Insider trading

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CDS and insider trading

A series of phone calls between a Deutsche Bank AG bond salesman and a hedge-fund trader has landed the two men at the center of a courtroom test of how far federal regulators can go in pursuing insider trading.

Jon-Paul Rorech, the salesman, was teeing up buyers for a bond offering for a unit of Dutch publisher VNU. In a call to portfolio manager Renato Negrin, he suggested that derivatives contracts based on the bonds could soar in value, regulators say. Mr. Negrin, they say, bought a huge trading position, reaping a $1.2 million profit.

"Great call. That's all I have to f------ say," Mr. Negrin later told the salesman, according to a recording of a phone call transcribed by regulators. Mr. Rorech told Mr. Negrin that the trading tip was a "nice little kiss," the regulators say.

Those 2006 conversations triggered a major civil insider-trading case that is slated to go to trial next week in a New York federal court. The Securities and Exchange Commission has accused the two men of improperly using nonpublic information, and are seeking disgorgement of profits and civil penalties. They deny the charges. Details about the conversations have trickled out in recent days in court filings.

Neither Deutsche Bank nor the hedge fund, Millennium Partners LP, has been accused of wrongdoing. Millennium says it cooperated with the investigation and has a "zero-tolerance policy" for insider trading. Deutsche Bank declined to comment.

The case has triggered a broader debate: Can federal securities regulators pursue insider-trading charges in the unregulated market for "credit-default swaps," financial contracts that provide insurance against debt defaults. Banks, hedge funds and traders use them to bet on the likelihood of bonds or loans going bad. The SEC says it has purview over policing the market.

The defendants in the New York case argue, among other things, that swaps aren't securities, but private contracts between financial players outside the SEC's jurisdiction. Unlike most stocks, bonds and options, swaps aren't traded on an exchange.

The case will test the SEC's authority at a critical time. In recent months, regulators have launched high-profile cases alleging insider trading by hedge fund Galleon Group and several technology executives. Just last week, the U.K.'s Financial Services Authority arrested seven people as part of what they say is a large insider-trading ring. The defendants have denied wrongdoing.

Insider trading occurs when someone makes an investment decision based on material information not available to the general public, and knows that information is coming from a person who has a responsibility to keep it private. The SEC traditionally has pursued insider-trading cases involving stocks, options and other securities. But as swaps have exploded in popularity in recent years, regulators have grown concerned that investors have been using inside information in trading them.

"What is at stake is the jurisdictional boundary of the SEC," says Frank Partnoy, a law and finance professor at the University of San Diego and a former Morgan Stanley derivatives salesman.

Mr. Rorech's sales call to Mr. Negrin involved a $1.6 billion bond offering for the Nielsen TV-ratings unit of Dutch publisher VNU, which has since been renamed Nielsen Co. Mr. Rorech, 39 years old, wanted to know whether Mr. Negrin was interested in buying the Nielsen bonds or credit-default swaps insuring against a default of VNU, according to papers filed by the SEC in the case.

Mr. Negrin, 46, balked, according to the SEC. Mr. Rorech told him there were possible "upsides" to buying VNU swaps, the SEC says. He indicated, among other things, that parent VNU—not just its Nielsen unit—could also issue more debt, the SEC says.

An increase in VNU's debt would heighten the company's risk of default, making the insurance on its debt more expensive. Information about an additional VNU debt offering wasn't known to the market, the SEC says.

"How do we define the odds?" Mr. Negrin asked, according to a recorded call transcribed by the SEC.

"I think they're very good," Mr. Rorech told him.

"Give me something to grab onto that they're very good," Mr. Negrin said.

"You're listening to my silence, right?" asked Mr. Rorech before they hung up.

Mr. Negrin called Mr. Rorech back on his cell phone where they spoke for three minutes, avoiding the recorded phone line, the SEC says.

A few days later, they talked again over cellphones about VNU. Three hours after the second call, on July 17, 2006, Mr. Negrin placed the first of two orders totaling €20 million (then about $27 million) for credit-default swaps on VNU debt, double the size of any VNU swaps position he previously held.

One week later, a deal involving VNU's Nielsen unit was announced that included VNU also issuing bonds. The move sent prices of VNU credit default swaps—the cost to insure against a default—surging.

Mr. Negrin later sold all his VNU swaps, for a profit of about $1.2 million, based on the exchange rate at the time, according to the SEC.

Lawyers for Mr. Rorech, who currently is on leave from Deutsche Bank, say the information wasn't confidential and he simply was generating interest in the bond offering to ensure it went off without a hitch, and that he never knew with certainty that VNU also would issue more debt. Lawyers for Mr. Negrin, who no longer works for Millennium, say he did nothing wrong.

In court documents, lawyers for Messrs. Rorech and Negrin argue that traders discuss potential deal terms "routinely" in marketing bond offerings. "If the Commission now believes that information flow in high yield bond deals creates a problem as it relates to credit default swaps," it needs to "develop rules to address potential abuses."

The SEC argues that the activity was insider trading and that it currently has jurisdiction over swaps because they're based on the value of VNU securities. The defendants say swaps are private contracts traded between dealers outside the SEC's purview.

When VNU's swap prices rose suddenly in the wake of the announcement of the additional debt offering, some traders unrelated to the case were frustrated, the SEC says. Paul Causer, a trader and Deutsche Bank client in London, suggested to a Deutsche salesman that some hedge funds had gotten early word of the bond deal, according to the SEC. According to a recorded line transcribed by the SEC, Mr. Causer said: "Has it got to the point where it can be as blatant as that?"

The Deutsche salesman, Sean Hunt, responded: "Is that insider trading or is that just you sort of having an interactive…"

Mr. Causer cut him off, according to the recorded call, saying: "It's insider trading. The whole market doesn't know, Sean. The people that are in the know, know, right?"

FSA probe said to focus on block trade front-running

Britain’s financial regulator is examining whether some of the seven people arrested in an insider-trading probe engaged in the front-running of block trades, a person with direct knowledge of the case said.

The Financial Services Authority is investigating whether individuals used knowledge of forthcoming securities sales to make a profit, said the person who declined to be identified because the details are private. A block trade is typically a large sale of securities on behalf of a corporate client.

“Blocks can take place in the space of an hour or they can take days to be prepared when a number of people are taken over the wall” and given private information on a sale, said Giorgio Questa, a finance professor at London’s Cass Business School. “Block trades tend to move markets, and the temptation is there to front-run them.”

The FSA this week arrested seven people in connection with the probe, including employees from Deutsche Bank AG, Exane BNP Paribas and Moore Capital Management LLC, in what it called its biggest crackdown on insider trading. The regulator is stamping down on the crime after being accused by lawmakers of not doing enough to eliminate it.

FSA Questioning

Those questioned by the FSA include Deutsche Bank’s Martyn Dodgson, Exane’s Clive Roberts, and Moore Capital’s Julian Rifat. Novum Securities Ltd.’s Graeme Shelley and Iraj Parvizi, a director of Aria Capital Ltd., are also being investigated. Ben Anderson was arrested as part of the probe, according to another person familiar with the case. Anderson’s employment details couldn’t be verified.

SEC charges board members for insider trading

Samuel Wyly and Charles Wyly -- billionaire brothers in Texas who have spent millions funding political campaigns -- committed violations of federal securities laws and fraud by using offshore accounts to secretly trade the shares of public companies whose boards they sat on, reaping more than $550 million in profit, according to a Securities and Exchange Commission complaint filed Thursday.

The politically-active Wylys, who have been generous donors to Republican causes over the years, have faced questions in recent years -- including a Senate probe -- about whether they ran an extensive network of tax shelters.

"The cloak of secrecy has been lifted from the complex web of foreign structures used by the Wylys to evade the securities laws," said SEC deputy director of enforcement Lorin L. Reisner. "They used these structures to conceal hundreds of millions of dollars of gains in violation of the disclosure requirements for corporate insiders."

The SEC alleges that the brothers created an elaborate network of accounts and companies in the Isle of Man and the Cayman Islands that they used to trade more than $750 million in stock in four public companies they served as board members. The SEC charges that they also committed an insider trading violation concerning one of the companies, earning almost $32 million.

The Wyly's attorney and stockbroker were also charged.

"After six years of investigations, the SEC has chosen to make claims against the Wyly brothers -- claims that, in our view, are without merit," says William A. Brewer III, partner at Bickel & Brewer and lead counsel for the Wylys. "It will come as little surprise to those who know them that the Wylys intend to vigorously defend themselves -- and expect to be fully vindicated."

The SEC complaint says the public companies whose shares the Wylys improperly traded include Michaels Stores Inc., Sterling Software Inc., Sterling Commerce Inc. and Scottish Annuity & Life Holdings Ltd.

The SEC alleges that by using offshore accounts to trade shares of these public companies, the Wylys were able to escape filing regulatory disclosures required of board members that they were buying or selling shares. "The Wylys and French also knew or were reckless in not knowing that the investing public routinely uses such disclosures to gauge the sentiment of public companies' insiders and large shareholders about the financial condition and prospects of those companies, relying on those disclosures when making investment decisions," the SEC said in a statement.

The fraud lasted 13 years and the Wylys were able to make gains -- hidden from the public -- of more than a half-billion dollars, according to the SEC.

The SEC's charges, which are civil in nature, seek various financial fines and sanctions against the Wylys and their associates.

Judge allows wiretaps in Galleon case

A federal judge on Wednesday ruled that federal prosecutors can use wiretap recordings in their criminal case against Raj Rajaratnam, the founder of the Galleon Group hedge fund.

The widely expected decision still deals a blow to Mr. Rajaratnam and a co-defendant, a former hedge fund consultant, Danielle Chiesi, whose lawyers had argued that the wiretaps were conducted improperly and should be thrown out.

But Judge Richard J. Holwell of Federal District Court in Manhattan wrote in his 68-page opinion, parts of which were heavily redacted, that government investigators were within their rights to record those conversations and followed the rules.


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