How The Hell Is This Legal? (Front-Running)


How The Hell Is This Legal? (Front-Running)

Posted by Karl Denninger

This is flatly unbelievable.

A senior Goldman Sachs executive sent an e-mail message to clients on Tuesday disclosing that the firm’s Fundamental Strategies Group might have shared investment ideas with the firm’s proprietary trading group or some clients before sharing them with others.

Got that?

In other words, the firm reserves the right to effectively front run by using what looks to be a dodge around the law.

That is, they reserve the right to tell their own internal trading group that they’re about to recommend that you buy or sell something before they tell you.

Is this legal?  Probably. 

Should it be?  That’s a different question.

If I call my broker and tell them “Buy 100,000 shares of Merck at the market” it is illegal for the broker to buy shares of the same security for its own account in front of (and with knowledge of) my order.  The reason is that the broker could then sell that position to me (at a baked-in profit) or simply execute my order and then sell immediately behind it, taking advantage of the price ramp that my order creates.

How is this different?  Well, Goldman doesn’t know that its clients will act on these “Trade Ideas” that it “shares”, for one. 

But really…. is this anything more than a dodge around the law dreamed up by a bunch of hob-knobbers with law degrees combing the SEC rules and regs for ways to “creatively exploit” various loopholes?

Second, exactly why is it that Goldman (and I presume other big trading houses) share these “trading ideas” in the first place?  Is it to make you money, or are they undertaking all this “work” to provide their prop desk with the ability to get in front of you and gain (yet another) advantage?

If you wondered why I believe that brokers should never, under any circumstances be permitted to run a prop desk and trade their own book, you now know why.  You, the client are put at a disadvantage in that the broker both can and might (and in this case it is blatantly disclosed) trade directly in front of something they will then advise you to either buy or sell.

Thanks guys.