Thomas Mazarakis, head of Goldman Sachs's fundamental strategies group, has admitted to some clients that Goldman has both traded on investment ideas before they were presented to clients and taken the opposite side of specifically recommended trades. The latter tactic is very much at the center of the firestorm brewing over Goldman profiting handsomely by betting against the same CDO products they pushed on customers.
In response, Goldman spokesman Lucas van Praag had the following to say:
the company has been "providing this disclosure, which we think is best practice, for a number of years and there is nothing new in the disclosure you were sent."
Here's where I'm a little confused. When I was in banking in the early '90s, front running was a very big deal. It was something the SEC watched out for almost as much as insider trading (and ratholing IPOs, but that's another topic altogether). To my knowledge, front running is still illegal. So I know Goldman wouldn't readily admit to committing a crime like that (notice I didn't say that they wouldn't commit a crime like that, I said they wouldn't admit it).
So I have to believe that what the New York Times is implying may be a crime (or at least a shady business practice) is in fact typical market making. In their function as a market maker -- that is, to maintain an orderly market in a given security -- Goldman and other market makers must be long or short that security at any given moment in order to maintain that orderly market. If trading happens to be long XYZ in the normal function of market making and Joe Shit the Ragman over in S&T happens to call a client and recommend XYZ, that's not front running. That's borderline coincidence.
If, however, there is a concerted effort in prop trading to build a position in XYZ and then talk it up to clients in order to drive the price up, well, that's a horse of a different color. To date, I don't think anyone has accused Goldman of doing that.
While I find the notion of Goldman shorting securities that they're recommending clients buy at the very least distasteful, this could probably fall under the category of market making as well. Trust me, it's way more of a stretch, but if there isn't enough distinction to keep you out of court there is at least enough distinction to keep you out of jail.
At that point, it is no longer a matter of legal versus illegal, it becomes a question of right or wrong. And history (my own included) teaches us that questions of right or wrong are best left to folks who aren't bankers.
On a slightly different subject, but I thought it was interesting that Blankfein admitted that "Goldman may have participated in what is now considered fraud in the market" in relation to MBS. Seems to me they always find very greyish areas to operate in. Apparently that's where the $$$ is.
Uncle Eddie,
You remember what they did to LTCM?
This was a very interesting post. I have always understood the role of the market maker and never seen it in a negative context.
The major difference between the two activities seems to be the line of trust. A financial adviser promoting a position is saying "this is a good position at this price". If simultaneously the firm takes the opposite position, then clearly the former position was not as profitable as the opposite, which would be illegal. The FA was supposed to act in the client's best interest but instead pointed him in the wrong direction.
I fail to see how Goldman's action were in any way legal. Market makers say "I am willing to buy/sell at this price". Their responsibility is to the firm, whereas FA is to the client. How can GS be allowed to recommend a course of action and then look for profits on the other side?
The only situation I can imagine this to be permitted is if GS can extract profits from the opposite trade that the investor couldn't.
You're right FAs are supposed to act in the interest of the client. But there is a giant disparity between what's supposed to happen and what actually happens. Everyone and their mother knows that the role of a guy in sales is to make money for the firm, period. A re-read of Liar's Poker might be worthwhile because clearly times have not changed. And that's the real problem.
Everyone knows you can't trust a salesman. From the car salesman who tries to sell you a lemon at Joe Blow's Automotive to the sophisticated GS CFA selling MBSs, there is always information asymmetry. And while I don't necessarily think GS is innocent, I think as an investor you need to be weary of that information asymmetry.
To the point of GS front running, we'll have to wait and see. If their strategy was to artificially run up prices in MBSs to the point where they knew those prices would come crashing down, then that is a serious problem and some ppl will need to go to jail. But if they simply sold the MBSs to make the bro and fees associated w/ making a market, and then recognized that the market was over-bought, then there really isn't a case for foul play.....
What legitimate purpose would these ideas have if they are not supposed to be financial advice? It seems to me that Goldman realizes there are investors out there that are too lazy and stupid to even understand what Goldman feeds them, sets them up, but says "Oh no, you took us all wrong, we're just a market maker," when they cash in.
They have been doing this for a while:
http://zerohedge.blogspot.com/2009/07/is-goldman-legally-frontrunning-i…
The fact that ER is tainted does not seem nearly as objectionable as the fact that PB is tainted. That said, people need to stop taking the piss out of GS. The firm prints money.
I believe he said "froth," not "fraud."
I remember the NYT running an article about computerized algo trading at GS and how they would enter a proprietary trade a fraction of a second before a client order came in. I commented on the article that that was the dictionary definition of frontrunning and just because you have fancy computers doing it instead of shady brokers in cheap suits doesn't make it any less illegal.
http://www.nytimes.com/2009/07/24/business/24trading.html?_r=1
Here's the article. Don't let the fancy jargon and french cuffs distract you. What this article describes is a crime and in a just world, everyone involved should be sent to jail.
The NYT article describes flash trading, not front running. They are completely different things. (Aside: It is very poorly researched. For example, flash trading has been around for a while; it's certainly not, "the hot new thing on Wall Street." I am constantly amazed by the new lows hit by the NYT.)
Like I said, don't let the fancy jargon distract you from what is a very simple concept. "Flash trading," or whatever they currently are calling it in order not to call it frontrunning, at the very least violates the spirit of the law and the SEC is currently taking steps to ensure that it is not allowed.
http://seekingalpha.com/article/150397-flash-trading-goldman-sachs-front-running-everyone-else
But haven't we all?
The thing is GS isn't selling to Grandma and Grandpa, they're selling to sophisticated investors who should also be doing their own research. That's one of my issues with this, people forget that they are selling to people who in reality have as much education and experience as they do. Meaning they can't blame GS for not doing their own homework. It's like a kid copying of my test and complaining when he fails as well. In the end both sides messed up but everyone is ready to throw rocks at gs
You guys should read this article:
http://seekingalpha.com/article/182215-goldman-admits-to-frontrunning-c…
GS has been sending clients trade ideas generated by its fundamental strategies group, which generates trade ideas for their proprietary trading, not for clients. If GS traded on those ideas before they told their clients, it only means that they really believe it's a good trade.
Most of friends who work at a legitimate buyside shop tell me when they receive GS research they look over in depth and do not trust half the shit their analysts say. This is why GS as great as they are I do not think has ever been able to dominate the ER space.
I think that guy's article is unrealistic, GS is a huge trading house your going to tell the S&T guys not to deal with them? You can not just avoid one of the largest traders in a security. Also not sure where you can prove that goldman has done the same trade before as well. Though the authoer is correct buyside traders and PMs ain't going to beleive crap from GS anymore.
Eos ratione aut sit perferendis quasi. Assumenda cum vel omnis et nihil maiores. Nobis repudiandae reiciendis temporibus laboriosam.
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