A federal jury in Hartford, Connecticut returned mixed verdicts in a fraud trial involving three former mortgage-bond traders who had worked for Nomura Holdings Inc. The case drew broad attention because of the unusual questions it raised: When is it all right to deceive a customer, and when is it not? How big does a lie have to be to be a fraud? Is it OK to lie if you assume your customer assumes you’re lying, because everybody lies?
1. What was the Nomura case about?
Ross Shapiro, Michael Gramins and Tyler Peters were accused of lying to customers about the prices of mortgage-backed securities, and training subordinates to do the same, in order to boost their compensation. Gramins was convicted of conspiracy but acquitted of six fraud counts, while the jury was hung on two other charges. Peters was cleared of all charges. Shapiro was cleared of eight counts but the jury deadlocked on one. Prosecutors must decide whether to retry Shapiro and Gramins on the deadlocked charges.
2. How did they allegedly lie?
Prosecutors pored over electronic records of hundreds of trade negotiations and presented the jury with 20 examples. In one, Nomura traders are shown telling a money manager, via electronic chat in 2011, that they paid 86 1/32 for a bond, when, in fact, they had paid 85 25/32. The false purchase price was used as a negotiating tactic to induce the money manager to pay a higher price for the bond.
3. Why is this case being prosecuted?
It’s part of a U.S. crackdown on illegal trading practices in the opaque world of securities backed by assets such as home mortgages. The effort started in January 2013 with the arrest of former Jefferies LLC bond trader Jesse Litvak, who is appealing his conviction and two-year prison sentence. U.S. prosecutors have brought a handful of criminal cases, and the Securities and Exchange Commission has extracted civil fines and trading bans.
4. Why is the mortgage-bond market susceptible to lies?
These highly complex securities don’t changed hands very often; when they do, transactions take place between specialized traders who haggle over prices. Those tussles determine the yields that investors ultimately earn on the bonds. But few everyday investors are knowledgeable enough to understand the connection between prices paid for bonds they own directly or indirectly, and the resulting investment returns.
5. What makes a lie a crime?
According to the government, traders are guilty when they intentionally misrepresent the acquisition or sales price of a bond during negotiations. The lie must be “material,” meaning a “reasonable investor” would consider it “important” in making an investment decision. As Assistant U.S. Attorney Liam Brennan told jurors in his summation in the Nomura case, “To say that these are sharp business practices, and everyone engaged in them, is not just an affront to everyone in the securities industry, it’s an affront to everyone in every industry that has ever tried to be an honest dealer.”
6. What did the defense say?
Lawyers for the traders maintained that mortgage-bond deals take place between sophisticated professionals backed by extensive research, and that claims about prices are taken with a grain of salt. They said a lie is material only if it “significantly altered the total mix of information available to the reasonable investor in making an investment decision.”
7. How widespread is lying in finance?
It’s hard to tell. Before the government crackdown, it had been common for bond traders to exaggerate to clients how much they had paid for a security. In the wake of the financial crisis, financial firms have added thousands of compliance employees seeking to keep their companies on the straight and narrow. Algorithms and artificial intelligence are helping to comb through terabytes of voice and data files, but sometimes it still takes human judgment to assess honesty. "When you’re dealing with people in the dark corner of the market, there’s going to be fraud," said Peter J. Henning, a professor at Wayne State University Law School in Detroit. "Nobody talks about stock prices. You look it up."
8. Is anything changing because of these cases?
In the bond market, many traders have become reluctant to do business over office phone lines, email and chats that leave a trail for bosses and authorities. Many are resorting to messaging apps that technically are a no-no on Wall Street. Still others are reluctant to discuss the prices they’re paying for bonds, for fear of getting caught in what might look like a lie. And market analysts say liquidity has been reduced, which makes it more difficult and expensive to trade. The mixed verdicts in the Nomura case could bolster the government’s claim that lying to even the most-sophisticated customers can amount to a crime. But it also underscores how difficult it is for prosecutors to prove such a case.
The Reference Shelf
- A QuickTake Q&A on the Federal Reserve’s rescue of mortgage-backed securities.
- A scorecard of players in the U.S. crackdown.
- Bloomberg View columnist Matt Levine on the lies traders tell.
- A look at the evidence in the Nomura case.