Posted: Sunday, October 6, 2013 6:00 am
When I was growing up, I’d sometimes hear my mother complain about the high cost of meat. My father had a solution: “Tell the butcher to keep his thumb off the scale!” Today, when it comes to Wall Street cheating Main Street out of its hard earned money, it’s the federal government that needs to stop banksters’ thumbs from tipping the scales in their favor … and the Securities and Exchange Commission (SEC) can do this by closing loopholes in our securities laws.
As proof the Street has no lack of tricks up its sleeve when it comes to fleecing the public, one has to look no further than WikiLeaks. There, among the millions of documents archived online by that not-for-profit media organization is an interesting file on insider trading. It contains a confidential, internal JP Morgan presentation entitled Hedging and Monetization, the so-called PrISM concept, Rule 10b5-1 and Postpaid PrISM.
To be sure, the issues are complicated. Suffice it to say, however, that Rule 10b5-1 clarifies what constitutes legal insider trading. Now, most of us consider insider trading illegal, regardless of how it’s conducted. Obviously, such things have never stopped Wall Street lawyers from searching through the fine print of the SEC’s Rules and Regulations for loopholes through which they eventually will drive Mack trucks. And find one they did.
What the lawyers succeeded in doing was to find a loophole in the law that allowed JP Morgan’s clients to continue trading on inside information legally. JP Morgan, in fact, established an entire “selling program” within its Securities division, which, according to the staff of WikiLeaks, was intended to help clients profit from the loophole. Here’s how it works:
1. A company insider client (e.g., the president, chief executive officer (CEO), or treasurer) transfers all or a portion of their company stock into a JP Morgan Securities brokerage account.
2. The company insider then develops, in conjunction with the JP Morgan 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.
Do pre-planned sales under Rule 10b51 work? Yes, and, sometimes, extremely well! Consider this example: In a class action lawsuit filed in the United States District Court Western District of Washington at Seattle in September 2011, Dr. Mitchell Gold, then-president and CEO of Dendreon Corp., was accused of selling $34 million of the company’s stock just prior to announcing in August of that year that the company would not meet its revenue guidance for the year. The announcement cut the value of the company’s stock by 67 percent. Gold and other insiders benefited well by selling ahead of the announcement under Rule 10b5-1 — as may have those, presumably, who assisted them in the planning of such sales.
Admittedly, these sales were immediately registered with the SEC and posted to the company’s Web site. So, the public certainly could have sold their stock at the same time as well. But insiders sell stock for any number of reasons: major purchases (e.g., homes), children’s college expenses, divorces, estate planning, investment diversification, options expiration, and the like. As such, insider selling is not always a harbinger of impending disaster. Nevertheless, in the case of Dendreon, given management’s prior guidance, investors were justifiably outraged after the dramatic fall in share price after management had previously voiced optimistic projections.
The Dendreon example is an extreme one, to be sure. In general, the history of such insider sales is less spectacular in nature. However, there is no question the scales are tipped in favor of insiders to the detriment of the public. How favorably? Alan D. Jagolinzer, an assistant professor at Stanford University Graduate School of Business, studied roughly 117,000 trades in 10b5-1 plans by 3,426 executives at 1,241 companies. He found that trades placed using the plans beat the market by 6 percent over the 6-month period he studied. By contrast, executives at the same firms who traded without the benefit of plans beat the market by only 1.9 percent.
All of this should give pause to those who favor even further deregulating the Street. Clearly, no one would gamble at a rigged casino. And the more the public looks at Wall Street, the more crooked it appears.
Theodore J. Cohen, Ph.D., Middletown, is a research scientist, financial writer for SeekingAlpha.com, and novelist.
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