Pennsylvania Treasurer Joseph Torsella has been appointed lead plaintiff in a lawsuit alleging that 15 Wall Street banks and trading desks conspired to fix bond prices, cheating investors such as pension funds and retirees out of millions of dollars.
Filed in federal court in New York, the suit, which seeks class-action status, alleges that bonds of Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”) were regularly overpriced for purchase and underpriced for sale between 2009 and 2016.
Torsella initiated the class action earlier this year on behalf of all commonwealth funds under his custodial care, he said. Pennsylvania bought and sold roughly $63 billion worth of Fannie Mae and Freddie Mac bonds during that period.
This week the treasurer, represented by the firms Lowey Dannenberg and Scott + Scott, filed an amended complaint with details from an insider at one of the banks, Torsella said.
In one chat, Morgan Stanley, Deutsche Bank and BNP Securities were trying to trade about $390 million in Federal Home Loan Bank bonds and appeared to agree to fix the price of bonds at an inflated price of $99.985:
“I just don’t want to create a race to the bottom between the 3 of us, doesn’t help anyone,” a Morgan Stanley trader wrote.
“Ugh this thing is a pig,” wrote the Deutsche Bank trader, who then proposed a free-to-trade (FTT) price of $99.985.
“Sure FTT at 99.985,” the Morgan Stanley trader responded.
“Good by me,” the BNP trader said.
"Government-sponsored debt, such as Fannie Mae and Freddie Mac securities, are found in most public institutional investment portfolios” including many of Pennsylvania’s $110 billion in assets, which Treasury oversees and invests, Torsella said. “Wall Street banks must be held accountable when they take advantage of investors by market manipulation.”
Other plaintiffs include labor unions, public pension systems and the cities of Birmingham, Ala., and Baltimore. Pennsylvania, at the moment, is the only state.
The complaint cites a June 2018 Bloomberg article reporting the existence of the Department of Justice’s investigation into the Wall Street practice of fixing Fannie and Freddie bond prices.
Torsella’s amended complaint, filed May 23, 2019, includes electronic chat logs indicating that traders were rigging the price of these bonds.
“The evidence shows investors were taken advantage of by Wall Street banks,” Torsella said. “That chat logs speak for themselves.”
Torsella declined to estimate specifically what financial damage the Treasury suffered as a result, saying it was “in the millions.”
But the practice was so common in this corner of the bond market that insiders gave trading desks a nickname, referred to as the James Bond movie, Casino Royale, the suit alleges.
Among banks named in the suit were Barclays, Bank of America/Merrill Lynch, Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, BNP Paribas, First Tennessee, TD Securities, Morgan Stanley, Nomura, JPMorgan, Cantor Fitzgerald, UBS, and HSBC.
Unlike with stocks, which trade on a national exchange at public prices, investors looking to buy or sell these bonds typically communicate directly with a salesperson or trader to request a quote. Prices are quoted individually by dealers in response to requests by phone or in electronic chats, making the process of pricing slow and opaque.
The Fannie/Freddie bond price-fixing conspiracy persisted even during other government investigations into interest rate and foreign exchange manipulations, and despite a resulting ban on multi-bank chat rooms.
Those other probes, which resulted in billions of dollars in fines, found that Wall Street traders used electronic chat rooms to fix prices, share proprietary trading and customer order information, and manipulate pricing benchmarks.
The DOJ’s Antitrust Division, the regulator allegedly investigating conduct in the Fannie and Freddie bond market, hasn’t confirmed or denied reports about a probe.
Fannie Mae, Freddie Mac and other similar types of “government sponsored entity” bonds are considered a safe credit risk for many municipalities.
Unlike U.S. Treasury bonds and bonds issued by certain federal agencies, Fannie and Freddie bonds are not guaranteed by the federal government, but are widely held for slightly higher returns than Treasuries.