Goldman Sachs as Bucket Shop

I wrote last year about brokers and bucket shops. In that article, the subject was detecting brokers that operated Ponzi schemes. But there is another way that your broker can act just like a bucket shop.

A bucket shop of the old days just sold you a piece of paper that gave you a short term profit or loss on stock price changes. Since there was no one on the other side of the trade, in effect the bucket shop always traded against the customer. For each customer long position on a stock the bucket shop effectively took a short position exactly opposed to the customer's position. Hence, bucket shops are customer adversaries, a phenomenon that should always make customers queasy about doing business with them. And, in fact, bucketing trades, in which the customer's order is not cleared on a general exchange with a counter-party that is not the broker, is presently illegal in most states.

Even in 1905, bucket shops were not reputable. A pleasingly quaint account of the business as it was conducted in then is described in an old New York Times article (PDF).

Any time a broker is acting more or less like it is taking positions opposite its customers, then, it is acting in effect as a bucket shop. A key part of Goldman Sach's offense, at least in the figurative sense, is that it shorted any market in which it also underwrote securities. Customers expect brokers to act in the customer's interest. That is why they are trusted. If the broker uses any element of the customer's business or information generated by that business to trade against the customer then it is in violation of that trust.

This is the gray area between bucket shop and concerned customer agent. I suspect that most Wall Street brokers have been operating in the gray area for so long that they have forgotten where customers draw that line. I know a number of individual traders who never take it for granted that their brokers, whether full service or discount, Merrill Lynch, Raymond James, TD Ameritrade, Charles Schwab, or even E*Trade, are honestly processing their orders without somehow making illicit use of the information represented by the customer's current account holdings or orders. They take it for granted that brokers are shaving something off of every trade, whether information, front-running, or collecting "contrary indicator" data in which customer trades are data-mined for correlations to future price movements.

But expecting a certain level of despicable broker behavior is not the same as condoning it, or even thinking that it should be legal. Customers only tolerate this "at the edge" behavior because they know of no way to prevent their brokers from engaging in it. That Goldman Sachs has purportedly been caught at engaging in it will not save them from a significant and public punishment. After all, Goldman has long touted its superior moral values. That makes Goldman's behavior both marginal and at odds with how it represents itself.

Actually, not all customers tolerate bucketeering or, to coin a phrase, "data trimming" by the broker from their accounts and orders. There are techniques for double-crossing a broker that is front-running your trades. I will describe some of more than 20 ways to trip them up in future posts.

References:
Goldman CEO, under siege, concedes changes coming (Reuters)
Aussie fund director's Goldman claim gets traction (Reuters)

The High Shrill Voice of the SEC

As this past week wore on and comments and observations from attorneys and analysts were weighed, it became increasingly evident that the SEC's civil fraud case against Goldman Sachs, announced one short week ago on April 16, was founded on slim evidence and had little chance of succeeding in court, even though it had a high-pitched emotional resonance. Mario Bartiromo found it wanting. Republicans charged that the suit was politically motivated, timed to correspond to debate over financial reform. The SEC itself decided to investigate ("UPDATE 1-Watchdog to probe SEC's Goldman lawsuit" http://www.reuters.com/article/idUSN2323274820100423?type=marketsNews).

But most damning is that Warren Buffett expressed his confidence in Goldman.
"Warren Buffett Has 'Great Confidence' in Goldman Sachs Says Berkshire Director"
http://www.cnbc.com/id/36742080

Looking at the charges and the assumptions behind them, you could make a strong case that the only way for Goldman Sachs to avoid being charged was that Goldman would have had to prove to its client in advance that Goldman would lose money on the deal.

Although the ACA portion of the suit is in tatters after a week's worth of reports, the IKB side of the argument will survive, reports the Washington Post.
"SEC confident on IKB part of Goldman Sachs lawsuit" http://www.washingtonpost.com/wp-dyn/content/article/2010/04/23/AR2010042305223.html