Credit Rating Companies, Deutsche Bank, Goldman: Compliance

European Union governments have scrapped plans for finance ministers to thrash out an accord next week on tougher rules for credit ratings companies.

Diplomats from the region’s 27 nations decided yesterday that more talks are needed by officials on the draft law before it can be agreed on by finance ministers, said an EU official.

The draft law has been taken off the agenda of a meeting of finance ministers on May 15, said the official, who can’t be identified in line with EU policy.

Michel Barnier, the European Union’s financial services chief, proposed last year to force businesses to rotate the credit ratings companies they use. Barnier has said the measure would boost competition and address conflicts of interest. Regulators and industry have warned that the step could reduce the quality of ratings in the short term.

The measure is part of a broader draft law presented by Barnier which would also allow investors to sue ratings companies in cases of misconduct or gross negligence, and give the European Securities and Markets Authority increased oversight powers over the industry.

Governments reached an agreement in March to scale back the rotation plans, without settling the details.

Denmark, which holds the rotating presidency of the EU, has proposed limiting rotation so that it only covers ratings of securitizations and other so-called structured finance instruments.

National diplomats are weighing whether to scale back the measures further so that rotation would apply only to so-called resecuritizations, such as collateralized debt obligations that are repackaged and used to back another round of securitized debt, the official said.

The credit-ratings law requires approval by national governments and by lawmakers in the European Parliament, before it can come into effect.

Compliance Action

Martin Currie Fined by SEC, U.K. FSA for Client Manipulation

Martin Currie Investment Management Ltd., an Edinburgh-based fund management group, was fined about $14 million by finance regulators in the U.S. and U.K. for manipulating a client to aid a hedge fund the firm managed.

The U.S. Securities and Exchange Commission charged Martin Currie Investment Management Ltd. and Martin Currie Inc. with advising The China Fund Inc. to invest in its struggling hedge fund with a “largely illiquid exposure” to a Chinese company, the regulator said yesterday.

“The misconduct in this case strikes at the heart of the fiduciary relationship between an investment adviser and its client,” said Robert Khuzami, SEC enforcement director, in the agency’s statement. The SEC investigation into individuals is continuing.

Martin Currie settled the charges with the SEC for $8.3 million and was fined 3.5 million pounds ($5.7 million) by the U.K. Financial Services Authority. It is the largest fine levied by the FSA for failing to manage a conflict of interest, the British regulator said.

Since it disclosed the conflict of interest in July, Martin Currie’s assets under management have fallen to about 5 billion pounds, according to its website, compared with 10.1 billion pounds in mid-2011.

The firm gave preferential treatment to its client, the Martin Currie China Hedge Fund LP, which had invested heavily in a Chinese printer-cartridge recycling company, Jackin International Holdings, and was facing increasing requests for redemptions from its investors, the SEC said.

Martin Currie’s unlisted investments division has now been closed, the firm said in a statement.

“The FSA and SEC investigations related to historic investments in a series of three unlisted bonds, the first of which took place five years ago,” the firm said. “Those investments gave rise to a conflict of interest between two client accounts, which also exposed certain weaknesses in Martin Currie’s systems and controls.”

The firm said it compensated the client and returned all related fees.

Martin Currie’s directors and external shareholders have also invested about 25 million pounds in the company, which gave it more than 300 percent of its regulatory capital requirement, the money manager said.

Compliance Policy

CFTC Votes to Finish Dodd-Frank Derivatives Exchange Rules

The U.S. Commodity Futures Trading Commission voted to require swaps exchanges to have pauses and halts in trading and abide by other restrictions to limit market risks under final Dodd-Frank Act regulations.

The agency voted 5-0 yesterday to complete a series of rules, including record-keeping and reporting requirements, that will apply to exchanges. The agency intends many of the regulations to be flexible guidelines for compliance instead of prescriptive rules, according to a CFTC summary.

“These exchanges for the first time will be able to list and trade swaps to bring the benefit of pre-trade transparency,” Gary Gensler, the agency’s chairman said before the vote.

Dodd-Frank, the financial-regulation overhaul enacted in 2010, seeks to have most swaps traded on exchanges or other so-called swap execution facilities, governed by separate rules yet to be completed. The rules are intended to increase transparency in the $708 trillion global swaps market after largely unregulated swaps helped fuel the 2008 credit crisis.

The agency delayed a final vote on the most controversial element of the rules governing exchanges, a restriction on the amount of trading that must occur in a centralized market. The agency postponed a vote on the provision amid internal dissent and opposition from CME Group Inc., owner of the world’s largest futures exchange. “The commission will be best served by continued dialog,” said Mark Wetjen, a Democratic commissioner.

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Obama’s Regulation-Killing to Save $6 Billion in Five Years

U.S. rule changes involving street signs, train control systems and hospital practices will save consumers and businesses almost $6 billion in the next five years, President Barack Obama’s administration said.

The savings is a large part of the annual cost of rulemaking, said Cass Sunstein, administrator of the White House Office of Information and Regulatory Affairs, in announcing the reforms yesterday at an American Bar Association meeting in Washington.

“That’s a significant chunk of the total costs of rulemaking in any given year and we have on one day taken away that cost,” he said.

Republicans have criticized some regulations Obama issued as too burdensome on business and made a campaign issue of his rule-making approach. Some of yesterday’s changes, including rules for vapor-recovery systems at gasoline stations, a partial exemption from installing railroad crash-avoidance technology, and streamlined health-care reporting, were disclosed last year.

“They’ve already taken credit for this,” said James Gattuso, a senior fellow at the Washington-based Heritage Foundation, which says it advocates conservative political positions.

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Big Four Auditors Welcome China’s Rule to Localize Their Firms

Two of the biggest global auditing firms are accepting a new directive from China to staff their operations with Chinese citizens, saying they are already trending that way.

Within three years, all senior partners for auditors’ operations in China must be Chinese citizens with local accountant certifications, according to rules posted on the website of China’s Ministry of Finance May 9. Two of the so-called Big Four auditing firms, whose U.S. affiliates are Ernst & Young LLP and PricewaterhouseCoopers LLP, said they support the move.

“Our business is well-positioned for this transition,” Ernst & Young said in a statement. “The new measures are in line with EY’s existing strategy to accelerate localization of our business in China.”

China drew particular attention last year as dozens of Chinese companies disclosed auditor resignations or accounting irregularities, leading to the suspension or delisting of their shares. The U.S. Securities and Exchange Commission and the auditor watchdog group it supervises have met repeatedly with Chinese counterparts to discuss lifting barriers for inspectors to review auditors of U.S.-listed companies in China.

PwC China, the local affiliate of PricewaterhouseCoopers, said in a statement that it has been “actively localizing its China practice by investing heavily in developing local talent and promoting local partners in past years.”

Colleen Brennan, a spokeswoman for the U.S. Public Company Accounting Oversight Board that oversees auditors, declined to immediately comment on the rules. Deloitte LLP and KPMG LLP, the remaining members of the Big Four, didn’t immediately respond to requests for comment.

The SEC sued Shanghai-based Deloitte Touche Tohmatsu CPA Ltd., the agency said May 9, alleging that the firm refused to provide documents related to a China-based company under investigation for potential accounting fraud against U.S. investors.


Goldman Lifts ‘Reasonably Possible’ Legal-Loss Estimate 13%

Goldman Sachs Group Inc., the fifth-biggest U.S. bank by assets, raised estimates of potential losses from legal claims by 13 percent and said a probe into its handling of Greek finances includes trading and research.

The forecast of “reasonably possible” legal costs rose to $2.7 billion as of March 31 from $2.4 billion three months earlier, according to a regulatory filing yesterday. The New York-based firm didn’t give specific reasons for the increase.

Banks started releasing estimates of possible losses after the U.S. Securities and Exchange Commission told finance chiefs in October 2010 that they should disclose such costs “when there is at least a reasonable possibility” they may be incurred, even if the risk is too low to require reserves.

The estimate doesn’t include potential losses from legal matters that are at an early stage or where the firm can’t determine the potential amount, according to the filing.

An investigation of the firm’s financing and swap transactions with the Greek government, which started about two years ago, also includes “trading and research activities with respect to Greek sovereign debt,” according to the filing. “Goldman Sachs has cooperated with the investigations and reviews,” the company said.

The company also disclosed that the U.S. Department of Justice and SEC are investigating the firm’s role in the 2008 financial crisis. Those inquiries stem from last year’s report by the Senate’s Permanent Subcommittee on Investigations, which said the firm misled clients about mortgage-related investments before the crisis. Goldman Sachs has denied wrongdoing.

The company is in arbitration with a California school district and the cities of Houston, Texas, and Reno, Nevada, over Goldman Sachs’s role as an underwriter and broker-dealer for more than $1.7 billion in auction-rate securities from 2004 and 2007, according to the filing.

Goldman Sachs is also facing a suit from the founders and majority shareholders of Dragon Systems Inc. who exchanged their stake in Dragon for stock in Lernout & Hauspie Speech Products NV in 2000, according to the filing. L&H went bankrupt on Nov. 29, 2000.


Deutsche Bank to Pay $202.3 Million in Mortgage Fraud Accord

Deutsche Bank AG agreed to pay $202.3 million to settle civil claims that its MortgageIT unit lied to qualify thousands of risky mortgages for a federal insurance program in what the U.S. called a “massive fraud.”

The U.S. claimed in a lawsuit filed May 3, 2011, that Frankfurt-based Deutsche Bank and MortgageIT falsely certified that they properly assessed the default risk of borrowers, qualifying loans for insurance by the Housing and Urban Development Department’s Federal Housing Administration.

The bank admitted to some of the conduct alleged in the complaint, according to a statement yesterday by the office of U.S. Attorney Preet Bharara in Manhattan. The U.S. sued under the False Claims Act, which permitted it to seek triple damages and penalties of more than $1 billion.

“MortgageIT and Deutsche Bank treated FHA insurance as free government money to backstop lending practices that did not follow the rules,” Bharara said in the statement.

U.S. District Judge Lewis Kaplan approved the settlement yesterday, according to the statement.

“We are very pleased to have reached this settlement, for which we have already fully reserved, and to put this issue behind us,” Renee Calabro, a Deutsche Bank spokeswoman, said in an e-mailed statement. “This marks a significant step in resolving our mortgage-related exposures.”

The case is U.S. v. Deutsche Bank AG, 11-cv-2976, U.S. District Court, Southern District of New York (Manhattan).

In the Courts

Santander Wins EU Court Challenge to French Tax on Funds

Banco Santander SA and other financial services companies including Societe Generale SA won a court bid to overturn a French levy on some mutual funds in a ruling that may lead to rebates for investors.

The European Union’s Court of Justice ruled that France was wrong to charge a 25 percent withholding tax on dividend payments to a type of EU-regulated funds, known as UCITS, outside France. French-based products aren’t required to pay the tax.

The measure “constitutes a restriction on the free movement of capital, which is in principle prohibited under EU law,” the court said in a statement yesterday.

France has already received claims for tax refunds of more than 4 billion euros ($5.2 billion) and could face more, said Kit Dickson, a tax partner at Deloitte & Touche LLP, in a telephone interview. EU countries have reacted to similar claims by changing rules that tax foreign-based funds differently.

“We’ll see tax policy changes coming in from different member states and they’ll either be starting to tax resident funds as well as non-resident funds or they’ll choose to exempt them,” Dickson said. “Spain changed some of its withholding tax rules in 2010, the Netherlands changed them in 2008, France chose to tax resident pension funds from 2009.”

The French Finance Ministry press office didn’t immediately respond to calls and e-mails requesting comment on the decision and the potential tax rebate.

While the ruling from the EU’s highest court is binding, final decisions on the case must be taken by an administrative court in Montreuil, France.

The cases are: C-338/11 FIM Santander Top 25 Euro Fi, Direction des residents a l’etranger et des services generaux, C-339/11 Cartera Mobiliara, C-340/11 Alltri Inka, C-341/11 DBI-Fonds APT no 737, C-342/11 SICAV KBC Select Immo, C-343/11 SGSS Deutschland Kapitalanlagegesellschaft, C-344/11 International Values Series of the DFA Investment Trust, C-345/11 Continental Small Series of the DFA Investment Trust, C-346/11 Sicav GA Fund B, C-347/11 AMB Generali Aktien Euroland.

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Traders Shifting to Risk Control Over Speed, Corvil’s Byrne Says

Traders dealing with the current electronic market are willing to sacrifice some speed if it allows them to better manage their risks, said Donal Byrne, chief executive officer of technology company Corvil Ltd.

“The environment we work in today is dramatically different,” Byrne said yesterday at the Bloomberg Enterprise Technology Summit hosted by Bloomberg Link in New York. “In 2008, 2009, it was speed at any cost. Now it’s speed fast enough at the right cost,” with the ability to manage the risks associated with the trading, he said.

The proliferation of high-speed, computer-driven trading means the profitability of transactions can be influenced in fractions of a second. Traders have invested in more powerful servers and techniques such as co-location, in which exchanges let them place computers close to the market, to improve execution speed. The faster speeds come with greater risks, Byrne said.

“A problem with these infrastructures is that they tend to have a cliff-edge failure scenario,” said Byrne, whose company’s products and services help clients measure latency, or the time it takes to process data, and speed up stock trades. “If we observe that there is a cliff, the risk is how close you want to go to the cliff edge,” he said. “Latency is really inversely proportional to risk.”

Speed isn’t only about how quickly a trader can access orders at a market, Stephen Ehrlich, CEO of New York-based Lightspeed Financial LLC, said at the same event. It’s about how quickly the trader’s systems can get the quotation and transaction data and analyze the information, he added.

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