U.K. Probes Structured-Finance Products

Thuesday, 14 Jul 2009 - The U.K.'s Serious Fraud Office is investigating sales of structured products such as credit-default swaps and collateralized debt obligations, amid concern some bankers may have knowingly sold complex assets based on flawed valuations before the global financial crisis struck two years ago.

"Some of them are incredibly complicated and they are sold by very, very clever people," Richard Alderman, the director of the Serious Fraud Office, said. "The question is not just were they mis-sold, because that gives rise to a number of regulatory issues, but was there actually fraud. Or in other words, did those selling them actually know they weren't worth what the institution said they were?"

Credit-default swaps are insurance-like contracts designed to protect investors against losses on bonds or loans, though in recent years they have been used more often to speculate on the health of companies or countries. CDOs are packages of different slices of debt that are given a single credit rating, enabling them to be traded.

The U.K. probe is the latest sign that policymakers and regulators on both sides of the Atlantic are scrutinizing structured products, which many believe were at the heart of the financial crisis, after years of taking a mostly hands-off regulatory approach.

In recent weeks, the U.S. Justice Department has examined the credit-default-swaps market, including the dominant role of data provider Markit Group Holdings Ltd. and its bank owners. In a statement, Markit said it has "been informed of an investigation by the Department of Justice into the credit derivatives and related markets."

Meanwhile, a key Senate panel, the Permanent Subcommittee on Investigations has issued subpoenas to such banks as Goldman Sachs Group Inc. and Deutsche Bank AG looking for evidence of fraud in the selling of mortgage-related securities. Those banks didn't comment. Like the U.K. SFO, the Senate panel is focused on whether bankers had doubts that the mortgage-securities they were selling were as sound as marketed.

The Obama administration in recent months has moved to regulate credit-default swaps and make them safer for the financial system, and proposed changes that would make it less lucrative for banks to package consumer loans into asset-backed securities. Last month, European regulators unveiled similar proposals for the credit-derivatives industry.

In the U.K., the SFO investigates complex, international fraud cases and it can press criminal charges on its own. The Financial Services Authority, the U.K.'s top financial regulator, also will look at whether structured products were mis-sold, the SFO's Mr. Alderman said.

The SFO plans further inquiries of asset-backed securities, he said. One case that has already been made public involves structured products sold by AIG Financial Products, the unit of American International Group Inc. that is largely responsible for the parent company's struggles. It sold billions of dollars of guarantees on complicated securities tied to mortgages, and those guarantees pushed the company into the rescuing arms of the U.S. government. The unit had offices in London and Wilton, Conn. AIG said it was unwinding certain businesses and portfolios of the unit.

"Valuation cases are fraught with difficulty, but the weight that certain financial products were made to bear was untenable," said Glyn Powell, joint interim head of the SFO unit responsible for London's financial district.

As part of the SFO's work on structured products, it has put together a red-flag system to unearth risks, as it has done in other areas such as hedge funds.

In a broader move, the watchdog is responding more quickly to evidence of fraud, rather than waiting for a report to go to police or company liquidators and then taking months to decide whether to pursue it, Mr. Alderman said. In the past, it "would mean seven to nine years before it would get to court," he said.

The office also is doing more to support whistle-blowers when they come forward and taking a closer look at accounting matters, he said.

In the past year, the office has worked on cases including Bernard Madoff's Ponzi scheme and the collapse of U.K. hedge fund Weavering Capital. In June, it obtained an order to freeze about $100 million of Allen Stanford's assets held at "certain London financial institutions."

Fraud cases that went to court in the U.K. rose last year, according to analysis by KPMG. The worst-hit sector was financial services, which suffered £388 million ($648.2 million) of fraud in 63 cases, a tenfold increase on the £37 million via 36 cases recorded in 2007. However, these figures were partly skewed by one case: an alleged £220 million attempt to hack into Sumitomo Mitsui Banking Corp.'s computer systems, which went to court in the first half of the year. Fraud cases to date this year in the U.K. financial sector total £111 million, KPMG said.

Source:http://online.wsj.com/article/SB124924962560099895.html?mod=googlenews_wsj