A tale of two trials

The trial of Raj Rajaratnam, a billionaire hedge fund manager, for insider-trading has just begun. This trial strike at the heart of corporate America, for Rajaratnam was getting information from a managing director of McKinsey, Anil Kumar. As if finance, and especially hedge funds - the villain of financial sectors in the eyes of the public - needed more bad publicity to hit rock bottom. 

Zingales thinks that for the industry to avoid being associated with the growing list of rogue traders, legitimate hedge funds should proactively disclose their past trades that are at least two years old. That suggestion prompted a reply from Stone Street Advisors, invoking hedge funds's "trade secrets" to argue that Zingales should get out of his office a bit more. I think the interesting point is that trading strategies, which HF fear could be reverse engineer, are elaborated in the perpetual quest of some kind of modern philosophical stone: the Alfa. Patterson's book on Quants gives a good account of that quest and its sociological underpinning. That being said, I think the bottom line is that some think it's naive to expect disclosure from hedge funds, because HF view their trading strategies as intellectual property.  It would be akin to ask pharmaceutical companies to be allow generic drug. Which they do ! and the period of time protecting their Intellectual Property (IP) cannot enter the line of arguments, because, as Zingales reminds us, the life of most trading strategies is very short.  The IP card cannot be played here. The benefit of invention, a common good, is usually the rational to protect, temporarily, Intellectual Property. So after all, so what ? if other investors can reverse engineer strategies that are more than two year old. It is not like everybody has benefited of the marvelous inventions of financial engineering.

The other trial ended up in a ruling of the German Federal Court of Justice against Deutsche Bank and in favor of Ille Papier-Service. 24 pending cases are still to come. The Court considered the structured product which took a bet on interested-rate spread - with 4 % of commission in it - sold by DB to that company as inappropriate. The complexity of these products and the trials that follow highlight a fundamental question: who are the financial sectors to serve (or to screw) ? SME's don't (and shouldn't) have the necessary financial literacy to fully understand these financial products, whose structures are so complex that it can hide large commissions and make their market value so hard to establish, that we begin to see intermediaries appearing between issuers such as DB and customer. It seems financial engineering has not been beneficial to SME's either.