securities
A security is a tradable financial asset. The term commonly refers to any form of financial instrument, but its legal definition varies by jurisdiction. In some countries and languages people commonly use the term "security" to refer to any for ...
valuation takes place when the value that is assigned to securities does not reflect what the securities are actually worth, due to intentional
fraudulent
In law, fraud is intentional deception to deprive a victim of a legal right or to gain from a victim unlawfully or unfairly. Fraud can violate civil law (e.g., a fraud victim may sue the fraud perpetrator to avoid the fraud or recover mone ...
mispricing. Mismarking misleads investors and fund executives about how much the securities in a securities portfolio managed by a trader are worth (the securities'
net asset value
Net asset value (NAV) is the value of an entity's assets minus the value of its Liability (financial accounting), liabilities, often in relation to open-end fund, open-end, mutual fund, mutual funds, Hedge fund, hedge funds, and Venture capital, v ...
, or NAV), and thus misrepresents performance. When a trader engages in mismarking, it allows him to obtain a higher
bonus
Bonus commonly means:
* Bonus, a Commonwealth term for a distribution of profits to a with-profits insurance policy
* Bonus payment, an extra payment received as a reward for doing one's job well or as an incentive
Bonus may also refer to:
Place ...
from the financial firm for which he works, where his bonus is calculated by the performance of the securities portfolio that he is managing.
Mismarking is an element of
operational risk
Operational risk is the risk of losses caused by flawed or failed processes, policies, systems or events that disrupt business operations. Employee errors, criminal activity such as fraud, and physical events are among the factors that can tri ...
. The trader engaging in mismarking is sometimes referred to as a "rogue trader."
During market downturns, determining the value of
illiquid securities
In business, economics or investment, market liquidity is a market's feature whereby an individual or firm can quickly purchase or sell an asset without causing a drastic change in the asset's price. Liquidity involves the trade-off between the ...
held in portfolios becomes especially challenging, in part because of the amount of debt associated with these securities and in part because of fewer mechanisms for
price discovery
In economics and finance, the price discovery process (also called price discovery mechanism) is the process of determining the price of an asset in the marketplace through the interactions of buyers and sellers.
Overview
Price discovery is diff ...
. As a result, during such periods illiquid securities are especially susceptible to fraudulent mismarking.
Notable cases
In 2007, two
Credit Suisse
Credit Suisse Group AG (, ) was a global Investment banking, investment bank and financial services firm founded and based in Switzerland. According to UBS, eventually Credit Suisse was to be fully integrated into UBS. While the integration ...
traders pleaded guilty to mismarking their securities positions to overvalue them by $3 billion, avoid losses, and increase their year-end
bonus
Bonus commonly means:
* Bonus, a Commonwealth term for a distribution of profits to a with-profits insurance policy
* Bonus payment, an extra payment received as a reward for doing one's job well or as an incentive
Bonus may also refer to:
Place ...
es. Federal prosecutors and the
Securities and Exchange Commission
The United States Securities and Exchange Commission (SEC) is an independent agency of the United States federal government, created in the aftermath of the Wall Street crash of 1929. Its primary purpose is to enforce laws against market m ...
charged that the traders' goal was to obtain lavish year-end bonuses that the mismarking would lead to. The traders engaged in what ''
The New York Times
''The New York Times'' (''NYT'') is an American daily newspaper based in New York City. ''The New York Times'' covers domestic, national, and international news, and publishes opinion pieces, investigative reports, and reviews. As one of ...
'' called "a brazen scheme to artificially increase the price of bonds on their books to create fictitious profits." A team of traders, facing an inquiry from Credit Suisse's internal controls Price Testing group, justified their bond portfolio's inflated value by obtaining "independent" marks from other banks'
trading desk
A trading room gathers traders operating on financial markets. The trading room is also often called the front office. The terms "dealing room" and "trading floor" are also used, the latter being inspired from that of an open outcry stock exc ...
s.Joe McGrath (2020) "Why Do Good People Do Bad Things? A Multi-Level Analysis of Individual, Organizational, and Structural Causes of White-Collar Crime," ''Seattle University Law Review''. The traders secured sham "independent" marks for illiquid securities that they held position in from friends who worked at other financial firms. Their friends generated prices that valued a number of bonds at the prices that the traders requested, which the traders then recorded as the true value of the bonds. The false profits allowed the head of the group to secure a cash
bonus
Bonus commonly means:
* Bonus, a Commonwealth term for a distribution of profits to a with-profits insurance policy
* Bonus payment, an extra payment received as a reward for doing one's job well or as an incentive
Bonus may also refer to:
Place ...
of more than $1.7 million and a stock award of more than $5.2 million. The bank was not charged in the case. Credit Suisse's outside auditor discovered the mismarkings during an audit. Credit Suisse took a $2.65 billion write-down after discovering their traders' mismarking.
Also in 2007, the
Royal Bank of Canada
Royal Bank of Canada (RBC; ) is a Canadian multinational Financial institution, financial services company and the Big Five (banks), largest bank in Canada by market capitalization. The bank serves over 20 million clients and has more than ...
, Canada's biggest bank, fired several traders in its corporate bond business, after another trader accused them of mismarking bonds the bank held by overpricing them, and marked down the values of the bonds and recognized $13 million of trading losses relating to the bonds. The bank said it investigated the accusations, and took remedial action. ''
The Globe and Mail
''The Globe and Mail'' is a Newspapers in Canada, Canadian newspaper printed in five cities in Western Canada, western and central Canada. With a weekly readership of more than 6 million in 2024, it is Canada's most widely read newspaper on week ...
'' noted: "traders might have an incentive to boost he bonds'prices because it could have an impact on their bonuses."
In 2008, a
Bank of Montreal
The Bank of Montreal (, ), abbreviated as BMO (pronounced ), is a Canadian multinational Investment banking, investment bank and financial services company.
The bank was founded in Montreal, Quebec, in 1817 as Montreal Bank, making it Canada ...
trader pleaded guilty to intentionally mismarking his trading book in order to increase his bonus from the bank.
In 2010, a
Merrill Lynch
Merrill Lynch, Pierce, Fenner & Smith Incorporated, doing business as Merrill, and previously branded Merrill Lynch, is an American investment management and wealth management division of Bank of America. Along with BofA Securities, the investm ...
trader in London who mispriced positions he had on behalf of the bank by $100 million to cover up his losses was banned by the United Kingdom's
Financial Services Authority
The Financial Services Authority (FSA) was a quasi-judicial body accountable for the regulation of the financial services industry in the United Kingdom between 2001 and 2013. It was founded as the Securities and Investments Board (SIB) in 1985 ...
(FSA) from working in the securities industry in the UK for at least five years.
Also in 2010, a trader at Toronto Dominion Bank in the UK was fined £750,000 ($1.16 million) by the FSA for intentionally mismarking his trading positions.
In 2016,
Citigroup
Citigroup Inc. or Citi (Style (visual arts), stylized as citi) is an American multinational investment banking, investment bank and financial services company based in New York City. The company was formed in 1998 by the merger of Citicorp, t ...
fired a trader for mismarking his portfolio.
Also in 2016, a trader at a company authorized by the Dubai Financial Services Authority (DFSA) was banned for six years from performing any functions in connection with the provision of financial services in the
Dubai International Financial Centre
The Dubai International Financial Centre (DIFC) is a special economic zone in Dubai covering , established in 2004 as a financial hub for companies operating throughout the Middle East, Africa, and South Asia (MEASA) markets.
DIFC is regulated ...
after he mismarked his trading book.
In 2019, SEC announced settled charges against a former Citigroup Global Markets Inc. (CGMI) trader for mismarking a book of illiquid credit derivatives while sustaining losses from unauthorized trading in U.S. Treasury securities (USTs).
In 2022, SEC charged James Velissaris, former Chief Investment Officer and founder of Infinity Q Capital Management, with overvaluing assets by more than $1 billion while pocketing tens of millions of dollars in fees.
Regulatory action
United States
To address mismarking, in 2020 in the United States the
Securities and Exchange Commission
The United States Securities and Exchange Commission (SEC) is an independent agency of the United States federal government, created in the aftermath of the Wall Street crash of 1929. Its primary purpose is to enforce laws against market m ...
proposed a new rule, entitled "Good Faith Determinations of Fair Value," intended to address valuation practices and the role of a fund's board of directors with respect to the fair value of securities investments.
See also
*
Bond valuation
Bond valuation is the process by which an investor arrives at an estimate of the theoretical fair value, or intrinsic worth, of a bond. As with any security or capital investment, the theoretical fair value of a bond is the present value of the s ...
*
Securities fraud
Securities fraud, also known as stock fraud and investment fraud, is a deceptive practice in the stock or commodities markets that induces investors to make purchase or sale decisions on the basis of false information.Valuation control