Case Opens New Front on Insider Trading - CDS

Discussion in 'Wall St. News' started by RedDuke, May 6, 2009.

  1. RedDuke


    Case Opens New Front on Insider Trading

    The Securities and Exchange Commission brought its first-ever case alleging insider trading in credit-default swaps -- an opaque derivative investment at the heart of the recent carnage in the financial industry.

    The swaps -- essentially a form of insurance against a bond default -- occupied a small Wall Street niche as recently as a decade ago. Since then, the traded value of swaps has ballooned to $38.6 trillion, while remaining largely unregulated. Both the White House and Congress have viewed the derivatives markets as having grown too large and unruly in recent years, contributing to the financial woes.

    "We are looking at a broad array of financial products associated with the financial crisis, including credit-default swaps," Kay Lackey, associate regional director of the SEC's New York office, said in an interview.

    A credit-default swap works like this: As a type of insurance, it pays off its holder if a company defaults on debt. Therefore, swaps can rise in value if a company starts to look as if it's at greater risk of defaulting -- which is exactly what happens if a company takes on a pile of new debt to do a buyout. A swap can be sold to other investors for a profit.

    The SEC's civil case, brought in U.S. District Court in the Southern District of New York, hinges on a relatively small profit earned in the 2006 buyout of Dutch media company VNU NV. The SEC alleges in a civil complaint that Jon-Paul Rorech, a 38-year-old salesman for Deutsche Bank AG, passed confidential information about VNU to Renato Negrin, a 45-year-old former trader for the hedge fund Millennium Partners.
    [massive market]

    Mr. Negrin allegedly used that information to earn a $1.2 million profit on credit-default swaps tied to the value of the company's debt. Mr. Rorech, in turn, got some of the trader's sales business, the complaint alleges.

    Attorneys for both men say their clients are innocent. The attorneys say that the SEC doesn't have jurisdiction, because the derivatives contracts are tied to European bonds that aren't regulated by the SEC.

    The case centers around the 2006 buyout of VNU by a group of six private-equity firms. The deal was initially announced in March, but the structure of the bonds that would be sold to finance the buyout changed shape in July.

    Prior to announcing the restructuring of the deal on July 24, the SEC alleges that Mr. Rorech learned about the new financing plans from bankers at Deutsche Bank. The SEC alleges that Mr. Rorech broke his obligation to keep the information confidential by telling Mr. Negrin the details of the new bonds between July 14 and July 17. The new terms meant the company would take on more debt, which would push up the value of VNU's credit-default swaps, the complaint alleges.

    The SEC alleges Mr. Rorech encouraged Mr. Negrin to buy the VNU CDS based on this information. In discussing the deal, the two men switched from talking on a regular phone, which was recorded by one of the men's employers -- common practice on trading desks -- and their cellphones, which weren't recorded, according to the SEC's case.

    In a conversation the morning of July 14, the SEC alleges Mr. Rorech told Mr. Negrin about the new bond offering for VNU. When Mr. Negrin asked to "handicap" the likelihood of the deal, Mr. Rorech said, "You're listening to my silence, right?"

    Mr. Negrin said, "OK, I'll call you back." The two then held a three-minute unrecorded phone call on their cellphones. By the afternoon of July 18, Mr. Negrin had bought €20 million of credit-default swaps on VNU. By July 24, he had profited on the trade by €950,000, or $1.2 million.

    Millennium Partners suspended Mr. Negrin in December 2008, and he has since left the firm, said Simon Lorne, the firm's vice chairman.

    "The SEC's case has no merit," said Mr. Rorech's attorneys, Richard Strassberg and Roberto Braceras of Goodwin Procter, in a statement. A Deutsche Bank spokeswoman said the firm is looking at the matter with the SEC. The firm put Mr. Rorech on paid leave several weeks ago.

    "Renato Negrin did not trade on inside information," said Mr. Negrin's attorney, Larry Iason of the firm Morvillo, Abramowitz, Grand, Iason, Anello & Bohrer.

    The SEC said it has jurisdiction because the swaps are "security-based," and the two traders are based in the U.S.