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.