The Department of Justice (“DOJ”) recently announced that it has narrowed its scope of investigation into numerous financial institutions’ involvement in manipulating the US Treasury market.  The Fraud Division of the DOJ initiated the investigation in June 2015 when it requested documents from banks that are “primary dealers” of US Treasury bonds.

A primary dealer is permitted to purchase US Treasuries directly from the Federal Reserve when an auction of treasuries is announced.  There are 22 primary dealers of U.S. government debt.  The market for US Treasuries functions in three stages.

  • First, the Treasury Department announces that an auction of Treasuries will take place, which creates the when-issued market. In this market, the primary dealers solicit potential investors to place orders for when-issued securities.
  • Next, the dealer and investor agree on a price on a conditional basis and the deal is finalized when the Treasuries are actually issued.
  • The primary dealers then submit bids for securities to cover the amount of when-issued sales made. The difference between the price paid by the dealers at auction and the price agreed to by the investors in the when-issued market is the dealers’ profit.

The DOJ is investigating whether the dealers are improperly using and sharing the information on the demand for Treasuries received as a result of the when-issued market.

Since the initiation of the investigation in June, many institutional investors have filed lawsuits against the primary dealers, alleging that their manipulation of the auction process has been detrimental to investors.  For example, in an action filed in the United States District Court in the Southern District of New York, the plaintiffs allege that the dealers communicated confidential customer information and coordinated trading strategies in order to increase the prices paid by investors in the when-issued market.  The complaint also alleges that the dealers coordinated trading strategies in order to depress the prices paid by the dealers at auction.  The suppression of a competitive market in the auction process drives down the prices of Treasury futures and options as the prices of these instruments are tied to Treasury auction prices.

To date, 25 such lawsuits have been filed in New York, Illinois, and the U.S. Virgin Islands. In December 2015, all 25 cases were consolidated and transferred to the Southern District of New York by the U.S. Judicial Panel on Multidistrict Litigation (“MDL Panel”).  The MDL Panel reviews complex cases filed in numerous federal courts that involve common questions of fact and determines whether the consolidation of pretrial proceedings would promote the just and efficient conduct of such actions.  The cases have been assigned to Judge Paul G. Gardephe, who has previously managed other multidistrict litigations related to financial products.