Are Merchant Banks Trading Using Stock Exchange Secrets?

Do Wall Street 'types' have access to stock exchange secrets?

This is a great place to start looking for the inside track. Unfortunately, most (or all) of this real inside knowledge is illegal to use. There are a few court cases every year which involve insider dealing from a source who should know better. This might be a journalist with access, a money manager or an analyst of some sort.

The usual image of this comes from the film Wall Street in which Michael Douglas won an Oscar. His character was Gordon Gecko, a super wealthy, ruthless and very powerful fund manager who uses Bud Fox (played by Charlie Sheen) to gather competitive intelligence on a company he was interested in.

This intelligence involved following a company chairman, posing as an office cleaner and copying sensitive documents. In other words, he was stealing his stock exchange secrets! Gecko then traded on the information through offshore sources to hide his involvement.

Whilst this may happen (who knows?), a more likely scenario is one where people working for the same firm have access to different departments with knowledge that may assist in multiple parts of a trading operation. In theory, there should be a 'Chinese wall' but this is very difficult to guarantee in any real business.

For example, one department may be working on the legal aspects of an IPO for a company whilst another department is trying to assess how to trade this new offering and what values and prices they feel are justified. If the 'Chinese wall' were breached, the trading department could obtain sensitive market information prior to launch that would impact strategy and trading methods.

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Whilst we are clearly not suggesting anything untoward, a quick look at this list of services offered by investment banking giant Goldman Sachs - for both companies and individuals - it is easy to imagine how staff members could be involved in exchanging information. In fact, colleagues could easily pass over sensitive information unwittingly or unknowingly.

Adding value by doing the same as everyone else

It is worth noting that most major investment banks offer a similar list of services. Some smaller firms will be more 'boutique' and offer a much more specialised service, but the bigger a firm becomes, the more of these operations they are involved in.

In the book Money and Power, which is about Goldman Sachs, by William D Cohan, the author describes at one point a saying that was apparently common within the company. "If you've got a conflict, we have an interest". While there is no way to know how pervasive this kind of approach may be within the merchant banking community, it is clearly problematic wherever it may exist.

The more areas a firm is involved in, the more potential conflicts of interest or information leaks there are - especially when many members of staff for the different departments work in the same building.

Since there is such a lot of money involved in major market deals, information sharing could easily be very profitable for all concerned. It would however, set the rest of the market at a significant disadvantage.

It is within the M&A space (mergers and acquisitions) that there is believed to be the worst insider information problems. There are many reasons for this including the fact that trying to make a bid for a quoted company is going to involve a lot of people (lawyers, analysts, upper management, strategists, traders and on and on) which makes keeping something a secret difficult. Another is the length of time between first discussing a deal and actually announcing it. In that time, all these people have had ample opportunity to establish themselves and their conspirators so that they purchase stock in the company to be bid upon in advance of the price spike.

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