this is the most involved and thorough study i have thus far found
<<Following the paper trail.(terrorists and securities trading)
Steve Zwick; Daniel P. Collins
11/01/2001
Futures (Cedar Falls, Iowa)
Page 78
Copyright 2001 Gale Group Inc. All rights reserved. COPYRIGHT 2001 Oster Communications, Inc.
The implement of the suspected terrorists' gains may light the path to their demise. While industry regulators investigate suspect trades leading up to the attacks in New York and Washington, D.C., traders debate the likelihood of tighter clamps being placed on industry standards of anonymity and money flow.
It's hard to find anyone whose gut hasn't been wrenched by the events of Sept. 11, but for some option clerks, brokers and market makers in Chicago and Amsterdam, the sense of nausea carried the unwarranted burden of guilt by association. Many had handled large option orders for airline and insurance company shares in the days before the terrorist attacks in New York and Washington, D.C., and most of that activity had come to them in the form of short calls or long puts -- positions that benefited big over the ensuing weeks. A sickening question soon formed in their minds: Had they inadvertently made payments -- via several intermediaries -- to Osama bin Laden? Had the terrorists used the markets to pay for the carnage they'd unleashed by pulling off the most brazen insider trade in history?
In the weeks after the attacks, more questions arose. Had the terrorists used derivatives to change ownership of money? And if they hadn't, might regulators still feel forced to restrict the free movement of people and money? If so, would that stifle the derivatives industry?
Fortunately, the answer appears to be a resounding no, but the questions still linger like the smoke over the ruins in Manhattan.
Dutch regulators quickly identified and exonerated the source of suspicious trades in KIM options on the French-Belgian-Dutch exchange Euronext, but they still refuse to comment on the short sale of individual shares or stock index futures. In Germany , sources close to the Federal Securities Supervisory Agency (BAWe, Bundesaufsichtsamt flier Wertpapierhandel) investigation say auditors have ruled out the theory that terrorists profited from stock options , but they continue to investigate short sales of individual shares and the Dax index futures, although a spokesman hints that no clear evidence has turned up.
"It's standard procedure in most countries any time there's suspicion of insider trading," the spokesman says. "Sometimes we'll respond to calls from brokers or exchanges, and sometimes we'll respond because public attention has been focused on a particular event."
Traders in Chicago echo that statement, but the Securities and Exchange Commission (SEC) and Federal Bureau of Investigation (FBI) are keeping tight-lipped about their investigation into 38 different stocks, as well as options on those stocks, Treasury bonds and possibly even stock index futures.
In the first two weeks after the attack, many feared that the efforts to clamp down on terrorist money would impact the derivatives industry -- after all, the derivatives markets theoretically provide an easy vehicle for scrubbing fingerprints off of honest money and planting them on ill-gotten gains: Simply open two accounts, each with offsetting positions, and then chalk the winnings up to winnings and give the losses to someone who needs the tax write-off. Presto! Your drug money came from a hunch about the weather, and your friend in the construction industry has a place to bury his profits. The trouble with that scenario is that unless you know ahead of time which position is going to make money and which is going to lose, you still have to change ownership of the accounts after the trades have been offset -- and that means you've simply moved the money trail but not erased it.</i. (my question-- those that did have prior knowledge why could they not use this method of removing "fingerprints"-max)
In Europe, some governments have moved toward abandoning bank privacy laws, many of which provide a degree of protection against revenue service intrusion of which Americans can only dream. The legacy of Germany 's history of government heavy-handedness, for example, is a clause that prevents authorities from peeking into an account unless they first prove a person has either laundered money or avoided paying taxes. In the wake of Sept. 11, those laws have landed on the chopping block. The ax has yet to fall, but the country's finance ministry recently announced it was setting up a centralized database to monitor all bank accounts -- just in case.
"There's a danger of going too far," warned Jurgen Julich, an investment advisor in Bonn. "That seems to be the German way. First, we make it so people can hide everything, and then we give bureaucrats the run of everyone's accounts."
For American derivatives traders looking to do business In Europe, the results of European over-regulation actually could be beneficial.
"A lot of people feel that if something related to the WTC attacks was done through derivatives, It was done OTC," Julich says. 'That perception -- which I feel is misguided -- could still lead to increased regulation of the OTC markets, or maybe banks avoiding the OTC markets as a [public relations] move. That could force OTC volume onto exchanges, which would make Eurex very happy."(it is repeatedly brought forth that any such event if it was confirmed would be a blow to the whole trading realm via increased regulations, therefore the strong sentiment is to not want to confirm such an event--so i can not conclude absolutely i am getting pure info.--max)
A spokesman for Eurex welcomed the hypothesis, but David DeRosa, editor of the DeRosa Market Letter, says it has little hope of graduating to the level of theorem.
"You may see an increase in costs of executing OTC [due to increased reporting requirements], but not prohibitively so," he says. "Ultimately, there's no reason that any increase in bank transparency or anti-money-laundering procedures would impact hedge funds, futures trading or legitimate offshore businesses."
John Bourbon, managing director of the Cayman Islands Finance Authority, agrees: "Since June of this year, we've been in compliance with the FATF [Financial Action Task Force on Money Laundering, which was set up by the OECD in the late 1980s to crack down on money laundering] guidelines on money laundering, and we are no longer on their list of non-compliance countries."
"Our laws are designed to provide flexibility and anonymity at the time of execution, but our transparency requirements and those of our funds are as stringent as anyone's when it comes to post-trade investigations, so a clampdown on money laundering won't affect our hedge funds or futures funds."
Dennis Behrman, an analyst with technology researchers Meridien Research, agrees that governments may try to increase their reach in the wake of Sept. 11, but he says that bank secrecy laws in one part of the world don't usually have an impact on legitimate money moves elsewhere. He says that's largely because cross-border wire transfers are filtered through the Office of Foreign Asset Control, which maintains a database of known terrorists, drug dealers and other criminals.
OTC derivatives traders also bristle at the accusation that exchange-traded derivatives are more transparent than their gentlemanly variety.
"Since 1998, everyone has been so careful about counterparties that you have to go through a million hoops to get into the game," says a trader with HSBC in Duesseldorf. "No one wants to deal with a defective counterparty, so only really big players get in."
He adds that the OTC world only looks less transparent when viewed from the outside, "But if you're on the inside," he says, "It's a pretty amazing view."
Hedge funds, everyone's favorite bogeyman two years ago, managed to avoid implication this time around.
"There's still room for money-laundering in some of these offshore funds, but it's more the kind of legitimization of illegal money that small-time criminals might get involved in than the kind of ownership-transfer business that terrorists would be interested in," says a London-based accountant familiar with U.K. offshore accounting practices. Still, hedge funds face the threat of curtailed short-selling privileges, as does the entire market. U.S. Congressman John LaFalce (D-N.Y.), ranking member of the House Financial Services Committee, asked SEC Chairman Harvey Pitt to curb the practice of short selling in the securities market.
"To the extent that short sellers have played a significant role in creating the current market conditions, I request that you consider the appropriateness of certain measures, including inhibiting short selling," he wrote in a letter to Pitt.
The SEC decided against restrictions, and a spokesman for LaFalce's office said the letter was only "intended to open the issue to debate."
In the week after the attack, the European edition of CNBC paraded a stream of locally famous London short-sellers across their screen, all of whom swore off their most profitable practice for the time being while simultaneously explaining that heavy short interest puts a bottom in the market thereby ensuring buying later on. In both the United States and Europe, banks voluntarily curtailed the lending of shares for short-selling, and London's newly-hatched regulator, the Financial Services Authority, went so far as to ask life insurance companies not to loan shares. Foreign & Colonial, a British bank, also temporarily prohibited the practice of share lending.
"We did have a concern about hedge funds that were shorting the market," said Jeremy Tigue, who manages the bank's investment trust. "We didn't want to be involved in that"
Analysts at both Deutsche Bank and Dresdner Bank, however, said their numbers indicated hedge funds and futures funds had mostly been short coming into September, but that a high percentage cashed out after the attack -- indicating they both provided a hedge against a market drop and helped stem the hemorrhaging afterwards.
Then came the options scare, which focused on shares of United Airlines' parent company, UAL, and American Airlines' parent company, AMR. One particular order grabbed the trading community's attention: on Sept. 6, Deutsche Bank executed an order to buy roughly 2,000 UAL October puts with a strike price of $30. The order, which was divided up equally among all the nation's options exchanges, drew little attention at the time and didn't even show up on the
"outlier" sheets, which list shares that trade more than double their average daily volume of the previous three months.
In the days after the attack, however, anything seemed possible, and we found ourselves playing connect-the-dots without numbers. Photos of Mohammad Atta's apartment in Hamburg were accompanied by news that Deutsche Bank, which had executed that retrospectively suspect order, was among the many institutions that had frozen possible terrorist accounts in Germany . The sum of two and two became limited only by the imagination. Over the ensuing weeks, as the highly profitable puts sat unexercised and unsold, more questions came up. Were the customers who placed those orders the same people who'd had their accounts frozen? Had greed sunk the terrorists? Had the people who planned this atrocity gotten their hands caught in the cookie jar?
Unfortunately, no, at least not in this case. The Deutsche Bank accounts that were frozen in Germany are retail bank accounts with total deposits of less than $500,000, and sources familiar with the bank's order book say the trades in question were placed by reputable U.S.-based investment managers who were likely hedging long positions. That would certainly explain why the puts hadn't been sold or exercised: If they remain open through the Oct. 19 expiry, they are simply converted to short positions, which can be offset against the long position being hedged.
What's more, the volume "spike" in UAL shares was really more of a hiccup, at least compared to the spike in Sabre Holdings on the same day. That company, which handles reservations for American Airlines, registered a volume spike of 1,216%, or more than 12 times the previous three months average. As spooky as it seems for an airline-related company so high on the list, consider this: Eastman Kodak, which has no obvious relation to the attacks, spent most of the week achieving volume spikes of 800% and more, hitting 1,474% on Sept. 10, just behind Georgia-Pacific's 1,479% leap.
Of course, you can't evaluate the significance of any volume spikes without considering the fundamentals in the market coming into the trading day. A 40% volume spike, such as the one achieved by AMR on Sept. 10, could take on meaning if there was no news to justify it.
Phil Erlanger, former senior technical analyst at Fidelity Investments who now publishes his own newsletter, is among those who called attention to the activity.
"The footprint for taking advantage of prior knowledge is definitely there," he says. "It's up to the agencies to find the shoe that fits the footprint."
A CBOE spokesman, however, points out that volume spikes are the rule rather than the exception in single-stock options .
"We are looking at trading that occurred ahead of the news event, which is what we would normally do after a news event that has a major market impact," the spokesman says.
Other traders point out that put premiums on individual stock options had not bloated in the week before the attacks and that the peculiar volumes hadn't registered with traders until after the fact. After all, if traders had sensed an insider was buying, they'd have made him pay for the privilege of raping the market.
"These were unusual only because of what happened afterward," one trader says, echoing the point that both airlines and insurance companies had been rocked by profit warnings in the weeks before Sept. 11. Another trader, however, says that UAL and AMR experienced a disproportionate amount of quirky trading compared to other airlines.
So, however, did KLM, the Dutch airline. Although the airline averaged just 8,000 total put and call volume monthly throughout the summer, roughly 5,000 contracts were traded in the week before the crash. Most of that trading took place on the Wednesday, Friday and Monday before Sept. 11, and it turns out that one large London-based broker, acting on behalf of a customer, had loaded up on an undisclosed number of October puts with strike prices of 12.50 and
15.00 and sold an undisclosed number of calls at 17.50.
Curious, of course, but not all that unusual -- a short-term low-delta play coming Into expiration month is typical of what someone with a little money and a sense of adventure might try. Either way, Dutch Finance Minister Gerrit Zalm told the Dutch Parliament in late September that his investigators had found the trader who had placed the orders and deemed him legit.
"If you have one or two large orders, it's not that difficult to track people down," Zalm's spokesman said. "The problem arises when you have multiple small orders from various brokers, but that would be inconsistent with indication of insider activity since the costs of setting up so many little accounts detract from the value of the operation."
Irish trader and exchange consultant Patrick Young, who edits the erivatives.com Web site, agrees: "If you're going to open a derivatives account of any size and deal in cross-border transactions these days, you've got to pass an astounding array of credit tests. To really delay discovery of your money trail, you would have to have established a long chain of interlocking financial relationships, each of which would be blown asunder by the revelation that you had abused them. The gains to be won probably aren't worth the trouble of establishing such relationships -- getting away 'cleanly' with the money is very difficult."
In Germany , attention focused on options in reinsurers Munich Re and Swiss Re, each of which carried a large chunk of WTC risk.
"If you look at the numbers, there's just nothing there," said a Eurex spokesman. Volumes of Munich Re, which is the most heavily traded of the two, stayed between 2,000 and 2,600 combined puts and calls daily except for a spike on Sept. 6. On Sept. 10, volume was 2,385. Open interest rose slowly from Sept. 3 through 10, indicating that people were adding to their positions, but it continued to rise after the attacks, indicating that no one was in a hurry to grab their money and run.
None of the exchanges or regulators officially has ruled out the possibility that insiders used stock index futures to make their money, and some traders say the premiums on S&P 500 September puts -- especially those with an 1100 strike price -- were bloated beyond fair value in the week before the market plunged. Orders large enough to cause such aberrations should show up on regulatory radar screens, according to Dutch and German authorities.
If the money trail does lead to the terrorists who organized the WTC attack, it may provide the rope that hangs them. If so, the victory will be ironic, for it will be a rope woven of the same twin temptations that have done in so many traders in the past, excessive greed and over confidence -- exactly the traits those associated with these atrocities claim to find so distasteful in our society.
[Graph omitted]
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STATE OF THE INVESTIGATIONS
While some of the investigations into questionable trades were over in a few days, some will linger for weeks, if not months. Here's where the regulators who are playing the biggest roles in these inquiries stand:
* Dutch regulators have uncovered and cleared both sides of trades in KLM options on Euronext. Still tight-lipped about short sales of actual stocks or index futures.
* Germany 's Federal Securities Agency has ruled out any illicit gains from stock options , Investigations in actual equities and stock index futures continue.
* The SEC and the FBI are investigating 38 stocks, stock options , T-bond futures and stock index futures. No announcements regarding exonerations or accusations have been made.
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