Nearly three years ago [6], we explained why when it comes to fixed income traders in the traditional, and very lucrative, over the counter market, "the days of rampant skimming on top of the bid/ask spread, and with them record bonuses for bond traders and salesmen, may just ended with a whimper not a bang, and all bond traders hoping to make millions by misrepresenting what the true purchase or sale prices are to buysider clients, even if completely voluntary on both sides, may want to seek employment elsewhere.
They have Jesse Litvak to thank for it.
Jesse is a former MBS trader from Jefferies, who got just a little too greedy, and proceeded to rip virtually all of his clients on seemingly every single trade he executed for the three years he was employed at Jefferies, lying to everyone in the process: both clients and in house colleagues, generating some $2.7 million in additional revenue for Jefferies for the duration of his tenure, and who knows how much in personal bonuses."
Today, in the first official criminal action following the Litvak bust from 2013, the SEC confirmed that our assessment was spot on after the regulator announced fraud charges [7]against three traders "accused of repeatedly lying to customers relying on them for honest and accurate pricing information about residential mortgage-backed securities (RMBS)."
In the complaint, the SEC alleges that Ross Shapiro, Michael Gramins, and Tyler Peters defrauded customers to illicitly generate millions of dollars in additional revenue for Nomura Securities International, the New York-based brokerage firm where they worked. They misrepresented the bids and offers being provided to Nomura for RMBS as well as the prices at which Nomura bought and sold RMBS and the spreads the firm earned intermediating RMBS trades. They also trained, coached, and directed junior traders at the firm to engage in the same misconduct.
In a parallel action, the U.S. Attorney’s Office for the District of Connecticut announced criminal charges against Shapiro, Gramins, and Peters, who no longer work at Nomura.
“The alleged misconduct reflects a callous disregard for the integrity and obligations expected of registered securities professionals,” said Andrew Ceresney, Director of the SEC’s Enforcement Division. “Not only did these traders lie to their customers, but they created a corrupt culture on Nomura’s trading desk by coaching more junior traders to employ the same deceptive and dishonest trading practices we allege in our complaint.”
Why did they do it? Simple: millions in bonuses paid to those who generated the most revenue, no matter how it was achieved. To witL
- The lies and omissions to customers by Shapiro, Gramins, and Peters generated at least $5 million in additional revenue for Nomura, and lies and omissions by the subordinates they trained and coached generated at least $2 million in additional profits for the firm.
- Nomura determined bonuses for Shapiro, Gramins, and Peters based on several factors including revenue generation. Nomura paid total compensation of $13.3 million to Shapiro, $5.8 million to Gramins, and $2.9 million to Peters during the years this misconduct was occurring.
- Customers sought and relied on market price information from these traders because the market for this type of RMBS is opaque and accurate price information is difficult for a customer to determine. Therefore it was particularly important for the traders to provide honest and accurate information.
- Shapiro, Gramins, and Peters went so far as to invent phantom third-party sellers and fictional offers when Nomura already owned the bonds the traders were pretending to obtain for potential buyers.
Looks like the three won't be trading much any time soon. Others were luckier: the SEC separately entered into deferred prosecution agreements (DPAs) with three other individuals who have extensively cooperated with the SEC’s investigation and provided enforcement staff with access to critical evidence that otherwise would not have been available.
“The SEC is open to deferring charges based on certain factors, including when cooperators come forward with timely and credible information while candidly acknowledging their own misconduct,” said Michael Osnato, Chief of the SEC’s Complex Financial Instruments Unit. “The decision to defer charges in this matter reflects the early and sustained assistance provided by these individuals.”
Which, of course, is the punchline: as we warned in January 2013, "all bond traders hoping to make millions by misrepresenting what the true purchase or sale prices are to buysider clients, even if completely voluntary on both sides, may want to seek employment elsewhere" because now that the SEC is apparently cracking down on bid/ask misrepresentation, all it will take is one disgruntled former employee and suddenly all those bonuses accumulated for the past 5 years become clawback-able, and is also the reason why fixed income sales and trading bonuses have been steadily leaking from the top left to the bottom right, and will continue to do so until all bonds are also traded on exchanges courtesy of "liquidity-providing" HFTs.
Now if only the SEC had the same ambition to crack down on market manipulation taking place every single day among the HFTs industry, one could almost say that the SEC will finally be doing its job for once.