Credit Default Swaps Grab Attention of Prosecutors and the SEC Chairman
State and federal prosecutors in New York are investigating whether traders manipulated the market for credit default swaps, a kind of securitized insurance that protects against defaults on corporate bonds.
The joint investigation by U.S. Attorney Michael Garcia of Manhattan and New York Attorney General Andrew Cuomo focuses on whether traders drove up the price of the swaps by reporting transactions to data providers that were never completed, the New York Times reports.
As the price of credit default swaps rises, concerns increase about the viability of the companies issuing bonds protected by the insurance, the Times explains. Higher default swap prices could benefit short sellers in those companies. Short sellers borrow stock shares from a brokerage and sell it, in hopes they can pay back the brokerage with stock purchased a lower price in the future.
A memo written by the law firm Wachtell, Lipton, Rosen & Katz last month indicated concern about “speculative traders” who short a company’s stock while sending misleading signals about the company’s financial condition through the credit default market. The law firm said the Securities and Exchange Commission should take action to protect the integrity of the markets.
SEC Chairman Christopher Cox, criticized in the past for inaction, says the problem lies with a regulatory gap. In an op-ed published Saturday in the New York Times, Cox says Congress decided not to regulate credit default swaps in 2000.
“Despite its enormous size, the credit-default swaps market has operated in the shadows,” Cox wrote. “There is no public disclosure nor any legal requirement for these contracts to be reported to the Securities and Exchange Commission or any other agency. So government regulators have had no way to assess how much risk is in the system, whether credit-default swaps have been accurately valued or honestly traded, and when people issuing and trading them have taken on risk that threatens others.”
He called for new disclosure laws for credit default swaps and authority for the SEC to issue rules against fraudulent, manipulative or deceptive practices.
