Editor’s note: This article was first published in July 2013, based on MarketWatch interviews from June 2013. Madoff died in prison in April 2021 and Bankia was absorbed by CaixaBank in 2021; the Pescanova and preferentes scandals are described as of 2013.
Insider trading and market fraud exist, persist and are on the rise. For the Securities and Exchange Commission (SEC), it’s something that happens and gets punished. For Bernie Madoff, the man behind a $50 billion Ponzi scheme (the biggest in history), insider trading and fraud are an everyday, normal part of the markets, an epidemic, and individual investors are the most exposed to these practices and therefore the hardest hit.
Insider information means having information that isn’t available to all investors, or that reaches a few people before everyone else. This happens every day in the markets, and for Madoff it’s impossible to control.
MarketWatch interviewed several financial criminals jailed for insider trading and fraud. They all say the same thing: the market is unfair to individual investors, driven by widespread deception that favors people and firms with inside information and expensive technology.
Hedge funds and high-frequency automated trading systems are major dangers to the market and big fleecers of retail investors’ capital, and they lack the regulation or supervision they should have.
According to the convicts interviewed, the fraud even extends to auditing. Madoff said that if audit firms were effective, they would have detected in time even the fraud he himself was running.
In a fair market, audit firms would in turn be audited by other auditors. That way we would avoid listed companies that report good numbers ending up bankrupt, only for us to discover afterwards that the few who had inside information about the company’s real state made a fortune betting against a company that, as far as small investors could tell, was doing perfectly well.
In Madoff’s words, more or less: nobody makes a big fortune on Wall Street without cheating in some way.
These remarks didn’t go down well with the government and the SEC, which tried to undermine the interviewees’ credibility by arguing that people convicted of insider trading and securities fraud are in no position to talk about the SEC’s ineffectiveness, since their attack could stem from resentment at having been arrested and jailed.
Still, I’m not one to believe in coincidences, and according to the testimonies MarketWatch reports, everyone from stockbrokers at major investment firms to hedge fund managers agreed on the same message: there are no big fortunes without inside information, and fraud happens constantly in audits.
Besides, we only need to look at the Spanish market to understand what Madoff is saying.
Who audited Pescanova? Remember that Pescanova (a Spanish seafood company) was doing perfectly well and rising on the stock market before its shares were suspended from trading and its disastrous real balance sheet came to light.
Who audited the accounts of Bankia, in one of the biggest heists ever inflicted on the Spanish public?
Which body was supposed to warn about the preferentes (preference shares that Spanish banks sold to small savers)? Precisely the one that encouraged their sale.
It’s hard to imagine a fair market when those in charge of controlling, auditing and warning are the first to be… less than entirely above board.
Even so, as we’ve said so many times before, once we know we’re playing in a somewhat rigged market, it’s a matter of adapting to the rules of the game.
Further reading
- Three investment ideas that can get you into trouble
- Seven lessons about money your parents taught you without realizing it
Featured image: 7 Years of My Life in NYC 02-08, CC BY 2.0, via Wikimedia Commons.
