At the end of last week, the Practicing Law Institute held its annual SEC Speaks conference with employees of the Securities And Exchange Commission. The program typically offers a wide range of insight into the securities regulator’s priorities for the coming year.
Over the past few days, we’ve seen the “coco bond carnage” (Bloomberg) play out in newspaper articles as “investors are freaking out” (Business Insider) and the “[m]usic stops for buyers of bank coco debt” (Financial Times).
There’s been a few smaller stories this first week of November that would be of interest to securities whistleblowers, so we thought that we would briefly touch on them in a mid-week update.
The U.S. Commodity Futures Trading Commission is preparing to announce new regulations aimed at managing the risk of automated trading. Automated trading strategies are used for more than 40 percent of futures traded in Treasury, energy, metals and agricultural markets.
One focus of the new regulations will be trading in Treasury bonds. The concern with the nearly $13 trillion government bond market stems from the flash rally in Treasuries last October where there was substantial volatility during a short 12 minute window.
The regulations have been debated for more than two years at the agency and could be announced as soon as a month from now. CFTC Chairman Timothy Massad spoke about this area in a speech this week. Any regulations will still need to go through notice and comment rulemaking so it would still be months or even years before they were actually implemented.
Among the proposals under considerations are increased registration requirements for proprietary trading firms, pretrade risk controls, and possibly even kill switches to aid efforts to stop out of control computer programs from impacting the markets.
The CFTC has placed increased emphasis on algorithmic trading and has begun enforcement actions against several traders and firms for spoofing, the placement of orders intended to manipulate the market rather than execute. It is unlikely to impose special requirements on high-frequency trading of the type that was detailed in Flash Boys because of the difficulties in defining the term.
As always, reporters of violations of these regulations, once they are implemented, will be eligible for whistleblower rewards when the monetary sanctions for noncompliance exceed $1 million and the individual otherwise meets the terms and conditions of the program set form in the Dodd-Frank Act and CFTC rules. Our CFTC whistleblower attorneys can assist you with answers to questions about this information as well as assistance reporting violations of the Commodity Exchange Act to the U.S. Government. To speak to an attorney, fill out our contact form or call 1-800-590-4116.
Twenty-two municipal underwriting firms agreed to pay SEC penalties of between $20,000 and $500,000 for inaccurate disclosures to investors concerning the continuing disclosure obligations and compliance of municipal bond issuers. It is the second round of settlements against underwriters via the Municipalities Continuing Disclosure Cooperation (MCDC) Initiative.
The program was announced by the Securities and Exchange Commission in March 2014 and offered standardized, favorable settlements for self-reported inaccuracies in bond offerings concerning compliance with continuing disclosure obligations specified in Rule 15c2-12 of the Exchange Act. This summer, the SEC brought enforcement actions against more than 30 municipal bond underwriters for material misstatements and omissions in offering documents voluntarily self-reported pursuant to the Initiative which was only open for a limited time.
Rule 15c2-12 requires information about an issuer’s failure to materially comply with continuing disclosure commitments for the past 5 years. It also prohibits underwriters from purchasing or selling municipal securities unless the issuer has committed to continuing disclosures. The Kings Canyon Joint Unified School District in California was the first to settle under the program in July 2014 for inaccurate investor disclosures in a 2010 bond offering.
The investment banks fined in this wave of announcements included PNC Capital Markets, UBS, Fifth Third Securities and Edward D. Jones & Co., among others.
In 2002, Time Magazine made three whistleblowers the persons of the year. If a global recession hits in the next few years, it is looking more likely that the people who blow the whistle on misconduct this time will actually be living overseas.
Global growth has been the talk of the morning with the Dow Jones Industrial Average plummeting more than a thousand points on the open before reversing course to a much more modest decline by mid-day. It reminds me of the volatility that hit the stock market in late 2007 as the financial crisis took hold. Unlike the past two recessions here in the United States where much of the talk of domestic excesses was oriented within the country at the tech bubble and the real estate bubble, this time it’s the world economy that is squarely on the radar of the financial professionals.
International Whistleblowers have made up slightly more than 10% of tips to the Securities & Exchange Commission for the past few years. But if this recession starts overseas, then that’s the most likely area to see whistleblowing.
This could also be the first time that multinational corporations are forced to shrink their workforces overseas and people who believe they are wronged by companies start talking to employment lawyers about their options. As the Wall Street Journal pointed out a few months ago, more misconduct is discovered during recessionary periods and emerging markets have been growing the entire existence of the SEC Whistleblower program.
Among these areas that we’re expecting to see misconduct with international ties include:
Accounting Fraud: China and Japan
There’s concern that both Chinese and Japanese companies are engaged in problematic accounting. The Toshiba scandal has put international companies squarely on the radar of investors in what has been described as the equivalent of Enron for Japan. And Chinese companies have been living in a quick growing economy that has sparked concern that investors will be left holding the bag when the music stops.
Some of the big banks have already settled investigations into market manipulation in the foreign exchange market but it is possible that this is only the tip of the iceberg. Emerging market currencies have been in for a wild ride so far this year and it’s possible that a global market selloff could create further problems as countries try to orient their monetary policies to the new reality and prop up the economy.
Commodities & Oil
Oil is under $40 a barrel and the Bloomberg Commodity Index hasn’t been this low since 1999. As demand for raw materials from developing economies has shrunk, the possibility for the discovery of issues at miners, oil companies or others selling to foreign countries to meet this demand. As the recession ends, it’s possible that there could be more violations of the Foreign Corrupt Practices as well as businesses try to get a jumpstart on the market.
Emerging Market Bonds
Investors have removed more than $2.5 billion from mutual funds in this area over the past week. If there is a “run on the bank” and these funds are not able to sell these illiquid investments at reasonable prices in order to keep up with outflows, the SEC may be forced to take a look at the disclosures made to investors or the practices of the banks selling these bonds for the foreign countries.
There’s areas in the United States, of course, where there is enough frothiness to potentially get a regulator to dive in with enforcement actions. These areas include High Frequency Trading in the market, the Bond Market, Venture Capital funds investing in tech startups and health care fraud. But right now, it looks like the biggest jump could be from foreign countries.
A public pension fund has sued twenty-two financial companies acting as primary dealers in U.S. Treasury securities charging them with a conspiracy to manipulate the auctions. Similar to the Forex, LIBOR and ISDAfix investigations, they are accused of using online chat rooms to share client information and coordinate transactions.
The lawsuit indicates that experts have analyzed the pricing of the Treasuries around the start of the DOJ probe of the LIBOR interest rate benchmark for manipulation. The analysis reportedly demonstrates a change in pricing that indicates an end to the manipulation due to a crackdown that may have
We’ve been talking about the possible emersion of a bond whistleblower due to future problems that will arise in bond market liquidity. However, we’ve focused less on the possibility of the emergence of an individual providing the government additional information of antitrust-like manipulation by investment banks after seeing what they have done in the other markets.
We’ve speculated internally that someone came forward to tell the government about the conduct happening in this area. The SEC and CFTC whistleblower programs pay rewards of 10 to 30 percent of the monetary sanctions. On the other hand, it may be that the government simply took the information that they received in discovery from the other investigations and was able to also find misconduct in this market.
Our CFTC whistleblower attorneys can assist you with answers to questions about this information as well as assistance reporting violations of the Commodity Exchange Act to the U.S. Government. To speak to an attorney, fill out our contact form or call 1-800-590-4116.
Corporations with debt financing needs are delaying bond offerings in the hopes that the Chinese stock market and Greece will stabilize. But if they wait too long, the Federal Reserve might increase interest rates and make their issuance more expensive. This is the latest from Bloomberg in an article about the M&A debt needs piling up as a result of financial uncertainty.
Bond issues, which had been on a historic pace for the year, fell 40% in June. In light of all the corporate takeovers and the impending interest rate increase, Bank of America analysts have predicted July and August will be the busiest months for corporate securities sales ever.
Charter Communications has taken the plunge today. It apparently doesn’t think the market is going to get any better as it announced a benchmark bond offering of between $12 and $15 billion priced later today. Bloomberg thinks it might “be the biggest junk-bond sale of the year.” The bond will help fund its acquisition of Time Warner Cable for $56 billion.
Why do we keep talking about bonds? Because this could very well be the next major area of corporate misconduct. If the bond market collapses, there will definitely be a need for whistleblowers to point out corporate misconduct related to accounting and market manipulation issues.
Meanwhile, the New York Stock Exchange took a historic pause in trading yesterday as the exchange reportedly had difficulties with implementation of a new software update and had to cancel all open orders by hand. This caused floor trading to shut down for a few hours before re-opening in the final hour of trading. While it’s incredibly news worthy, it will be interesting to see if the SEC will actually pursue an enforcement action because of the problem. Chair Mary Jo White issued a statement yesterday that the SEC was monitoring the situation and in contact with the NYSE.
If you have evidence of corporate wrongdoing in the bond market, contact one of our SEC whistleblower attorneys to learn about the rewards for bond whistleblowers. An attorney can be reached by our contact form or calling 1-800-590-4116.
A fair amount of corporate misconduct has been discovered during economic downturns. When times are good, meaning the economy is booming and stock prices are headed up, certain issues within companies are covered up or dealing with them is pushed off in order not to disrupt the company. In a downturn, it’s harder for a company to hide its problems as economic pressure exacerbates accounting problems and the government comes looking to apportion blame among those at fault for the economy’s woes.
CNBC has commentary by Ron Insana today titled “For stocks — the Four Horsemen of the Apocalypse?” The four issues identified are Greek bonds, the Chinese stock market, the Federal Reserve’s potential September interest rate hike and Puerto Rico’s announcement that it can’t pay its debts.
Let’s look a bit deeper at each:
Greece will vote on July 5th on whether to accept the terms of additional bailout funds. A default on a $1.5 billion euro payment to the International Monetary Fund is now expected. The country has suspended its stock market and closed its banks. This has already spilled over into bond yields from Italy, Spain and Portugal.
The New York Times called the restructuring of Puerto Rico’s debt an “unprecedented test of the United States municipal bond market.” Bankruptcy is not an option for the country, and the island has more municipal bond debt per capita than any American state, according to the New York Times. As a result, investor appetite for municipal bonds by local governments could be impacted.
We wrote last week about the potential problems in the bond market that a selloff spurred by fear of interest rate increases could create given the liquidity issues. Nevertheless, the New York Fed President says an increase in interest rates is still on the table if the U.S. economy remains strong. The Financial Times called William Dudley a “key voice” in the discussions about whether the Federal Reserve should raise rates.
The Shanghai stock market plunged 7 percent on Friday and is down 20 percent over the past two weeks. Although it is still in positive territory for the year, there are fears that this could be the start of a pullback due to tighter margin restrictions and excessive valuations. Today’s New York Times called China “a Bear Market.”
The combination of the four makes it a precarious time for the economy and the market. The first three, of course, directly implicate the bond market. And since our previous post, I’ve discovered two more things that put the bond market at risk:
Exchange Traded Funds have become a popular way to invest in the bond market. If money starts flowing out of them, it could create problems. The funds are traded on a minute-by-minute basis, while the assets that they hold are not easily sold and could take days to dispose. The flood of supply into an illiquid market could create serious issues.
2. Concentrated Holdings
The top 20 fund managers account for 40 percent of all assets, according to a Bank for International Settlements report. If they were to start reversing out of their positions, liquidity could be destroyed. Even if they believed in their positions, redemptions may require them to liquidate assets and create an order imbalance that would send prices plummeting.
If these conditions were to occur at the same time as the falling Chinese market drags down international companies who had been projecting revenue growth because of their operations in China, the economy would be in trouble. On the other hand, we could definitely see the exposure of more corporate misconduct.
We’re starting to look for misconduct in the bond market because of widespread signals that problems in bonds could precipitate the next economic crisis here in the United States. If a market meltdown occurs, we think that the government will be looking for bond whistleblowers to identify misconduct at the major players. Unlike during the financial crisis of 2007-09, the SEC whistleblower program will be incentivizing individuals to report violations of the securities laws during the next crisis.
Major market leaders are already warning that bond market liquidity could be the next issue to spark “global panic,” “precipitate the next great financial crisis,” and evaporate trillions of dollars of wealth overnight. The President of Goldman Sachs, although not using this extreme language, is among them. Nouriel Roubini wrote a piece published on May 31, 2015 called “The Liquidity Time Bomb.” Major players like PIMCO are worried as well. PIMCO has cut back on its government debt, selling treasuries ahead of what is expected to be an imminent Fed rate hike. Art Cashin warned CNBC that Fed rate hikes could “start spontaneous combustion” in the bond market.
The trigger for this crisis is expected to be Federal Reserve moves to increase interest rates. Low interest rates since the last financial crisis have driven investors into the $3.7 trillion corporate bond market and government debt. If these players begin to sell bonds as they lose their luster amidst rate increases, there are concerns that no one will buy them and prices will go into free fall as investors panic. Interest rates can’t remain at or near zero forever. The Federal Reserve is expected to start hiking by the end of the year.
A similar free fall in securities prices during the last crisis took down Bear Stearns and Lehman Brothers, who were holding large portfolios of commercial mortgage backed securities. When prices began to plummet because there were no buyers, the liquidity crunch and the declining value of these leveraged assets caused a loss of confidence in their ability to weather the storm, precipitating their downfall.
Roubini pointed out the oddity of some of the moves that have been happening in bonds already. Back in October 2014, for example, US Treasury yields plummeted nearly 40 basis points in minutes, a move that should happen only once in three billion years according to statisticians.
Of course, when the financial markets are universally concerned about an event, the contrarian play is sometimes the safest. Governments do not like to let market volatility effect the economy if they can help it. And the Federal Reserve is certainly no slouch in responding to economic forces with appropriate monetary policy.
Yet, there were warning about the real estate bubble as well. And it spilled over not only to the financial markets but to the greater economy as well. The bond market is big, too. The U.S. bond market is estimated at $37 trillion, higher than the market capitalization of U.S. stocks of $22.5 trillion (calculated 10/21/14). If it tanks, the ripple effect could be widespread throughout the market and the economy.
This analysis doesn’t even touch the potential sovereign debt crisis that could happen if institutional investors stop buying government paper. The rates investors are accepting for Treasuries assume that their money is safe. What if a Greek default makes them question whether it really is safe? Changes in the assumptions about the potential for default were among the sparks to the crisis in Commercial Mortgage Backed Securities.
There’s also been a slower recovery in the U.S. economy following each recession. The public no longer has the wealth to dampen external shocks to the economy.
Why would no one buy bonds? In stocks, market makers normally act as the provider of liquidity when there are no buyers and an investor wishes to sell. Prior to 2008, the big banks provided that liquidity. Now, apparently, the government’s capital rules have caused them to trim their trading operations. Major bond dealers hold one quarter of the amount of corporate debt compared to their 2007 holdings. Institutional investors are already noting that trades in bonds are taking longer than normal to happen.
Banks are also blaming the bond sale reporting requirements. Because they must report trades, they can no longer fleece investors with impunity. With tighter margins, fewer banks are going to be willing to try to step in and catch bonds when prices are falling like a knife. With fewer players willing to take chances because of less profit potential and less capital committed to bond trading by the major banks, the potential for a liquidity crunch and a crisis emerges.
Others have pointed out that the Fed has been buying bonds in order to keep interest rates down through quantitative easing. If the Fed exits or cuts back in the market at a time when more bond holders want to sell, it could deepen the serious liquidity issues.
This is an issue of concern to government regulators already. FINRA met last week with regulators and financial firms to discuss the corporate bond market, and plans to hold another meeting in July.
The financial industry is also pushing for measures that would decrease transparency. They have argued for weakening the bond sale reporting rules. There are also talks between a financial firm and regulators about creating the first dark pool for corporate bonds. These measures might sound eerily similar to the 2004 SEC meeting which allowed large financial firms to take on more leverage.
If these sound a bit like business as usual Wall Street and fluctuating markets, why would we be looking for potential bond whistleblowers? Because we know from past experience that the financial institutions holding bonds and their employees may break the rules when the crisis strikes. They may try to manipulate bond prices in the market to protect themselves against mark-to-market accounting. They may commit accounting fraud to avoid a capital crunch or causing a run on their stock or assets as they disclose losses. Or they may come up with a way to break the law that we haven’t even thought of because we are whistleblower attorneys and not knee deep in the bond market.
The collapse of the bond market isn’t likely to be a soft landing without government fines, in other words. And where the government is handing out fines to large financial institutions, it needs whistleblowers to tell them where to look. This, in a nutshell, is why we are looking for bond traders and fixed income professionals. If your company is breaking the law, we would like to help you report it.