Southard: Fear and greed drive investors

WASHINGTON (MarketWatch) — Insider trading is impossible to stop, and retail investors are at a disadvantage in the financial markets unless they can afford the sophisticated trading tools used by the pros.

That’s the perspective of former investment broker Jeffrey Southard — the man known to some as “New Jersey’s Bernard Madoff.”

Southard, 48, is serving 15 years at the Federal Correctional Institution in Fort Dix, N.J., for defrauding investors — including elderly clients — out of $1.8 million through a Ponzi scheme.

Photo of Jeffrey Southard taken in March at the Fort Dix Federal Correctional Institution.

According to court documents, the former resident of Pittsgrove, N.J., promised investors fictitious tax-free “Ohio bonds” with 6% to 10% returns but instead took the cash and spent it on his mortgage, auto payments for a Lincoln Navigator and other vehicles, vacations and private school for five children.

He pleaded guilty to first-degree money laundering and second-degree securities fraud. As part of the sentence, Southard lost his trading licenses and now works in a commissary at the prison, with chores that include cleaning.

In a phone interview with MarketWatch, Southard argued that insider-trading laws are constantly being skirted and that a complex investment world filled with computerized speed traders makes markets unfair for everyday retail investors — unless they have the right trading platform.

Here’s what the incarcerated ex-broker had to say:

MarketWatch: Do you think insider-trading laws are effective?

Southard: Being part of the investment world for over 11 years, until I lost my licenses, I believe there are two emotions that drive investor decisions: fear and greed. We are basically living in a very competitive world, at anything and everything we do, and many times we become greedy and don’t even realize it. I believed I was going to assist my most emotional clients. Fear makes people do crazy things.

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Based on this philosophy I feel that insider trading happens a lot more than the SEC or the Financial Industry Regulatory Authority can detect or monitor. In fact, it is impossible for the SEC or Finra or any other regulator to stop the so-called gray area of insider trading.

MW: Is there one kind of insider trading you believe the SEC and Finra do a particularly bad job of catching?

‘The SEC and Finra focus on the individual investor and miss the networks of investors that claim they “buy on rumors” and “sell on the news.” ’

— Jeffrey Southard

J.S.: The SEC and Finra focus on the individual investor and miss the networks of investors that claim they “buy on rumors” and “sell on the news.” The gray area of this strategy — buying on rumors and selling on news — is whether the rumors are really rumors or rather information leaked out before the public is informed.

MW: How does the SEC and/or Finra distinguish between a rumor and inside information?

J.S.: There are so many occasions when a company’s stock drops significantly days or weeks before the company reports their quarterly earnings. After that the earnings and revenues are reported, and the company has missed Wall Street’s expectations. How do so many investors/institutions know this before it becomes public knowledge? Someone knows something before it becomes public. I would think people react to inside information that is negative, not realizing that it is “inside information,” and they are only focused on saving the value of their assets.

Now there is the other issue of positive inside information being disseminated that will drive a company’s stock up (e.g., a drug that is going to get approved by the FDA). If a multitude of brokers do this, the question is: Was it based on a “rumor” or is it blatant “insider trading”?

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If only a few react, then the SEC and Finra won’t have any problem detecting it. However, when a large network of brokers/dealers/institutions get this information and react upon it, it’s still insider trading, but it won’t be presented like this because of the amount of people reacting. Under these circumstances it is much too difficult for SEC or Finra to prove it’s inside info.

MW: What do you plan to do when you get out of jail?

J.S.: I can’t act as a broker for other investors because my licenses were taken away. But I plan to focus on trading for myself.

MW: Are the markets fair for retail investors? How has the advent of computerized high-speed trading affected the environment?

J.S.: The advent of computerized high-speed trading is an incredible advancement for brokers and dealers alike. However, for the “everyday” or “smaller investor,” it comes down to whether that investor is knowledgeable about the different platforms offered on the three main trading exchanges.

There are three platforms or levels on the trading exchanges: Level 1, Level 2 and Level 3.

Level 3 isn’t available to any investor — it is specifically developed for the specialists and market makers that work on the New York Stock Exchange (as the Nasdaq is all computerized).

The “everyday/smaller investor” has access to Level 1 and Level 2 platforms to make their trades. Level 1 platforms are offered by your standard online brokers such as E-Trade, TD Ameritrade
Charles Schwab
 and Fidelity. The problem is that the information on [the Level 1] platform is delayed …. so in actuality this investor can have the greatest state-of-the-art equipment and still have issues with slippage, meaning the difference between the price they expected to execute at versus the actual price.

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Level 2 platforms are considered “direct access” to the trading floors, so the information is “live.” There are some excellent direct-access companies that investors can use. I’m very familiar with one in particular, RealTick.

To sum it up: If more “everyday/smaller investors” were informed about the Level 2 platform, their trading would become much more efficient and effective.

MW: Aren’t Level 2 platforms prohibitively expensive for retail investors and typically utilized by day traders and institutional investors?

J.S.: It’s about timing. Any serious investor is going to utilize a Level 2 system. If a small investor’s goal is to become a big investor, then the $300 average monthly cost is worth it. Level 2 offers the smaller investor an opportunity to trade like a pro. Level 2 offers the same information that used to be privy only to stockbrokers and dealers.

To trade on Level 1 you will often need the advice of a stockbroker, and you will remain an amateur.

On Level 2, you will be able to see all the orders placed by market participants on the bid and ask, or offer, side of a stock. This can offer an investor the ability to predict whether the price of the stock is going to fall or rise, which helps the investor to make a decision to buy or sell.

The quicker you are able to make a decision on a position and the speed with which your equipment acts levels the playing field. It gives you the edge over market players that want your money.

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