On Friday, we reported that in the latest in a long series regulatory crack downs of low grade high frequency traders - because obviously nobody will touch the big boys - the "SEC busted HFT firms for "tricking people into trading at artificial prices." What is notable is that the owner of one of the charged firms, Joseph Dondero who was the head of Visionary Trading, and who agreed to a $1.9 million settlement and to be barred from the securities industry for spoofing order flow which is a low-grade form of quote stuffing, has had an extended track record of run ins with the law.
As BusinessWeek reported back in 2007, according to NASD records Dondero was the subject of the regulator's inquiry letters because of "wash" trades, among other things. Wash trading is when someone buys and sells the same security simultaneously—or in quick succession—to create the appearance of active trading. It can be done to generate commissions for a broker or for tax purposes. This is quite comparable to the "spoofing" which Dondero was busted and barred for at his latest firm, Visionary Trading.
BusinessWeek adds that the New Jersey Bureau of Securities records pertain to Dondero's time at a day-trading firm in Iselin, N.J. called Evolution Financial Technologies. The records say that, "As a result of his trading activity, Mr. Dondero was on heightened supervision and probation which resulted in his changing from a proprietary trading to a customer. This did not involve customers or a loss." Dondero, who attended the College of New Jersey until 1999, has worked at a series of small financial firms. One of them, Heartland Securities, was sued by the Securities & Exchange Commission for alleged stock manipulation and falsifying records. Heartland closed in 2003 after two executives, Sheldon Maschler and Jeffrey Citron, paid $29.2 million and $22.5 million, respectively, without admitting or denying wrongdoing. (Citron went on to found the Internet phone company, Vonage Holdings (VG)). Dondero was at the firm after the alleged wrongdoing, but before the settlement.
Needless to say, Dondero had quite a "track record" of illegal trading activity before he was finally busted for one last time engaging in HFT spoofing.
However, it is not his FINRA brokercheck record that is of interest, but the fact that back in 2007, in the first ever CNBC Million-Dollar challenge, it was none other than Dondero who almost won. And yes, he nearly manipulated his way to the $1 million prize money then too. Only, the way he did fudged his winning percentage was not as most other competition participants had, by abusing the widely known system glitch that allowed contestants to see which stocks were rising in after-hours trading and then to buy those stocks at the lower, 4 p.m. EST closing price, but using a far more devious scheme. One which is reminiscent of the crime that last week just ended his trading career in the real world as well.
[Dondero's] trades drew criticism from other finalists, nonetheless, with at least three contestants complaining about his choices early in the final round. Because Dondero was picking thinly traded stocks in the CNBC contest, the other finalists worried that he could be manipulating the prices of those stocks in real-world markets. "He only picked stocks that could be manipulated," says Jim Kraber, one of the finalists who says he flagged CNBC. Kraber emphasizes that he has no way of knowing whether Dondero was indeed manipulating stocks.
CNBC took somewhat-belated action to prevent such manipulation. BusinessWeek has learned that on May 18, midway through the final two-week round of CNBC's contest, the cable channel asked each of the 20 finalists to sign a statement that any real-world trades they made were not "for the purpose of, or with an intent to, affect or manipulate the price" of the stocks they were picking in the contest. The penalty for failing to sign was stiff: "If you fail to return the attestation or your attestation is not truthful, you may be disqualified from the contest," wrote CNBC Vice-President of Marketing Tom Clendenin in an e-mail.
A close examination of Dondero's trading in the CNBC contest raises questions about his approach, but offers few definitive answers. The primary concern of other finalists was that Dondero was buying stocks in his CNBC portfolio and then driving up the price by buying the same stocks in the real market the next day. That's easier to do with thinly traded stocks than heavily traded ones. Dondero did pick some thinly traded stocks, but not all of those trades were successful. He also made other kinds of purchases that contributed to his portfolio returns.
In the final round of the CNBC contest, Dondero saw nice gains on picks of BioProgress (BPRG), a British pharmaceutical company, and Hanarotelecom (HANA), a Korean telecom company, which both trade on Nasdaq (NDAQ).
On a typical day, neither stock sees much action in the real world. BioProgress trades an average of 3,100 shares a day on Nasdaq, while Hanarotelecom averages 7,400 trades a day. But both saw huge jumps in volume in the days after Dondero picked them. Hanaro soared from close to 19,000 shares on May 14, to well over 27,000 the next day. Dondero realized a 6.4% gain for his contest portfolio, as the stock rose. The following day, when Dondero chose BioProgress, more than 5,000 shares changed hands, compared with zero shares the previous day. Again, Dondero saw a healthy gain of 4.5%.
In retrospect a brilliant strategy: picking microcap, illiquid, and ultra-thinly traded stocks in a virtual portfolio and then manipulating these stocks in real life using oddblocks to reap giant profits, without much capital at stake (so unwinding the trade wouldn't cost him much in the end), then rinsing and repeating, all the way until the $1 million prize.
To be sure, Dondero was smart, and inbetween the manipulated blocks, he injected some normal-course winners and losers.
But Dondero didn't always make money on his thinly traded stocks. On May 21, he again picked BioProgress, and again volume spiked, this time to 23,000 shares from 1,400 the previous day. But Dondero lost 2.64% on the trade.
Other thinly traded stocks Dondero picked included Velcro (VELC), the famous fastener maker, and Macronix International (MXIC), a Taiwan-based manufacturer of computer memory. Neither were big winners for him in the final round.
Indeed, Dondero's biggest winner during the finals was Fremont General (FMT), the subprime mortgage lender whose stock trades an average of 4 million shares a day. Dondero picked the stock on May 22 and after the market closed that day, the company said that it would sell its commercial real estate business for $1.9 billion. The news drove shares up 26.7%, a huge one-day gain in the contest.
Of course, when one strings a series of 9 "sure" winners in a row, the 10th one is not nearly as relevant, and can be left to chance, especially if it is subsequently used as the alibi to claim Dondero never cheat or manipulated the game. And speaking of manipulation, 2007 appears to have been one of the last years in which CNBC actually cared about something called "integrity":
Dondero's picks in CNBC's contest could be examined as part of the cable channel's investigation into "unusual trading." Beyond looking at traders who may have benefited from its own software glitch, CNBC says that it has retained an "independent securities expert" to look into allegations of market manipulation. CNBC declined to comment for this story. But it previously said, "Integrity is paramount to CNBC. We are taking all allegations of improprieties very seriously."
Whether it did or not is unclear. Dondero finished fourth in the contest with a total 32% return, while some or all of the contestants above Dondero were likewise accused of rigging the competition.
But the final outcome was negative: Dondero did not win, and whatever capital losses he may have suffered while "spoofing" the thinly traded stocks he used as picks for his virtual portfolio he had to fill out of his own wallet.
Incidentally, the winner of that particular CNBC stock-picking challenge: it was an Ohio waitress who had never bought a stock in real life.
We wonder which HFT shop she works at now?