Levine on Wall Street: Bapsolute Spoofing

Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
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Some Mathew Martoma.

I know, you've read a lot about the SAC Capital insider trading story, but this New Yorker piece by Patrick Radden Keefe is nonetheless pretty amazing. Ponder, for instance, the difference between insider trading and legitimate research:

Martoma had always been avid about research, and he was impressed by S.A.C.’s resources. At his disposal was a boutique firm full of former C.I.A. officers who could monitor the public statements of corporate executives and evaluate whether they were hiding something; S.A.C. also had a “buffet plan” with the Gerson Lehrman Group, giving Martoma unrestricted access to thousands of experts.

There is Mathew Martoma's fascination with bapi, the drug that was developed by the company he was convicted of insider trading: "The fixation became a running joke" between Martoma and his wife, "and her conversations with him were often punctuated by the word 'Bapsolutely!'" There is the cruelty of the FBI, telling Martoma "You’re going to lose all your friends, and your children are going to grow up hating you, because you’re going to live your years in a jail cell." There's the silliness of federal prosecutors, who have to begin every insider trading case with the dumb bromide "The case is about cheating." And there is this sick, sick burn on Duke:

When Martoma’s father first came to America, he was admitted to M.I.T., but he could not afford to attend. He retained a fascination with Cambridge, however, and prayed daily that his oldest son would go to Harvard. Martoma graduated from high school as co-valedictorian, but he ended up going to Duke. Shortly after Mathew’s eighteenth birthday, Bobby presented him with a plaque inscribed with the words “Son Who Shattered His Father’s Dream.”

A spoofing prosecution will be hard.

One theory that you sometimes hear is "white-collar crime X is so complicated, prosecutors will find it hard to get a jury to convict." I do not find this theory remotely plausible; juries seem happy to convict white-collar criminals of crimes that they don't quite understand. But the problem with the first-ever spoofing prosecution is not so much that it will be difficult to get a conviction, but that it will be difficult to get a conviction on a theory that doesn't make, like, all stock trading illegal. Here is Peter Henning, who literally wrote a book called "Securities Crimes":

Mr. Coscia can offer a good faith defense, which is available for any crime requiring proof of fraudulent intent. He may try to show that other high-frequency traders routinely cancel orders, with estimates of as many as 90 percent of all orders being canceled before they are executed. It is not a matter of claiming that what he did was right because everyone else did it, but rather that there was no intent to defraud when traders know that most orders quickly disappear and are never filled.

Umm. Well. This is a conceptually simple distinction: A lot of legitimate market-maker-type strategies post orders to buy Stock X for $10 and sell it for $10.05 on 50 different trading venues. That's 100 orders. Then a buyer lifts the offer at $10.05 on the New York Stock Exchange. That's one executed order. Then the algorithm updates and decides that, based on that demand, the stock now should be at $10.01/$10.06. So it cancels 99 orders and re-enters them a penny higher. That's a 99 percent cancellation rate due solely to market-making and market fragmentation. Or more generally: If information updates -- if there's new economic news, or trades in correlated securities -- you have to update your orders, and you have a lot of them, because there are a lot of venue.

Spoofing is different; it's entering orders intending to cancel them, and with no intention of them executing at the time you enter them. But intent is hard to know directly, and it requires some economic intuition to interpret the indirect evidence of it. So will prosecutors lean on "well he canceled a lot of orders" as evidence? Probably! If so, will that make legitimate trading riskier? Maybe?

Snapchat is not Alibaba.

One model of Yahoo would be that it is a venture capital firm, open to public shareholders, run by a former top Google executive, with a track record that includes some lame failures but also a colossal home run in the form of a $1 billion investment in Alibaba that has generated over $50 billion in value. That model sounds ... not horrendous, right? I know it's not what Starboard Value wants, but on the other hand, what's the alternative, focusing on the core business? Anyway that model might momentarily soothe your rage at Yahoo's random $20 million investment in Snapchat, but here is Dan Primack having none of it:

Yahoo’s reported deal for Snapchat would be an investment of around $20 million at a $10 billion valuation. To get the same multiple [as Alibaba], Snapchat would need to be valued at around $501 billion.

Which is too much. But even then, because Yahoo only put in $20 million, it would only make a billion dollars, which won't move the needle for it. In addition to being a weird random venture capital firm, Yahoo is sort of a timid one. Elsewhere, the Washington Post will be an app or something. And Mark Zuckerberg negotiated the Oculus VR deal over WhatsApp, and did you know that when I was in college the facebook was an actual book and we communicated over e-mail using Pine?

Prosecutor has role model.

I guess if you want to catch crooks you should, ehhhhh, I don't know, read this:

In the past year, Graber has won almost $37 billion in penalties from some of the world’s largest banks, a record haul for prosecutors. To colleagues, he compares his job to that of Blake, the notorious motivational speaker played by Alec Baldwin in David Mamet’s 1992 film Glengarry Glen Ross, who chastises real estate salesmen for failing to lock in deals.

Super. Elsewhere Eric Schneiderman seems to be winning the bidding war against the Securities and Exchange Commission to attract whistleblowers; the SEC has more money but Schneiderman moves faster. How should you think about that? On the one hand, tipsters motivated by the desire to actually see changes might be, like, better tipsters than tipsters motivated by money. On the other hand, Schneiderman's haste can occasionally look ... sort of hasty.

Investment banks as corporate monitors.

Before 1914, investment bankers often served on the boards of directors of the railroads that they underwrote. After 1914, that was forbidden by antitrust law. Here is a paper finding "that railroads that had maintained strong affiliations with their underwriters saw declines in their valuations, investment rates and leverage ratios, and increases in their costs of external funds," after their bankers were kicked off their boards, a result that the authors find "consistent with the predictions of a simple model of underwriters on corporate boards acting as delegated monitors" and an instance of "the potential risks of unintended consequences from financial regulations." It's also just sort of a quaint throwback to 100 years ago. Imagine arguing today that the role of an investment bank should be to monitor companies and make sure they do a good job so they can raise capital appropriately, and that a company's investment banker -- the one, with whom it has a close relationship -- should normally serve on its board so she can monitor its business. In the last century the business has become almost entirely transactional, to the point that it's hard to imagine a regulator saying "oh yeah the best way to monitor a business is to put an investment banker on the board."

Things happen.

Bill Gross: "The markets are my butterflies and my roses." Why the Gross vs Ivascyn comparison is misleading. Duncan Niederauer has a new job. Banks may need to have capital and loss-absorbing liabilities equal to 25 percent of risk-weighted assets. Fixed income derivatives are increasingly based on private rather than government interest rates. A U.K. Libor rigger-to-be-named-later pled guilty, and Deutsche Bank is talking about a settlement. David Einhorn donated $50 million to a vague-sounding Cornell community engagement initiative. Why one insurance firm wants to start using drones. Spreadable beer. Skepticism Is Warranted When It Comes to Facebook Likes. Doves cannot cry.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Matthew S Levine at mlevine51@bloomberg.net

To contact the editor on this story:
Zara Kessler at zkessler@bloomberg.net