SEC Files Another Action Centered on Trading in Opaque Markets

by Dorsey & Whitney LLP
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The Commission filed another action centered misrepresentations made in opaque trading markets for mortgage backed securities. Unlike its earlier actions in this area, however, the case settled simultaneous with filing. In the Matter of Deutsche Bank Securities Inc., Adm. Proc. File No. 3-18367 (Feb. 12, 2018).

The action is based on the trading of commercial mortgage backed securities from 2011 to 2015 by the registered broker-dealer and the head of its trading desk for those securities, Benjamin Solomon. During the time period the firm traded CMBS in the secondary market. Frequently the purchase and sale of the securities took place within minutes or hours. Little risk was involved for Deutsche Bank. Since the market for the securities “is opaque and lacks easily accessible information on the prices at which CMBS trade, the broker-dealer arranging the sale of CMBS often provides information about the current market price of the bond,” according to the Order.

During the relevant period certain salespeople made false and misleading statements, often in coordination, while negotiating with customers. In many instances the misrepresentations were made through electronic chats or were captured on Bloomberg chats. Examples of the misrepresentations are cited in the Order. Those include instances where during negotiations over the price the firm sales person or trader misrepresented the price paid for the security in order to induce the customer to make a purchase at a specific price. In other instances where there were negotiations regarding the sale of a bond, the sales person would falsely claim to be negotiating its acquisition from a counter party and a certain price.

In several instances when Mr. Solomon was supervising the trading desk he learned of, or participated in, misstatements to customers of the bank involving the CMBS traders. Again, the Order quotes electronic messages showing that the traders involved misrepresented pricing information to customers in order to induce a transaction. Based on this conduct the Order alleges that those involved violated Securities Act Section 17(a) and Exchange Act Section 10(b).

During the period Deutsch Bank had policies and procedures which required clear and fair communications with customers. That requirement was also reflected in the firm’s code of business conduct. Nevertheless, the Bank failed to reasonably implement the policies. The compliance and surveillance procedures and systems were not reasonably designed to prevent and detect CMBS Desk traders and salespeople making false representations during trade negotiations, according to the Order.

The surveillance efforts were also not effectively implemented since they used generic price deviation thresholds in monitoring trades to flag potentially suspicious transactions rather than tailoring the procedures to specific types of securities. Accordingly, the supervisory systems and procedures were not reasonably designed or implemented to prevent and detect the kind of misrepresentations involved here.

In resolving the matter Deutsch Bank cooperated with the Commission’s investigation and undertook remedial actions. The bank implemented improved procedures and conducted an internal investigation. The firm also agreed to certain undertakings which included making payments to certain customers totaling $3,727,743 – the amount of profit made by the bank.

In resolving the action the firm agreed to the entry of a censure, to pay disgorgement of $1,476,245, prejudgment interest of $123,741 and a penalty of $750,000. Mr. Solomon will be suspended from the securities business for a period of 12 months and pay a penalty of $165,000.

This is not the first case centered on trading mortgaged backed securities in opaque markets. Previously, the U.S. Attorney’s Office and the SEC initiated similar actions. See, e.g. U.S. v Litvak, No. 13-cr-00019 (D. Conn. Jan. 25, 2013); U.S. v. Shapiro, 15 cr 00115 (D. Conn. Sept. 3, 2015); SEC v. Shapiro, Civil Action No. 15-cv-07045 (S.D.N.Y. Sept. 8, 2015); SEC v. Im, Civil Action No. 1:160 cv 00313 (S.D.N.Y. May 17, 2017). Each of these cases centered on trading a specific type of mortgage backed securities. In each the traders made false statements similar to those made by the salespeople at Deutsche Bank. The criminal cases generally resulted in not guilty verdicts, although in each the jury did return a guilty verdict on at least one count. The Commission cases are in litigation. The defense presented in each generally focused on claims that the misrepresentations were not material to the traders because of the nature of the markets as discussed in here. While the U.S. Attorney’s Office appears to have stopped filing criminal cases, as the Deutsche Bank proceeding illustrates, the Commission has persisted.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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