Mismarking insecuritiesvaluation takes place when the value that is assigned to securities does not reflect what the securities are actually worth, due to intentionalfraudulent mispricing.[1][2] Mismarking misleads investors and fund executives about how much the securities in a securities portfolio managed by a trader are worth (the securities'net asset value, or NAV), and thus misrepresents performance.[3][4] When atrader engages in mismarking, it allows him to obtain a higherbonus from the financial firm for which he works, where his bonus is calculated by the performance of the securities portfolio that he is managing.[3]
Mismarking is an element ofoperational risk.[5] The trader engaging in mismarking is sometimes referred to as a "rogue trader."[6]
During market downturns, determining the value ofilliquid securities held in portfolios becomes especially challenging, in part because of the amount of debt associated with these securities and in part because of fewer mechanisms forprice discovery.[2] As a result, during such periods illiquid securities are especially susceptible to fraudulent mismarking.[2]
In 2007, twoCredit Suissetraders pleaded guilty to mismarking theirsecurities positions to overvalue them by $3 billion, avoid losses, and increase their year-endbonuses.[7][8][9] Federal prosecutors and theSecurities and Exchange Commission charged that the traders' goal was to obtain lavish year-end bonuses that the mismarking would lead to.[10][11] The traders engaged in whatThe New York Times called "a brazen scheme to artificially increase the price ofbonds on their books to create fictitious profits."[7] A team of traders, facing an inquiry from Credit Suisse's internal controls Price Testing group, justified their bond portfolio's inflated value by obtaining "independent" marks from other banks'trading desks.[7][12] The traders secured sham "independent" marks for illiquid securities that they held position in from friends who worked at other financial firms.[11][7][12] Their friends generated prices that valued a number of bonds at the prices that the traders requested, which the traders then recorded as the true value of the bonds.[7][12] The false profits allowed the head of the group to secure a cashbonus of more than $1.7 million and a stock award of more than $5.2 million.[7] The bank was not charged in the case.[7] Credit Suisse's outside auditor discovered the mismarkings during an audit.[13] Credit Suisse took a $2.65 billion write-down after discovering their traders' mismarking.[11]
Also in 2007, theRoyal Bank of Canada, Canada's biggest bank, fired several traders in its corporate bond business, after another trader accused them of mismarking bonds the bank held by overpricing them, and marked down the values of the bonds and recognized $13 million of trading losses relating to the bonds.[14] The bank said it investigated the accusations, and took remedial action.[14]The Globe and Mail noted: "traders might have an incentive to boost [the bonds'] prices because it could have an impact on their bonuses."[14]
In 2008, aBank of Montreal trader pleaded guilty to intentionally mismarking his trading book in order to increase his bonus from the bank.[15][16]
In 2010, aMerrill Lynch trader in London who mispriced positions he had on behalf of the bank by $100 million to cover up his losses was banned by the United Kingdom'sFinancial Services Authority (FSA) from working in the securities industry in the UK for at least five years.[17][18][19][20]
Also in 2010, a trader atToronto Dominion Bank in the UK was fined £750,000 ($1.16 million) by the FSA for intentionally mismarking his trading positions.[21]
In 2016,Citigroup fired a trader for mismarking his portfolio.[22]
Also in 2016, a trader at a company authorized by theDubai Financial Services Authority (DFSA) was banned for six years from performing any functions in connection with the provision of financial services in theDubai International Financial Centre after he mismarked his trading book.[23]
In 2019, SEC announced settled charges against a former Citigroup Global Markets Inc. (CGMI) trader for mismarking a book of illiquid credit derivatives while sustaining losses from unauthorized trading in U.S. Treasury securities (USTs).[24]
In 2022, SEC charged James Velissaris, former Chief Investment Officer and founder of Infinity Q Capital Management, with overvaluing assets by more than $1 billion while pocketing tens of millions of dollars in fees.[25]
To address mismarking, in 2020 in the United States theSecurities and Exchange Commission proposed a new rule, entitled "Good Faith Determinations of Fair Value," intended to address valuation practices and the role of a fund's board of directors with respect to the fair value of securities investments.[26][27]
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