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Easy Street

Front-running Goldman Sachs From A TD Ameritrade Account

Heidi Moore Sep 21, 2011

In horror movies, you always know it’s bad when the threatening call is coming from inside the house.

Wall Street investment banks may want to practice their screams, because they certainly are having a little trouble with the enemy within.

After the rogue trader brought down UBS’s credit rating and perhaps even its CEO, there’s another example of a bold rogue trader – except, in this case, the allegedly rogue was trading against his own bank, not taking big bets on its behalf.

The Securities and Exchange Commission accuses former Goldman Sachs trader Spencer Mindlin of figuring out some of the bank’s trading strategies and then beating his own bosses to the punch. The full complaint is here.

On Wall Street, there’s a name for what Mindlin is accused of doing: “front-running.” You can picture the image: a guy sees a trade, and runs in front of it to get to it first. He makes a profit before someone else gets to it. The problem is that the person he’s front-running is usually his own client – or, in the alleged case of Mindlin, his own employer.

Mindlin’s case, like UBS rogue trader Kweku Adoboli, has to do with ETFs: exchange-traded funds. These are baskets of securities, like commodities or stocks, that are all bundled together and sold like a single stock on a fund. By buying into an ETF, investors can invest in a wide swath of a sector they’re interested in without actually having to go out and buy 20 or 30 different stocks or commodities.

ETFs are also pretty complex. The one Mindlin played with was called the XRT. The SEC explains pretty well how it works:

The XRT is an equal-weighted ETF, composed of a mix of U.S.-based apparel, automotive and bargain retailers. The XRT is designed to replicate the S&P Retail Select Industry Index (“S&P Retail Index”) and rebalances quarterly on the third Friday of the last month of the quarter (the “Rebalance Effective Date”) to mirror the S&P Retail Index. The securities to be added and deleted from the S&P Retail Index are published before each Rebalance Effective Date. On the Rebalance Effective Date, the XRT adds and deletes the same securities from its holdings as the S&P Retail Index adds and deletes from its holdings.

To translate, the EFT is supposed to look like the S&P retail index, and every three months, it examines its holdings to make sure that they’re reflecting the S&P retail index as exactly as possible.

The SEC notes in its complaint that “Goldman was the largest institutional holder of XRT in December 2007 and March 2008,” meaning that it was the bank or institution that also dominated how the XRT was traded. When you’re a big holder of any stock, you exert some influence over its future depending on how much you buy and sell.

According to the SEC, Mindlin allegedly figured out which stocks Goldman would buy and sell, and when, and then he worked with his father to trade those stocks from a relative’s TD Ameritrade account first.

What Mindlin is accused of doing in the SEC complaint is pretty brazen – not because it was particularly ingenious, but because he did it against one of the biggest firms in the business, Goldman Sachs, from within one of the biggest firms in the business.

On Wall Street, a certain amount of wariness between trading partners is implied. It’s even expected. Traders lure clients into bad trades sometimes; it’s known as “ripping your face off,” in the usual colorful patois of trading rooms.

So it’s one thing – and a very common one – to think that you can put one over on a small client. But trying to put one over on Goldman Sachs takes an enormous amount of chutzpah.

It’s surprising that Mindlin would take on that kind of risk because front-running is an advanced Wall Street game, usually played only by the big boys against each other. Good ideas about which stocks to trade – and when – are highly sought-after and jealously protected on Wall Street. Goldman is so entrenched in the markets, and has so much good data on who’s trading what, that many of its rivals, in casual smack-talk, try to accuse the firm of front-running* them* with all the juicy market knowledge it has. (A Goldman memo to clients couple of years ago fueled these fears about potential conflicts between its own trading interests and those of its clients.)

And then here you have Spencer Mindlin, all of 29 years old, allegedly trying to front-run Goldman Sachs itself. Mindlin is 33 now, but worked at Goldman between 2007 and 2009.

An interesting coincidence here is that Mindlin worked at Spear Leeds & Kellogg, a market-making firm, between 2001 and 2007. Goldman acquired Spear Leeds in 2000. In 2004, Spear Leeds was one of a group of market-markets who paid a $240 million fine to the SEC to settle the agency’s long-time investigation of them for front-running. There’s no evidence that Mindlin had anything to do with that – much of the subject of that investigation would have been far above his pay-grade back then – but it’s an interesting historical and cultural footnote.

What’s also remarkable about this case is that it required some pretty advanced maneuvering including nimble trading of options – and yet, Mindlin and his father allegedly did it all from a TD Ameritrade account, just like the kind anyone can sign up for. Using a plain-vanilla consumer day-trading account to front-run a Wall Street giant is an especially bold move.

Mindlin does, from his Internet trail, seem to be exceptionally bright- an honors student in high school in Long Island who now develops software. He seems to be the same Spencer Mindlin who won a prize recently for an Android app; he and his tech partner each won an iPad and split $17,500.

Of course, that’s nothing compared to the $57,000 in profits the SEC alleges he made from his insider trading at Goldman Sachs.

And horror movie fans can have a wry smile: The SEC alleges that many of the calls Mindlin made to his father were made to and from his family home. So the call really was coming from inside the house.

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