Don’t lie about debt prices or you could end up in jail. And if you’ve already lied, watch out.
That’s the message to traders in the US$375 billion opaque market for collateralized loan obligations (CLOs) after Matthew Katke, a former Royal Bank of Scotland Group Plc CLO trader, pleaded guilty Wednesday in the U.S. to committing securities fraud. Katke agreed to cooperate with federal prosecutors’ investigation into a multimillion-dollar scheme to cheat customers who bought and sold bonds.
While investigators have been scrutinizing the activities of several mortgage-bond traders since the credit seizure of 2008, their latest action shows they’ve also been focusing on a market that’s tried to distance itself from debt backed by home loans that spurred the crisis. CLOs, which slice pools of speculative-grade corporate debt into pieces of varying risk and return, have been issued at an unprecedented clip during the past few years.
“The investigation started on the mortgage side because that was so obvious—it was in the public eye,” said Erik Gordon, a professor at the University of Michigan’s Ross School of Business in Ann Arbor. Regulators “are poking around. What they find out is nobody knows what the value is of the CLOs.”
While subprime mortgage-backed bond issuance hasn’t really revived much since the financial crisis, CLO sales have surged. Investors bought a record $123.6 billion of the deals in 2014, surpassing the previous high of $94 billion in 2006, according to JPMorgan Chase & Co. data.
The U.S. CLO market now includes about $375 billion of debt, according to Wells FargAo & Co. data. That amount is about equal to the size of Colombia’s annual economic output.
The Financial Industry Regulatory Authority (Finra) discloses prices on corporate-bond trades within a short period of time to increase transparency, but doesn’t publish those details for CLOs. The debt is largely traded through phone calls. In other words, it’s essentially traded in the dark.
Katke’s actions show how things can go awry in this opaque environment. He was charged with conspiring to boost RBS’s profits by telling clients the bank bought or sold debt at higher or lower prices than the firm actually did. He worked at the firm’s Stamford, Connecticut, office from 2008 to 2013, when he left to join Nomura Holdings Inc., according to records maintained by Finra.
Richard Albert, a lawyer for Katke, declined to comment on the plea.
“RBS has been cooperating and intends to continue to cooperate with the government with respect to this investigation,” Sarah Lukashok, a spokeswoman for the Edinburgh-based bank, said in an email Wednesday.
The case follows the prosecution of Jesse Litvak, a former Jefferies Group LLC mortgage-debt trader who was convicted in March 2014 of securities fraud for lying to clients. Litvak has appealed the conviction.
Katke, meanwhile, is cooperating with authorities. Documents released Wednesday by the U.S. Attorney’s office in New Haven, Connecticut, show he agreed to disclose anything he knows about the charges to which he pleaded guilty as well as unrelated activities by others.
–With assistance from Jody Shenn and Kristen Haunss in New York, Christie Smythe in Brooklyn and Tom Schoenberg in Washington.