The Culture of a Hedge Fund

What is life like at a hedge fund?

The popular show “Billions” is about a hedge-fund king and the U.S. prosecutor out to ensnare him relies heavily on the testosterone-fuelled dynamic between the two. This is a show where we see the extent of how masculine aggressiveness plays out in the world of high finance. Wall Street is a place where people desperate to make money congregate…and weird things happen when money is at stake. At the core of this show, Chuck Rhoades, played by Paul Giamatti, is trying to indict Bobby “Axe” Axelrod for insider trading.

What is insider trading?

Insider trading is a term you’ve probably heard before. It’s associated with illegal conduct. It’s why Martha Stewart went to jail, right?

Very simply: insider trading occurs any time someone trades shares of a company while having access to information that the general public does not.

The definition is purposefully vague (so as to be able to be applied broadly at a legal level), but imagine you had a seat on the board of Exxon Mobil. You attend all these high-level meetings and have access to information and the opinions of people who are very close to the business – information that would be incredibly difficult to get your hands on without that seat on the board.

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What if, all of a sudden, you decided to sell 5 million shares of Exxon? That looks pretty suspicious, right? Why would you, someone invested in the well-being and future of the company, decide to sell your shares? Could it be because you know something we don’t and are trying to cut and run? That’s a form of insider trading. If you are privy to news that Exxon is doing really badly – before anyone else – and you sell shares on that information, you’re profiting from your privileged position within the firm. That’s just not fair game.

What happens when you get caught? 

In practice, it’s actually difficult to prosecute someone for insider trading. This is because not all trading on information that isn’t readily available to the public is insider trading. For example…you could overhear the CEO of Exxon talking to a friend about how the company is going down the drain. If you sold shares on that information that would NOT be insider trading.

It’s also difficult because knowing something is different from proving that someone knew something. You following?

In a scene from Billions, our hedge-fund king is visited by two of his employees at his son’s baseball game. They’ve come to him for advice and Axe asks one of them how certain he is of the trade, at which point we see a flashback of the guy paying off an informant. Axelrod cuts him off before he can hear any of the details. If he doesn’t know the details, there’s plausible deniability. It’s kind of like a mafia don issuing a hit to one of his capos in coded language.

It’s easy to see how much pressure there must be for traders in the hedge-fund environment. Hedge funds make big money, for their managers and employees, when their trades go the right way. The 2 and 20 rule ensures that. Basically what that means is hedge funds charge a 2% fee every year on the funds they collect (so if you manage a billion dollars, you’re guaranteed $20 million) and 20% of all the profits they make. If you lose money you only make the 2% fee.

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This relentless drive for profit is likely the source of hedge-fund corruption. Reports on hedge-fund corruption find that more than a third of professionals in the industry believe they have to break the rules to get ahead. Of a survey of 127 hedge-fund pros, nearly a third said that if a leader of their firm learned of insider trading, the misconduct would be swept under the rug. They would condone the illegal behavior. Half of them said that the SEC, the Securities and Exchange Commission, is ineffective when it comes to rooting out and prosecuting corruption.

Honestly…that doesn’t come as too much of a surprise. The SEC is a bit like the meter maids of the finance world, driving around and issuing parking tickets when they find someone parked illegally. The SEC can only bring civil suits to companies that violate SEC regulations, i.e. they can only hit you with a big fat fine. As one of Axelrod’s advisors says to him – SEC fines are a “fact of life”. The real trouble is the U.S. Attorney’s office that can bring about some serious jail time.

It’s fascinating, but not altogether surprising, to learn that insider trading is rampant. These hedge-fund kings don’t get rich by playing it safe. It’s their aggressiveness and drive to win at all costs that gets them where they are. Axelrod even has to win at things that you wouldn’t think could be won. In one scene, he takes a reporter out to lunch where after he gets what he wants, he leaves – leaving the reporter to dine alone. That’s his way of winning the lunch.

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So that’s what Paul Giamatti’s character has to deal with it – even though he’s got a bit of the same mentality in him as well. He, too, wants to win at all costs. He isn’t afraid to lean on, or exert pressure in the right spots to the people from whom he wants information. His perfect record of 81 wins and 0 losses didn’t come from nowhere.

Maybe when Billions rolls around this week, we’ll find out whether he can make it 82 wins on the trot.

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