Commentary on the economic , geopolitical and simply fascinating things going on. Served occasionally with a side of snark.
Wednesday, June 11, 2014
Regulatory capture and systemic cultures of corruption ( June 11 , 2014 ) Battling the Banksters , Hedge Funds stealing by way of HFT , corruption found throughout the financial sphere takes men and women courageous enough to defeat the vast web of conspirators found throughout the Government , the so called Regulators and the politicians ( good bye Eric Cantor ) who march in lockstep and enable laws to be passed to protect the system !
U.S. District Court Judge, Jed Rakoff, of the Southern District of New York
Last week, three Federal appellate judges with lifetime appointments, meaning they will be receiving salary and benefits for as long as they choose on the taxpayer’s dime and then a nice, fat, secure pension also courtesy of the taxpayer, ruled that the very same public that makes their own existence so cushy is not entitled to truth or facts or justice when it comes to Wall Street. Truth, facts, justice are quaint relics of a bygone American past. Today, when it comes to Wall Street, Federal judges are simply there to rubber stamp the settlements of captured regulators and then quickly re-ink the stamp for the next shady settlement.
To fully grasp what happened last week you will first need to purge your mind of everything you think you know about Federal District Court Judge, Jed Rakoff, rejecting a smelly deal fashioned between the Securities and Exchange Commission and Citigroup and getting slapped down by an impartial appeals court for doing so. Other than the fact that Rakoff did reject the deal, you’ve likely been misled on all other facets of the matter.
That’s the world we live in today: corporate-owned media and corporate-owned political appointments are producing corporate-owned reality.
For starters in the SEC v Citigroup case, Rakoff was not a lone voice in the wilderness calling out the SEC for sweetheart pacts with Wall Street that didn’t pass the smell test. Not only did 20 securities law experts around the country file amicus briefs arriving at the same conclusion as Rakoff in the matter (more on that shortly) but more than a year before Rakoff rejected the SEC v Citigroup settlement, Judge Ellen Segal Huvelle on August 16, 2010 in the U.S. District Court in Washington, D.C. rejected another SEC v Citigroup settlement deal that had the stench of cronyism all over it – and still does to this day.
The Huvelle case involved the SEC letting Citigroup off the hook for $75 million in settlement fines for falsely telling the public and shareholders it had $13 billion in subprime debt when it actually had over $50 billion. And instead of charging senior executives with securities fraud for lying about the bank’s financial condition, the SEC dropped its fraud charges and let two Citi executives off the hook with $100,000 and $80,000 fines, respectively.
Huvelle was highly critical of the terms of the settlement but approved it a month later after the SEC tweaked the terms to attempt to show it would hold Citigroup accountable for any further lawbreaking. But when Huvelle approved the settlement in 2010, she was not aware that there was a whistleblower inside the SEC who, five months later, was going to turn to Senator Chuck Grassley with written claims that this SEC settlement had been procured through untoward cronyism between Citigroup’s lawyers and the head of enforcement at the SEC at the time, Robert Khuzami.
According to the SEC’s Office of Inspector General which investigated the whistleblower’s claims against Khuzami, this is what transpired: On June 28, 2010, Khuzami spoke on the phone with Mark Pomerantz, a partner at Paul, Weiss, Rifkind, Wharton & Garrison, the law firm representing Citigroup. Pomerantz and Khuzami knew each other from their work at the U.S. Attorney’s office in the Southern District of New York. SEC attorneys working under Khuzami had already decided to bring fraud claims against Citigroup’s CFO, Gary Crittenden, for misstating the amount of Citigroup’s exposure to subprime debt by almost $40 billion.
On the call, Pomerantz told Khuzami that Citigroup would experience collateral damage if a key executive were charged with fraud. Shortly after this call, another Citigroup lawyer, Lawrence Pedowitz of Wachtell, Lipton, Rosen & Katz (the law firm that helped former Citigroup CEO Sandy Weill maneuver the repeal of the Glass-Steagall Act) told SEC Associate Enforcement Director, Scott Friestad, that Khuzami had agreed to drop the fraud charges against Crittenden. The Inspector General’s report says that Khuzami denies ever making this promise.
But the fraud charges were dropped and the deeply redacted Inspector General’s report does not inform the public as to how they came to be dropped. The report essentially whitewashes the claims against Khuzami, ensuring that fewer and fewer whistleblowers within or outside the SEC will go to the trouble of reporting wrongdoing.
The SEC’s Inspector General’s report is dated September 27, 2011 but it was not released to the public until November 17, 2011 – at which time it was obvious that someone had demanded confidential treatment for large swaths of the report, at times making the language unintelligible. One gets the feeling that the delay was caused by those same Citigroup lawyers who seem to have their way at the SEC and took a machete to the findings.
There was further evidence residing inside the SEC that Citigroup’s CFO, Gary Crittenden, should have been charged with fraud. On October 23, 2007, the SEC’s Kevin Vaughn sent a letter to Citigroup, writing as follows:
“We note your response to our prior comment 2 in our letter dated July 3, 2007 in which you state that you did not disclose the amount of mortgage backed securities and residual interests collateralized by non-prime mortgages held by U.S. Consumer due to immateriality. From your disclosures in your Forms 8-K filed on October 15, 2007 and October 1, 2007, it appears that you do have a material exposure to non-prime instruments as these instruments caused you to record a $1.56 billion loss in the third quarter. Please revise to disclose the specific amount of your exposure to these types of instruments. Please separately quantify the amount of exposure related to loans held for investment, loans held for sale, investments held as a result of securitizations, and any other types of instruments you may hold for each segment in which you have exposure. Quantify the amount of non-prime loans you hold in your loan warehousing facility at each period end.”
Citigroup did not respond to that SEC demand for further information until December 14, 2007 and then, at that time, asked the SEC to protect its responses from the prying eyes of reporters or members of the public who might file a Freedom of Information Act Request (FOIA). Pages 22 through 32 of this correspondence have been completely redacted with the notation “The following information has been redacted in accordance with Citigroup’s request for confidential treatment,” with no explanation at all as to why the SEC is still cowering to the secrecy demands of this serial miscreant.
It is now more than six years later and the redactions remain on the SEC’s web site, further denying the public the truth about a global banking behemoth that was shored up with $45 billion in taxpayer equity infusions, over $300 billion in asset guarantees and $2.5 trillion (yes, trillion) in below-market rate loans to prevent an insolvent bank from causing alleged “collateral damage.”
On November 28, 2011, six business days after the news broke of the SEC’s Inspector General report revealing charges of cronyism between the SEC’s Director of Enforcement and Citigroup lawyers, Judge Jed Rakoff rejected the SEC’s $285 million settlement with Citigroup over charges similar to the Goldman Sach’s Abacus deal – except Citigroup had created a toxic debt instrument designed to fail and then shorted it itself, unlike Goldman which designed Abacus to fail but let a hedge fund do the shorting.
The SEC alleged in its complaint that Citigroup had falsely represented to its investors that an independent investment adviser had rigorously selected the assets. But knowing that the toxic debt would deteriorate further, Citigroup took short positions in some of the same assets, seeking to profit from their continued decline in value. Citigroup allegedly realized $160 million in “net” profits, while investors allegedly lost over $700 million. And, yet, all the SEC was seeking from Citigroup was disgorgement of $160 million in profits, $30 million in prejudgment interest, and a $95 million civil penalty along with the requirement that Citigroup would undertake certain compliance measures for three years.
Rakoff, who repeatedly and unsuccessfully attempted to wring from the SEC the evidentiary basis for this weak settlement, wrote in his decision to reject the deal:
“Purely private parties can settle a case without ever agreeing on the facts, for all that is required is that a plaintiff dismiss his complaint. But when a public agency asks a court to become its partner in enforcement by imposing wide-ranging injunctive remedies on a defendant, enforced by the formidable judicial power of contempt, the court, and the public, need some knowledge of what the underlying facts are.”
The SEC and Citigroup separately appealed Rakoff’s decision to the Second Circuit Court of Appeals. One of the Judges assigned to sit on the appeal was none other than Raymond Lohier who had (wait for it) been the Deputy Chief and then Chief of the Securities and Commodities Fraud Task Force at the U.S. Attorney’s office in the Southern District of New York during the height of the financial collapse in 2008, 2009 and early 2010 when, amazingly, on March 10, 2010 President Obama nominated Lohier to become a Federal Appellate Judge, skipping that nuisance detail of first serving as a District Court Judge. Equally amazing, Lohier was quickly confirmed by the U.S. Senate.
Raymond Lohier, Second Circuit Appellate Judge, At His Confirmation Hearing
Lohier was the man in charge when the trail and evidence was still hot against the largest Wall Street banks for engaging in fraud and causing the greatest economic collapse since the Great Depression. Lohier did not bring one criminal case against any one of those banks’ executives. Now, he is sitting as Judge over the fairness of wrist slaps as a suitable alternative to the criminal cases he failed to bring.
In his Senate confirmation hearing, it was noted that Lohier prosecuted the case against Bernard Madoff. It was not noted that Madoff turned himself in and confessed to the crime, after the SEC had for decades ignored evidence that Madoff was running the largest Ponzi scheme in history.
Nineteen securities law scholars filed a joint amicus brief with the Second Circuit Appeals Court explaining why Rakoff was correct to reject the Citigroup settlement. Harvey Pitt, the former General Counsel and later Chairman of the SEC, filed a separate amicus brief agreeing with Rakoff.
The nineteen securities law professors were from universities that included Duke, George Washington, Columbia, Villanova, Cornell and others. They told the court that:
“…the events of the last few years bear a striking resemblance to the events that led to the enactment of the federal securities laws eighty years ago. Those laws were enacted because Congress recognized that investor confidence is essential to strong and efficient capital markets. In particular, Congress recognized the need to reform the securities sales practices of investment bankers that led to the 1929 Crash. Similarly, the turmoil of the current financial crisis has had a detrimental impact on investor confidence that needs to be restored.”
The securities scholars also informed the appeals court that:
“…the SEC’s complaint, if true, means that Citigroup engaged in serious and intentional fraud in disregard of the interests of its customers and for its own substantial gain. Yet, although the first sentence of paragraph one of the complaint labels this a ‘securities fraud action,’ the complaint charges Citigroup only with negligence…the prophylactic measures imposed for three years are relatively inexpensive measures that appear to be ‘window-dressing’…the penalties are modest, given the gravity of allegations, the investors’ losses, the harm to the public and the fact that Citigroup is a recidivist.”
The securities scholars concluded that, despite all of this, “The SEC and Citigroup essentially argue that district court should play no meaningful role in reviewing consent judgments and that the court must give total deference to the desire of the parties to compromise, without taking into account the public interest. This is not the law, nor should it be. This court should affirm the district court’s order denying entry of the parties’ proposed consent decree…”
Harvey Pitt, who joined the SEC in 1968, served as its General Counsel from 1975 to 1978 and its Chairman from 2001 to 2003, told the Court that:
“The invocation of this Court’s jurisdiction, however, poses a danger that, in arguing the district court abused its discretion, the SEC effectively contends the district court had no discretion to withhold approval of the settlement. Since there is no basis for that proposition, the danger is that courts, in response, may recalibrate the ‘nice adjustment and reconciliation between the public interest and private needs.’ Hecht Co. v. Bowles, 321 U.S. 321, 329 (1944). That is a danger this Court should avoid…”
Lohier dominated the oral arguments in the case but when the final decision came out it showed that a different Judge wrote the decision: Rosemary S. Pooler. That’s likely because Lohier wanted to weigh in with a stricter interpretation in a concurring opinion.
The Court found that Rakoff had abused his discretion in not showing adequate deference to the SEC and by his ordering the case to go to trial. The Court wrote:
“Trials are primarily about the truth. Consent decrees are primarily about pragmatism.”
The Court, however, returned the case to Rakoff for continued deliberation. Lohier went further in his concurring opinion, writing:
“I would be inclined to reverse on the factual record before us and direct the District Court to enter the consent decree. It does not appear that any additional facts are needed to determine that the proposed decreee is fair and reasonable and does not disserve the public interest.”
This whole affair sends the message to the public that we are looking at far more than generalized regulatory capture. It seems we are, specifically, looking at Citigroup’s lawyers capturing both the SEC and the Court that previously functioned as a check and balance over crony capitalism running amok in Manhattan.
Southern states are mad as hell and aren’t going to take it any more. After more than five years of watching their cities and towns suffer foreclosure and mortgage abuse from the biggest firms on Wall Street, rigged Libor swaps impoverishing local governments, and massive stock losses to municipal workers’ pensions, the South is rising up and suing Wall Street over its latest fleecing scheme – high frequency trading.
And before anyone starts to chuckle about the chances of Southern lawyers outfoxing the mega Wall Street law firms in their own stomping ground in the U.S. District Court for the Southern District of New York, you should know this one salient detail: one of the key Southern lawyers involved is Michael Lewis. That’s not bestselling author Michael Lewis; that’s Big Tobacco Cartel suing and winning lawyer Michael Lewis who mightily assisted in bringing the tobacco cartel out of the shadows and changed the health of a Nation forever.
Even more problematic for Wall Street and its hideously shrewd lawyers is that one of the smartest programming brains in U.S. markets, Eric Hunsader, is cooperating with the Southern lawyers. (Wall Street On Parade has previously written about Hunsader hereand here.)
Last Friday, Andrew Smith, writing for the U.K. Guardian newspaper, featured Hunsaderin a story about the lawsuit. Smith revealed that on May 6 of this year, Hunsader met with Lewis and his “dream team” of class action lawyers in Chicago to provide his technical expertise.
Why is Hunsader who runs a successful data business involving himself in what is likely to be the biggest legal free-for-all of the century? Andrew Smith of the Guardian shares this with us:
“When Hunsader’s finance friends pointed out that nobody was driving busloads of children over cliffs, he would grab their wallet and remove a $20 bill, then hand the wallet back. ‘Does anyone in the world really care what just happened there?’ he would ask. ‘It makes no difference to anyone but you, and even then not much. It’s just that in a civilised society, we don’t tolerate that. Civilisation breaks down when people don’t follow the rules, because nobody can trust anybody else.’ ”
Wall Street On Parade completely agrees with Hunsader. And while the morally challenged brains that occupy those Armani suits on Wall Street may not have literallybeen driving busloads of children over cliffs, there is the fact that one in five children in the U.S. now lives below the poverty level; that homelessness is hitting record highs in Wall Street’s home town of New York City; and that according to the National Center for Homeless Education, an agency funded by the U.S. Department of Education, the latest data available show there were 1.2 million homeless students during the 2011-12 school year — a 10 percent increase from the previous year and a 72 percent jump from the start of 2007-08, an all-time high.
We checked the Federal web site, Pacer, this morning which allows access to lawsuits filed in Federal Courts. We found that Lewis and three other law firms have filed not one lawsuit seeking class action status, but three separate ones. (The separate lawsuits are based on the delivery system of the data.) The law firms involved are: Lewis & Lewis Attorneys of Oxford, Mississippi; Richardson, Patrick, Westbrook & Brickman, LLC of Charleston, South Carolina; McCulley McCluer PLLC of Oxford, Mississippi and Birmingham, Alabama; and Keller Rohrback of New York and Seattle.
The lawsuits are filed against a total of 14 exchanges, including the biggest in the U.S. like the New York Stock Exchange, Nasdaq and the Bats Exchange. The plaintiff in each case is a Harold Lanier who resides in Fairhope, Alabama. Lanier had subscribed to the exchanges’ data feeds on the basis that he would get timely trading data on a par with everyone else. That didn’t happen.
The thrust of the cases has to be causing a lot of heartburn in New York legal circles this week. They are based on the enshrined precedents of contract law – you promised us this and you didn’t deliver; and, you had an impure motive for not delivering the terms of your contracts. It’s a case that any Judge or jury can understand.
Here’s an excerpt:
“…the Exchange Defendants failed to live up to their promise to provide Subscribers with the market data in a non-discriminatory manner. In an effort to increase their profits, the Exchange Defendants entered into lucrative side deals with certain customers to whom the Exchange Defendants sold advance access to the market data that Subscribers had contracted for through (1) direct feeds (‘Private Feeds’) and (2) co-location services (‘Preferred Data Customers’). As detailed in Section IV.C. of this Complaint, for a price, the Exchange Defendants provided access to the data to Preferred Data Customers through arrangements that guaranteed they would receive the data substantially in advance of the Subscribers.”
None of the names of the Wall Street law firms that will be defending against these charges have been entered into the record as yet.
On July 17, 1996, the U.S. Justice Department charged the biggest names on Wall Street, names like Merrill Lynch, JPMorgan and predecessor firms to Citigroup, with pricing fixing on the electronic stock market known as Nasdaq.
The Justice Department felt the firms were so untrustworthy to make a fair electronic marketplace that as part of its settlement it required that some traders’ phone calls be tape recorded when making Nasdaq trades and it gave itself the right to randomly show up and listen in on the traders’ calls. The scandal made headlines for years and revealed that the price fixing had been going on under the unwatchful eye of regulators for more than a decade.
Now, more than six years after the greatest Wall Street crash since 1929, the public is still learning stomach-churning details about the lingering effects of de-regulating Wall Street.
Yesterday we learned that the very same Wall Street firms charged with price fixing in the 90s have somehow conned their regulators into allowing them to own their own dark pools – effectively unregulated stock exchanges – and make markets in the stock of their very own Wall Street bank.
The Financial Industry Regulatory Authority (FINRA) – a self-regulatory Wall Street body (which under a previous name was responsible for missing the Nasdaq price fixing for more than a decade) released trading data yesterday for the dark pools operating the week of May 12 – 16. This was the first time such data has been released. The data releases are set to continue.
There are three major concerns that are immediately raised by the trading statistics: that Wall Street banks are allowed to make a market in their own stock inside an unregulated dark pool; that the other largest banks are making large markets in each other’s stocks; and why the public is just seeing a sliver of sunshine – instead of what went on in the previous 51 weeks or prior years of trading in these dark pools? Since the Wall Street firms knew this public data release was coming, it’s possible that higher trading volumes were previously occurring in their own and each other’s stocks.
Bank of America’s trading arm, Merrill Lynch, owns two dark pools, one of which is Instinct X. Last evening, FINRA data showed that during the relevant week Merrill’s dark pool, Instinct X, traded 8,207,150 shares of its own parent’s stock in a total of 16,246 trades. Merrill is now stating that it provided erroneous numbers to FINRA and the figure is really just 4,103,575 shares and 8,123 trades. A second Merrill Lynch dark pool, which goes by the letters MLVX, last evening showed it traded in its company stock to the tune of 66,200 shares in 94 trades. This morning, those figures have been cut in half.
Citigroup, which became insolvent during the 2008 crisis and required multiple bailouts from the taxpayer, owns a total of four dark pools according to a list posted at the SEC’s web site – none of which the general public has ever heard of: LavaFlow, LIQUIFI, Citi Credit Cross and Citi Cross. (The more dark pools a Wall Street firm owns the greater the concern that it could be trading between these pools to effectively paint the tape, i.e., manipulate the price of a stock.) Dark pools match buyers and sellers in the dark, without disclosing the bids and offers to the public marketplace.
According to FINRA data for the relevant week, Citigroup’s dark pool, LavaFlow, traded 645,756 shares of Citigroup stock in 1,838 trades while Citi Cross traded another 39,997 in 256 trades.
Merrill Lynch’s dark pool, Instinct X, has dramatically changed its data as to what it traded in Citigroup stock for the referenced week: last night it showed it was the largest trader among the dark pools in Citigroup stock with total shares traded of 1,791,492 in 10,282 trades. This morning those figures have been cut exactly in half, making it the seventh largest share volume trader in Citigroup for the referenced week among the dark pools. Ranking above it in share volume are, in order, the dark pools of Credit Suisse (CrossFinder), Deutsche Bank (DBAX), UBS, Goldman Sachs (Sigma-X), Barclays (LATS) and Morgan Stanley (MSPL).
Data for the same week for JPMorgan shows its dark pool, JPM-X, traded 826,614 shares of its own stock in 1,483 trades. JPMorgan ranked seventh among the dark pools for trading in its stock that week with the following dark pools trading a million or more shares of JPMorgan: Credit Suisse’s CrossFinder (1.9 million); UBS (1.57 million); Barclays LATS (1.15 million); Deutsche Bank’s DBAX (1.12 million); Goldman Sachs’ Sigma-X (1.07 million). Three of Citigroup’s dark pools — LavaFlow, LIQUIFI and Citi Cross — traded a total of 939,072 shares in JPMorgan.
Another serious concern that has arisen since the release of the book, Flash Boys, by bestselling author Michael Lewis, is the introduction of tricked up order types that let high frequency traders fleece the ordinary investor along with revelations that exchanges and dark pools are now offering payment for order flow and other cash incentives to attract trades from high frequency traders.
On September 22, 2009, Citigroup released the following press release concerning a new order type and rebate program at LavaFlow:
“Citi’s LavaFlow ECN has introduced a new order type, Hide to Comply, an execution instruction that allows liquidity providers to enter displayable limit orders at aggressive prices and obtain the best possible time priority at the order’s posted price level, all while receiving a rebate.
“Hide to Comply adjusts aggressively priced orders such that they are hidden on entry, and their limit price set to the opposite side of the national best bid and offer (NBBO). While hidden at this price, the order will be eligible for a full rebate. When the NBBO updates such that the order is no longer at a locking price, the order will be displayed at this new limit, maintaining its original time priority; the order will not be re-priced.”
We have asked the SEC to weigh in on how Wall Street banks, which caused the greatest economic collapse since the Great Depression, are allowed to make markets in their own stocks. We’ll update this article when we hear back.
Terrence Duffy of the CME Group Testifying Before the Senate on May 13, 2014, Effectively Telling the Panel That His Exchanges Are As Pure As the Driven Snow
Evidence of ‘clandestine’ documents has turned up which may make it rough-sledding for one of Wall Street’s biggest go-to law firms in the position they staked out last Friday in Federal court.
R. Tamara de Silva, a lawyer representing three traders in a closely watched Federal class action lawsuit in Chicago, told the court in April that the world’s largest futures exchange has “entered into clandestine contracts with HFTs [high frequency traders] knowing that the activities of the HFTs would adversely affect all other individuals and entities…” (See High Frequency Trading Lawsuit Against CME Group, et al for the full text.)
De Silva and lawyers from O’Rourke & Moody in Chicago are facing off against the 1600-lawyer strong Skadden, Arps, Slate, Meagher & Flom, LLP who are known for their splashy motions to dismiss — which come very close to libeling opposing counsel. They did not disappoint in this case.
Last Friday, Skadden Arps told the Federal court on behalf of their clients that the complaint is “reckless,” based on “implausible and unsupported guesswork” and “nearly incomprehensible pleadings that are so poorly constructed as to be functionally illegible.” (Skadden Arps is clearly praying that the Judge in the case, Charles P. Kocoras, has not read Flash Boys, the new Michael Lewis book that details a massive conspiracy involving high frequency traders in U.S. markets.)
As for the purported “clandestine contracts,” Skadden Arps had this to say to the court:
“The centerpiece allegation — that the Defendants entered into ‘clandestine contracts’ with undefined ‘high frequency traders’ or ‘HFTs’ to secretly provide them data to the detriment of other market participants — appears from thin air with no hint as to the factual basis to make such a dangerous assertion in a federal lawsuit. Indeed, while claiming that the whole ‘scheme’ has been fraudulently concealed from the world for the prior seven years, Plaintiffs offer no clue about what facts they recently discovered, or how they discovered them, that now cause them to level such serious allegations in this action. The whole thing reads like a fishing expedition, driven by nothing more than current pop-culture wordspeak and wild rumor.”
On Tuesday of this week, the Federal regulator of futures exchanges in the United States, the Commodity Futures Trading Commission (CFTC), held a public meeting where it was revealed that the futures exchanges had increased ‘incentive’ programs from 56 to 340 programs. Some of these incentive programs involve the payment of cash to high frequency traders.
Wall Street On Parade went to the web site of the CFTC to read the details of these incentive programs that have been filed with the CFTC for many years. What we found instead was the multi-year use of a rubber stamp with the words “Confidential Treatment Requested.”
Over and over and over again, for years, instead of details of these 340 incentive programs, we found (wait for it)…clandestine contracts so secret that they needed to be protected from Freedom of Information Act requests, from the snooping eyes of Congress or subpoena power. If outside requests were made to the CFTC for the documents, the exchanges asked their Federal regulator to become their inside tipster and give them a heads up.
“…the Exchange requests that confidential treatment be maintained for Appendix A and Exhibit A until further notice from the Exchange. We also request that the Commission notify the undersigned immediately after receiving any FOIA request for said Appendix A or Exhibit A or any other court order, subpoena or summons for same. Finally, we request that we be notified in the event the Commission intends to disclose such Appendix A or Exhibit A to Congress or to any other governmental agency or unit pursuant to Section 8 of the CEA. The Exchange does not waive its notification rights under Section 8(f) of the CEA with respect to any subpoena or summons for such Appendix A or Exhibit A.”
The letters are signed by Christopher Bowen, a Managing Director and Regulatory Counsel at the Chicago futures exchanges’ parent, the CME Group.
America Is Having Buyer's Remorse With SEC Chair Mary Jo White
SEC Chair Mary Jo White’s untenable position that “markets are not rigged” is bringing unwelcome attention to the SEC’s dismal record on ensuring that stock exchanges operating in the U.S. are fair.
Since bestselling author, Michael Lewis, went on 60 Minutes on March 30 to detail, step by step, how the stock market is rigged – there has been a slow, but steady, realization that the woman President Obama sold to the American people as the white knight who would rein in abuses on Wall Street has failed miserably in that role.
Under the Securities Exchange Act of 1934, codified at 15 U.S. Code § 78f, the Securities and Exchange Commission is statutorily mandated to ensure that the rules of the stock exchanges are designed “to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade…to remove impediments to and perfect the mechanism of a free and open market and a national market system, and, in general, to protect investors and the public interest; …”
In addition, the legislation requires that the exchanges’ rules cannot “permit unfair discrimination between customers, issuers, brokers, or dealers…”
Despite that very precise and clear language mandating a “free and open market” devoid of “discrimination between customers,” the SEC has not just sat idly by and watched the stock exchanges rig the market, it has played an involved and instrumental role in the process.
With the imprimatur of the SEC, the New York Stock Exchange and Nasdaq are selling the right to high frequency traders to co-locate their high speed computers next to the exchanges’ own computers so high frequency traders can get an early peek at order flow and jump in front of slower traders. In addition, the big broker dealers on Wall Street are no longer required to subject their stock orders coming from the public to sunshine; they simply match up the buy and sell orders inside their own firms in what are called “dark pools.” These are, effectively, unregulated stock exchanges operating in darkness.
In this Google cache of a promotional piece aimed at high frequency traders, the New York Stock Exchange boasts that it is offering a “fully managed co-location space next to NYSE Euronext’s US trading engines in the new state-of-the-art data center.” The NYSE says it is for “High frequency and proprietary trading firms, hedge funds and others who need high-speed market access for a competitive edge.”
Despite the clear language of the Securities Exchange Act of 1934 which bars the “unfair discrimination between customers, issuers, brokers, or dealers…” we have the most iconic stock exchange in America openly boasting that it will give a “competitive edge” to high frequency traders. There is no better example than this promotional piece to show how greed has overtaken rational thought on Wall Street.
Not only are the New York Stock Exchange and Nasdaq allowing high frequency traders to co-locate their computers next to the main computers of the exchanges to gain a speed advantage over other customers at a monthly cost that only the rich can afford, but they’re now tacking on infrastructure charges that price everyone out of efficient use of the exchanges except the very top tier of trading firms. This filing by the SEC in the Federal Register proves that the SEC is not only aware of the practice but has thoroughly embraced it.
Lewis writes in his latest bestseller, Flash Boys, that “both Nasdaq and the New York Stock Exchange announced that they had widened the pipe that carried information between the HFT [high frequency trading] computers and each exchange’s matching engine. The price for the new pipe was $40,000 a month, up from the $25,000 a month the HFT firms had been paying for the old, smaller pipe.”
All of this has the media steaming. On May 4, Alec MacGillis penned a scathing critiqueof White in the New Republic. Columbia law professor, Rob Jackson, is quoted as follows in the article:
“Tell me one thing that [White's] board has done that’s investor friendly—I can’t think of one…It’s astonishing. And the reason it’s been missed is that she’s established this notion that she’s going to be the top cop on the beat. That disguises the fact that she’s the most investor-unfriendly chair in two decades.”
More troubling, on May 22, Leah McGrath Goodman wrote in Newsweek that the magazine had learned that “since the New York state attorney general in recent weeks started subpoenaing trading firms, banks and exchanges across Wall Street, the SEC has refused to take a cooperative tack in its investigations.”
Goodman goes on to explain that ordinary investors without the money to pay the obscene fees being charged by the exchanges are receiving stale prices that lag by “about 15 to 20 minutes.”
“If you have the money, you can see up-to-date prices. If you don’t, you cannot. Knowing the difference, of course, means those with access to real-time prices and other information can see where the market is heading before everyone else—and profit handsomely off that insight. In the meantime, investors relegated to the ‘current’ prices available on websites like YahooFinance are actually receiving prices that are old.”
As clear-cut as the law is, those benefitting from these abusive practices are more than willing to appear on CNBC or Bloomberg News and tortuously rationalize why all of this is just good ole capitalism at work.
A particularly noteworthy performance took place on May 29 when Kevin McPartland, a principal at Greenwich Associates who actually specializes in Market Structure and Technology, with a BS in Computer Science from Rensselaer Polytechnic Institute, had this to say:
Kevin McPartland of Greenwich Associates, Their Technology Guru, Thinks Retail Investors Are Getting Stock Prices at the Same Time as Everyone Else
McPartland: “We’re safer today in the markets – retail and institutional investors are safer today in the markets than they’ve ever been. If you think back to the 80s and we had the floor of the exchange, sort of the good ole fashioned way, spreads were much, much wider, there was a much larger information difference between what the retail guy was seeing and what the guys on the floor were seeing. Today, we’re all on line, we’ve all got real time data to our desk tops; you know what the price of the stock is to the penny.”
Later in the program McPartland adds: “I really don’t like the use of the word fair when we talk about capital markets – really about the industry in general. It’s not about it being fair, right, it is capitalism, right. So as long as we’re all following the rules and we know what the rules are, everybody’s in the business to [interrupted]” You can watch the full exchange here.
New York State Attorney General Eric Schneiderman delivered an address to the New York Law School on March 18 of this year and said that these co-location practices at the exchanges are currently one of the areas his office is looking at. Schneiderman noted that Mary Jo White was in the audience and, on multiple occasions, he appeared to be lecturing her that she hadn’t taken this matter seriously enough or done enough to stop it.
Schneiderman detailed additional abuses by the exchanges, stating:
“We know that high-frequency traders are uniquely able to take advantage of co-location, but there are other services also offered…They [exchanges] supply extra bandwidth, special high-speed switches and ultra-fast connection cables to high-frequency traders, so they can get, and receive, information at the exchanges’ data centers even faster. These valuable advantages, once again, give them a leg up on the rest of the market.”
Since folks like White and McPartland can’t seem to grasp the idea or the law that requires exchanges to function “to protect investors and the public interest,” to be free of “discrimination,” and devoid of “impediments” to a “free and open” market, Wall Street On Parade has found an analogy that might help remedy their potential for cognitive dissonance as the media gains a better understanding of the core issues.
A Pinewood Derby is an event held by Cub Scouts around the United States. Its rules are fascinatingly comparable to the conceptual underpinning of the law under which stock exchanges are required to function to create a level playing field for all comers.
Cub Scouts take a little chunk of wood and carve out a race car. But the rules are very strict to make sure everyone comes to the start of the race with no advantage other than their own creativity and hard work on the project.
We found a typical set of rules for a Pinewood Derby here. Stock exchanges selling super perks and high frequency traders buying multi-million dollar state of the art computers and hiring Ph.D.s to design artificial intelligence trading algorithms might want to pay close attention to what they have apparently forgotten from childhood. The SEC may find it useful to be reminded about what the role of “inspection” is.
Excerpted from the Pinewood Derby rules:
Cars may not be sent to third party facilities for tuning or other performance enhancements.
Prohibited Items: Starting devices or propellants.
A. Width – Not to exceed 2 3/4 inches
B. Length – Not to exceed 7 inches
C. Weight – Not to exceed 5.0 ounces on scale accurate to 1/10 ounce.
D. Height – Not to exceed 3 inches
Each car must pass inspection by the Official Inspection Committee before it may compete. The Inspectors will disqualify any car not meeting these rules.
Cars may be reclassified or disqualified if they are determined by the race officials to not meet these requirements.
Good Sportsmanship and Behavior is Expected: Race Officials may ask anyone not following this rule to leave.