Rigged Chapter 14

"Allnighter"

by

Ross M. Miller
Posted July 26, 2004

“Let’s eat,” was my next executive order. “I’ll call room service, we’ll find Tara, and the four of us can put together a battle plan while we’re waiting for dinner.”

As a master in the art of spending other people’s money, I picked up the phone and ordered a smattering of items from the menu that I figured would make everyone happy. I led Zero and Randy back to the Admiral’s Suite and then knocked on Tara’s door.

“What’s up?” she asked. Everything from her posture to the expression on her face told me that she was on top of things.

“We’re getting together for dinner. Zero’s loading up the data and we have to make some sense of it all. My meeting with Ken was interesting. I get the feeling that we’re onto something, only I’m not entirely sure what it is.”

“I can use more data. I’d like to see their holdings in real-time, rather than what they eventually report to the SEC. I’ve squeezed just about all that I can out of what I’ve got. All I can tell you is that something’s going on, it’s big, I don’t know what it is, and it bothers me.”

“You’re not alone,” I said. It seemed best to be sympathetic rather than grill her on the precise nature of the problems she encountered. “By the way, did you learn anything interesting from Lars or the others at Lowell?”

“They are not happy campers and they blame GFF for it,” Tara said. “Everyone is worried about his bonus; they are announced in December and paid in January. Most guys are willing to stay until then—no point in leaving before bonuses are paid—but they are already looking to ‘jump ship’ as they put it.”

“Where are they looking to jump to?” I asked.

“Hedge funds. They say that’s where the big money is. There are no more senior partnerships at Lowell now that GFF is in the picture, so the big incentive to stick it out is gone.”

“They want to become hedgehogs, do they? Why am I not surprised? What else?”

“Lars was part of the first group from Lowell to go down to Hastings for one of GFF’s training programs. They had a good time, but thought it was rather hokey.”

“Richard Warren mentioned something like that this morning.”

“They also got a pitch on Alpha-Omega. There’s talk of a grandmaster coming up here to train them.”

“Lucky them. Anything else?”

“Not off the top of my head. I did get the impression that I was welcome to come along with them wherever they went.”

“I don’t doubt that for a second,” I said. “Why don’t you change into something less formal and meet us next door in a few minutes.” Tara was an Alaskan—not a Venusian—so I held out some hope that she wouldn’t take long.

When I returned to the Admiral’s Suite, my male comrades were on their hands and knees. “Looking for something?” was the obvious thing to ask.

“Bugs,” Zero replied. “You can never be too careful.”

“There’s always the cone of silence,” Randy said while peering under a sofa.

I went into my bedroom and changed out of my suit while my fellow male Alaskans completed their sweep.

“Find anything?”

“It’s clean except for these three champagne corks,” Randy said and then juggled them.

Tara soon joined us and headed straight for the piano. She played what she said was the largo from J.S. Bach’s F Minor Concerto for Piano and Orchestra. While Tara performed this captivating piece, which I felt certain that I had heard somewhere before, I sat and thought.

No book that tells you what to do in the situation that I faced. We had raw data and talent in abundance; the question was what to do with them. This might have been the stuff of business school case studies, had I not known better.

GFF was constantly barraged with requests by business school professors to write up cases based on the Mighty Quinn’s latest coup. Soon after I arrived at the old lab, a young assistant professor from a business school that thought itself prestigious was referred to me. It was most likely a ploy to get rid of him and it worked. He wanted to use game theory to explain some of the Mighty Quinn’s unorthodox strategic decisions. I doubt that he had spoken for five minutes before I stopped him in mid-sentence and ripped his theory to shreds. I never saw another case writer after that.

My solution to this real-world case was to set up an assembly line that exploited the strengths of each of my team members. Zero could do the programming necessary to extract the data from the database. Randy could see connections that eluded everyone else and so he would organize things—taking the raw data and turning it into something useful by imposing the right structure on it. Once that was done, Tara would be able to analyze the data, performing the computations necessary to determine if the data contained anything useful. Finally, I would interpret Tara’s results, using probability theory and any insight I had into The Lowell Group to determine their significance.

It was like Zero was making the hay, Randy was arranging it into stacks, Tara was finding everything hidden in it, and I was trying to piece together a needle. Under ideal circumstances, Zero would finish his work before Randy started his, and so on, but we didn’t have time for that. As soon as Zero had anything useful, he would hand it off to Randy and on down the line. Furthermore, as Tara and I began to find things, we could influence what data Zero should dig out next. The only way to do this was to gather everyone and every computer together in the Admiral’s Suite for one big data-mining party.

With Tara still playing piano, we huddled around her and discussed my plan. All agreed with my basic concept and helped fill in the details. We assembled everything in the suite’s living room—servers, laptops, and cables. As Zero and Randy were powering everything up and hooking the machines together, room service arrived. I intercepted the delivery in the hall. We had been provided with a complimentary bottle of wine, which I sent back. Tara and I wheeled the three carts of food into the room and set everything up next to what little table space remained.

Dinner looked and smelled amazing—a seafood extravaganza along with medium-rare beef tenderloin and assorted veggies. We caught a bite here and there while we were setting things up. The leftovers supplemented by a dessert tray and pots of coffee brought to us at regular intervals would fuel us through the night. It was nine in the evening by the time Zero’s system was ready to roll. Twelve hours remained before we would go the next round with Lloyd and the gang.

Considering that Tara had already been stymied in her efforts to make sense of Lowell’s portfolios using publicly available data, it made more sense to start by looking for a pattern in the individual trades made for each of Lowell’s funds. We sat around a coffee table while we worked—Tara and I took the sofa while Zero and Randy were sprawled on the chairs that flanked us. As for computers, each of us had one of the laptops that Zero had brought from Alaska and the servers had their own two seats across the coffee table from the sofa. A mirror copy of the backup drive was being installed on the second server, but we could still access data from the first server during this procedure. Zero had unmounted the backup drive, removed it from the server, and given it to me for safekeeping. All six computers were tethered with cables to a blue box underneath the coffee table.

It didn’t take long for us to establish a rhythm. Tara and I would describe what we were looking for so that Zero and Randy could work together to find it for us. It was like we were playing a multi-person videogame with an awesome amount of computer power and something real at stake.

We soon learned why the trading database was as large as it was. Whenever Lowell Aggressive Growth went into a new stock, it could take thousands of trades to build up its position. The initial purchases were small, spread over several days. Then, a week or two of accumulation followed—a few large buys and a great many small ones. Finally, there were several weeks of what seemed like fine-tuning of the position that included both purchases and sales.

Getting out of a position also took many trades, but things happened much more quickly. At least it used to. Before April, Aggressive Growth could exit its positions in under a week; after April, it often took as long as a month. There was no obvious explanation for this shift—the fund was not appreciably larger and market conditions were roughly the same. What was going on?

Just before midnight, after looking at some sample data that Zero and Randy had pulled for her, Tara said, “Something similar is happening when it takes on a position. I wonder if Lowell’s other funds are having the same problems.”

In a few minutes we determined that not only were Lowell’s other funds not having the Aggressive Growth’s problems. In fact, their situation had improved.

“Look here,” Tara said. “Last year, Harvey’s high-tech sector fund is buying up this chipmaker one week and selling it off the next. Not only that, he’s taking a loss. But when Ken buys, he hangs on for months or years.”

“That’s interesting,” I said. “Does the pattern continue after GFF enters the picture?”

It took several minutes for Tara to answer my question, but when she did she said, “No.”

“So Ken behaves one way,” I said, “and everyone else behaves another way. And all their behavior is quite different after the acquisition than it was before. It looks like we’re going to need a lot more coffee.”

Tara did not stop for coffee. She was pounding furiously away at her laptop. Finally, she looked up and said, “Consider this. Taken separately each fund exhibits its own peculiar behavior. But maybe something bigger is going on here. The only way to understand all this is to look at how the different funds interact. Ken’s fund is like a star and the other funds are its planets. They may not literally orbit around it, but it’s difficult to imagine that they are not influenced by its tremendous gravitational pull.”

Randy said, “Sounds good to me. I’ll start preparing time slices of Lowell’s trading activity. You can think of each one as a snapshot of the sky.”

Tara approved. That was something she knew how to handle. It was well into early hours of the morning before Randy could prepare the snapshots of Lowell’s trading on a minute-by-minute basis for the six months before and after the acquisition. Tara made a curious noise before she snapped her laptop closed and declared, “I’ve got it.”

She waited a moment for dramatic effect and then said, “Before the acquisition, whenever Lowell Aggressive Growth was purchasing a particular stock, the other funds that held it were selling it. Conversely, when Lowell Aggressive Growth was selling a stock, at least one of the other funds was buying it. This behavior continued for a few weeks after the acquisition and then not only stopped, but it now appears to be going in the other direction. Sort of like what happens when the earth’s magnetic poles flip, with north becoming south and vice versa. After the acquisition, whenever Aggressive Growth sells, the other funds are also selling, only at an accelerated rate. Analogously for purchases, the other funds are getting in before Aggressive Growth.”

The ball was now in my court. I had to figure out what it all meant. “I can’t help but wonder about something that Ken said to me at the Aquarium. He was talking about how he thought that GFF was able to make its numbers so precisely every quarter. He talked about how GFF kept its potential earnings and losses in what he referred to as silos. When GFF needed to bump its earnings, it could reach into a silo by selling a business that had accumulated profits.”

Randy asked, “How does this apply to Lowell?”

“For Lowell,” I said, “it could be more complicated than that. Maybe the other funds function—or used to function—as silos for the Aggressive Growth Fund. Remember Lloyd talking about how when Lowell goes to the market to buy it tends to drive prices up and when it sells it drives them down. But if Aggressive Growth can buy from the other Lowell funds, it can do so without affecting the market at all. Indeed, it might be able to arrange a price that is lower than the market price. Same thing for sales. Rather than take a bath on the open market, Aggressive Growth can sell to the other funds and then they can dispose of the shares later and be the ones to suffer any losses.”

“That’s interesting, but it raises several questions,” Tara said. “The first question is: How can they trade with themselves?”

“They may just be able to do it internally or they may enlist the aid of one of their brokers to arrange the transfer without sending the shares to the market. Considering that the brokers had people on the boards of Lowell’s funds, that’s certainly possible.”

“The next question is why they would have done this and then stopped shortly after Lowell purchased them.”

“As for before the acquisition, the answer is easy. Aggressive Growth is by far Lowell’s most visible fund—it’s their rainmaker. As long as it does well, Lowell gets good press and more customers not only for Aggressive Growth, but also for all its other funds. As for what happened after the acquisition, it could have something to do with the why the people are Lowell are eager to jump ship.”

“Anyone searching for a new job would be unlikely to care how Lowell’s business as a whole was doing.” Tara said.

“And might want to make sure that their own track record was as good as possible.” I added.

Tara thought for a moment and said, “My last question is that if you are right and Lowell’s funds are, directly or indirectly, trading with each other, is this legal?”

“The SEC is online,” I said. “Zero can hunt down the answer to that for you while the other three of us continued to sort through all these trades. He’s not a securities lawyer, but he’ll have to do for the moment.”

Zero, who was already antsy, established a connection to the hotel’s wireless network. Randy and Tara continued to sift through the data while I looked over what we already had.

It was a while before Zero had anything to report. “The good news is that the Internet is running smoothly again, no congestion anywhere in North America, so I could easily download documents from the SEC’s site. The bad news is that I couldn’t find anything about funds trading among themselves. If they use a broker to do the trades, it seems clear that that’s illegal, but trades that stay inside Lowell look like a gray area.”

As Zero reconnected to our network, he said, “I’ll upload all this regulatory stuff onto a separate partition of the server so that you can take a look. I did find several ways that mutual funds can manipulate their results, but nothing matches what we suspect is going on at Lowell.”

“Such as?” I asked, wondering what else might pop up.

“There’s something called portfolio pumping. It happens when a fund owns a company that doesn’t trade much and doesn’t have many shares on the market. At the end of a quarter, the fund can buy a bunch of shares to artificially inflate the price of the stock, which then goes back down when the fund sells the shares at the beginning of the next quarter. It’s illegal to do this, but there are only a few cases I can find where the SEC goes after someone for it even though some academics have statistical evidence showing that it’s a fairly common practice.”

While Zero and I talked, Tara found the answer to her first question. “It certainly looks like they are trading amongst themselves,” she said. “Whenever a fund has a trade with ‘CR’ in the ‘Exchange’ field, there is a matching trade—same price and quantity—for some other fund.”

“Do the prices appear legitimate?” I asked.

Tara replied, “I’ll let you be the judge, but nothing I see jumps out as unusual.”

“What about the quantities?”

“They tend to be small by their standards—never more than three thousand shares.”

“You don’t say.”

Tara’s eyes met mine as she responded, “Indeed, I do.”

“Who are Aggressive Growth’s trading partners?”

“Mostly the sector funds, but the index funds are also there.”

“One has to wonder if, contrary to what we were told, Lowell chooses those sectors that overlap the most with Aggressive Growth’s holdings to determine which new funds to offer.”

Randy restructured the database along sector lines and it was not long before he shouted, “Leapin’ Lizards! Whenever Aggressive Growth gets interested in a sector, a new fund dedicated to that sector soon follows.”

“There could be an innocent explanation for that,” Tara interjected. “Perhaps Aggressive Growth is always looking to move its money into hot sectors and Lowell is looking to start new funds in them as well.”

Again, I thought of Ken and his talk of synchronicity and said, “I agree with Tara. For now, we have to assume that there are innocent explanations for everything we’ve found, and Lowell will have a chance to provide them tomorrow.”

“It’s already tomorrow,” Randy said as he gazed toward the light that was beginning to fill the room. He got up, walked to the windows, and parted the shades. “Look at this!”

The rest of us got up to see what Randy found so interesting. It was the sun—large, surreally red, and coming up over the sea. Eight eyes watched until it was clear of the horizon.

Copyright 2004 by Ross M. Miller. Permission granted to forward by electronic means and to excerpt or broadcast 250 words or less provided a citation is made to RiggedOnline.com.