January 24, 2012
So, here we go again. YAWN.
On January 18, 2012, the Securities and Exchange Commission ("SEC") and the The U.S. Attorney for the Southern District of New York announced civil and criminal charges involving multi-billion dollar hedge fund advisory firms, fund managers and analysts who allegedly engaged in a multi-million dollar insider trading scheme based upon nonpublic information involving Dell and Nvidia Corporation.
Is it just me or isn't this deja vu all over again?
The picture painted by the prosecutors and regulators is one of a network of traders and analysts determined to get the inside dope before the rest of us, and to handsomely profit from their unfair advantage. Oh my, there are fraudsters and crooks on Wall Street. Now, there's a big revelation!
SIDE BAR: To read the details of the SEC and the US Attorney's charges, see:
Khuzami's January 18th Speech
On January 18, 2012, Robert Khuzami, the SEC's Director of Enforcement, gave a speech during a news conference announcing the insider trading case. Among his remarks, Khuzami noted that:
[O]nce again, so-called white collar professionals who enjoy so many advantages break the law in a likely craving for more money, more celebrity, and the mirage of success.
Once again, so-called white-collar professionals who should know better disregard the most basic wisdom that we teach our children - to do right and not wrong.
Once again, in a new year, I find myself here alongside our criminal law enforcement partners announcing new but troublingly familiar charges of insider trading by hedge fund firms, fund managers, and analysts.
Aside from the hyperbole, at least Khuzami gets it right when he characterizes this latest Wall Street expose as involving "new but troublingly familiar charges." Why then, the need for another new but troubling familiar press release, press conference, and speech?
Khuzami views this latest insider trading case as more important, more dramatic than prior cases. Ah, yes, sure it is, of course - but didn't Khuzami and his predecessors also tell us that those prior cases were more important and more dramatic than those that came before? In advancing his thesis about the historic nature of the latest crop of insider trading cases, Khuzami asks:
Why is this action so significant?
First, today's action lays bare an organized network of analysts and fund traders who set up and used a corrupt network to obtain insider information.
This is very different from - and far more disturbing than - cases where we see opportunistic trading by someone who happens to come into possession of valuable inside information, such as a once-in-a-lifetime takeover of other extraordinary corporate announcement, and succumbs to the temptation of illegal profits.
Rather, this involves professionals who illegally obtain routine business information, such as quarterly earnings and profit margin estimates. . .
. . .
This is systemic dishonesty, and it exposes a deeply embedded level of corruption.
The Wall Street Mob
Lemme see if I got all of that. This is both an organized and a corrupt network. Impressive, truly. As in the mob being organized crime, right? Nice imagery. Then there's the refrain about systemic dishonesty and deeply embedded corruption. Also a nice word picture. Unfortunately, the good SEC Enforcement honcho doesn't quite seem to go for the jugular. What's delivered comes off more like a pulled punch. After all, Khuzami seems determined to present himself as a fair man and unbiased regulator. He reassures us that not all hedge funds are inherently evil:
There is nothing wrong with hedge funds, which can and do provide valuable services for clients and liquidity for markets.
But hedge funds are also characterized by a lack of transparency in trading practices, market power that can give them influence over those who possess insider information, access to leverage and enormous amounts of capital, and the techniques to trade extremely quickly.
On the one hand, Khuzami warns us about how pernicious these defendants are and how the problems afflicting the hedge fund industry are systemic and deeply seeded, but, on the other hand, the hedge funds can help mankind realize its greatest aspirations. Yeah, I know, I'm overstating it. Regardless, it strikes me as extolling the potential terror of a nuclear bomb but then acknowledging that if you don't arm the device it can't go off. The moral hazard of such comments are frightening.
SIDE BAR: In attacking United States District Court Judge Rakoff's recent rejection of the SEC's proposed $285 Million settlement with Citigroup, Khuzami offered what I viewed as an inconsistent rationale:
Last month, a federal district court declined to approve a consent judgment because, in its view, the underlying allegations were ‘unsupported by any proven or acknowledged facts.' As a result, the court rejected a $285 million settlement between the SEC and Citigroup that reasonably reflected the relief the SEC would likely have obtained if it prevailed at trial. . .
We believe the court was incorrect in requiring an admission of facts . . .
SEC Enforcement Director's Statement on Citigroup Case (SEC Press Release, December 15, 2011).
According to Khuzami, Judge Rakoff's rejection was wrong because the settlement reasonably reflected the likely outcome of a winning trial where, unless I'm misunderstanding something fairly basic, the SEC's charges would have been sustained as proven. And the difference between a guilty verdict by trial and one by admission as part of a settlement is what exactly? Oh, yeah, Khuzami argues that as long as the SEC gets the same bucks from a settlement as in winning a trial, why bother requiring an admission of guilt.
Consequently, Khuzami complains that there is no sound legal basis for requiring Citigroup to admit wrongdoing as part of over a quarter of a billion dollar settlement because if the SEC went to trial and won, Citigroup would likely have been ordered to pay the same dollars by the Court and would have been found guilty of the charges that Khuzami does not believe the too-big-to-fail organization should be required to admit as part of the settlement. Say what? Am I the only one struck by the circular logic? By that same line of reasoning, why don't we simply let the Mafia capos reimburse the government for their ill-gotten gains from the drug trade and just call it even? After all, it's such a pain having to take another generation of Gottis into court and keep trying to get a guilty verdict. Why not just let ‘em write out a check?
The Regulatory Chameleon
Khuzami comes off as quite the regulatory chameleon. He warns us about the dangers of organized corruption on Wall Street. He trumpets how each successive case exposes even worse industry crimes and frauds. He tells us that these ills are systemic, pandemic, and in need of aggressive response. When it comes to pounding out tough settlements to root out this deeply embedded problems, however, Khuzami would frequently draw the line: Let's not get silly here and demand the big bucks and that oh-so painful admission of guilt.
As with far too many Wall Street regulators, Khuzami advocates the expediency of allowing the wealthy to write out checks for their misdeeds as a form of penance - never quite grasping the fundamental point of Judge Rakoff's objection, or of mine, or of so many other Wall Street reformists:These settlements not only fuel the cost-benefits analysis that prompt fraud but they have proven ineffective as a deterrence.
Integrity and the Level Playing Field
In summing up during his January 28, 2012, speech, Khuzami affirmed my worst fears with this comment about the current hedge-fund insider-trading scandal:
These characteristics, if put to use for illicit purposes, present a grave threat to the integrity of the markets and the level playing field that is the foundation for those markets.
A grave threat to the integrity of the markets and the level playing field that is the foundation for those markets?
Respectfully, what Wall Street has Enforcement Director Khuzami been regulating the past few years? Is it truly his contention that there exist meaningful market integrity? Does Khuzami truly believe that Wall Street is a level playing field? I would commend to Khuzami's consideration one of my favorite George Bernard Shaw quotes: The love of fairplay is a spectator's virtue, not a principal's.
Watch a professional soccer game. You ever notice how a player seems crippled for life by a phantom trip and miraculously recovers when the penalty is called?
Watch a professional baseball game. You ever notice how an outfielder pretends to have cleanly caught the ball when he knows he one-hopped it?
Watch a professional football game. You ever see linebacker intentionally drive his helmet into the quarterback's chin long after the ball was thrown?
Watch a professional basketball game. You ever see one player "accidentally" elbow another in the face when contesting a rebound?
One of the quirks of human nature is that many athletes want to win at all costs, even if it means cheating. What other explanation is there for using corked bats or taking banned steroids?
To some extent, Wall Street is just another sports venue where professionals play a game from the opening to the closing bell and will do whatever it takes to win. Just as the famed New York Yankee pitcher Lefty Gomez said that "I'd rather be lucky than good," the maxim on Wall Street seems to be that "I'd rather book a profit than be honest." The truth, the sad truth, folks, is that there is little integrity in the markets and the only thing on the level on Wall Street is the water in the toilet bowls.
Which is not to say that an honest trader can't make money in a rigged market. Which is not to say that everyone on Wall Street is a cheat. But it is to say that those who know better - for example, regulators like Khuzami - should stop pretending that Wall Street is afflicted with only a handful of crooks and that our markets are paragons of virtue.
The pros in the pits and at the trading desks throw sharp elbows and will stomp on you when you're down. It's a game played dirty and for keeps. You think that you can go up against the big boys at Goldman Sachs, JP Morgan, Berkshire, or any number of hedge funds? Hey, good luck with that. This ain't amateur hour. The motto of Wall Street always has been and always should be "Caveat Emptor."
When you step onto the playing field that's Wall Street, watch your back, put your mouthpiece in, and don't expect the refs to protect you.