By Martina Rejsjö, Director of Regulatory Affairs, Eventus
SEC Charges an Asset Management Firm for Abusive Bond Trading
The Securities Exchange Commission (SEC) has brought charges against an asset management firm and its founder relating to their advice and execution of trades in clients’ fixed income portfolios. The firm agreed to pay more than $19.3 million in combined disgorgement, prejudgment interest, and civil penalties to settle the charges, as the SEC announced in April.
The SEC states that the asset management firm’s trading in the targeted fixed income securities had the effect of increasing the prices of those generally illiquid securities in a way that was disconnected from economic reality. SEC further states, “We remain vigilant in rooting out such misconduct in the marketplace, including in the fixed income sector, where investments can be less liquid,” indicating the continued focus on the fixed income market.
In this particular case the asset management firm sold corporate bonds for one client while a different client purchased the same bonds. The firm engaged in these trades to address portfolio constraints such as industry or issuer fund concentration limits, to meet investor redemptions, and to allocate capital inflows and outflows. The order further finds that these trades were executed at prices that the firm proposed and had the effect of increasing the price of the bonds at a significantly higher rate than the prices of similar securities. The SEC claims the firm’s trading in the bonds accounted for the vast majority of trading in those securities and therefore over time had a material effect on their pricing.
The firm then also calculated the net asset values (NAVs) of their client funds’ holdings using pricing data that was based, in part, on the firm’s trading prices. As a result, during the relevant period, the NAVs of the firm’s clients were higher than they would have been if the subject trades were removed from the market bonds, which, in turn, resulted in higher fees being charged to the clients, according to the SEC.
The full SEC order in this matter can be found here.
Validus in Practice
There are valuable lessons for compliance practitioners in studying enforcement cases, and cases relating to fixed income market manipulation are not as common as cases within the equity, commodity, and derivatives markets. So when there is one, it is worth taking the time to analyze the behavior.
The core of the asset management firm’s manipulative trading activity could be captured by a combination of procedures offered through the Validus Trade Surveillance platform. One issue the SEC highlighted was that the firm executed transactions on both sides of the market at the same time but for different clients. Another issue was the firm had dominated the trading in the particular bond and, by that, was essentially setting the price of that security.
Validus maintains several trade surveillance procedures to identify the fraudulent behavior in the described manipulative trading scheme. These include:
- Different types of Wash Sales and Offsetting/Pre-Arranged Trades procedures to capture activity on both sides of the market during a defined time window;
- Alerting if a firm’s Orders or execution account for a significant portion of the Average Daily Volume (ADV) in the market for a specific security;
- A comprehensive suite of Price Impact procedures to alert for unusual price movement in a security.
All of these procedures can be configured based upon asset class and liquidity and tailored to identify anomalous activity.
Eventus has regulatory affairs experts to assist with the identification of appropriate procedures to address the risks facing your business as well as to provide guidance in setting trade surveillance parameters based on asset class.
About Eventus
Eventus is a leading global provider of multi-asset class trade surveillance, market risk and anti-money laundering (AML) solutions. Its powerful, award-winning Validus platform is easy to deploy, customize and operate across equities, options, futures, foreign exchange (FX), fixed income and digital asset markets.
Validus is proven in the most complex, high-volume and real-time environments of tier-1 banks, broker-dealers, futures commission merchants (FCMs), proprietary trading groups, market centers, buy-side institutions, energy and commodity trading firms, and regulators. The company’s rapidly growing client base relies on Validus and Eventus’ responsive support and product development teams to overcome its most pressing regulatory challenges. For more, visit www.eventus.com.