The legitimate part of the Madoff operation may not have been.
This story has been evolving over roughly five financial quarters now. One constant has been the distinction between the trading (market making) side and the asset management (or investment advisory or just IA) side of Bernie Madoff's operations, a distinction always described as crucial. Madoff's trading operation, which had been quite innovative when launched in 1960, was controversial in some respects (especially among those of us who consider the practice of payment-for-order-flow inherently dubious), but it was legal.
Madoff was often suspected of attaining the unusually consistent results of the account management operation by "front-running," i.e. by making illegal use of information he acquired as a market maker. The SEC would periodically investigate Madoff, only to find that he wasn't front running, so he must be clean! The truth of course is that he wasn't front running because he wasn't really trading through the IA wing of his company at all. It was all a sham, and those surprisingly consistent results were simply invented. So the possibility of front-running was serving perhaps two purposes. First, as noted it was a false scent that kept the regulators harmlessly occupied. But, secondly, it may have helped attract investors. "Pssst, this guy is likely front-running the info from his market maker side. We should get us a piece of that action."
Again, the above two paragraphs state the conventional wisdom. But the new arrest indicates there was still more to the story. Daniel Bonventre, the Madoff associate now under fire, was for thirty years the director of operations of the market-making part of the operation. Here's the criminal complaint against him.
Authorities allege that the income from the ponzi scheme was used to support the market-making operation at least from 1997 onward, and that the necessary transfers were accounted for on the books in such a way as to conceal their true source. Most reports indicate that they caught on to Bonventre because Frank DiPascali has been squealing like a stuck pig of late.
I hereby point out, as is only right, that Bonventre through his attorney has denied doing anything wrong and that he is innocent until proven guilty.
Still, if the investigators are on to something, this changes a good deal. Other potential defendants arise once the supposed wall between the legitimate and illegitimate sides of the supposedly bifurcated operations turns out to have been porous.
Showing posts with label payment for order flow. Show all posts
Showing posts with label payment for order flow. Show all posts
Sunday, February 28, 2010
Wednesday, December 31, 2008
Three brief items
1. Chicago Sun-Times solicitations.
The next best thing to a proxy fight is a consent solicitation campaign.
It is a more slow-motion, though. The shareholders seeking a material change solicit written consent to that change from more than 50% of the outstanding voting shares. This is often more difficult than winning a true proxy campaign, after all, in the case of a consent solicitation, inaction always amounts to a pro-management vote, a refusal to consent to the change.
Anyway: the Davidson Kempner hedge fund wants a new board of directors on the Sun-Times. They've sent a letter of solicitation that blames the incumbents for "the near total erosion of stockholder value."
On Thursday, December 11, the Chicago Sun-Times announced that the proxy-advisory firm Glass Lewis & Co. is taking its side.
2. Bullish report on Asian securities exchanges.
The consultancy Celent has posted a report on the Asian securities exchanges as businesses. It's pretty bullish.
The report says that a total of more than 14 trillion shares, with a value equivalent to $21 trillion US dollars, was traded on the major Asian exchanges in 2007. the top six of those exchanges account for 80% of that value.
The author of the report, Arin Ray, says: "The Asian exchange industry, following a worldwide trend, has undergone major changes in structure and governance model, and many exchanges have become publicly traded companies through demutualization. The exchanges are highly profitable and growing, with an average profitability of almost 50 percent.”
3. On Madoff.
When the Bernie Madoff story first broke I wrote here about the "payment for order flow" angle, postulating that Madoff's determined defense of that practice back in May 2000 should already have been a red flag to the observant.
I'm happy to report that I'm not the only one thinking along those lines. On December 24, the Financial Times ran a story by Greg Farrell under the headline "SEC inaction that helped fuel scheme."
The second graf of this story reads: "But it was the SEC's decision in the 1990s not to take a stand on the controversial issue of 'payment for order flow' that helped fuel the rise of Bernard Madoff Investment Securities, the successful broker-dealer operation two floors above Mr Madoff's private fund operation in Manhattan."
That way of putting it implies a government-centered way of looking at the world. There are lots of parties other than the SEC who missed this and shouldhave gotten it -- like the folks responsible for due diligence at the various institutions than invested in Madoff's operations.
Still, I do think the whole idea of payment-for-order-flow stinks. If the Madoff meltdown does help finally discredit it, that will be some slender silver lining.
The next best thing to a proxy fight is a consent solicitation campaign.
It is a more slow-motion, though. The shareholders seeking a material change solicit written consent to that change from more than 50% of the outstanding voting shares. This is often more difficult than winning a true proxy campaign, after all, in the case of a consent solicitation, inaction always amounts to a pro-management vote, a refusal to consent to the change.
Anyway: the Davidson Kempner hedge fund wants a new board of directors on the Sun-Times. They've sent a letter of solicitation that blames the incumbents for "the near total erosion of stockholder value."
On Thursday, December 11, the Chicago Sun-Times announced that the proxy-advisory firm Glass Lewis & Co. is taking its side.
2. Bullish report on Asian securities exchanges.
The consultancy Celent has posted a report on the Asian securities exchanges as businesses. It's pretty bullish.
The report says that a total of more than 14 trillion shares, with a value equivalent to $21 trillion US dollars, was traded on the major Asian exchanges in 2007. the top six of those exchanges account for 80% of that value.
The author of the report, Arin Ray, says: "The Asian exchange industry, following a worldwide trend, has undergone major changes in structure and governance model, and many exchanges have become publicly traded companies through demutualization. The exchanges are highly profitable and growing, with an average profitability of almost 50 percent.”
3. On Madoff.
When the Bernie Madoff story first broke I wrote here about the "payment for order flow" angle, postulating that Madoff's determined defense of that practice back in May 2000 should already have been a red flag to the observant.
I'm happy to report that I'm not the only one thinking along those lines. On December 24, the Financial Times ran a story by Greg Farrell under the headline "SEC inaction that helped fuel scheme."
The second graf of this story reads: "But it was the SEC's decision in the 1990s not to take a stand on the controversial issue of 'payment for order flow' that helped fuel the rise of Bernard Madoff Investment Securities, the successful broker-dealer operation two floors above Mr Madoff's private fund operation in Manhattan."
That way of putting it implies a government-centered way of looking at the world. There are lots of parties other than the SEC who missed this and shouldhave gotten it -- like the folks responsible for due diligence at the various institutions than invested in Madoff's operations.
Still, I do think the whole idea of payment-for-order-flow stinks. If the Madoff meltdown does help finally discredit it, that will be some slender silver lining.
Monday, December 15, 2008
Payment for order flow
There is an intermittent controversy among those whom manage stock exchanges, brokerage houses and related institutions -- and among those who regulate them -- about a practice known as "payment for order flow."
Back in January 2003, for example, the then-chairman of the Securities and Exchange Commission, Harvey Pitt, wrote to the heads of each of the five US exchanges where stock OPTIONS are listed, just to give them what one might call a heads up.
"Hey guys, we're looking at this issue down here in DC. I'm not saying nothing, I'm just sayin'." [Not his exact words].
The idea was that an exchange would pay a brokerage firm for routing an order to them rather than elsewhere -- the payment might be a penny per share.
The controversy arises because your broker is suppsoed to be working for you, the investor, trying to get you the best deal. If he can get you a better deal for certain options on exchange A than on exchange B, shouldn't he rout your order through exchange B? If a payment from exchange B persuades him to do otherwise, aren't they cheating you?
The same might well be asked also if you're trying to buy the underlying stocks, though Pitt's January 2003 letter involved options for reasons I won't get into today.
Likewise, the same questions might be asked when it is a market maker, rather than an exchange, that is paying to keep orders on some form of security or other flowing. From whomever the money is coming, the broker who receives that money may be putting itself into a conflicted situation vis-a-vis its client.
I'm thinking about such matters today because an investment manager named Bernard Madoff is all over the news this weekend, even putting the continuing controversy over the auto bail-out in the shade for the moment.
Prosecutors claim that Madoff told senior employees at his firm, a market maker, that his operations were "all just one big lie," and "a giant Ponzi scheme."
If there is anything to the charges, the ongoing scandal may further discredit the whole idea of anyone -- exchange or market maker -- paying for any kind of market flow. Because Madoff had been closely associated with the practice, and was in fact a public voice in its defense.
He once told a reporter from CNN who interviewed him on the subject (May 2000): "If your girlfriend goes to buy stockings at a supermarket, the racks that display those stockings are usually paid for by the company that manufactured the stockings. Order flow is an issue that attracted a lot of attention but is grossly overrated."
The analogy is borderline absurd. The stocking manufacturer isn't in a relationship of contractual privity with the shopper, so such issues don't normally arise.
Here's some further reading for the curious.
Anyway, when this is all sorted out we may think of the whole idea of payment for order flow as an important warning sign. For the mark of a pyramid schemer is an increasingly desperate desire to keep increasing order flow.
Back in January 2003, for example, the then-chairman of the Securities and Exchange Commission, Harvey Pitt, wrote to the heads of each of the five US exchanges where stock OPTIONS are listed, just to give them what one might call a heads up.
"Hey guys, we're looking at this issue down here in DC. I'm not saying nothing, I'm just sayin'." [Not his exact words].
The idea was that an exchange would pay a brokerage firm for routing an order to them rather than elsewhere -- the payment might be a penny per share.
The controversy arises because your broker is suppsoed to be working for you, the investor, trying to get you the best deal. If he can get you a better deal for certain options on exchange A than on exchange B, shouldn't he rout your order through exchange B? If a payment from exchange B persuades him to do otherwise, aren't they cheating you?
The same might well be asked also if you're trying to buy the underlying stocks, though Pitt's January 2003 letter involved options for reasons I won't get into today.
Likewise, the same questions might be asked when it is a market maker, rather than an exchange, that is paying to keep orders on some form of security or other flowing. From whomever the money is coming, the broker who receives that money may be putting itself into a conflicted situation vis-a-vis its client.
I'm thinking about such matters today because an investment manager named Bernard Madoff is all over the news this weekend, even putting the continuing controversy over the auto bail-out in the shade for the moment.
Prosecutors claim that Madoff told senior employees at his firm, a market maker, that his operations were "all just one big lie," and "a giant Ponzi scheme."
If there is anything to the charges, the ongoing scandal may further discredit the whole idea of anyone -- exchange or market maker -- paying for any kind of market flow. Because Madoff had been closely associated with the practice, and was in fact a public voice in its defense.
He once told a reporter from CNN who interviewed him on the subject (May 2000): "If your girlfriend goes to buy stockings at a supermarket, the racks that display those stockings are usually paid for by the company that manufactured the stockings. Order flow is an issue that attracted a lot of attention but is grossly overrated."
The analogy is borderline absurd. The stocking manufacturer isn't in a relationship of contractual privity with the shopper, so such issues don't normally arise.
Here's some further reading for the curious.
Anyway, when this is all sorted out we may think of the whole idea of payment for order flow as an important warning sign. For the mark of a pyramid schemer is an increasingly desperate desire to keep increasing order flow.
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