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Potential Manipulation of GSE Trades May be Just Fine with FBI

by devteam January 14th, 2014 | Share

The Federal Bureau of Investigationrn(FBI) is looking into a sophisticated scheme using “unsophisticated tradecraft“rnto front run interest rate swaps and thus defraud government sponsored enterprisesrn(GSEs) Fannie Mae and Freddie Mac. Reuters is reporting the investigation intornunnamed U.S or Canadian traders or banks which it says may have resulted inrnprofits of $50 to $100 million for those involved.  </p

According to the report written by RichardrnLeong, traders may be “conspiring to rig rates on large orders submitted byrnFannie Mae and Freddie Mac, or front running them in the interest rate swapsrnmarket”.  By front running someone withrnadvance knowledge of an upcoming large transaction by another party can put anrnorder in first, profiting from the market move when the large trade goesrnthrough. </p

Reuters obtained the information from anrnFBI bulletin issued to securities officers at financial services firms.  The bulletin contained information “from arnformer high-level employee at a U.S. bank and an employee at a Canadian Bank,rnplus interviews with other bank workers” conducted earlier.  </p

According to the bulletin, swap tradersrnat the bank may have programmed their phones with different ring tones tornsignify calls from certain customers who customarily place large swaps orders. ThernBanks may have encouraged traders to listen in on calls to gain transaction information.  The traders would then use hand signals torninform other traders of the details of the planned swaps.  Senior bankers were reported to havernencouraged this activity on the part of employees because it led to higher bankrnrevenues.  “GSEs frequently submitrnlarge interest-rate swap trades, making them easy targets for front running andrnlucrative targets for market manipulation,” the bulletin said.</p

Interest rate swaps are agreements between two companies to exchange fixed for floating cash flows.  In most cases, it’s risky for a large firm to be exclusively receiving solely fixed or floating payments.  For instance, if a firm receives mostly fixed-rate payments and market rates rise significantly, it will lose money.  Instead, a portion of that debt would be swapped with counterparties who have more floating rate payments coming in, thus providing more balance vs risk for both sides of the transaction.</p

While the FBI was reasonably confident in the information it received, prosecutions are unlikely as the bureau says there doesn’t appear to be any wrongdoing.  So why is this news?  In the words of an FBI Spokesperson: ““It is standard policy for the FBI to share intelligence information with our private sector partners to help protect our economy, thwart crime, and prevent threats impacting American businesses.” 

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About the Author

devteam

Steven A Feinberg (@CPAsteve) of Appletree Business Services LLC, is a PASBA member accountant located in Londonderry, New Hampshire.

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