Tuesday, 7 July 2009

A Curious Statement (worth pursuing further)

It was the main business news of the day that “Ex-Worker Said to Steal Goldman Code”, as the New York Times put it.

The story involved one Sergey Aleynikov, an ex-Goldman employee, who allegedly downloaded the firm’s proprietary trading software to his computer before leaving for greener pastures.

The story was jazzed up for maximum effect, with code words such as “sophisticated high-speed trading”, “a server based in Germany”, “a memory device” and, of course, “Sergey”! But it had too many holes in it and I didn’t buy it for a second. Apparently, neither did the judge, who released the said individual on a $750,000 bond.

If Sergey Aleynikov did what he is alleged to have done, he must have been a geek who learned nothing about finance while at Goldman. The superiority and, therefore, the value, of Goldman’s trading software does not come from some special insight into how markets work. It is, rather, due to the firm’s capital; Goldman could throw hundreds of millions of dollars into the market in order to create, and simultaneously profit, from an arbitrage position. The arbitrage opportunities are available at the wholesale level only. There is no opportunity in these markets for poverty-stricken geniuses. Fools with money will trump them every time.

What grabbed my attention, though, was the argument of the assistant United States attorney handling the case who told the federal judge that “Mr Aleynikov’s supposed theft posed a risk to United States financial markets”. He went on to add that “the bank” – that would be Goldman – “raised the possibility that there is a danger that somebody who knew how to use this program could use it to manipulate markets in unfair ways.”

That is a very curious statement. Now, if I were a systemic risk regulator, of the kind the Federal Reserve is soon to become under Obama administration’s proposals, I would approach Goldman and insist on getting answers to the following questions:

1. How and in what way could this program pose a danger to the U.S. financial markets?

2. How and when did you become aware of this potential danger of the program – at the planning stage, after it was coded, after it was put into use?

3. When and what were the circumstances in which you became aware of the potential danger of the software to the financial system?

4. What actions were taken after the potential danger to the financial markets was discovered? Who was the highest ranking officer to be informed of the potential threat?

5. What department was responsible for developing the program?

6. What department is responsible for maintaining the program?

7. Who wrote the technical specifications (the “specs”) for the program?

8. How long has the program been in use?

9. Who has used the program since it was put in production?

10. Is there a flag in the program that alerts the user to a “red line” beyond which the normal use would turn into a danger to the financial systems?

11. If Yes, explain how. What would happen if the red flag were ignored?

12. If No, how would the user know that he/she was crossing a red line?

13. Provide a detailed history of how Goldman used the program since it was installed.

14. Provide a detailed “what if” scenario of how someone bent on harming financial markets would have used the program since it was installed.

These are questions I would ask Goldman if I were a systemic risk regulator.