Client Affairs

Freedom From Wealth: Society Defines Insider Trading

Charles Lowenhaupt Lowenhaupt Global Advisors Chairman CEO President 25 May 2011

Freedom From Wealth:  Society Defines Insider Trading

All too often private wealth holders are the victims of fraud and financial theft, which is why standards of conduct for managing wealth are necessary to exceed the minimum standards embodied in statute and case law, writes Charles Lowenhaupt, chairman, chief executive officer and president of Lowenhaupt Global Advisors.

Defining acceptable behavior is the bedrock of any functional community or enterprise. Sound legal systems, distinct governance structures, and clear rules allow societies and families to flourish.

Look at the effort now underway in the US to tame insider trading by hedge funds; Galleon and FrontPoint are in the press with others because they violated rules. In its case against Raj Rajaratnam and his colleagues, the US Attorney successfully clarified for society what constitutes insider trading. The court made clear that their behavior was not proper and thereby made clear what is proper. In fact, stock manipulation through insider trading is a zero-sum game. Rajaratnam and his colleagues enriched themselves by stealing wealth from someone else, thus making them poorer. 

You might ask what this has to do with private wealth and freedom from wealth. First, private wealth is typically a major victim of systematic fraud. Private wealth is where the big  money is, as Madoff, Stanford and a parade of other thieves know. All too often, significant private wealth lacks the proper investment oversight, so it is an easy mark. Somewhere hidden in the Galleon booty we will find stories of private wealth selling too cheap or buying too high.

Second, if markets are allowed to be manipulated, they cease being trustworthy. Financial markets depend on trust. It is the common bond that holds together buyers and sellers, irrespective of geography or culture. Trust in the large financial institutions was already badly damaged from 2008. Rajaratnam’s conviction further poisons the well we call “trust”.  For the wealth holder, this is a setback for achieving freedom from wealth. Fraud invariably prompts wealth holders to micro-manage and devote every moment guarding against malfeasance. They become trapped by protecting their wealth.

Third, the clarification and imposition of standards is just as important for private wealth holders as it is for societies. Community and society work when laws and standards are articulated and periodically reinforced. A recent European study reported in the Wall Street Journal notes that nations without good institutions, such as universal property rights, impartial courts and equitably enforced laws, produce societies that are poor. Just as countries do better with proper governance, so do families.

For a private wealth holder or family, standards of conduct for managing wealth are necessary to exceed the minimum standards embodied in statute and case law. Private wealth holders cannot rely exclusively on legal regulation for protection. There are too many jurisdictions, too many regulations, and too little genuine concern by society about truly wealthy families. Instead, principles-based standards, carefully adopted and clearly expressed to all members of the family, provide the protection a family needs. In this way, family members and service providers can understand expectations of behavior and their understanding and compliance can be verified.

A fortune squandered

Here is an illustrative example of how standards can protect and preserve wealth – and how the failure to do so also left a trail of ruin. A Los Angeles family had a liquidity event from great wealth created by the patriarch. The wealth creator had a wife and three daughters. Ten years ago, he gave $100 million to a charitable foundation, $30 million to each daughter, and he and his wife kept $100 million. The foundation today has $150 million dollars. Each daughter has spent and lost all but $5 million; he and his wife invested in Madoff, commodities, the deals of friends and other “smart” managers and today have $20 million left. 

This catastrophe occurred because there were no standards set to govern the education and nurturing of the daughters. There were no standards to govern investment strategies and policies in the private portfolios.  How could the father, who built wealth in technology, have known how to bring his daughters into wealth, how to build a disciplined portfolio, how to say no to his friends with great deals, and how to “smoke out” the crooks and liars who crawled out from under their rocks in 2008?  By contrast, the foundation was operating under well-established standards known as “fiduciary practices”. Those standards protected the portfolio and kept it diversified and out of the hands of crooks.

Society has had generations of lawyers and regulators to build the standards to be enforced by the US attorney against Galleon and FrontPoint and others. Standards for private wealth holders cannot easily be built from the ground up by each individual or family. The goal of the Standards initiative by the Institute of Wealth Management Standards is to provide the framework on which each family can build its own principles-based standards. However these standards are created, articulating and enforcing and assessing standards are crucial to protecting against fraud and poor decision-making. The protection provided allows each family member or wealth holder to live life to its fullest and achieve the ultimate objective: freedom from the burdens of managing significant wealth.

Charles Lowenhaupt is chairman, chief executive officer and president of Lowenhaupt Global Advisors and is a co-founder of the Institute for Wealth Management. He is co-author along with Don Trone of an upcoming book, Freedom From Wealth.


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