Whatever happened to Chinese walls?

Almost in prehistory, back in the 1980s, before “Big Bang” of 1986, the UK financial services industry was regulated and segregated. There were merchant banks, stock-brokers and jobbers, and they were all separate institutions. If you were a merchant bank, you weren’t allowed to be a stockbroker or a jobber. Then, after Big Bang, you were allowed to do what you liked, but you had to have chinese walls.

Merchant banks raised money for  their clients, who were enterprises. They did this by  creating  financial instruments such as bonds and shares, doing the paperwork, writing the prospectuses etc.  They had lots of inside information about their clients; it was in the nature of their business with them, so they weren’t allowed to buy and sell those shares on their own account; they made their money from fees charged to their clients.

Jobbers were members of the Stock Exchange; they walked the floor of the exchange – back then, trading was by open outcry. They were the market-makers; they would buy and sell shares and bonds on their own account, but basically only to sell or buy again. They had some capital, but not a lot; they weren’t in it to hold stock. Many of them were individuals, not companies or partnerships.  They didn’t have separate clients because they only bought and sold from brokers on the floor of the exchange, and they made their money from a margin between the buy and sell price.

Stockbrokers acted for clients: private investors like your or me, and institutional investors like our pension funds.  They made their money from commission that they took whenever a stock was bought or sold.

After Big Bang, there was a concern that the merchant bank department of the merged conglomerates would leak inside information about the stocks being marketed to the jobbing and broking departments, so the regulators insisted that there should be Chinese Walls between the departments, and the new banks had to employ compliance officers whose job it was to ensure that procedures were tight enough not to let information leak across the Chinese walls; and tighter new laws were introduced against insider trading.

This brings me back to Goldman Sachs.  Surely there should have been a Chinese wall between the department making the Abacus instrument (the “merchant bank”) and the department selling it? But it seems that Fabrice Toure had a hand in all of it, and that this was standard practice in the industry.

I’ve always said that the seeds of the 2oo8 financial crisis were sown in the deregulation of the 1980s; this is – almost – a concrete example. But not quite. Deregulation took a different path on Wall St and in London, because the regulations were different before. I don’t know quite enough about the way things worked on Wall St before and after deregulation, which happened earlier and and in a more piecemeal way there.  And, of course, in the 1980s there were no such things as synthetic collateralised debt obligations packaging mortgage-backed securities…..


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