As bond supply looms, firms eye primary dealership

The prospect of money to be made trading U.S. debt directly with the Federal Reserve is making “primary dealer” status appealing to a broader range of institutions.

The number of primary dealers shrank to a record low of 16 this week as Merrill Lynch became the latest in a number of prestigious firms whose primary dealer status fell victim to the financial crisis.

The record low number of dealers has raised some fears about whether there will be enough demand for the estimated $2 trillion of debt the Treasury will need to sell to fund its economic rescue packages.

But the looming avalanche of supply, coupled with a smaller and thus less-forbiddingly competitive field, may make primary dealing look like a good deal for a wider ranger of firms.

Primary dealers are banks and securities brokerages that trade in U.S. government securities with the Federal Reserve System. Dealers must qualify in terms of reputation, capacity, and adequacy of staff and facilities.

Futures and options broker MF Global Ltd (MF.N: Quote, Profile, Research) and Japan’s Nomura Holdings have applied to the New York Federal Reserve to become primary dealers, respective company spokesmen said this week. Canada’s RBC Capital Markets and mid-sized U.S. investment bank Jefferies are also reportedly interested in becoming primary dealers.

Nomura withdrew its primary dealership, which obligates it to bid at Treasury auctions, in November 2007, saying it was focusing on its “core operations” in the United States. Earlier that year, another dealer, CIBC World Markets, also withdrew.

“When Nomura dropped out in 2007 there were fewer opportunities to make money in being a primary dealer,” said Ted Ake, head of bond trading with Mizuho Securities, a primary dealer in New York.

“Now you have not only arbitrage opportunities, but opportunities in market-making, and there is more volatility in Treasury issuance.”

An example of the increased volatility is the growing gap between high and low yields at Treasury auctions. At Thursday’s record $14 billion sale of new 30-year bonds, the spread between high and low yields submitted was 24 basis points, compared with a spread of 15 basis points at a $13 billion 30-year auction a year earlier.

At the height of the debt boom in the late 1980s, the number of primary dealers peaked at 46. In 1999, there were 30. The crowded field made it difficult to make much of a profit, economists say.

Another benefit to being a primary dealer in the current environment could be some of the various Fed facilities available to customers only via a primary dealer.

“There seems to be a focus on government guaranteed products at the moment,” said Tom di Galoma, head of government bonds at Jefferies in New York.

“Any time you get access to the Fed window for financing purposes it has to be a very good thing. It seems to be that every firm worries about funding itself, and making that financing available is crucial to anybody’s business model in this environment.”

There are likely a wide range of institutions that may be interested in becoming primary dealers, including other foreign banks, hedge funds and medium-sized firms, said Stephen Stanley, chief economist at RBS Greenwich Capital, a primary dealer.

“I don’t think there is any question that the Treasury would say ‘the more the better,’ even if the ones being added aren’t among the top tier,” he said. “Every different name brings with it a new investor base and broadens the government’s sponsorship pool.”

The last time more than one firm was named a primary dealer at once was in 1988, when three firms were added to the list.

That said, Scott Pardee, a professor of monetary economics at Middlebury College and a former New York Fed official, cautions that primary dealers have to have a developed investor base and be big enough players not to be pushed around by other dealers on large transactions.

Merrill Lynch Government Securities was dropped from the Fed’s list of primary dealers this week as a result of its parent’s acquisition by Bank of America (BAC.N: Quote, Profile, Research). Lehman Brothers, Bear Stearns and Countrywide Financial Corp were all deleted last year.

Source

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Rules on Securities Misrepresentation

Section 10 of the Securities Exchange Act of 1934 states:

“It shall be unlawful for any person…(b) To use or employ, in connection with the purchase or sale of any security…any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe… .”

Sec. 15 of the Exchange Act states:

“No broker…shall… effect any transaction in, or induce or attempt to induce the purchase or sale of any security…by means of any manipulative, deceptive, or other fraudulent device or contrivance.”

For Chicago Securities Arbitration attorneys call 312-782-0844.

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NASD Rule 2310

(a) In recommending to a customer the purchase, sale or exchange of any security, a member shall have reasonable grounds for believing that the recommendation is suitable for such customer upon the basis of the facts, if any, disclosed by such customer as to his other security holdings and as to his financial situation and needs. (b) Prior to the execution of a transaction recommended to a non-institutional customer…a member shall make reasonable efforts to obtain information concerning: (1) the customer’s financial status, (2) the customer’s tax status; (3) the customer’s investment objectives; and (4) such other information used or considered to be reasonable by such member or registered representative in making recommendations to the customer.
Visit Security Lawyer Don Thompson for all Chicago Arbitration Matters in Chicago.

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SEC Audit Assails Ties of Lawyer and Official

A rare inside look at an enforcement case against Bear Stearns Cos. that was ultimately dropped highlights the sensitivity of the “revolving door” between government and industry.

In one of several scathing reports released in recent weeks, the Securities and Exchange Commission’s inspector general said that a senior SEC official closed a long-running case against Bear Stearns amid an “ongoing personal relationship” with the lawyer representing Bear in the matter, who was a former colleague at the SEC.

David Nelson, director of the SEC’s Miami regional office, shut the 3½-year-old investigation into whether Bear Stearns improperly valued complex debt securities — even after the firm agreed to settle the case, the report says. In a phone call with Michael Trager, a senior partner at the law firm Arnold & Porter LLP, which represented Bear Stearns, Mr. Nelson said: “You’re going to be happy with the surprise,” according to testimony by Mr. Trager. “Christmas is coming early” and “Bear Stearns can keep their money.”

While the inspector general “did not find evidence of a direct connection” between the relationship and the decision to close the investigation, “even the appearance of a conflict is disturbing and could potentially damage the reputation of the Commission.” The report recommends disciplinary action against Mr. Nelson.

Messrs. Nelson and Trager didn’t respond to requests for comment. In a statement, the SEC said “the report does not cite a single instance of improper communication or undue influence.” The recommendation for disciplinary action against Mr. Nelson “has been referred to the agency’s administrative review process.” The SEC won’t comment “on any specific individuals or personnel actions until that process has been completed.”
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Account Transfer Problems Can Cause Much Trouble

When a customer switches brokerage firms his accounts must be transferred. Sometimes this is not done quickly and the investor is unable to trade. As a result the investor may be unable to sell securities the price of which is falling.

This delay or other account transfer problems can be a violation of applicable rules.

Call 312-782-0844 to contact Chicago Arbitration Lawyer, Don Thompson.

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Are Securities Brokers Also Victims?

In July, Anotolio Pellizzetti, a 70-year-old retired physician in Tavernier, Fla., filed an arbitration claim accusing UBS AG’s wealth-management unit of fraud in selling him $2.5 million of auction-rate securities. Arbitration claims over investment products gone bad are nothing unusual on Wall Street, but one feature of this litigation stands out: Mr. Pellizzetti was referred to an attorney by his son — a former  UBS broker who first sold his father the securities.

For years, financial advisers promoted auction-rate securities to clients, friends and even family. Now, in the latest twist of the roiled credit markets, some brokers are siding with customers who allege that the securities weren’t as billed. They were widely pitched as higher-yielding alternatives to easily bought-and-sold, super-safe money-market mutual funds — but investors like Mr. Pellizzetti have been trapped in them since February, unable to cash out at full value after the market for auction-rate securities collapsed.

The auction-market crisis appears to be slowly working itself out. In recent weeks, most of Wall Street’s biggest brokerage firms, including UBS, have agreed to buy back more than $40 billion of auction-rate securities from their clients, including individuals, charities and small businesses. Some have reached pacts with state and federal authorities to resolve probes into their sales, while other investigations continue. The pacts may help investors like Mr. Pellizzetti get their money back.

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