By Pam Martens: April 9, 2014
The caribou have vanished on Wall Street and the wolves are in a feeding frenzy against each other. Yesterday, the Wall Street Journal reported that Goldman Sachs is considering shuttering its Sigma X dark pool, a business that brought in $7.17 billion from equity trading in 2013, before accounting charges.
There are only three reasons that a Wall Street mega bank shutters a $7 billion business instead of selling it: it’s crazy; its regulators told it to shutter it; there’s more bad news ahead about this business and the firm is trying to get out in front of the fallout. We know Goldman Sachs is only crazy like a fox, so that leaves options two and three.
On March 13, Bloomberg News reported that Goldman Sachs sent refund checks to some of its customers for trades that had occurred in August 2011 where it had failed to execute trades at the National Best Bid and Offer (NBBO), a requirement under U.S. securities laws. Whether that is happening routinely within dark pools is anyone’s guess since…well, they’re dark…and the Securities and Exchange Commission still doesn’t have a consolidated audit mechanism able to keep up with the market it is charged with overseeing.
What triggered this benevolent refund action on the part of Goldman Sachs has yet to be explained. Who discovered the errors is left unanswered as is why we are just learning about something that occurred in 2011 three years later.
There is also the major Goldman snafu that disrupted markets last summer. On August 20, 2013, Goldman sent thousands of erroneous trading orders for options into the exchanges, wildly moving prices in the opening minutes of trading. The problem was blamed on a computer systems upgrade gone awry. Most of the trades were cancelled by the exchanges involved but the matter evoked outrage at the top of the firm since it put Goldman’s customers on the other sides of those trades at risk and could have resulted in big trading losses and/or lawsuits to Goldman and alienation of key clients.
Ten days before author Michael Lewis went on 60 Minutes to discuss his new book, “Flash Boys: A Wall Street Revolt,” in which Goldman Sachs’ high frequency trading operations come under scrutiny, the President and COO of the firm, Gary Cohn, wrote an OpEd for the Wall Street Journal. In the piece, Cohn says that “A fragmented trading landscape, increasingly sophisticated routing algorithms, constant software updates and an explosion in electronic-order instructions have made markets more susceptible to technology failures and their consequences.”
Just how susceptible Goldman might be gathers some sunlight in “Flash Boys.” Two full chapters of the book are devoted to the prosecution of Sergey Aleynikov, a sympathetic character who loses his marriage, his home, his freedom, his career, his savings and is sentenced to eight years in prison for taking some high frequency trading code that he had created at Goldman Sachs when he left for another job. Aleynikov was arrested by the FBI on July 3, 2009 and despite an overturned conviction, he is still being pursued by Manhattan prosecutors.
Goldman’s high frequency trading system is characterized as a “bulky, inefficient system” and the code as “slow and clunky” in the book. Lewis writes: “Goldman had bought the core of its system fifteen years earlier in the acquisition of one of the early electronic trading firms, Hull Trading. The massive amounts of old software (Serge guessed that the entire platform had as many as 60 million lines of code in it) and fifteen years of fixes to it had created the computer equivalent of a giant rubber-band ball. When one of the rubber bands popped, Serge was expected to find it and fix it.”
Aleynikov’s conviction in December 2010 was overturned in a stunning decision by the Second Circuit Appeals Court which found that Aleynikov had neither taken a tangible good from Goldman nor had he stolen a product involved in interstate commerce – noting that at oral argument the government “was unable to identify a single product that affects interstate commerce.”
The Second Circuit’s detailed decision was delivered on April 11, 2012 by Dennis Jacob, the Chief Judge. There was the distinct impression that the three-judge panel was interested in sending a message to Goldman Sachs that it understood fully the nuances of this big Federal government prosecution.
Chief Judge Jacob wrote:
“Goldman’s HFT system was neither ‘produced for’ nor ‘placed in’ interstate or foreign commerce. Goldman had no intention of selling its HFT system or licensing it to anyone. It went to great lengths to maintain the secrecy of its system. The enormous profits the system yielded for Goldman depended on no one else having it. Because the HFT system was not designed to enter or pass in commerce, or to make something that does, Aleynikov’s theft of source code relating to that system was not an offense under the EEA [Economic Espionage Act of 1996].”
Since Lewis provides a birds eye view into the inner workings of Goldman’s high frequency trading system in those two book chapters, even taking Aleynikov to a two-night dinner feast to discuss it with other Wall Street programmers in a mock trial to see if he really was guilty of anything in the eyes of a jury of his actual peers, Goldman’s secrets are now an open book and its slow, clunky system has lost a lot of its resale value. Goldman has also lost its programming genius. Lewis shares the fact that a head hunter on Wall Street says that there are only 20 people on Wall Street that can do what Aleynikov does – and he is the best at it. Which might explain why the hounds of prosecutory hell have been unleashed on him.
Rather than allowing Aleynikov to get on with his life, he is now being pursued by the Manhattan District Attorney, Cyrus Vance, in what looks to some like malicious prosecution. (Only mid level people have been prosecuted at any of the mega Wall Street banks while settlements and deferred prosecutions are handed out for far more egregious crimes.)
An appeal to dismiss Vance’s new charges on the basis of double jeopardy was rejected by a New York State court, finding that the state’s charges were different from the Federal ones, even though they were based on the same allegations. Aleynikov did win one court battle last October in the new case: Goldman Sachs will have to pay his legal expenses since he held the title Vice President. The court found that Goldman’s own bylaws require it to pay the legal fees of any officer named in a civil or criminal complaint related to their position at the bank.
Given the scrutiny that the Lewis book is drawing to Aleynikov’s prosecution, exactly what the firm was using this secret code to do in its proprietary trading operations, expect Vance to fold up his tent any day now in this highly questionable pursuit of “justice.”