Interdealer broker

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Interdealer worry about new swap clearing rules

The regulatory agencies are hosting a public roundtable Friday to help shape new rules on swap clearing in line with the requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

The Dodd-Frank law requires all swaps that are standardised enough for central clearing to be traded on a designated contract market, registered securities exchange or a new breed of 'swap-execution facility' (SEF).

The creation of the new entities has attracted interest from a host of firms who plan to file for designation as an SEF, including InterContinentalExchange, TradeWeb, MarketAxess, and Bloomberg.

In an open letter to the SEC and the CFTC the Wholesale Markets Brokers' Association, Americas (WMBAA) has called on the regulators to ensure "open and non-discriminatory access to swap clearing organisations".

Julian Harding, executive director at Tradition and chairman of the WMBAA, comments: "Direct or indirect impediments created to enhance a clearing organisation's affiliated trading platform would frustrate Congressional intent. Competition in execution, with its attendant benefits to all participants, is inherently encouraged in the legislation but would be stifled as a result of such monopolistic tendencies."

The inter-dealer brokers would like to see the establishment of an unaffiliated self-regulatory organisation to enforce rules and police the markets operated by swap-execution facilities and root out abuses.

MSRB offers guidance for broker’s brokers

The Municipal Securities Rulemaking Board has issued draft guidance warning broker’s brokers of their obligations under its rules following recent enforcement actions by the Securities Exchange Commission and the Financial Industry Regulatory Authority alleging rule violations.

The guidance was issued in a notice on Thursday, but the board said it may incorporate some of the guidance in proposed rules or rule changes in the future.

The MSRB invited market participants and members of the public to submit comments on the guidance by Nov. 15.

The guidance details how Rules G-18 on execution of transactions, G-30 on prices and commissions, and G-17 on fair dealing apply to broker’s brokers, which typically match dealer sellers with dealer buyers of municipal securities.

Much of the guidance relates to bid-wanteds, in which a selling dealer asks a broker’s broker to obtain the best bid that it can find for certain muni securities, without specifying a desired price or yield, the board said.

Bid-wanteds, which were the subject of several of the recent enforcement actions, tend to involve smaller retail-size blocks of bonds and relatively infrequently traded securities, the notice said.

The board defines a broker’s broker as “a broker, dealer, or municipal securities dealer that principally effects transactions for other brokers, dealers and municipal securities dealers ... or that holds itself out as a broker’s broker.”

A broker’s broker may be a separate business or part of a larger business, according to the MSRB.

“Under Rule G-18, a broker’s broker has an obligation to its dealer client to make a reasonable effort to obtain a fair and reasonable price in relation to market conditions — the same duty that a dealer has to a customer in an agency transaction,” the MSRB said in the notice. “The broker’s broker must employ the same care and diligence in doing so as if the transaction were being done for its own account.”

The board stressed that a bid-wanted is not always a conclusive determination of fair market value.

It said that, particularly when the fair market value of a security is not known, the broker’s broker may need to “check the results of the bid-wanted process against other objective data to fulfill its fair pricing obligations.”

The MSRB suggested that a broker’s broker trying to comply with G-18 should widely disseminate a bid-wanted to obtain exposure to multiple dealers with possible interest in the block of securities.

“No fixed number of bids is required,” the board said.

However, if the securities are small, have unusual features, or are of limited interest, “the broker’s broker must reach dealers with specific knowledge of the issue or known interest in securities of the type being offered,” the MSRB said. “It is not consistent with the Rule G-18 obligation of a broker’s broker for it to encourage off-market bids.”

Broker’s brokers also should not be representing both the seller and the bidder “unless that is disclosed prominently and both parties agree in writing in advance of a transaction.”

The MSRB said when broker’s brokers “effect” or execute occasional transactions with customers, Rule G-30 applies if they are principal transactions.

Rule G-30 states: “No broker, dealer or municipal securities dealer shall purchase municipal securities for its own account from a customer or sell municipal securities for its own account to a customer except at an aggregate price (including any mark-down or mark-up) that is fair and reasonable, taking into consideration all relevant factors, including the best judgment of the broker, dealer or municipal securities dealer as to the fair market value of the securities at the time of the transaction and of any securities exchanged or traded in connection with the transaction, the expense involved in effecting the transaction, the fact that the broker, dealer or municipal securities dealer is entitled to profit, and the total dollar amount of the transaction.”

Under Rule G-17, broker’s brokers “shall deal fairly with all persons and shall not engage in any deceptive, dishonest or unfair practice,” the MSRB said.

If a broker’s broker has a customer, it must “disclose that to both sellers and bidders in writing” because of the potential conflict of interest, the board said.

Furthermore, the broker’s broker “must put information barriers in place to ensure that customers are not provided with information about securities of other clients, including the ownership of such securities and information about bids (other than the winning bid that is reported to the MSRB).”

If a broker’s broker is part of a larger business, it must put information barriers in place to prevent non-public information from being transferred to the rest of the business organization, the board said.

“It is clearly a deceptive, dishonest, and unfair practice for a dealer holding itself out as a broker’s broker to purchase securities for its own account, rather than for the account of the highest bidder when a seller has engaged the broker’s broker to effect a trade on its behalf,” the MSRB warned.

The board said Rule G-17 prohibits broker’s brokers from providing preferential information to bidders in bid-wanteds on where they stand in the bidding process. “This prohibition precludes 'last looks,’ directions to a bidder that it should 'review’ its bid or that its bid is 'sticking out,’ ” the board said.

A broker’s broker also cannot submit fake cover bids, adjust a bid without the bidder’s knowledge; fail to inform the selling dealer of the highest bid, accept bids after deadlines, or submit fictitious trade prices, the MSRB warned.

The board said a broker’s broker must keep records of all bids, including “quick answer” bids, together with the time of receipt for at least three years, and records of bids cannot be “overwritten” when new bids are entered, the board said.

ICAP Securities USA LLC to pay $25 million to settle SEC findings

ICAP Securities USA LLC to Pay $25 Million to Settle SEC Findings


Washington, D.C., Dec. 18, 2009 — The Securities and Exchange Commission today charged a U.S. subsidiary of the world's largest inter-dealer broker, U.K.-based ICAP plc, with fraud for engaging in deceptive broking activity and making material misrepresentations to customers concerning its trading activities.

Additional Materials

Administrative Proceeding Release No. 33-9097

As an inter-dealer broker, ICAP Securities USA LLC (ICAP) matches buyers and sellers in over-the-counter markets for various securities, such as U.S. Treasuries and mortgage-backed securities, by posting trade information on computer screens accessed by its customers who make trading decisions based in part on such information. Inter-dealer brokers with greater trade activity on their screens often are better positioned to attract customer orders and earn more commissions than those whose screens reflect little or no trading activity.

The SEC's enforcement action finds that ICAP, through its brokers on its U.S. Treasuries (UST) desks, displayed fictitious flash trades also known as "bird" trades on ICAP's screens and disseminated false trade information into the marketplace in order to attract customer attention to its screens and encourage actual trading by these customers. ICAP's customers believed the displayed fake trades to be real and relied on the phony information to make trading decisions.

ICAP agreed to settle the SEC's charges by, among other things, paying $25 million in disgorgement and penalties. The SEC additionally charged five ICAP brokers for aiding and abetting the firm's fraudulent conduct and two senior executives for failing reasonably to supervise the brokers. The individuals have each agreed to pay penalties to settle the SEC's charges.

"It is essential that ICAP and other inter-dealer brokers refrain from engaging in conduct that discredits their privileged position in the marketplace," said Lorin L. Reisner, Deputy Director of the SEC's Division of Enforcement. "ICAP engaged in deceptive practices that violated the legal and professional standards required of market participants; our action today demonstrates zero tolerance for such conduct."

The seven individuals at ICAP charged by the SEC are:

  • Ronald A. Purpora, the former President of ICAP North America, ICAP's U.S. parent and a member of ICAP plc's Global Executive Management Group.
  • Gregory F. Murphy, the Chief Operating Officer of ICAP.
  • Peter M. Agola, a broker on the UST long bond desk, and the assistant manager of the desk since 2005.
  • Ronald Boccio, a broker on the UST 5-year desk.
  • Kevin Cunningham, a broker on the UST shorts desk, and the manager of the desk since 2005.
  • Donald E. Hoffman, Jr., a broker on the UST 10-year desk until his retirement in 2006.
  • Anthony Parisi, a broker on the UST 5-year desk, and a co-manager of the desk during the relevant period.

According to the SEC's order, ICAP's UST brokers displayed thousands of fictitious flash trades to ICAP's customers between December 2004 and December 2005. The SEC also finds that ICAP represented to its off-the-run UST customers that its electronic trading system would follow certain workup protocols in handling customer orders. Such ICAP customers therefore expected that their orders, once entered onto ICAP's screens, would be filled according to the workup protocols. However, ICAP's brokers on the UST desks used manual tickets to bypass such protocols and close out of thousands of positions in their ICAP house accounts, thereby rendering ICAP's representations concerning the workup protocols false and misleading. In some instances, ICAP's customers' orders received different treatment than the customers expected pursuant to the workup protocols.

The SEC's order further finds that ICAP held itself out as a firm that did not engage in trading that subjected its own capital to risk. ICAP's regulatory filings routinely made this point, noting specifically in one instance that the firm "does not engage in proprietary trading." During the relevant period, however, two former ICAP brokers on the voice-brokered collateral pass-through mortgage-backed securities (MBS) desk routinely engaged in profit-seeking proprietary trading that rendered ICAP's representations regarding proprietary trading false and misleading. The SEC's order also finds that ICAP failed to make and keep certain required books and records on the UST desks and the MBS desk.

According to the SEC's order, Purpora and Murphy supervised the respondent brokers on the UST desks, and, despite red flags, failed to prevent and detect the brokers' fictitious flash trades until after the conduct had been uncovered by the SEC. Both Purpora and Murphy were aware that the respondent brokers used manual tickets to close out of positions in their house accounts, but failed to inquire into the brokers' practices regarding the use of manual tickets to circumvent the workup protocols concerning customer orders.

The SEC's order finds that ICAP willfully violated Section 17(a)(2) and 17(a)(3) of the Securities Act of 1933, and Section 15C of the Securities Exchange Act of 1934 and 17 CFR Parts 404 and 405. The order also finds that each of the five brokers willfully aided and abetted and caused ICAP's violations of Section 17(a)(2) and 17(a)(3) of the Securities Act, and that Purpora and Murphy failed reasonably to supervise the brokers.

Without admitting or denying the SEC's findings, ICAP has agreed to a censure, to cease and desist from committing or causing any violations of Section 17(a)(2) and 17(a)(3) of the Securities Act, Section 15C of the Exchange Act and 17 CFR Parts 404 and 405, and to pay $1 million in disgorgement and $24 million in penalties. ICAP also has agreed to retain an independent consultant to, among other things, review ICAP's current controls and compliance mechanisms; its trading activities on all desks to ensure that the violations described in the order are not occurring elsewhere at ICAP; and ICAP's books and records pertaining to trading records. Based on its review, the independent consultant will recommend any additional policies and procedures which are reasonably designed to ensure that ICAP complies with applicable provisions of the federal securities laws.

Without admitting or denying the SEC's findings, each of the brokers has agreed to cease and desist from committing or causing any violations of Section 17(a)(2) and 17(a)(3) of the Securities Act; to be suspended from association with any broker or dealer for a period of three months; and, with the exception of Hoffman, to pay a $100,000 penalty. Hoffman, who retired from ICAP nearly four years ago, has agreed to pay a $50,000 penalty.

Finally, without admitting or denying the SEC's findings, Purpora and Murphy have each agreed to be suspended from association in a supervisory capacity with any broker or dealer for a period of three months and pay a penalty of $100,000.

Credit seizure? $6 million pay turns on relationships

So-called interdealer brokers pair bids and offers between the world's largest banks in derivatives markets that have no public exchanges such as credit-default swaps and interest-rate products. Unlike traders and investment bankers, the brokers don't take on risk or devise trading strategies for their clients.

As the notional amount of credit-default swaps ballooned from less than $1 trillion in 2001 to $62.2 trillion last year, the brokers became more valuable. According to the International Swaps and Derivatives Association, the amount outstanding expanded 81 percent in 2007. Interest-rate swaps grew 34 percent to $285.7 trillion and equity derivatives gained 39 percent to $10 trillion.

Fees for brokerages, including GFI, ICAP Plc, Tullett Prebon Plc, Creditex Group Inc. and Cantor Fitzgerald LP's BGC Partners Inc., may rise as much as 20 percent to $12 billion next year, according to Citigroup Inc. analyst Donald Fandetti.

`Matching Up Trades'

A Morgan Stanley trader who wanted to reduce his exposure to General Electric Co. debt by buying credit-default swaps would telephone a credit-default swaps broker, who would then find a trader at another bank to take the other side of the deal. A broker enables both to retain anonymity.

``They're just matching up trades, Cohan said.

Some brokers make more than customers at top-tier investment banks, based on numbers supplied by Options Group, a recruiting and consulting firm in New York.

The average managing director on the credit-derivatives trading desk at a Wall Street firm, such as Morgan Stanley or Goldman Sachs Group Inc., earned between $1.5 million and $1.8 million. A head trader is paid about $4 million in salary and bonuses, according to Options Group.

Demand for brokers comes while Wall Street eliminates 65,000 jobs to compensate for a slump in sales and trading of asset- backed securities and high-yield corporate debt. Credit-default swaps skirted the freeze in credit markets that began with the collapse of subprime-mortgage securities in July as investors and traders used the instruments to bet on potential losses for companies from Bear Stearns Cos. to Ambac Financial Group Inc. to Tribune Co.

`All About Relationships'

Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company's ability to repay debt. They pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. A rise indicates deterioration in the perception of credit quality; a decline, the opposite.

GFI handled as much as 40 percent of the credit-derivatives trades between the world's banks in 2007, collecting $318 million in revenue, according to Citigroup's Fandetti. Derivatives are financial instruments linked to stocks, bonds, loans, currencies and commodities, or linked to specific events such as changes in interest rates or weather.

``It's all about relationships, said Andy Nybo, a senior analyst at Tabb Group in New York, who analyzes market structures and exchanges. ``It's more than a phone call. You invite him to a Yankees game. It's tight-knit and built on entertainment and social interaction.

Massage Parlors

That's not unusual in the world of derivatives brokers, according to Willy Stemp, 52, a consultant at London-based Mark to Market Plc. Some entertain traders every night of the week in the hope of winning a client, said Stemp, a former broker.

``Brokers aren't looking for highly technical Ph.D.s and MBAs, Stemp said. ``They're looking for personality people, with a decent education and sharp wits.

The entertainment can go further than expensive restaurants and bars. According to a complaint filed by former Tradition broker Brett DiLiberto in the Southern District of New York and made available on electronic databases, the firm ``regularly paid prostitutes to entertain traders.

DiLiberto, as part of his job, frequently ``visited brothels masquerading as massage parlors, and was ``required as part of his entertaining duties to retain other prostitution services, according to the complaint. DiLiberto also said he went on a January fishing trip to Costa Rica in 2006 that was an ``extended orgy. On one occasion, DiLiberto said he was recalled from vacation to attend a ``customer drinking and drug party.

Axiom Suit

DiLiberto sued Tradition, saying the job drove him to alcohol and drugs and almost broke up his family. He claimed the brokerage refused to let him resign, preventing him from finding new employment at rival firms.

Jennifer Van Hofwegen, a spokeswoman for Lausanne, Switzerland-based Tradition in New York, declined to comment. Assentato didn't return calls. DiLiberto didn't return repeated calls to his home in the past two days seeking comment.

In 2005, the partners of now-defunct New York-based credit- derivative brokerage Axiom Global Partners LLC accused James Cawley, the chief executive officer, of spending $40,000 one evening at a strip club entertaining a client, according to a court affidavit. The partners, who also accused Cawley of hiring prostitutes, wanted Axiom shut down. They later settled the case and agreed to withdraw the allegations.

Prostitutes, Strippers

Cawley is now CEO of New York-based IDX Capital, another derivatives firm. ``False and defamatory allegations were made against Mr. Cawley three years ago because he attempted to change this culture, according to an e-mailed statement from spokesman Lewis Goldberg. Cawley is suing for libel, Goldberg said.

Brokerage firms spend as much as 5 percent of their revenue on entertaining, Citigroup's Fandetti said. On fees of $10 billion, that would come to $500 million for the industry.

GFI ``has a longstanding policy of not reimbursing employees for adult entertainment, according to a statement.

Still, the defecting GFI employees spent $1.6 million last year entertaining clients who paid the firm about $50 million in fees, GFI President Colin Heffron said in an affidavit for the suit against Tradition seeking to prevent the brokers from joining the competitor. The firm spends ``large sums of money to foster ``crucial broker-trader relationships, Heffron said.

Three Amigos

Tradition's raid on GFI followed the departure of three London-based GFI brokers, dubbed the Three Amigos, who quit in June to join Tullett for 2 million pounds ($4 million) in a signing bonus and a guaranteed minimum of 2 million pounds annually for three years, GFI said in legal documents.

Fewer, 44, earned $3.2 million last year in addition to dividends from his ownership interest in Gooch's Jersey Partners Inc., the majority owner of GFI, the company said in its suit.

Babcock, the former head of GFI's most-profitable credit- derivatives desk in New York, took home $3.5 million, according to GFI's petition to the Supreme Court of the State of New York asking for a temporary restraining order against the departing brokers. Fewer and Babcock didn't return repeated calls seeking comment.

GFI, down 50 percent this year, fell 65 cents to $11.89 in Nasdaq Stock Market trading. Tradition rose 1.2 Swiss francs to 197 in Swiss trading. The company has a market value of about 1.1 billion francs ($1 billion).

Marking the Peak?

The salaries commanded by the GFI brokers may mark the peak, Citigroup's Fandetti said.

Eight banks led by Morgan Stanley and UBS AG may spend $40 million to create a brokerage that will cut costs by using combined electronic and so-called voice brokering. While GFI introduced electronic trading for credit derivatives in 2004, it hasn't taken hold in the U.S.

Like credit derivatives, brokering trades in U.S. Treasuries was conducted over the phone until 1999, when Cantor Fitzgerald introduced ESpeed Inc., an electronic-trading service. Now all trading is screen-based, Tabb Group's Nybo said. Because credit derivatives are more complex, it may be years before they are traded electronically, he said.

Three days after Assentato hosted the steakhouse dinner, none of the brokers showed up at GFI's trading desk at 100 Wall Street. GFI that day matched one trade instead of the few hundred it typically averaged, credit-derivatives broker John Piluso said in an affidavit.

For many of the brokers, the money was too much of a lure.

``I am just a guy from upstate New York who was offered a lot of dough; what can I do? Daniel Polidore, one defecting broker told Piluso before departing, according to the affidavit.

The case between GFI and Tradition is GFI Securities LLC v. Tradition Asiel Securities Inc., 601183/2008, New York Supreme Court (Manhattan).


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