Reuters published an article yesterday that confirms long-running rumors that the FBI is investigating a front-running scam involving orders from Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) orchestrated by traders at major U.S. and Canadian banks. According to the article, Reuters reviewed an FBI intelligence bulletin to confirm the story. The FBI bulletin described the scam as “unsophisticated tradecraft,” including hand signals and special telephone ring tones.
Description of Fannie Mae and Freddie Mac scam
According to the article, some traders are conspiring together to rig the rates offered on large orders submitted by Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC), or “front running” them in the interest rate swaps market.
Front running means someone with advance knowledge of another player’s plan to undertake a sizable transaction puts an order in first, so they can profit from the market move that results when the large transaction goes through.
The FBI report also said the informants claimed that senior management at the two banks “planned and encouraged this behavior because it led to higher revenue for their respective parent banks.”
Source of the information
The FBI bulletin reported the information about the fraud against Fannie Mae / Federal National Mortgage Association (OTCBB:FNMA) and Freddie Mac / Federal Home Loan Mortgage Corp (OTCBB:FMCC) came from a former senior employee at a U.S. bank familiar with the fraud and an employee at a Canadian Bank, as well as interviews with other bank employees and traders conducted in 2012 and 2013. The former senior bank employee said that the front running had resulted in profits of much as $50 to $100 million at his bank alone. No names of those suspected in the scam were released in the report, and there was no indication of whether the fraud may extend beyond the two banks already being investigated.
Prosecution seen as unlikely
According to the report, the FBI only has “medium confidence” in the information, which was described as coming from “multiple corroborating sources with first-hand access.” Disappointingly, the report only professed “low confidence” that law enforcement would be able to successfully prosecute those perpetrating the fraud because the trades appeared legitimate. The implication seems to be that insider testimony would be required to assure criminal convictions against the scammers.