Is Goldman's Selective Trading Disclosure A Legal Way For Preferred Clients To Front Run The Market?
Zero Hedge has long been discussing the impact of selective informational disclosure, be it in the context of trading or research asymmetries, which promote a two-tiered market, where privileged accounts of major broker dealers receive "tips" ahead of "everyone else." The quid's pro quo is that these "privileged" few end up executing the bulk of their trades with the broker-dealer, thus ramping up riskless agency revenues. In essence the clients' capital risk is mitigated, while the return to the "perpetrator" is augmented by collecting a disproportionate share of the bid/offer spread in the given security. Whether this tiering mechanism occurs via Flash orders, SLP provisioning, actionable IOIs, advance selective notice of a large flow order, a phone call, a limited Bloomberg blast, or an Instant Message, the ethics of the practice are undoubtedly shady, and potentially borderline criminal. But no one is the wiser, as both sender and receiver of information know to keep their mouth shut. Until today, when the WSJ blows one aspect of this practice out of the water, by focusing on Goldman's selective informational disclosure to preferred clients, and is likely to create much more headache for Goldman's PR department and its staunchest CNBC-based prosecutor-turned-supporter and soon to be Sellout author.
In a long-overdue article titled "Goldman's Trading Tips Reward Its Biggest Clients" author Susanne Craig brings much of the firm's dirty laundry to the front page. While a must read for anyone interested in how Goldman Sachs "cultivates" its key client relationships, the summary is as follows:
Goldman Sachs Group Inc. research analyst Marc Irizarry's published rating on mutual-fund manager Janus Capital Group
Inc. was a lackluster "neutral" in early April 2008. But at an internal
meeting that month, the analyst told dozens of Goldman's traders the
stock was likely to head higher, company documents show.
The next day, research-department employees at Goldman called about 50
favored clients of the big securities firm with the same tip, including
hedge-fund companies Citadel Investment Group and SAC Capital Advisors,
the documents indicate. Readers of Mr. Irizarry's research didn't find
out he was bullish until his written report was issued six days later,
after Janus shares had jumped 5.8%.
This pretty much summarizes the "magical" performance that many hedge funds generated in Wall Street's golden age: Goldman (and other firms, many of which however now are defunct) treated several clients preferentially, creating a "club" in any given name, running it up, then releasing what the club already knew to the broader investing public, as the club unloaded its positions to the witless majority. And this went on for many years, and in many aspects, still does.
Critics complain that Goldman's distribution of the trading ideas
only to its own traders and key clients hurts other customers who
aren't given the opportunity to trade on the information.
Securities laws require firms like Goldman to engage in "fair
dealing with customers," and prohibit analysts from issuing opinions
that are at odds with their true beliefs about a stock. Steven
Strongin, Goldman's stock research chief, says no one gains an unfair
advantage from its trading huddles, and that the short-term-trading
ideas are not contrary to the longer-term stock forecasts in its
Not contrary indeed, just useful, selective, tongue-in-cheek hints that provide a 10% front-running riskless arbitrage to those lucky enough to trade hundreds of millions of [stocks/bonds/CDS/options/fx/treasuries/munis] with the 85 Broad Financial Holding Company.
Ed Canaday, whom Zero Hedge respects very much for always proferring accurate and unspun information, is prompt in explaining this situation:
Goldman spokesman Edward Canaday says the tips are "market color" and
"always consistent with the fundamental analysis" in published research
reports. "Analysts are expected to discuss events that may have a
near-term or short-term impact on a stock's price," he says, even if
that is a different direction from an analyst's overall forecast.
Goldman's published research reports include a disclosure that
"salespeople, traders and other professionals" may take positions that
are contrary to the opinions expressed in reports. But the firm doesn't
disclose the trading huddles.
Mr. Canaday says analysts are told that any comment at a meeting that
could result in a change in a rating, earnings estimate or stock-price
target "must be published and disseminated broadly to all clients." He
adds, however, that it is rare that tips arising from the meetings
reach that threshold.
Rare, last time we checked, had a special judicial meaning, that was almost on par with never. But not quite. Mr. Canaday elaborates further:
The tips usually go to top clients who have expressed interest in
having the information and have short-term investment horizons, he
says. Goldman doesn't want to overload other clients with information
that isn't relevant to them, he says. "We are not in the business of
serving thousands of retail customers," he says.
Indeed- the firm is purely in the business of making sure the several dozen multi-billion hedge funds it does serve make practically risk free returns by taking advantage of the gullibility of John Q. Public, who is not relevant enough to be addressed by Goldman's massive trading floor, yet whose bail out is more than welcome when the firm's stock price is in the mid $50's, and about to hit $0.
So what does the law say about this:
"The spirit of the law is twofold," says Eric Dinallo, who in 2003,
when serving as a deputy to former New York Attorney General Eliot
Spitzer, helped negotiate a $1.4 billion stock-research settlement with
10 major Wall Street firms, including Goldman. "Analysts should give
consistent advice to all their customers, be they small investors or
big trading clients." Any views that differ from an analyst's published
rating but are "worth sharing with certain customers," he says, should
be made "available to everyone."
Mr. Cuomo, we hope you read this (we know you are).
Yet, most entertaining, in this little transgression is the presence of who else than the Federal Reserve:
The research business is considered a loss leader at most firms,
despite persistent attempts by Goldman and other securities giants to
squeeze more revenue from it. Goldman was looking for a leg up on
rivals when it started the trading huddles in 2007. That year, Goldman
ranked ninth in Institutional Investor magazine's annual list of the
best equity analysts, as determined by a survey of big institutional
investors. Goldman was rated eighth in last year's competition.
The huddles began in earnest around the time Goldman's research
department got a new boss, Mr. Strongin. He came to the firm in 1994
from the Federal Reserve Bank of Chicago, where he had been director of
The great confluence of the two greatest things in the world, the Fed, and Chicago-style goal pursuit, sure got the job done:
Mr. Strongin, 51 years old, set out to improve Goldman's research
operations. The firm asked important clients for suggestions. One idea
that took hold was giving certain customers and traders more access to
The idea was controversial with some Goldman research staffers. "I
am not sure we should be giving recommendations that go against our
research," said one Goldman employee at a meeting where the trading
huddles were discussed, according to one attendee.
Institutional memory truly is short - certain customers getting privileged information a mere 4 years after the settlement: have we gotten your attention now Mr. Cuomo?
So just who are the proud nominees of Goldman's insider club:
Documents reviewed by the Journal indicate that anywhere from six to 60
clients are contacted, depending on the investment. For example,
clients specializing in financial stocks are given recommendations
about that sector. Each call typically includes comments about the
overall market and the kinds of investors Goldman believes are
propelling it, and ends with a stock tip.
And lest someone think that Goldman's ubiquitous prop trading group is somehow exempt from benefiting in this backdoor arrangement, read on:
The meeting where Mr. Irizarry suggested that Janus shares were
worth buying, held on April 2, 2008, was attended by Goldman's
financial-research analysts and traders who handle customer orders. It
also included another class of traders called "franchise risk
managers," who sit with and advise the traders handling customer orders
-- and make bets with Goldman's money.
Typically, traders who wager firm capital are walled off from those
handling customer orders so that they don't take advantage of
information about client trading, which securities regulations forbid.
Goldman says its franchise risk managers don't trade on client
information and must first share trading-huddle tips with clients
before acting on the tips themselves.
"Typically", just like "rare", are two of legal counsel's favorite expressions. But at least we have Goldman's affirmations that everything at the big firms runs according to regulations. After all, in numerous prior transgressions that company has "neither admitted nor denied guilt" - why should this change now?
And as for the regulators: it is good to know that at least they are on top of this scheme.
Last year, the Financial Industry Regulatory Authority, the
industry's self-regulatory body, proposed new rules meant to clarify
existing disclosure obligations under the rule requiring "fair dealing"
with all clients. Firms could issue contradictory ratings as long as
clients were told that such inconsistencies were possible.
A Finra spokesman said the agency still is reviewing comment letters
filed in response to the proposal. Goldman hasn't commented on the
Surely, upon reviewing the numerous comment letters, Finra will have something relevant to say on this practice...at about the time the recently issued 30 Year Bond matures.