Beating Wall Street at Its Own Game (Part 1)

Monday, April 12, 2010

Here comes the flood – of books roasting Wall Street, that is. Roger Lowenstein’s new book title, The End of Wall Street, is tame compared to those being released later this year.

Wall Street – Those words can conjure up negative visions for many investors. They feel Wall Street’s guiding principle is anything goes, so long as it makes money. A line from Oliver Stone’s coming movie, Wall Street – Money Never Sleeps, is a good example. Gordon Gekko, confronted with the statement “It’s about doing the right thing,” retorts, “It’s about the game.”

So, this week, I am addressing the question, “How can we beat Wall Street at its own game?”

Today, let’s set the stage

“Wall Street” is an all-encompassing label applied to investment firms, regardless of their location. There are many investment-oriented activities going on under that one label:

  1. Securities trading – Whether on the floor of an exchange or on an electronic system, Wall Street is at the heart of all securities trading
  2. Investor advice and product sales – Most know this area, where investors retain control over their investments
  3. Money management (non-proprietary) – Direct and fund management for investors (both individuals and institutions)
  4. Money management (proprietary) Wall Street’s “trading profits,” often a sizeable part of income, come from firms buying and selling for their own accounts
  5. Investment banking – Issuing new securities, engaging in merger/acquisition activity and helping organizations with special financial needs

There are many firms that engage in just one of these areas (e.g., a discount broker, a mutual fund firm, an independent financial adviser, etc.). While part of Wall Street, they are not the source of angst. That comes from the multi-line firms that could profit from inside information.

A word about inside information

Because many of the large Wall Street firms operate in two or more of the areas above, there is the opportunity to profit in one by taking advantage of the information gathered in another. There are strict rules and regulations to prevent this sharing of inside information.

But it does occasionally happen, and the public revelations can be upsetting. They show a willingness by the participants to engage in selfish, unethical behavior against the interests of those who trusted them.

There are important considerations about the improper use inside information.

  1. The firm’s executives do not want it to happen because the firm’s long-term success is dependent on doing things well – and legally
  2. Misuse of inside information is small because most people are focused on building their careers honestly and ethically
  3. As an “incentive” to do the right thing, rules and regulations are strongly enforced by the firms, the industry and the government

So… Wall Street is neither evil nor omnipotent. Do not fret about them being able to control and take advantage of the investment markets. Wall Street cannot deprive us of a fair opportunity, and, therefore, we can beat them at their own game.

Tomorrow: Part 2 – Defensive moves needed

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John Tobey on Seeking Alpha

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April 2010