I wrote the following piece in November. I would like to publish it here for all of you, especially those who are mystified or confused by the many recent posts concerning this subject. I hope this might assist in making current events clear to all who are here.
O.A.
A Corrupt Bucket
In the early part of the last century, during another famed manic period in stock market history, so-called “bucket shops” reigned, fleecing unwitting investors of many millions of dollars, and scorning the successful few. They operated much like the casinos of today in Las Vegas and Atlantic City: lose, and you are an instant VIP; profit, and you are unceremoniously shown a quick, if indiscreet, exit. In his trading and investment classic, Reminiscences of a Stock Operator, published in 1923, Edwin Lefevre writes, “There is nothing new in Wall Street.” He was right, of course. Doors wide open, the bucket shops remain. And yet today there is no longer any need to leave home to find them: through the glorious invention of the Internet, and so-called electronic day trading, the modern bucket shop is brought home to the investor.
Day trading is nothing new. In Ancient Greek times, an Ithacan speculator buying a gold bar in Piraeus for 25 drachmas, then selling it for 33 a few hours later in Athens, can be said to have executed a day trade, however crude by modern standards. Only he had his stamina and sandals to limit the speed of his transaction, where today we have Ciscan routers and the speed of a double-click. Mr. Lefevre day traded three-quarters of a century ago, as did captains of industry such as Mssrs. Rockefeller, Morgan, Vanderbilt, Mellon and Frick.
It is beyond question that the increasingly active participation of ordinary citizens in the stock markets has directly led to investor savings of untold billions of dollars in reduced spreads, lowered commissions, and increased liquidity. One spectacular result was the August 8, 1996 censure of the Nasdaq National Market by the Securities and Exchange Commission for price-fixing violations, which followed from the study of curiously and regularly wide stock spreads by two university professors. In December 1997, thirty of Wall Street’s most prominent investment banks agreed to pay $1 billion to settle claims of massive, organized fraud. In the aftermath, thousands of Americans came to see our markets in a new light.
Day trading in its purest form is nothing more or less than a microcosm of investing. A year is boiled down into ten hours, with all its consequent rallies and declines. A trader’s investing is predicated on minutes and hours, rather than months and years. Traders perform the critical functions of providing liquidity to the market and lending transparency to the establishment of Wall Street. Like the Nasdaq Price-fixing Scandal of 1996, however, the field of day trading has been prey to corrupt activity on a grand scale for over a decade, a pattern of systemic fraud almost unimaginable to most Americans.
Many investors are familiar with the age-old saw about brokers and their investment advice, churning to enormous commissions. Nowhere can this crude method to defraud be more ingeniously applied than in the pantheon of electronic day trading. Countless convoluted schemes of deception and theft may be carried out through so-called “instant-execution” brokerage firms and Internet “chat sites” where unlicensed investment advice is given on a daily basis.
There are convincing indications that a large number of specialist day trading brokerage firms have concluded illegal, undisclosed arrangements with Internet trading sites providing for brokerage commission kickbacks to site owners. In what has become a fraudulent industry worth hundreds of millions of dollars annually, typical arrangements call for kickbacks of as high as 35% of brokerage commission receipts to the sites. The proceeds are often laundered through non-standard advertising contracts. Such arrangements encourage Internet sites to lead their members into frequent in-and-out trading, not only when this is justified by market conditions but mostly because this generates larger commission revenues for the brokers and therefore larger kickbacks to the sites. Many broker-dealer firms are now suspected of kicking back commissions to sites who encourage the highest volume of trading, through such deceitful schemes as encouraging the practice of scalping, rapid-fire, trigger-happy trading-by-the-second, and constantly whipping up traders to a fever pitch of elation and despair. Most traders dare not leave their “trading platform” for a single minute because of this – for whatever reason. One brave soul in recent memory, residing in North Carolina in 1999, refused to abandon his trading post during the Category Two Hurricane, Floyd. As his front door was blown away and his windows shattered, he remained steadfast behind his screens, buying and selling on emergency power.
To put these agreements in proper perspective, the Charles Schwab Corporation purchased the most famous of all day trading, instant execution brokerage firms, Cyber Corporation, for $560 million earlier this year in an all-stock deal. One other well-known brokerage firm, The Executioner, now offers $7.95 trades for those who place a minimum of two thousand trades each month. In other words, annual payment of commissions in excess of $190,000 secures the “discounted” rate. Those trading to this volume of tickets are extended the premium advisory services of the prominent and purportedly independent trading site, Pristine.com, at no cost. More placid traders are charged $525 monthly for the same service. On its homepage, Pristine claims no less than 60,000 subscribers. The exact nature of the business relationship between the two is unclear. However, they are both headquartered in White Plains, New York. Another trading site, known for its high-tech, “gee-whiz” set-up, and infamous in trading circles for its allusions to the sway lunar cycles hold over the stock markets, KingCambo.com, recently held evening “seminars” promoting the practice of scalping 50-80 trades daily. Several representatives of the specialist trading brokerage firms Manhattan Beach Trading and Cyber Corporation, now a subsidiary of Charles E. Schwab, Inc., were in attendance. Manhattan Beach Trading has designed “specialized” trading software for KingCambo members. The precise nature of the relationship between Manhattan Beach Trading and KingCambo is likewise unclear. Originally, this site assessed no disclosed access fees. Its lead analyst is known as “SteadyEddie.”
In joint consultation, some specialist brokerages and sites closely monitor churned trades through breathtakingly complex computer program calculations. In a process which would give the National Security Agency pause, “tracers” are sent to every point of the Internet compass, monitoring trades placed at all times and by all parties, computing the millions in illicit bullion by the split-second. Broker-dealers and chat sites have cleverly programmed traders to believe that high-volume trading leads to success, and that any failure is that of the trader, and not their leaders. This is not the case, however. Traders assume they receive unbiased advice, while sites are in fact under the effective control of brokerage firms. As a result, the guiding light of brokerage commission kickback fraud controls every aspect of the industry. This conjures up a nightmare scenario where site owners gather their hoard through the full-time employment of legions of unwitting traders, who, in an orchestration of Orwellian dimension, are puppeted as a marionette on a string, and, unbeknownst to them, are led to work on behalf of their leaders, in direct opposition to their own interests. When they dare raise the slightest objection, they are shouted and slapped down immediately. It reminds one of the mind-control displayed in Jonestown, Guyana, many of these sites.
Finally, in a frightening prospect to both traders and investors alike, some brokerage firms are also suspected of apprising site owners of confidential client stock portfolio and trading activity by the hour, to facilitate front running of recommendations.
A number of broker-dealer firms and Internet sites are currently under S.E.C. investigation concerning allegedly undisclosed order flow practices. Yet one significant weakness in current securities law is the lack of any regulations requiring that trading sites be officially registered with the Securities and Exchange Commission, as licensed Investment Advisers. Throughout the past several years, S.E.C. officials and Congressional legislators have utterly and unforgivably neglected their responsibility to protect all market participants from criminal predators. The worthy principle of fair market participation must be safeguarded, for all who provide a foundation of and fuel for the growth of this great country, regardless of the duration or frequency of their buying and selling. To this end, I have proposed to Congressional and S.E.C. officials a simple legislative solution: require all trading and investment sites to officially register as Investment Advisers, that their activities are made subject to a code of standards and that compliance with those standards be supervised and enforced. In particular, all affiliations between such sites and brokerage firms that expose site members to the risk that the advice they receive on their site is biased not towards their interest but towards the interests of the owners of the site, should be prohibited.
Protection of the public against criminal practices has always been a principle objective of the laws of this nation. Extending such protection to day traders is no more than a logical step in the pursuit of this objective. It should be noted that riverboat casino gamblers are better protected by our laws than are day traders, who are directly responsible for American investors saving billions annually in reduced spreads and lowered commissions. A corrupt bucket of device, scheme and artifice must have no place in the equities markets of the United States of America. It is time we regulate day trading. From the dark hiding places of charlatans and their imposture, we must lead our markets into a different future, where the rule of law and its effective enforcement prevail.
by Olivier L. F. Asser
November, 2000
Washington, D.C. |
