I Didn't Mean To Steal From You

Polite applause for the Financial Services Authority who upheld their April decision which found the now-Swiss-based Stefan Chaligné, manger of the near $130mm Iviron Hedge Fund, guilty of market abuse for his Dec 31st 2007 gratuitous ramping of US and European shares held in his portfolio. He was, the FT reported, fined GBP900,000, ordered to repay profits/fees resulting from the umm... errrr ..... [shenanigans, tomfoolery, charade, escapade, peccadillo] (please choose one), and banned for life from the UK Securities Industry. Mr Chaligné, it would seem, in the last hours, of the last day of the performance measurement and crystallization year, simply could not resist the temptation of buying more of that which he already owned, in sizes which - relative to exchange volume and liquidity - allowed him to his goose performance by nearly 300bps. ***Sigh*** It was not reported precisely how it came to the FSAs attention (the SEC? NYSE? Whistleblower? Jilted mistress or ex-wife) nor whether or why US authorities, too, who might wish to make a statement about the integrity of their preserve, have not sought similar charges or prosecution being that the sins certainly ran afoul of US securities laws forbidding the creation of false and misleading markets. 

Yet (polite) applause is still in order, I think, if for no other reason than because the FSA bothered to follow through at all on an ostensibly small, though apparently blatant case of abuse. This view is not setting the bar of justice (no pun intended) very high, but since such abuse is more-than-rampant, it is a signal to traders that they DO (however remotely) risk losing one of the best gigs in town if they are caught, not that this even is the end of the world since like Mr Chaligné and other before in similar predicament, can simply pack-up and move to, say, Geneva.
I emphasize "polite" because, according to the FT, in the appeal ruling, the three-member panel were willing to agree with Mr Chaligné that he "probably" wasn't trying intentionally to cheat his investors - apparently on the grounds that most were friends and family as well as himself. In the decision they say (to paraphrase) despite his obvious lying and willful neglect of civilized behaviour and the rule of law, it was insufficient to categorically brand him a sociopath whose intention was to profit at the expense family and friends, because (get this): what kind of guy would intentionally steal from his friends, family and self??!?. Well, where does one start with THAT one. 
First, what are family and friends to a sociopath? Not much besides cannon-fodder one would be forgiven for surmising. Perhaps his allowance was too small for his lifestyle. Perhaps he had penis-envy of the bigger-swinging dicks. Who knows. But, we do know that the fact of the matter WAS that he directly stole several hundred thousand euros. One can infer that he was below high-water mark before the ramp, since IF he was positive for the year with no hurdle, the theft would have been nearer to EURO 600,000. His argument thus may have been predicated upon the fact as he was on the wrong side of zero, and since he didn't have profits, he couldn't have been intentionally trying to steal money from them. But since he earned SOME performance fees as a result (but not 20%-like fees on a 2.7mm goosing) the ramps must have swung the fund from loss to profit for the year as a result. I think this is a bullshit excuse, and am surprised the FSA saw some merit to leave open the possibility it was somehow unintentional.

Second, the FSA only demanded he pay back investors the fees he dishonestly earned by ramping the shares. Sadly for his family, and his perhaps his now-former-friends, they likely lost a tidier sum on the difference between his average cost in and average cost out in addition to transaction costs and additional management fees charged on the subsequent, inflated, beginning of period assets. Experience suggests that the market can spot such ramps a mile away and unless it is one's intention to continue to buy gobs of stock, reversion will be short and sweet and without the ramper being able to liquidate his/her position. He should have been made to pay FULL restitution of imputed losses to investors. Mr Chaligné also asked that fines be directed to investors in the fund (himself!), and this is, again, absurd. Any fines should defray the agency's costs in pursuing the matter, for the market integrity which benefits the public interest, full-stop.
Third, he used the lamest excuse - i.e. the "Dog Ate My Homework" alibi, which in this case was that he was fearful that "his stocks might come under attack by short sellers". WHAT??!?? This is laughable, and in itself should cause he FSA to quadruple penalties and disregard any potential goodwill. Primarily because IF that was, in fact, a concern and not a completely irrelevant and oxymoronically bogus factoid, then the broker could have been given a limit order to maintain price, and IF the price DID come under attack by nefarious aliens or black-hats lurking and conspiring against his stocks, to support it, rather than sending it scurrying up the flagpole resulting from an order that specifically instructed his brokers to put the stocks up as much as possible. Second, even if we ignore this, as vigilantes are frequently told: two wrongs do not make a right. An experienced fiduciary - of the non-sociopathic variety - takes advantage of short-selling attacks to buy stock cheaper, and do it scale-down AT THE CHEAPEST PRICES. They then explain to their family and friends how smart they were buying stock CHEAP at the end of the year, rather than buying it at ever-upwards in a thin market, at prices that will certainly bugger them (financially). And then there is the chestnut about the quantity. IF the intention was to prevent getting devalued at year-end by short-sellers, there was no need to give orders of magnitudes of prevailing liquidity - especially on New Year's Eve, Dec 31st, typically a half-day of trading. It is uncertain why the FSA gave him the benefit of what should have been, beyond the shadow of doubt.

But what has NOT been contemplated, and the truly pernicious act of systematically painting a false and mis-leading market is the potential impacts the deception (not theft but deception) would have upon the decisions and perceptions of both present and future investors. As you may remember, this was the basis for the first 'shot across the bow' by regulators to Hank Greenburg at AIG (and which should have sent AIG shareholders scurrying for the exits). AIG for a decade traded at a large premium to other insurers and reinsurers because of its smooth earnings growth and, perhaps more importantly, its better-than-market underwriting results, which gave credence to its claim that it was a better, smarter and more disciplined underwriter. We now know they were managing (read intentionally smoothing) their earnings. And they were busted for this. But Hank was unrepentant. He implied it was NOT a sin because he didn't steal from investors - just moved earnings from one period to another, a common act in the insurance world (which AIG and Warren Buffet would help facilitate for you for a price). But you see, AIG was also using such unsavoury methods to transform the nature and characterization of earnings by turning underwriting losses into investment losses. So this wasn't understating earnings to save for a rainy day - the way reinsurers have operated since time began - but intentionally trying to fool all the insurance analysts and rating agencies and investors in order to convince them that AIG was better than they actually were. This illusion of quality likely caused much over-investment in AIG at higher-than-was-justified prices, and probably allowed them finance themselves at basis points less than might have otherwise been possible and grow at rates higher than otherwise possible. A seemingly small white lie causing large malinvestment. In fact, one might argue further that IF AIG had been seen as the not-so-special underwriter that they were, they might not have been able to insure the amount of subprime which they did. OK, these are a lot of ifs, but it IS a slippery slope in the descent towards insolvency. Or between increasing investor allocations or the liquidation of your hedge fund.

Mr Chaligné of course is no Hank Greenburg. And stealing from friends and family may not, after all, have been the primary objective. But the FSA should be chided for leaving the door open that it might have been vanity, when the very obvious greater sin went uncommented upon which has the grail of boosting performance to grow your business to entice more investors to give you their capital on the basis of that performance (and risk deception) which is, in the view of this investor, forever unforgivable.