Securities and Exchange Commission v. Jon-Paul Rorech and Renato Negrin

The Situation

The Securities and Exchange Commission (SEC) filed charges alleging insider trading in credit default swap contracts (CDS) against defendants Mr. Rorech, a high-yield bond salesperson at Deutsche Bank, and Mr. Negrin, a portfolio manager for the hedge fund Millenium Partners, L.P. The CDS at issue referenced bonds issued by VNU N.V. (VNU), a Dutch media holding company. Defendants disputed that CDS were within the jurisdiction of the SEC as the CDS in question were not “security-based swap agreements” and thus were not covered by section 10(b) and Rule 10b-5’s antifraud provisions. Specifically, in order to establish jurisdiction by showing that the CDS were security-based, the SEC needed to demonstrate that the material terms of the VNU CDS contracts were based on the price, yield, value, or volatility of VNU’s securities.

NERA's Role

NERA was asked by the SEC to examine the relationship between bond spreads and CDS spreads for VNU. The results of NERA’s analysis were presented in the expert report and subsequent trial testimony of Senior Vice President Dr. Chudozie Okongwu. First, the report presented a thorough survey of the academic literature, outlining the reasons to expect a long-term relationship to hold between CDS spreads and bond spreads and providing an overview of relevant empirical academic papers. It then analyzed available data on VNU bonds and CDS referencing VNU bonds, demonstrating through statistical analysis that the relationship between bond spreads and CDS spreads for VNU was consistent with that predicted by academic theory and found in previous empirical work (i.e., that bond spreads and CDS spreads tend to move together). The report also showed that VNU’s bond spreads contributed to price discovery in the CDS market.

The Result

The SEC prevailed on jurisdiction but lost on the insider trading allegations. The US District Court, Southern District of New York, ruled that the material terms of the VNU CDS contracts were based on the price, yield, value, or volatility of VNU’s securities and hence subject to section 10(b) and Rule 10b-5’s antifraud provisions. The Court extensively cited the results of the statistical work performed by NERA in its opinion. Based upon the evidence produced at trial, however, the Court dismissed the SEC’s insider trading allegations brought under section 10(b) and Rule 10b-5 as the Court found no evidence that defendants shared material and nonpublic information, breached their duty of confidentiality, or acted with scienter.