STOCK MARKET WATCH -- Friday, 12 December 2014

[Demeter]

33. Bill Black: Second Circuit Decision Effectively Legalizes Insider Trading

http://www.nakedcapitalism.com/2014/12/bill-black-second-circuit-decision-effectively-legalizes-insider-trading.html?utm_source=feedburner&utm_medium=email&utm_campaign=Feed%3A+NakedCapitalism+%28naked+capitalism%29

YVES ON THE RULING:

What does this mean in practical terms? The court has just provided a very-easy-to-satisfy roadmap for engaging in insider trading legally. Don’t give the person who gave you the choice tidbit any explicit payoff. You can give him all sorts of buttering up before hand (fancy meals, hot women, illicit substances, box seats, whatever you think will induce cooperation and show your seriousness and ability to pay) and just engage in vague winks and nods. As long as you don’t pay the tipster for the trade in any crass or traceable way (and no communications that point to an explicit payoff), you are good to go. Compensation down the road, in hard dollar or soft forms is perfectly kosher.

Needless to say, the implications are terrible. Thanks to high frequency trading, way way too cozy a relationship between the Fed and its preferred banks, and years of suspicious trading patterns (markets too consistently not breaching technically significant price levels, with the trading looking decidedly not organic) has sapped the faith of retail and even smaller institutional investors in the integrity of markets. The Second Circuit has just announced open season on pervasive misuse of inside information.

And this decision pretty much puts the SEC out of the enforcement business, unless the agency gins up the nerve and skills to take on targets other than insider trading. The SEC had pretty much retreated to pursuing only insider trading cases; to the extent it does anything else, its policy is to (at most) file a claim and negotiate a settlement. But its targets know that the agency’s reluctance and presumed inability to go further makes it a paper tiger. That in turn leads to the widely ridiculed “virtually no admission of facts” settlements, which leaves courts (when asked to approve settlements) and the public in the dark as to whether the punishments were remotely adequate. It also deprives private plaintiffs to leverage the government case to seek restitution. Oh, there may be some remarkably stupid crooks who didn’t get the Second Circuit memo and will be fair game for the agency. But they are likely to be few in number and penny-ante in the scale of their activity.

BILL BLACK'S TURN:

We know that insider trading is an activity in which cheaters prosper. We know that Wall Street and the City of London are dominated by a fraudulent culture and we know that firm culture is set by the officers that control the firm. We know that the Department of Justice (DOJ) has allowed that to occur by refusing to prosecute any of the thousands of senior bank officers who became wealthy by leading the three most destructive financial fraud epidemics (appraisals, “liar’s” loans, and fraudulent sales of these fraudulently originated mortgages to the secondary market) in history. No one is surprised that Wall Street’s elites have also engaged in widespread efforts to rig the stock markets so that they can shoot fish in the barrel through insider trading. Unlike the three fraud epidemics, one DOJ office, the Southern District of New York, has brought a series of criminal prosecutions against these officers.

Wall Street’s court of appeals (the Second Circuit) has just issued an opinion not simply overturning guilty verdicts but making it impossible to retry the elite Wall Street defendants that grew wealthy through trading on insider information. Indeed, the opinion reads like a roadmap (or a script) that every corrupt Wall Street elite can follow to create a cynical system of cutouts (ala SAC) that will allow the most senior elites to profit by trading on insider information as a matter of routine with total impunity. The Second Circuit decision makes any moderately sophisticated insider trading scheme that uses cutouts to protect the elite traders a perfect crime. It is a perfect crime because (1) it is guaranteed to make the elite traders who trades on the basis of what he knows is secret, insider information wealthy absent successful prosecutions and (2) using the Second Circuit’s decision as a fraud roadmap, an elite trader can arrange the scheme with total impunity from the criminal laws. The Second Circuit ruling appears to make the financial version of “don’t ask; don’t tell” a complete defense to insider trading prosecutions. The Second Circuit does not simply make it harder to prosecute – they make it impossible to prosecute sophisticated insider fraud schemes in which the elites use junior cutouts to create (totally implausible) deniability....

Wall Street’s most recent effort to rig the markets through insider trading is far larger and more audacious than any prior effort, including those by Michael Milken and Boesky. Wall Street elites sought to institutionalize the corruption of officers of a wide range of publicly traded corporations. The goal was to gain a corrupt advantage over honest investors in trillions of dollars in securities trades.

The Second Circuit decision admits that the prosecutors presented evidence established a massive conspiracy designed to allow Wall Street elites to profit by engaging in insider trading, a conspiracy that greatly enriched the defendants that were convicted in the case under appeal.

At trial, the Government presented evidence that a group of financial analysts exchanged information they obtained from company insiders, both directly and more often indirectly. Specifically, the Government alleged that these analysts received information from insiders at Dell and NVIDIA disclosing those companies’ earnings numbers before they were publicly released in Dell’s May 2008 and August 2008 earnings announcements and NVIDIA’s May 2008 earnings announcement. These analysts then passed the inside information to their portfolio managers, including Newman and Chiasson, who, in turn, executed trades in Dell and NVIDIA stock, earning approximately $4 million and $68 million, respectively, in profits for their respective funds.

The Second Circuit was not distressed that senior Wall Street officials received information that was clearly insider information that they knew they should not have access to. The insider information they were provided was the crown jewels – two major corporations’ soon to be announced “numbers” – at least one of which was sure to be a major surprise to the markets. A senior trader that knows “the number” in advance, particularly when he knows that the number will be a surprise, can shoot fish in a small barrel with a large shotgun. The insider information allows the senior trader to reduce the risk of loss to trivial levels while increasing the probability of gain to near certainty. The trader makes a fortune by cheating, not through any unusual skill. The senior trader knows that no employee of any publicly traded corporation is permitted to release such secret and proprietary insider information to investors.

The Second Circuit was not distressed that the senior Wall Street officials did not react to being provided what was clearly insider information by demanding to know how their analysts got the information and instructing them that their actions violated the firms’ ethical standards and would lead to their termination if it were ever repeated. The firm’s ethics manuals banned the senior traders from trading on the basis of insider information. Instead, of serving as ethical leaders in training the analysts not to engage in such behavior and instead of following their firm’s ban on trading on the basis of insider information, the senior officers engaged in a cynical financial version of “don’t ask; don’t tell.” The analysts and the senior officials that traded on the inside information understood the wisdom of the old line “ask me no questions and I’ll tell you know lies.” The senior officers proceeded to profit by exploiting this advantage over honest investors while minimizing the risk of a successful prosecution not by being ethical, but by consciously maintaining (not remotely) “plausible deniability.”

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The three judges on the panel were appointed by Presidents Reagan and Bush II. The opinion does not contain even a perfunctory statement of regret that it creates a path to the perfect crime and the further corruption of Wall Street at the expense of honest traders and investors.

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The Second Circuit forbade any retrial. Worse, the Second Circuit appears to be declaring that even a modestly sophisticated use of cutouts by elite traders using insider information creates the perfect crime. They will be made wealthy by the “sure thing” of insider trading and no future prosecutor will be permitted to even prosecute such a perfect crime.


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