Insider Trading On The Universe

Here are some things that are happening:

– Oooh correlation is one oooh.

– The SEC has proposed rules that would ban banks from “betting against” securitizations that they create for one year after marketing them, a sort of anti-Abacus rule.

– The SEC is also investigating whether people traded on inside information ahead of the S&P’s downgrade of the U.S. Amusingly:

It isn’t clear if securities regulators also are looking at trading of U.S. Treasurys. Inside information might not have been a blessing with these securities. Investors who bet against U.S. government debt suffered losses immediately after S&P’s downgrade because rattled stock investors retreated into Treasurys as a safe haven. Such losses wouldn’t be a defense against accusations of insider trading, lawyers said.

– Raj Rajaratnam may be going to jail for a million billion years for talking to some people about some stuff and then buying and selling some stocks. The Times is seeing him off with this bizarre quote:

The question is whether such a sentence — longer than the average federal prison term for murder — is appropriate. “Given the magnitude of the crimes, it’s hard to feel any pity for him,” said Harlan J. Protass, a defense lawyer …

These things seem puzzling – with the puzzle being, what do we want out of our capital markets?

Some smart people believe that insider trading should be legal and find it puzzling that our legal system considers it worse than murder. But if you are going to make insider trading a crime, you probably do so on some sort of theory of fairness: the little guy reading 10Ks and watching Jim Cramer should have just as good a chance of making money as the big mustachioed guy who gets calls from corporate directors as soon as they get out of board meetings. This is kind of a nutty theory but we seem to like it. It may be related to our theory that all Americans should have the same opportunity to invest their own retirement funds or make their own decisions about future healthcare needs.

But that theory gets murkier when you talk about shorting broad indices because you think that someone is going to say something negative about USTs which, by the way, will go up on the news. Here there’s no “real” corporate event that will make earnings go up or down – there’s just a self-interested, conflicted, quasi-competent market participant saying some words about a debt issuer, which apparently people used to make money trading securities of different issuers.

Similarly, the public perception of the anti-Abacus rule is kind of hard to argue against – OMG, you BUILT A SECURITY TO FAIL, then you BET AGAINST IT – but the reasoning is sort of puzzling to me. Let’s grant that banks shouldn’t be able to stuff a CDO with mortgages chosen for their poor underwriting and general dodginess, sell them to clients, and buy naked protection on them. But what if you built a securitization of, like, every subprime mortgage? Or maybe only the top 10% best-underwritten subprime mortgages? And then you bet against it – because you believed that all subprime mortgages were going to get whacked by house price declines and rising unemployment? That would have been more or less a winning strategy.

Is that a conflict of interest? Well, yeah, sure. You had clients who bought something on macro thesis X (no one bought Abacus because they especially liked the underwriting of its loans), and you sold it/bought protection on it based on macro thesis Opposite Of X. If you were their fiduciary they’d be all “WTF, you told me macro thesis X, and you didn’t believe it?” But you’re not. You’re just selling stuff. They can take their own counsel on the world economy. It’s no different than betting that gold or the Swiss franc or interest rates will go up, or down. Some people will take the other side, and that’s their business. You may have better insights than them – in hindsight, I guess, someone will always turn out to have had better insights – but it’s hard to imagine how you could be an insider on a macro bet. Or why your conflict of interest – your taking the opposite position from your customers on a macro question – should prevent you from making the trade.

I worry that the regulatory-and-political response to the financial crisis too easily conflates the micro and the macro – and that the everything-is-correlated effect makes it easier to do that. The packaging of Abacus seems to have been shady – investors were apparently misled about the roles of Paulson and others in picking mortgages to put into the CDO, and those mortgages seem to have been cleverly selected for dodginess – but basically the long investors in that trade lost money because the mortgage market went to shit, not because of the selection of the loans. People made money after the S&P downgrade not because the S&P is correct about the declining credit quality of Treasuries – it would be weird if that were true since rates went down on the downgrade – but because there continues to be a lot of uncertainty in the global economy and the S&P downgrade was one small symptom of that.

Banning “betting against clients” and investigating “insider trading” on the S&P downgrade suggests a mindset that no one should have an unfair advantage not only in corporate/earnings/M&A news, but also in having macro knowledge about the universe. And that seems like a hard thing to regulate.

And poor Raj. He seems to have made money mostly by doing a lot of research and making good bets on stocks. Some of that research – his lawyers say less than 1% – involved calling up directors and saying “hey, got any inside information for me?” So, not good. But in an all-correlations-to-one world, anyone arrested for garden-variety shenanigans like that becomes a symbol of Wall Street Evil and you-stole-grandma’s-house. Which is not great for sentencing.

85 comments (hidden to protect delicate sensibilities)
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Comments (85)

  1. Posted by HAM05 | September 20, 2011 at 12:51 PM

    may have missed the take-away of the post, but that tubby tiger makes me smile – look how happy he is!

  2. Posted by pazzo83 | September 20, 2011 at 1:01 PM

    best-underwritten subprime mortgages : subprime mortgages :: curvy woman : fat chick

  3. Posted by NowOnePerson | September 20, 2011 at 1:03 PM

    I was getting prepared to answer the question: "what do we want from our capital markets?"… shoulda known that there was a 32-paragraph answer to the question waiting on the other side of that link. Ooooh Tricked me ooooh!

    -Guy who's now going to go back and read it all because he secretly enjoys these posts, despite his poking fun at Matt.

  4. Posted by Paycheck update | September 20, 2011 at 1:05 PM

    You don't work for Goldman any more, Matt.

  5. Posted by spanishmoon | September 20, 2011 at 1:12 PM

    Matt – you seem like a nice kid. But now, a few facts:

    1) Raj ran a criminal enterprise.

    2) He was never any good – he got his start in the business front-running customer orders (including mine) on the Needham desk to build his track record and continued his criminal ways at Galleon.

    3) He got caught on about 1% of the crimes he committed, not vice-versa as you suggest.

    4) We are all going to lose our jobs in this industry unless it cleans up its act.

    Sorry to be a buzzkill…but we need to keep it real as most of us face no bonuses this year and the certainty of many of our friends losing their jobs this winter.

    Your sympathy for this fat, criminal fuck is grossly misplaced.

    The judge should give him 10 extra years for that shirt alone.

  6. Posted by NYRebel2003 | September 20, 2011 at 1:15 PM

    "The judge should give him 10 extra years for that shirt alone. "

    best line ever

  7. Posted by PMCO_sucks | September 20, 2011 at 1:22 PM

    This was a seriously good post.

    -beginning to question why I dismissed all of the other TMLDR posts / examining motives

  8. Posted by SEC | September 20, 2011 at 1:24 PM


    You seem to have a slight obsession with insider trading. Got something to share???

  9. Posted by Guest | September 20, 2011 at 1:25 PM

    Matt just likes to drink Raj's curry. What's wrong with that?

  10. Posted by pazzo83 | September 20, 2011 at 1:30 PM

    But what about his legitimate years?

  11. Posted by PermaGuestII | September 20, 2011 at 1:36 PM

    He ate them.

  12. Posted by Hm. | September 20, 2011 at 1:38 PM

    Add 5 more years for having your pinky extended while drinking.

  13. Posted by Roomy Khan | September 20, 2011 at 1:39 PM

    Rajratnam & Wollensky

  14. Posted by C. Gasparino | September 20, 2011 at 1:40 PM

    I buy extra-small naked protection.

  15. Posted by Steve C | September 20, 2011 at 1:54 PM

    Killing it spanishmoon, good work.

  16. Posted by trojan_ | September 20, 2011 at 1:57 PM

    not just his pinky…

  17. Posted by Guest | September 20, 2011 at 2:00 PM

    Wait, when did EP come back?

    -guy who actually likes these posts and is mostly kidding

  18. Posted by CurrencyTrader | September 20, 2011 at 2:00 PM

    Well fucking played SpanishMoon. I think it moved after seeing your post, but then I scrolled up again and saw Raj and it went down again, but then I saw this post again, then I saw raj. It's like one of those whacky inflatable tube men.

  19. Posted by Gary Cohn | September 20, 2011 at 2:03 PM

    It takes a GS alumnus to use a blatant insider trader case to defend GS' most profitable, slightly unethical sell-side venture of screwing the customer.

  20. Posted by Lazy Fare | September 20, 2011 at 2:04 PM

    I miss the takeaway on most of Matt's posts.

  21. Posted by Guest | September 20, 2011 at 2:09 PM

    Horchata just shot out of my nose.

  22. Posted by early_hominid | September 20, 2011 at 2:13 PM

    Plus campaign season's coming up. Timberwolf may have been one shitty deal, but it might smell pretty sweet next to what Washington can come up with in an election year.

  23. Posted by Nailz6 | September 20, 2011 at 2:23 PM

    Amen. This game shouldn't be rigged. Raj puts to shame all of the legitimate and superb managers who bust their ass doing research to add value. Not mention making a fool out of individual investors.

  24. Posted by UBS Sucks Guy | September 20, 2011 at 2:27 PM

    The operative word is "WAS"

    Look how happy her WAS.

    Fixed it.

    Oh, and UBS Sucks!

  25. Posted by UBS Sucks Guy | September 20, 2011 at 2:30 PM

    If only you knew …

  26. Posted by Real_AltEST | September 20, 2011 at 2:32 PM

    Definitely weak, but I have a feeling that if we do enough of it we'll be okay.

  27. Posted by winning! | September 20, 2011 at 2:34 PM

    So, if I hire those lawyers, and 99% of my trades make -0.1% combined, but ~1% of them make 50-500%, and they're the largest trades in my book, it's all okay? Suh-weet.

  28. Posted by NowOnePerson | September 20, 2011 at 2:36 PM

    a little teeny-weeny mini inflatable tube man?

  29. Posted by The Wolf | September 20, 2011 at 2:38 PM

    Matt, please go look up a few of Bess's posts. Now make your posts look like hers so they can actually be readable. Ugh!

    Bravo on the comment authors!!!!! You guys save Matt's ass on each and every post!

  30. Posted by Cilantro Fund | September 20, 2011 at 3:19 PM

    I applaud your use (and spelling) of the word "mustachioed"

    Bravo, Matt, indeed

  31. Posted by Line Adjudimacator | September 20, 2011 at 3:24 PM

    I beg to differ. Best line ever was "I troll for ass at the Penn Station Taco Bell."

  32. Posted by Guest | September 20, 2011 at 3:29 PM

    Did you just compare being upset about buying Abacus to taking a bad currency position? That's sort of like blaming the convenience store guy for selling me cigarettes even though he's pretty sure they are bad for me, right? Well except for this particular shop keep put cyanide in the cigarettes, grossly overpaid someone to lie and say they not only aren't bad for you but certainly don't contain any cyanide, took a life insurance policy out on me and waited for me to die. All I wanted was to make friends outside bars but serves me right for not having the right macro hypothesis.

  33. Posted by kenny_lingus | September 20, 2011 at 3:52 PM

    You mean those legitimate and superb managers who cannot outperform random dart-throwers by any statistically significant measure?

    The "legitimate" research sub-industry is just part of the long con of financial services.

  34. Posted by Touch Base Later | September 20, 2011 at 3:56 PM

    Is Raj resting the wine glass on his stomach? I need to learn to do that.

  35. Posted by Put_Option | September 20, 2011 at 4:13 PM

    Agreed. Raj is the type of manager who would scold equity research analysts if they had a lower EPS for a company in which Galleon was long. Definitely the type of guy that would send a cooked model to the analyst with the looming threat of 'accept my model or find a new customer'. Completely corrupt buy-side mentality.

    Those 'gray' areas of insider trading are amazingly shady.

    Even more amazing is the claim from his investors that they knew nothing about Galleon's red flags nor insider trading. Well, I guess I could see that because his investors/sales were far from smart or sophisticated; Banque Privee Edmond de Rothschild, Peter Peterson, Blackstone co-founder, Jeffrey Vinik, former manager of Fidelity Magellan mutual fund. Talk about total amateurs.

    But I digress. Send this turd away.

  36. Posted by FLOTUS | September 20, 2011 at 4:17 PM

    I wish Barry would smoke some of those cigarettes…talk about getting your 'macro' views wrong.

  37. Posted by yawn | September 20, 2011 at 4:27 PM

    what happened to EP, after she ran off to zerohedge things kind of tapered of

  38. Posted by kenny_lingus | September 20, 2011 at 4:42 PM

    +26 (and counting) for pointing out a witticism. We're all lemmings.

  39. Posted by veleno | September 20, 2011 at 4:56 PM

    I would send all the bond traders on wall street to jail for what they did with CDOs and CMOs before I send Raj for what he did, which really did not hurt anyone. And you want to send him to jail for 20 years? When murders and rapists get less? GIve me a break!

    Let me tell you, spanishmoon, if you work in the financial industry, the fact that you don't make a bonus this year pleases me to no end. You should not have made a bonus for the past 10 years!

  40. Posted by MeVC | September 20, 2011 at 9:35 PM

    100% on target. Only reason this ass-hat gets any sympathy is that the Feds were not able to go back far enough (mid 90's) to show/prove the other 99% of his crimes. Back then it was more than just talking to directors on the board, anyone was fair game.

  41. Posted by Citicorp Shareholder | September 20, 2011 at 10:00 PM

    I suggest that you save your posting. Then, ten or so years from now, when you have grown up, and gotten your head out of your ass, re-read it. Your next step should be to apologize to the entire world for your having been such a douchebag.

  42. Posted by Rajaratnam V | September 21, 2011 at 12:19 AM

    one more thing… he became fat in the late 90's when things were going well..

  43. Posted by Special guest | September 21, 2011 at 11:13 AM

    I swear I'm going to crush whoever snapped that fucking picture.


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