by Pam Martens and Russ Martens, Wall St On Parade:
This coming Saturday will mark the 16-month anniversary of former Wall Street Journal reporter Mike Derby setting off a media firestorm with his reporting that the then President of the Dallas Fed, Robert Kaplan, had “made multiple million-dollar-plus stock trades in 2020,” a year in which Kaplan was a voting member of the Fed’s Federal Open Market Committee (FOMC) with access to inside information.
While the trading scandal spread to numerous other Fed officials, including Fed Chairman Jerome Powell, the case against Kaplan seemed like a prime candidate for a criminal investigation by the U.S. Department of Justice.
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Not only was Kaplan sitting on inside information gleaned from the Fed, but he was making market-moving statements himself on television.
When Wall Street On Parade obtained Kaplan’s trading records from the Dallas Fed shortly after Derby’s article appeared, it became clear that the stock trading was the least of the problem. Kaplan had also engaged in a far more brazen type of trading for a man sitting on inside information.
With the apparent approval of the then General Counsel/Ethics Officer of the Dallas Fed, Sharon Sweeney, who had signed her name to Kaplan’s trading records for years, Kaplan had repeatedly placed million-dollar-plus trades in S&P 500 futures and had been doing so for the entire five years he had been at the Dallas Fed. (See Kaplan’s financial disclosure forms from 2015 through 2020 here.)
S&P 500 futures allow an individual to trade almost around the clock from Sunday evening to Friday evening, while stock exchanges in the U.S. are open only on weekdays from 9:30 a.m. to 4:00 p.m. ET. S&P 500 futures gave Kaplan access to making directional bets on where the market would go after the stock market closed, which is typically when the Fed makes market-moving announcements. The most popular and liquid S&P 500 futures contract is the E-mini. A trader can obtain as much as 95 percent leverage on this contract – far more than the 50 percent leverage that is available for stock trades.
There was also the strong stench that Kaplan had intended to defy the public disclosure requirements of the Federal Reserve that mandated that he disclose the specific dates of his trades. Kaplan simply typed the word “multiple” where the specific date of each trade should have been entered on the disclosure form. (In the early part of Kaplan’s career, he was a CPA for Peat Marwick Mitchell. He should have known that how he listed his trading transactions violated the very clear instructions that came with the reporting form.) Wall Street On Parade, other members of the press, as well as Senator Elizabeth Warren demanded that the Federal Reserve turn over Kaplan’s trading dates. The Fed refused. (For how cavalierly Wall Street On Parade’s Freedom of Information Act request was handled by the Fed, see here.)
Kaplan was a sophisticated Wall Street veteran who worked at Goldman Sachs for 22 years, rising to the rank of Vice Chairman. As such, he would have certainly understood that the type of trading he was doing could subject him to an investigation for insider trading. (Goldman Sachs has refused to tell Wall Street On Parade if Kaplan did his trading at Goldman Sachs while serving as President of the Dallas Fed. The fact that Kaplan lists proprietary products from Goldman Sachs as “GS” on his financial disclosure forms suggests that he did at least some of his trading there.)
The year 2020 presented an ideal opportunity for a sophisticated trader (with inside information on actions the Fed planned to take) to make large profits in the stock futures market from short-term trading, going both short and long. As a result of the lockdowns from the pandemic, GDP fell by 31.4 percent in the second quarter of 2020 – the largest decline on record. At numerous times during 2020, the Fed was making dramatic market-moving announcements of interest rate cuts and the creation of a multitude of emergency lending facilities and emergency measures that caused the stock market to soar.
Since it does not appear that any brokerage firm that was executing trades for Kaplan blew the whistle on him, the obvious question is, why not? Was there a quid pro quo going on between Kaplan and a Wall Street trading house?
Every licensed broker that would have been placing Kaplan’s “over $1 million” trades is required under regulatory rules to “Know Your Customer.” The rule states that “Every member shall use reasonable diligence, in regard to the opening and maintenance of every account, to know (and retain) the essential facts concerning every customer and concerning the authority of each person acting on behalf of such customer.”
In this case, knowing your customer should have meant frantically calling your compliance department when an officer of the U.S. central bank, who sits on some of the most sensitive, non-public market intelligence in the world, instructs you to make “over $1 million” trades, multiple times, in S&P 500 futures contracts. The S&P 500 futures trades by Kaplan should have resulted in an immediate, all-hands-on-deck meeting of the entire compliance department of the brokerage firm. Instead, the trading went on unimpeded for more than five years, according to Kaplan’s financial disclosures.
Every brokerage firm is required to have a compliance department that monitors the trades being placed by its brokers. The compliance department has access to the personal data for each client that indicates who their employer is, along with significant other personal information. Clients whose jobs involve having access to confidential market information, like an investment banker or a central banker, should have their trades closely monitored in a properly functioning compliance department.
In addition to the Know Your Customer Rule, the U.S. Treasury Department’s FinCEN (Financial Crimes Enforcement Network) has its own Customer Due Diligence Rule (CDD Rule). One of the requirements under the rule is that financial institutions “use a specific method or categorization to risk rate customers; or automatically categorize as ‘high risk’ products and customer types that are identified in government publications as having characteristics that could potentially expose the institution to risks.”
Every single safeguard that is built into the U.S. trading system to detect improper trading appears to have failed when it came to Kaplan. That suggests there were plenty of aiders and abettors – the very kind of case that belongs at the Justice Department, not at the Fed’s Inspector General’s Office, which reports to the Fed’s own Board of Governors. And yet, as far as the public knows, the Kaplan case remains in the hands of this conflicted investigator.
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