In an unusual partnership, New York state and US federal prosecutors are investigating trading in credit-default swaps, the insurancelike securities that have come under close scrutiny for their role in the financial crisis.
Prosecutors are looking at whether traders manipulated the largely unregulated market for credit-default swaps to drive down the price of financial shares over the past year, people briefed on the investigation said.
In the swaps market, investors buy and sell insurance protection against defaults on bonds. The cost of the protection, also known as a spread, rises when investors grow more concerned about the viability of companies.
Since the spring, spreads surged on swaps tied to debt issued by Lehman Brothers, Morgan Stanley, Goldman Sachs and other financial firms. Those firms’ shares also tumbled, in part, analysts say, because the cost of protecting their debt was rising.
Collaborations between New York Attorney General Andrew Cuomo and US Attorney in Manhattan Michael Garcia are not frequent, legal experts say. That suggests the two men believe the case is too big and significant to pursue independently.
Representatives for both men confirmed their effort on Friday. The Securities and Exchange Commission is also looking into credit-default swaps.
Cuomo and Garcia are investigating whether investors drove up the price of swaps in transactions that were reported to data providers but never actually completed, according to people briefed on the investigation. If so, that would have helped anybody who sold short financial shares. In a short sale, investors sell stocks they do not own in the hopes of buying them back later at a lower price.
To identify whether there was any manipulation, Cuomo’s office has issued subpoenas seeking data from various parts of the industry, including stock exchanges, investment firms and three companies involved in processing trades in swaps and stocks, people briefed on the inquiry said.
Those firms are: Depository Trust Clearing Corp, which serves as the clearing agent for most financial transactions including swaps and stocks; Markit, which provides swaps data to Wall Street banks and investors; and Bloomberg, the financial data company whose electronic system is used by traders to track markets and communicate with one another.
The inquiry is in preliminary stages, and people familiar with the investigation say it may not lead to a prosecution.
One investor, who asked for anonymity to avoid drawing attention to his firm, said the swaps market was becoming a convenient scapegoat for regulators.
He said that evidence of traders’ manipulating share prices was largely circumstantial.
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