Toomre Capital Markets LLC ("TCM") first wrote about the use of credit default swaps ("CDS") as a means of insider-trading back in October 2006 in the post Possible Insider Trading Using Credit-Default Swaps?? On May 5th 2009, the Securities and Exchange Commission finally filed its first case alleging that credit-default swaps were used to facilitate illegal insider-trading activities. Hopefully, this will be just the first of many such cases filed involving the abuse of insider information and the credit default swap market.

According to this story on Bloomberg News written by David Scheer, the SEC has now alleged that a Deutsche Bank AG salesman, one Jon-Paul Rorech, 36, passed on information about a pending bond sale to a now former Millennium Partners LP money manager, one Renato Negrin, 45, who then bought credit default swaps that resulted in profits of $1.2 million once the VNU high-yield bond transaction was formally announced. The securities market regulator wants these two individuals to forfeit "unlawful trading profits" and pay unspecified fines. “Rorech and Negrin checked their integrity at the door and schemed to engage in insider trading of CDS to the detriment of investors and our markets,” Scott Friestad, the SEC’s deputy enforcement director, said in the statement announcing the lawsuit.

Mr. Rorech’s lawyer, Richard Strassberg of Goodwin Procter LLP in New York, said his client denies the SEC claims. “Mr. Rorech did not commit insider trading or any other violation of the securities laws,” Strassberg said. “He was simply doing his job trying to help the bank and its client, VNU, sell a high-yield bond deal.”

Similarly, Mr. Negrin “flatly denies the charges, and he intends to contest them,” said his lawyer, Lawrence Iason of Morvillo, Abramowitz, Grand, Iason, Anello & Bohrer, P.C. in New York. “We are confident he will be vindicated.” Attorney Iason said the SEC lacks the legal authority to bring the case because the underlying Dutch bonds aren’t subject to the U.S. regulator’s oversight. He also said his client didn’t receive illicit inside information. “I don’t think there’s jurisdiction and I don’t think there’s insider trading here,” Mr. Iason said.

As Toomre Capital Markets wrote then and still maintains, "Times are certainly getting interesting in the CDS market." Portfolio, compliance and risk managers will do particularly well to monitor activity in this largely unregulated financial market. There is considerable reputation risk present, especially in this era of Main Street vis-à-vis Wall Street. One certainly does not need the bad publicity like Millennium Partners LP is now receiving. Is the reader's investment operation prepared to be dragged before some Congressional committee for a "fact finding" hearing?