, testifying before the House Banking Committee, stated (C. 38): "Nor can private counterparties restrict supplies of gold, another commodity whose derivatives are often traded over-the-counter, where central banks stand ready to lease gold in increasing quantities should the price rise [emphasis supplied]." This statement, amounting to a declaration that gold prices were being suppressed, both invited bullion banks and others to borrow gold at low risk and pressured private holders of gold to sell or lease it since they could not expect significant price increases.
In a letter to Senator Joseph I. Lieberman dated January 19, 2000, Mr. Greenspan elaborated on his 1998 congressional testimony (C. 39; DOJ Ex. E): "This observation simply describes the limited capacity of private parties to influence the gold market by restricting the supply of gold, given the observed willingness of some foreign central banks -- not the Federal Reserve -- to lease gold in response to price increases [emphasis supplied]." Mr. Greenspan himself has thus admitted that some central banks lease gold for the purpose of supplying the bullion banks during periods when strong demand is pushing up prices.
Mr. Greenspan had at least two obvious vantage points from which to "observe" gold lending by central banks: the N.Y. Fed and his board seat at the BIS. A significant portion of the gold leased by foreign central banks appears to have come from the foreign earmarked gold accounts at the N.Y. Fed. These accounts decreased by over 1500 tonnes from 1995 to 1999, and the largest outflows generally coincided with periods of relative strong gold prices (C. 40). Central banks frequently use the BIS for their transactions in gold, which include making gold deposits that may subsequently be loaned out by the BIS. Gold lending by the BIS has increased sharply in recent years, indicating not only the important role of gold in its activities but also the active role that it plays in the gold market. In its annual report for the year ending March 31, 2000, the BIS disclosed that during the year its total gold lending increased 47 tonnes to 360 tonnes, almost double the level of 185 tonnes four years earlier (C. 41).
The most noticeable price fixing activities have occurred on the COMEX, which has high international visibility, but being predominantly a paper market, is more easily subject to manipulation (C. 45). Over the past two years, Chase, Goldman, and Deutsche Bank have regularly appeared as heavy sellers of gold on the COMEX whenever necessary to kill any significant rally (C. 8, 10-11, 45). In the past year, many observers of the gold market have noticed a pronounced tendency for gold prices to rise in overseas trading only to be knocked back to prior levels on the resumption of trading in New York. This anomalous phenomenon has recently been confirmed by two independent studies (P.A. 26, Ex. S; P.A. 28, Ex. T). In one (Ex. S), Professor H. J. Clawar calculates that for the year beginning January 25, 2000, net overseas price increases amounted to $ 160/ounce, while net decreases on the COMEX in New York equaled $ 173/ounce (P.A. 27). These two studies further confirm the analysis of Michael Bolser (P.A. Ex. Q) referenced in the complaint (C. 45-49) demonstrating very heavy or "preemptive" selling of gold on the COMEX at critical times since 1994 to counter threatened or developing price surges (C. 50-51, 53-55, 60).
During 1999, the gold market experienced two bizarre events that served to unmask the manipulative scheme. The first began with an initiative led by President Clinton and Prime Minister Blair to sell some gold held by the International Monetary Fund, ostensibly to fund aid to heavily indebted poor countries. On May 7, 1999, just as gold threatened to surge over $ 300/ounce in response to new doubts whether these IMF sales would proceed, the Bank of England announced that on behalf of the Exchange Equalisation Account in the British Treasury, it would sell 415 tonnes of gold in a series of public auctions. Although the announcement was completely unexpected by the market, Deutsche Bank apparently received advance warning (C. 42).
British officials have tried to explain the gold auctions as an effort to diversify Britain's international monetary reserves, yet British gold reserves were already comparatively low (C. 43). British officials cannot seem to agree on who made the decision, but it almost certainly came directly from the prime minister since it put Britain in the position of front-running the IMF's proposed sales for which he was a leading advocate. Nor is the manner of the British sales -- periodic public auctions in which the entire lot is sold at the lowest price accepted for any portion -- consistent with obtaining the best available return.
However, the bimonthly scheduling of the British gold auctions of 25 tonnes each is entirely consistent with a plan to manipulate gold prices on the COMEX. Each of the 11 auctions held so far has fallen within about a week of the bimonthly expiration of a COMEX gold futures and options cycle (P.A. 21-23, Ex. R). The auctions appear intentionally designed to supply gold for delta hedging each new options cycle and/or to meet demands for physical delivery into expiring futures contracts (P.A. 24-25).
Following announcement of the periodic British gold auctions in May 1999, gold prices declined from $ 290/ounce to around $ 260 by September, setting the stage for the second big unexpected gold event of 1999. On September 26, without prior warning and with the European Central Bank, Banque de France and Bundesbank in key leadership roles, 15 European central banks announced an agreement to limit their gold sales and not to expand further their gold lending (C. 54). Unveiled in Washington, D.C., after the annual meetings of the IMF and World Bank, this agreement is generally referred to as the Washington Agreement. According to most European press reports, the agreement was prepared in secrecy and without the knowledge of American, British or BIS officials, although the Bank of England was given and accepted an opportunity to sign onto the agreement just before the announcement.
The Washington Agreement triggered an explosive rally in gold prices, which was quickly met with a massive wave of preemptive selling in excess of two standard deviations (C. 55). According to reliable reports received by the plaintiff, this effort was later described by Edward A. J. George, Governor of the Bank of England and a director of the BIS, to Nicholas J. Morrell, Chief Executive of Lonmin Plc (C. 55):
We looked into the abyss if the gold price rose further. A further rise would have taken down one or several trading houses, which might have taken down all the rest in their wake. Therefore at any price, at any cost, the central banks had to quell the gold price, manage it. It was very difficult to get the gold price under control but we have now succeeded. The U.S. Fed was very active in getting the gold price down. So was the U.K.
A major consequence of the gold rally following the Washington Agreement was the near bankruptcy of Ashanti Goldfields Ltd., a large gold mining company based in Ghana, due to huge paper losses from hedging strategies devised for it by Goldman apparently in the conviction that gold prices could not rally as they did (C. 56). Goldman's actions with respect to Ashanti were the subject of scathing comment, including allegations of serious conflicts of interest, in an article by L. Barber and G. O'Connor, "How Goldman Sachs Helped Ruin and then Dismember Ashanti Gold," Financial Times (London), Dec. 2, 1999. The principal shareholders of Ashanti, which is listed on the New York Stock Exchange, are Lonmin and the Government of Ghana.
Another major result of the rally, although it took longer to surface publicly, was a huge increase in the gold derivatives of Morgan, Chase, and Citibank (C. 57). The following table shows the total notional amount of gold derivatives, all maturities, of Chase, Morgan, Citibank and Other as reported by the OCC from December 1998 through June 2000. All amounts are in US$ billions. (Columns do not add due to rounding and exclusion of separately stated figures for Bankers Trust prior to June 1999.) The largest relative and absolute increases are highlighted in bold.
Bank 12/98 3/99 6/99 9/99 12/99 3/00 6/00
Chase 24.1 23.7 20.5 22.6 22.1 31.5 35.0
Morgan 16.8 15.1 18.4 30.5 38.1 36.3 29.7
Citibank 6.7 7.3 7.2 10.7 11.8 11.8 11.4
Other 15.0 13.5 14.2 19.3 15.7 15.9 15.7
Total 68.3 65.1 61.4 83.3 87.6 95.5 92.1
In the foregoing table, the figures for 9/99 are as of September 30, and thus reflect positions as of four trading days after announcement of the Washington Agreement. During these four days the gold price moved from about $ 265/ounce to over $ 300 (C. 58). The rally continued into October, with gold prices trading as high as $ 325 during the first two weeks, and then generally declining to just under $ 300 by the end of the month. For the rest of 1999 and into February 2000, gold traded in a $ 20 dollar band under $ 300. In the second week of February, a sharp rally took gold to over $ 315, but again the price was quickly brought under control, and it remained generally in the $ 280-290 range from the beginning of March through June, although falling into the low $ 270's in May.
Taking each line of the table, the following picture emerges: (1) Chase's gold derivatives remained flat until the first quarter of 2000, when they started to accelerate sharply; (2) Morgan's gold derivatives almost doubled in the third quarter of 1999, grew sharply in the fourth, leveled off in the first quarter of 2000 and declined in the second back to the September 1999 level; (3) Citibank's gold derivatives jumped sharply in the third quarter of 1999, then remained stable at this higher level over the next three quarters; and (4) the Other category of gold derivatives, which includes all banks not separately identified, also jumped sharply in the third quarter of 1999, but returned in the fourth to prior levels, where they have remained.
Morgan traditionally acts as the Fed's bank. See W. Greider, Secrets of the Temple (Simon & Schuster, 1989), p.269. Its sudden emergence in the third and fourth quarters of 1999 as a major font of gold derivatives is consistent with playing a major role in the Fed's efforts "to manage" and "to quell" the gold price as described by Mr. George, Governor of the Bank of England and a director of the BIS. Similarly, the growth of Chase's gold derivatives in the first two quarters of 2000 is consistent with being pressed into service as gold derivatives threatened to swamp Morgan, particularly as producers began to try to reduce or cover forward positions put in place prior to the Washington Agreement. The smaller notional amounts in Other suggest that these banks responded to client demands immediately following the Washington Agreement, and then quickly brought their gold derivatives back under relative control. Citibank, on the other hand, has never brought its gold derivatives back to pre-Washington Agreement levels, suggesting that it, like Morgan and Chase, is involved in helping the Fed to control gold prices.
Another important point is the relative size of these derivative positions. Total reported official gold reserves of the United States amount to not quite 8200 metric tonnes. At the 1999 year-end gold price of about $ 290/ounce, the total $ 87.6 billion notional amount of gold derivatives on the books of U.S. commercial banks equated to almost 9400 metric tonnes, of which more than two-thirds were held by two banks, Morgan and Chase. Similarly, the notional value of Deutsche Bank's 1999 year-end gold derivatives, which more than tripled during the year, equated to over 5000 tonnes at a $ 290 gold price, exceeding by nearly 50% Germany's official gold reserves of just under 3500 tonnes. Common sense says that positions of this size and concentration could not have been assumed without the knowledge and support of top officials in both the parent holding companies and the supervising central banks, most likely including some sort of government backing.
The published financial statements of the ESF indicate that it has participated along with the Fed in the gold price fixing scheme, probably through some form of participation in, or backing of, gold derivatives (C. 62). As detailed in the complaint (C. 63-64), discrepancies between relevant gold accounts in reports of the Fed and ESF strongly point to losses in connection with gold as the main cause for the ESF's generally poor trading results over the past several years (C. 65 and table). During this period, the ESF's profits generally coincided with periods of falling gold prices while its losses coincided with rising gold prices (C. 66).
Its third largest quarterly loss ever occurred in the last calendar quarter of 1999, coincident with the explosion in gold derivatives on the books of Morgan, Citibank and Deutsche Bank. However, the ESF achieved excellent trading results in the prior calendar quarter dominated by falling gold prices resulting from the May 1999 announcement of British gold sales. While the Asian financial crisis might explain the ESF's losses in 1997, the Clinton administration reported to Congress that it did not engage in any currency interventions from 1998 through March 2000.
Best Regards, J.T. |
