Tis the season to take stock in your year. With the holidays fast approaching, many of us will be starting to wonder whether we’re on Santa’s naughty list or his nice list. Yet, there are a few on Wall Street who have already earned themselves a permanent place on the naughty list through astounding acts of greed and corruption.
Sure, Wall Street can represent the best benefits of open, free markets, but there are also plenty of examples of financial leaders abusing their money and power in ways that would put Ebenezer Scrooge to shame. In that Grinch-like spirit, here’s a quic
k look back at some of the biggest Wall Street crimes to have made Santa’s naughty list.
This Stock is NOT RCA-okay: The Original Pump and Dump
Okay, “original” isn’t exactly true, but the scandal that really cemented the pump and dump in the public consciousness took place during the 1920s and involved stock in the Radio Corporation of America, better known as RCA, and a cabal of market titans lead by one Michael J. Meehan.
At the time, it was common practice to form investment “pools,” which consisted of a group of wealthy traders and investors pooling their money to buy large quantities of a certain stock. The idea was to find a cheap stock, drive the price up by buying hundreds of thousands of shares, then sell at a big profit when the stock hit high levels. One part of the strategy was participating in what was known as “painting the ticker.” At a time when market news was sent out on an actual, physical piece of ticker paper, making more transactions would result in more trades getting printed up on the ticker. The pool members would trade large chunks of stock back and forth to make the stock look like it was receiving more action than it really was, piquing public interested and keeping more people flowing into the stock.
This was, of course, a bunch of bull plop being sold to the public to drive the stock up. RCA peaked at $549 a share in 1929, plummeted to under $10 after the crash, and wouldn’t return to the previous highs until the mid-1960s. Meehan would ultimately be the first person prosecuted by the SEC (though not for the RCA fiasco), an organization that was created in 1933 largely due to the sort of shenanigans that Meehan and others had pioneered.
Boesky, Did That Guy Break the Law
As Wall Street fraud goes, insider trading is an absolute classic. If you can find out that Company A is going to make a substantial offer to buy Company B prior to anyone else, you can buy in low and make a fortune when the news hits.
Enter Ivan Boesky. While certainly not the first person to engage in insider trading, Boesky’s wild trading of the 1980s helped make him one of the best-known cases. Boesky, who would ultimately serve as the inspiration for the character of Gordon Gekko in Wall Street, was one of the biggest players on the market during the 1980s.
Boesky made his fortune by using tips from corporate insiders to learn about corporate buyouts ahead of their announcement, allowing him to jump into those stocks immediately before they spiked. This was an especially effective strategy, but one that was a little bit too transparent even for an SEC that, during the 1980s, seemed to show a lot of willingness to turn the blind eye to such things. Boesky didn’t exactly do himself any favors, though, often hopping into a stock just days before the major event he had been tipped to.
Boesky would ultimately go down for his insider trading. He managed to get his sentence reduced, though, by cooperating with the SEC and feeding them information that helped result in the indictment of “junk” bond king Michael Miliken in 1989. Boesky would ultimately serve just 3.5 years and pay a $100 million fine for his crimes because of his cooperation, but his approach to the go-go 1980s was immortalized by Oliver Stone.
There’s No Accounting for This Behavior…
You can’t be sure you have a real, grade-A Wall Street crime until congress has to pass a specific piece of legislation in response to whatever loophole you were exploiting. Enter the 2002’s Sarbanes-Oxley Act that created a whole slew of new regulations dictating how publicly-traded corporations should maintain their books. Why? In a word: Enron.
Beginning in 1985 when Enron emerged from a merger of Houston Natural Gas and InterNorth, Chairman and founder Kenneth Lay and CEO Jeffrey Skilling ultimately engaged in a series of creative accounting tricks that kept the true state of the company’s finances from the general public. The result was a soaring stock that made its way into even the most-conservative investment funds and pension plans even as it was drowning in debt. By shifting debt through a series of shell corporations, Skilling and Lay ensured that the balance sheet they showed the public looked squeaky clean even as their company careened towards bankruptcy.
The reality, though, hit hard in October of 2001. The resulting bankruptcy of a company worth nearly $65 billion at the time was a severe blow to the markets, posing a major systemic risk and wiping out pensions and retirement accounts for thousands of individuals. Lay and Skilling were ultimately prosecuted for their role in the scandal. Skilling was ultimately sentenced to 24 years in prison while Lay shrewdly avoided jail time by dying prior to the trial.
The Enron collapse, followed by the even-bigger bankruptcy of WorldCom the next year, made it clear that reform was necessary and led to the Sarbanes-Oxley Act of 2002 which laid out standards for accounting practices that would hypothetically prevent another major corporate scandal like those of WorldCom and Enron.
Today, the Sarbanes-Oxley act has helped to create an atmosphere where mega-cap companies are subjected to plenty of scrutiny in their accounting, thus insulating public markets from the dangers of the sort of massive collapse that nearly laid low the whole stock market in 2001-2002, even if they have also created an environment that is patently unfair to small- and micro-cap companies.
He’s Madoff With All Our Money!
As far as Wall Street scandals go, it’s unlikely that anything is ever quite going to compare with Bernie Madoff. It’s not just the scale of the fraud committed – which was massive – but the fact that potentially the biggest stock scam in history was a result of one of the oldest cons in the book.
Bernie Madoff didn’t seem to see any need for complex derivative swaps to confuse people. No, Madoff rocked it old school with the tried and true Ponzi Scheme. On some level, you have to admire the man for his audacity. Many, many people have employed the Ponzi Scheme over the years to varying levels of success, but Madoff, in the midst of an era of electronic trading that he helped pioneer, with the Internet providing more dissemination of information than any previous period in history, still managed to take one of the oldest tricks in the book and went bigger with it than anyone else had ever managed, ultimately bilking investors out of some $65 billion.
So on some level, Madoff’s failings as an investor are overshadowed by his being one of the most successful con artists in history. That said, I get the impression that the people who lost their life’s savings to Madoff found little solace in how impressive his scam was from a historical perspective.
I’d love to tell you there’s an elaborate story of just how Madoff pulled off such an incredible fraud, but there really isn’t. He built a reputation based on early successes with penny stocks, translated that reputation into a massive fund that attracted investment from all corners of America for its huge returns, and, at some point along the way there, stopped getting actual returns and just kept using new investments to cover any money he had to pay out. And for as long as he was at it, he managed to keep convincing everyone that he was trustworthy enough that they didn’t need to get any more details than he was already giving them.
The whole thing couldn’t have been simpler. Just another example of how easy it can be for even the savviest investors to fail to conduct even the simplest scrutiny for their investments.
I Don’t Understand Any of This, But I’m Making Too Much Money to Care
It’s interesting that the breaking of Madoff’s scandal was juxtaposed with the housing market crash of 2007, a fraud steeped in complex financial instruments that were difficult to understand.
While maybe the most amazing thing about the housing bubble is just how much of what was being done was entirely legal, there was still some clear outliers that, even in the context of the insanity that was 2000-2006, represented something clearly different. One such case may come from Paulson & Co., the investment firm created by legendary hedge fund manager John Paulson.
Paulson ultimately made $15 billion off of the $12.5 billion he invested in shorting the housing market through complicated credit default swaps, a move some have dubbed the single greatest trade ever. I for one think we should applaud him for having the confidence to recognize the mass hysteria of his peers and swim against the current (though, somehow I doubt our approval matters much to someone who’s banked $15 billion on one position).
However, while I see no broad crime in his actions, he may have significantly overstepped with the ABACUS deal he cut in April of 2007. In this case, Paulson & Co. paid Goldman Sachs (GS) (a company whose name you KNEW was going to make an appearance on this list) $15 million to create synthetic collateralized debt obligations (CDOs). Why was this potentially criminal? Because Paulson knew they were garbage. He wanted Goldman Sachs to create the financial product and sell it to clients solely so Paulson could take a short interest against them.
Paying to create a financial product you know is going to fail is a bit much even for many of the cut-throat types working on Wall Street, and Paulson & Co. is currently battling lawsuits filed against the company and Goldman Sachs by the SEC and ACA Financial Guaranty in 2010 and 2011 respectively.
Insider Trading II: Electric Booglaoo
The fact that insider trading is going to make a second appearance on this list should indicate that this is one Wall Street crime that never goes out of style. One that reared its ugly head again in recent years with two major scandals involving hedge funds.
The first involved Raj Rajaratnam, billionaire founder of the Galleon Group, who was arrested and indicted for insider trading along with Anil Kumar and later Rajat Gupta. Gupta, who was a board member at Goldman Sachs, apparently called Rajaratnam to tip him to the $5 billion purchase of preferred stock Berkshire-Hathaway’s ($BRK.A) Warren Buffett was planning on making. This came amidst the darkest days of the housing crash, and the injection of capital meant Goldman Sachs would remain solvent, making the announcement of the deal a lock to boost the ailing investment bank’s stock. Rajaratnam jumped on the information, entered into a large position in Goldman, and then sold out of the stock immediately after it got a bump the next day.
This was, of course, super illegal and Rajaratnam and Gupta were caught on tape by the FBI. Whoops. Rajaratnam also traded based on tips he received from several other sources, like Kumar, and ultimately wound up being convicted and sentenced to 11 years in prison.
The second prominent case involving insider trading revolved around another major hedge fund, SAC Capital and its billionaire founder Steve A. Cohen. In November of 2013, SAC agreed to plead guilty to all counts brought against it and paid a fine of $1.2 billion. It was the culmination of a six-year investigation by the SEC that included a November 2010 raid of offices run by former SAC traders.
The fine was hefty, but it’s interesting to note that Cohen managed to escape the scandal relatively unscathed, unlike Rajaratnam. Nine SAC traders were charged with eight ultimately being found guilty. Matthew Marota was the most prominent fall guy for the fiasco, getting sentenced to nine years in prison and asked to forfeit more than $9 million after just a four-week trial in February of this year. Cohen, meanwhile, turned SAC Capital into a family office earlier this year and continues to manage his extensive fortune.
On Wall Street, Crime Pays a Whole Ton
Push comes to shove, even in a world with perfect regulation, and even one where the SEC is actually an efficient and competent organization capable of keeping up with the members of the private sector they’re tasked with policing, there would still probably be a lot of crimes on Wall Street.
The simple fact is, there’s too much money to be made to expect everyone to play things straight. Add to that the fact that expensive lawyers can usually argue down plea bargains to a slap on the wrist and a hefty fine and there doesn’t appear to be any real incentive to the Street to get its house in order. No, the long history of criminality in our public markets appears to be a feature we can’t hope to completely stamp out anytime soon.
However, while we can never hope to have a completely crime-free public market, it does seem possible (if wildly improbably) that regulators and market makers could work together to create a framework that would remove/limit incentives to break the law, ushering in a new era of open markets that benefit a broader swath of the investing public. Don’t hold your breath, though.
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