Alleged RBC sham futures trading scheme explained

Posted by Preet on Apr 4, 2012 | 3 comments

First, I’ll note that nothing has been proven in court and right now it’s a matter of “he said, she said” in the Commodity Futures Trading Commission’s (CFTC) civil suit against RBC which hit the headlines as “hundreds of millions of dollars in sham futures trading”. This post is simply to explain the basis of claim by the CFTC against RBC since no one has really done that in detail.

Also, I wanted to see how many times I could use the word “alleged”.

What’s the charge?

The CFTC (a US regulator of futures and options markets) is alleging that RBC conducted a series of wash trades on futures markets in the US between 2007 and 2010 to the tune of hundreds of millions of dollars in order to capture tax benefits associated with holding dividend paying companies while not being materially exposed to price changes in those companies. A wash trade in this context means you are trading against yourself by buying a security in one account and at the same time selling it in another. What money is lost by one account is offset by the money gained in the other account. Further, it is alleged that the overall strategy was conducted using Single Stock Futures (SSFs) and Narrow Based Index Futures (NBIs) with two foreign subsidiary companies in a manner that was non-arm’s length in nature.

What is an NBI?: A Narrow Based Index future is a cash-settled future on a custom index. Upon expiration, one party of the transaction must pay to the other party a cash payment depending on whether or not the underlying index outperformed or underperformed the contract price. These contracts can be rolled over to future settlement dates if the parties so decide.

What is an SSF?: A Single Stock Future is the same thing, except the underlying investment is not an index, it is simply a single stock, and the settlement can be handled with the actual stock, OR a cash payment. If you are short the SSF, you deliver the stock to whomever is long the SSF contract at expiration.

The Basic Breakdown

It’s alleged that a few key senior RBC employees controlled the trading behaviour of three units which they argue are distinct, but which the CFTC argues are acting in a consolidated matter. That means the view of the CFTC is that the transactions were non-arm’s length in nature since one group within RBC allegedly directly controlled the trading of all three units in an orchestrated manner.

Now, the exchange on which the trades were made permitted two parties to enter into pre-arranged block trades (large trades essentially) as long as they were at reasonable prices that were mutually agreed to and subject to “The Rules of The Exchange”. The exchange did NOT have a rule that explicitly permitted block trading between affiliated parties. This is the crux of the whole thing. Everything up until now would’ve been fine had the two trading parties not been affiliated with each other within the SSF or NBI trades.

Essentially, the charges are that RBC 1) Engaged in wash trades and fictitious trades to limit market exposure to underlying stocks (for the purpose of capturing tax benefits associated with holding the underlying stocks in two of the units), 2) Engaging in non-competitive transactions – which means that they did not seek non-affiliated trading partners who would presumably help set prices through an open market system (think open bids and asks like you see at your retail discount brokerage account) and 3) Made false statements to the CFTC during the investigation into this trading activity.

What are the tax benefits alleged to have been sought?

As per the CFTC document:

1. Canadian taxpayers are entitled to an offset against their Canadian taxes equal to the US taxes they pay on dividend income from US securities.
2. Canadian companies are entitled to an offset against Canadian taxes equal to Canadian taxes paid on dividend income from securities issued by other Canadian companies, so long as the securities are held for one year or longer.

The Technical Breakdown

NBI Side

On the NBI side, this was conducted between the RBC Canadian Transit group in Toronto and the RBC Europe Limited group in the United Kingdom (London). This is a four legged strategy in which offsetting positions are held in the underlying stock (Toronto was long, Europe was short) and Toronto sold NBIs to Europe. The gain or loss on one side of the futures contract were offset by the other side since profit/loss between these two groups were consolidated. RBC Canadian Transit captures the tax credit (the end goal) while overall, there was no material market exposure to the underlying investments.

SSF Side

The SSF side is basically the exact same thing. The only difference is the use of SSF contracts which are timed to expire just after the dividends are collected, to ensure capture of the tax benefit for the offshore Canadian account at the RBC Caribbean unit. These trades were executed, allegedly, in coordination with the RBC Capital Markets Arbitrage group based in Luxembourg (with offices in New York). Again, the offsetting trades ensured that there was no material market exposure overall, but one of the groups captured tax credits that increased the consolidated groups’ bottom line.

Also of note is that the Central Funding Group (CFG), which oversaw both the NBI and SSF sides of these wash trades, was based in the Caribbean, but “Member 1″ of the CFG was a member, and then later Chairman, of the board of directors for the Capital Markets Arbitrage group (the other side of the SSF trades from the Caribbean).

Final Note

As mentioned, this post is simply to explain the details of the scheme as alleged by the CFTC. The point of debate is whether or not the groups acted independently in a manner that would provide proper price discovery of the futures contracts had there been other trading partners (i.e. non RBC affiliated trading partners), and whether the trades were of a wash or fictitious nature.

Hope that helps clear things up.

2012 Bloggers’ Stockpicking Contest Q1 Update

Posted by Preet on Apr 2, 2012 | 0 comments

Welcome to the Q1 Update of the Fourth Annual Personal Finance Bloggers’ Stock Picking Contest.

I’m still the guy who doesn’t take it seriously. Still nice to meet you.

So far, my “shoot from the hip” picks have done very well. I’m leading the competition with a +35.91% return in only the first 3 months. I don’t know about you, but my gut reaction is that this may not bode well for the final year-end results! :)

Here are my four picks for this year, the original rationale and a refresher of the rules for the competition. The overall rankings and links to the other competitors follows.

Top 2012 Stock Picks

The criteria is to pick four securities in equal dollar amounts listed on a Canadian or American exchange (not including derivatives) to just sit on for the duration of 2012 with no changes allowed. We are to provide updates every quarter and the contest ends on the last trading day of 2012. The initial prices will be based on the closing prices on December 30th, 2011. The final prices are based on the closing prices on the last trading day of 2012.

1. Starbucks @ $46.01 (NASDAQ:SBUX) – I just had one so it’s top of mind right now. NOW: $55.89, +21.47%

2. Apple @ $405.00 (NASDAQ:APPL) – iPad 3, iPhone 5, and Apple might re-invent the TV this year. I also understand Steve Jobs and Tupac will release a collaborative album in 2012. NOW: $599.55, +48.04%

3. Research in Motion @ $14.50 (NASDAQ:RIMM) – Perhaps they got beaten up too much, perhaps they get bought out. Then again, perhaps they have further to fall. NOW: $14.70, +1.38%

4. Bank of America @ $5.56 (NYSE:BAC) – Bit of a contrarian play… and that’s about as much thought I put into it. NOW: $9.57, +72.12%

This Doesn’t Sound Like You

Regular readers know that I don’t normally talk about specific investments. For the first year’s contest I initially hesitated since I was worried that some readers might take some of these picks to heart and actually buy them themselves as part of their investment portfolios. However, I decided to participate anyways deciding that I’ll just disclaimer the heck out of it. To that end:

This Is Just For Funsies

THIS STOCK PICKING CONTEST IS JUST FOR FUN, IT IS NOTHING MORE THAN GAMBLING. DON’T EVEN THINK ABOUT BUYING THE STOCKS LISTED HERE OR ON ANY OF THE OTHER BLOGGERS’ SITES WITHOUT FIRST CONSULTING A PROFESSIONAL FINANCIAL ADVISOR. IF YOU BUY THEM ANYWAYS BASED ON THIS POST, YOU MUST RAISE YOUR RIGHT HAND BEFORE PLACING THE ORDER AND REPEAT, “I AM A NUTBAR”.

What The Other Guys Are Picking

Here is a list of links to the other participating members’ performance:

WhereDoesAllMyMoneyGo.com +35.91%

Intelligent Speculator +16.37%

Dividend Mantra +13.71%

Wild Investor +11.78%

My Traders Journal +11.17%

Beating The Index +10.87%

Million Dollar Journey +7.84%

The Passive Income Earner +4.77%

Dividend Growth Investor +4.43%

The Financial Blogger +0.10%

CORRECTED: Diversification Visualized with Google Motion Chart

Posted by Preet on Mar 31, 2012 | 3 comments

Apologies to email subscribers: this morning’s first email did not include the video or chart (and it wasn’t a lame attempt at an April Fool’s prank!). This data was actually published last week but removed so it could run exclusively in The Globe and Mail on Friday. Now that it ran there, I can re-publish on this blog (part of my deal with them). Sorry for the multiple confusions!

I was just goofing around and put together this spreadsheet to play with Google’s motion charts. I took the annual returns from one of Libra Investment Management’s spreadsheets and created a “growth of $1″ simulation for a bunch of asset classes as well as a diversified portfolio. I’m embedding two things: a YouTube video to explain how to use the chart, and the actual chart for you to play with.

FYI: The diversified portfolio in this version is 30% Canada, 15% US, 15% EAFE, 30% CDN Long Bonds, 10% Gold. I’ll make the full spreadsheet available another time in which you can change the asset mix of the diversified portfolio to anything you want and see the new visualization results.

First the explanation video:

Then the chart to play with yourself:

Not all Market News Moves Markets

Posted by Tusk Trader on Mar 29, 2012 | 2 comments

This is a guest post on trading from Tusk Trader (check out the newly launched site: www.TuskFund.com), an experienced Bay Street trader who will be writing here until Tusk’s own blog is set up. Tusk had a front row seat to the twists, turns, and almost collapse of our capital market systems a few years ago and provides a unique perspective you won’t find anywhere else. For most people, financial literacy is the elephant in the room. Let Tusk Trader help change that. If you are on twitter, make sure to follow Tusk at @TuskTrader

[Editor's note: Yesterday's post on visualizing diversification was removed and will instead appear in The Globe & Mail on Friday. I'll link to it when it has been published there.]

This week’s business news websites and papers are jam-packed in Ontario as both the provincial and the federal budgets are being presented to the public. This type of business news is very important. It tells businesses that reside in (or conduct business in) the area what changes might be made to any tax structure or about the plans for any stimulative events the government might be initiating. The news is critical to businesses for planning efforts and long term forecasting, but it is not always market moving. For news to be market moving, it must change a set of assumptions in a distinctive way that market participants currently have for the business and economic environment. This does not mean that budgets do not move markets. They have many times in the past and will continue to sometimes have that affect. However, just because a budget is released, does not mean you will see a market move from it or gain a trading idea.

The same is true for sector specific news and stock specific news. Just because there is news on a stock does not mean it will move the stock. Even if the stock does start to react to a piece of news, it does not always translate into a solid trading idea or good trading environment that you can make money from. A lot of at home investors I speak to mistake a piece of news on a stock for a trading idea. It is often not the case. It doesn’t mean the news is not important, it just means that it does not create a tradable idea. Keeping on top of a lot of general business news is very important as is staying current on the news of any stocks that you trade. Many good trading opportunities come from having a solid understanding of the issues a company is facing and being in the position to react quickly when actual market moving news is reported. A tradable opportunity arises when news comes out that changes (or opens the possibility of changing) the trajectory of the company. The news has to either promote buying or selling by shareholders to create a trading opportunity from that news piece.

Simply hearing a bad news story about a company should not trigger your sell finger to spring to action. You don’t want to be the only one selling. The negative news story must change the outlook or the current position of the firm.

This week, definitely review the budgets tabled, stay on top of as much sector and stock specific news as is relevant to you, just don’t do it with your hand constantly on the keyboard. When it comes to the markets, the more you know, the better. Just do not think you are seeing trading or market moving news, when you are really just seeing really important news.

Thanks Tusk. Make sure to check out the site: www.TuskFund.com or follow Tusk Trader on twitter: @tusktrader

A Tale of Two Oils: WTI vs Brent

Posted by Tusk Trader on Mar 22, 2012 | 0 comments

This is a guest post on trading from Tusk Trader (check out the newly launched site: www.TuskFund.com), an experienced Bay Street trader who will be writing here until Tusk’s own blog is set up. Tusk had a front row seat to the twists, turns, and almost collapse of our capital market systems a few years ago and provides a unique perspective you won’t find anywhere else. For most people, financial literacy is the elephant in the room. Let Tusk Trader help change that. If you are on twitter, make sure to follow Tusk at @TuskTrader

I have been hearing some interesting conversations on the subway lately from some want-to-be financial analysts (yes I am eaves dropping again). Oil is a common theme in these conversations, but most of the time both people involved in the conversation were quite confused about the price of oil without actually realizing their error. I think the confusion is coming from not understanding that there are two common prices quoted: West Texas Intermediate (WTI) and Brent Crude. WTI is the oil from North America. Brent is the oil from the North Sea. Most of the time, when you see the price of oil quoted in Canada, it is WTI. In theory, these two should trade relatively close in price. In reality, Brent Crude has been trading at a huge premium to WTI for a while now. Brent has been trading around $125 US a barrel and WTI around $105 US a barrel. That is a large gap. Overtime, they should start to close the gap. Currently, most market participants predict Brent will fall in price to meet up with WTI and do not predict that WTI will rise to the levels of Brent.

WTI and Brent are not exactly the same type of oil, but they are a very similar product compared to most oil products traded. What this mini oil lesson points out, is that you need to sometimes go a bit deeper into your chart or price analysis than you might initially think to understand the dynamics of a particular area of trading. All oil traded is not the same and comparing a WTI chart to a Brent chart without noticing they are two different things, will never lead you to an educated opinion. To review and analyze a price quote or chart, you first must understand what you are looking at it. The basics of oil pricing are simple supply and demand (often mixed in with a healthy dose of fear on either side) but to do so effectively does take some background knowledge and a bit of research. It is not hard, generally very interesting, and it is a step not to be missed.

Thanks Tusk. Make sure to check out the site: www.TuskFund.com or follow Tusk Trader on twitter: @tusktrader

Which Hollywood Stars Would be in the Ultimate Financial Crisis Movie?

Posted by Preet on Mar 20, 2012 | 7 comments

Which Hollywood stars would be in the ultimate financial crisis movie? And would it be a drama or a comedy?

Timothy Geithner

U.S. Treasury Secretary Timothy Geithner

DRAMA: Mad Men's John Slattery. He'd need to dye his hair, but he is a dead ringer otherwise.

COMEDY: Will Ferrell. C'mon - worth the price of admission alone.

Nouriel Roubini

Nouriel Roubini - Dr. Doom, one of the most cited, pessimistic (realistic?), economists during the crisis

DRAMA: Saul Rubinek (Seen here playing Kivas Fajo from Star Trek TNG)

COMEDY: Sacha Baron Cohen. You may know him from roles such as Borat (pictured here), Bruno, the French F1 driver in Talladega Nights, and more.

Barack Obama

U.S. President Barack Obama

DRAMA: Harry Lennix - you might remember him as Commander Locke in The Matrix Reloaded

COMEDY: Samuel L Jackson, mostly because it would just be badass. Imagine a performance that builds to a crescendo like his storytelling in the kid's book, Go the #uck to Sleep.

Hank Paulson

Hank Paulson (Former US Treasury Secretary)

DRAMA: Bruce Willis. While known more for action roles, his on screen presence in dramatic roles can't be denied.

COMEDY: Larry David (of Seinfeld fame). Just picture him in that scene from Wall Street: Money Never Sleeps in the boardroom with all the bank heads.

Alan Greenspan

Former US Federal Reserve Chairman Alan Greenspan

DRAMA: George Burns. The resemblance is uncanny.

COMEDY: Jerry Stiller (George Costanza's dad in Seinfeld). Imagine him testifying to congress and saying, "YOU WANT A PIECE OF ME? YOU GOT IT!"

Ben Bernanke

Ben Bernanke: Current U.S. Federal Reserve Chairman

DRAMA: Stanley Tucci. A finer actor is hard to come by. Paul Giamatti did a great turn playing Bernanke, but I've got plans for him. :)

COMEDY: Bill Murray. He would be brilliant. He was awesome in Zombieland if you haven't seen it.

David Cameron

David Cameron: British Prime Minister

DRAMA: Colin Firth, should be old hat playing upper crust Brits.

COMEDY: Ricky Gervais. 'nuff said.

Warren Buffett

Warren Buffett: The Oracle of Omaha

DRAMA: Ernest Borgnine (even thought he couldn't fly Airhawk with the turbo boost). I'm not sure if this should also be a comedy candidate.

COMEDY: Denver Pyle (Uncle Jessie from The Dukes of Hazard). Not 100% on this either, I just liked the picture. Finding both a dramatic and comedic actor for Warren was tough, but perhaps I'm missing the obvious choices? Feel free to chime in down below.

Jim Cramer

Jim Cramer: Host of CNBC's Mad Money

DRAMA: Paul Giamatti. Bernanke can't be half as fun to play as Cramer.

COMEDY: Louis CK (You NEED to see his internet comedy special BTW). His voice is even similar to Cramer's. I saw him on Letterman one night and he had me in stitches. His comedy routines on Youtube are a great way to lose a day (and a few pounds from laughing so hard.)

Mark Carney

Mark Carney: Bank of Canada Governor, Head of the Financial Stability Board

DRAMA: George Clooney. The resemblance is uncanny.

COMEDY: Norm Macdonald, seen here playing Burt Reynolds on Celebrity Jeopardy on SNL... and that's just how he should play Carney in a comedy. If only there was some way to bring in Will Ferrell as Alex Trebek in addition to being Geithner... :)

Jim Flaherty

Jim Flaherty: Canadian Minister of Finance

DRAMA: Nathan Lane. Doppelgänger.

COMEDY: Nathan Lane (now think Birdcage)

Angela Merkel

Angela Merkel: German Chancellor

DRAMA: Meryl Streep, because there isn't anything she can't do.

Comedy: Lisa Lampanelli, insult comic and celebrity roaster. The Chancellor of Comediennes.

Nicolas Sarkozy

Nicolas Sarkozy: French President

DRAMA: Sean Penn. Some similar features.

COMEDY: Robert Downey, Jr. Also some similar features, but putting the "Downey, Jr." stamp on the role would be priceless.

Jean-Claude Trichet

Jean-Claude Trichet: Former President of the ECB

DRAMA: Steven Gilborn (The hard assed math teacher from The Wonder Years who we all secretly looked up to.)

COMEDY: Surely you can't be serious picking Leslie Nielsen? Yes I can, and don't call me Shirley.

Mario Draghi

Mario Draghi: New President of the ECB

DRAMA: A young Al Pacino. What a mind job.

COMEDY: Mr. Bean as played by Rowan Atkinson. Also a mind job.

Silvio Berlusconi

Silvio Berlusconi: Former Italian Prime Minister

DRAMA: Tony Soprano aka James Gandolfini

COMEDY: Christopher Walken. The Man. The Legend. This particular photo is from the SNL "Cow Bell" sketch. Will Ferrell is also great in that particular scene.

Tony Blair

Tony Blair: Former British Prime Minister

DRAMA: Michael Sheen. Heck, he already did a bang up job in The Queen.

COMEDY: Russell Brand. Let it sink in. This might seem a bit of a stretch, and I am open to suggestions for replacements for any roles mentioned on the page, but I think the injection of Brand's special brand of comedy would be welcome.

Bernie Madoff

Bernie Madoff - Multi billion dollar ponzi scheme fraudster currently in prison where he will probably never sit down again

DRAMA: Cousin Larry from Perfect Strangers (Mark Linn-Baker). An obscure one, but bang on the money looks wise.

What Do You Think?

Feel free to leave a comment with alternate suggestions. I don’t know about you, but I think I would line up to see the comedy first. :)

What is a trading floor like on a day when a big market swing occurs?

Posted by Tusk Trader on Mar 15, 2012 | 4 comments

This is a guest post on trading from Tusk Trader (check out the newly launched site: www.TuskFund.com), an experienced Bay Street trader who will be writing here until Tusk’s own blog is set up. Tusk had a front row seat to the twists, turns, and almost collapse of our capital market systems a few years ago and provides a unique perspective you won’t find anywhere else. For most people, financial literacy is the elephant in the room. Let Tusk Trader help change that. If you are on twitter, make sure to follow Tusk at @TuskTrader

I get questions often about what it is like to work on a trading floor of a busy firm. The most popular question is:

“What is a trading floor like on a day when a big market swing occurs?”

The answer is that it depends on the market mood and why it is moving so quickly. For starters, the market has to actually move a particular distance. A trading floor is usually at its most boring when the market open up or a down a lot and just hovers at a particular level all day. When the market is actually moving a number of points, the office environment can become very exciting on its own. Most market moves between 150 and 250 points create a very loud trading office. Sometimes the volume rises because people are making money, sometimes because they are losing money, and sometime just out of an abundance of activity to follow and to trade off of. When the market moves that much, most traders feel a bit of energy and this can lead to louder voices, more chatter and more phones will also be ringing. A move of 250 to 350 has the same level of activity but usually louder voices and more trader-to-trader interaction as traders try to get multiple opinions on what is occurring. A market move over 250 points is usually from a big news item and traders want to try to catch as many news up dates and analysis as they can. Often traders need to rely on those around them for input when there is a lot going on. Most good, well-run, trading floors really show what they can do in this environment and often will stand out from the other trading floors where few people get along or work together well.

An office environment when the market that is up 400 or 500 points can often sound the same as one that is up about 300 points. On the downside however, that is rarely the case. Once a market begins to be down 400 points or more, the office actually gets quieter and quieter. There is still activity but the volume goes way down. During the crisis in 2008, I remember a down day of around 800 points and you could have heard a pin drop in the office. When a market falls to that extent, it is not a sector that is falling or a company with problems, it is a systematic problem causing a form of uncertainty in the capital markets overall. A drop of over 700 points at that time caused a trader to not think about the solvency of the company they want to short, but the solvency of the company they work for.

Thanks Tusk. Make sure to check out the site: www.TuskFund.com or follow Tusk Trader on twitter: @tusktrader