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Nye Lavalle
Bonds' Pricing
Is Questioned
In Email Trail
Former Trader at RBC
Alleges Mismarking
Of Plain-Vanilla Issues
October 26, 2007; Page C1
Growing distrust about Wall Street's ability to determine accurate prices for securities -- a foundation of the financial system -- isn't confined to esoteric mortgage-backed bonds.

In a series of emails to senior bank executives, a former Royal Bank of Canada trader alleged that some of his colleagues intentionally "mismarked," or improperly valued, plain-vanilla government agency and corporate bonds in a bid to boost profits at the firm's New York-based investment-banking unit.

"Losses have been intentionally hidden over the last 5 months," trader Gregory O'Connor told a top Royal Bank of Canada executive in a July 24 email, which was reviewed by The Wall Street Journal.

RBC last month recognized trading losses totaling $40 million, $13 million of which was related to bonds Mr. O'Connor alleges were mispriced, and fired several traders in its corporate-bond business, though the firm didn't acknowledge that the terminations were related to mismarking securities. Mr. O'Connor says in an interview that the fired traders' books were marked down to reflect losses after they left.

"Mr. O'Connor knows full well that the firm took pains carefully to investigate the facts and took remedial action," RBC said in a statement. "He is choosing to distort facts and damage the firm's reputation for his personal gain." Yesterday, the firm fired Mr. O'Connor after inquiries from the Journal.

Amid the credit crunch, there's been growing uncertainty in the financial world over what assets are really worth at financial firms, and in mutual funds and hedge funds that hold complicated mortgage-backed securities. Wall Street firms have announced write-downs totaling more than $25 billion in recent weeks, largely relating to mortgage securities. On Wednesday, Merrill Lynch & Co. valued complicated mortgage securities it holds at a price $3.4 billion lower than it had valued them just a few weeks earlier -- bringing a total write-down of $8.4 billion.

At issue in the RBC matter, by contrast, are bonds whose values are relatively easy to determine, as their prices are posted on trading screens. Traders could have incentive to inflate prices because their pay is based on the value of their securities positions.

RBC said in its statement that Mr. O'Connor's allegations are "meritless" and that the bonds in question by Mr. O'Connor can be difficult to value when markets begin gyrating. The firm said some bond products, such as "callable agency bonds," go through prolonged periods when they aren't actively traded. Other traders, however, note that fair values for such bonds are actively quoted on trading screens.

Valuation problems at the bank are due to "complete and utter chaos and mismanagement and fraud in the trading books of the U.S." unit, Mr. O'Connor alleges.

Mr. O'Connor, who worked in the bank's Memphis, Tenn., office, is seeking a severance package from the bank. He was notified in a termination letter yesterday that he had violated company policy in disclosing firm information without approval.

"This is another example of how companies react to whistleblowers whose motivations are in the best interests of the company," says Jeffrey Liddle of Liddle & Robinson LLP, Mr. O'Connor's lawyer in New York. He says Mr. O'Connor was "trying to do the right thing" and wasn't motivated by a desire for a severance payment from RBC.

The allegations surfaced in February, when Mr. O'Connor says he alerted Ali Jalai, who oversaw the government agency trading desk, that certain government bonds were mispriced.

Then, in a July 24 email to Jonathan Hunter, RBC's U.S. bond chief, Mr. O'Connor said: "The treasury market was fairly volatile in late Feb and I instinctively know this is trouble for [certain government] Agency positions so I see if things were OK. What I found was the book was...mismarked."

In the July 24 email, Mr. O'Connor says he called Mr. Jalai on Feb. 26 and said, "I think you have a problem. You need to see where bonds are being offered and see where bonds are marked out. That's how you can see the problem," he says he told Mr. Jalai. Mr. Jalai didn't return calls for comment.

Mr. O'Connor was referring to the difference between the price at which at least one RBC trader was offering a bond for sale and the value at which the bond was being carried on RBC's books. Mr. O'Connor tracked a series of government agency bonds owned by RBC during the period and found that a number of bonds were being offered for sale at prices below where the traders had valued them on RBC's books.

For instance, Mr. O'Connor said, one $45 million position in Federal Home Loan Bank bonds due March 7, 2022, was valued on one trader's books nearly $100,000 above where a trader offered the bonds for sale on Feb. 23, 2007. Even that price didn't attract buyers. On March 2, the same bond was valued at $145,000 above where it was offered, again failing to sell.

On July 11, Mr. O'Connor sent an email to Mr. Hunter, asserting that there was a "large disparity between where bonds are marked out in these Agency callable books and current market levels."

"Let me be very clear about one thing," the email, which was reviewed by the Journal, said. "You would be extremely lucky to sell any of these bonds at the levels I have here," Mr. O'Connor said in the message.

Within 36 hours, RBC began to mark down the value of the bonds highlighted by Mr. O'Connor, leading to $13 million in losses. RBC took separate write-downs on corporate bonds that had been improperly marked. Those write-downs led to losses of $27 million in the corporate-bond division.
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