Dennis Berman has this interesting article in yesterday’s WSJ about an advanced form of insider trading that is rarely discussed–trading in credit-default swaps. 

The article explains that

This insurance, also known as a credit-default swap, is an important part of the insider-trading picture. The closer a company is to going private the greater the risk of a debt default — because in these transactions the company is loaded up with a pile of new debt — and the more expensive to insure against it.

These swaps are private contracts between two parties but the aggregate of these contracts has effectively become a market unto itself, with prices fluctuating by the hour based on market information. Options and equity investors obsessively monitor the price movements. Swaps are traded only by the most sophisticated players — hedge funds, banks and insurers — and it is difficult to identify who is trading these instruments.

Using the First Data Corp. buyout as a case study, the article shows how the price of a First Data Corp. credit-default swap contract went from $32,000 prior to the first discussions of the buyout to over $112,000 by the time 5 banks and their lawyers were involved in finalizing the transaction several  months later.

The article also points out that "while the SEC looks at basic stock and option trading, a lot of the insider-trading action appears to be moving to these swaps, and it isn’t even clear whether the agency has regulatory authority over them."

Thanks to this post on Dealbreaker.com for the link to the article.

Wednesday, June 20th, 2007 at 10:33 am
Filed under Securities Enforcement