Decision on SEC’s First Insider Trading Case Involving Credit Default Swaps


On June 25th, a federal district court judge ruled against the Securities and Exchange Commission (SEC) in U.S. regulators’ first lawsuit alleging insider trading of credit default swaps (CDS).  On May 5, 2009, the SEC had charged a portfolio manager at hedge fund investment advisor Millennium Partners L.P. (Millennium) and a bond and CDS salesman at Deutsche Bank Securities Inc. (DBSI) with insider trading.  The SEC’s complaint alleged that the bond salesman became privy, through his employment at DBSI, to confidential information concerning the restructuring of an upcoming bond issuance by VNU N.V. (VNU), a Dutch media holding company, and passed that information on to a Millennium portfolio manager, who traded CDS based on that information.  DBSI was the lead underwriter for the bond issuance.

According to the complaint, based on confidential information from the bond salesman, the portfolio manager purchased CDS protection on VNU, then profited $1.2 million by closing out his positions after the public announcement was made regarding the issuance and the price of CDS on VNU surged.  In making its case, the SEC pointed to the fact that, while discussing the VNU restructuring, the two switched from their recorded work telephones to their mobile telephones, which demonstrated that they knew what they were doing was improper.  Neither DBSI nor Millennium were accused of any misconduct by the SEC.  For a more detailed description of the SEC’s claims, please click here.

The defendants first argued that the SEC lacked jurisdiction to bring the case because CDS are private contracts, not securities.  Following a civil bench trial, the judge disagreed.  The judge pointed out that the SEC has antifraud enforcement jurisdiction over “securities-based swap agreements,” which are agreements for which “a material term is based on the price, yield, value or volatility of any security or any group or index of securities, or any interest therein.”  Id.  The judge decided that the material terms of the CDS contracts at issue were, in fact, based on the price, yield, value, or volatility of VNU’s securities and, therefore, constituted securities-based swap agreements over which the SEC had antifraud enforcement jurisdiction.

However, the judge also ruled that information exchanged in the telephone calls between the two presented by the SEC as evidence did not adequately demonstrate that they had engaged in insider trading.  In fact, in his decision dismissing the case, the judge stated that there was no evidence to support either the SEC’s attempt to attribute “nefarious content” to the calls between them or that the bond salesman had any motive to provide inside information to the portfolio manager.