Saturday, November 07, 2009

The First Call Before The First Call

At one end of the spectrum, you have so-called informationless traders who are the cheap bastards of the equity investment world. Not only do they desire to pay as little as possible to trade but many want/demand/expect to actually BE paid in the form of rebates. One might call them suppliers of liquidity, and they are desperate to be first in the queue. SO desperate are they, that they are competing to put their computers INSIDE the exchange's computers. OK, I exaggerate, but you get my drift. To facilitate this, some have conspired (errr sorry, I mean worked) with the exchanges to gain preference, however brief. Call it "first dibs". Others e.g. Timber Hill) have set up their own brokerage firms (e.g.Interactive) in order to directly capture the order flow (and thus the spread) before anyone else even sees it (and there is nothing wrong with that according to the letter of the rules though it must be said that bar of wrongness has not been set very high).

At the other end of the spectrum gather the information-based traders (and note my semantics - I do NOT term them information-based investors). They are the polar opposite of the cheap bastards when it comes to "commissions". They, it would seem, are relatively insensitive to commissions. In fact, they are willing to pay A LOT of commissions (so long as they are not in the nick). A fuck-of-a-lot of commission. A fuck-of-a-lot more of commission than the reasonably hefty commissions so-called research-clients pay for bundled brokerage and research services. Indeed brokers LOVE them. They love them so much, they call them often and often with good information (though admittedly they get called often with bad information too). And let me tell you (if you haven't had the pleasure) it is a brain-numbing and painful task reading through Wall Street research rife repetitive hackneyed cliches, all so dull as to make the literate amongst us positively suicidal. Galleon apparently is a good example of such a valued client.

But as Wall Street is a hotbed of efficient markets (umm errr right??!?) one might rightfully ask: What is the correct price that a 'good client' should be willing to pay for such 'good information'? This is not a simple question, but the answer lies (no pun intended) in examining several examples. At the extreme end, we have (or had) Raj who might cut you in by forming a side-venture with you, hiring you, promising to hire you, or letting you invest, the former more direct forms of profit-sharing. Others, like Marshall Wace (discussed in this I.A. Ehrenberg post) who systematically electronically capture and analyze broker tips, want to be the first to receive information updates, and will pay handsomely for it. Only not directly, and only if it makes them money. This is, in essence, a sort of reverse-rebate for the brokerage tipster. They (MW) of course apply strict rules to how they play - some of which might raise ethical eyebrows, were they not the eyebrows of the FSA. The beauty of their approach is that while ethically dubious, it games the system allowing the brokerage to recapture some of the value of their work - even if the value is the self-fulfilling, probably temporary, impact. Finally we have the "early bird catches the worm" approach. These are people who will pay whatever it takes to be the call before the first call. Heck 20-cents-a-share for execution is terribly cheap where the information is bankable, which is what for years SAC was rumored to frequently pay to be the first call before the first call. Such calls help the brokerage client get bigger. Who then does more business at high commissions in a veritable virtuous circle. It was with this in mind I read with some amusement in the online Wall Street Journal that as a result of information garnered in the Galleon investigation, the SEC is [finally?] turning it's attention to such less-than-salubrious arrangements, and that Mr Cohen and SAC are now the subject of inquiry which will see a more thorough examination of their trading records. It is no understatement to say that it is no easy task delving into a global trading organization with multitudes of mid and high-frequency strategies, carve-outs, etc., but nonetheless it something that a determined researcher could find in the patterns and footprints of position-sizing and relative success around market-moving events. Moreover, Wall Streeters, tough as they appear are really sissies when it comes to jail, and like Galleon, have again proven themselves notoriously mercenary when it comes to ratting out their colleagues (and bosses).

This is, of course, just the high profile tip-of-the-iceberg in respect of market abuse and manipulation. Ramping (and liquidation) for periodic performance fees and bonuses and corporate window dressing, insider trading, pump-and-dump, (or the inverse of bear-plunging) re all prevalent. To combat, I've an indecent proposal. which goes as follows: The exchanges and DTC & clearinghouses should be required to create and release the entire trade-by-trade data-set with ultimate customer delineation in some anonymized form. ALL shorts will be tagged as such. It can be lagged by a sufficient amount to prevent predatory short-squeezing, but it should be released in timely fashion. Options and Futures included. It should be available to any all who desire it. Researchers all over the world will be permitted to find the patterns and submit the likely errant violations to SEC, and if egregious and prosecuted, the finders would be entitled to an incentive fee of the disgorged profits, say 20% (50% in SAC's case). This would allow the market to recapture some of their lost profits. Fidelity would be as fair game as say for example, Steel Partners. I think this would result in some new financial innovation, but it would not necessarily the type that contrapreneurs would be pleased to see.

12 comments:

phoneranger said...

I am totally down with your rec to sunshine trades with some lag. Why not start by making 13fs monthly and comprehensive?

Anonymous said...

Well explained for laymen like myself who are merely viewing trading activity as purely a spectator sport nowadays.On a lighter note Leonard Cohen's song comes to mind (whose concert I am eagerly looking forward to in Las Vegas next week): http://www.youtube.com/watch?v=S0Ay4K7UOsY&feature=PlayList&p=2FF74A21E0DBF4BC

"Cassandra" said...

Anon

http://nihoncassandra.blogspot.com/2008/01/everybody-knows.html

Anonymous said...

Touché.
Any opinion as regards Silver? It seems like the gold/silver price ratio might put the stepchild in play lest a sudden pullback in gold crumples out the recently flowing new money.
Your opinion would be appreciated.

Anonymous said...

I loved the movie about Sirius XM: "Stock Shock" because it explains how the whole naked short selling stock market manipulation thing works-and how the company nearly went bankrupt. Good DVD. Amazon has it or stockshockmovie.com has a movie trailer.

Anonymous said...

Cassandra, “Fancy a pint?”

"Cassandra" said...

Phoneranger - There is no time urgency and lags are fine. The additional frequency would be useful. Sunshining the actual time&sales (per Canadian SEDAR) to me is more important since it will show WHO is goosing what and when, and MOST IMPORTANTLY FOR INVESTORS IN SAID FUNDS, SHOW THEM WHO IS STEALING FROM AND GAMING THEM FOR PAROCHIAL OR PAROCHIAL CORPORATE BENEFIT IN VIOLATION OF THEIR FIDUCIARY REPONSIBILITIES. Like fearing the omniscient eyes of one's preferred deity, sunshining this information will go a long way to keeping potential strayers honest for fear of consequences with proper enforcement. "Plausible deniability" then becomes the operative phrase, but the threat to one's business by accusations by authorities should be sufficient.

Anon - I really have no opinion on the Gold/Silver ratio. Since the same thing/people/pheoms are driving both, technical structural factors will dominate. I suppose with Paulson/Tudor/Einhorn etc. long gold and conspiring to see it/talk it higher, silver will be dragged along by punters.

Anon-Haven't seen stock shock

Anon- usually up for a pint if you;re in my region (msg via email...)

Anonymous said...

Cassandra,
You say "technical structural factors will dominate",so are you in the Jim Rogers/Peter Schiff camp that tends to parlay the elusive dollar collapse scenario against inflation protected hard assets?
I am thinking of getting a regular ID to post as the Anon category is getting crowded.

"Cassandra" said...

Anon - the flip-side of dollar-collapse/inflation is generally believed to be so-called inflation-protected hard-assets. They are/will provide a [temporary] hedge against the former. IF this is what schiff/rogers suggest, I don't argue against it though I think asset markets are more connected, and there are many assets that provide forms of the same temporary inflation-protection. But you must someone learned like Mencius Moldbug for an opinion on the Gold Silver ratio. I only observe that if BOTH are driven my unforecastable and fickle spec demand there is no way to gauge any kind of absolute or relative equilibrium for either. What I meant by technical/structural was that perhaps Gold is more readily loanable than silver, or that some large investors Paulson/Tudor seemingly prefer Golds higher value/lower storage costs so this demand might distort the ratio punctuated by conversion during corrections or bargain hunting for as long as elevated demand for precious metals is at the fore.

Pat Shuff said...

Bug's prison penpal Marty 'frames' the gold market structural underpinnings in his IBM-Selectric iconoclastic way. Mandelbrot declines to aver, unsure if reduction of bloomin' buzzin' natural world confusion to elegant mathematical formulae applies to irrational hominid
actions. Burns disputes while agreeing with both, finding all Gang aft agley,
An' lea'e us nought but grief an' pain,
For promis'd joy! I'm with Burns, 1st degree.

http://www.martinarmstrong.org/files/GOLD-5000-11-11-09.pdf

Prison interview.

http://economicedge.blogspot.com/2009/10/new-yorker-piece-on-martin-armstrong.html

Much thanks for the origins of queasing
and delving into its Orwellian patinas.
Swiss chose 'forceful relaxing', different PR firm maybe.
Also the detailed explication of Creswell's crimes.

Safracide is painless it brings on many changes.

-Hotlips

She's not a real nurse.

-Ted Maher

Neither is he.

-Nurse Ratched

I feel so much better now.

-McMurphy

Just an uneducated retired nobody of dime-a-dozen story on a side street over yon. Uneducated is probably key,
no inside, outside, any side of a box, they couldn't give me one, some people just ain't got no class.

Pat Shuff said...

Err, Cresvale's.

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