Friday, March 13, 2009

Merrill Traders Mismarked P&Ls By Up To $7 Billion To Game Bonus

We are surprised to have missed this the first time around. On page 4 of the Cuomo accusations against Merrill (and Lewis), the Attorney General raises a huge allegation against Merrill's trader employees: the AG claims that traders "willfully" manipulated their P&Ls, potentially by up to $7 billion, in order to make it seem they were more profitable in advance of the early mid-December bonus evaluation, knowing full well they would subsequently remark their books lower, having been already paid for the previous fake P&L number.
The Office has also learned that, less than a week after Merrill voted its premature bonuses, Merrill determined that it would incur an unexpected additional $7 billion in losses for the fourth quarter of 2008, beyond the $8 billion it was already anticipating (Id. at Ex. D at 9-11 and Ex. H at 128-29). It appears that some of these losses may have been booked by Merrill employees who marked down their portfolios only after their 2008 bonuses were set (Id. at Ex. W). Despite the gargantuan unexpected losses, Merrill did not reconsider its bonus awards (which had been voted but not yet paid out) and Bank of America neither requested nor demanded that Merrill reduce its bonus pool (!d. at Ex. C at 106-07, Ex. D at 115-17, Ex. E at 86, and Ex. H at 28). Again, these material developments were undisclosed to the company's shareholders or to the legislators considering how to salvage the American banking system (!d. at Ex. C at 146-49).
As any derivatives trader will attest, this calendar "straddle" as it is lovingly called by some, is by far the oldest trick in the book, where multivariate models' inputs are jiggered in order to spew one number, only to have the correction subsequently "discovered" and fixed at the bank's expense while the bonus has already been pocketed. It is also a reason why many banks have pushed their bonus determination late into the subsequent year so that they are able to have at least semi-audited numbers serve as the basis for bonuses.

If Cuomo pursues this avenue successfully and obtains proof of malfeasance, the consequences would be much more dire than a mere slap on the wrist and bonus disgorgement, as mark manipulation does have criminal connotations associated with it, for both the perpetrator and the enabler/supervisor. It is likely that many if not all derivatives traders at Merrill are likely sweating bullets right now and "opportunistically" looking for exit opportunities in an attempt to cover the tracks expeditiously before the Attorney General's office realizes that there are such things as desk trading blotters that keep track of any trade done during the day, and any P&L mismatch between the "official" record and the trader's own would be immediately obvious by just comparing entry/exit levels on the blotter. Sphere: Related Content
Print this post

14 comments:

Anonymous said...

Make no mistake about this. The MER traders definitely played games with marks and hiding positions to boost their bonus pool.

I can say this 100% certainty because I was a junk bond trader for a large firm back in the 1990's and we ACTIVELY mismarked illiquid positions and hid ugly positions using derivatives swaps with firms like Harvard Managment in order to give our bonus pool a big boost.

I can guaranty you that the MER traders violated every rule in the SEC book plus all codes of ethics.

THAT IS 100% CERTAIN - I'VE BEEN THERE DONE THAT.

Anonymous said...

I am a derivatives trader, worked on sell side both on flow and prop desks. I don't see how the trader can get away with it without the head of the desk, risk management, and the financing group being complicit. At any period end my marks are reviewed by risk management, head of desk, and for reporting period ends the head of trading. If I have an open trade then I am either posting or receiving margin on the trade. So if I mark my position well above market then my counterparty is going to post collateral to me and will be raising a complete shit storm about where they are marked on the trade. Not saying this doesnt happen but it is hard to pull off. I did many derivatives trades with ML and while I may not have always agreed with their marks never found them to be egregious.

Anonymous said...

I was both a prop and flow trader in junk bonds. Ran very large positions. I worked in conjunction with the head of the desk to rig marks on very illiquid positions (some names we were the market) and hiding positions using ISDA swaps.

It is very easy to pull the rug over risk control eyes and I would almost bet that our risk area - being that we were at the time a bank - was extremely risk averse and watchful.

Tell me how that Soc Gen trader was able to rig his book on billions.

Not only is it possible, I would be my last nickel that was done by the MER traders.

Anyone who thinks traders can't play games with marks and positions is naive. And I was trading in the time of Joe Jett at Kidder. Remember him? Back then this was only an issue affecting 10's to 100's of millions. Now it's a multi-billion dollar problem.

Anonymous said...

I've actually heard the opposite has been happening at other desks.

Traders no they ain't getting paid in 2008 so marked positions down. then up the marks to start off 2009 on a positive note and hope to get paid this year.

who knows.

Anonymous said...

I agree it is much easier to do with cash bonds that aren't being repo'd but still maintain harder to do with derivatives. I trade all kinds of fixed income swaps and am subject to maintenance margin on the trades. Have had many painful arguments about marks requiring posting of collateral on things that are not substantially out of market. If I mark my position much higher than market, guaranty the counterparty will call bullshit on your mark very quickly. Of course if you have some bespoke deriv that hasn't traded in months than much easier to manipulate your mark but then I think it would stand out if some group trading something like mezz CRE CDO made multibillion profits in '08. Socgen guy totally different case, he was not manipulating marks he was exceeding trading limits and hiding the existence of trades. That does prove how useful the risk managers really are but its the counterparty that will call you on your mark not the risk guy.

Anonymous said...

It's not about marking positions up to create the illusion of profits. It's about not marking really ugly positions down to a nickel or a dime from 50 cents.

Whenever we played games with marks and position swaps, it was to prevent marking down a big position that was already overmarked.

I can easily see trading desk supervisors who are going to lose their job after the MER/BAC deal consummated colluding on ficticious marking of positions to avoid big write-downs...

Hell, there's not one big bank in this country with an inventory of ABS, MBS, CDO, SIV, etc that's not severely overmarked. NOT ONE. I've looked at the balance sheets and corresponding footnotes of all of them. If the bank debt and alternative asset guys are overmarked, so are the trading desks.

That's not even open to debate with me because I've been there done that and I've looked at the current numbers on these banks.

Anonymous said...

It's not about marking positions up to create the illusion of profits. It's about not marking really ugly positions down to a nickel or a dime from 50 cents.

Whenever we played games with marks and position swaps, it was to prevent marking down a big position that was already overmarked.

I can easily see trading desk supervisors who are going to lose their job after the MER/BAC deal consummated colluding on ficticious marking of positions to avoid big write-downs...

Hell, there's not one big bank in this country with an inventory of ABS, MBS, CDO, SIV, etc that's not severely overmarked. NOT ONE. I've looked at the balance sheets and corresponding footnotes of all of them. If the bank debt and alternative asset guys are overmarked, so are the trading desks.

That's not even open to debate with me because I've been there done that and I've looked at the current numbers on these banks.

Anonymous said...

because you managed a position in the 90s and marked up your positions doesnt tell me with certainty that the MER guys did it. not sure how its related frankly

i mangaged a large position of all kinds of products, i agree with many comments here regarding deriv's being hard to mark to anything other than in the context of the market due to margin calls.
it would have to be done on other kinds of illiquid products.

there is another posibility, they could be marking their positions way down prior to the merger, in hopes that future profits will be extra large. kind of like, MER is over, lets just dump P&L this year because who cares, and then next year we will show large profits.
many times the aquiring company desks can mark the aquired positions way way down. why take on a bunch of positions at market levels when i can hammer your levels and make profit on them in the future.

not everyone is over marked i can assure you. we sold or unwound almost all our positions in the past couple years, and our desk made profit every quarter.

Anonymous said...

Anon 12:38 PM: You might try to mark up the books in 09 if you were certain that you would have a job at the end of 09. But the Merrill traders already knew about the BoA merger and were probably expecting the standard "redundancy" cuts that go along with mergers. I'm surprised at the scale of this - they didn't mismark by say 10% but a whopping 88%.

Kevin John said...

"..and we ACTIVELY mismarked illiquid positions and hid ugly positions.."

Thanks for your honesty. I hope you have since found forgiveness in the one true God whom will give you peace and security.

In the mean time I suggest, if you have not already done it to purchase a quality cutting knife (CUTCO comes to mind)

and cut off your balls, or if you are squimish about a little blood, have a neighbor or asshole like me that lost a fortune from your bullshit graciously help you with the chore.

It might just protect the rest of us from bad genes. Can never be too careful yaknow.

Anonymous said...

@Kevin John - GOLD ... pure gold.

Anonymous said...

When it comes down to it, hasn't the American taxpayer more or less been victimized by the Best Ponzi Scheme Ever? Traders and CEOs have already made off with the money and now the United States of Goldman Sachs is signing us up for the scheme after the fact..

MarketBlogic said...

These days it's a tough challenge identifying the "Best Ponzi Scheme Ever", but for sheer dollars the Social Security and Medicare scams are hard to beat.

I'm surprised no one here has brought up the name of a former business school classmate of mine - Andrew Krieger of Bankers Trust fame:

http://www.nytimes.com/1988/07/21/business/bankers-trust-data-on-restatement.html?sec=&spon=

Anonymous said...

Shhhh!

Don't you people listen to Rush Limbaugh and the Republicans.

All the ABS CDS traders at these places might quit MER/BAC and go work for some Kuwaiti bank or worse retire to Kansas and work against stem cell research.


Then where would be!