In 2002, for example, the German small companies market, Neuer Markt, was closed down completely after prices fell by around ninety five per cent following revelations of massive stock-price manipulation and fraud by insiders. After the 1929 US market crash, it took over thirty years until sufficient investors were coaxed back into the market to push shares back up to their pre-1929 level. And following the dotcom fiasco, share prices stayed flat for ten years as many savers put their money into things like property rather than risking getting burnt once again by over-hyped, over-inflated and outrageously manipulated share prices. Unfortunately, so much money flowed into property that there was an unprecedented housing price bubble which eventually burst causing losses for many savers and almost destroying the financial system.
"The investing public is sceptical and rightly so. It's no surprise that people are staying away from stocks. There has been an accumulation of blows from Bernie Madoff, the financial crisis, bail-out of Wall Street and flash crash that feeds into a perception, rightly or wrongly, that the game is rigged."
It's vital for stock markets' survival that ordinary savers believe in the basic integrity of markets. So, most stock markets claim that they have established regulatory systems that protect ordinary savers and ensure a level playing field balancing the interests of outsiders with those of insiders. However, there is increasing evidence that this self-regulation is ineffective, that the main markets are heavily rigged against ordinary savers and that insiders are getting obscenely rich at our expense.
The most basic advantage insiders like traders and brokers have is that they learn about any new information affecting share prices long before we, our unit trust managers or our pension fund managers find out something is up. So the insiders can buy or sell well in advance of the general public and even those who manage our savings. Theoretically, this constitutes insider dealing and is illegal. But it is seldom discovered and even when discovered it is rarely prosecuted. After all, stock markets fear loss of public confidence from the publicity surrounding insider dealing much more than they care about a few people making millions defrauding ordinary savers.
"Many clients sat on the boards of public companies and were more than happy to brief us about their own shares. They used coded signals and texts to get the message out that the time was right to buy or sell their stock before the public got hold of the information."
When rampant insider dealing is discovered, usually everything is quickly swept under the carpet signalling to insiders that they can do whatever they want as long as they don't get caught. Unlike mugging or burglary, insider dealing may at first sight seem like a victimless crime. But we are the victims. Every hundred million extracted through insider dealing is a hundred million taken directly from us or from our savings and pensions. It is theft on a massive scale and it is theft that normally goes undetected and even when accidentally detected is almost never punished. This makes it one of the easiest, virtually risk-free ways of becoming fantastically wealthy.
While trading on insider information is supposedly illegal yet seldom punished, using smart tricks to manipulate share prices is less obviously frowned upon. There are several techniques insiders use to profit from share price movements at our expense. Churn-and-burners increase their commissions through excessive buying and selling of their clients' portfolios making themselves money with each transaction while simultaneously reducing their clients' wealth. With many unit trusts increasing the percentage of their holdings they trade each year from thirty per cent in 2007, to fifty per cent in 2008 to almost ninety per cent now, one could be forgiven for suspecting that managers are making themselves and their brokers rich by churning-and-burning our money.
With pump-and-dump (also called 'ramping'), insiders buy up shares in a target company and spread rumours of upcoming good news about the company or else get helpful analysts to issue 'buy' recommendations. When others rush in to seize this 'opportunity' the price goes up and the pump-and-dumpers get rid of their shares, banking a tidy profit.
Poop-and-scoop is the opposite of pump-and-dump. The poop-and-scooper uses false or exaggerated information or 'sell' recommendations to drive down the price of a share. They then buy up shares at the lower price and make money selling when the share drifts back up to its normal price. Short-and-distort is similar with the difference that insiders also short shares before pushing the price down.
Then once you add in other methods like circular trading, jitney, dividend pumping, double-dipping and bucketing, you're virtually guaranteeing that insiders will always make very healthy profits at the expense of outsiders.
The profits to be made from pushing share prices up or down a few per cent are limited by the amount of money an insider has to buy the shares whose prices they are manipulating. But potential profits can be massive when insiders leverage their money so that they can take huge positions with quite modest sums. They can, for example, use spread betting where it's not uncommon to earn thirty to fifty times the money bet. Or else insiders can work like hedge funds by borrowing massively to take speculative positions gambling on specific share-price movements.
The huge extent of this price manipulation was revealed in an interview with a former hedge-fund manager who then became a financial pundit. He explained that if a hedge fund had taken a short position on a stock (i.e. bet that the price would fall) and what he called 'pay-day' was coming, then the fund couldn't afford to let the market rise. As he said, 'it's critically important to use a lot of your firepower' to lower prices.
"I would encourage anyone in the hedge fund business to do it because it's legal and it's a very quick way to make money and it's satisfying."
He would apparently throw about $5 million to $10 million into bringing prices down, spread a few negative stories by ringing up a few brokers and use what he called the 'bozos' on the main financial papers to orchestrate a fall in the stock's price. He went on to explain, 'these are all the things you must do day-to-day and if you're not doing them, maybe you shouldn't be in the game'. Similarly, if he had gone long on a stock (bet that the price would rise), he would spread imaginative stories to push the price up. Investment specialists will continually tell us that the price of shares is linked to the fundamental value of companies being traded. But this former hedge fund manager claimed that 'the mechanics' (the way he could manipulate share prices to make huge amounts of money) were much more important to share price movements than 'the fundamentals' (the real underlying value of the shares).
A more recent development which is enabling well-funded insiders to profit while outsiders lose is called 'high-frequency trading'. The big trading houses and banks have developed powerful computer algorithms that can scan the main marketplaces, identify the buy and sell orders before they are carried out and then execute millions of orders a second just ahead of the orders coming into the market. It's the ultimate in gambling certainty. It's like betting on thousands of horse races when you already know all the results. You can't possibly lose. High frequency traders know exactly what's going to happen to a share price, including how much buyers are prepared to pay and at what price sellers will sell, after the buy and sell orders are launched but before they are executed. By exploiting this knowledge they will always be able to make easy profits.
"This (high-frequency trading) is where all the money is getting made. If an individual investor doesn't have the means to keep up, they're at a huge disadvantage."
One research group estimated that high-frequency trading was giving profits of over $20 billion a year in the US. And that $20 billion or more is money that comes directly from the investment returns that would otherwise have gone to ordinary savers and investors in unit trusts and pensions. High-frequency trading has further reinforced what has increasingly become a two-tier market which makes insiders wealthy while working against ordinary investors in shares, unit trusts and pensions.
With cash savings and bonds giving such poor returns, there seems to be nowhere else we can put our savings apart from stock markets, either through shares, unit trusts or pension funds. We ordinary investors might make a little money from stock markets over the medium to longer term. But there are many indications that the markets are massively rigged in favour of insiders who make millions while leaving just a few scraps on the table for us outsiders. Moreover, all this is happening in supposedly well regulated US and European markets. The abuses that are going on daily in the Wild East - Russia, India, China and other Third World stock exchanges - don't bear thinking about.