Market Professionals, Insider Trading And Credit Default Swaps

The SEC brought another market crisis cases earlier this week, SEC v. Rorech, Civil Action No. 09 CV 4329 (S.D.N.Y. Filed May 5, 2009). This action is based on an insider trading claim against two market professionals for trading in credit default swaps. The trading was not for their personal accounts. Rather, it was for the benefit on one defendant’s employer.

The facts to the case, as detailed in the complaint, present a straight forward insider trading fact pattern. According to the complaint, Renato Negrin, a former portfolio manager at investment adviser Millennium Partners, L.P., and Jon-Paul Rorech, a salesman at Deutsche Bank Securities, Inc., engaged in insider trading regarding the credit default swaps of VNU N.V., a privately held Dutch media conglomerate, now known as the Nielsen Company. The company had been taken private by a group of private equity companies. The restructuring of the financing for that transaction included a bond offering which is the predicate for the case here.

According to the SEC, Mr. Rorech learned about the restructuring of the bond offering related to VNU through his employment at Deutsche Bank in July 2006. In a series of phone calls, some of which were recorded and some of which were made on cell phones, Mr. Rorech told Renato Negrin about the transaction. Mr. Negrin purchased CDSs covering the VNU bonds based on information about the restructuring when that information was non-public. At the time of these conversations, there was a limited supply of bonds covered by the CDSs. An increase in the supply of VNU bonds deliverable into the CDSs would result in more exposure and demand for the credit default swaps covering the default of the bonds. This would increase their market price, according to the complaint.

The complaint alleges that Defendant Negrin purchased about 20 million euros worth of VNU CDSs in two transactions on behalf of a hedge funds advised by Millennium. After the public announcement of the restructuring, the credit default swaps were sold for a profit of about $1.2 million.

For passing on the confidential information, the SEC claims that Mr. Rorech received a benefit because it solidified his client relationship with Mr. Negrin. He also received credit from his employer toward compensation for trades placed by his clients, including those of Mr. Negrin.

The SEC’s complaint alleges violations of Section 10b and Rule 10(b)-5. In this regard is specifies that: “The CDSs at issue in this matter qualify as security-based swap agreements under the Gramm-Leach-Bliley Act of 2002 and are therefore subject to the antifraud provisions set forth in Section 10(b) of the Exchange Act and the rules promulgated thereunder.” Under Section 206B of that Act, a security based swap agreement is one “of which a material term is based on the price, yield, value, or volatility of any security or any group of index or securities, or any interest therein.”

In its complaint, which is in litigation, the SEC seeks an injunction, disgorgement and civil penalties against Messrs. Rorech and Negrin. This is the Commission’s first insider trading case based on trading in credit default swaps.