By Matt Scully and Chris Dolmetsch
(Bloomberg) --It won’t go down as America’s trial of the decade, but in certain Wall Street circles it may be close.
During the past month in a federal courtroom in Hartford, Connecticut, secrets of the nation’s mortgage-bond business spilled into public view.
Prosecutors told a tale of lies and manipulation that struck at the heart of the markets. Defense attorneys countered that bond trading takes place between sophisticated professionals who can’t be fooled by such bluffing.
It ended Thursday with a mixed verdict that shows the difficulty of policing fraud in opaque corners of the market.
In a mixed verdict, former Nomura Holdings Inc. trader Michael Gramins was convicted of conspiracy and cleared of six fraud counts, while the federal jury was hung on two other charges. Tyler Peters was acquitted on all nine charges. Jurors cleared a third trader, Ross Shapiro, of eight counts of fraud, but deadlocked on one. Prosecutors must decide whether to retry Shapiro on one count and Gramins on two.
Reverberations from the crackdown will continue to rattle bond traders. The case, coming on the heels of a similar trial in January in New Haven, hit unusually close to home for some. Many saw shades of themselves in the Nomura three. The sober realization: Maybe, just maybe, this could’ve been us.
The cases have been a wake-up call for traders who long believed they could do most anything to sell a bond, said a chief compliance officer at a major bank who wasn’t authorized to speak publicly about the case. Traders have become well aware of the potential for embarrassment, professional fallout or worse, the person said.
Revelations of conversations, recorded or captured in chat transcripts, reflect what was thought to be everyday business on Wall Street. Buying, selling, bluffing, puffing, haggling over price -- that’s how the market works. But in recent years, prosecutors began to describe common tactics as fraud. Now, doing your job -- fighting over every 32nd of a point in price -- could land you in prison.
First it was Jesse Litvak, who was twice convicted and twice ordered jailed for misleading his customers (his first conviction was reversed on appeal). Then it was traders at Royal Bank of Scotland Group Plc and Cantor Fitzgerald LP who faced criminal charges.
There’s a reason the Bloomberg News dispatches from the Nomura trial were among the terminal’s most read stories. Many have done what the trio are accused of, or know someone who did, or were on the receiving end of a fib, or were unsure about what they could or couldn’t say to clients.
When Alejandro Feely and Caleb Chao testified for the government about their experiences as junior traders on the mortgage-bond desk at Nomura, it sounded familiar to many Wall Streeters, taking them back to when they first broke into the business.
“I just graduated from college and I had no other prior experience,” Chao said. “I was relying on how my bosses told me how the market operated."
Feely told jurors that colleagues would pretend “there was a seller on the other side of the trade, where in the truth, the bond was owned by the desk.” He thought the practices were “bad for business” and “bad for me” -- but he was young and just trying to succeed.
What’s fraud? Even after the trial it isn’t clear. Though he was portrayed as victim of the Nomura traders’ lies, Zachary Harrison, a former portfolio manager at Putnam Investments, told jurors that he used similar tactics as the three defendants. “I may make the choice of lying to that person if I thought it was protecting my clients’ interest,” he testified under cross-examination by defense lawyers.
Harrison wasn’t accused of a crime.
In the years since Litvak’s 2013 arrest, traders have learned that their every word may be scrutinized. The compliance chief said his bank expanded training. An omission can have the same effect as a misrepresentation, the officer said, adding that even sophisticated customers can be defrauded by a lie.
At Nomura, Shapiro and Gramins attended compliance training after Litvak’s arrest. They were admonished: “Do not lie.”
Along with the criminal cases, the Securities and Exchange Commission has also cracked down with civil fines and trading bans. The only lingering question for traders and their lawyers is whether the election of President Donald Trump may lead to less emphasis on scrutinizing how business is done.
Still, dozens have lost their jobs. Nowadays, traders hesitate to do business over office phone lines, email and chats so as not to leave a trail for authorities. Some are using messaging apps that are barred on Wall Street. Others won’t discuss the prices they’re paying for bonds so as not to be accused of lying.
Virtually every American holds some stake in the $10 trillion market for asset-back bonds -- the debt might be owned by a pension fund and the yield will help determine whether it can cover retirement obligations. For three decades, traders in the rough-and-tumble of the market thought they understood the rules, especially because no one had ever been prosecuted for making misrepresentations.
To contact the reporters on this story: Matt Scully in New York at [email protected] ;Chris Dolmetsch in New York State Supreme Court in Manhattan at [email protected] To contact the editors responsible for this story: David Glovin at [email protected] Paul Cox