Another MF Global / Goldman Puzzle Piece: Rule 606: Order Flow

As we await the results of a probe into MF Global and its missing clients’ funds that will no doubt be conducted with the same tactical zeal with which authorities across the country arrested over 4000 Occupy Wall Street protestors it’s interesting to note another component of the MF Global - Goldman Relationship. Beyond the past-leadership of Goldman Sachs by former MF Global head, Jon Corzine, and fact he was brought to the helm by former Goldman buddy, Christopher Flowers, there was also a nice little execution business-sharing going on between the firms. An examination of those transactions, each less than $200,000 , could be illuminating.

Under Rule 606 (formerly SEC Rule 11Ac1-6), as part of its strategy to rely on the companies it is supposed to be regulating to reveal whatever part of their hand they want to, the SEC requires a quarterly report  from brokerage firms on  their order-routing services. Specifically, the report covers ‘non-directed’ orders, or ones that customers haven’t specifically requested go through a particular vendor for execution.  The report has four sections: one each for securities listed on the New York Stock Exchange, The Nasdaq Stock Market, the American Stock Exchange and 'Other' exchange-listed options, and indicates the venues most often selected.

So, according to MFG's third quarter non-directed routing report, guess what vendor showed up prominently? Yep - Goldman Sachs Execution and Clearing LP.

Of course, not all information must be disclosed, and, as MFG notes in its report “statistics capture only a portion of MFG order flow” and “do not create a reliable basis on which to assess whether MFG or any other trading venue has satisfied its duty of best execution. “ But sill.

On the NYSE (the body taken public by former Goldman Sachs co-President, John Thain), the order flow of non-directed customer orders less than $200,000 (or 69.1% of total orders) mostly went through Goldman Sachs Execution and Clearing LP. (SGMA) The entity executed 46.4% of total non-directed orders including 58.4% of limit and 37% of ‘other’ orders.  The rest of the NYSE orders went through the Nasdaq, Knight Direct and NYSE ARCA.

On the Amex, non-directed orders of $200,000 or less comprised 23.24% of all orders, of which 31% went through Goldman, including 29.5% limit and 32.2% ‘other’ orders.

Of the orders that went thought the Nasdaq, 94.8% were under $200,000. Of those, 70.4% limit and 40.3% other, went directly through the Nasdaq. Goldman executed 12.1% of the limit, and 8.1% of the other orders.

The reports, as per the SEC being useless, don’t include the trade volume represented by these percentages, yet, for the most part, when MF Global didn’t execute directly its non-directed client orders through an exchange, it used Goldman. There may be some interesting – and co-mingled – 'missing' transactions that slipped in there. Just saying.

Pocket-Change SEC Fines: Barely a Bark and No Bite

There's a reason yesterday's announcement that JPM Chase would 'settle' for a fine of $156.3 million, while neither admitting nor denying any wrong-doing, thereby forking over the whopping equivalent of a normal person's weekly grocery budget, pisses people off. Because it's a marginal fleabite on the teflon hand of the nation's second largest bank in terms of punitive pain, and absolutely meaningless in altering the grand scheme of toxic securities creation or  complex financial institution business as usual. 

The trivial settlement appears even tinier in comparison to the financial aid JPM Chase received in the wake of its financial crisis. Despite all of CEO Jamie Dimon's disingenuous, though fervently delivered, remarks to the contrary (he didn't need a bailout, he took it for the 'team' to ensure no bank would be singled out to sport a scarlet 'B' of bailout shame), JPM Chase at one point, during the height of the bank's federal subsidization program, floated on nearly $100 BILLION dollars worth of - exceptional assistance. That figure included: $25 billion from the TARP fund, which has since been repaid, $40.5 billion dollars of new debt backed by the FDIC's Temporary Liquidity Guarantee Program (TLGP), which has since been retired, about $6 billion through various aspects of the TARP HAMP program which aided a fraction of underwater borrowers, and $28.8 billion behind its Fed-backed, Treasury-pushed acquisition of Bear Stearns, which is still in place. That's aside from its government aided acquisition of Washington Mutual.

There are those that believe that the bailout program (which they continue to equate to just the $700 billion TARP program) was a success (like the Fed, Treasury Department, or any Administration).

Yet, subsidizing Wall Street's most powerful creatures, altered nothing for the banks that survived, while promulgating ongoing economic pain for the general population caught in the wake of a $14 trillion dollar asset creation machine, which became a globally leveraged $140 trillion still-decaying mess, spurred by rapacious speculation, that sat on just $1.4 trillion of sub-prime loans and various other properties. 

Banks want us to believe that widespread economic pain has nothing to do with them, that they were innocent participants. Maybe they made a few mistakes - for which they're paying SEC directed fines, but hey, we all do.

Meanwhile, the budget bantering that drones on in Washington keeps missing the fact that part of the bank subsidization process remains on the Fed's books. This includes $1.6 trillion dollars in EXCESS bank reserves - i.e. reserves for which the Fed is paying banks 0.25% to NOT lend, about $900 billion worth of mortgage-backed securities, and $1.5 trillion worth of Treasuries, partly from the QE2 program. That's an awful lot of captive non-stimulus. It sure isn't helping drive job creation or small business expansion sitting there.

Of course, this latest SEC settlement is not the first non-punishment for a bank's role in producing or promoting a leveraged mountain of faulty assets. The hush money action is part of a now-two-year SEC program to address, in the commission's own words, 'misconduct that led to or arose from the financial crisis.'

Leaving aside, the tepid characterization 'misconduct' instead of say 'racketeering', these fines don't, and won't, change the banking system. And nowhere does this fining regulatory body suggest a way to do so. It would be refreshing for the SEC, founded in conjunction with the Glass-Steagall Act that separated banks into institutions that dealt with the public's deposit and financing needs from those that created and traded speculative securities for private profit purposes, to suggest a modern equivalent of that act. It might help the commission do its job of protecting the public before unnecessary devastation, not years afterwards, or at the very least, untangle the web of layered borrowing and debt manufacturing at the core of these complex giants.

But, that's not going to happen. Not as long as small fines, absent any form of attached probation, stringent monitoring, or cease-and-desist requirements, can slowly make the issue go away. Seriously, it takes longer to argue a traffic ticket than it took Goldman Sachs to 'agree' to a $550 million settlement on July 15, 2010, after the SEC charged the firm with defrauding investors only three months earlier. People caught with minor amounts of crack or pot undergo stricter plea processes, probationary measures and detainments. 

To date, the SEC has charged four firms with CDO related fraud, including Wachovia, Goldman Sachs, and JPM Chase, who settled for $11 million, $550 million and $156 million respectively. A case against ICP Asset management remains open. 

The commission has charged five firms with making misleading disclosures to investors about mortgage-related risks, including American Home Mortgage, whose former CEO settled for a paltry $2.45 million fine and a 5-year officer and director bar, Citigroup, that settled for a $75 million penalty, Bank of America's Countrywide, whose former CEO, Angelo Mozilo agreed to a $22.5 million penalty and a permanent officer and director bar (a fraction of his pre-crisis take), and New Century, whose executives paid $1.5 million and agreed to a five-year bar. There is an ongoing case against IndyMac Bancorp.

In addition, the SEC charged six firms with concealing the extent of risky mortgage-related assets in mutual and other similar funds. Those included Charles Schwab that settled for a $118 million fine, Evergreen that settled for $40 million to mostly repay investors, TD Ameritrade that settled for $10 million, and State Street that settled to repay investors $300 million.

Separately, Bank of America agreed to a $150 million settlement for misleading its investors about bonuses paid to Merrill Lynch and not disclosing Merrill Lynch's mounting losses. This didn't stop the Federal Reserve and Treasury Department from remaining steadfastly behind the Bank of America/Merrill Lynch make-a-too-big-to-fail-bank-bigger merger, upon which the settlement was based.

In total, the SEC, mildly policing the vast financial system that pushed a criminal musical chairs game of last-one-holding-a-toxic-asset-or-underwater-mortgage-loses, charged 66 entities and individuals with 'misconduct', imposed 19 officer or director bars, and levied $1.5 billion of penalties, disgorgement, and other monetary relief fines. Put that in perspective, say, with the $28 billion in bonuses that JPM scooped up for just 2010, or the $424 billion in total bonuses the top six banks bagged between the crisis book-end years of 2007-2009, or the $128 billion of bonuses Wall Street got last year. Now, consider that not only is the penalty amount a pittance, but the impact of these fines, is even smaller. And, that's the bigger problem with fines, particularly tiny ones. They offer this illusion of a fix that leaves us worse off from a stability perspective than we were before.

Lies my Fed Chairman told me

I've often wondered whether Fed Chairman, Ben Bernanke, believes his own hype, or if he is just so personally and professionally invested in perpetuating the story of the success of the greatest bailout ever compared to the most heinous of consequences that would have befallen us without it, that it doesn't matter.  

Either way, I cringed a little inside when he told the Financial Crisis Inquiry Commission this morning, 

"The single most important lesson of this crisis is we have to end the 'too big to fail' problem."

This coming from the man who, sat at the helm of the Fed in the fall of 2008, and approved without any conditions or questions, as per the Fed charter that equally provides for rejecting:

- The acquisition of Bear, Stearns and Washington Mutual by JPM Chase - making a big bank, bigger

- The acquisition of Merrill Lynch by Bank of America - making a big bank, bigger

- The acquisition of Wachovia by Wells Fargo - making a big bank, bigger

- The re-classification of Goldman Sachs and Morgan Stanley into bank holding companies - making the arena of big banks, riskier

Of course, no one on the commission asked probing questions about those brainiac decisions and how or why other alternatives weren't considered, particularly given the substantial government subsidies these institutions enjoyed on the way to becoming bigger and more Fed co-dependent. No one asked specifics of what the remaining subsidies to Wall Street still are. No one asked Bernanke what he meant when he implied that the new so-called financial reform bill would reduce the possibility of too-big-to-fail in the future,  given that the Fed totally ignored the fact that 3 of the institutions above subsequently surpassed or hit the already existing 10% concentration limits that had been designed to keep a lid on the notion of 'too-big' to begin with, and given the fact the the Fed either by itself, or in its position beside the Treasury Secretary on the new Financial Oversight Council, can override most future bailout decisions anyway.

Yet, we are supposed to believe that Bernanke is concerned about 'too big to fail? Really??