Mismarking in
securities
A security is a tradable financial asset. The term commonly refers to any form of financial instrument, but its legal definition varies by jurisdiction. In some countries and languages people commonly use the term "security" to refer to any for ...
valuation takes place when the value that is assigned to securities does not reflect what the securities are actually worth, due to intentional
fraudulent
In law, fraud is intentional deception to secure unfair or unlawful gain, or to deprive a victim of a legal right. Fraud can violate civil law (e.g., a fraud victim may sue the fraud perpetrator to avoid the fraud or recover monetary compensa ...
mispricing.
Mismarking misleads investors and fund executives about how much the securities in a securities portfolio managed by a trader are worth (the securities'
net asset value
Net asset value (NAV) is the value of an entity's assets minus the value of its liabilities, often in relation to open-end, mutual funds, hedge funds, and venture capital funds. Shares of such funds registered with the U.S. Securities and Exch ...
, or NAV), and thus misrepresents performance.
When a
trader engages in mismarking, it allows him to obtain a higher
bonus
Bonus commonly means:
* Bonus, a Commonwealth term for a distribution of profits to a with-profits insurance policy
* Bonus payment, an extra payment received as a reward for doing one's job well or as an incentive
Bonus may also refer to:
Plac ...
from the financial firm for which he works, where his bonus is calculated by the performance of the securities portfolio that he is managing.
Mismarking is an element of
operational risk. The trader engaging in mismarking is sometimes referred to as a "rogue trader."
During market downturns, determining the value of
illiquid securities
In business, economics or investment, market liquidity is a market's feature whereby an individual or firm can quickly purchase or sell an asset without causing a drastic change in the asset's price. Liquidity involves the trade-off between the ...
held in portfolios becomes especially challenging, in part because of the amount of debt associated with these securities and in part because of fewer mechanisms for
price discovery
In economics and finance, the price discovery process (also called price discovery mechanism) is the process of determining the price of an asset in the marketplace through the interactions of buyers and sellers.
Overview
Price discovery is diff ...
.
As a result, during such periods illiquid securities are especially susceptible to fraudulent mismarking.
Notable cases
In 2007, two
Credit Suisse
Credit Suisse Group AG is a global investment bank and financial services firm founded and based in Switzerland. Headquartered in Zürich, it maintains offices in all major financial centers around the world and is one of the nine global " ...
traders pleaded guilty to mismarking their
securities positions to overvalue them by $3 billion, avoid losses, and increase their year-end
bonus
Bonus commonly means:
* Bonus, a Commonwealth term for a distribution of profits to a with-profits insurance policy
* Bonus payment, an extra payment received as a reward for doing one's job well or as an incentive
Bonus may also refer to:
Plac ...
es.
Federal prosecutors and the
Securities and Exchange Commission
The U.S. Securities and Exchange Commission (SEC) is an independent agency of the United States federal government, created in the aftermath of the Wall Street Crash of 1929. The primary purpose of the SEC is to enforce the law against market ...
charged that the traders' goal was to obtain lavish year-end bonuses that the mismarking would lead to.
The traders engaged in what ''
The New York Times
''The New York Times'' (''the Times'', ''NYT'', or the Gray Lady) is a daily newspaper based in New York City with a worldwide readership reported in 2020 to comprise a declining 840,000 paid print subscribers, and a growing 6 million paid ...
'' called "a brazen scheme to artificially increase the price of
bond
Bond or bonds may refer to:
Common meanings
* Bond (finance), a type of debt security
* Bail bond, a commercial third-party guarantor of surety bonds in the United States
* Chemical bond, the attraction of atoms, ions or molecules to form chemica ...
s on their books to create fictitious profits."
A team of traders, facing an inquiry from Credit Suisse's internal controls Price Testing group, justified their bond portfolio's inflated value by obtaining "independent" marks from other banks’
trading desk
Trade involves the transfer of goods and services from one person or entity to another, often in exchange for money. Economists refer to a system or network that allows trade as a market.
An early form of trade, barter, saw the direct excha ...
s.
[Joe McGrath (2020)]
"Why Do Good People Do Bad Things? A Multi-Level Analysis of Individual, Organizational, and Structural Causes of White-Collar Crime,"
''Seattle University Law Review''. The traders secured sham "independent" marks for illiquid securities that they held position in from friends who worked at other financial firms.
Their friends generated prices that valued a number of bonds at the prices that the traders requested, which the traders then recorded as the true value of the bonds.
The false profits allowed the head of the group to secure a cash
bonus
Bonus commonly means:
* Bonus, a Commonwealth term for a distribution of profits to a with-profits insurance policy
* Bonus payment, an extra payment received as a reward for doing one's job well or as an incentive
Bonus may also refer to:
Plac ...
of more than $1.7 million and a stock award of more than $5.2 million.
The bank was not charged in the case.
Credit Suisse's outside auditor discovered the mismarkings during an audit. Credit Suisse took a $2.65 billion write-down after discovering their traders' mismarking.
Also in 2007, the
Royal Bank of Canada
Royal Bank of Canada (RBC; french: Banque royale du Canada) is a Canadian multinational financial services company and the largest bank in Canada by market capitalization. The bank serves over 17 million clients and has more than 89,000& ...
, Canada's biggest bank, fired several traders in its corporate bond business, after another trader accused them of mismarking bonds the bank held by overpricing them, and marked down the values of the bonds and recognized $13 million of trading losses relating to the bonds.
The bank said it investigated the accusations, and took remedial action.
''
The Globe and Mail
''The Globe and Mail'' is a Canadian newspaper printed in five cities in western and central Canada. With a weekly readership of approximately 2 million in 2015, it is Canada's most widely read newspaper on weekdays and Saturdays, although it ...
'' noted: "traders might have an incentive to boost
he bonds'prices because it could have an impact on their bonuses."
In 2008, a
Bank of Montreal
The Bank of Montreal (BMO; french: Banque de Montréal, link=no) is a Canadian multinational investment bank and financial services company.
The bank was founded in Montreal, Quebec, in 1817 as Montreal Bank; while its head office remains in ...
trader pleaded guilty to intentionally mismarking his trading book in order to increase his bonus from the bank.
In 2010, a
Merrill Lynch
Merrill (officially Merrill Lynch, Pierce, Fenner & Smith Incorporated), previously branded Merrill Lynch, is an American investment management and wealth management division of Bank of America. Along with BofA Securities, the investment bank ...
trader in London who mispriced positions he had on behalf of the bank by $100 million to cover up his losses was banned by the United Kingdom's
Financial Services Authority
The Financial Services Authority (FSA) was a quasi-judicial body accountable for the financial regulation, regulation of the financial services industry in the United Kingdom between 2001 and 2013. It was founded as the Securities and Investmen ...
(FSA) from working in the securities industry in the UK for at least five years.
Also in 2010, a trader at
Toronto Dominion Bank
Toronto-Dominion Bank (french: links=no, Banque Toronto-Dominion), doing business as TD Bank Group (french: links=no, Groupe Banque TD), is a Canadian multinational banking and financial services corporation headquartered in Toronto, Ontario. ...
in the UK was fined £750,000 ($1.16 million) by the FSA for intentionally mismarking his trading positions.
In 2016,
Citigroup
Citigroup Inc. or Citi (Style (visual arts), stylized as citi) is an American multinational investment banking, investment bank and financial services corporation headquartered in New York City. The company was formed by the merger of banking ...
fired a trader for mismarking his portfolio.
Also in 2016, a trader at a company authorized by the
Dubai Financial Services Authority
The Dubai Financial Services Authority (DFSA) is the financial regulatory agency of the special economic zone, the Dubai International Financial Centre (DIFC), In Dubai, United Arab Emirates. It is distinct from the UAE's federal Securities and Co ...
(DFSA) was banned for six years from performing any functions in connection with the provision of financial services in the
Dubai International Financial Centre
The Dubai International Financial Centre (DIFC) is a special economic zone in Dubai covering , established in 2004 as a financial hub for companies operating throughout the Middle East, Africa and South Asia (MEASA) markets. DIFC is regulated by ...
after he mismarked his trading book.
In 2019, SEC announced settled charges against a former Citigroup Global Markets Inc. (CGMI) trader for mismarking a book of illiquid credit derivatives while sustaining losses from unauthorized trading in U.S. Treasury securities (USTs).
In 2022, SEC charged James Velissaris, former Chief Investment Officer and founder of Infinity Q Capital Management, with overvaluing assets by more than $1 billion while pocketing tens of millions of dollars in fees.
Regulatory action
United States
To address mismarking, in 2020 in the United States the
Securities and Exchange Commission
The U.S. Securities and Exchange Commission (SEC) is an independent agency of the United States federal government, created in the aftermath of the Wall Street Crash of 1929. The primary purpose of the SEC is to enforce the law against market ...
proposed a new rule, entitled "Good Faith Determinations of Fair Value," intended to address valuation practices and the role of a fund's board of directors with respect to the fair value of securities investments.
See also
*
Bond valuation
Bond valuation is the determination of the fair price of a bond. As with any security or capital investment, the theoretical fair value of a bond is the present value of the stream of cash flows it is expected to generate. Hence, the value of a ...
*
Securities fraud
Securities fraud, also known as stock fraud and investment fraud, is a deceptive practice in the stock or commodities markets that induces investors to make purchase or sale decisions on the basis of false information, frequently resulting in los ...
References
External links
*Vladimir Atanasov, John J. Merrick, Jr., Philipp Schuster (2019
"Mismarking Fraud in Mutual Funds"
{{DEFAULTSORT:Mismarking
Crimes
Deception
Finance fraud
Fraud
Operational risk
Securities (finance)
Confidence tricks
Valuation (finance)