Bank One Corp. v. Comm'r

*181 LARO, Judge: These cases were consolidated for purposes of trial, briefing, and opinion. In docket No. 5759-95, First Chicago Corp. (FCC) and its affiliated corporations, one of which was a corporation formerly known as the First National Bank of Chicago (FNBC), petitioned the Court to redetermine *182 respondent's *17 determination of deficiencies of $ 1,661,112 and $ 2,956,794 in the affiliated group's consolidated Federal income taxes for 1990 and 1991, respectively. In docket No. 5956-97, First Chicago NBD Corp., the successor in interest to FCC and affiliated corporations, petitioned the Court to redetermine respondent's determination of a $ 95,156,499 deficiency in the 1993 consolidated Federal income tax of FCC and its affiliated corporations. The latter petition placed in issue a nonnotice year, 1992, by alleging entitlement for that year to adjustments which would affect the notice year 1993.

As relevant herein, the deficiencies stem from FNBC's claim to "swap fee carve-outs" of $ 5,468,418 for 1990, $ 3,543,182 for 1991, $ 4,294,471 for 1992, and $ 5,799,724 for 1993. ¹ As to swaps (defined infra p. 17) for which it was a party, FNBC valued these swaps at the mid-market values which it computed on its version of a computerized system known as the Devon Derivatives System (Devon system) (as discussed infra, FNBC's midmarket valuation using the Devon system was based on the midpoint between a swap's market bid and ask rates, or, in other words, the average of those rates). FNBC's swap fee *18 carveout as to each of those swaps represented the difference, determined at or about the time of each swap's initiation, between the swap's midmarket value and the bid or ask price which it paid or received for the swap. FNBC treated the carved-out amounts as deferred income designed to compensate it for (1) the perceived credit risks of its counterparties (credit adjustments) and (2) the estimated administrative costs which it expected to incur in holding and managing the swaps until maturity (administrative costs adjustments). Respondent determined that the method by which FNBC claimed the carveouts was improper in that the method did not clearly reflect FNBC's swaps income in accordance with section 446² and section 1.446-3, Income Tax Regs. Respondent determined that FNBC was required to report its swaps income by using a method that reported each swap's midmarket value without any adjustment.

*183 *19 We hold that neither FNBC's method of accounting as to its swaps income nor respondent's method of accounting as to that income clearly reflected FNBC's swaps income. We direct the parties to file with the Court a computation (or computations) under Rule 155 that reflects (or reflect) FNBC's swaps income in a manner consistent with this Opinion.

             FINDINGS OF FACT

Many facts were stipulated. We incorporate herein by this reference the parties' stipulations of fact and the exhibits submitted therewith. We find the stipulated facts accordingly.

The trial of these cases began on October 30, 2000, and (with recesses) concluded on November 28, 2001. The record, which includes a trial transcript of approximately 3,500 pages memorializing the testimony of 21 fact witnesses and 7 expert witnesses, consists of 43 "red" files and more than 10,000 pages of exhibits. For briefing purposes, the Court ordered the parties to file written briefs conforming to Rule 151 with copies on CD-ROM that included Hyperlinks to the relevant part or parts of the exhibits, testimony, pleadings, or stipulations relied upon *20 for each proposed finding of fact. The written briefs, inclusive of their proposed findings of fact and objections to the other party's proposed findings of fact, totaled more than 3,300 pages. The copies of the briefs on CD-ROM were very helpful to the Court.

1. FCC

FCC was a Delaware corporation and registered bank holding company. By virtue of its status as a bank holding company, FCC was regulated during the relevant years by the U.S. Federal Reserve Board (FRB). At all relevant times, including at the time of the filing of its petition to this Court, FCC's principal place of business was in Chicago, Illinois.

*184 For Federal income tax purposes, FCC was an accrual method taxpayer that joined with its affiliates in the filing of consolidated Federal income tax returns. FCC filed those returns timely and on the basis of the calendar year.

2. First Chicago NBD Corp.

First Chicago NBD Corp. was a Delaware corporation and registered bank holding company. First Chicago NBD Corp. was the corporation resulting from the merger, effective December 1, 1995, of FCC with and into NBD Bancorp, Inc., a Delaware corporation and registered bank holding company. At all relevant times, *21 including at the time of the filing of its petition to this Court, the principal place of business of First Chicago NBD Corp. was in Chicago, Illinois.

3. FNBC

FNBC was a national bank organized and existing as a national banking association under the National Bank Act, current version at 12 U.S.C. secs. 21-216 (2000). By virtue of its status as a national bank, FNBC was regulated by the Office of the Comptroller of the Currency (OCC).

During the relevant years, FNBC was FCC's primary subsidiary. For Federal income tax purposes, FNBC was an accrual method taxpayer, and it joined in the consolidated Federal income tax returns filed by FCC.

4. Bank One Corp.

Bank One Corp. is a multibank holding company registered under the Bank Holding Company Act of 1956, ch. 240, 70 Stat. 133, currently codified at 12 U.S.C. secs. 1841-1850 (2000). It was incorporated in Delaware on April 9, 1998, to effect the merger of First Chicago NBD Corp. and Banc One Corp., an Ohio corporation and registered bank holding company. The merger was effective October 2, 1998. ³ By virtue of its status as a bank holding company, Bank One Corp. was regulated during the relevant years by the FRB. Bank One Corp.'s principal *22 office was in Chicago, Illinois, at all relevant times.

1. Definition of a Swap

A swap is a bilateral agreement obligating the parties (often referred to as counterparties) to exchange at specified intervals (e.g., monthly, quarterly, semiannually) cashflows ascertained from applying specified financial prices (e.g., interest rates, currency rates) to a specified underlying amount. The specified underlying amount is either a notional principal amount which is not exchanged (as usually occurs when the subject matter of the swap is interest rates) or an amount which may actually be exchanged (as usually occurs when the subject matter of the swap is currency rates). The exchange of cashflows at the periodic intervals is sometimes referred to as "periodic payments" and is *23 usually done on a net settlement basis. Each party to a swap bears the risk that its counterparty will default on its obligation to make a periodic payment, and, thus, that it (the party) will not receive a periodic payment owed to it by the counterparty.

2. Swaps Are Derivative Financial Products

Swaps are derivative financial products (financial derivatives). A financial derivative is a bilateral agreement the value of which is derived (as implied by its name) from the performance of an underlying asset, reference rate, or index.

Other common forms of financial derivatives during the relevant years included: (1) Interest rate guarantees such as caps, floors, and collars; (2) interest rate options; (3) swaptions; and (4) forward rate agreements (FRAs). ⁴ Interest rate caps, floors, and collars are contracts with notional principal amounts but not necessarily with periodic payments. Interest rate caps and floors require the seller, in exchange for a fee, to make a payment to the purchaser only if, in the case of a cap, a specified market interest rate exceeds the fixed cap rate on specified future dates or, in the case of a floor, the specified market interest rate falls below the fixed *24 *186 floor rate on specified future dates. ⁵ Interest rate options are contracts that grant one party, for a premium payment, the right to either purchase from or sell to the other party a financial instrument at a specified price within a specified period of time or on a specified date. Swaptions are options to purchase a swap in the future. FRAs are contracts with notional principal amounts that settle in cash at a specified future date on the basis of the difference between a fixed interest rate and a specified market interest rate. ⁶ FRAs are different from swaps in that FRAs lack periodic payments.

3. Types of Swaps in the Marketplace

Swaps in the marketplace *25 during the relevant years consisted primarily of interest rate swaps (sometimes, IRSWs), currency swaps (sometimes, CYSWs), and commodity swaps (sometimes, COMs). ⁷ An interest rate swap, the primary swap at issue, is a bilateral agreement calling for the periodic exchange of interest payments ascertained by applying specified interest rates to an agreed-upon notional principal amount. A currency swap is a bilateral agreement to exchange payments denominated in different currencies. A commodity swap is a bilateral agreement to exchange cashflows ascertained by applying commodity prices to a notional quantity of a particular commodity.

1. Origin of the Market

The origin of the swaps market is generally traced to a currency swap negotiated between the World Bank and IBM in 1981. That transaction involved an exchange of payments in Swiss francs for payments in deutschmarks. The first interest rate swap was negotiated with the Student Loan Marketing Association in 1982. The first *26 commodity swap occurred in 1986.

*187 2. Growth of the Interest Rate Swaps Market

Interest rate swaps were the most common swaps during the relevant years. In 1992, dealers generally participated in four to five interest rate swaps daily and one currency swap every 2 days. The corresponding figures for 1987 were three interest rate swaps every 2 days and one currency swap every 4 days. A dealer's use of commodity swaps during 1987 and 1992 also was less common than the dealer's use of interest rate swaps during the same years.

The outstanding notional amount of interest rate swaps worldwide totaled approximately $ 683 billion, $ 12.8 trillion, and $ 43 trillion at the end of 1987, 1995, and 1999, respectively. ⁸ The growth of the outstanding notional amount of interest rate swaps is attributable primarily to the use of interest rate swaps as an effective, inexpensive way in which to manage financial risks from interest rate fluctuations. Those who use financial derivatives in general can identify, isolate, and manage separately the fundamental risks and other characteristics which are bound together in traditional financial instruments. In addition to increasing the range of financial products *27 available, financial derivatives have fostered more precise ways of understanding, quantifying, and managing financial risk. Most institutional borrowers and investors currently use financial derivatives. Many of these entities also act as intermediaries dealing in those financial products.

1. Terms of an Interest Rate Swap Agreement

Interest rate swaps generally require that the parties thereto negotiate and agree upon several economic terms. These terms generally include (1) a notional amount, (2) a fixed interest rate, (3) a floating interest rate index, (4) a duration (term or tenor) of the contract, (5) an effective date of the contract, and (6) a payment schedule. The parties to an interest rate swap also must negotiate a particular country's currency (or countries' currencies) in which a swap is denominated. During the relevant years, the U.S. dollar was*188 overwhelmingly the dominant individual currency for interest rate swaps.

2. Notional Principal Amount and Related Terms

The notional principal amount of an interest rate swap is not actually exchanged *28 but is simply the reference point for the parties' obligations. ⁹ The parties to an interest rate swap agree to exchange for a set length of time (term or tenor) and as of specified intervals (payment schedule) streams of interest payments ascertained on the basis of a notional principal amount. At least one of these streams of payments is ascertained on the basis of a floating-rate index. The respective streams of payments are often referred to as "legs"; e.g., a fixed leg and a floating leg.

The party that is paying the fixed rate (i.e., receiving the floating rate) is said to have bought the swap. ¹⁰ The party receiving the fixed rate (i.e., paying the floating rate) is said to have sold the swap. The party that is receiving the fixed rate also is said to be "short" the swap, while the party paying the fixed rate is said to be "long" the swap.^11*29

The trade date is the date on which the swap transaction is agreed. The effective date is the date on which the interest included in the payments begins to accrue. Once interest has begun to accrue, it continues to accrue until the day before the termination date. The termination date is the date on which the last payment is due. The termination date sets the maturity of the contract.

3. Different Types of Interest Rates

Swaps generally involve two types of interest rates. The first rate, a fixed interest rate, is applied for each payment date to ascertain the agreed-upon payment in the fixed leg. By definition, the fixed interest rate is fixed in that it is constant. The second rate, a floating interest rate, is applied for each payment to ascertain the agreed-upon payment in the floating leg. By definition, the floating interest rate floats in *189 accordance with an agreed-upon index and usually changes with time.

The date on which the floating interest rate is changed (i.e., is "reset") is known as the reset date. Except in the case of the first payment, the floating interest rate applicable *30 to each payment period is generally set at the beginning of the interval, on the basis of the interest rate in effect 2 business days before the most recent reset date. The floating interest rate applicable to the first payment is generally set on the trade date, 2 days before the effective date.

4. Use of LIBOR as a Floating Interest Rate Index

The most common floating interest rate index for interest rate swaps is the London Interbank Offering Rate (LIBOR), the rate of interest at which banks are willing to offer deposits (i.e., lend Eurodollars) to other prime banks, in marketable size, in the London Interbank market. In order to determine the LIBOR rates, the British Bankers' Association maintains a reference panel of banks with London offices. Each of these banks ascertains the rate at which it could borrow funds, were it to do so by asking for and then accepting interbank offers in reasonable market size just before 11 a.m. that day. The deposits have a zero-coupon structure, meaning that no interest is paid during the life of the deposits but is accrued and paid at maturity. ¹² Each LIBOR rate is computed by disregarding the four highest and the four lowest rates offered by these *31 banks and then taking the average of the others.

The LIBOR rates, when determined, are instantly communicated around the world by electronic (on-line) services such as the Associated Press/Dow Jones Telerate Service, Bloomberg, or Reuters Monitor Money Rates Service. Separate LIBOR rates are available and quoted for each standard term (e.g., 1-month, 3-month, 6-month, 12-month), and the parties to a swap may agree on any of these LIBOR rates. In most cases, the floating-rate payor pays no increment or decrement (spread) with respect to the LIBOR rate, and the rate is said to be quoted flat.

In lieu of a LIBOR rate, the parties to an interest rate swap may agree to use a less common floating interest rate index. *190 Other common floating interest rate indices during the relevant years included the T-bill rate (the rate on the most recent issue of U.S. Treasury bills), the commercial paper rate, the bankers acceptance rate, the prime rate, and the tax-exempt rate.

5. Plain Vanilla Interest Rate Swaps

Interest rate swaps may be of the plain vanilla type. A plain vanilla interest rate swap, the simplest and most common type *32 of interest rate swap, is a swap with standard terms and without another financial derivative as part of the agreement. One party to a plain vanilla interest rate swap (first party) agrees to pay to the other party (second party) amounts equal to a fixed rate of interest multiplied by a set notional amount. The second party agrees to pay to the first party amounts equal to a floating rate of interest multiplied by the same notional amount. The fixed and floating amounts are offset against each other as of each payment date, and the party paying the higher rate of interest remits a payment to the counterparty equal to the notional amount multiplied by the difference between the interest rates. An analogy of a plain vanilla interest rate swap is the exchange of a fixed-rate loan for a floating-rate loan. The schedule of payments on a plain vanilla interest rate swap exactly matches the schedule of net payments on an exchange of the fixed-and floating-rate loans.

In contrast to a plain vanilla interest rate swap, a more creative interest rate swap may have nonstandard terms. ¹³ A combination deal (sometimes, COMB) has embedded option features such as a callable or extendable swap or a *33 contract giving one of the parties the option, but not the obligation, to enter into an interest rate or currency swap at prearranged terms. An amortizing or accreting swap has a notional amount that decreases or increases, respectively, during the life of the transaction.¹⁴ A basis swap has two floating legs, instead of a fixed leg and a floating leg, with each party agreeing to exchange payments determined by a different floating-rate index (e.g., one party floats with LIBOR *191 while the other party floats with the commercial paper rate). In some swaps, the payment dates for the counterparties do not coincide, whereas in other swaps the counterparties' payments are in different currencies. There also are swaps with different fixed rates during different periods.

6. Lack of Payments at Inception

For most interest rate swaps during the relevant years, neither counterparty made a payment at the inception of the swap to effect *34 the transaction. The entire consideration for a party's promise to make future payments to the counterparty lay in the counterparty's promise to make its agreed-upon future payments. An initial payment was not generally required to induce the counterparties to enter into the swap agreement.

One exception to the nonpayment rule was off-market swaps which required upfront payments. In an off-market swap, a counterparty agreed to receive or pay an interest rate that was significantly different than the going market rate.

7. Example of an Interest Rate Swap

To illustrate the mechanics of an interest rate swap, assume that a plain vanilla interest rate swap originated on November 29, 1992, the trade date, with the following terms:

Notional principal      $ 1 million

Fixed rate           5 percent per annum

Floating rate         6-month LIBOR rate

Effective date         Dec. 1, 1992

Termination date        Dec. 1, 1995

Payment dates         June 1 and Dec. 1 of each year

Fixed-rate payor        F

Floating-rate payor      L

Day count conventions     Actual /360/ ¹

The table below shows the payments *35 on the swap for a hypothetical scenario of the 6-month LIBOR rate over the life of the swap. In this example, F has promised to pay to L a semiannual interest payment calculated on the basis of a notional principal of $ 1 million and a fixed 5-percent interest *192 rate as adjusted by a ratio the numerator of which equals the number of days in the payment period and the denominator of which equals 360. L has promised to pay to F a semiannual interest payment calculated on the basis of the same $ 1 million amount but using, instead of the fixed rate, a floating 6- month LIBOR rate as adjusted by the same ratio. The sixth column, the net of the fixed and floating payments, is the only amount that is actually paid by one party or the other.

     Number of

Payment   Days in   Fixed    Hypothetical     Floating  Net

Cashflow

 Dates   Period   Payment  6-Month LIBOR Rate   Payment   To L (To F)

_______  _________  _______  __________________   ________   ____________

6/1/1993   182    $ 25,278     4.0%      $ 20,222    ($  5,056)

12/1/1993   183     25,417     4.320       21,960 (3,457)

6/1/1994   182     25,278     5.130       25,935      657

12/1/1994   183     25,417     5.901       29,997     4,580

6/1/1995 *36   182     25,278     6.210       31,395     6,117

12/1/1995   183     25,417     6.842       34,780     9,363

A plain vanilla currency swap involves the exchange of a series of fixed-rate interest payments denominated in a foreign currency for a series of floating-rate interest payments denominated in U.S. dollars. Other currency swaps include exchanging a fixed rate in a foreign currency for a fixed rate in U.S. dollars, exchanging a fixed rate in U.S. dollars for a floating rate in a foreign currency, or exchanging a floating rate in a foreign currency for a floating rate in U.S. dollars.

The main participants in the interest rate swaps market are end users, dealers, and brokers.

1. End Users

a. Typical End Users

End users are typically major corporations, government or governmental-related entities, investment funds, or other financial institutions. These end-users typically use interest rate swaps to combat interest rate movements, express market preferences through position taking, and/or reduce their cost of funding. As to the size of an end user, swaps end-user entities entering into swaps in connection with the conduct *193 of their business *37 must have assets over $ 10 million or a net worth over $ 1 million in order to qualify their swaps for a safe-harbor exception from most of the regulatory requirements of the Commodity Futures Trading Commission (CFTC). ¹⁵

b. End Users' Uses of Interest Rate Swaps

i. Combat Interest Rate Changes

End users commonly use interest rate swaps to hedge (minimize) their risk of adverse changes in interest rates. Interest rate risk is the potential fluctuation in the value of a financial instrument due to a change in the level of interest rates. Whereas the market values of fixed-rate *38 loans are exposed to significant interest rate risk, the market values of floating-rate loans are not. A fall (or rise) in interest rates causes the market value of a fixed-rate loan to increase (or decrease). The fall (or rise) in interest rates leaves the market value of a floating-rate loan unchanged; the interest payments on the floating-rate loan fall (or rise) together with interest rates.

Managing interest rate risk is an important function of financial managers in entities such as corporations and financial institutions, and an interest rate swap is a tool with which financial managers may readily change their exposure to interest rate fluctuations. Through a swap, an institution may change the nature of its liabilities from fixed-rate liabilities to floating-rate liabilities, or vice versa. A company liable on debt paying a floating interest rate, for example, may guard against a rise in interest rates by entering into a swap under which it pays a fixed rate of interest and receives a floating rate. The swap transfers to the counterparty the risk of a rise in interest rates. ¹⁶ Likewise, a financial manager *194 may need to increase or decrease the interest rate exposure of an *39 entity's liabilities. The financial manager of a corporation, for example, that has assets which are positively exposed to interest rate risk (i.e., the value of the assets increases with interest rates) may seek to match this exposure with liabilities that are positively exposed to interest rate risk so as to create zero exposure in the corporation's net position.

ii. Prosper From Market Forecast

End users also use interest rate swaps to attempt to prosper from their forecast of the movement in interest rates. For example, a company that believes that interest rates will fall may enter into an agreement under which it pays a floating interest rate. In 1992 and 1993, for example, when interest rates were at extremely low levels, many companies elected to issue long-term debt at fixed rates and then enter into shorter-term swap agreements under which the company paid a floating rate. The company, *40 in effect, converted the early years of its financing from a fixed rate to a floating rate.

iii. Reduce Cost of Funding

End users also use interest rate swaps to reduce the transaction costs which are a natural consequence of raising funds. If, for example, a corporation wants to borrow at a fixed rate but has a shelf registration for commercial paper paying a floating interest rate, the corporation may be able to minimize its transaction costs by issuing commercial paper with a floating rate and then swapping the commercial paper for an obligation with a fixed rate.

2. Dealers

a. Typical Dealers

Since at least 1992, the swaps market has been almost entirely intermediated by institutions acting as dealers. Swaps dealers are generally major financial institutions (e.g., securities firms and banks such as FNBC) which hold themselves out as market- makers; i.e., entities ready and willing to take either side of a swap transaction for the purpose of *195 earning a profit by originating new swaps. ¹⁷ On some occasions, these institutions enter into swaps in their capacity as swaps dealers. On other occasions, these institutions enter into swaps in their capacity as end users to manage the overall *41 structure of their portfolios to minimize the net exposure to interest rate movements. Swaps dealers trade with both end-users and other dealers.

Swaps dealers maintain a portfolio of swaps on their books and usually attempt to maintain a neutral, hedged position in the market. Swaps dealers attempt to maintain a neutral, hedged position either by: (1) Serving as a counterparty to opposite sides of two matching swaps or (2) managing the overall structure of the portfolio so as to minimize the net exposure to interest rate movements.

c. Price Quotations

Prices in the interest rate swaps market are quoted in the form of interest rates, and major swaps dealers (e.g., FNBC) regularly quote the bid and ask prices at which they stand ready to buy and sell plain vanilla interest rate swaps with standard maturities of 1, 2, 3, 5, 7, and 10 years. The bid price is the fixed interest rate that the dealer is ready to pay in exchange for a specified floating rate. The ask price is the fixed interest rate that the dealer demands to receive in exchange for paying a specified *42 floating rate. The ask rate is greater than the bid rate, and the dealer's profit when taking the opposite sides on two identical swaps is the difference between the fixed rate it receives and the fixed rate it pays.

Among dealers, it is common to refer to the spread reflected in the pricing of a swap, and the convention is to quote the fixed rate on the assumption that the floating rate is LIBOR flat (i.e., with no spread or premium attached to the floating rate). A swap, however, may be negotiated with the floating payment tied to an index plus or minus a spread; i.e., a margin.

*196 d. Role in the Market

When the swaps market first began, every swap generally was facilitated by a dealer. The dealer was not a party to the transaction but, generally for a fee, arranged the swap by introducing the counterparties to each other and helping them to effect the mechanics of the transaction. With the evolution of the market, dealers became parties to each swap. In the early years of the market's evolution, a dealer would effect a swap transaction by warehousing the swap (i.e., entering into the swap without having entered into a matching swap but with the expectation of hedging the entered-into *43 swap either through a matching swap or a portfolio of swaps or temporarily in the cash, securities, or futures market) until the dealer could arrange an offsetting swap with another counterparty (i.e., match a book). In the later years of the market's evolution, the dealer would simply accept a position opposite the counterparty without expecting to locate another counterparty transaction to match the first transaction.

e. Need for Strong Credit

With the evolution of the interest rate swaps market, intermediaries could during the relevant years do far more deals if they were willing to offer themselves as counterparties. Major commercial banks, as compared to investment banks, were more highly capitalized and were more willing to assume the credit risks inherent in acting as a counterparty. The importance of credit risk was a factor during the relevant years in the dominance of commercial banks as dealers; e.g., 16 of the world's 20 largest swaps dealers in 1993 were commercial banks. A dealer with a weak credit rating in the swaps market was hurt in its ability to enter into swaps.

3. Brokers

Swap brokers do not take a position or act as a principal in a swap transaction, and they do *44 not maintain any exposure with respect to a swap. Swap brokers simply arrange for dealers to enter into interdealer swaps by matching dealers who want to effect a particular swap with other dealers who want to effect a similar swap. The clientele of a swap broker *197 is limited to dealers; e.g., an end user may not use the services of a broker unless the end user is a recognized dealer in the interbank market. A swap broker is paid a standard fee for its services based on a percentage of the notional principal amount.

1. Types of Markets

a. Primary Market

Interest rate swaps are transacted in the over-the-counter (OTC) market. That market is highly competitive and includes many active dealers. Throughout the relevant years, the primary market for plain vanilla U.S. dollar interest rate swaps between counterparties of relatively good credit quality was liquid and as active, deep, and competitive as almost any other market. The fact that there was an active primary market in benchmark swaps made it possible for potential counterparties to shop around quickly for competitive terms for an interest rate swap and agree on the swap's value. The appropriate range of terms for *45 a large interest rate swap between high-quality counterparties was at least as transparent and easily determined at a moment's notice as was the appropriate price for a comparatively large position in the most liquid equities traded on major U.S. stock exchanges.

b. Secondary Market

No active secondary market exists for swaps, other than in the case of buyouts (which occur by number of swap transactions approximately 10 percent of the time in the interbank market) and to a much lesser extent, assignments. Because of contractual restrictions, ¹⁸ nonstandardized terms, the requirement of bearing the credit risk of a specific counterparty, and the ability to buy out a swap at the going market rate, a liquid secondary market for the assignment of swaps has never developed. When swaps were sold before maturity, e.g., when a portfolio of swaps was sold by one dealer to another, the terms were not publicly available.

*198 2. Brokers' Dissemination of the Dealers' Quotations

a. Daily Quotations

During the course of each business day, swap brokers would contact a large number of swaps dealers (including FNBC) and request *46 their bid and ask quotes on several plain vanilla swaps. These swaps were commonly quoted on the convention of semiannual payments and on the basis of the 6-month LIBOR floating rate and had standard maturities of 1, 2, 3, 5, 7, and 10 years. These quotations (as well as the midmarket swap curve (discussed infra p. 43) assumed that the counterparty was a dealer with a credit rating of AA. ¹⁹ No service reported regular and reliable quotes on swaps negotiated with lower rated counterparties.

Upon receiving these quotations from the dealers, the brokers disseminated publicly the best interdealer price quotations by way of electronic broker quotation services *47 such as Bloomberg, Reuters Monitor Money Rates Service, or Associated Press/Dow Jones Telerate Service. These services, to which swaps dealers had access on their "dealer screens", normally made it unnecessary for a dealer to shop around when the dealer wished to enter into a swap transaction because the dealer knew that the quoted rate was a competitive price. If a dealer wanted to enter into a specific swap, the dealer could contact a broker, and the broker would call one or more dealers and confirm their quotes on the specified swap. The broker then reported back to the first dealer (the one wanting to enter into the particular swap) on the best quote that the broker had obtained. If that dealer ultimately entered into a swap agreement with another dealer supplied by the broker, the broker received a fee for its services based on a percentage of the notional amount.

b. No Dissemination of Actual Swap Prices

The actual prices at which swaps closed during the relevant years were not publicly disclosed. The only publicly *199 available data on swap prices during those years was the quoted bid and ask rates in the interdealer market as to plain vanilla swaps. Those quotations were normally *48 the best indicator of the market price at a particular moment.

c. Spreads Included in Quotations

Swap bid and ask rates in U.S. dollar denominated swaps with maturities exceeding 1 year were commonly quoted in terms of a spread to the corresponding U.S. Treasury yield. The table below lists the U.S. Treasury yield, the bid spreads quoted in the market, a