Asymmetrical Information

I thought that was a nicely done little movie - more as a character study than as an expose of off-Wall-Street brokerage firms, mind you.

The crime that I saw was that J T Marlin was *creating* shell companies, writing up false prospecti, and knowingly pitching valueless securities as if they were something else.

I'm one of those crazy anarcho-capitalists who favors getting rid of the SEC and allowing individual brokerages to declare whether or not they will make markets in firms that allow insider trading.

...but the crime depicted in the movie was a real crime. Selling a jar of milk, sawdust, and water as if it is pure milk is an act of fraud, and pitching stock in a "medical devices company" that is really a single rented storefront with no personell is likewise an act of pure fraud.

Also, note that there was no two-way market in the stock; investors were only allowed to buy, and then could not sell their positions. So shorting the stock was not really an option.

Yeah...even in minarchist heaven, Pump-n-Dump scams (where a company that exists only on paper is misrepresented to investors for the sole purpose of capitalizing on a temporary groundswell in speculative buying by the victims of the scam) will still be illegal.

People stupid enough to buy shares in a fake business that they know is fake don't deserve to keep their money. But people who buy shares in a fake business represented as a real business by con artists are genuine victims of a genuine crime. We're not just talking about mala prohibida minutia from the depths of the Securities Act here, or even Gordon Gecko's morally-debatable behavior in Wall Street. The scam depicted in the movie is fraud by the libertarian definition of that word.

The crime is simple:

1) create paper company
2) sell lots of shares and funnel the money out of the company
3) declare bankruptcy

Later rinse repeat until shareholders track you down and kill you.

The pump and dump aspect is how you get a shady brokerage to go along with selling the shares. I imagine (hope) the one in Boiler Room was just a caricature of this.

The real crime in that movie was Ben Affleck's acting.

Obviously, Winterspeak missed the part where it was a shell company. Not having seen the movie, this makes me wonder if the scriptwriter and director failed to make the actual crime clear in their enthusiasm for showing evil capitalists in action...

I didn't follow all of the bridge financing discussion when I first saw the movie, but the shell company part was obvious. They guy drove by a delapidated storefront in the slums and the voice-over said something like, "there was no medtronic."

I think the financing arrangements on the prospectuses (Latin accusative plural would be prospectūs) were just supposed to be a hint; the real crime was simple fraud.

The whole point of the Securities Act was to require companies to have written prospectuses for public sales of stock and to make the issuer and the underwriter liable for material misstatements in the prospectus. Before that, buyers couldn't sue the issuer and the underwriter because they were not in privity of contract with them. They could sue the broker, but the broker's usually didn't do anything wrong. In the movie, the broker made everything up, so any buyer could sue it for fraud regardless of any securities laws.

2 "companies" were mentioned in the movie.

One was the pharma-company that the rube bought that "made drugs which helped premature babies live longer". This company actually existed as there were newspaper articles about its falling share price.

The other company was the retractable syringe company, and it did not exist (the protagonist went and checked it out). Clearly selling shares in this is fraudulent.

But the major dramatized crime in the movie was the protagonist selling the rube shares in the drug company, which then tanked.

It is true the rube could not sell when he wanted to, but I'm not sure why this was the case (yes, the broker refused to do it, but on what grounds? Today, if your broker won't sell eTrade will).

Clearly it was all way over my head.

Some of the companies they were selling stock for were fake.

Thanks, aaron!

I always liked Glenngarry Glenn Ross. It was one of the first movies I rented for my wife and I to watch after we got married. After watching Alec Baldwin go on his rant, she turned to me and asked, why don't all these guys just quit.

That's always been the problem for me about "Glengarry"; Mamet really didn't capture the reality of commission sales work, where anybody who is in the business for more than three months fully grasps that changing jobs is like changing your shirt. It isn't a big deal, and if you find your boss to be an insufferable jerk, the only reason to stick around is if you are making gobs of money, in which case one is not really in a desperate situation, but merely a mildly inconvienient one.

I have the same problem with 99% of courtroom dramas (actually, I also find Mamet's use of dialogue entirely too contirved, and thus overrated), in that they so wildly distort what legal conflicts are like, be it criminal or civil, that they may as well be about aliens arriving in giant space ships and President Bill Pullman doing battle with them in a fighter plane with an alcoholic Randy Quaid flying as his wingman.

At least having Will Smith and Jeff Goldblum hacking into the aliens' computers doesn't contain any pretense of Important Human Drama, unlike the dreck which is produced about legal conflicts. I prefer the alien shoot'em ups every time, on those unfortunate occasions I'm stuck in an airport hotel room without reading material, a laptop, or nothing on ESPN to watch.

What if you're an elf and Alec Baldwin promises you the Glengarry tools and gives you the Always Be Cobbling speech?

http://blueberrytofu.blogspot.com/2005/12/always-be-cobbling.html

"It is true the rube could not sell when he wanted to, but I'm not sure why this was the case (yes, the broker refused to do it, but on what grounds? Today, if your broker won't sell eTrade will)."

No liquidity?

My problem with Wall Street is that the Gecko character isn't a businessman -- he's what a leftie like Stone thinks of as a businessman. For example, he has some line in the movie where he lumps investments and inheritances together as examples of unearned wealth, and goes on to brag about how he himself creates nothing, wrecks things just to wreck them, etc. I can't imagine an educated person with a background in economics or business would say something that laughably stupid and untrue.

Wintersmith wrote:
>It's not like the unscrupulous brokers are trying
>to sell stock that they *know* will go down (if
>they were smart enough to know that they'd be smart
> enough to be selling it short and making a
>bundle).

Well, suppose that the company is "real," but doesn't merit a high total value.

More specifically, suppose that (1) the total number of shares that exist is small, and (2) the market for the shares is thin, and (3) the initial share price is low (penny stock ish). (BTW, that makes likely that (4) the total initial market value of the company is rather low. And it might be that (5) the company's expected future value is rather low also.)

Given the first three conditions enumerated above, the unscrupulous brokers probably couldn't make very much money by simply selling the stock short, *even if* they know that ultimately the stock will be worthless. The total likely profit obtainable by selling the stock short is constrained not only by the (small) total current market value of the company, but by the likelihood that short-selling more than a small fraction of the existing shares of the company encourages a competing group of unscrupulous-but-sophisticated people to try to catch the short-sellers in a short squeeze. Or with too much short selling, a short squeeze could even happen spontaneously without anyone intending to create it.

On the other hand, a small group of unscrupulous brokers hard-selling the stock to a goodly number of relatively naive investors can drive the stock price up in a temporary bubble. The increase in total market value of the company provides more opportunity for the unscrupulous brokers to make money. The higher the hard-selling unscrupulous brokers can flog the stock price, the more they can make in commissions, and for a while, the easier it is for the unscrupulous brokers to sell more stock, since earlier investors 'clearly are making money' on this 'rising' stock.

*Presumably* the unscrupulous brokers could sell the stock short in mid-bubble to make even more money. But in general, the benefit of short selling is iffy, because even if a stock is truly overvalued relative to its long term profit prospects, it's hard to know *when* the stock's price will finally drop, and in the meantime the short seller is vulnerable to margin calls. It's safer for the unscrupulous brokers to start by going long in the stock (by buying penny-stock-priced shares or options) and flog the stock price upwards through large-scale hard-selling, finally completely liquidating their long position into an increasingly overvalued market.

As an aside, part of the puzzle comes from the ambiguity of the question 'do the unscrupulous brokers *know* that the stock they are selling will go down?' Initially, the unscrupulous brokers "don't know" that it will go down--absent their own interference in the market. But when they hard-sell a thinly traded stock in a low-value company to the point of creating a bubble in the market for that stock, they just about guarantee that the stock price will eventually crash and a lot of invested money will be lost. So in that sense they "do know" that it will go down.

I feel it's odd that I'm bothering to (over or under?)explain these ideas on a website presumably frequented by people with economic sophistication. More idiot me. But at least I don't assume that you believe in the efficient market hypothesis or in fairies.

ONE-SENTENCE ALTERNATIVE POSTING:

If I am not explaining this well, see the movie "The Producers." :-)

I agree Dan. Wall Street was full
of philosophies that make sense in a leftist/economically ignorant mind set.
The part when Gekko states that
making money is a zero sum game is
moonbat stuff. Oliver Stone
is clearly a paid up member of the fixed-wealth fantasy club.

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