JP Morgan's Insider Trading How-To On Wikileaks

An anonymous reader writes "In an internal JP Morgan document published recently, Wikileaks exposes JPM's efforts to circumvent insider trading regulations, enabling their wealthy clients to profit even when others are losing. The document reads like a how-to and explains how to take advantage of SEC Rule 10b5-1, which has long been considered ripe for abuse. Now this abuse is publicly documented and will be hard to ignore."

Comments

Not a "leak" ?

[aleph42]

It should be stressed that this leak is not, in fact, revealling illegal activity. I even doubt that Wikileaks made it public; I mean, they must have some kind of advertisment or at least a publicly available description of this service, no?

If it was already public, then it's interesting for the process of defining the role of Wikileaks: here, it's role would be to raise awareness rather than reveal, which means acting like a news site.

Personaly, I think that Wikileak should not stride from it's original goal: when you're run anonymously, you must keep close to your original description; it's the only kind of accountability you offer.

Re:Not a "leak" ?

[sed quid in infernos]

The SEC was very aware of this situation. They explicitly OKed this activity in May 2001:

After the written trading plan described in Q&A 11(a) has been in effect for several months, the person terminates the selling plan by calling the broker and canceling the limit order.

(a) Does the act of terminating a plan while aware of material nonpublic information result in liability under Section 10(b) and Rule 10b-5?

No. Section 10(b) and Rule 10b-5 apply "in connection with the purchase or sale of any security." Thus, a purchase or sale of a security must be present for liability to attach. See Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723 (1975).

Re:Not a "leak" ?

[nycguy]

The SEC is aware of the problem. It doesn't take much link-following from the original post to find this speech by Linda Chatman Thomsen of the SEC.

Putting that aside, the fact is that regulations rarely have their full, intended effect, especially on the first go. If you read the aforementioned speech, it's pretty obvious that the SEC is trying to do the right thing: Allow executives (particularly founders and other holders of large percentages of stock) the ability to sell those shares on a pre-determined schedule, unencumbered by any insider information they have at a given time during the execution of that plan and unconcerned about the way the market would view the sale, since it had been planned and announced far in advance. For someone with a large percentage of stock, the ability to trade out of that position smoothly over time is critical, since any large sale would be disruptive to the market, and frequent small sales would likely be difficult due to the fact that they might coincide with the common circumstance of having insider information.

The problem, of course, is while the executive is not supposed to initiate the sales plan based on insider information, that same executive may cancel a sale or withdraw from the plan entirely based on non-public, material information. In doing so, they create a bias in that their sales that were initiated would be expected to perform "better than average", since any sales that would have performed "worse than average" are more likely to have been canceled. Such a bias is precisely what academics found and is referenced in Thomsen's speech. The SEC can then amend/interpret the rule so as to close any loophole. Such a process may go through multiple iterations before all the holes are patched.

In terms of the Wikileaks article itself, there are a few problems: First, it is not just "small investors" who are hurt by this. Any investor, small or large, who is not an "insider" would be disadvantaged by such activity. There's no need to be a populist to see the potential for abuse here. The second problem is that it is JP Morgan's fiduciary duty to offer the best product available to its clients, including taking advantage of the specifics of SEC regulations, if necessary. Of course, this particular opportunity is available only certain, very wealthy insiders, but that's the circumstance that the SEC created, not JP Morgan. This situation is no more unethical than Mercedes or Volvo building a "safer" automobile that is only available to those wealthy enough to afford it--and it carries the same hazard for others, actually, since a "protected" driver may be more reckless and endanger other drivers.

In short, there's no need to get bent out of shape when a necessarily imperfect law or regulation is exploited to someone's advantage. This is just what people will do in any system. The only solution is to keep in mind unintended consequences and improve the framework that one has for the future.

Re:Not a "leak" ?

[sed quid in infernos]

May 2001 - that would be four months after George Bush, Jr., went into the White House.

Ah, the great tragedy of Slashdot-the slaying of a beautiful political screed by an ugly fact. (With apologies to Thomas Huxley.)

The first SEC commissioner appointed by Bush to the SEC was Harvey Pitt on August 3, 2001 - more than 2 months AFTER this ruling issued. Every SEC commissioner at the time this decision issued was appointed by Clinton. Even if lower-level Bush appointees were involved in drafting the answer, the commissioners could have stopped this from issuing.

They didn't, most likely because they couldn't. The Supreme Court decision at the root of the reasoning has been in place since 1975. This must be corrected legislatively, either by removing the predefined plan affirmative defense entirely or, more likely, by making the revocation of such a plan an event to which liability can attach.

Re:Not a "leak" ?

[Glonoinha]

Here's the deal : the law says that an insider can submit massive buy or sell orders if he does not know anything (ie, no insider knowledge of events that will affect the stock price.)

Insider has tons of company stock.
He structures a massive recurring sell order, sell as much as possible, to hit every month - does this a long time ago (or now, setting it up for years to come.)
He doesn't know what the future holds for his company, so it's perfectly legit.
Every month he calls in and cancels his sell order. This is also perfectly legit.
Stock goes up, slowly over years. He still has it because he keeps calling in to cancel the sell orders he arranged years ago.
A few years from now something really bad starts brewing for his company - he gets insider knowledge that the stock price is going to die in a few days (ie. Bear Stearns this week)
He conveniently forgets to cancel this month's sell order. The pre-arranged sell order goes through, he sells his entire holdings at the current high price.
The next day the 'bad thing' happens and the stock price tanks - he's all set, sold all of his before it happened.
The entire thing is legal because the law only restricts buy or sell orders based on insider knowledge - it doesn't prevent him from not canceling orders that were placed years before.
Profit! Sucks ass, but it is a perfectly legal loophole in the law.

And I agree - time to close the loophole. The visibility brought to the issue via wikileaks ... may just start the ball rolling on doing exactly that.

Re:So what's the problem with insider trading anyw

[Shihar]

You can't entirely "withhold" the information. If the CEO of a company suddenly dumps stocks in his own company, that should be a signal that something is up. The whole point of a stock price is that it moves with the financial viability of the company. There are in fact legal ways for a CEO to go ahead and sell of his stock based upon insider information, but there are a pile of loops he has to jump through and the move needs to be made public. This isn't a bad thing. Simply by selling stock you cause the price to fall. If you are selling stock because you know the price will fall in the future, you are actually evening out the eventual drop and making it take place slowly over time rather than suddenly all at once.

All trading that isn't done with a coin flip is "insider trading" to some small extent. If you think you see a pattern in the markets and make a trade, your trade is only worth something if everyone else hasn't already spotted that same pattern. In a sense, you think you have information that other people don't and make a trade based upon that information. This is what Milton Friedman is talking about when he says that insider trading is good.

There are real issues with insider trading, but it isn't necessarily true that all insider trading is bad. It is one thing for a CEO to declare he is about to make a trade based upon information he has. It is another entirely to make a trade in secret and then make some sort of move with his company to capitalize upon that trade at the expense of the company.

Re:Legality and the Jewish tradition

[Anonymous Coward]

There is a long tradition in the Jewish faith of following the letter of the "Law" and finding new and clever reinterpretations of the Law to fit the time and place. One very blatant example is the redefinition of the "eruv". The Jewish God declared that no work could be done on the Sabbath, except within the home.

Ummm, no. Aside from the fact that you sound like an antiJewish nutcase, the story of Genesis describes that God rested on the seventh day. Many religions don't engage in work on the sabbath. Not that long ago, it was illegal in many parts of the USA to work on sunday. In many parts of the world, it still is illegal to work on the sabbath.

Further, God said nothing about working in the home or not working the home. In Judaism, all work is prohibited on the sabbath, regardless of location.

Finding God's Law to be a bit confining, the Jewish religious leaders redefined "the home" to encompass a much larger area through the creation of the eruv. Now, work may be done anywhere within an eruv since it is considered to be "the home", though it is hard for anyone with common sense to understand it as such.

Absolutely not. Religious Jews do not work on the sabbath (with one major exception: you are allowed to save a life, so medical doctors & ambulance drivers are ok).

Now, what does work mean? Is it gainful employment? Cooking? Driving? It's not a trivial question. So, the wise Rabbis discussed and debated this question a long time ago. They came to the conclusion that there are 39 categories of work that are prohibited on the sabbath.

One of the categories of prohibited work is carrying. You can't carry an item to your neighbor's house. Does that mean that you can't carry things in your home? Can I carry a plate from the kitchen to the table? Well, you can do that. So, what is a home? Is it your apartment? Your apartment building? Your house? Your house and yard? If you have a large plot of land, can you carry in your large plot of land? Yes. What defines a plot of land? A plot of land has some indication that is marked off and separated from the surrounding land. So, if you had a fence, or marking stakes that would indicate that this was a contiguous piece of land. A long time ago, you would stake a claim to land by physically marking it off with stakes and twine. That is an Eruv.

So, if an Eruv is in place, it is indicated to be a contiguous piece of land, and you can carry within it on the sabbath.

RTFM(emo) -- Overhyped, Misleading

[cfulmer]

First, didn't the OP read the stinking memo? It's all about hedging against the risk that the price would fall -- it doesn't really say anything about canceling the 10b5-1 plan. This is just jumping on the "Corporate Executives are Bad" stereotype.

Secondly, 10b5-1 has not "long been considered ripe for abuse." There is a very narrow factual scenario where it could allow an insider to make money off inside information. But, it's difficult.

Here's the problem: insiders cannot trade stock if they possess non-public material information about a Company. When a corporate executive receives most of his compensation in stock, this is a problem for him, since they often have non-public material information.

So, to solve that, the SEC came up with rule 10b5-1: at a time when you don't have that sort of information, you can set up a future trading plan where you tell your broker "this is when you buy; this is when you sell," and that's the end of your input unless you cancel the plan. The existence of the plan is made public.

And, that's the narrow place where you can escape the insider trading rules: if your plan calls for you to sell some stock, but you know that the price is probably about to rise, you can just cancel the plan and hold on to those shares. Even though you didn't actually trade, the decision NOT to trade was based on inside information.

Now, the executive still has those shares, and so he needs to create another 10b5-1 plan, which (again) is made public. However, now the SEC questions whether either plan was "entered into in good faith and not as part of a plan or scheme to evade" the insider trading rules. As a result, trades made under either plan can be called into question.

The end result is that by canceling a trade under a 10b5-1 plan, the executive makes it much more difficult to ever get rid of his stock.

Re:RTFM(emo) -- Overhyped, Misleading

[mgblst]

Maybe you could read up on shorting stock. It has been quite popular for the last few years.

If you know a stock is going down, you can sell it now, and but it later, when the price has gone down. This is called shorting. You don't own any stock, so there is no need to setup another sale, as you mentioned. You can just arrange to do this in a few months, then when you get no bad information coming in, you cancel the sale, thus having nothing to repay. You can set these up every month of so, at no loss of stock and a small fee, and only make rewards when you now something bad is coming along.

Re:So what's the problem with insider trading anyw

[TubeSteak]

All trading that isn't done with a coin flip is "insider trading" to some small extent. No it isn't.
"insider trading" has a very specific meaning as far as the SEC is concerned.

Here's what the SEC has to say about insider trading:
http://www.sec.gov/answers/insider.htm

This is what Milton Friedman is talking about when he says that insider trading is good. No it isn't.
Milton Friedman is talking about exactly the same kind of insider trading the SEC is.

If Friedman had his way, there would be no SEC regulation of insider trading, because he believes that insider trading introduces information to the marketplace as soon as it becomes known to the insiders. OTOH, the SEC isn't so keen on allowing this to happen.

Re:So what's the problem with insider trading anyw

[Anonymous Coward]

The problem lies in where you say:

"The benefit of insider trading is information enters the markets quicker. That is good for me."

This, as one might immagine of such an overarching and glib statement, is not true. Here are a few examples of situations where you get information faster but lose:

You are at a poker table, and the man accross from you is allowed to peak to see what the next card delt will be. By observing whether or not he folds, the information of how good a card that was for him reaches you faster ! But you somehow leave the table poor.

A local government official knows in advance where a new highway exit will be placed, condeming some houses and increasing the values of others. By watching looking up his real estate purchases in the deed office, you know also ! But he already bought all the good investments.

You are sitting in the audience of a company wide meeting of Enron in August of 2001. Your company officers are asked by someone in the audience how much of a person's 401k plan should be in Enron stock, and the giggly blonde former secretary who married the CEO and somehow got promoted says "all of it" and her husband nods. Somewhere in the efficiency of the stock market the signal that the CEO was dumping his stock was there, but you still ended up carrying your belongings out of the building in a cardboard box on Dec 24th, 2001.

The problem, in allowing insider trading, is that the stock market needs more money than just insiders and Milton Friedman cultists to operate. What if ordinary savers and investors, not afflicted with Friedmanism, knew there was insider trading and thus decided not to by stocks ? Surely you don't expect the likes of Ken Lay and Ivan Boesky to use only their own money, do you ?

A ban on insider trading is necessary to get people of ordinary intelligence to lend money to companies, which is of such enormous general benefit in terms of an increased economy, that it cannot possibly be offset any information gleaned after the operations of a few insiders are jumbled in with the rest of the trades.

Of course, we know that in spite of the law, insider trading happens on a wide scale. The wikileaks documents from J.P. Morgan are only a small, institutionalized and organized corner of all the insider trading that happens. And the modern stock market is not particularly efficient at distributing that insider information -- supposedly there were insider trades on Bear Sterns stock last Wednesday, but by Monday morning any non-insider wakes up and finds that the stock has lost 98% of it's value.

I think your view of insider trading is just a small part of a general flaw in all of current economics: it does not distinquish between economic activity that is the result of force or fraud and activity which is not.

Let us suppose there is a community where everyone believes they have to give a tenth of their crops to the priest on the hill to make it rain. One day the priest dies and people see it still rains, so they store the 10 percent for bad times. Economists would say "holy shit 10 percent of the economy vanished" while even a Down's Syndrome kid, and many smart dogs, would say "wow our community just got much more productive".

Let us suppose there is a community in a "state of nature" where theft and robbery is common. One member of the community gets a coin, and he only keeps it until he meets the first person who is bigger than he is. Eventually the biggest person gets all the stuff, but each night while he is sleeping the quietest ones take it. One day a smart guy (i.e., has never talked to Milton Friedman) says "listen up pig fuckers, from now on you only get to keep what you earn, and only I can steal (tax)." He has family members who are strong and have weapons and are loyal to him without regards to economics. People begin to plant and save up more, because these "aristocrats" don't steal everything, unlike their neighbors. An economist would say "this is horrible, the volicity

Re:No, you are missing the point

[Forbman]

/So, first of all, what you're describing is illegal as well./

So, how exactly does Carl Icahn and his ilk make money?

Hmm... buy large blocks of stock. Start rattling board of directors that management sucks or that the company is holding too much cash that should go to shareholders. The board can ignore Icahn for only so long before its involved in a proxy fight, which usually results in Icahn getting a couple of board members placed, or Icahn figures out some other way to rock the company so that it acquiesces.

Icahn gets his extortion money either way, and the rest of the shareholders with their hands tied to the oars (i.e., execs, ESOP) or other owners might get a bump in dividends once, but long-term the company has had a major blood-letting, and they get to watch as Icahn's blocks of shares sell, but they can't get rid of their much larger shares...

Granted, not quite insider trading until he gets his puppets onto the board, but just as manipulative and damaging.

Re:The Fundamental reason this is legal

[Alascom]

However, if you schedule to sell 1000x shares of stock in 1 year under 10b5-1, then giving the seller the ability to cancel the sale amounts to nullify the entire point of the plan.

Consider this. I have inside knowledge of next years events, and I have 10,000 shares and I file a 10b5-1 saying I will sell all 10,000 shares during the next year. When the next year arrives, I "DO" have insider knowledge and I cancel the sale of all my shares. Then I file another 10b5-1 for the next year and say I will sell all 10,000 again. The next year I have insider knowledge that the company is in trouble so I sell all the stock. In effect, I have skirted the purpose of 10b5-1 plans, but still sold my stock based on insider knowledge.

The point is, I can still legally (thought no ethically) sell on insider knowledge.

Re:So what's the problem with insider trading anyw

[Apu]

Not an expert but, in my understanding... A wash sale isn't illegal in and of itself. You just can't claim the interim loss as a tax deduction.

Market manipulation is another issue entirely but that gets murkier.

RTFA, idiot

[Alex Belits]

If you bothered read the linked article you would find that:

1. JP Morgan established a whole service specifically designed to abuse this rule.
2. Service was offered to people who would profit from such abuse without any announcement to the public or regulators.
3. The article shows a specific example of service being offered to a particular person, Barry Diller, and subsequent drop in stock value that the person was supposed to be shielded from (I assume, it is not known if the service was actually used in that situation).

Now you, and two morons that were so eager to praise you in responses, can take your sorry attempt of rebuttal, and tattoo it on your foreheads in 12pt Helvetica font.

Re:So what's the problem with insider trading anyw

[Anonymous Coward]

It's really late, and I don't remember all the details, but Stiglitz won the Noble prize in economics for work on the effect of asymmetric information http://en.wikipedia.org/wiki/Asymmetric_information.

The side with more information can manipulate the situation to their advantage. Duh.

If you mother brought you up right you would recognize this as cheating. Clearly, neither your mother or Milton Friedman's mother did a very good job.

Re:I'd tend to agree.

[Vlad_the_Inhaler]

I thought they had their DNS entry blocked (but not that of their mirrors outside the US) because they did not defend themselves in court when that Swiss bank applied for the block. The same judge reversed the ruling a few days later.

Re:The loophole

[bkaul01]

Where is everyone getting this information about "cancelling"?

From TFA:

Here's how it works:

1. An insider client transfers all or a portion of their company stock into a JP Morgan Securities Inc. brokerage account.
2. The insider then develops, in conjunction with the 10b5-1 team, a 'phased, pre-planned sales program to be executed at either market or specified prices'.
3. Depending on the information available to the insider (but not the public), the insider can decide whether to execute the sale or not.

So, they enter the plan and then later, based on inside information, decide whether or not to actually execute the sale. In other words, they (in advance) make tentative plans to sell, then can cancel that before it occurs if their inside information does not support a sell-off.

Only works for stocks that drop, but that is significant when considering corporate scandals, companies in financial straits, etc.

I don't claim to know whether the article's description is correct, but it's where we're getting the idea of canceling.

*sigh*

[EmagGeek]

All they are doing here is providing a vehicle for insiders to have a "stop loss" order without the required advance notice of sale.

Yes, it is a leak.

[RingDev]

The specific document was NOT public. The act that it describes is legal, the steps used to take that action are for the most part public knowledge (although, only a very slim portion of the society knew them), but the document that was posted was a private document to be viewed by only specific employees of JP Morgan, and select clients.

Just because it's legal, that does not mean that it is not a leak. Hell, they could get a document showing that some Senator is gay, being gay is not a crime, but releasing a private document with that information in it would still be a leak.

-Rick

Re:If I may...

[Hemogoblin]

I took your advice and edited the article. If the person would like to re-edit it with proper information and better detailed accusations, then by all means they can go ahead.

In the wind.

[Fantastic Lad]

What would you rather have:

1) The Feds bailing out Bear Sterns, using the services of JP Morgan, or
2) Bear Stearns being unable to meet short term cash flows, going backrupt, and completely destroying the economy of the United States and world?

Naturally, I'm all for seeing things steady and stable. It's the larger questions which need to be examined, though.

There is every indication that the various structures now crashing, including Bear Sterns, were planned in back rooms specifically by people hoping to reap benefit from the resulting situation. Bear Stearns was crippled a year back when changes were made to its operating system. I'm not going to get into the details right now, (I'm busy as heck tonight), but take a look at what has been happening over the last twelve months with regard to how Bear Stearns borrows and lends money and certain critical privileges which were revoked; its demise has been nervously expected for quite some time, and the results we are seeing are exactly the sort of thing which people like JP Morgan were able to plan for and almost certainly had a hand in engineering. JP Morgan basically just made a huge, huge power move on the world economic chess board; These are the institutions which make up the Fed, and dictate how the Western economy works, and JP Morgan's power as a central bank, if there still happens to be a world in the next few years, will determine the shape of the Western economy for decades to come.

This kind of stuff doesn't happen without some serious scheming. --And it's apropos to keep in mind that the Great Depression may have seemed like a terrible time of want, but that for those who became the power-brokers of the last ninety years, did so as a direct result of a few small and well-positioned groups setting things up so that they could legally scoop up nearly ALL the property and material wealth in America for themselves. --Before the big crash a century ago, everybody was mortgaged and levied and in debt up to their ears, on both the personal and corporate level, just as everybody is today, and when the market was tipped, those few people ended up owning everything which they were able to re-sell at enormous profit. This is king-making stuff, and we're seeing the same scam happening again, right now. This is history unfolding, and the little people like us are expendable chaff in the wind.

-FL

Re:If I may...

[Hemogoblin]

Well that was pointless: Wikileaks reverted both my edits without an explanation, so we're stuck with a shitty article. I wonder why it's called "Wiki"-leaks if they won't let anyone edit it.

Re:If I may...

[Hemogoblin]

Ugh... the wikileak admins don't understand the the topic, so they accuse me of being an employee of JP Morgan Chase. Talk about admin abuse... I'm never using that site again.