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.