Piggyback Trades Don't Qualify as Foul Play
Date Published: 5/23/02 1:29 PM ET
Story Type: James J. Cramer
Author: James Cramer
Callout: Gaming order flow isn't insider trading, unless you're in a world where
intelligence is a liability.
Piggybacking is a time-honored concept. Let's say a big buyer of puts surfaces
-- and he does surface because everybody wants to know flow.
I will walk you through the process: Hedge Fund A comes in and buys 500
puts on Bristol-Myers. Why does he do that? Maybe he read any of the numerous
headlines that said that Bristol-Myers was going to blow up. I can't even count
how many times I read that.
The trader who handles the order, after he places it and gets the order
done, picks up the phone, calls other accounts and says "SmartGuy buying Bristol
puts." Right now, that is legal to do. In fact, it is called merchandising flow,
and until it is outlawed, that's what will happen.
Hedge Fund B gets that call and its trader takes a look at what the
printed stuff is on BMY; he checks Bloomberg, RealMoney Pro, MarketWatch, Dow
Jones and Reuters. If he sees something -- and in this case, he would have seen
tons -- he piggybacks: He buys 500 puts himself.
Next thing you know, there are two put buyers of Bristol and lots of
hedge funds that do nothing but monitor put activity see it. Then they do the
same checks. And so on.
That's how Wall Street works. Given the "mood" around Wall Street these
days, I bet that some people are going to say "that's outrageous" and demand
that nobody be told about orders. Others will probably start saying "it is not
fair that people even buy puts as you would only buy puts if you know something
bad is going to happen, and if you know something bad is going to happen, then
you know something someone else doesn't know, which means you have inside
information, which means you should be prosecuted and should go to jail."
Again, don't kid yourself. That's where we are going. When we started down the
path of Regulation FD, which said that no one could have a legal edge over
anyone else and that any edge is simply illegal, we started inexorably down a
path that says if you know anything anyone else doesn't know, you can't trade on
it.
Ultimately, if you are able to outsmart or outthink the market, you will
not be able to prove that you did. You will be per se, an "insider." That's
wrong. An insider is someone who has material inside information or was given
material inside information. If you have material inside information from the
company or one of its agents or someone deemed an agent and you trade on it, you
can get in trouble. But if you have figured out something on your own or read
something that was not widely disseminated that was intelligent and honest and
hard-hitting, you aren't doing anything illegal. There is a clear distinction in
the law, but the situation has become so fluid that people are going to be
worried that they crossed the line even if they didn't.
I can see a world where people who buy puts are immediately going to be
handed over to the SEC and anyone who piggybacks off them is going to be
investigated, too. They will be presumed insiders or tippees!
Unless they are wrong. Where does it all end? Pretty simple: If you
aren't allowed to have a legal edge over anyone else, I can see a world where
beating the market is an illegal game, per se. I can see a world -- and believe
me, we aren't that far from it -- where outperformance is considered crooked and
any attempt to defend outperformance will have to fail.
I can tell you that this world I see is a world that is untenable for
the vast majority of hedge fund managers. It is a world where insight will be a
detriment and intelligence a distinct liability. Oh sure, I can see people
saying that there are always examples where you can still find out something
that is relatively unknown through reporting and research. But that still will
lead you to be investigated as the government will most likely be interested in
why you outperformed.
I know this: Right now, if I were at my old job and someone from the
sell side came to me and said "size buyer of puts, Bristol Myers," I would say
"no thanks. Too dangerous to look." What a nightmare. |
