Tag: Credit Default Swaps

Insider Trading on Credit Default Swaps

sec-seal

The Securities and Exchange Commission brought its first insider trading enforcement action involving credit default swaps. Renato Negrin, a former portfolio manager at hedge fund investment adviser Millennium Partners L.P., and Jon-Paul Rorech, a salesman at Deutsche Bank Securities Inc., are charged with insider trading in credit default swaps of VNU N.V., an international holding company that owns Nielsen Media and other media businesses.

The SEC’s complaint alleges that Rorech learned information from Deutsche Bank investment bankers about a change to the proposed VNU bond offering. This change was expected to increase the price of the CDS on the VNU bonds. Rorech tipped Negrin about the contemplated change to theVNU bond offering, and Negrin then purchased CDS on VNU for a Millennium hedge fund. When news of the restructured VNU bond offering became public, the price of VNU CDS substantially increased. Negrin closed Millennium’s VNU CDS position at $1.2 million profit.

“This is the first insider trading enforcement action involving credit default swaps,” said Scott W. Friestad, Deputy Director of the SEC’s Division of Enforcement. “As alleged in our complaint, Rorech and Negrin checked their integrity at the door and schemed to engage in insider trading of CDS to the detriment of investors and our markets.”

James Clarkson, Acting Director of the SEC’s New York Regional Office, added, “CDS may still be obscure to the average individual investor, but there is nothing obscure about fraudulently trading with an unfair advantage. Although CDS market participants tend to be experienced professionals, there must be a level playing field with even the most sophisticated financial instruments.

It should not come as no surprise that the buying and selling of Credit Default Swaps is subject to the insider trading laws.

See:

Ruder Calls for Regulation of Hedge Funds

Former SEC Chair David Ruder testified to the House Oversight and Government Reform Committee that the SEC should be given the power to register hedge funds advisers and force them to disclose their risks. This testimony was part of the testimony of Congress Examining Hedge Funds. You can read the Testimony of David Ruder (.pdf).

Mr. Ruder states that:

New regulations are needed in order to protect hedge fund investors and in order to monitor hedge fund contributions to systemic risk. These regulatory needs can be accomplished by giving the Securities and Exchange Commission power to register and inspect hedge fund advisers, including the power to require disclosure of activities that might injure investors, power to require hedge fund advisers to disclose hedge fund risk activities, and power to monitor and assess the effectiveness of hedge fund risk management systems.

I disagree with the statement that regulation is needed to protect investors in hedge funds.  The exemptions from registration of hedge funds is for those funds and advisers with significant assets and understanding of risks.

As for the systemic risk posed by hedge funds, I remain unconvinced. Mr. Ruder refers back to the Long Term Capital Management in the late 90s.  We have not been hearing about hedge funds causing the current crisis. It appears that the investment banks and rating agencies were the parties most at fault. It also seems the lack of regulation in the derivatives markets, especially Credit Default Swaps, and poorly underwritten residential mortgages and mortgage securities were the tools that caused the most damage.