George Noble (@gnoble79) has been holding excellent Twitter Spaces in recent months with a stellar lineup of guests. I am embarrassed to admit one of the recent spontaneous additions to a panel was a high-profile investor whose Twitter handle I had been completely oblivious. Legendary short seller, Jim Chanos, joined the panel and the discussion turned to fraud.
Chanos is a forensic accounting expert and teaches classes at Yale on fraud. His ilk (Marc Cohodes another example), along with investigative journalists, who unfortunately may be going the way of the Dodo Bird, like Bethany McLean, are the real market sheriffs. They are the shoot. Federal and state regulators are the work - they act like they are around to protect investors and maintain the rule of law, but in reality, they are really just around for mop-up once the cycle turns down.
Chanos mentioned this on the Spaces panel, as he described the fraud cycle typically only breaking out after prices go down. Whether it was Enron (McLean’s big break as a journalist), Madoff, etc., as Buffett might say (my characterization), they become exposed only when the tide goes out. Buffett famously liquidated his hedge fund in 1969, which turned out to be the inflation-adjusted peak in the market in the post-WWII bull market, which would not be eclipsed until the early 1990’s. From the January 5th, 1972 New York Times, just as the tide from a former cycle began to go out:
PHILADELPHIA, Jan. 4—The former finance chairman of the bankrupt Penn Central Transportation Company and two of his business associates were charged today in criminal warrants with illegally diverting more than $21‐million from America's largest railroad.
As Doomberg (a must-follow/read Twitter and substack) wrote yesterday while chronicling developments with prices and activities in private equity markets, some of this stuff has been and remains egregious. As some people I respect have declared, this really does seem like a golden era of money laundering and fraud.
In the US, we have had Federal Reserve board members allegedly trading on material non-public information, yet nothing is done. Members of Congress appear to be a veritable orgy of insider trading and even carved themselves out an exclusion within the law. When will all the fraud and corruption be exposed and people held accountable? Do not hold your breath.
The current bullish cycle in commodities follows a dark period for extraction industry investors, as the prior cycle peak had been in the 2011-2012 period. A timeline and handling of alleged nefarious activities in metals markets may be instructive:
Nearly four years ago, Kovel sued J. P. Morgan on behalf of a colorful hedge fund operator and big-stakes poker player, Daniel Shak, and two metals traders, Mark Grumet and Thomas Wacker. The civil lawsuit accused J. P. Morgan of manipulating the silver futures market from 2010 through 2011, costing Kovel’s clients $30 million in losses.
That is from an article published on CNBC’s website on November 13th, 2018. Another article in 2019 offers some insight into the teeth of so-called regulators in related alleged activity:
In July 2017, a panel of the COMEX Business Conduct Committee found that Smith had spoofed in the gold futures markets in July and August 2013. As part of the settlement, which Smith neither admitted or denied the panel’s findings, he was ordered to pay a $95,000 fine and was suspended for 10 business days from trading on the CME Group exchange.
With the alleged activities in the initial lawsuit that took place in 2010-2011, it was not regulators who kicked off the sequence of events, but rather a lawsuit from the private sector.
Eventually, the adults at the DOJ became involved, and all of a sudden what went from a slap on the wrist to a junior trader turned into a potential RICO case. But let’s go back to the November 2018 article and the opening paragraph:
A previously secret guilty plea by a former commodity trader at J. P. Morgan Chase, who admitted that he rigged precious metals markets, has drawn the attention of a lawyer who has already accused traders at the nation’s largest bank of similar conduct.
‘Secret guilty plea’ was an interesting development given the other activities and related suits and regulatory involvement unfolding at the firm. It appears the private lawyer may have pushed things upon this revelation and the DOJ seems to have stepped up the investigation - surely just a coincidence:
(Reuters) - JPMorgan Chase & Co has agreed to pay more than $920 million and admitted to wrongdoing to settle federal U.S. market manipulation probes into its trading of metals futures and Treasury securities, the U.S. authorities said on Tuesday.
But it has not just been metals markets, as this article from 2015 recounts how the government called upon Luca Bras…
I mean a trader from a prominent ‘market maker’ as part of prosecuting an individual who apparently was not protected by the Don:
A trader who works for the hedge fund owned by Illinois' richest man took the stand for the government in federal court Wednesday but revealed little about how Citadel uses complicated computer trading programs to make money.
Sollozz….
I mean the target of that prosecution was eventually convicted and sentenced to 3 years for activities that reportedly netted him $1.4 million. Is the fox protecting the hen house?
It’s not strange to see a hedge fund involved in a whistleblower lawsuit. But usually it isn’t on the side of the whistleblower.
That, however, is the situation with Citadel, a $24 billion hedge fund. Citadel’s general counsel reportedly submitted a whistleblower claim to the Commodity Futures Trading Commission after Citadel uncovered manipulative trading, or “spoofing,” on the Chicago Mercantile Exchange.
Revolving door?
(Reuters) - Citadel Securities has appointed Heath Tarbert as chief legal officer, the electronic trading firm said on Thursday, months after he resigned as chair of the Commodity Futures Trading Commission (CFTC).
So we have a high-frequency trading market maker/hedge fund playing the hero to defend the integrity of markets and working with regulators to protect us all? We are all saved! Here is the shoot:
But what Twells did not say is that, irrespective of its algorithms’ estimate of gold futures’ “fair value,” the reason Citadel placed orders in the same direction as Panther’s alleged spoof orders is that it was almost certainly trying to profit off Panther by trading ahead of them.12 After all, this is one of the primary ways that HFTs make money.
As explained by Professor Irene Aldridge, “The central value proposition of HFT is enabled by tick-by-tick data processing and high capital turnover. The technology behind identifying small changes in the quote stream is what differentiates this business and enables a trader to send rapid-fire signals to open and close positions.”13 In simple terms: HFTs profit by quickly reacting to orders placed by other traders; while profits from each individual HFT transaction may be no more than a single tick, huge sums can be generated because algorithms are able to enter thousands or even millions of trades every day.14
While this overarching business model encompasses a variety of specific strategies, Twells’ testimony suggests Citadel’s algorithm was quote-matching, a tactic that involves “mimic[king] the limit orders of another trader,” “rid[ing] the market impact the original orders generate,” and then quickly taking “advantage of the move, reversing positions and capturing the profit.”15 Essentially a legal form of “electronic front running,” this strategy seeks to detect large order entries and then profit by trading in front of them at supra-human speeds.
The entire analysis from a UK-based attorney is worth a read.
Rather than ‘free and fair markets,’ we appear to have a protection racket cloaked as a regulatory regime. Money laundering, fraud, market manipulatio…I mean making, appears to be rampant. The buy button being turned off in January 2021? Do not count on Tom Haden riding to the rescue- he’ll be sending in Amerigo Bonasera on mop-up duty, eventually.
How did all those mortgage fraud prosecutions from 2008 go - remember those? Me neither - equal justice under the law, indeed. The Don and The Family will NOT be implicated.