NEW YORK—A federal-court trial held in the shadow of Wall Street will soon determine whether federal securities regulators can pursue and prove insider trading in the $30 trillion market for credit derivatives.
In a civil case brought by the Securities and Exchange Commission in federal court, the agency said nonpublic information about a bond offering was shared between a salesman and a client and used for insider trading. The defendants said the information wasn’t confidential and was part of the “free flow” of chatter in lining up buyers.
In opening arguments Wednesday, the SEC alleged that a salesman at Deutsche Bank‘s Wall Street arm, Jon-Paul Rorech, provided inside information to a favored client in 2006 about a bond offering by Dutch media conglomerate VNU NV, allowing the client to profit from improper trades in credit-default swaps linked to that firm’s debt.
“This case, like all insider-trading cases, is a case about selective disclosure,” argued SEC lawyer Richard G. Primoff. Mr. Rorech’s lawyer, Richard Strassberg, said the high-yield, or junk-bond, market is premised on the “free flow” of information between potential buyers and the underwriters.
The case is test for the SEC as it tries to pursue insider-trading charges in the unregulated market for credit-default swaps, where banks, hedge funds and others trade insurance against debt defaults, betting that a bond or a loan will go bad.
The swaps market is unregulated, though banks that trade the swaps are overseen by banking regulators. Using derivatives to make bets on companies has injected a new gray area in financial regulation at a time when regulators more aggressively pursue insider trading.
In papers filed in the case, the defendants have argued, among other things, that swaps aren’t securities, but rather private contracts between financial players outside the SEC’s jurisdiction. Unlike most stocks, bonds and options, swaps aren’t traded on an exchange.
The SEC’s Mr. Primoff alleged that the Deutsche Bank bond salesman called Renato Negrin, a former trader at hedge fund Millennium Partners LP, at least two times in July 2006 and shared nonpublic information that VNU might issue a new batch of bonds deliverable into credit-default swaps tied to the company’s debt.
An increase in VNU’s debt would heighten the company’s risk, making insurance on its debt more expensive.
Mr. Rorech—who according to a call transcribed by the SEC described the tip as a “nice little kiss” to Mr. Negrin—violated federal securities laws and the bank’s policies, Mr. Primoff said. Mr. Negrin made a profit of $1.2 million on the swaps purchases, the SEC says.
Mr. Negrin, the first witness to testify in the case, said he didn’t believe he was in possession of any confidential information in buying the VNU swaps—and wouldn’t have done so had he known.
Mr. Negrin conceded that after he discovered the SEC was investigating his activities, he called another Deutsche Bank employee to see if the bank recorded phone calls. Mr. Negrin, who testified that he has memory issues from an undisclosed health problem, said he was seeking information that might help him recall the transactions.
“I never thought I traded on inside information,” Mr. Negrin testified. “I panicked.”
Messrs. Rorech and Negrin each face civil insider-trading charges. The bench trial is expected to last about two weeks.
Millennium and Deutsche Bank haven’t been accused of wrongdoing in the case. Millennium has said it has a “zero-tolerance policy” for insider trading and has cooperated in the investigation.
A Deutsche Bank spokesman said Wednesday the bank has been cooperating with the probe, but declined further comment. Mr. Rorech is on leave from Deutsche Bank.
Mr. Strassberg argued that the SEC has no “direct proof” that Mr. Rorech shared the information with Mr. Negrin, but if he did, he was authorized to do so. “Everything he knew, he was authorized to share with customers,” Mr. Strassberg said.
Mr. Strassberg said Deutsche Bank’s salespeople shared details about the proposed offering with prospective buyers to gauge interest in the offering and said the information wasn’t considered confidential.