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Post Insider Trading and Other Wall Street Frauds
Created by John Eipper on 02/11/14 9:21 AM

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Insider Trading and Other Wall Street Frauds (Tor Guimaraes, USA, 02/11/14 9:21 am)

There is no doubt in my mind about Ric Mauricio and John Eipper's negative statements regarding the character of Wall Street in general. (See Ric's post of 5 February.) Also it is also true that we have some honest professionals getting swept away by a crooked system. Some years ago I was fascinated by the question of Wall Street corruption, the variety of ways they use to separated the greedy, the naïve, and the innocent from their money. I kept track of the variety and depth of Wall Street corruption and was amazed at what I named "very well organized crime," where the criminals are so smooth and competent that they don't have to break the law to rob the unaware until it is too late. My folders documenting specific cases of Wall Street fraud, deceit, etc., are so full I stopped collecting them. Among the many general lessons learned, let's just mention three:

1. The government controlled the banking system extremely well until the last huge financial crisis. While the Fed giving preferential treatment to the few big banks seems very unfair, it is widely known. Other than that, banking regulations and the FDIC protect the American people very well. In the stock market and the institutions comprising it, they control themselves. The entire system is designed and implemented to limit their risk and increase their reward. Starting with commissions, brokers get paid whether their customers make money or lose; ending with analyst misinformation and other "pump and dump" schemes.

2. The banking system deals on this commodity called cash; thus all the transactions are watched very closely, and there are relatively few opportunities for fraud and corruption in the system. In the stock market they deal in these things called stock shares, whose value depends on buyers' perceptions of each company's worth, and expected future earnings. There is a huge opportunity for inflating and crashing the perceived worth of a company or even the stock market as a whole. There is the domain of the piranhas, sharks, and barracudas inhabiting the Wall Street world.

3. John Eipper had a question: "How can we be sure the big-time analysts don't profit from their ratings actions?" There is no guarantee, and they do it all the time. Don't ever bet the farm on any analyst opinion. JE continued, "Specifically, when a firm lowers a stock from 'buy'/'long' to 'hold'/'neutral,' the price will fall a few percentage points; an upgrade moves the price in the opposite direction. I understand that rules exist against insider trading, but what prevents Analyst X from calling her brother-in-law 24 hours before an upgrade or downgrade, who then lets his neighbor in on the Big Tip, with everyone divvying up the profits?"

Insider trading happens all the time: analysts on the know may tip their grandmas, a company CEO may buy/sell his company shares based on extremely accurate inside information, crooks may set up a wide variety of systematic schemes to forecast share movement and get ahead of the market by a few seconds up to a few months. The regulators monitor the market transactions, looking for suspicious activities (huge buys/sells just before shares rise/fall). Then they try to explain how/why did the buys/sells occur. If they can make a case for system corruption, then the lawyers go to work. The rest is history. Was Martha Stewart a crook or a victim? Who knows what really went on? She must have done something wrong; otherwise her lawyers would have saved her.

JE comments: I suppose the regulators have sophisticated computer algorithms to sniff out the largest and shadiest trades, but what about using insider info to pocket a few thousand here and there?  To my mind, these schemes would be nearly impossible to detect. 

Brokerage veteran Ric Mauricio has also sent a follow-up comment on insider trading. Stay tuned.

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