Ringleader Of Insider-Trading “Fight Club” Didn’t Want Any Sarcastic Comments With His Inside InformationBy Matt Levine
I suppose in like 1985 there were people who worked on Wall Street and un-self-consciously ate cheeseburgers for breakfast, got shoeshines at their desks, went to strip clubs every night, and slammed down their phones hard enough to break them, but my assumption is that in 2013 any remaining “stereotypical Wall Street behavior” is mediated through popular culture. Some people go into finance with the goal of having a memoir that reads exactly like Liar’s Poker,1 and no one wears contrast-collar shirts because they look good. You wear them – if you do (do you?) – because you saw them in that movie.
In 2009, Tortora e-mailed a group that included Abbasi and Adondakis: “Rule number one about email list, there is no email list, fight club reference. Rule number two, only data points can be sent, no sarcastic comments. Enjoy. Your performance will now go up by 100 percent in 09 and your boss will love you. Game theory, look it up.”
Look it up, yo. That’s also from Bryan Burrough and Bethany McLean’s amazing Vanity Fair article on the endless pursuit of Steve Cohen, and while the fact that Tortora and his crew of cheeseballs called themselves “Fight Club” has been reported before, the fact that Tortora had to remind them of it BY SAYING “FIGHT CLUB REFERENCE” AFTER HIS FIGHT CLUB REFERENCES is new to me and makes me ashamed to be a human.
Why did these tools insider trade? You can’t dismiss out of hand the possibility “because they were tools.” “Blue Horseshoe loves Annacott Steel,” they probably snickered to each other at their data smackdowns. Having a secret stupid club, especially one imbued with genuine risk, can be fun in itself.
But Burrough and McLean are mostly interested in exploring other explanations for why so many analysts at SAC, and at spin-off hedge funds run by SAC alumni, have been caught insider trading. They focus on, for instance, the pressure at SAC, described in appropriately Wall-Street-stereotype ways:
SAC is a notoriously cutthroat environment; those who don’t perform don’t last. … [W]hen asked in the deposition what the threshold for a good idea was, Cohen responded, “You don’t want to hear an idea that you’re going to make 5 percent in a year on. I don’t think anyone would embarrass himself by bringing me an idea like that.”
And there is a structure in which portfolio managers recommend stocks to Cohen without explaining where they got their ideas, which serves to insulate upper management from the misdeeds of their underlings:
“Steve knows his business model protects him,” says the former SAC analyst. “There’s not a single hedge fund that hasn’t somewhere, sometime, gotten sketchy info. But this is different. You think Steve wants you to have inside information but doesn’t want to know you do. Why do it? Why did A-Rod take steroids? Because it’s worth it…. The payout is huge and you can get swayed. What would you do for, say, 20 percent of $276 million? You do stuff. You fucking do stuff. You can’t be in this job without navigating a gray line constantly.”
Burrough and McLean also imply pretty hard that SAC insider traded as a matter of course in the olden days, but changed course, or at least personnel, in the mid-2000s:
In the 1990s, SAC earned a reputation for pumping brokerages for advance notice of analyst recommendations, a rumor that was never proved. In the early 2000s it was known as a fund that hoovered up all available information on every conceivable stock, to the point where some of it crossed the line into illegal insider information, another suspicion that was never proved. In response Cohen beefed up SAC’s compliance department (its internal police) and began hiring a new breed of trader. The stereotypical Wall Street trader, the hard-charging, foulmouthed kid from Staten Island, began to disappear from SAC’s halls; in his place came Ph.D.’s from Harvard and Stanford, traders always referred to as “super-smart,” who took jobs at SAC over offers from Google or Microsoft.
Or from somewhere else? Coincidentally today I got a draft of a paper called “Low-Risk Investing Without Industry Bets”. It’s written by Cliff Asness, whose PhD is from Chicago, and two of his AQR employees, a Yale PhD and a Stanford PhD, and it’s about factor weightings and industry-neutral low-beta strategies and I’ll stop talking about it now.2
But that’s kind of how I imagine using your PhD at a hedge fund. You assume the market efficiency that was drummed into you in your PhD program,3 and you spend your days looking for small but exploitable anomalies within that basically efficient background. “I think this company will beat earnings this quarter” does not count as an anomaly, no matter where you heard it from, and “an idea that you’re going to make 5 percent in a year on” – of excess returns natch – is pretty good.
Here’s how Burrough and McLean describe tech-stock-picking:
The information sharing, it seems, was a way of life in the high-stakes world of trading technology stocks, which were evaluated not on whether the company was a good long-term investment but on whether it was going to please investors in a given quarter. “We came to the conclusion that that was the way they [people who traded technology stocks] did business,” says one person close to events. “They were doing it for so long that it became normal.”
“The line had been blurred,” says another hedge-fund executive. “It became extremely fast and furious, and all that mattered was who you were and what you knew.” He adds, “It was: What data points do you have? That was your Edge.”
High-stakes world! Fast! Furious! Edge with a capital E! What were the PhDs doing?
You hire authentic foulmouthed 1990s-vintage Staten Islanders and … I guess they make money on insider trading, or semi-insider trading, or getting lucky, or reading the tape or whatever stereotypical Wall Street traders do, I don’t know, whatever it is I’m sure it’s fast and furious. Certainly they don’t wear wires or email each other their insider trading ideas.
You replace the foulmouthed Staten Islanders with dorky PhDs hired to do the same job and what do you get? Maybe you get a more academic environment focused on legitimate fundamental research rather than favor trading. I suppose that’s the idea, and it’s a plausible one. Or maybe the dorky PhDs emulate their predecessors from the time when giants walked the earth and gestured with cigars. Maybe they even embellish a bit. They’ve seen the movies, they know what to do.
The Hunt for Steve Cohen [VF]
Earlier: Before They Were Wearing Wires And Trying To Get Each Other To Make Incriminating Statements Re: Securities Fraud, SAC Capital Employees Were Using Threesomes As A Front For Insider Trading
2. Here’s a sample:
We show that a betting against beta (BAB) strategy has delivered positive returns both as an industry-neutral bet within each industry and as a pure bet across industries. In fact, the industry-neutral BAB strategy has performed stronger than the BAB strategy that only bets across industries and it has delivered positive returns in each of 49 U.S. industries and in 61 of 70 global industries. Our findings are consistent with the leverage aversion theory for why low beta investing is effective.
3. “But my PhD is in physics and no one ever drummed EMH into me!” Well. And your model of stock prices is based on Brownian motion? Physics is even more EMH than finance.