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

Oh snap!

[Anonymous Coward]

Wikileaks is on a roll!

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" ?

[esocid]

It may not be confidential information but it is however informative about the prevalence of the sort of abuse that goes on with investing. You can't tell me that you were aware of such a blatant tool designed to aid with insider trading. It may be technically legal, but 100% unethical. And even more so for an investment firm to prepare a "how-to for dummies." I'm not sure how aware the SEC is of this problem, but that may get wind of it now if you weren't aware of it before.

Re:Not a "leak" ?

[aleph42]

I absolutly agree about the fact that this information was interesting, and deserved awareness.

I am just saying that, if what they did boils down to finding the obscure *public* document or webpage which described that service, then they acted just as boinboing when it finds some cool looking roadsing in Japan: intersting, but not a leak.

And by acting as a news website, *even* as a stellarly good one, they would not be fullfying the role they claimed they would.
Which is a problem because what they claimed they would do is the only thing that serves to provide accountability to a service which GREATLY needs it.

Don't take me wrong; I think WIkileak is a wonderful thing; but because it is the embodiment of openess of information. Not because they are good at finding cool stuff

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" ?

[Whiney Mac Fanboy]

I even doubt that Wikileaks made it public;

Please point us to other places this document can be found online.

I mean, they must have some kind of advertisement or at least a publicly available description of this service, no?

All documents on Wikileaks were distributed somewhere, I don't see what your point is.

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" ?

[quanticle]

I think his point is that WikiLeaks should confine itself to highlighting illegal or unethical activities by eliciting internal documents that don't have general public distribution. I, like you don't agree with this, since, companies can often dig themselves into a hole by marketing illegal or unethical services (like this) to certain clients while trying to hide those same services from other clients.

Re:Not a "leak" ?

[afidel]

I would think that in general JP would have OTHER clients who are shareholders in the companies in question and so by facilitating a backdoor to insider trading they are unfairly enriching one client at the cost of another who happens to have insider information. This is exactly the situation that the insider trading regulations were written to eliminate.

Re:Not a "leak" ?

[SerpentMage]

It does not mean anything if they don't comment. Here are possible scenarios for JPMorgan when confronted with the document.

1) They don't comment, and people are saying, "this doesn't sound like very "ok" activity." Thus implied is that they are guilty.
2) They say it is not theirs. People will comment on how this is spin.
3) They say it is theirs, and as previously noted it's legal, yet people will say, "oh look how unethical JPMorgan is."

In each of the scenarios JPMorgan is dammed so they take the route of not saying anything which is simplest from a legal perspective...

Re:Not a "leak" ?

[ATMAvatar]

Or 4) They say it is theirs, demonstrate that it is legal, and use it as advertising. "We can game the rules to get you more money on your investments!"

Not that many people care about ethics when presented when more money as the alternative - just look at corporations the world over who will circumvent and even break the law, calling it merely a cost of doing business.

Re:Not a "leak" ?

[nolife]

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

It is not the same at all. When the insider takes advantage of this inside information, the money or advantage is not created out of thin air, it comes from the other investors that did not have that inside advantage. This is not paying more for something better like your car example. This is using information that others will not find out about until a future date.

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,

Wrong again. I don't think JP Morgans only "clients" are only a few people with inside information. What about JP Morgans other clients? Help a few and screw over every other client they have? Not quite fiduciary duty.

The loophole

[aleph42]

The 10b5-1 loophole itself apparently consist of making a "plan" to sell your action, and then, when you would have used your insider information, cancel or go with the plan.

It really sounds so obvious like this, that you wonder how the lawmakers could miss it. One hint for them: start compiling with "-Wall".

Re:The loophole

[Creepy Crawler]

Who said the lawmakers missed anything?

So what's the problem with insider trading anyway?

[Psionicist]

On one hand I think this is good. Insider trading should not be illegal. To quote Milton Friedman:

"You want more insider trading, not less. You want to give the people most likely to have knowledge about deficiencies of the company an incentive to make the public aware of that."

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

There are also tax lawyers who can help me create complex holding / offshore structures to make me pay less taxes, so from that point of view I fail to see the problem with help how to avoid insider trading regulations. No one would be surprised if these banks helped their clients to avoid paying specific corporate tax, for example. So what's so sacred about the insider trading regulations?

Anyhow, my problem I have with this is bad laws should be rewoked, not left in place to be circumvented with the right know-how.

Play on the playground, then bulldoze the park

[SirSlud]

Screw it being unethical; it is things like this which break the axioms that systems like markets are designed for.

Ultimately, whats important is that if some people can circumvent the risk-reward aspect of an economic, political, judicial, or social system, they're basically saying they're above the protections that western civilization grants them.

I think ethics is a poor way to frame cases like this - the very people who say, "Well, its legal, so there you go" arn't interested in ethics, they're interested in gaming a system. That system would not exist if everyone was able to take advantage of the method of abusing it. Ultimately, they're acting in a way that would destroy the system were everyone able to do what they did. I think the idea of protecting the health of institutions is an easier sell to people than saying, "Hey, that's unethical." Lots of people do unethical things, every day - whats more important is pointing out where unethical behavior is rewarded by an institution rather than punished. These institutions are set up from the very start to attempt to mitigate unethical behavior .. so when it happens, it seems pretty obvious to me that you need to change the rules. If somebody is motivated and talented enough to earn wealth, they are the last people on earth who need an FAQ. Markets are intended to reward performance and promote capitalization, not provide and easier way for individuals to make money.

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

[FusionDragon2099]

The benefit of insider trading is information enters the markets quicker. That is good for me. Except for the part where information won't enter the market, as inside investors benefit more from withholding inside information as it profits them.

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

[TheLink]

You want the Casino (or a favored player) to be able to know what the next cards are before other people at the table?

If there are other Casinos around, nobody will want to play at your "Milton Friedman approved" Casino.

Finally! The missing Step !

[gc8005]

For so long it's been clouded by question marks. This is the missing step #3.

Before:
1. Beg, borrow, or steal 1 million dollars
2. Take ill-gotten gains to JP Morgan
3. ??????
4. Profit!!!

Now:
1. Beg, borrow, or steal 1 million dollars
2. Take ill-gotten gains to JP Morgan
3. Follow rule 10b5-1
4. Profit!!!

Re:Finally! The missing Step !

[xaxa]

+5 Funny coming in 3... 2... 1...

Re:Finally! The missing Step !

[SpaceLifeForm]

You blew it. Could have had a +5 Funny, but you forgot:

Follow rule 10b5-1

Q.E.D.

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:So what's the problem with insider trading anyw

[evanbd]

You're missing the point. The act of trading inherently gives away information -- the information enters the market through the trade records.

The fact that this is so is easy to determine from careful analysis of stock markets. Whether that makes insider trading any more or less ethical is left as an exercise for the reader...

The Fundamental reason this is legal

[Dr Reducto]

The fundamental problem is that the SEC made trading on insider information illegal, they didn't make "not trading" on insider information illegal, and that should never be made illegal.

Re:The Fundamental reason this is legal

[pitchpipe]

they didn't make "not trading" on insider information illegal, and that should never be made illegal.

Maybe you didn't read how the whole thing works.

They set up a trade to sell at such and such a date in the future. If they get hold of some inside information that is very bad for the company, they let the trade proceed. The SEC says it's OK because the sale was set up before the knowlege of the insider information. If all is A-OK with the company, they cancel the trade, and because there was no stock bought or sold, the SEC says it's OK.

The scam is in the fact that the sale (or not) of the stock was influenced by insider information, but the SEC says it's OK whether they sell or no.

Here is my bitch, because I don't have $BIGNUM to invest in individual securities and I also will probably not come into contact with insider info, it is inherently unfair. But more importantly, it lowers my confidence in the system, making me less likely to value this market over any other, maybe even value those markets more. I know that I'm just one guy, but if lots of people start to feel this way, then it devalues the securities that are traded on that market.

Martha Stewart is PISSED

[EdIII]

I bet Martha Stewart wishes she was a JP Morgan client right now :)

No, you are missing the point

[Travoltus]

The only information that insider trading gives away, via the trade records, is that someone on the inside is selling a lot of stock - not their personal reasons why.

Insiders - people who typically have tons of stocks - will pump and dump, harming the company itself and leaving the small investors holding the bag.

After a few years of this going on, there won't be a single company out there, no matter how solid it is, that will survive this recurring, erratic cycle of binge & purge. Small investors, who constantly get burned time and time again, will lose faith in the system.

What happens next is fairly obvious.

Re:No, you are missing the point

[evanbd]

I'll agree that it's obvious, but not in the way you think. There's plenty of evidence that insider trading occurrs to at least a moderate degree, and not much evidence (as distinct from appeals to intuition) that it does more than minor harm to the market.

The reasons why someone is selling stock are actually far less interesting than the fact that they're selling it. People regularly look to trade records for information, and don't ask why the trades occurred. Yes, the people with inside info profit from it -- but the information gets out when they do so, even if all the details don't.

The amount of harm caused by this process is very unclear and a subject of much debate. I'm willing to believe it's non-zero (what can I say, the appeals to intuition work), but there's no evidence it's gigantic. And there's certainly no evidence of outside investors getting scared off by insider trading -- though there's plenty of evidence that they get scared off by bad management, as they should, but that's for other reasons. Pump and dump is a symptom of bad management...

As I said before, I'll leave the ethics of insider trading to others. But I'm far from convinced there's more than minor harm resulting from it.

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

[Fishead]

Except that the CEO of said corporation could then manipulate this lemming mentality to his benefit, at the expense of the little guy (me).

Imagine CEO of XYZ company owns 1,000,000 shares of his company that is trading at $50 per share on Friday. He wants to build a new bungalow by the lake, but has all his capital tied up in his company. What does he do? Calls up his broker on Friday afternoon and sells 900,000 shares for $45,000,000. The media picks up on this, and it is all that is talked about all weekend. Widespread panick ensues. Monday morning opens with XYZ falling through the floor. By Tuesday afternoon, the CEO calls up his broker and buys back his 900,000 shares at $20 each for a total of $18,000,000. The CEO now has $27,000,000 to spend on his cabin. After a couple weeks, everyone realizes that there was nothing wrong with XYZ and share prices begin to climb back up.

But hey, what do I know? I don't own any stock, or have any money to play with, but I am drinking a really fine stout that makes me think I have savvy!

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

[TheLink]

Yeah. My brain is not working.

Anyway point is if players think the Casino isn't fair and there are too many players cheating they might go elsewhere.

Yes I know a stockmarket isn't like a casino. The top stockmarkets don't operate for 24 hours all year :).

I disagree

[Hemogoblin]

I'm not a financial advisor, but I have taken quite a number of finance and derivative courses. I've read the pdf file at least three times now, as well as some other materials, and it seems to me that the Wikileaks analysis is flawed.

In itself, the services being offered by JP Morgan are perfectly legal and ethical; they are essentially a "collar", but with different instruments. They're a way of creating a position in which you're mostly immune to changes in the stock price. Wikileaks mentions this briefly by saying

The techniques outlined in the 31-page document ... are really only useful for insiders who anticipate their company shares will decline...(Emphasis added) ... which is misleading. Entering into a collar doesn't necessarily mean that you have insider information, it just means that you don't want any risk at all. I would guess that 99.99% of CEO's with stock options / stock will enter into a collar of this sort to protect the value of their portfolios.

So what I'm saying is that there isn't anything wrong with JP Morgan offering these services, period. There is a very practical and ethical reason to enter this sort of contract, and there are a number of safeguards to prevent insiders from large short-selling before things go bad. Nowhere does it even imply in the pdf that JP Morgan "wants to help you inside-trade and beat the market by 6%!"

Unfortunately, the 10b5 rules are not strict enough to prevent inside-traders from also using the services. It's still better than allowing insiders to trading around "blackout" dates.

Anyway, read the businessweek article; it will explain things better than I can. As for this story, it seems to me more of a case of someone offering legitimate services which are being abused by some bad apples.

Re:I disagree

[Hemogoblin]

One last thing:

Wikileaks implies that the slide saying "[we can] help insiders with the successful sale of restricted stock", is unethical and illegal. However, I believe that they are misunderstanding what the slide is saying: Rule 10b5 is a way for insiders who do NOT currently possess non-public information to legally sell/collar restricted stock. In other words, the SEC created a way for "innocent" restricted stockholders to liquidate and access some of the value in their portfolios, which JP Morgan is quite happy to help them do so.

If the SEC could ever prove that someone with insider information was abusing one of these plans, they would come down on them like a ton of bricks.

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.

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

If I may...

[aleph42]

If I may...

You had the energy to read the pdf three times, and you sound pretty sure that you found a problem in the current version of the Wikileak page, based on factual and verifiable information... that's the perfect oportunity to edit that article!

If you're not sure, "be bold" (a wikipedia guideline: http://en.wikipedia.org/wiki/Wikipedia:Be_bold): edit it anyway, but add some explanations to the discussion thread (actually, your slashdot post would be perfect for that).

Remember, a wiki is that cool thing were a spotted mistake is a corrected one!

Re:I'd tend to agree.

[It doesn't come easy]

It's an old mainframe thing (you know, geeky). In the old days devices were controlled by directly embedding control codes in the characters sent to a device. Control H (that is ^H) was/is the code for the backspace key. So if you typed something and wanted to erase it, your character string would look like "John is the the REAL asshole^H^H^H^H^H^H^Hpower behind the scenes." In truth, you didn't really send strings like this for a text printout, at least not for devices like teletypes, because it would be too late for you bub!

In any case, instead of ^W the original poster should have used ^H if he meant to backspace. A Control W is an End of Transmit Block. How a device responded to a End of Transmit block would vary for each device.

I think he expected the imaginary device to erase a word for each control W. However, to know how the device would respond, we would have to know what the output device was.