Who Knows First
In 1888 the New York Detective Bureau was run by Inspector Thomas Byrnes, a forty-six-year-old Irishman with a shaggy moustache and eyes that Dash likens to steel needles. He was thought to be the smartest policeman in the city. He started the famous Rogues’ Gallery—a collection of criminals’ photographs—and perfected methods of interrogation that were brutal but worked.
He was also rich. According to Dash, Byrnes took advice from Wall Street insiders and bought up property and securities. All told, it was worth seventy times his annual salary of five thousand dollars. Not bad for a cop.
Think about what Wall Street was paying him for. Byrnes guarded the financial district against pickpockets and thieves. And the bankers and brokers he guarded paid him not in money but in knowledge: what to buy before everyone else knew. The policeman didn’t take bribes. He took tips. Nobody called it a crime back then: America had no federal law against insider trading yet.
Before There Were Rules
There still wasn’t one forty years later. In the twenties, on the American market, whoever knew first made money off whoever found out last. Speculators formed pools, pumped up a share price, spread rumours, sold to the public at the top and walked away. Companies didn’t have to disclose what they were doing. Bankers sold their clients paper they knew more about than they let on.
Then came October 1929.
From the spring of 1932 to the spring of 1934 a Senate committee—named the Pecora Commission after its chief counsel, Ferdinand Pecora—worked out how the whole thing had been rigged. It found plenty. J. P. Morgan Jr himself admitted that he and many of his partners had paid no income tax in 1931 and 1932. In the committee’s wake came the laws the market still lives by. Under the 1933 Act, a company is liable if it lies in its prospectus. The 1934 Act created a federal commission that has policed the market ever since. The SEC, for short.
President Roosevelt made Joseph Kennedy its first chairman—father of a future president, and a man who had done very nicely out of the very stock-market manoeuvres that were now to be banned. Plenty of people were outraged. But the logic was simple: nobody knows the tricks better than the man who’s used them. Put the fox in charge of the henhouse—at least he knows where the holes are. In a little over four hundred days in the job, Kennedy managed to give people back their faith in the market. The fox did fine.
Show Your Face
The idea behind the laws is simple. A market is honest when everyone plays knowing the same things. So a public company has to publish its accounts and its risks, report what its directors buy and sell, and say who holds large stakes. And anyone who knows what others don’t yet know has no right to trade on it until the knowledge is public.
Remember Lefty, who couldn’t put his twenty per cent of the fish business in his own name? The rules on disclosing beneficial owners were written against people exactly like him. A hidden owner can run a company without answering for anything, and when it suits him, sell his shares to people who don’t know who he is.
Gambetta, drawing on the economist Reuter, explains why disclosure is not just a duty but an advantage. An illegal firm can hardly ever borrow big money: it has no audited accounts, and nobody can keep an eye on it. Transparency makes capital cheaper.
Friends on the Exchange
The Mafia went to the stock exchange too, of course. Why should the police have all the fun? On 2 March 2000 a federal grand jury in Brooklyn indicted nineteen people. Six of them, according to the prosecution, were tied to the Bonanno, Genovese and Colombo families. From 1993 to 1996, through two brokerage firms they partly controlled, they used false promises to pump up the share prices of four small companies. Clients weren’t allowed to sell. The insiders sold their own stakes at the top and moved the money offshore. Prosecutors sought the forfeiture of about forty million dollars.
The journalists immediately thought of The Sopranos, which that same year showed Tony’s nephew Christopher getting someone else to sit his broker’s exam for him and hanging around a firm that pumped junk stocks. The series beat the prosecutors by a few weeks.
The scheme was exactly the one the speculators ran in the twenties. Only in 2000 it got you locked up.
Know Your Customer
Disclosure has another side: the bank wants to know who you are, too.
In 1976 Joe Pistone, barely started on his life under cover, went to open an account at a big New York bank. Under “previous accounts” he wrote nothing: Donnie Brasco had no past. The clerk turned him down: without checking his signature with a previous bank, they couldn’t open the account. That, Pistone writes, was his first lesson in life on the other side of the law. You can’t open an account without a credit history, even with a thousand in cash in your pocket. At the bank across the street he went on the attack: he told the clerk he’d just got out of prison and his rights were being violated. The clerk got flustered and made an exception.
Today customers are checked far more strictly, and the rules are aimed at people like Donnie Brasco. The real ones. But the episode is worth remembering: every filter rests on the person at the window. And a person can be flustered, talked round or frightened.
Secrets You Don’t Buy
Once the manager of a big hotel we had long wanted to work with came to Don Vincenzo and, for a small favour, offered to show him the price our competitor had quoted for the laundry in a sealed tender. We’d have bid a little lower and won.
The Don refused, politely and at once. The manager left offended. I asked why: it was a good contract. “A man who sells me someone else’s secret,” said the Don, “will sell mine tomorrow. I don’t want to work where everyone knows the prices except the honest ones.” We never got that contract. Two years later the manager was fired for doing the same thing again, and the new one called us himself.
The Bottom Line
Rules don’t save you from being cheated. They only punish it and make it more expensive. Checking who you’ve sat down at the table with, and how your neighbour knows what he knows, is still your own job.