‘Wash sales’ said to be common practice

The practice of “wash sales,” or the illegal buying and selling of securities where no real change of ownership takes place, is a common practice and an “open secret” in the local financial system, according to industry insiders.

Speaking to the Inquirer, banking and financial industry officials said that the practice is known to regulators who frown on the activity, but generally look the other way when the amounts are “not big enough to be noticed.”

“A lot of banks do this,” said a treasury official from a universal bank who requested anonymity because of the sensitive nature of the issue. “Everyone knows it’s illegal, but no one seems to mind. The problem with DBP was that the volume was huge.”

He was referring to the P14.3 billion in wash sales of Development Bank of the Philippines from January to March 2014.

The Commission on Audit was alerted to the sales, which it described to be unsafe and unsound banking practices.

Totaling 28 transactions, the sales were all made with a single counterparty, First Metro Investment Corp. (FMIC), the investment banking unit of the Metrobank group.

DBP’s government securities were sold to FMIC and bought back on the same day at the same price, but resulting in a P717-million loss for the government bank at the end of the scheme.

“All banks do wash trades. It doesn’t happen everyday, but it happens,” said another bank treasurer, who also requested anonymity. “Pero garapal ‘yung sa DBP, kaya napansin (DBP’s trades were too big to be ignored). It was poorly executed.”

The treasurer said banks carry out wash sales to either hide paper losses or inflate paper gains temporarily, or to show increased trading volume and raise their financial institutions’ ranking in the league tables compiled by the local bond exchange.

Because of this, many wash trades are executed toward the end of reporting periods, like the end of the month or the end of a quarter.

“Some do it to massage their books, some do it for bragging rights [of showing large trading volumes],” the treasurer explained.

Wash sales have, however, the effect of distorting market dynamics, affecting the prices of securities and the volumes being “mapped” (or monitored) on the trading platform of the Philippine Dealing and Exchange Corp. bond bourse.

Because of this, wash sales are expressly prohibited by the Securities Regulation Code.

In the case of DBP, the treasurer said the bank could have just opted to sell their money-losing portfolio of government securities outright, and “biting the bullet” on the P717-million loss, without having to execute the prohibited securities buybacks which was questioned by auditors.

“Or they could have simply approached the Bangko Sentral ng Pilipinas to admit that they were being saddled with all these floating losses, and asked the regulators to allow them to reclassify these bonds from their trading account to their long-term investment account (where mark-to-market losses are not recognized),” the treasurer explained.

“That transfer is allowed, and they wouldn’t even have to be penalized, as long as they ‘confess’ and promise not to do it again.”