Volatility: Has Wall Street Found One More Index It Can Rig?

By Pam Martens and Russ Martens: February 14, 2018

Wall Street Street SignOn Monday, an anonymous whistleblower sent a letter via his lawyer to the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) charging that traders were manipulating the stock market volatility index known as the VIX. The whistleblower said that a flaw exists in the VIX that “allows trading firms with sophisticated algorithms to move the VIX up or down by simply posting quotes on S&P options and without needing to physically engage in any trading or deploying any capital.”

The Chicago Board Options Exchange (CBOE) where VIX options and futures trade, quickly denied the claims.

This whistleblower claims come at a time when billions of dollars are blowing up around the globe because traders placed wrong-way bets that the VIX would maintain the low volatility levels it has enjoyed over multiple years as a result of low volatility in the stock market. As the stock market plunged more than a thousand points on two days last week and saw big intraday reversals on other days, traders nursed big losses as the VIX spiked.

The CBOE explains the VIX as follows: “The VIX Index is based on real-time prices of options on the S&P 500 Index (SPX) and is designed to reflect investors’ consensus view of future (30-day) expected stock market volatility. The VIX Index is often referred to as the market’s ‘fear gauge’.”

For a detailed academic paper by the creators of this concept, Menachem Brenner and Dan Galai, see here.

The new whistleblower’s claims come in an era when Wall Street firms have been charged with rigging other major indices and markets in brazen collusion schemes.

In December 2012, UBS paid $1.5 billion to settle charges with U.S., U.K. and Swiss authorities for its role in participating in the rigging of the interest rate benchmark known as Libor. UBS received a non-prosecution agreement with the U.S. Department of Justice which covered all of its subsidiaries except UBS Securities Japan. That unit pleaded guilty to one count of wire fraud. Six months earlier, Barclays Bank PLC agreed to a $160 million settlement with the U.S. Department of Justice over illegal activities related to Libor and Euribor, another interest rate benchmark.

On December 4, 2013 a group of Wall Street trading firms were charged by the European Commission and paid a collective $2.32 billion for rigging interest rate indexes.  Wall Street titans JPMorgan and Citigroup admitted to participating in the Yen Libor financial derivatives cartel to the European Commission and paid fines of  €79.8m and €70m, respectively. Deutsche Bank and RBS admitted to taking part in both Libor and Euribor cartels and agreed to fines of €725m and €391m, respectively. Societe Generale agreed to pay €446m related to Euribor. RP Martin, a broker, paid €247,000.

At the times the charges and fines were levied, Joaquín Almunia, the European Commission Vice President in charge of competition policy, said this:

“What is shocking about the Libor and Euribor scandals is not only the manipulation of benchmarks, which is being tackled by financial regulators worldwide, but also the collusion between banks who are supposed to be competing with each other. Today’s decision sends a clear message that the Commission is determined to fight and sanction these cartels in the financial sector. Healthy competition and transparency are crucial for financial markets to work properly, at the service of the real economy rather than the interests of a few.”

The indexes the banks were attempting to rig were described by the European Commission as follows:

“Interest rate derivatives (e.g. forward rate agreements, swaps, futures, options) are financial products which are used by banks or companies for managing the risk of interest rate fluctuations. These products are traded worldwide and play a key role in the global economy. They derive their value from the level of a benchmark interest rate, such as the London interbank offered rate (Libor) — which is used for various currencies including the Japanese yen — or the Euro Interbank Offered Rate (Euribor), for the Euro. These benchmarks reflect an average of the quotes submitted daily by a number of banks who are members of a panel…They are meant to reflect the cost of interbank lending in a given currency and serve as a basis for various financial derivatives. Investment banks compete with each other in the trading of these derivatives. The levels of these benchmark rates may affect either the cash flows that a bank receives from a counterparty, or the cash flow it needs to pay to the counterparty under interest rate derivatives contracts.”

On May 20, 2015 we reported on criminal felony counts against five Wall Street banks:

“The U.S. Department of Justice held a press conference in Washington, D.C. this morning at 10 a.m. to announce that two of the largest banks in the United States, Citicorp, a unit of Citigroup, and JPMorgan Chase & Co., would plead guilty to felony charges in connection with the rigging of foreign currency trading. Two foreign banks, Barclays PLC and the Royal Bank of Scotland (RBS), also pleaded guilty to felony charges in the same matter. A fifth bank, UBS, pled guilty to rigging the interest rate benchmark known as Libor.

“Today’s felony charges fall just short of the 19th anniversary of the U.S. Justice Department charging almost every major firm on Wall Street, including JPMorgan, the predecessors of Citigroup, and UBS with fixing prices on the Nasdaq stock market. No criminal charges were brought. That now looks like a serious mistake…

“Barclays was found to have violated its June 2012 non-prosecution agreement involving Libor and required to pay an additional $60 million criminal penalty. UBS was also found to have violated its December 2012 non-prosecution agreement and was required to plead guilty to a one-count felony charge of wire fraud in that matter and required to pay a criminal penalty of $203 million.

“All five banks were put on a 3-year probation which will be overseen by a Federal Court and ordered to cease all criminal activity.

“Other regulators imposed additional fines, bringing the total today to $5.4 billion.”

Clearly, the rigging of indexes and markets by Wall Street banks is not being deterred by criminal charges, by big fines, or by reputational damage. As a Barclays trader was quoted in the foreign currency trading charges, the new Wall Street motto is: “if you aint cheating, you aint trying.”

It’s always been this way on Wall Street and it will always be this way. The only thing meaningful that Congress can do is to restore the Glass-Steagall Act that will separate the den of thieves from the FDIC-insured deposit-taking banks so that the wrongdoers can’t use depositors’ funds to facilitate their crimes. This will also put an end to their status of too-big-to-fail, which forces the taxpayer to bail them out of their insidious crimes.

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