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Speaker 1: Welcome to the Bloomberg Law Podcast. I'm June Grosso. Every

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Speaker 1: day we bring you insight and analysis into the most

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Speaker 1: important legal news of the day. You can find more

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Speaker 1: episodes of the Bloomberg Law Podcast on Apple Podcasts, SoundCloud

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Speaker 1: and on Bloomberg dot com slash podcasts. The Secured Overnight

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Speaker 1: Financing Rate It is time to meet the Secured Overnight

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Speaker 1: Financing Rate or so FAR, a new reference rate introduced

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Speaker 1: by the Federal Reserve Bank of New York today. It's

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Speaker 1: basically the u s is LIBOR replacement, and so fur's

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Speaker 1: debut is a critical step in the effort to wean

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Speaker 1: more than three d fifty trillion dollars of securities off Libor.

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Speaker 1: Joining me is Eric Tally, co director of the Millstein

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Speaker 1: Center for Global Markets and Corporate Ownership at Columbia Law School. Eric,

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Speaker 1: we've talked a lot on the show about the rigging

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Speaker 1: of Liebor by US and European lenders that were forced

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Speaker 1: to pay billions of dollars to settle charges. Is that

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Speaker 1: the main reason for the push to replace library or

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Speaker 1: are there other reasons? I think in part it is that,

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Speaker 1: but you have to remember that the reason for the

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Speaker 1: rigging scandal was itself born of the very design of libor,

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Speaker 1: which was to try to collect an enormous amount of

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Speaker 1: information about all kinds of different tenors of borrowing in

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Speaker 1: different types of securities, so much so that the banks

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Speaker 1: that we're having to make the reports couldn't actually report

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Speaker 1: that they were doing transactions for some of the reports

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Speaker 1: that they were supposed to be talking about. So it

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Speaker 1: quickly became known that this was sort of a hypothetical

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Speaker 1: form of reporting. It was almost an invitation for various

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Speaker 1: types of manipulation. So I think in part this is

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Speaker 1: because of the scandal, the library reporting scandal, but that

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Speaker 1: itself the seeds for that, I think we're sown and

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Speaker 1: what was ultimately a well intentioned but poorly designed products.

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Speaker 1: So what is sulfur and how is it better than library? Well,

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Speaker 1: here's what sulfur does. So the sofa rate basically uses

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Speaker 1: uh not just hypothetical statements about what cost of borrowing

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Speaker 1: would be, but uses a specific type of borrowing, which

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Speaker 1: is overnight repo or repurchase agreements. This is a very

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Speaker 1: very active market and instead of basing it on a survey,

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Speaker 1: you can actually benchmark the sofa rate to the you know,

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Speaker 1: the actual transactions that are made in the market. That

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Speaker 1: turns out to be very very helpful because it's not hypothetical,

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Speaker 1: it's real, and its adjusts in a real way from

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Speaker 1: a day to day basis. So so in in in

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Speaker 1: going with this new benchmark rate, the New York Fed

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Speaker 1: has has essentially decided that, uh, that that or that

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Speaker 1: the Alternative Reference Rate Committee has decided that this was uh,

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Speaker 1: you know, an area where data or quality of data

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Speaker 1: was going to eclipse the you know, the heterogeneity of

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Speaker 1: the product. That's also one of the weak spots of

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Speaker 1: the of the new rate in that it is only

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Speaker 1: relating to overnight rates in US dollars, and it's secured lending.

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Speaker 1: Usually these uh, these so called repurchase agreements have a

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Speaker 1: lot of collateral associated with them, and and because of that,

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Speaker 1: it may not be as useful for contracts that are

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Speaker 1: trying to find an appropriate benchmark for say year long

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Speaker 1: or six month lending on an unsecured basis. And that's

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Speaker 1: going to be one of the biggest adjustment costs in

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Speaker 1: trying to trying to adapt to the new rate. Well,

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Speaker 1: how complex will the transition be from live or to sofa? Well,

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Speaker 1: in some ways, it will be very very quick, particularly

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Speaker 1: for short term borrowing. I could certainly imagine the benchmark

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Speaker 1: rate uh, you know, and it's already happened to some extent,

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Speaker 1: has already transitioned within some private contracting over to the

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Speaker 1: sofa rate, and and that will be a pretty easy

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Speaker 1: transition to make. I think it really is when you're

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Speaker 1: talking about maybe longer term instruments in which you know,

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Speaker 1: the short term rates and the long term rates don't

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Speaker 1: necessarily line up as well, and maybe there's more volunteer

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Speaker 1: volatility in the yield curve, or there the difference between

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Speaker 1: long term rates and short term rates, that you'll start

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Speaker 1: to see a little bit more of a resistance to

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Speaker 1: pick up these uh these uh, these new benchmarks. You

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Speaker 1: have to remember, however, that by one the British regulators,

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Speaker 1: the Financial Conduct Authority, is going to stop requiring firms

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Speaker 1: to to make reports into liebor. So it may be

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Speaker 1: that by the time we hit that point, everyone's going

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Speaker 1: to realize that the jig is up and they're going

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Speaker 1: to have to find some other form of of benchmarking rate.

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Speaker 1: This is a reliable one is particularly good for short

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Speaker 1: term UH instruments. It is not going to be as

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Speaker 1: good for longer term instruments, but it maybe the best

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Speaker 1: thing that's around. So the Federal Reserve began publishing the

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Speaker 1: rate today, what happens next and how long? Yeah? Yeah,

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Speaker 1: So so a lot of a lot of this is

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Speaker 1: up to private contracting, right There is a lot of

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Speaker 1: private contracts out there right now that are built on

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Speaker 1: Liebor as their benchmark. Great, and that's gonna involved, and

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Speaker 1: that's got a lot of network x ternalities associated with it.

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Speaker 1: People are used to those sorts of contracts. Uh. Some

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Speaker 1: of those uh, some of those entities that author those

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Speaker 1: form contracts, such as ISDA, are going to maybe want

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Speaker 1: to adapt their contracts to say, here's a new template

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Speaker 1: that you could that you could use SOFA as the

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Speaker 1: as the benchmark rate for And then people are gonna

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Speaker 1: have to start adopting that as a benchmark rate. To

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Speaker 1: some extent, that's already started to happen. And my guess

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Speaker 1: is that with a greater notoriety and greater sense that

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Speaker 1: other people are using this rate, people are gonna have

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Speaker 1: greater degrees of comfort in in uh, in adapting to

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Speaker 1: it itself. One has to remember that when labor, you know,

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Speaker 1: liborar hasn't been around forever as well. It's only been

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Speaker 1: around since the since the late nineteen eighties, and it

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Speaker 1: really did pick up steam relatively quickly. This industry is

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Speaker 1: now much larger of financial contracting. The hinges on some

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Speaker 1: type of a reference benchmark, and so there's really going

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Speaker 1: to be a perceived need to find something that works well.

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Speaker 1: And my guess is that the shorter term instruments are

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Speaker 1: going to migrate to it pretty quickly. Longer term ones

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Speaker 1: may hold off for a while just to make or

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Speaker 1: that that you know, their their simulations and modeling make

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Speaker 1: it look like they're not bearing risks that they were

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Speaker 1: unaware of, and they're they're slowly going to come on board.

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Speaker 1: And by the time that that the sea stops collecting

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Speaker 1: live or information, you know, in about three years, um,

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Speaker 1: you know, most people will have made this transition. Now,

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Speaker 1: could works go ahead? No? I was I was going

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Speaker 1: to ask you, is this is libor is um so

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Speaker 1: for the only benchmark in the running, let's say, or

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Speaker 1: are there other countries suggesting alternatives? Yeah? And there are

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Speaker 1: other countries suggesting other alternatives in There have been several

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Speaker 1: alternatives that have been bandied about, and to some extent

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Speaker 1: those are still being bandied about. My sense is that

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Speaker 1: that some form of short term repo or other or

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Speaker 1: commercial paper rates are the ones that are most likely

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Speaker 1: UH to to have legs. UH though there are some

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Speaker 1: UH financial authorities that are considering using the rate paid

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Speaker 1: for government borrowing. That was one of the candidates that

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Speaker 1: that the the Alternative Reference Rate Committee considered. One of

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Speaker 1: the reasons they decided not to go with UM with UH.

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Speaker 1: You know, something related to say US treasuries or other

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Speaker 1: types of bank borrowing is that sometimes those are safe

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Speaker 1: havens in times of gotta stop you there, Eric, we

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Speaker 1: will come back to sofa. I'm sure many times. That's

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Speaker 1: Eric Tallely of Columbia Law School. Jurors are getting a

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Speaker 1: rare look at Washington's political intelligence industry at the trial

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Speaker 1: of consultant charge with passing government information to hedge funds,

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Speaker 1: the first trial of its kind. The prosecutor says, is

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Speaker 1: a case about greed on Wall Street and corruption in

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Speaker 1: d C. The defense attorney says, New York is the

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Speaker 1: city that never sleeps, and d C is the town

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Speaker 1: that never shuts up. My guest is an expert in

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Speaker 1: Insider trading. Peter Henning, a professor at Wayne State University

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Speaker 1: Law School, Peter David Blaze Act. The console is on

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Speaker 1: trial with the former government employee who allegedly tipped him

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Speaker 1: and the two partners of the hedge fund Dear Fielm Management.

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Speaker 1: Tell us a little about the charges. Well, this is

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Speaker 1: one part of the case is a standard insider trading case,

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Speaker 1: so they're accused of securities fraud wire fraud, which is

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Speaker 1: also usually brought together with this. Another part of the

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Speaker 1: case is interesting though, that the defendants are also charged

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Speaker 1: with illegal conversion of government property. In other words, that

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Speaker 1: uh Warral, the government employee essentially improperly took government information

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Speaker 1: and then passed it on to the others. This is

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Speaker 1: like receiving stolen property. And so this is something you

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Speaker 1: normally don't see in an insider trading case, and I

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Speaker 1: suspect prosecutors have this charge in their essentially as a

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Speaker 1: backup in case the insider trading part falls apart. Why

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Speaker 1: is the insider trading part more difficult for prosecutors than

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Speaker 1: the typical what you call the typical Wall Street insider

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Speaker 1: trading cases that we've seen so much of in the

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Speaker 1: Southern district. Right. Well, usually in the typical insider trading case,

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Speaker 1: it's corporate information that is being taken from the company.

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Speaker 1: So in earnings announcement, a deal, perhaps a new invention,

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Speaker 1: something like that that's gonna bump the stock up or down. Um,

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Speaker 1: what this is is about information about how the government

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Speaker 1: was going to reimburse for Medicare and Medicaid procedures or

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Speaker 1: procedures in which doctors would be reimbursed. And typically that

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Speaker 1: type of information seeps out in advance. So an interesting

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Speaker 1: question here, and that's what the defense attorney referenced. That

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Speaker 1: wasn't really confidential information. Corporate information is usually kept confidential,

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Speaker 1: at least until the company has to disclose it to everyone.

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Speaker 1: Government information has a way of washing through the system.

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Speaker 1: And you know, this idea of Washington is the culture

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Speaker 1: of leaks, and everybody talks in Washington. How far do

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Speaker 1: you think that defense will take them because we've seen cases,

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Speaker 1: for example, the Jesse Lit back case, the bond trader.

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Speaker 1: Who's that everybody does this and it doesn't always work, right, Yeah,

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Speaker 1: everybody does it. It usually is not a very good appeal.

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Speaker 1: It didn't work in kindergarten. It's probably not going to

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Speaker 1: work in a federal court, but it'll be interesting to

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Speaker 1: see how a Manhattan or or a New York jury

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Speaker 1: responds to a description of how Washington works and what

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Speaker 1: we know Washington is filled with leaks. But there's also

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Speaker 1: an aspect here that there is a level of transparency

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Speaker 1: that we expect out of the government, that the government,

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Speaker 1: leaving out the national security area, the government doesn't suddenly

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Speaker 1: announce a complete change in policy that this is usually signaled,

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Speaker 1: And so might it be that this really wasn't the

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Speaker 1: kind of market moving information that we see in the

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Speaker 1: corporate context. If you're going to announce blockbuster earnings or

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Speaker 1: a drop in your earnings, that usually has an effect

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Speaker 1: on the stock. This was about something a step removed,

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Speaker 1: even from the companies that had a stake in the

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Speaker 1: amount of government reimbursement through Medicaid and Medicare. The government

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Speaker 1: star witness is a former deer Field partner who pleaded

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Speaker 1: guilty in as cooperating. So that's a tough witness for

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Speaker 1: the defense. Are they admitting a lot of the facts

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Speaker 1: here and going with the this isn't confidential line, or

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Speaker 1: are they disputing Well, I think and this is typical

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Speaker 1: and most insider training cases. They're admitting a lot of

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Speaker 1: the facts. They all admit the deer field. The hedge

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Speaker 1: fund investors say yeah, we bought the shares um blaze

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Speaker 1: Ack said yeah, I passed along this information. So really

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Speaker 1: what this is a fight about is figuring out um

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Speaker 1: was it confidential and was it material information in other words,

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Speaker 1: important to the market. And then also you have another

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Speaker 1: aspect here too with the two hedge fund defendants. Did

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Speaker 1: they know about the benefit that Blazak passed along to

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Speaker 1: war Out the government employee. That's part of the famous

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Speaker 1: Newman case that remains viable that Tippy it it's called

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Speaker 1: a downstream Tippy has to know about the benefit or

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Speaker 1: at least that there was a benefit provided to the

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Speaker 1: source of information. So that's probably going to be another fight,

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Speaker 1: at least for those defendants. So government has a lot

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Speaker 1: of issues it has to deal with in this case.

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Speaker 1: So I don't think this is an easy one. They

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Speaker 1: have a good record in insider trading cases, but it'll

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Speaker 1: be interesting to see how this one plays out. Depending

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Speaker 1: on how this one plays out, does this indicate that

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Speaker 1: federal prosecutors are going to trade sending Wall streeters to

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Speaker 1: prison for trading on inside information to taking on Washington's

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Speaker 1: culture of leak. Well, that that's interesting. Uh, this is

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Speaker 1: the first one, and it's what's called a political intelligence firm,

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Speaker 1: is what blazek ran Um? Are we going to see

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Speaker 1: more policing in this area? This may be the start,

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Speaker 1: but this also may just be the best case that

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Speaker 1: they have, and they're probably hopeful that it sends a

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Speaker 1: message to other political intelligence firms. You had better be careful,

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Speaker 1: Peter about a minute here. But the problem seems to

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Speaker 1: be that many government employees go on to become consultants,

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Speaker 1: and their clients expect them to leverage their former colleagues

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Speaker 1: to get heads up on information or other kinds of information.

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Speaker 1: Isn't that why they're hiring them? Oh? Absolutely, I welcome

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Speaker 1: to the revolving door. That I mean, we see it

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Speaker 1: in every agency. An agency, I'm quite familiar with the SEC.

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Speaker 1: High level people routinely go to law firms U And

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Speaker 1: one of the things that you sell is your access

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Speaker 1: um not in formation, but I can get to the

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Speaker 1: people who have information. Um. Will this stop the revolving door? No,

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Speaker 1: but it might put a little bit of a chill

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Speaker 1: into companies that are looking to hire people because they

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Speaker 1: want their rolodecks. It's it's a fascinating case and we

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Speaker 1: are going to follow it closely with you. That's Peter Henning.

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Speaker 1: Thanks so much, Peter. As always, he's a professor at

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Speaker 1: Wayne State University Law School and expert in the area

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Speaker 1: of insider trading in criminal white collar criminal law. Thanks

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Speaker 1: for listening to the Bloomberg Law Podcast. You can subscribe

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Speaker 1: and listen to the show on Apple Podcasts, SoundCloud, and

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Speaker 1: on Bloomberg dot com slash podcast. I'm June Brosso. This

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Speaker 1: is Bloomberg. Yeah.