Why does today's stock market seem to reward the well-connected while working against the everyday investor?
It’s not only that the market has necessarily changed (and has never really been a "level playing field"), says Charles Gasparino in his new book Circle of Friends: The Massive Federal Crackdown on Insider Trading -- And Why the Markets Always Work Against the Little Guy
(Harper Business, 2013), it’s also that there are more "regular folks" in the markets than ever before.
“In these days, even blue-collar workers are forced to save and invest for retirement given the erosion of guaranteed retirement plans that corporate America has replaced with 401(k) plans and other investments," he writes.
Currently of Fox Business
(NYSE:NWS), formerly of CNBC, and a contributor to The Daily Beast
, and New York
, Gasparino has the relationships, connections, and experience to get inside investigations and offer a rarely-seen look at the inner workings of financial crime and the enforcement apparatus trying to stop it. With dozens of convictions obtained by the US government for insider trading in recent years, but not a single case brought against the bank executives who triggered the 2008 economic meltdown, Gasparino maintains the SEC, Justice Department, et al are simply looking to “satisfy the public’s demand for Wall Street scalps,” without going after the real culprits. Why has no one from Citigroup
(NYSE:C), an institution Gasparino calls “an evil empire” for “radical risk taking," been prosecuted? Or anybody from Merrill Lynch
(NYSE:BAC), an entity that Gasparino says “shared honors” in this area with Citi?
Whatever your perspective (some agree with Gasparino’s thesis that less public harm comes from insider trading than the SEC would have you believe, others strongly dismiss it), Circle of Friends
is a fascinating read.
Minyanville recently sat down for a Q&A with the author.
Minyanville: After reading
Circle of Friends, it’s clear you had extraordinary access to not only Wall Street insiders, but also regulators, law enforcement agents, and other highly placed sources. Can you explain some of the "story behind the story"? How did you go about researching the book? Was it difficult getting people to talk?
Very difficult. On the law enforcement side, investigations such as these need to be kept confidential, and the defense bar doesn’t want to do anything to get clients in even more trouble. But you look for ways into the story by tapping into sources who work at hedge funds, people who are friends of the accused, and former investigators with direct knowledge of what went down. After a while you develop a pretty good outline narrative of what happened, e.g., how long the government has been pursuing SAC Capital and how exactly and what methods were used.
MV: The book certainly makes clear how tight these cliques are, and it is difficult to overestimate the effects of human nature and money. How deeply entrenched is the culture of insider trading?
I don’t want to say everyone is doing it, but at least for a time, insider trading was business as usual at hedge funds. I should caution that some stuff that looks like insider trading, e.g., trading on “material non-public information,” doesn’t really fit the legal definition of what is a dirty trade. But hedge funds run on information that isn’t generally known. The pressure to post better returns ramped up dramatically with the expansion of the hedge fund business. Put all that together and you know why people stepped over the line, which they obviously did a lot. What I found so interesting is that most of the people caught up in this stuff had no idea what the consequences were. If you told me that if I committed insider trading I could be put in jail for a decade, I wouldn’t do it. I think most of these guys who were caught had no idea what the sentencing guidelines were. Yes, many were arrogant because they didn’t think they would get caught. But they also had no idea that insider trading is treated as the equivalent of armed robbery by the criminal justice system.
MV: In telling the intertwined tales of David Slaine, Raj Rajaratnam, Steven Cohen, et al, you are critical of the government’s priorities in prosecuting “victimless” insider trading cases versus holding top executives at large institutions responsible for big gambles that had negative effects on the broader economy. If insider trading was sort of “decriminalized,” what would that look like in practice? Wouldn’t traders just have to be quickly reined back in with a new raft of regulations, after realizing they don’t have to worry about trades looking suspicious anymore?
By decriminalizing it, you wouldn’t be giving insider trading a free pass. The SEC can bar people from the business, which to me, seems like the appropriate remedy to something that simply doesn’t add up to armed robbery, as the Justice Department treats insider trading. It also frees the feds to focus on real white-collar rip-offs. Remember, the insider trader isn’t really hurting anyone, à la Bernie Madoff. The person on the other side of the trade would lose money anyway even as the person with the inside information gains from his knowledge of what isn’t public yet. I don’t think we should give cheats a free pass, but the punishment should fit the crime. Does Raj Rajaratnam really belong in jail for 11 years? He’s in jail as long as people who commit violent crimes.
MV: What about congressional insider trading? Do you see any hypocrisy in the politicians’ actions?
Hypocrisy yes, but
, remember: Insider trading is hardly black-and-white—that’s one of the problems prosecuting it. It’s a crime based on a series of court rulings, which is why the congressional stuff, where public officials trade on non-public legislative information, doesn’t meet the standard. If the government wants to expand the definition, they should do so by first enacting a law, though I wonder how the courts will deal with this. Insider trading is still very murky (there are differing opinions on what really constitutes “misappropriation” or stealing non-public information and trading on it), and that’s after years of court decisions.
MV: What is the most important idea you would like for people to take away from Circle of Friends?
CG: That as much as the government tries to make the stock market a “level playing field,” it isn’t, that professionals will beat the average investor every time, with or without inside information, and that there is a political reason why the government has made insider trading such a big deal in recent years. After the 2008 financial collapse, the feds needed scalps from Wall Street; they couldn’t bring charges against the big bailed-out firms for many reasons, including they didn’t understand the complexity of bank balance sheets and how they could be manipulated. All of a sudden they had this easy, sexy crime with people like Raj on wiretaps doing stuff that had nothing to do with the financial collapse but instead were guilty of “cheating the system.”
No positions in stocks mentioned.
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