May 23, 2013
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How would you like to invest $10,000 and watch it grow
over 20 years into $1,461,920? Well that's what happened at the giant
hedge fund, SAC Capital Advisors, which made a 30% return for 20 years
in a row.
How is it possible to make such profitable investments
again and again and again? The U.S. Attorney for Manhattan, Preet
Bharara, believes he has the answer: SAC is cheating ... again and again
and again. In fact,
Bharara suggests that hedge funds that engage in insider trading may be rotten to the core:
"Given
the scope of the allegations to date, we are not talking simply about
the occasional corrupt individual; we are talking about something
verging on a corrupt business model, for the defendants seem to have
taken the concept of social networking and turned it into a criminal
enterprise. " [refers to a 2011 hedge fund indictment, not the current
case against SAC.]
To date, nine current
and former SAC employees face insider trading criminal charges stemming
from their work at the firm. Four have pled guilty and two are still
fighting their indictments. Now the head of SAC, multi-billionaire
Stephen A. Cohen (note the initials), will be subpoenaed to appear
before a grand jury. The federal strategy may be to indict the entire
hedge fund and shut it down,
according to the New York Times.
We
do not know as yet to what degree SAC relied on illegally obtained
information (or other illicit activities) to amass its extraordinary
profits. But we do know this: hedge funds don't like to gamble. Rather
they want to make their billions by betting on sure things. In
researching my book,
How to Make a Million Dollars an Hour,
it became clear that that the hedge fund industry as a whole is up to
its eyeballs in a series of unethical maneuvers that sometimes are
legal, sometimes are borderline and often are outright criminal.
But aren't there many (some?) honest and ethical people working in America's 8,000 hedge funds?
Maybe
so, but the overwhelming culture within hedge funds makes cheating a
way of life, according to Lynn Stout of UCLA Law School. In her article,
"
How Hedge Funds Create Criminals,"
Stout claims that hedge funds flash three critical signals that promote unethical behavior:
Signal 1: Authority Doesn’t Care about Ethics.
Since the days of Stanley Milgram’s notorious electric shock
experiments, science has shown that people do what they are instructed
to do. Hedge-fund traders are routinely instructed by their managers and
investors to focus on maximizing portfolio returns. Thus, it should
come as no surprise that not all hedge-fund traders put obeying federal
securities laws at the top of their to-do lists.
Signal 2: Other Traders Aren’t Acting Ethically.
Behavioral experiments also routinely find that people are most likely
to “follow their conscience” when they think others are also acting
prosocially. Yet in the hedge-fund environment, traders are more likely
to brag about their superior results than [about] their willingness to
sacrifice those results to preserve their ethics.
Signal 3: Unethical Behavior Isn’t Harmful.
Finally, experiments show that people act less selfishly when they
understand how their selfishness harms others. This poses special
problems for enforcing laws against insider trading, which is often
perceived as a “victimless” crime that may even contribute to social
welfare by producing more accurate market prices. Of course, insider
trading isn’t really victimless: for every trader who reaps a gain using
insider information, some investor on the other side of the trade must
lose. But because the losing investor is distant and anonymous, it’s
easy to mistakenly feel that insider trading isn’t really doing harm.
Brilliant Criminals?
The
more we dig into what hedge funds actually do, the more we find that
insider-trading is just one of many unethical strategies used to rig
bets. Their goal always is to find a sure thing. And the only sure way
to secure such infallible investments is to cheat.
At
the height of the housing bubble, large banks colluded with hedge funds
to sell mortgage-related securities that were designed to fail so that
the hedge funds could collect insurance on that failure. (This is
exactly like building a home that will burn down in three months so that
you, the seller and builder, can collect the insurance.)
High
frequency hedge funds set up their super-computers next to the stock
exchanges so they get the information a few nanoseconds before the rest
of us. This allows them to deploy automated systems to front-run our
trades. Between the time you press your E-trade button and the time the
trade actually goes through, a high-frequency trader is buying what you
want and selling it back to you for a few pennies more. By
systematically fleecing stock-market participants, high-frequency
traders extract $5 to $20 billion a year from the rest of us.
Jim
Cramer (host of CNBC's "Mad Money") admits to planting false stories
with his media colleagues while he was running a successful hedge fund.
Through manipulating the media, Cramer was able to move stocks in the
direction he wanted in order to cash in. In a startling
kiss-and-tell online interview
he admits that the hedge fund game consists of one lie after the other.
Furthermore, he says that if you're not willing to lie, cheat and
violate the law, "maybe you shouldn't be in the game."
To
provide even more incentive for hedge fund managers to cheat their way
to riches, the federal tax code rewards them with a special tax loophole
called "carried interest." As a result, billionaire hedge fund managers
pay a lower tax rate than the rest of us, and neither political party
has the nerve to remedy this blatant injustice.
Let us now praise famous hedge funds?
Because
so few of us know these stories, and because so few of us feel
comfortable wading into the muck of high finance, hedge fund moguls
preen about the universe bestowing a small part of their ill-gotten
gains upon institutions that can help them enhance their reputations.
Central Park and the New York Public Library are receiving $100 million
each from prominent hedge fund managers seeking to polish their images.
Colleges want hedge fund managers on their boards and in charge of their
endowments. Non-profits, even progressive ones, kiss up to them, hoping
to score big donations. Pension funds scramble to invest in hedge
funds, looking to secure a share of the booty.
But
very few have the nerve to ask where hedge fund riches really come from.
If you're receiving such largess, you don't want to know if the money
is tainted. Better to pretend that these guys are just brilliant
investors with the uncanny gift for making 30 percent a year, year after
year after year.
All of us should be grateful that
our Wall Street-riddled government still has honest prosecutors like
Preet Bharara who are not afraid to ferret out the cheats and put them
away. So far his Manhattan office has secured 81 indictments against
hedge fund managers and traders, 74 of whom have either have pled guilty
or have been convicted.
Only another 10,000 or so to go.
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