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Wall Street Analyst Views Used for Hedge Fund Insider Trading

The US Attorney’s office in Manhattan has been on a tear recently over insider trading, arresting and convicting several high-profile investors and making the issue a hallmark of criminal justice around the financial industry. But Preet Bharara will be busy for the rest of his life if he thinks he can clean up the markets in this fashion. Because insider trading is simply endemic to the system.

They are supposed to be among Wall Street’s most closely guarded secrets: changes in research analysts’ views, up or down, of a company’s prospects. But some of the nation’s biggest brokerage firms appear to be giving a handful of top hedge funds an early peek at these sentiments — allowing them to trade on the information before other investors get the word.

The signals come from questionnaires that analysts answer and submit electronically, either monthly or quarterly, to some of their firms’ largest hedge fund clients. Chief among the questions posed to the analysts are those about possible earnings surprises at companies they follow.

What analysts tell investors about the companies they follow — and when — is central to the concept of a level playing field on Wall Street. When disseminated, analyst downgrades and upgrades can make a stock sink or soar. Getting that information early can be very profitable for traders. As a result, regulatory rules require brokerage firms to restrict the information flow from research departments to prevent the potential for trading ahead of research reports.

We’re not talking about one insider sitting on a corporate board and using information gleaned there to gather information used in trading. We’re talking about systemic corruption, the way the markets get rigged to favor the institutional investor. You would have to dismantle core processes of the markets built up over many years to get at this.

And you probably should end up doing so. It’s beyond clear that the stock market has little to do with an efficient allocation of capital or the relative health of public firms. It’s a blackjack game where some of the participants at the table don’t just count the cards, but they deal themselves aces and kings out of their own deck. The stock market bears almost no resemblance to the actual state of the economy anymore; it’s more a way for rich people to get richer. And nonpublic information plays a major role in that. This information gets traded over and over again.

And it’s not like you can really stop this poking and prodding for information, which has probably always been with us. Whenever you set up a market, people will try to take advantage of it. Maybe it’s better to look at the larger frauds being perpetrated on masses of people, rather than taking up insider trading cases that are easier to prosecute.

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David Dayen

David Dayen