If you have ever seen the movie Jerry Maguire you’ll remember that the hero, Jerry, has a crisis of conscience and writes a memo to all of his coworkers detailing everything that is wrong with his company. In the memo he attacks the very system and policies that have made him wealthy and put him into a position of authority.
Fast forward a few years and now our hero has a new name. Its Greg Smith. Now, there are a couple of differences in this story. For one, Greg is not in the sports management business he works for the worlds largest investment banker, Goldman Sachs. Secondly, his crisis of conscience memo doesn’t go to all the employees of Goldman but rather to the op-ed page of the New York Times. Third and most important, this is not a movie, this really happened.
On Wednesday March 14, 2012, after a dozen years with Goldman, Greg Smith, the (now former) Executive Director for Europe, the Middle East and Africa, sent a letter the opinions and editorial page of the New York Times detailing his disgust at the general moral decay of the investment bank. After too many years of hearing the clients being referred to as stupid and being called “Muppets”, Greg had seen and heard enough. So he threw in the towel and told the whole world why. The most profitable bank in the world is morally bankrupt.
What is truly funny about this story is that it even makes the news. We treat it like an amazing insider revelation. “What? The investment bankers don’t have my best interests at heart. You mean to tell me that they are only in it for the money; to make a quick buck? I am sooo…. shocked.”
Anyone with any well informed experience with these companies can tell you that it happens all the time and it has been going on for a lot longer than the last 12 years.
Greg mentions that his clients have an asset base of over a trillion dollars. Let’s think for a minute about just how much a trillion dollars really is. If all of that money were being managed by Greg, given that, in addition to all the nickel and dime transaction fees, Goldman is keeping around one quarter of a percent per year of the money under management. So Greg is bringing into the firm some 2 billion five hundred million dollars every year in money management fees alone. He has probably made enough money over the years to keep himself afloat for a while.
First as an adviser they convince you to buy stock then once they have your permission to buy they go into the market and buy the stock for themselves driving the price higher. Then they make your purchase driving the stock higher still and then they dump theirs for a quick buck that comes directly out of your pocket. Don’t make the mistake of thinking that it only happens to the whales. They have learned over the years that if they direct all the advisers to call their clients and have them buy the target stock, that with trillions of dollars under management they will move enough of it for the scheme to work, so they will buy the target stock and then start calling clients.
They are buying stock at it’s market price down to the nearest one hundredths of a penny, while you and I are buying it at the nearest penny and they keep the rounding.
Suppose you or I did this. Suppose I went out to everyone I have ever worked with during my career and convinced all of them to put $10,000 each into a certain stock on a given morning. The result would be an influx of demand to the tune of more than 100 million dollars. Because I know that the “big buy” is coming I go in, the afternoon before, and buy up big blocks of the stock. Then the next day after the buying has reached a fever pitch I sell my stock into the feeding frenzy for a healthy profit.
If you or I did this the SEC would put us under the prison. We’d be sharing a cell with Bernie Madoff. Yet the investment banksters are out there doing it everyday. Its called front running and, despite being inundated with complaints from the public, the SEC simply turns a blind eye to the practice. If you are the Mayor of some small, backwater town, and you own the police department, you could park in a handicapped spot that was also a school crossing and on top of a fire hydrant and it will mysteriously go unnoticed.
The question to ask is not “how do we change the status quo?” Its, “how do we make money from it?”
As unfair as it is, you have to ask yourself if you are a businessman or an activist. Activists (who are not named Al Gore) are not, historically, well paid but that is a whole other story. I don’t think the practice of front running is going away any time soon and unfortunately, so far, I haven’t been able to figure out a way to make money off of it. As we have discussed, there are a number of such practices that do not always play to the advantage of the institutional big boys but rather to our advantage as independent traders. In the end, it is up to us, as traders, to find a way to win.