Cornering the Market Just Got Harder…

Against the backdrop of Danielle Chiesi’s sentencing for insider trading and quite bizarre press conference  yesterday, we found ourselves contemplating what would have happened if a situation similar to the inside trading that took place between her and Raj played out in the futures world. The answer?

Nothing.

Turns out, there is no such thing as insider trading in futures trading. So, if you work at an oil processing plant in Houston and find out it will be shut down for 10 days, there is nothing stopping you from buying up Gasoline futures ahead of the news coming out. Similarly, if you work at a beef processing plant and are one of the first to know that some of the beef has been found to have mad cow disease – there are no laws against using that information for your own financial gain. Contrast that to the stock world, where it is against the law to trade on material non public information.

Crazy, right? Yes and no. Yes, because people can and will get out in front of non public information to make some money. No, because it is rare for any news big enough to move an entire commodity market to be isolated in a single person or location.  It isn’t the case where only the executives of the Midwest know about a drought in the country’s corn growing region, for example.

The bigger worry for futures markets is market manipulation, such as was recently alleged against two oil traders who allegedly built up inventories in Oklahoma in order to drive up prices (story here).

The basic idea is that, if you buy enough of something to create an artificial shortage, prices will go up, as will the value of whatever you’ve stockpiled, creating even more wealth for you in the end (ignoring the fact that you have to somehow get out of the trade). This is called market manipulation, and that you can go to jail for. Even so, claiming enough of anything to cause such a shortage is difficult (read: expensive) to do. There have certainly been those who have tried over the years, but at the end of the day, their fates serve as cautionary tales for those interested in following in their footsteps.

Gangsta. Can you tell who is who?
  • Look at 1869, when Jay Gould and James Fisk tried to corner the gold market, only to create a financial panic that resulted in major Congressional investigations.
  • In the 1950’s, two farmers, Sam Seigel and Vincent Kosuga, attempted to corner the market on onions, which ultimately lead to a ban on trading in onion futures- period.
  • In the 1970’s and 80’s, the most famous market cornerers of all time – the Hunt brothers –  at one point, held the rights to over half of the world’s deliverable silver, only to be caught in a margin raise that lead to massive losses for them.
  • Yasuo Hamanaka attempted to corner the copper market in the 1990’s, but his gamble lost him $2.6 billion and landed him in prison for eight years.
  • In 2010, Anthony Ward bought over a billion dollars worth of cocoa, establishing ownership of 7% of the market, ultimately leading to a price surge and industry wide ostracization.

Along these lines – the CFTC just today finalized their rules on market manipulation (CFTC market manipulation rules), making it more broad and encompassing that the old rules, which as can be see above didn’t act as too much of a deterrent.

According to Reuters:  “The rule …outlaw[s] actions that directly or indirectly manipulate or attempt to manipulate the price of a swap, a commodity in interstate commerce or a future.”

Also in the rule, a new bit prohibiting trading on material non-public information that was obtained through fraud or deception, which keeps open the door for all material non-public information gained by means other than those to be traded on. If regulators vigorously pursue violators of these regulations, the next generation of Hunt Brothers may be ditching their Versace duds for bright orange jump suits, or taking a permanent vacation in a nation without extradition agreements. Al Capone did once say, “Capitalism is the legitimate racket of the ruling class.”

One comment

  1. Nice post Lauren. It puts the news in an entertaining and interesting context. Perhaps the spectacular Amaranth blow-up in 2006 while cornering the Nat Gas market also deserves a dishonourable mention.

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