Credit Default Swaps as Insider Trading Violation

“Yet on a wholesale basis, Goldman Sachs and others not only had the inside information, they had created it. That is why Goldman started trading against the the interests of its clients to whom it was selling mortgage backed securities that were designed to fail”

“Both the investor and the borrower would have understood that sometimes very little of the investors’ money was actually being used to fund mortgages, with the rest being sued to buy insurance, credit default swaps, pay fees, profits, kickbacks and commissions.”

As this article points out from NY Times Mark HulBert, the insiders always make money. That is the game when the people minding the store get to know everything about the inventory and push the old produce on you so you don’t realize that it will turn brown by the time you get home. Martha Stewart went to jail for a tiny arguable violation of using inside information.
Yet on a wholesale basis, Goldman Sachs and others not only had the inside information, they had created it. That is why Goldman started trading against the the interests of its clients to whom it was selling mortgage backed securities that were designed to fail.
Nobody is in  jail for that — at least not yet. Goldman made money selling the securities to investors, made money selling the loans into esoteric (impossible to audit) pools, made money underwriting securities, made money trading in credit default swaps — all of which required the signature of some hapless borrower who thought the people who had procured this loan were acting in accordance with law and good faith.
While nobody knew about credit default swaps when the Truth in Lending Act was passed, it was precisely this kind of behind the scenes shenanigans that TILA was designed to prevent. With transparency the borower would understand that fees, profits, insurance policies and credit default swaps were being created and purchased out of the proceeds of a transaction between the borrower and an investor who was advancing the money.
Both the investor and the borrower would have understood that sometimes very little of the investors’ money was actually being used to fund mortgages, with the rest being sued to buy insurance, credit default swaps, pay fees, profits, kickbacks and commissions. Both of them would have understood that the quality of their investment was secretly being undermined by the people selling them this wonderful opportunity.
Bottom Line: The loan was sold most of the time as a passive investment that would enable the homeowner to profit from increasing value of real property that was overleveraged (without the homeowner knowing that the appraisal was suspect believing that it had been confirmed through normal underwriting procedures). Forward this article to any securities attorney and see if he doesn’t agree that what was sold to homeowners was a security and that the rules regarding rescission, damages, disclosure etc. under securities laws, rules and regulations apply.
February 28, 2010
Strategies

More Often Than Not, the Insiders Get It Right

By MARK HULBERT

CORPORATE insiders are sending fairly positive signals about the market.

When stocks began to fall in mid-January, insiders cut back on sales of their companies’ shares and increased their purchases, according to David Coleman, editor of the Vickers Weekly Insider Report.

That adds up to at least a “neutral” stance, he wrote to clients, and implies that the recent decline won’t turn into a full-blown bear market.

But, as a market indicator, how reliable are the sell-and-buy decisions of insiders like corporate officers, directors and big shareholders?

While these insiders have a long history of correctly anticipating the market’s direction, they haven’t done all that well in the last few years. As a group, insiders failed to recognize the top of the bull market in October 2007, and didn’t anticipate the depth of the decline that followed.

After these missteps, have insiders’ trades outlived their usefulness as a basis for market timing?

Probably not, says H. Nejat Seyhun, a finance professor at the Stephen M. Ross School of Business at the University of Michigan, who has studied the behavior of corporate insiders for many years. In an interview, Professor Seyhun said that insiders were not infallible, and that their recent failures were hardly their first misreading of the market’s direction.

But since 1975, the earliest year he has studied, insiders have been correct far more often than they’ve been wrong, and this is still likely to be the case, he said.

And there is no evidence, he added, that insiders have lost their ability to tell when their own companies’ stocks are undervalued. In the late 1970s and early ’80s, for example, he found that the average stock bought by an insider outperformed the overall market by three percentage points in the 50 days after the purchase.

For the most recent 10-year period in his sample, through 2008, the comparable 50-day advantage for the insiders was 3.3 percentage points. That’s striking because it includes the bulk of the 2007-9 bear market.

Given the variability of the year-by-year results, Professor Seyhun cautions that it’s not clear whether insider purchases are more profitable today than they were 30 years ago. But, he argues, his results show that insiders by no means are losing their touch.

Though the professor’s analysis extends only through 2008, data collected by the Vickers Weekly Insider Report show that even though the insiders missed the bear market, they can nevertheless take credit for anticipating the market rebound that began a year ago. Leading up to the market’s low in March 2009, for example, insiders as a group behaved more bullishly than they had in more than a decade.

Consider an indicator that Vickers calculates each week, representing the ratio of the number of shares that insiders sold over the previous eight weeks to the number they bought. That ratio dropped to as low as 0.45 to 1 in the weeks just before the bear market ended. That was the ratio’s lowest level since December 1990, at the beginning of the great ’90s bull market.

The more recent low, of course, was followed by a 10-month rally in which the Standard & Poor’s 500-stock index gained some 70 percent.

By November, in contrast, this sell-to-buy ratio had risen as high as 5.21 to 1, according to Vickers, more than double its long-term average of around 2.5 to 1. That signaled to Mr. Coleman that the market was vulnerable to a decline — and, indeed, the market did start to fall in mid-January. At its lowest point, the S.& P. 500 was down nearly 9 percent from the mid-January high.

But in recent weeks, insiders have been cutting back on sales and increasing their purchases. As a result, the sell-to-buy ratio has fallen back to 3.52 to 1, according to Vickers.

Though that is still higher than the long-term average, the trend suggests to Mr. Coleman that the recent downturn is likely to be “only a near-term correction.” He said that his firm was “increasingly optimistic about the future performance of the overall markets.”

Had the sell-to-buy ratio increased in the wake of the market’s pullback, Professor Seyhun added, we would have had reason for worry. It would have meant that insiders had no confidence that their shares would be recovering anytime soon, he said.

“Fortunately, and at least for now,” he said, “insiders are not exhibiting such eagerness” to sell.

Mark Hulbert is editor of The Hulbert Financial Digest, a service of MarketWatch. E-mail: strategy@nytimes.com.

2 Responses

  1. Does anyone have any caselaw or thoughts regarding violations of the Investment Company Act, Investment Advisor Act, Broker Dealer Registration, etc in regards to the pooling and/or credit default swaps? Also, has anyone looked into “Prospectus Liability” -materially and knowingly false information in a prospectus?

    It’s my understanding most of these “trusts” or “pools” were created so that they were exempt under SEC exemption status of the above mentioned acts – which is amazing to me because that means no governing body regulated them, i.e. “free for all”.

Leave a Reply

%d bloggers like this: