The government is cracking down on insider trading; isn’t that great news for you? Last Friday, the Securities and Exchange Commission charged hedge fund mogul Steve Cohen with failing to supervise two employees who themselves face insider trading charges; on Thursday morning the Justice Department filed criminal charges against his firm, SAC Capital. Earlier this summer, the news broke that New York’s attorney general, Eric Schneiderman, was investigating the early release (by Thomson Reuters, which publishes this column) of the University of Michigan’s widely-watched index on consumer sentiment to a group of investors. Faced with a court order, Thomson Reuters agreed to suspend the practice, while asserting that “news and information companies can legally distribute non-governmental data and exclusive news through services provided to fee-paying subscribers.”
In a statement, Schneiderman said that “the securities markets should be a level playing field for all investors.” Preet Bharara, who is the U.S. Attorney for the Southern District of New York, has also invoked the notion of fairness. He told CNBC’s Jim Cramer, “I think people need to believe that the markets are fair, and that the same rules apply to everyone…I don’t want to buy a stock because I have a feeling that someone knows more than I do.”
Let’s give both Schneiderman and Bharara credit for good intentions. What could be more desirable than a level playing field in the all-important game called our financial security? But the playing field isn’t level, it never has been, and I’m not sure it can ever be. If history is any evidence, attempts to level it have only tilted it all the more. So, maybe the real problem is the pretense of fairness.
The notion that individual investors could compete with big institutions in the stock market began, according to my friend, co-author, and New York Times columnist Joe Nocera, on May 1, 1975, which was when commissions were deregulated. That gave rise to discount brokerages like Charles Schwab, which catered to individual investors. The movement gained currency (no pun intended) as the first dot-com bubble made investing seem easy, and brokerage moved online. Technology democratizes everything! Information is free! A veritable flood of ads, including those featuring stock-trading teenagers with their own helicopters and tow truck drivers with private islands, all preached “some version of the mantra that you can get rich faster if you take charge of your own investments,” as the New York Times put it in an October 1999 piece — which, not incidentally, noted that the top 10 online brokers were budgeting about $1.5 billion in the coming year for advertising, more than Walt Disney and Coca-Cola combined. Old line brokers like Merrill Lynch and Morgan Stanley Dean Witter got into the game too, offering low-priced trades with the perk of access to their stock research, which was supposed to help guarantee your success. In a message meant to scare people away from operating without access to the firm’s research, Morgan Stanley warned investors, “Life’s not fair.”
No, life isn’t fair, and as we all know now, the playing field hadn’t been leveled. Individual investors, whether operating via discount brokerages or with the dubious benefit of Street research, were just cannon fodder for the so-called smart money—including, not surprisingly, Cohen’s SAC Capital — which made fortunes by shorting dot-com stocks ahead of the crash. (The “smart money” isn’t necessarily smart, but it is well-connected.) Nocera has argued that without fixed commissions, research was less profitable, so research became a subsidiary of the investment banking division — oh, the law of unintended consequences. Along came Eliot Spitzer (I’m hitting all of the summer’s headlines!), who documented that research analysts, far from providing investors with objective advice, were basically shills for the investment bankers. A buy rating bought investment banking business, instead of paying for your retirement. Ten big firms jointly paid $1.4 billion to settle charges, and agreed to changes in how they did business, such as putting a wall between research and investment banking, and compensating analysts based solely on their performance.