Whenever there’s a surprise takeover bid at a significant premium to the (formerly) prevailing stock-market price, dozens of journalists and bloggers immediately pull up options-volume data. Much of the time, they discover a suspicious spike in options volume just before the deal was announced. The conclusion is obvious: insider trading!

So many thanks to Baruch for bringing a bit of context to bear on such exercises. His main points: is that options volumes are by their nature extremely lumpy. Just about any options contract, if you look at it, will have occasional extremely large spikes. As Baruch puts it, “the volume of a particular option resides in Extremistan”.

What’s more, the options markets are constantly awash in rumors, any one of which can easily cause on of these spikes. Baruch provides one example: last Friday, a rumor hit the market that Palm would be bought by Nokia. It wasn’t, but that didn’t stop 21,000 options being traded in one day on the $12.50 calls alone. That’s over five times the size of the option volume in 3Com before it was bought by HP.

And one other thing: if you did have inside information that 3Com was being bought by Nokia, you’d make more money simply buying the stock than you would buying the options. The only reason to buy the options is if you simply don’t have the cash to buy the stock.

None of which is to say that there wasn’t insider trading in 3Com, of course. It’s pretty hard to prove a negative. But statistically speaking, if you look at options volumes on every takeover bid which crosses the transom, eventually one of them is going to see this kind of spike, even if there’s no insider trading at all.

The Pragmatic Capitalist gets his hands on Galleon’s monthly returns, and finds them very suspicious:

These guys just couldn’t lose. Whether the market was up or down they cranked out 25% returns like they were printing money. It makes you wonder just how long these guys were trading on insider information?

I have run the risk adjusted returns on hundreds if not thousands of portfolios throughout my career and I have never seen numbers like these. NEVER. There is virtually ZERO downside volatility in these figures… Gauging from the returns I would be willing to bet the insider trading was going on for most of Galleon’s existence and was likely much more rampant than currently reported.

I’m not completely convinced, for two reasons. Firstly, Galleon’s returns were pretty volatile: the fund was up 14.53% in May 1997, for instance, and then down 8.54% five months later, in October of the same year. That doesn’t seem abnormally consistent to me.

More generally, if you want returns which rarely turn negative, insider trading is not your strategy. Madoff-style outright fraud works, of course: you just report fictional returns instead of real ones. But Galleon isn’t being accused of making up its returns: it has the money it says it has. It just (allegedly) used illegal means to amass it.

A sophisticated insider trader isn’t trying very hard not to lose money. Quite the opposite, in fact: he’s putting a lot of money at risk, and knows there’s a significant downside. He just also knows that he’s got an informational edge which gives him an advantage over the rest of the market. Such advantages don’t always pay out, and as a result you’d expect an insider-trading strategy to show relatively frequent negative returns. Even if, over the long term, it was very successful.

(Via)

This isn’t the first time that Bernie Madoff’s lover has tried to make money by taking dirty laundry and printing it:

After the affair ended, Weinstein rebuilt her emotional life with her husband… She took antidepressants. They began to run a commercial laundry trade publication.

Apparently the two are still together. Commercial laundry trade publications: they’re just like marriage counselors, but cheaper.

Rick Bookstaber, after mentioning that “we have no clue” how Goldman is making all that money, then adds:

I am in the middle of writing a novel that begins in the midst of the 2008 crisis. In the novel there is an investment bank where one of the trading units gets requests from its clients to price their illiquid inventory. (This is an exercise that occurs in real life, because the clients have to mark to market, and for some assets there is no market. So they go out and get bids from a couple of banks, and then mark at the average of these two prices). This trader puts in incredibly low-ball prices. One bank prices a security at $92. He prices it at $50, leading to a mark to market price of $71. The trader knows that with such a low price, the client will be forced into liquidation mode. The trader positions his book for the forced sale that he helped precipitate, generating big profits from his scheme. This is fiction.

I just can’t wait for the movie. Any chance of getting Dan Aykroyd and Eddie Murphy back together?

Well done to the FTC for putting some serious resources into attacking business opportunity scams. It doesn’t hedge, it doesn’t say that some are better than others — instead it says in a simple and forthright manner that if someone is advertising a “business opportunity”, even if it’s a celebrity like Adam West, you should run fast in the other direction:

Want to “be your own boss,” “work from home,” or just “make extra money“? Then you may be tempted by an ad for a business opportunity. Before you open your checkbook, check out the offer. Fraudulent business opportunity promoters use the classifieds and the Internet to tout all kinds of offers, from pay phone and vending machine routes to work-at-home businesses like medical billing and envelope stuffing. Too often, these ads make promises - about earnings, locations, merchandise, or marketability - that sound great, but aren’t truthful. The result: consumers are getting ripped off, losing money instead of making it.

The FTC does have a guide for the media, which seems to be very widely ignored: is there any way that it could grow some teeth and actually punish media outlets which willingly broadcast these scams? I hope TV and radio stations, in particular, don’t manage to wriggle their way out of the oversight of the FTC, the FCC, and the new consumer financial product commission: these ads really should be regulated heavily.

The NYT yesterday finally got around to covering what it called “the curious case of Mr Arbizu” — I appreciate the reference to a series of blog entries I wrote in June and July last year (1, 2, 3, 4).

It’s unclear why the NYT is publishing the story now, when they started talking to Arbizu almost a year ago. But after all that time one would have hoped for something much more explosive, because there’s loads of really juicy stuff in the Arbizu story, including mind-boggling incompetence on the part of UBS and gun-toting thugs in Paraguay.

I’ve spoken to Arbizu at some length, and I think he’s reliable. Everything here comes from him — and he is, by his own admission, a criminal who stole money from his clients. That said, everything he’s said both to me and to the Argentine authorities has panned out so far; he’s always been upfront and honest about what he did wrong, and his story is both internally consistent and consistent with everything I know from reading court filings and talking to JPMorgan.

The story starts with Arbizu working for UBS as a private banker, being pressured to sign up $150 million in new money every year. One of Arbizu’s clients, Alberto Lopez, had about $2 million with the bank, and said he was leaving for greener pastures. At this point a panicked Arbizu did something very, very, very stupid: he promised Lopez interest payments of 21 percent per year, in dollars.

The problem was that Lopez’s money wasn’t earning anything close to 21 percent in interest. And so Arbizu started raiding Lopez’s own principal to make the interest payments: the $2 million was going down fast, as it kept on getting paid out in “interest” payments to Lopez. Eventually, there was so little money left that Arbizu had to find the money somewhere else. He turned to another one of his accounts at UBS — that of the Acevedo Quevedo family, which was based in Paraguay and had about $3 million in it. Arbizu started sending Lopez his “interest” payments, on now-nonexistent principal, from the Acevedo account. A simple, obvious, unambiguous fraud — he was stealing from Acevedo to pay Lopez. And UBS had no idea this was going on.

All the while, of course, Arbizu was helping some of his Latin American clients evade taxes, both by sneaking funds offshore illegally and by using little-known legal loopholes. These skills, it seems, were in high demand, and in October 2006, when he was still very much in UBS’s good books, Arbizu was poached from UBS by JPMorgan.

At this point the story gets seriously crazy: UBS never seems to have informed Arbizu’s clients that he had left the firm, and so both Lopez and the Acevedos continued to deal with him, via his cellphone, in the belief that he was their account representative. What’s more — and this boggles the imagination — Arbizu was somehow able to continue to make those “interest” payments from the Acevedo account to the Lopez account, even after he had left the firm — all the way through April 2008.

And UBS is arguably the foremost private-banking operation in the world.

What Arbizu was doing was, of course, extremely fraudulent and illegal. At one point, he got a message at his new job, at JPMorgan, from the head of compliance at UBS. He thought the game was up, but with that sense of relief that at least it’s all over now, he called back. It was just an enquiry about getting a job reference from Arbizu if the officer ever wanted to change jobs.

Things finally came to a head in April 2008. Arbizu was in Argentina, and got a phone call from the Acevedos, in Paraguay. They were furious, having just been told by UBS that far from having $3 million in their account, they only had $200,000. What, they asked, reasonably enough, was going on?

Arbizu flew to Asuncion — a dodgy enough city to begin with — and then on to Pedro Juan Caballero, a real Wild West town on the Brazilian border. When he got there, he was greeted by beefy men with machine guns.

The Acevedos weren’t happy: they were in the midst of a major land deal, and needed the money immediately. Arbizu decided he didn’t have any choice. He told the Acevedos that he’d get their money back immediately.

The problem is that he couldn’t get the money from Lopez, who had no money in his account either. And of course Arbizu didn’t personally have that kind of scratch. So he raided a third account, this one at JPMorgan, and belonging to a media executive named Natalio Garber. He transfered $1.1 million of Garber’s money straight to the UBS account in Paraguay, and another $1.7 million, in three different transactions, to the people selling the Acevedos their land. The Acevedos were thereby made whole, but only at the cost of Garber losing $2.8 million.

It turns out that JPMorgan’s controls over such things were rather more effective than UBS’s: the bank found out very quickly that something was amiss, and fired Arbizu on the spot. But Arbizu was in Argentina, and JPMorgan wanted him in the United States.

Arbizu’s wife was in the United States, and agreed to meet Arbizu’s boss in a Starbucks in Fairfield, Connecticut. He talked to her for three hours, trying to persuade her that Hernan should return to the United States. The two sides talked on the phone quite a lot, but Arbizu wanted to be near his family and his lawyer in Argentina, and eventually JPMorgan gave up negotiating and said they were going to throw the book at him.

At that point, Arbizu essentially turned himself in to the Argentine authorities. Yes, he said, I broke the law in the US, while I was working on behalf of Argentine clients. Many of those clients were evading taxes. There’s a massive tax-evasion scheme going on in both countries, and if I’m going to come clean about my own misdeeds, I’m also going to come clean about the bigger-picture scandal. He alleged Argentines have $150 billion offshore, but report to the authorities only $30 billion. Private banks like UBS and JP Morgan help them to avoid reporting those assets to the Argentine authorities, and — he said — I know exactly how they do it.

The Argentine authorities raided the JPMorgan offices in Buenos Aires, and the list of account holders got leaked to the Argentine press. (I believe Arbizu when he says it was the Argentine justice department, not himself, who leaked the list.)

Arbizu then started going through all manner of legal proceedings in Argentina. At one point he told an Argentine judge about a very commonplace — but technically legal — way in which Argentines managed to avoid paying taxes on the $30 billion of assets which they do declare every year.

It worked like this: in the 1970s, during the junta, the Argentine government was buying a lot of arms from the Austrian government. And somewhere along the way, the military government passed a rule saying that Argentine citizens didn’t need to pay taxes on Austrian bonds. Amazingly, that was pretty much the only law from the days of the military government which survived the transition to democracy. Every year, in December, Argentines would sell everything they had, and put all their money into Austrian bonds for year-end. They paid no taxes. And then, in January, they went back and bought whatever they were invested in in the first place.

JPMorgan, says Arbizu, was even working on something called “the Austrian structure” — a special bond designed to solve the problems of illiquidity in December when lots of Argentines all wanted to buy Austrian bonds at the same time. It would be issued by the Austrian government at JPMorgan’s request, and would have a yield linked to a balanced portfolio, so that the yield on the bond was the yield on the portfolio and the Austrian government itself would pay no interest at all.

Thanks to Arbizu’s testimony, however, the Austrian loophole was wiped from the Argentine books.

Arbizu has lots of information on other structures, too: trusts, shelter companies, back-to-back loans, Standard Bank Letters of Credit — a whole panoply of instruments designed to help private-banking clients evade taxes and which he’s happy to explain to the authorities in Argentina and the United States.

But there’s still a criminal case against Arbizu, and a request for extradition, making its way slowly through the Argentine legal system. Arbizu is happy to admit that he’s guilty, but he’s trying to essentially do a deal with both the Argentines and the Americans, where he will cooperate on tax-evasion investigations in return for lenient treatment when it comes to the criminal cases.

The UBS clients are content. Lopez thought he had $2 million in the bank but doesn’t; on the other hand, he got paid some $2.4 million in “interest” payments he never should have got, so he’s not complaining too much. He hasn’t lost money. The Acevedos were made whole. So it’s really only Natalio Garber who lost money — he was paid back by JPMorgan, but that means JP Morgan is hungry for restitution and justice.

My guess is they won’t get it: Arbizu is useful enough to the leftist Argentine government that he’s unlikely to be extradited any time soon. But at the same time, Arbizu is going to have a lot of uncertainty over his head for the foreseeable future: no one is going to guarantee that he won’t eventually get extradited, and he’s still not able to leave Argentina.

The real scandal here surrounds UBS, whose controls were unbelievably lax. Here’s the NYT:

Panicked about covering the shortfall, Mr. Arbizu said he ‘pretended’ he was still the family’s banker at UBS, and secretly raided a JPMorgan Chase account held by Natalio Garber, a prominent media executive in Buenos Aires, for the funds.

He did so, he said, by faxing transfer requests with forged client signatures to UBS’s New York offices, and then visiting the offices to ensure … that the transaction had gone through. ‘Everybody there liked me and trusted me …,’ Arbizu recalled. ‘I think that my presence there saying that it was OK made people not follow the controls’.

Do ex-employees regularly turn up in person when transferring money? Is that really a sign to be reassured rather than alarmed? There are some tough questions here for UBS; I hope that someone forces the bank to answer them.

(Spokesmen for UBS and JP Morgan declined to comment to me.)

My new colleague Matt Goldstein wonders today why it took so long to nail Allen Stanford:

Bryan Burroughs, in the most recent issue of Vanity Fair, does a good job detailing how just about every US investigative agency was on Stanford’s tail for more than 15 years…

I’m told Houston and New Orleans agents from DEA and IRS even considered running an ABSCAM-style sting on Stanford in 1998… The agencies planned to invite Stanford and some of his cronies to the party to see if he’d be willing to do business with the drug dealers… The sting never happened. It’s not entirely clear why.

Sure, a lot of the difficulty in going after Stanford stemmed from the simple fact that he kept the core of his operation in a tiny country, whose political leaders were all too cozy with the native Texan and dependent on his largess to fuel the nation’s economy. But there probably also was a simple lack of will on the part of the SEC, FBI, DEA and IRS to follow things through, in part because so many of Stanford’s banking customers were Latin Americans.

Or, as Burroughs describes, may be it was the aggressive lobbying by the investigative firm Kroll that tamed the authorities looking into Stanford.

The Kroll connection is fascinating. Here’s Burroughs:

Behind the scenes, Stanford was even more aggressive. as the company grew, he became renowned within law-enforcement circles for aggressive counter-intelligence. Stanford’s security chief was a former head of the FBI’s Miami office. But his greatest asset may have been a top security firm, Kroll associates, whose Miami office worked with Stanford for years. “Stanford was spending millions of dollars a year trying to figure out who was looking at him, and aggressively combating whoever it was,” recalls the former FBI agent. “Kroll was essentially running a propaganda campaign in defense of Stanford’s good name.

Kroll’s role in defending Stanford’s reputation, in both law-enforcement circles and the wider banking community, was an example of a controversial practice known within the private-security world as “reputational self-due diligence,” that is, vouching for a client’s good name… “It is, by all accounts, an exceedingly lucrative business… It is controversial, even inside the firm. Kroll is considered—how to say this nicely—well, they’re willing to take more controversial clients for this type of service.”

Kroll worked for Stanford for over a decade, and if it does turn out that they were running a regulator-quashing operation, this could turn out to be extremely bad for their reputation.

Incidentally, Matt’s still adjusting gingerly to the world of blog: like the careful reporter that he is, he’s still describing Stanford as “the man who allegedly ran an $8 billion Ponzi scheme”. My response to the ritual insertion of the word “allegedly” in such sentences is to say that you can’t be running an alleged Ponzi scheme if there’s no one doing the alleging. And I’m perfectly happy to be one of the people alleging that Stanford was a Ponzi, even if Matt isn’t quite there yet.

How incompetent are the lawyers at the SEC? Here’s what happens when they use the material non-public information at their fingertips to indulge in insider-trading schemes:

[#2] testified that at the time of her testimony in October 2008 she owned more than 50 stocks after a recent sell-off of stocks. She testified that her stock portfolio was then valued at about $45,000, but that it had been valued at about $170,000 at one point.

This particular attorney said that the markets were her “main hobby and passion”. An expensive one, too, it would seem.

The Stanford International Bank Ponzi scheme could and should have been shut down as early as 2003: regulators had more than enough information to do so. Fox Business Network has the story, after receiving 237 pages of SEC documents related to Stanford dating back as far as 2002. This one, I think, is the real smoking gun. It’s worth reading in full — it’s not long — but here are a few snippets:

This letter discloses another possible case of Corporate Fraud being perpetuated by the Stanford Financial Group and its owner, banking and real estate mogul Mr. Allen Stanford.

Stanford Financial is the subject of a lingering corporate fraud scandal perpetuated as a massive Ponzi scheme that will destroy the life savings of many, damage the reputation of all associated parties, ridicule securities and banking authorities, and shame the United States of America…

With the mask of a regulated US corporation and by association with Wall Street giant Bear Stearns, investors are led to believe these CDs are absolutely safe investments. Notwithstanding this promise, investor proceeds are being directed into speculative investments like stocks, options, futures, currencies, real estate and unsecured loans…

The questionable activities of the bank have been covered up by an apparent clean operation of a US broker-dealer affiliate… Registered representatives of the firm, as well as many unregistered representatives that office within the B-D [broker-dealer], are unreasonably pressured into selling the CDs. Solicitation of these high risk offshore securities occurs from the United States and investors are misled about the true nature of the securities.

The offshore bank has never been audited by a large reputable accounting firm, and Stanford has never shown verifiable portfolio appraisals…

By the size of the portfolio, this would be one of the largest Ponzi schemes ever discovered.

This letter is being written by an insider who does not wish to remain silent, but also fears for his own personal safety and that of his family.

It’s all pretty unambiguous stuff, and it was received by the SEC in September 2003 — more than five years before Alex Dalmady published his own, similar, analysis. What’s more, the letter was copied to the Wall Street Journal, the Miami Herald, and the Washington Post; none of them seem to have done anything with it.

If Stanford had been shut down in 2003, billions of dollars would have been saved. But no one seemed to care — certainly not enough to do anything about it. Which is quite disgraceful.

HOUSTON, April 30 (Reuters) - Allen Stanford, the Texas billionaire facing civil fraud charges, attempted to turn himself in at the federal courthouse in Houston on Thursday but was turned away because there is no warrant for his arrest, his lawyer said.

Remember, this is a man who still claims that he’s innocent. If you’re innocent, and there’s no warrant out for your arrest, what on earth are you doing trying to turn yourself in?

(Via Alea)