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Sheelah Kolhatkar: Hedge Funds Are The Robber Barons Of Our Time

And have enjoyed unfair advantage for far too long
Sunday, April 2, 2017, 10:14 AM

Sheelah Kolhatkar, former hedge fund analyst and staff writer at the New Yorker, thinks hedge funds have enjoyed enormous unfair advantages for far too long.

In her recent book Black Edge: Inside Information, Dirty Money, and the Quest to Bring Down the Most Wanted Man on Wall Street, she details out how many hedge funds use financial engineering and accounting tricks -- even illegal insider information -- to fill their coffers at investor expense. And then they use those ill-gotten gains to influence politics.

The hedge fund industry grew up quietly out of almost nothing into this enormous force on Wall Street. There's almost $3 trillion estimated to be under management at hedge funds around the world -- but hedge funds are lightly regulated, so we don’t always know what's going on in that sector.

The people who have founded many of these hedge funds have become enormously wealthy. They have become the new robber barons of our time. The most successful among them have amassed multi-billion dollar fortunes largely based on trading and extracting very large fees from their investors for trading their money.

These people now exert outside influence in our society, including as major political donors and lobbyists and in the world of philanthropy and other areas as well. So, I always like to keep an eye on that world -- I think there’s a lot going on there that explains what’s going on in Washington, and we don’t always realize it’s connected

In this podcast, Chris and Sheelah discuss the racket the hedge funds run, and as a case study, give close examination to the US government's tortured (and ultimately, unsuccessful) efforts to convict hedge fund kingpin Steve Cohen of SAC Capital on insider trading charges. Given their vast resources and paid influence, these modern robber barons remain practically untouchable.

Click the play button below to listen to Chris' interview with Sheelah Kolhatkar (44m:50s).

Transcript: 

Chris Martenson: Welcome to this Peak Prosperity podcast. I am your host, Chris Martenson, and it is March 27, 2017. Today, we’re going to be talking more about the fraud and structural issues that seem to be running rampant, if I can put that across both of those terms, the financial landscape here in the United States. Now, in the past we’ve talked with Bill Black, Carolyn Baum, Danielle DeMartino and together they have painted a picture for us that… with Bill Black talking about control fraud as a structural form, Carolyn Baum really diving into a lot of the issues as she dove into some of the very specific cases of bank malfeasance, Danielle DeMartino talking about how the fed is institutionally sort of myopic in looking in one direction and maybe not another.

We’re going to really add to that story today. We are talking with the author of the New York Times best-seller Black Edge: Inside Information, Dirty Money, and the Quest to Bring Down the Most Wanted Man on Wall Street. That author is Sheelah Kolhatkar, a former hedge fund analyst, a staff writer at the New Yorker, and there she writes about Wall Street, Silicon Valley, economics, national politics among other things. Previously, she was a features editor and a national correspondent at Bloomberg Businessweek and a regular contributor to Bloomberg television. She has profiled characters as diverse as Massachusetts senator Elizabeth Warren, that would be my senator, PIMCO founder Bill Gross, hedge fund mogul John Paulson, and President Trump. In 2010, her work was honored with a New York Press Club award and she is the author of this book, Black Edge which we’re going to be talking about today.

Black Edge, it’s a real-life thriller about the government’s attempts to get Steve Cohen of SAC Capital on insider trading charges. I can’t wait. Welcome to the program, Sheelah.

Sheelah Kolhatkar: It’s great to be here, thanks.

Chris Martenson: Let’s start here: tell us about Black Edge. Why did you write it and what really drew you to this topic?

Sheelah Kolhatkar: For starters, I formerly worked as a hedge fund analyst before I got into journalism. So, I have always been very interested in that part of the economy. The hedge fund industry kind of grew up quietly out of almost nothing into this enormous force on Wall Street. There are almost three trillion dollars estimated to be under management at hedge funds around the world and hedge funds are lightly regulated. So, we don’t always know what is going on in that sector, but the people who have founded many of these hedge funds have become enormously wealthy. They have become the new robber barons of our time. The most successful among them have amassed multi-billion dollar fortunes largely based on trading and extracting very large fees from their investors for trading their money. These people now exert outsize influence in our society including as major political donors and lobbyists and in the world of philanthropy and other areas as well. So, I always like to keep an eye on that world. I think there’s a lot going on there that explains what’s going on in Washington and we don’t always realize it’s connected.

Chris Martenson: So, as a quick aside then, this industry which I know you work for and I know lots of people are in the hedge fund industry and I do anger them from time to time, but it’s really a skimming operation in many respects. They don’t produce houses, cars, clothes, goods. They’re really just there trading and basically pulling money off and that’s ok, I guess, but if we really want to understand the story, we have to understand the absolute massive degree of financialization that has really begun to dominate the American economy. You were there during the growth of that industry. Was there a sense within that industry of… do they feel like… are they doing well for the world or… What’s the sense there?

Sheelah Kolhatkar: Obviously, there are thousands of different hedge funds and they all do different things. So, of course, you don’t want to lump them all in together. Some of them are doing very long term activist investing where they’re getting really involved with individual companies they’re invested in. Others are trading on global markets. Others are just trading derivatives and options. Then there are others that do this more short term stock trading, mostly, around different corporate events and that is the area that is the focus of the story that I write about in this book. That particular sector became extremely competitive. When I started out in the business there were far fewer hedge funds and it was much easier to go to work every day and make money trading, depending on whatever your strategy was as a hedge fund manager. Over the last 20 years, people figured out that this was such an incredibly effective way to become very, very wealthy very quickly that the hedge fund industry literally exploded and you had the best and brightest graduates of colleges or young people coming out of training programs at big investment banks like Goldman Sachs all fighting and flocking to get hedge fund jobs because you could become rich so quickly. There was also a certain amount of freedom to it.

Hedge funds were originally conceived as private investment vehicles that catered to wealthy and sophisticated investors. So, the idea behind them was that they would only invest money of people who could afford to lose the money. They would not take money from average, working people who would be financially ruined if they lost all their investment. So, in exchange for agreeing to only take sophisticated investors’ money, the regulators said well, we will only regulate you very lightly. You can have a lot more freedom in the market than say, a mutual fund, which is managing people’s retirement money. So, hedge funds overall can invest globally, they can borrow a lot of money to make their investments, they can short stocks, which is betting against a stock and that is a very risky activity. Often, we don’t really know what’s going on in the, but the people who got in there early amassed this incredible wealth and I think that largely their influence in the economy has been one to show everyone that by focusing your activity on short-term speculation, financialization, you can really increase your profits. I think we’ve seen both big banks trying to imitate the hedge fund business model, but even totally non-finance related companies, just regular, old corporations. A lot of them have been trying to focus more on financial engineering and accounting tricks rather than the harder work of long-term investment. I really think hedge funds are credited with that because they really showed everyone that this was a really quick and easy way to make money.

Chris Martenson: Well, it was and then it became very competitive and, of course, we had the other large structural change which was around 2007 and 2008, the algorithms really came online and changed a lot of the strategies. I’ve known a number of hedge funds who had strategies that were in play for 30 years and have recently broken down. So, I’m raising all of this kind of as the backdrop, maybe, for your book which says that there was a case where a hedge fund allegedly seeking additional advantage. Obviously, everybody is always seeking advantage insider trading, that’s nothing new on Wall Street. But really the backdrop for this must be this explosion of the number of entrants into, not just the hedge fund universe, but you had mentioned also the private and proprietary trading desks of the big banks which, I don’t even know if we can call that competitive. JP Morgan announced recently that last year they had zero days of losses with an average daily haul of 80 million. I’m not sure if you can call that trading because if there’s any risk involved you can’t have a perfect record. So, they’re doing something else, but anyway, it became a very competitive field. Is that competition a necessary backdrop for your story or is insider trading just always part of the game?

Sheelah Kolhatkar: Well, I think the two kind of went hand in hand. Hedge funds, particularly very trading-oriented hedge funds of the sort that I’m writing about in this book, they are driven by information. They spend their days with armies of analysts and portfolio managers just scouring the market for useful, actionable information that they can use to make money trading. The problem is, of course, when you have so many people all from the best schools and all very highly motivated by the prospect of enormous bonuses and very smart, of course, some of the smartest people our society produces in this field, they’re all out there trying to do the same thing every day. So, the competition is extremely intense and I think that definitely contributed to this spread of this particular type of insider trading that I write about.

I can illustrate it a little bit by just explaining the title of the book. On Wall Street, there is a term, “edge” which refers to your information advantage in the market. People would say to one another, what’s your edge on this stock? That means what is the thing that you know, what have you figured out that’s going to allow you to make money trading this stock that other people don’t know? Because you have everyone out there trying to figure out the same thing that you are. Within SAC Capital, the giant hedge fund that I write about, there were some other… They had a system for categorizing information. There was white edge, which was considered to be very legal, easily available information that anyone could get. For example, something that’s on a website or a public SEC filing. That information is actually not that valuable because presumably, everyone else in the market has it already. So, whatever the information is, it’s probably already reflected in the price of the stock. Then there is gray edge which is the gray area. Something you’re not quite sure whether it’s legitimate or possibly inside information. That might be something you learned as a result of a conversation with an executive at a public company. They might have hinted something to you. You’re not quite sure if that’s ok to trade on or not, maybe you need to consult with your legal counsel at your hedge fund before you make a trade. Then there’s black edge which is inside information. That’s material, non-public information that will certainly move a stock price.

Of course, what the FBI agents and the SEC regulators learned as they were investigating this and as I describe in the story, many people working in the hedge fund world felt pressure to get black edge because once one person does it, it’s a bit like doping in sports. If you have one person getting an extra advantage, suddenly it increases the pressure on everyone else to get it as well. So, that was sort of what happened. It became almost an arms race to get the good information and they found that this had spread among a number of hedge funds by 2008, 2009 and that led to this big crack down.

Chris Martenson: Alright, so this black edge information, which is material, nonpublic information… By the way, I believe that it’s legal for congress to trade on black edge information, is it not?

Sheelah Kolhatkar: Well, it was. A few years ago, a piece of legislation was passed that was long overdue called the STOCK Act which made it illegal for members of Congress to trade on information they had gained from their work as members of Congress. For example, legislation that they’re working on. That legislation passes and it has a huge impact on stock prices and it is now illegal for members of Congress to trade on that. What is sort of shocking about it is that it took so long for that to be outlawed. It’s a little odd, but yes, they’re not supposed to be doing that. You can imagine how that could really skew their work in government, if they are able to trade on the side and make money from the bills that they’re passing.

Chris Martenson: Sheelah, preposterous to think that incentives have an impact on human behavior, clearly. So, was it gray edge before the STOCK Act to trade on and follow… I know people were following that strategy. What are the Congress people up to? Let’s just follow that. If they’re doing… is that white edge, what is that?

Sheelah Kolhatkar: They must be doing something right. Yeah, I guess it’s gray edge and of course Tom Price, President Trump’s cabinet member is reportedly under investigation for just this sort of behavior. So, it hasn’t gone away, obviously, entirely.

Chris Martenson: So, let’s start with this case, then. We’ve got SAC Capital and they’re beginning to be investigated. How did this case start? How did it get developed? These are very complex cases, not a lot of them get initiated, but this one did. What happened here?

Sheelah Kolhatkar: This particular case involving SAC Capital, this huge hedge fund that Steve Cohen who was the founder of the hedge fund, who is one of the most powerful men on Wall Street, it really emerged out of an earlier insider trading case involving Raj Rajaratnam who is another big hedge fund manager who is currently serving a prison term for insider trading. The SEC got a number of reports starting in 2006 of suspicious trading activity and they started to look into it. Over the next few years, the FBI got involved and they started to realize that this kind of behavior, trading of material nonpublic information, had spread all over Wall Street among a number of hedge funds. They decided at one point that they were going to employ the investigative methods that they had previously used in mafia and organized crime cases to Wall Street. So, they started wiretapping people, they started recruiting confidential informants to go and wear wires and collect evidence.

Over a number of years, they pieced together a whole bunch of cases that spread all over the industry suggesting that… By this point, this had really reached its peak around 2008, 2009. Hedge funds all over Wall Street had quite openly embraced the idea of collecting inside information about different public companies. You had hedge funds sharing the information with one another and trading off of it and making money from it. I’ll just mention as an aside, the reason this is really not a very good thing for the market is that we’re now living in a world where we’ve eliminated defined pensions. Almost everyone is being encouraged to park their retirement money in the stock market through 401Ks or IRAs or whatever other accounts they can access and we’re all in there swimming around in this market with our financial future tied up in it. Regulators and investigators figured out that really there were two markets. There was one market for the sophisticated insiders, many of whom were paying to get information that wasn’t public yet and then there was the market for everyone else. The suckers who weren’t professionals, they didn’t really know what they were doing and had to hope that this worked out well because otherwise, they would not be able to retire when the time came.

So, the government figured this out and at one point in 2012, the FBI sent some agents down to Boca Raton, Florida and they arrested a gentleman named Mathew Martoma. He was a former portfolio manager at SAC Capital, this big, powerful hedge fund that had 15 billion plus in assets. One of the largest hedge funds in the world. The FBI dragged him out of his house in handcuffs, took him away and I, as a journalist, I was working at Bloomberg Businessweek at the time, was following this all very carefully, but I had not really started to work on it as a reporter. But when they arrested this particular person, I got very intrigued because it was clear that they were trying to connect Martoma’s trading to that of his former boss, Steve Cohen. I was very familiar with Steve Cohen’s reputation. He was an iconic figure in the hedge fund world, one of the most successful hedge fund managers of all time. He had only had one down year since beginning his hedge fund in 1992. His one down year was 2008, so that was a pretty rough year if you recall. That was the height of the financial crisis. Every other year, he had made money and not just some money. He had made enormous returns. He was the envy of the industry. A lot of people wondered how he could do so well every year. It was just what you mentioned earlier about risk. Typically, you’re going to have good years and bad years. He just always had good years.

When they arrested this guy, it became really clear to me, as a journalist, that they were preparing to go after Cohen himself. I just knew that that was going to be both a very interesting and juicy story, but also one with a lot of public relevance because it’s very rare that the government decides to pursue a very wealthy and powerful businessman in the United States. It just never happens. I knew that was going to be really important and something I wanted to watch very closely. That’s really when I got involved in the story.

Chris Martenson: So, they’re doing all this wiretapping, they’re starting to build a case. How hard is it to build a case like this?

Sheelah Kolhatkar: That depends a little bit on who you ask. It’s important to know how many of these cases really start. They start with a referral at a regulatory agency called FINRA. It’s all very boring sounding, but basically if someone notices something suspicious in the market, you’re a trader at a bank and you notice that there’s a huge increase in trading volume of a particular stock and it seems odd, it’s not typical for that stock to shoot up like this and then the next day, a merger is announced and the price goes up even more. You might wonder to yourself, ok, somebody knew something and bought these shares yesterday before the news was public. So, you might write a little letter to FINRA, this regulatory body, and say, I noticed this suspicious trading, I want to flag it for you guys. FINRA will look into it and if they think it looks suspicious, they’ll forward it to the SEC, the Securities and Exchange Commission which is the main regulatory body responsible for policing the public markets.

The SEC, of course, is often subject to political whims and the political atmosphere at the particular moment and whether they have enough funding, whether they have the right numbers of people working in the right areas, that’s all something that flows out of Washington. The chair of the SEC is appointed by the president. So, at this particular time when these trades that I write about in this book came to their attention, there happened to be a gentleman running the SEC who had been appointed by George Bush. His name was Chris Cox and he was someone who did not really believe in aggressive enforcement of market regulations. He felt that the stock market could regulate itself and that Wall Street could regulate itself and it did not need a bunch of bureaucrats in Washington looking over their shoulder. So, the SEC was starved for resources and was also in the throes of this deregulatory fever. There was a real message internally that you just should not pursue these cases very aggressively.

In spite of that, a group of SEC enforcement attorneys decided that these particular suspicious trades that someone pointed out to them looked really fishy and they decided to spend a lot of time really looking into it, but it's painstaking. Especially at the early stages because you’re really just having to look at documents and trading records and phone records and see if you can piece together a connection between a suspicious trade at a particular firm and some kind of insider who would have known about a confidential piece of information before the rest of the market and you really need to make a connection before you know that you might have a case. You can imagine that there’s a lot of time spent chasing dead ends before you hit on something. That is exactly what happened with these folks. Once they had figured out who they particular actors were, you know, they had a trader at a hedge fund, they had an insider at a drug company, they had a record that they had been talking. Then they say, ok, this looks significant enough that we’re going to get the criminal prosecutors involved. Then they have to call up criminal prosecutors, the FBI agents who work on these sorts of cases and sell them on the case.

Once they get involved, then it can move up to a higher level and then they might use wiretaps, they might use informants, they use the more traditional law enforcement methods to try to build the case. That can go on for years, that whole process can take years. Eventually, you may end up in a situation where you have a criminal trial which is what happened in the case of SAC. There were several high-profile trials of traders who were accused of trading on inside information and you have these defendants arriving with very high powered, high priced defense lawyers many of whom previously worked at the SEC or at the US Attorney’s office so they’ve been on both sides of the table. They still end up losing many of these cases. It’s a remarkable amount of energy that they spend on these and they do not always work out.

Chris Martenson: They might not work out for your win ratio as a prosecutor, but potentially you might still shape the industry and get it back in line, let them know that you’re still looking. Let me back up a bit, we cover a lot of this stuff on my program and one of the pieces we covered a while back was Harry Markopolos and his efforts to go through this escalation process that you described. You start at FINRA, you flag some stuff, maybe it gets up to the SEC, it goes from there and gets up to the FBI. There’s this what sounds like a prudent, normal escalation process, but Harry was attempting to alert people to Bernie Madoff, who he, on a silver platter, gave perfect evidence that it was impossible for his stated returns that were on public file to have been delivered in the way he said because there simply weren’t enough E-mini options and E-minis themselves to have accomplish what he said he did given the time frame. So, there was a person giving perfect statistical and, what I would say is even beyond statistical evidence which suggests here is blatant crime. That seems like an easy case. Still, that took... there was some difficulty getting that one through. Massive fraud, all of that and so I understand Christopher Cox thought, well, it will regulate itself. Didn’t happen in the case of Madoff. Was Madoff the backdrop that helped provide some extra fuel for this case to say maybe we should do this now or has that sense of regulatory lack of zeal, was that at all shaped by Madoff? Is it different than it used to be or are we still in a laissez-faire climate here?

Sheelah Kolhatkar: I think that the revelations of the Madoff case and just all of that warning that the SEC had gotten from Mr. Markopolos and all of the blatant red flags around Madoff’s business definitely shook up the SEC. I think that was a major embarrassment and source of shame for them. They definitely woke up. Now, I would say that these insider trading cases that I’m writing about were kind of going on already when the Madoff thing was made public and when everyone at the SEC realized, but it definitely had an impact. I know that just from my reporting that was a shock wave around that agency. Again, you raise an interesting point. Many of these Markopolos warnings happened during the same period of time when the insider trading was happening and it also coincided with the run-up to the mortgage fraud crisis which… I just think it’s very interesting that all of those things were allowed to flourish and spread unchecked for years until this period of 2008, 2009, 2010 when it all blew up and we realized that, in fact, letting Wall Street regulate itself does not really work. It’s just not a coincidence that all of this happened around that same time.

Chris Martenson: Interesting. Of course not and again, incentives and humans and accountability…all of that. One of the things that we’ve heard a lot recently watching Janet Yellen come out and talk about income and equality and say, well, if people just had more early childhood education and they were more entrepreneurial and maybe they had richer parents… I kid you not, she said all those things in 2014. But this income and equality that’s really out there, it’s a very socially destabilizing thing and my view, out here in the cheap seats, the person without the black edge information, is that it’s really a rigged game. That’s how it feels. That there are people who still have vast insider advantages whether that’s because they have servers co-located with fiber optic pipes that give them microsecond advantage or whatever the advantage is, still it appears like there’s a vast skimming operation happening because one group is really doing extraordinarily well and everybody else seems to be fighting over scraps. Whether or not that’s a fair perception, does the SEC, do you think, at all feel like part of its mandate is to create a fair and level system or are they just there to police and nip down a few of the bad actors from time to time?

Sheelah Kolhatkar: If you speak with the most earnest employees at the SEC, they will definitely talk about fair, open markets and how important that is. Now, I don’t know if they view their roles as central to addressing income and equality even though, of course, they are part of that…the way the system is skewed against certain groups of people. I think the most earnest people there definitely see their job is making sure the market is fair and they’ll always talk about confidence in the markets and how important that is. They did get a lot of flak as did the… So, the criminal prosecutors who work in the white-collar area, there was a lot of criticism about the fact that they brought all these insider trading cases, but they brought relatively few or zero high-level mortgage fraud related cases that came out of the financial crisis.

People are rightfully very upset that no one went to jail over the many, many frauds that occurred in the run-up to the financial crisis. If you confront someone at the SEC about that, they’ll say, well, insider trading was still a really important thing for us to do because the integrity of the public market is really critical and once we allow a two-tiered system to really become accepted by just ignoring certain types of securities crime, that’s going to have a terrible effect. I think they’re right about that. There is, of course, another debate to be had about how they decided to allocate resources to what sorts of cases and there are people who feel really strongly that they should have done less insider trading and more big bank level fraud. I don’t think that’s an invalid argument. I guess in an ideal world, they should be able to do both and it didn’t seem to happen.

Chris Martenson: Yes, we clearly would have resources for both if we had prioritized it, but let’s turn to that big bank fraud for a minute. I’m not aware… I would have to hunt through my memory banks to find a market that the big banks have not been charged with or convicted of, at least in a civil sense, of manipulating. Everything from LIBOR to Forex to precious metals, you name it, they’ve all been dinged. I’m equally hard-pressed to name as many as one person who went to person for each one of these mega-crimes. So, LIBOR, one dude. I’m aware of one person who got charged in England. That’s a pretty big thing there because eight banks are submitting their information to LIBOR and you have to take the center of four banks and that’s the actual LIBOR rate. So, at a minimum, you have lots of people involved in that. I’ve seen the squawk boxes, the emails, there are a variety of ways they were communicating, collaborating, conspiring and one person gets charged.

Sheelah Kolhatkar: Right, and a low-level person.

Chris Martenson: And a low-level person, very low-level. How should people out here in the cheap seats again, feel about that? It doesn’t look very fair to us.

Sheelah Kolhatkar: I think it’s a big problem, yes. I think it’s a big problem. I can tell you from the perspective of the government and the justice department, at some point in the years after the financial crisis really blew up and we all realized this massive mortgage fraud, securitizing stuff is going on all over the world, banks packaging mortgages of poor quality into derivatives, putting ratings on them that were misleading, selling them to other banks, this spread very widely. Clearly, someone there was misrepresenting the value of these securities and the value of the mortgages and of course, there were people giving mortgages to people who shouldn’t have had them in the first place. There were frauds happening all along the chain and it is shocking that they could not find a single senior level bank executive to even charge with any of those things. It really flies in the face of basic logic.

Now, from the government's perspective, they would say well, we tried, we were not able to find criminal intent in the high level of these firms that we needed. They would say that… There was definitely a philosophy that took hold about charging companies rather than individuals and I think it happened after 2000, 2001 when someone decided in the justice department, well, you know what, we can really change the culture of the company by charging the company rather than a person. So maybe what we’ll do is we’ll make it more of a priority to file a civil or even a criminal case against a corporation and we can extract fines from that corporation, we can impose changes on the company, impose new compliance measures, force them to hire monitors to monitor their behavior, all sorts of things. That will really change the company’s priorities and behavior. Then we had a number of years where instead of charging individuals, they were charging these companies.

many of the cases you described were those sorts of cases.

Even the Madoff case, many of the banks handling Madoff’s business like JP Morgan, they charged the corporation. They charged all sorts of companies with mortgage-related frauds, with manipulating different markets, you have currency market rigging for example. They extracted these huge fines, tens and tens of billions of dollars in fines. However, they, at the same time, never charged any of the people who had been involved in these frauds and I think over time it showed that, in fact, it has very little deterrent effect. Many of those fines of these publicly traded companies, the fines are borne by shareholders, actually, not employees of the banks. So, you don’t even have people having to give up their bonuses, necessarily, even though their companies are paying these huge fines which the shareholders are ultimately responsible for. So, it’s actually a very ineffective way of changing the culture of Wall Street. I think we’ve seen by just the ongoing number of enforcement actions and cases filed that it has had very little impact and now here we are with a new administration in Washington that seems to be very determined to water down the regulations we have had enacted to address all these problems. So, it’s worrying and yes, they set a terrible precedent by not charging anyone.

Chris Martenson: Well, I understand the rationale you gave is the official rationale, but again, from the cheap seats, it’s a little suspicious that you had somebody like Eric Holder come out from Covington and go in and then declare everybody too big to jail because oh my goodness, that might shake the markets and then go back to the same firm that actually defends these companies from the very things that he failed to charge them for. So, that just really…again, it just doesn’t pass any optics test I’ve got out here. It looks wrong, smells wrong and it’s destined to continue to deliver the terrible results that we’ve had which, by the way, that level of unfairness, I think from my view, contributed to why we had Donald Trump elected in the first place which is that with Hillary Clinton representing a very strong sense of – more of the same, I won’t rock the boat, I’ll continue the policies of Obama. Well, the policies of Obama with the people he selected for his justice department included one of the most unfair prosecutorial landscapes in my adult lifetime. That’s saying something because I thought nobody could outdo Ed Neese and then Ashcroft and I was wrong. So, that was astonishing to me, but you’re telling me that it might even be wronger than that if we get somebody else in so the arch of this doesn’t give me confidence at this stage. Is there anything from your point of view, though, that says wait a minute, we’re starting to get our arms around this, it was maybe a little too late but better late than never? Are we there or are we still in the process of dismantling the system?

Sheelah Kolhatkar: I think it’s going to get worse before it gets better. That’s just my sense of it. President Trump has already made pretty clear that he wants to do a number on Dodd-Frank. Dodd-Frank was the huge legislation passed after the financial crisis that was intended to make the system more stable. It was intended to reduce the threat of having to have a tax payer bail out of any of these banks in the future and it did create incentives and disincentives for financial crime in the future, but there are many critics of that legislation. There are people who say it’s too long, it’s too complicated. They may have a point, of course, in some areas. It’s not perfect, but it did make it harder for banks to trade their own money, to speculate in the market with their own money, for example. I don’t think that’s a bad thing at all. Yeah, it seems pretty clear that they’re planning to kind of go after that and gut it as much as they can. The consumer financial protection bureau, which also came into being in response to this, is under dire threat and I think we’re going to be hearing a lot more about that in the future. The justice department has already indicated that it’s going to be attacking bureau’s legitimacy in court. Just to take one example of something that that agency was really instrumental in. This case involving Wells Fargo, that’s… Unlike a lot of the mortgage fraud and even insider trading stuff, that Wells Fargo case is very easy for people to understand. Basically, you had the bank structured to incentivize and pressure people very heavily, tellers, low-level employees at Wells Fargo banks across the country under intense pressure to sell new accounts to bank customers. Some of them were supposed to be opening multiple accounts a day, making dozens of sales calls a day and they were at risk of losing their relatively low paying jobs if they didn’t deliver on these enormous quotas. So, what happened? You had bank employees opening accounts for people that they had not asked for. An enormous fraud that affected thousands of people and we wouldn’t have even known about that if the CFPB had not charged the bank and fined them. It should be noted, of course, that the… it was News Report that first brought attention to the fact that this was going on. Many, many customers were affected, their credit scores were damaged, they were paying fees that they shouldn’t have and they had mortgage applications and bank account applications opened in their names and who is going to be policing the market for that type of behavior and protecting consumers if the administration is allowed to shut down all of those agencies? I think that’s a big concern. I think people should add that to the list of things that they’re calling their representatives about. It’s not always at the top of the list. Healthcare is more urgent to people and I understand why, but these things actually affect everyone’s pocketbooks and their financial health and people need to be really proactive, I think, because it’s in danger of being really rolled back aggressively.

Chris Martenson: That Wells Fargo case is, I think, easy to grasp for most people where we understand that if you or I fraudulently opened an account in somebody else’s name, transferred money from another one of their accounts and then syphoned those funds out, we would probably be facing some jail time or at least a criminal action, right? That’s criminal behavior, but again, the corporation escaped any criminal action whatsoever on that front. Yes, the CEO had to bail with a golden parachute, very tough times, I understand, it must have been so embarrassing. At the same time, we have Citizens United saying corporations are people. They have personhood, but they don’t get charged like people so there’s a real mismatch there. If you were going to encourage people to, whom would they write about this sort of dichotomy between how corporations are treated on the one hand versus the other hand? How would we begin to get at the heart of this which is that without accountability, Sheelah, nothing ever changes? There are just a few minutes.

Sheelah Kolhatkar: I know. Well, it’s easy to become incredibly frustrated. I think for starters, people can do one simple thing which is vote with their business and choose not to do business with companies that are not behaving in a way that they feel is fair and reflective of their values, I think that has already happened with Wells Fargo where they did suffer a huge drop in account applications over the last few quarters. I would also add I think that the investigation of the Wells Fargo case is not entirely over so we’re not sure yet exactly who will or will not be held responsible for all of that. But, yeah, people can have an impact. That, to some extent, is the only thing that these companies pay attention to is when their business suffers. So, that is a way that people can express their disapproval. Beyond that, I don’t know what to say. It’s extremely frustrating, yeah. Citizens United is part of the problem, campaign finance reform is really important. I think when you have hearings, for example, the new SEC chair had a confirmation hearing last week. It was mostly ignored. People need to really make an effort to educate themselves and pay attention to these things because they will have an effect on all of our financial futures. I think when the CFPB comes up again in the news, people should decide to make that a rallying cry and write to their representatives or make phone calls the same way they are now about other matters because it’s just very important.

Chris Martenson: Absolutely it is and of course it is a little bit frustrating because the arch has been moving against us for a while and as you say it may get worse before it gets better, but, the way this all begins is with education and understanding the lay of the land. That’s why I consider Black Edge, yes, it’s a gripping Wall Street detective story, people will enjoy it on that front, but really essential reading for anybody who has that desire to understand what’s happening and why. I think there are some predictive power in understanding the landscape because then at least, as they say in Texas if you’ve been at the card table for half an hour and you don’t know who the sucker is, it’s you. So, this is part of understanding how the game actually is structured. Knowing that is important. Get away from the whole, oh, yes, we have a free and fair system. No, we don’t, here’s the data. I think knowing that is very helpful for everyone, but if we’re going to shift this at all, it begins with sharing a common understanding of what the problem actually is. So, Sheelah, thank you so much for writing this book.

Sheelah Kolhatkar: Thank you so much for having me on.

Chris Martenson: Very quickly, how can people follow your work and what are you working on now?

Sheelah Kolhatkar: I just finished a big piece for the New Yorker about another hedge fund manager named Bill Ackman and his battle against a company called Herbalife which...

Chris Martenson: Oh, yeah, we like that story.

Sheelah Kolhatkar: Yeah, there are many, many interesting threads to that story. Herbalife, of course; he’s accused the company of being a pyramid scheme. The company has been fighting back against him, but it really, I think, sheds some light on the American economy because so many people have been drawn to this company Herbalife as a way to try and make extra money. There’s so much economic desperation. Then you have a powerful hedge fund manager who recognizes that and tries to make money from that himself and it all went very poorly for him, but I think it really provides insight into the American moment, as they say, and why President Trump is in the position he is in right now. There’s just a lot of frustration out there.

Chris Martenson: Well, thank you so much for your time today, Sheelah and best of luck with all of your writing endeavors.

Sheelah Kolhatkar: Thank you very much.

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8 Comments

Pandabonium's picture
Pandabonium
Status: Bronze Member (Offline)
Joined: Aug 30 2008
Posts: 84
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Pandabonium's picture
Pandabonium
Status: Bronze Member (Offline)
Joined: Aug 30 2008
Posts: 84
Justice

Lamp posts aren't just good for hanging street lights.enlightened

cmartenson's picture
cmartenson
Status: Diamond Member (Offline)
Joined: Jun 7 2007
Posts: 5201
"Black Edge"

It seems to me, the more I dig into things, that insider trading, rackets and fraud at the highest levels are really more the rule than the exception.

Perhaps this is just what should be expected from humans?  Or maybe its just something that appears during a late cycle expansion - this one including the expansion of empire beyond its useful limits, and humans into a tasty, available energy source. 

Maybe the loss of a narrative that makes sense, and in which we can believe, untethers people from a sense of fair play and social cohesion liberating them to not follow rules and take whatever they can?

aggrivated's picture
aggrivated
Status: Platinum Member (Offline)
Joined: Sep 22 2010
Posts: 513
Rackets and human nature

Reflecting on your comment made me remember the insider trading that has been the hallmark of many/most small town economies. From secret hand shake societies to country club golf courses the allure of the deal based on special knowledge is almost universal. Many a start up business has been doomed to failure for failure to make correct contacts. Many a fortune has been sealed at the expense of outsiders.

A bigger town or city provides more niches to operate without bowing to the local powers that be, but there are limits to what one can accomplish on the outside.

All of this behavior is writ large in your hedge fund discussion. Very typical human behavior, but not fair by any measure.

lambertad's picture
lambertad
Status: Silver Member (Offline)
Joined: Aug 31 2013
Posts: 125
Black Edge

The Richmond Fed president resigned yesterday in regards to leaking information in, wait for it..... 2012. 

Here's a link to the New York Times piece. Of course he won't face any legal charges, nor is it likely will the people who traded based on his confidential information. This again confirms the concept that there are two sets of rules, one for us and one for them. 

It's astonishing that it took 5 years for them to figure this out and for him to resign, but it just goes to show that even Fed presidents are guilty of disclosing this information. Here's a quote from the Marketwatch article on the same topic: "When Medley published a report by the analyst the following day...it contained this important detail about one of the policy options and I realized that my failure to decline comment on the information could have been taken by the analyst, in the context of the conversation, as an acknowledgment or confirmation of the information,”. So, basically his argument was that by not denying information that information was inadvertently confirmed to the analyst. Why is a Fed president talking to a private financial analyst to begin with? Isn't that just opening the door to some sort of insider trading whether or not it's intended? 

Great Podcast and this article just confirms it. 

Uncletommy's picture
Uncletommy
Status: Gold Member (Offline)
Joined: May 4 2014
Posts: 379
Wisdom from the strangest places

"Always be nice to bankers. Always be nice to pension fund managers. Always be nice to the media. In that order"  -  John Gotti

I wonder if that applies to hedge fund managers and other short sellers?

cgolias's picture
cgolias
Status: Bronze Member (Offline)
Joined: May 13 2011
Posts: 33
Gods and the Herd

I can't help but be reminded of the Latin proverb, "Quod licet Iovi, non licet bovi", of which a possible modern translation would be "Gods do what the herd may not."* Bankers can inside trade, but we can't. Celebrities can possess drugs, but we can't. The Fed can print money but we can't. And so on. Laws are for the herd while the gods live out their epic dramas.

*(For latin buffs, I know this isn't literal, but it's pretty spot on for this discussion)

KugsCheese's picture
KugsCheese
Status: Diamond Member (Offline)
Joined: Jan 2 2010
Posts: 1318
Regulations Don't Work

Regulations don't work.   The Regulated capture the Regulators ALWAYS.   The only solution is punishment, punishment by the market which means no bailouts!   The Wells Fargo sales scam would not have happened if Wells Fargo and the other big banks were left to meet the market enforcer and bankrupting them to sell off what assets remain in 2009.

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