Brewing Scandal at CNBC: Allegations of Cheating in Stock Contest.--

There is a fascinating, though minor, scandal brewing over at CNBC.

CNBC has delayed announcing the winner of its Million Dollar Portfolio Challenge contest, which ended a week ago, because of allegations of cheating in the form of a version of after-market trading. With a $1,000,000 annuity as the prize, the contest proceeded in two stages: a 10-week contest followed by a 2-week finals for the 10 weekly winners and 10 others with the best overall portfolio results. There was also a 2-week consolation contest for those who didn't make the finals. Although CNBC and its corporate blog have not explained the nature of the problem, commenters to other blogs have been posting some superficially plausible speculations about the complaints of the losing finalists.

So far we have:

(1) a string of highly suspicious (and almost impossibly savvy) trades by some of the 20 contestants in the finals,

(2) an unsubstantiated claim by an anonymous blog commenter that he knows how such trades were accomplished because he found a software glitch that he used to cheat his way to a near-winning performance in the consolation round contest, and

(3) the announcement by CNBC that patterns of suspicious trading and allegations of irregularities have caused them to launch an internal investigation before declaring a winner in the contest that ended a week ago.

It will be interesting to see how the journalists at CNBC handle this CNBC scandal, in particular what they disclose about when they first heard about any problems and what they tried to do to prevent any violations. So far Mark Koba, the corporate blogger assigned to the contest, has performed shamefully. If Koba has been muzzled by his superiors, he should disclose this fact in a matter of fact way. If he has been muzzled and ordered not to disclose that he has been muzzled, then he's in a tougher spot (journalism jobs are hard to come by; not every outrage is a quitting offense). Will CNBC sweep any irregularities under the rug or instead engage in serious financial journalism and be tough on anyone that they find to have used a software glitch to violate the rules of the contest.

In the absence of meaningful disclosure by CNBC, here is what has been alleged about how after-market trading might have been accomplished. Some companies release earnings before the market opens or during the trading day, but some release just after the market's 4pm close. Contestants could make only one set trades every day, with their choices supposedly made by 3:59pm ET each afternoon, just before the market's close. Traders were working with an imaginary portfolio of a million dollars. Each day before 4pm one could, for example, enter trades buying 200,000 shares of each of 50 stocks including the dozen or two stocks releasing earnings just after that day's close. If nothing further were done, only the first of the 50 trades submitted would be completed, investing essentially all of the contestant's portfolio in one stock (with perhaps a single share of a later low-priced stock being purchased as well with the few dollars remaining after the first trade was entered). Before the 4pm market close, the contestant could alter the priority of her 50 orders, which would change which stock trade would consume 99.9% of that day's investment.

But according to allegations by blog commenters, if a contestant kept her computer CNBC pending trades window open at the close, she could wait for earnings to be released after 4pm and watch the movements of those stocks in after-market trading until perhaps 4:30pm. (Scroll down to comments on a non-CNBC blog here at 5/25/2007 10:09 AM, 5/25/2007 3:16 PM, 5/25/2007 3:38 PM, 5/25/2007 3:59 PM, 5/25/2007 4:31 PM, and 5/27/2007 6:14 AM.) The stock that jumped the most in after-market trading until 4:30pm could be moved to top of the priority list, and CNBC would then process that stock trade as if it had been made BEFORE the 4pm close, rather than AFTER the earnings were released a few minutes after 4pm.

If these allegations are true--and for now CNBC is not saying anything informative--CNBC has a mess on its hands, since presumably the same tactic could have been performed during the rest of contest as well. At least as to the 20 finalists, one hopes that CNBC has adequate computer time stamps to show when the priority of a set of orders was changed by a contestant. If not, they would be forced to rely on the statistical probabilities of one person (or several people) picking strings of winners.