Suppose you’re the universally reviled face of a market crash popularly blamed for causing the deepest economic disaster in generations. Suppose further that you need to put someone new in charge of the division at your company that was most closely associated with that meltdown.
Presumably you’d want to avoid promoting a guy who, four years later, might settle with the Securities and Exchange Commission for “repeatedly abus[ing] his fundamental duty to serve as an honest transmitter of market information.”
Yet that’s precisely the situation Goldman Sachs confronted Tuesday, after the SEC announced a $400,000 civil settlement with former bond trading lead Edwin Chin for misleading clients in the shadowy market for mortgage-backed securities.
The facts outlined in the settlement itself provide a telling glimpse into how to get ahead in the cutthroat bond trading business -- supposing you don’t get caught. To that end, they also throw an unfortunate light on that most sensitive of Goldman’s sore spots: its mortgage desk.
Like any other salesperson, bond traders make money by purchasing securities cheaply from one client and selling them dearly to another. The bank’s cut is the difference between the two, known as the spread. The trader is compensated accordingly.
It’s an especially important role when it comes to mortgage-backed securities, which are composed of thousands of home loans bundled into tradable products. Mortgage securities trade over-the-counter, meaning there’s no public ledger of bids and offers. Exchanges occur over emails and chats, and clients rely on the Goldman Sachses of the world to learn what’s moving and for how much.
That’s where Chin comes in. Between 2011 and 2012 -- during which time he was the most active mortgage trader at Goldman -- Chin allegedly misled his clients over the nature of the bonds he was hawking, generating a larger spread for the bank and a bigger bonus for himself.
The SEC laid out three instances of alleged deceit. They’re not complicated. After buying a bond, the SEC said, Chin would turn around and market it to a client at a higher price. So far, so good -- that’s just what traders do. But Chin allegedly goosed the deals by misreporting what he had paid for the bond and further, by telling potential buyers there were other bidders when there weren’t. (Chin neither confirmed nor denied the details of the settlement.)
In one instance, in July, 2011, Chin scooped up $11 million of residential mortgage-backed securities called BNCMT at a price of 35 -- that is, at 35 percent of the face value of the bond.
That was at 10:13 a.m. At 10:18, the SEC said, he wrote to a customer: “I am getting a 36-16 counter on the bncmt on 10mm.” Translation: Someone else is making a counter-offer to pay 36.5 percent for the bond. (36-16 means 36 and 16/32 percent.)
The problem with that statement was that the other potential buyer didn’t actually exist, according to the SEC. There was no counter-offer. Under pressure, the real client increased bid 35.75 percent, up from 35.5 percent. Then the following exchange took place:
Chin: i think 36 gets the trade done
Customer A: i figured, but didn’t want to go there and have him nickle and dime @ the qrter . . . if you get them 36, can pay u from there
Chin: on it
Customer A thinks Chin is haggling ruthlessly on his behalf. In reality, the SEC said, Chin simply concocted outside interest in order to nudge the price up. Eventually, the client bought the bond at 36.125 percent, with the added 0.125 providing compensation for the deal. Customer A thought that Goldman had bought the bond at 36 and sold it for 36.125. The spread was actually a whole percentage-point larger, bringing Goldman $100,000 in profits, according to the SEC.
Anyone who has ever tried to close on a house or sign a lease knows this routine. Invariably there’s a line of people desperate to offer even better terms, and this is a take-it-or-leave-it offer. In the parlance of bond traders, it’s “fok”: Fill or kill.
It’s easy to fill when there’s no one on the other end to kill.
Goldman ended up discharging Chin in late 2012 after he made trades without authorization, according to the Financial Industry Regulatory Authority. But the fact that he rose so far draws unwanted attention to Goldman’s bond-trading business, which has been in a bright regulatory spotlight since the subprime mortgage fiasco, which has cost Goldman billions in fines.
Chin, who joined Goldman in 2003, was part of a team of traders that tried to manipulate mortgage derivatives for their own benefit, according to a 2011 Senate report. Whatever role Chin played in that affair, he didn’t suffer any apparent blowback from the bank, which promoted him shortly after the government exposé.
There’s also a broader legal issue at play in Chin’s case. Used-car salesmen don’t get hauled into court for fibbing about what they paid for a lemon. But financial regulators have attempted to hold securities brokers to slightly higher standards.
That effort has suffered setbacks. Last year an appeals court threw out the conviction of Jesse Livtak, a former Jefferies and Co. trader accused of lying to clients about bond prices in terms that the SEC called “unfit for a used-car lot.” His defense later argued that his tactics were indeed similar to those of a used-car salesman -- thus they were kosher. The appeals court agreed.
With that precedent, it’s no surprise that the SEC sought a civil settlement with Chin, who in addition to paying $400,000 is barred from securities markets for at least two years. No word in the settlement on whether he’s welcome on used-car lots.