Friday, August 26, 2005


Speechless . . . [Updated]

So, Jim Petro knew BWC was getting ripped off by brokers but did nothing to stop it. And - big shocker - at least some of the brokers involved in the thievery were big political political players.

[Update] From the Plain Dealer:
Brokers for the six firms, their family members and associates gave a combined $48,900 to Deters' campaign from 1998 through April 2002, the review found. They also gave $144,000 to the Hamilton County Republican Party, where Deters acknowledged his campaign directed contributors. A trio of his associates were ultimately convicted in the scheme.
This boils it down:
Ohio Senate Democratic Leader C.J. Prentiss of Cleveland said. “This begs the question — why no action? As we peel away each layer of the onion, are we going to find a kickback scheme that was institutionalized by this administration to reward their campaign contributors? Why didn’t Governor Taft act? Why didn’t Attorney General Petro act?”
You know, there's stupidity - and then there's convenient stupidity. BWC was awash in the latter:
The SEC’s general complaint was that the bureau paid some of its brokers almost one cent more per share than it should have. This means that if a broker traded 10,000 shares of a stock 100 times during the course of a year, he could earn $60,000 in fees versus $50,000 in fees.
We're, of course, tempted to point out that a "discount" broker would charge about $10 a trade. Comparing BWC's trading expenses to that charged by Scottrade or Schwab is a little unfair, but not much.

From a purely technical point of view, the equity trades that BWC and other big state agencies need to be made are no different than that a small investor. The act of buying or selling 100 shares of Intel is not that different than for 10,000 shares. Actually, on a cost-per-share basis, the cost of trading 10,000 shares should be significantly less.

But, BWC and the others also expect their traders to do two other very important tasks - act quickly and keep their mouth shut. When there is trading on the scale that big institutions do, the very act of trading can shift market prices one way or another. For example, if BWC suddenly puts in an order for 10,000 or 20,000 shares of stock XYZ, the price often rises in response. If everything goes right, this change in price happens after the trade is made.

However, if word gets out in advance that BWC will be making a purchase, than the price will rise before the trade is made, thus potentially costing BWC thousands of dollars more than it should have paid. Secondarily, prior knowledge of a looming trade creates conditions for all sorts of game-playing (and potentially illegal) and betting in the stock market through various options.

So, it's not unreasonable for large institutions to pay something of a premium to brokers based on the costs of quick trades and maintaining tight security on all trade discussions. But the cost of providing these extra services should be somewhat offset by the discounts (compared to retail brokerages) they should provide based on the size and frequency of the trades).

To be sure, being speedy and keeping that kind of security is not an easy task. Since most brokers serve multiple clients, surrounding looming transactions in constant secrecy requires that those handling the institutional accounts are totally insulated from the rest of the business, and that there is an entire management structure devoted to maintaining that security.

Although they'd never admit it, small brokers simply cannot provide this level of security. In fact, there are probably less than 10 firms nationally that can. When you add quality and cost considerations, the number probably drops to five or fewer. And, let's be perfectly clear about one thing - none of these firms are Ohio firms. That's why the state's retirement funds cried "bullshit" when the legislature tried to force them to adopt a "Buy Ohio" mandate for investment services.

The difference between the retirement funds and the BWC is that they fought and defeated the stringent Buy Ohio requirements while BWC was gung ho for it.

Now we know why.


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