SEC Charges Three Traders with Dishonesty (with Lofchie Comment and YouTube Selection)
Commentary by Steven Lofchie
The SEC charged three traders with fraud pursuant to Section 10(b) and Rule 10b-5 ("Employment of Manipulative and Deceptive Devices") of the Securities Exchange Act, and Section 17(a) ("Fraudulent Interstate Transactions") of the Securities Act. The three traders were accused of lying repeatedly to customers who "relied" on them for "honest and accurate pricing information about residential mortgage-backed securities" ("RMBS").
The SEC alleged that the three traders "defrauded customers to illicitly generate millions of dollars in additional revenue for the New York-based brokerage firm where they worked." The SEC found that the three traders intentionally misrepresented (i) the bids and offers being provided to the firm for RMBS, (ii) the prices at which the firm bought and sold RMBS and (iii) the spreads earned by the firm through intermediating RMBS trades. The SEC charged that the three traders also trained, coached and directed junior traders at the firm to engage in the same misconduct.
According to the SEC's press release: "Customers sought and relied on market price information from these traders because the market for this type of RMBS is opaque and accurate price information is difficult for a customer to determine. Therefore it was particularly important for the traders to provide honest and accurate information."
Commentary
This case does not address fundamental questions of whether the aggrieved investors had (i) the right to obtain the information they requested and (ii) a legitimate expectation of receiving an honest answer. Another interesting question is whether the broker would be entitled to an honest answer if the broker had asked a customer, "How much are you willing to pay for these bonds?" The first question is important (whether or not the customers had a right to the information) because it goes to the obligation of the broker to provide any relevant information. If the customers were legally entitled to "rely" on the information, then the brokers might have been required to provide it. On the other hand, if the investors were only entitled to answers that were honest, then the brokers could have avoided getting into trouble by refusing to answer the customers' questions. It is interesting to consider whether customers – particularly large institutional customers – must be careful what they say to brokers. In other words, is the obligation to be honest a one-way street?
Simply stated, firms need to tell their traders not to answer investors' questions dishonestly. Firms also will have to consider whether or in what circumstances their traders can refuse to answer a customer's questions; e.g., does it matter whether the customer is a sophisticated institution?