I want to ask a question about the purpose of the chinese wall in Investment Banks.
As far as I’m aware, the idea of a “Chinese Wall” or an “Ethical Wall” in Investment Banks is to prevent insider trading, where the sales & trading side of the bank for instance has no idea of the deals that the investment bankers are working on.
The intuition I gathered is that (in the example above for sales and traders) people working in sales can’t buy a stock of a company that’s not yet public nor can they influence the decision of the clients that they provide a service for.
However, I haven’t found any real reason about why a Chinese Wall exists in the first place between the different functions of a bank. Why can’t a Salesperson buy the stock before it goes up, or tell their clients about it ahead of time? Are there any other reasons that the bank would choose to put up a Chinese Wall aside from leaks to the public domain, for instance?
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Buying or selling a stock based on information not available to the public is insider trading, and very illegal.
If Joe Public can’t make the same decision you can, you can’t trade the stock.
The insider trading laws are in place to protect people from losing money in a trade because the other person knew a lot more then them. And not because they did more due diligence but because they have access to information. You can not legally get the knowledge they have so you can not trade fairly with them. And those kinds of unfair trades have been made illegal to protect people from them.
A seller in a bank may have access to a clients financial documents which have not been made public yet. And those documents contain information which controls how much their stocks are worth. Only a few people within the company in addition to the bank sellers working on the project have access to these documents and many of them can directly influence what they are going to say. It would not be fair for them to start buying or shorting stocks in the company based on this secret information as the people they are trading with does not have this option. Even just giving their other clients good leads based on this information in order to gain favors later is grossly unfair to most traders. And that is why insider trading is illegal and why banks need to run a tight shift with customers financial information.
> Why can’t a Salesperson buy the stock before it goes up, or tell their clients about it ahead of time?
Suppose the salesperson picks a stock and buys up a bunch. Then they tell their clients to buy the stock, knowing that they will end up buying that stock from the salesperson at a higher price!
The clients were manipulated by the salesperson into making purchases which directly benefited the salesperson. That isn’t legal, the clients could be cheated out of huge amounts of money.
By keeping the salesperson ignorant of the investments the bank makes they can’t take advantage of their clients that way, and so even if the banks end up winning in trades vs. clients it isn’t intentional.
It feels like you’ve answered your own question? Why should any member of the investment bank be allowed to trade on insider information when it decreases the odds for the general retail investors?
I mean, the primary goal for a bank to ‘bookrun’ a company is for the fees it will receive, and less of whether or not the company is truly the best company to list. Throughout the process though, the bank would come across non public information which may or may not affect the stock price of said company.
That said, no matter how the stock price of the company goes, it remains an unfair advantage in which other investors can sue the Bank for.
If the share price goes up post IPO and the Bank and its employees made ridiculous gains, then it’s unfair why they should be allowed to trade on information not available to public. These public investors would then sue said company/ bank to the ground.
If the share price goes down post IPO, and the public makes losses, they would similarly sue both entities to the ground that the entire due was misrepresented.
Obviously there are other permutations to this, but at the end of the day, just know that you don’t mess with an investor/ group of investors who’ve made losses, since a good chunk of them probably have nothing else to lose.
The ‘Chinese wall’, as with most compliance policies are not ironclad per se, but just there to demonstrate that the Bank/ Financial Institution (FI) has applied adequate effort such that the Bank/ FI has taken measures to prevent unfair practices, and by extension, lawsuits against them for misrepresentations and foul play.
Of course, several parties such like Pelosi appears to be immune to this lol.
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