Scam Science: Crossing & Boxing Stocks

The best way to get rich and famous as a young stockbroker back in the day was to accumulate a massive position in one or more growth stocks and then sell the entire position when the stock took off. This was drilled into our heads during training. Our one purpose in life was to find a stock we liked, buy it every day regardless of price, and never sell a share for less than a 500% return.

If this is your investment strategy, you don't do a lot of selling. 5-baggers are pretty rare in any market, and were especially rare in the decade following Black Monday. When your every waking hour is devoted to buying a particular stock, you get a little cranky when a client wants to sell that stock. Seeing the stock leave your "book" is like watching your hard work go down the drain. So you manage your position.

If you haven't read yesterday's post about chop, do so now as chop is the basis of the stock cross.

Let's say you have a customer who calls up and wants to sell 5,000 shares of WXYZ, a stock you've been accumulating for a while now. There's a couple things you can do in this situation. Obviously, you could just sell the stock on the open market and make your 5% markdown. The stock disappears into the market and some faceless schmuck you don't know will make the money on those shares when they 5-bag. (yeah, right!)

Perhaps a better option would be to see if any of your buddies in the office had a client willing to buy 5,000 shares of WXYZ. By arranging a buyer for the shares your client is selling, you and your buddy could go to the trading department and tell them you had offsetting trades. That means trading doesn't have to do anything but the paperwork. What it also means is that you and your buddy get to split the entire spread on the stock (minus a penny or two per share that you'd kick back to trading for handling the paperwork).

You've just successfully crossed a stock.

Now let's take it a step further. Rather than ask your buddies if any of their clients wanted the 5,000 shares, what if you just went to another one of your clients and convinced him to buy them? Now the stock doesn't leave your book (it just transfers from one of your clients to another) and you get to keep the entire spread without having to split it with your buddy. You might pocket 20% or more of the value of the trade for a couple of phone calls.

This practice was actually encouraged by the guys upstairs, and was euphemistically referred to as "managing your position". Even then, admitting you were crossing stocks sounded kinda sleazy. But "managing your position" was A-OK. After all, you didn't want that stock to leave your book, did you?

Here is where crossing stocks gets really abusive. Sometimes brokers would get together to arrange crosses before the open of the market. I heard stories about one massive cross in my office where the buy tickets matched with the sell tickets covered the entire conference room table. In a nutshell, a wide variety of stocks changed hands inter-office, a shitload of commission was generated, and a raft of clients were no better off at the end of the day than they were at the beginning.

When a single broker decided to do this on his own, he'd find himself recommending one client to buy a stock and then on the next phone call recommending another client to sell the same stock. I can't think of a more clear conflict of interest.

One complete moron in my office actually got busted doing this by his clients. He called one client and told him what a great company WXYZ was to get him to buy it. Then a minute later he called another client and told him what a piece of shit WXYZ was and that he had to sell now. What he forgot was that these two clients worked for the same company. In fact, they were in adjoining offices. Oops.

Ever wonder how a clear piece of shit stock maintains a premium over its IPO price when, by all rights, the stock should be in the toilet? It's probably being boxed. When an investment bank (I'm using the term loosely in this case) takes a company public, the bank has a certain responsibility to support the stock.

These days, banks are content to let their ER guys look like fools as they point out every positive facet of a company that clearly sucks. How often do you see a SELL recommendation on a company that has a relationship with the bank? That's right, never.

In the old days, though, banks were willing to more aggressively support their deals. They would do this by controlling the amount of a given stock held outside the firm (by being very selective about who got IPO shares) and thus limiting the potential selling pressure on the stock. Then, they'd bid the stock up.

Since stock pricing at the time was based upon the bid of the stock, someone bidding well above the market for a stock could dictate where that stock traded. Inverted markets almost never happen (where the bid is higher than the ask), so a high bid guaranteed an even higher offer.

Never mind that the bid may only be good to buy 3 or 4 shares of a stock under $10 a share. We used to joke that boxed stocks had "scared, naked little bids" that would collapse if someone dumped some shares on them. The real market for a boxed stock might be 50% or more lower than the artificially elevated quoted price.

But that elevated price sure looked good when account statements were sent out at the end of the month. Which reminds me of one last scam. It's called painting the tape.

Painting the tape was a common practice among shady shops. On the last trading day of the month, brokers would put in a Market On Close (MOC) buy order for 1 share of every stock they held in their book. That ensured that the last trade of the month in that stock would be a buy, and on the high end of the spread. That way, client statements would reflect the highest possible value and account balance. And back then, a monthly account statement would often be the only time a client would look at what his stock was worth. So if you were slinging shit, it was a good idea to paint the tape.

I tried to keep this post brief, so if you think I've left something out or have any questions about crossing, boxing, or painting the tape fire away. I'll do my best to answer them.