Joe Duarte
05-14-2007, 09:43 AM
Everyone Has An Angle
This week will see significant attention being paid to the dark side of winning, the potential for, and the systematic use of cheating, as a means of achieving big time success.
Over the weekend, the New York Times reported billions of dollars worth of potential fraud involving Iraqi oil. No, this isn't a rehash of the Saddam Hussein-U.N. Food for Oil scandal, although that also made the news last week, when Chevron Texaco settled a case of kickbacks involving that still festering affair.
Next, defrocked Tour de France winner, American Floyd Landis will be taking part in a public hearing aimed at clearing his name.
Former Deputy Defense Secretary Paul Wolfowitz, widely known for his alleged steering of the U.S. into the war in Iraq based on false evidence provided by alleged Iranian double agent Ahmed Chalabi, is also in hot water, as news of his using his influence as head of the World Bank to provide a Wall Street style compensation package for his girlfriend, also a World Bank employee, is set for even more major prime time air play than it's been getting.
And last, but not least, is the Marketwatch.com story about "dark pools," the latest method in which big time Wall Street brokerage houses make secret deals away from the markets, in order to make trades that don't affect the price of large blocks of stock.
At the center of all of these situations are two major principles. First, there is the feeling amongst all who reach a certain position in life that they are above the rules that govern the rest of us. And second is the corollary, because they are above the rules, they are not going to get caught.
The truth is, that some of the time, these people do get caught. And when they do, there are scandals, and on occasion, these scandals have the potential to move the markets.
Such is the story of Wall Street's latest method of grinding out profits from institutional investors, and its questionable effects on the public at large.
Wall Street's Dark Secret
In a world that seems to have been drawn from the cloak and dagger motifs of graphic novels and summertime thrillers, a couple of phone calls can set up trades that move hundreds of millions of dollars worth of stock, without it registering on anyone's trading screens, other than those who make the deal.
This is Wall Street's latest advantage peddling to the big guys, at the expense of everyone else, and it's called the "dark pool."
According to Marketwatch.com: "dozens of new private trading networks that -- in just two years' time -- have ushered in a sea change that challenges Wall Street's top institutions while posing vexing questions for regulators and investors alike," are changing the trading game. These new quasi-exchanges, for lack of a better word, operate mostly in secret, and are definitely away from the public eye, raising questions about the way that traditional market analysis works, and answering questions about how unexplained price movements affect the prices of stocks on a daily basis.
Marketwatch paints a picture of emerging danger for individual investors, as "Driven by the boom in electronic trading and other technological advances, a range of upstart entrepreneurs now are doing the kind of bulk trading that up until a few years ago was practiced exclusively in upstairs trading rooms at big brokerages like Morgan Stanley and Lehman Brothers."
But don't feel sorry for the big guys, for a big number of the "dark pools" are owned and operated by the large investment banks, including Goldman Sachs, Merrill Lynch, Citigroup, and Bank of America, according to the report.
Furthermore, according to Marketwatch, 500 million shares of stock are exchanged in these "alternative" markets, with the number expected to rise significantly in the next few years.
So, why have these things popped up? It's simple. According to Marketwatch: "Without the easy access granted by dark pools, big institutions would have to move big orders through the market by calling a broker who would, in turn, send that market to the floor. As the information leaked -- first to the broker, then to the floor -- an investor's intentions were exposed. But in a dark pool, a big institutional investor like Fidelity Investments or New York Life can shop or put a buy order out for stock without alerting a regular broker.
In other words, the big guys want to beat the system, by sneaking their trades by as many people as possible, and by not being held responsible for their trading tactics, and the consequences of having made mistakes for buying and selling a dog.
Diplomatically, Marketwatch notes the following: "These markets are largely unregulated and because of the anonymity are open to abuse. They are, at times, inefficient. Critics say they run counter to the spirit of new market regulations by the Securities and Exchange Commission that require that investors get the best price available for their order."
In fact, what's happened is that the Wall Street money machine, which generates a big chunk from commissions, has figured out a new way to make money as "To many of those behind the dark pools -- entrepreneurs and tech heads who cut their teeth in jobs at electronic exchanges -- the nascent industry's rapid growth came out of necessity. The volatility of prices and whimsy of retail investors trading on the exchanges after the tech bubble burst left behind a changed landscape. Cutthroat competition from new, low-cost electronic markets erased already thin profit margins."
Hmmm- Let's see, a bubble, frothed up by Wall Street analysts who were on the payroll of companies like Worldcom to pump up share prices, and who were sharing research notes with the brokerage side of their companies while writing secret e-mails to their friends about how awful the dot-com losers they were pumping up, finally burst. The individual investor, badly burned, began to raise his game, and became a savvy trader.
That's bad, so the game has to be changed. Let's create some double secret trading floors, outside the regulators and the rules, and let's make some money.
The argument seems to be that institutions are often acting on behalf of individuals, as pension funds and mutual funds hold large amounts of individual investor cash.
But, the returns on these vehicles, especially mutual funds, have been downright awful, meaning that even though these behemoths may have had access to what is essentially off the books trading, it hasn't helped them very much.
Perhaps the most ironic of all aspects of this story, is that the SEC has had rules in place to govern "dark pools" since 1998, but many in the market are calling the rules "outdated," meaning that nobody really knows what's going on in this murky world.
In fact, according to Marketwatch, "the SEC didn't know how to regulate a market that looked like an exchange but wasn't an exchange. For instance, brokers trade on their networks but also act as police, creating a conflict. Hedge funds are controversial players. Some systems exclude them and when Liquidnet offered to include them to boost its market share in a competitive market, some existing customers threatened to pull out."
Furthermore: 'Different venues have different rules. Pipeline doesn't force clients out of the system altogether, according to founder Fred Federspiel. When a violation is found, Pipeline rebuilds the platform to prevent abuse. "We have had to kick a few people out until we got a fix deployed," he said.'
The consensus is that "dark pools" will never replace the open market. But significant questions are being raised, nevertheless.
Conclusion
Cheating is on the rise, and is on the minds of lots of people. Just do a Google search on the word, and you'll get 1,200,000 links.
Stories on students cheating on exams appear on a frequent basis, and scandals are revealed on a regular basis.
Are "dark pools" another venue for cheating? If there are rules at the SEC that govern such activities, then it's hard to peg the label of "cheating" on the practice of using "dark pools" as trading venues.
But, as Marketwatch's report illustrates, "dark pools" are "murky," and there is clearly some cheating that goes on within them, or participants wouldn't have to be "kicked out" from them, and algorithms wouldn't have to be rewritten in order to close loopholes.
What Marketwatch won't say, but we will, is that our society is now full of cheating. It goes on all the time, and is getting more frequent.
It is indeed becoming part of its fabric. And it will have significant consequences, today, tomorrow, and in the future.
And just as it did in 1999's dot-com bubble, we would expect that cheating will be a central cog in whatever brings down the current bull market.
This week will see significant attention being paid to the dark side of winning, the potential for, and the systematic use of cheating, as a means of achieving big time success.
Over the weekend, the New York Times reported billions of dollars worth of potential fraud involving Iraqi oil. No, this isn't a rehash of the Saddam Hussein-U.N. Food for Oil scandal, although that also made the news last week, when Chevron Texaco settled a case of kickbacks involving that still festering affair.
Next, defrocked Tour de France winner, American Floyd Landis will be taking part in a public hearing aimed at clearing his name.
Former Deputy Defense Secretary Paul Wolfowitz, widely known for his alleged steering of the U.S. into the war in Iraq based on false evidence provided by alleged Iranian double agent Ahmed Chalabi, is also in hot water, as news of his using his influence as head of the World Bank to provide a Wall Street style compensation package for his girlfriend, also a World Bank employee, is set for even more major prime time air play than it's been getting.
And last, but not least, is the Marketwatch.com story about "dark pools," the latest method in which big time Wall Street brokerage houses make secret deals away from the markets, in order to make trades that don't affect the price of large blocks of stock.
At the center of all of these situations are two major principles. First, there is the feeling amongst all who reach a certain position in life that they are above the rules that govern the rest of us. And second is the corollary, because they are above the rules, they are not going to get caught.
The truth is, that some of the time, these people do get caught. And when they do, there are scandals, and on occasion, these scandals have the potential to move the markets.
Such is the story of Wall Street's latest method of grinding out profits from institutional investors, and its questionable effects on the public at large.
Wall Street's Dark Secret
In a world that seems to have been drawn from the cloak and dagger motifs of graphic novels and summertime thrillers, a couple of phone calls can set up trades that move hundreds of millions of dollars worth of stock, without it registering on anyone's trading screens, other than those who make the deal.
This is Wall Street's latest advantage peddling to the big guys, at the expense of everyone else, and it's called the "dark pool."
According to Marketwatch.com: "dozens of new private trading networks that -- in just two years' time -- have ushered in a sea change that challenges Wall Street's top institutions while posing vexing questions for regulators and investors alike," are changing the trading game. These new quasi-exchanges, for lack of a better word, operate mostly in secret, and are definitely away from the public eye, raising questions about the way that traditional market analysis works, and answering questions about how unexplained price movements affect the prices of stocks on a daily basis.
Marketwatch paints a picture of emerging danger for individual investors, as "Driven by the boom in electronic trading and other technological advances, a range of upstart entrepreneurs now are doing the kind of bulk trading that up until a few years ago was practiced exclusively in upstairs trading rooms at big brokerages like Morgan Stanley and Lehman Brothers."
But don't feel sorry for the big guys, for a big number of the "dark pools" are owned and operated by the large investment banks, including Goldman Sachs, Merrill Lynch, Citigroup, and Bank of America, according to the report.
Furthermore, according to Marketwatch, 500 million shares of stock are exchanged in these "alternative" markets, with the number expected to rise significantly in the next few years.
So, why have these things popped up? It's simple. According to Marketwatch: "Without the easy access granted by dark pools, big institutions would have to move big orders through the market by calling a broker who would, in turn, send that market to the floor. As the information leaked -- first to the broker, then to the floor -- an investor's intentions were exposed. But in a dark pool, a big institutional investor like Fidelity Investments or New York Life can shop or put a buy order out for stock without alerting a regular broker.
In other words, the big guys want to beat the system, by sneaking their trades by as many people as possible, and by not being held responsible for their trading tactics, and the consequences of having made mistakes for buying and selling a dog.
Diplomatically, Marketwatch notes the following: "These markets are largely unregulated and because of the anonymity are open to abuse. They are, at times, inefficient. Critics say they run counter to the spirit of new market regulations by the Securities and Exchange Commission that require that investors get the best price available for their order."
In fact, what's happened is that the Wall Street money machine, which generates a big chunk from commissions, has figured out a new way to make money as "To many of those behind the dark pools -- entrepreneurs and tech heads who cut their teeth in jobs at electronic exchanges -- the nascent industry's rapid growth came out of necessity. The volatility of prices and whimsy of retail investors trading on the exchanges after the tech bubble burst left behind a changed landscape. Cutthroat competition from new, low-cost electronic markets erased already thin profit margins."
Hmmm- Let's see, a bubble, frothed up by Wall Street analysts who were on the payroll of companies like Worldcom to pump up share prices, and who were sharing research notes with the brokerage side of their companies while writing secret e-mails to their friends about how awful the dot-com losers they were pumping up, finally burst. The individual investor, badly burned, began to raise his game, and became a savvy trader.
That's bad, so the game has to be changed. Let's create some double secret trading floors, outside the regulators and the rules, and let's make some money.
The argument seems to be that institutions are often acting on behalf of individuals, as pension funds and mutual funds hold large amounts of individual investor cash.
But, the returns on these vehicles, especially mutual funds, have been downright awful, meaning that even though these behemoths may have had access to what is essentially off the books trading, it hasn't helped them very much.
Perhaps the most ironic of all aspects of this story, is that the SEC has had rules in place to govern "dark pools" since 1998, but many in the market are calling the rules "outdated," meaning that nobody really knows what's going on in this murky world.
In fact, according to Marketwatch, "the SEC didn't know how to regulate a market that looked like an exchange but wasn't an exchange. For instance, brokers trade on their networks but also act as police, creating a conflict. Hedge funds are controversial players. Some systems exclude them and when Liquidnet offered to include them to boost its market share in a competitive market, some existing customers threatened to pull out."
Furthermore: 'Different venues have different rules. Pipeline doesn't force clients out of the system altogether, according to founder Fred Federspiel. When a violation is found, Pipeline rebuilds the platform to prevent abuse. "We have had to kick a few people out until we got a fix deployed," he said.'
The consensus is that "dark pools" will never replace the open market. But significant questions are being raised, nevertheless.
Conclusion
Cheating is on the rise, and is on the minds of lots of people. Just do a Google search on the word, and you'll get 1,200,000 links.
Stories on students cheating on exams appear on a frequent basis, and scandals are revealed on a regular basis.
Are "dark pools" another venue for cheating? If there are rules at the SEC that govern such activities, then it's hard to peg the label of "cheating" on the practice of using "dark pools" as trading venues.
But, as Marketwatch's report illustrates, "dark pools" are "murky," and there is clearly some cheating that goes on within them, or participants wouldn't have to be "kicked out" from them, and algorithms wouldn't have to be rewritten in order to close loopholes.
What Marketwatch won't say, but we will, is that our society is now full of cheating. It goes on all the time, and is getting more frequent.
It is indeed becoming part of its fabric. And it will have significant consequences, today, tomorrow, and in the future.
And just as it did in 1999's dot-com bubble, we would expect that cheating will be a central cog in whatever brings down the current bull market.