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Federal Judge Milton Pollack dismissed class-action claims brought against Merrill Lynch & Co. and its former analyst Henry Blodget by investors in two Internet stocks that collapsed when the market bubble burst. Must reading for all those who refuse to take responsibility in the great zero-sum game called the markets.
Case Excerpts
The market “bubble” burst intervened before plaintiffs got out of their holdings and their holdings lost value. The plaintiffs, learning of the subsequent actions of the regulators concerning the conflicts mentioned above, rushed to the courts in these cases seeking to recover the losses they experienced due to the intervening cause, the burst of the bubble. The companies involved herein were duly registered with the SEC. Their assets, liabilities and economics were there disclosed for any holder or purchaser including these plaintiffs to evaluate at his own risk. What was missing, was what a willing buyer would pay to a willing seller to own the stock with all the relevant information of the fully published underlying corporate values there for everyone to see and evaluate. In the euphoric early phase of the bubble experienced by the market buyers of stock traded in the optimistic expectation of finding someone who valued acquiring and possessing the stock at a level higher than the holder did even if some of the risk analysts of the stock privately had doubts from time to time, on price, future market value, but not underlying assets. The risk manager’s forecasts on future price were both correct and incorrect depending on the timing of the mercury level in the market thermometer. “Buy” or “accumulate” opinion was an appraisal of the direction of the unsteady market fever. Those who listened to those prognostications were rewarded with huge paper profits if they cashed in — depending on the cycle of the bubble. Others missed out with the collapse of the fever.
This next excerpt goes right to the notion that you can’t sue if you lose in the zero-sum game:
The record clearly reveals that plaintiffs were among the high-risk speculators who, knowing full well or being properly chargeable with appreciation of the unjustifiable risks they were undertaking in the extremely volatile and highly untested stocks at issue, now hope to twist the federal securities laws into a scheme of cost-free speculators’ insurance. Seeking to lay the blame for the enormous Internet Bubble solely at the feet of a single actor, Merrill Lynch, plaintiffs would have this Court conclude that the federal securities laws were meant to underwrite, subsidize, and encourage their rash speculation in joining a freewheeling casino that lured thousands obsessed with the fantasy of Olympian riches, but which delivered such riches to only a scant handful of lucky winners. Those few lucky winners, who are not before the Court, now hold the monies that the unlucky plaintiffs have lost, fair and square, and they will never return those monies to plaintiffs. Had plaintiffs themselves won the game instead of losing, they would have owed not a single penny of their winnings to those they left to hold the bag (or to defendants).
Judge Pollack’s ruling is one of the clearest statements of the zero-sum reality of markets ever produced by a federal court. The sentence that matters most is the last one: “Had plaintiffs themselves won the game instead of losing, they would have owed not a single penny of their winnings to those they left to hold the bag.” This is the complete description of how markets work. Money does not disappear when a stock collapses. It transfers. The investors who bought at the peak and held through the collapse transferred their capital to the investors who sold into their buying. The court’s phrasing, “those few lucky winners…now hold the monies that the unlucky plaintiffs have lost, fair and square,” is accurate. Whether the winners were lucky, systematic, or something in between, they have the money. The losers do not. And the federal securities laws were not designed to insure against the consequences of speculation.
The phrase “cost-free speculators’ insurance” is the judicial equivalent of what TurtleTrader has always said about buy-and-hold investors who lose money and look for someone to blame. The market offered the information. The SEC filings were public. The assets and liabilities were disclosed. The investor chose to speculate in “extremely volatile and highly untested stocks.” The outcome of that speculation was a loss. The loss is the correct outcome of the decision made. A trading system with predefined exit rules would have produced a different decision, a different position, and a different outcome. The lawsuit is what happens when investors who would not have shared their winnings with anyone try to share their losses with someone else.
Frequently Asked Questions
What did Judge Pollack rule and why does it matter for traders?
Pollack dismissed class-action claims by investors who lost money in internet stocks during the bubble, ruling that the plaintiffs were high-risk speculators who knowingly undertook unjustifiable risks and cannot use securities law as speculator’s insurance. The ruling confirms that markets are zero-sum and that losses from speculation are the responsibility of the speculator, not of the advisors whose optimistic recommendations they chose to follow.
What does “cost-free speculators’ insurance” mean in the context of trading?
It is Judge Pollack’s description of what the plaintiffs were seeking: the ability to speculate for gains while transferring losses to others when the speculation fails. If the stocks had continued rising, the plaintiffs would have kept all the profits. Since the stocks collapsed, they sought to recover the losses from Merrill Lynch. The court correctly identified this as an attempt to have upside without downside, which is not how markets work.
Where did the money go when internet stocks collapsed?
As Judge Pollack stated, it is held by the investors who sold into the bubble’s euphoria. Trading is zero-sum over any completed transaction. The investors who bought at inflated prices transferred their capital to the investors who sold to them. The collapse did not destroy the money. It completed the transfer that the purchase began. This is the fundamental reality of the zero-sum game that every market participant enters when they take a position.
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