NEW YORK Were conversations between a bond salesman and a trader over credit default swaps a case of illegal insider trading, or were they just the sharing of information that typically occurs in negotiations over high-yield bonds?
That depended on who was arguing in court on Wednesday as a trial began of Deutsche Bank AG bond salesman Jon-Paul Rorech and former Millennium Partners hedge fund portfolio manager Renato Negrin on civil insider trading charges.
The trial is the U.S. Securities and Exchange Commission's first enforcement involving credit default swaps, financial instruments used to insure against defaults. Legal experts consider the case a test of whether regulators can make insider trading cases in the unregulated market for the swaps.
Lawyers for the defendants said in their opening arguments in Manhattan federal court that the SEC does not have the authority to regulate the CDS at issue because they are not securities-based swap agreements under securities laws.
CDS have been the focus of investigations in the financial crisis after giant insurer American International Group ran into trouble with them and was bailed out by the U.S. government. At least two U.S. prosecutors attended parts of Wednesday's opening arguments as observers.
In May 2009, the SEC charged Rorech and Negrin over a 2006 transaction for Dutch media conglomerate VNU NV. Neither Deutsche Bank, the underwriters, nor Millennium were accused of any wrongdoing. VNU was taken private in 2006.
The agency contended that Rorech obtained confidential information from Deutsche Bank investment bankers about a change to a proposed VNU bond offering that was expected to increase the price of the credit default swaps on VNU bonds.
It said he illegally tipped Negrin, who took a position on the swaps to reap $1.2 million in profits. Both men have denied any wrongdoing. They have not been criminally charged.
"Like any other insider trading case, this is a case about selective disclosure," SEC lawyer Richard Primoff said in opening arguments of the nonjury trial presided over by U.S. District Judge John Koeltl.
He cited evidence of recorded phone calls and other non-recorded calls between the two men on mobile phones. Primoff alleged that in one of the recorded calls, in July 2006, Rorech told Negrin the tip was "a nice little kiss."
Primoff said: "This court will hear evidence of how important it was to a 20-year veteran like Mr. Negrin to grab on to facts he could get, not just opinion."
The SEC called Negrin to the stand as the first witness in a trial that is expected to last up to three weeks. Negrin testified that he did not remember the conversations of July 14 and 17, 2006 that were played in court. He also said he did not believe he ever traded on inside information.
In one call, Negrin asked Rorech to define the odds VNU would issue more debt.
Rorech is heard saying, "You're listening to my silence right, hang on a second, you're listening to my silence, right?"
They then switched to mobile phones, calls that were not recorded. Asked whether it was unusual to switch to a mobile phone from a landline phone for business calls as he had done with Rorech, the fund manager told the court, "I would say that it happened, but it is unusual."
Rorech's attorney, Richard Strassberg, argued in court that his client followed the bank's policies on the VNU deal and that he was allowed to share information with clients to help market the VNU bond issue.
He told the judge that typically in the high-yield bond market, offerings are not like stock transactions. He said they involve a series of negotiations and a "two-way flow" of information.
"You are going to see that none of that back and forth information is considered confidential by the market participants," Strassberg said.
The case has gone to trial following a decision last December by Koeltl, who declined to dismiss insider trading charges against the men. The trial is expected to last up to three weeks.
Steven Thel, a professor of law at Fordham University in New York, said in a telephone interview that among the legal questions were whether swaps are subject to insider trading provisions of securities law.
"A second question is when is it unlawful to trade in a derivative or a swap based on inside information where the duties to keep that information secret and not misuse it are not at all clear," Thel said. "We have developed that pretty well for stocks and bonds but we haven't developed it very well for derivatives."
Negrin's lawyer, Lawrence Iason, told the judge that an internal probe by the bank did not discover wrongdoing by Rorech or any other bank employee. He said the SEC did not have evidence of any impact on the price, yield or value of a security.
At the time the men were charged, Millennium said it was cooperating with the probe. Deutsche Bank spokesman Ted Meyer said Rorech was on administrative leave.
"We have been cooperating with officials throughout this process but have no further comment on pending judicial proceedings," Meyer said in an emailed statement.
The case is SEC v Rorech et al, U.S. District Court for the Southern District of New York, No. 09-04329.
(Reporting by Grant McCool; Editing by Phil Berlowitz and Tim Dobbyn)