Wall Street makes it hard to earn legal living

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: Alice Schroeder

A group of university students I spoke to recently asked if it was possible to make a living on Wall Street without compromising your values. I had to tell them no. Wall Street has many decent, honorable people, but they work in a system that fundamentally compromises people’s ethics. The high pay is like an anesthetic that numbs you from feeling how you are being corrupted.

The goal of investing is to get an edge, whereas the securities laws presume all investors should have the same information at once. If ever there was a recipe for a system rife with abuse, this is it. The harder that money managers, traders and analysts must work to get information that gives them that edge, the more likely some are to cross a legal line. Last week, Manhattan federal court dealt with a case of insider trading when Michael Koulouroudis pleaded guilty to charges that he traded on secret tips from UBS AG investment banker Nicos Stephanou, who previously took a guilty plea.

People who are looking from the outside at the Galleon hedge fund insider-trading case may also be thinking, “How could they have been so stupid?” Admittedly, naming the ringmaster “Octopussy” wasn’t the brightest move, yet the reason insider traders create networks to exchange illegal information isn’t because they are dumb. It is because so few money managers outperform market averages over time.

There is only so much alpha—that excess return above a baseline average—to be had in an efficient market. The incentive to create some artificial alpha one way or another is very high. Those who bend the rules successfully post good numbers, which adds to pressure on other Wall Streeters to push the gray boundaries of legal information flow.

One had to wonder if that’s what happened when the volume of 3Com call options surged to the highest level since September 2007 before Hewlett Packard said it would buy the computer-networking equipment maker for $2.7 billion this week.

Investors also form an “us against them” mentality of sleuthing by whatever means is necessary to counter the stonewalling and obfuscation of company executives. A lot of inappropriate blabbing on Wall Street takes place by people who are outraged at some atrocity that is being committed by a company whose stock is overvalued.