Aug 9, 2011

Merrill Lynch, Trading Against the Deck


Merrill Lynch, Trading Against the Deck

By: Admin

Merrill Lynch, Trading Against the Deck
Posted by Jeff Carter
on January 26th, 2011
Jeffrey Carter is an Independent Speculator. He has been trading since 1988. He is a former member of the CME Board of Directors. He currently does commentary on markets for CNBC, Fox Business, Bloomberg Television, CNN International, Canadian News Network, Bloomberg Radio, WTTW, WBEZ-FM, WGN, CBS Chicago and CBS News. (More)

No one is talking about this except pro traders today. Full disclosure, Pro traders are more paranoid than the worst schizophrenic. The left thinks that Glenn Beck spins conspiracy theories. I laugh in their general direction. Spend some time on a trading floor and you will hear some whoppers.

Unfortunately, an old saw is turning out to be true.

Merrill Lynch was caught with its hand in the cookie jar. Their prop desk was trading in front of, around and against customer orders. The Wall Street Journal had the story this morning.

"the proprietary-trading desk, which traded electronic messages with its nearby counterparts, was illegally spoon-fed information about what Merrill's clients were doing, and then copied an unspecified number of trades between 2003 and 2005. Merrill also encouraged market-making traders to generate... ... and share "trading ideas" with the proprietary-trading desk,"

On trading floors, we used to call it front running, bucketing, or trading against the deck. Stealing. When a broker engaged in that sort of unethical practice, they made a risk free profit. Some made millions. If they could cajole a couple of bagmen in to the scheme, they could steal more, and eliminate their errors.

To be clear, not all floor brokers were like this, but there were enough that the CME banned dual trading in the 1990′s. But, virtually everyone on the floor suspected that the prop shops off the floor consistently traded against and in front of order flow. Too many coincidences. Hopefully, regular readers of this blog that once patrolled a trading floor can enlighten the public with some stories in the comments section.

But, this whole "industry standard" gets worse. Recall that Goldman Sachs ($GS) didn't lose money for entire quarters. Morgan Stanley ($MS) would lose on only four days in a quarter. Today, it was reported that equity options volume was being traded in dark pools. CBOE chief Bill Brodsky has spoken out. Kudos to Mr. Brodsky and it would be nice if the chairman of the other public exchanges would speak out as well. Fragmentation is killing the market. At the end of the day, the public will be a huge loser.

If one looks at foreign exchange, muni bond and corporate bond markets, there is little if any price and quantity transparency. The banks keep a stranglehold over supply and it's impossible and inefficient to get a quote. Don Cummings runs a muni bond advisory firm at Blue Haven Capital and explained to me how the muni market works once. Trust me, it's not a level playing field and they get you coming and going. "Haircut" is the polite term for it. Guess that's why I am bald. (Blue Haven left a comment; it is centralized trading and clearing that he wants)

This is one of the things that ruin consumer confidence in free markets. When they are rigged so an elite few can make money risk free, the public runs away. Unfortunately, the SEC has written rules and regulations to support the under the table activity of the big shots. They can point to the law and regulation and shrug their shoulders.

Legal doesn't make it ethical.

An old friend of mine who works as a lawyer now says that there are several lawsuits pending to try and level various playing fields. From computerized trading systems to the structures of the market. I don't hold out a lot of hope for those legal actions. But, traders are smart enough to know the market is slanted against them. That's the way many markets are today. Only public outcry will cause regulators to change them.

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