Honest Dollar and Dividend Stoppers

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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Honest Dollar.

Goldman Sachs is buying Honest Dollar, a retirement-savings robo-startup, and wouldn't it be funny if they rebranded the whole company after the new acquisition? Like, "Goldman Sachs is now Honest Dollar." "Honest Dollar is number three in the energy M&A league tables." "We traded a lot of Apple shares in the Honest Dollar dark pool." "I'm choosing between job offers in restructuring at Blackstone and the special situations group at Honest Dollar." "Today a select group of managing directors will be elevated to Wall Street's most exclusive club: the partnership of Honest Dollar." "Honest Dollar accused of conflicts of interest in advisory assignment." "Honest Dollar agrees to pay millions of dollars for mortgage violations." "Why I Left Honest Dollar." @HDElevator. I cannot stop myself with these. Just swapping the names gives all of recent financial history a sort of plump absurdity. Try it. Don't forget the logo, a cartoon hand holding up two fingers, which would look bright and cheery in a pitchbook.

Anyway:

Honest Dollar, a year-old start-up based in Austin, connects employees of small and midsize businesses and self-employed workers with individual retirement plans managed by the Vanguard Group for a per-person, per-month fee as low as $8.

Employees answer questions online and get a portfolio recommendation composed of combinations of four Vanguard exchange-traded funds.

That seems like pretty easy work for $8 a month, especially since most of it is done by the robot, but I guess you have to send out statements and have an app and stuff. "For Goldman," says the Wall Street Journal ominously, "the purchase could add a new distribution channel for a key business currently more in favor with regulators—asset management—than the company’s flagship trading and investing businesses." Even more ominously, Honest Dollar's chief executive officer, William Hurley, "prefers to go by the name 'whurley,'" "pursued a career as a bassist in a funk band before a serious car accident sparked an interest in computing," and launched Honest Dollar "almost exactly a year ago in Austin at South by Southwest." I remember that SXSW! Not that I went, but I did read this story about an awkward Goldman Sachs party:

Turns out I had approached the two people from Goldman who’d organized the event. Their easy smiles turned cold once they spotted the “Press” label on my conference badge. One of them even moved his Oakley sunglasses, which had been hanging around his neck via neck strap, onto his face like a professional poker player trying to hide his thoughts.

Off the record, he told me, Goldman threw the party for some fluffy non-answer reason I cannot write because I agreed to talk off the record. “What’s the on-the-record answer?” I asked. “We never go on the record,” he said.

I hope the sunglasses guys met whurley there at least.

(Disclosure, I guess: I used to work at Goldman Sachs, back in the old days before it became Honest Dollar.)

CoCos.

One loose way to think about "contingent convertible" additional tier 1 capital instruments is that they are an intermediate layer of bank capital. You have:

  1. Common stock, which never needs to be paid back, has no fixed value, has no cash payment obligations (you can turn off dividends), absorbs losses, and is generally the best capital.
  2. AT1/cocos and similar instruments, which never need to be paid back, have a fixed value, have weak cash payment obligations (you can turn off coupons but it would be embarrassing), and absorb losses when the bank's capital falls below some pre-set trigger level.
  3. Debt, which needs to be paid back, has a fixed value, has cash payment obligations, but at least absorbs losses if the bank fails.
  4. Important stuff -- deposits, derivatives liabilities, secured funding -- which isn't really supposed to absorb losses in any scenarios, though you are not quite allowed to say that.

In this little model, cocos are senior to equity but junior to debt. But last month's freakout about European bank cocos seems to have been driven in part by investors realizing that they hadn't quite understood the cocos' actual seniority. For instance: Did you know that banks can stop paying coupons on their cocos while still paying dividends on their common stock? (Also: employee bonuses?) That seems like the reverse of the seniority situation you'd expect. Also, many AT1 securities are "write-down" cocos: If the bank's capital falls below the trigger, instead of converting into common stock (as the name sort of implies), the cocos just poof away into nothing. The result is a weird hybrid seniority where in many cases the common is senior to the coco; like:

 

(Schematically, the coco pays nothing in very bad states of the world, skips coupons in merely bad states, and pays back its coupons in mediocre to good states; the common is more linear with states of the world.)

When you put it like that -- and last month sort of put it like that -- the coco is pretty grubby-looking, and regulators are rethinking it. The difficult balance is that you want to make it easy for banks to stop paying coco coupons to conserve capital when they need it, but you don't want to make it too easy to stop paying coupons, because then cocos can become an instrument for spreading panic rather than containing it. It is possible that the European Union does not have the balance quite right:

A so-called dividend stopper, which would bar dividend and bonus payments unless coupons are paid on additional Tier 1 bonds, could be a solution for the European Commission as it seeks to reassure the market, investors said. A staff note to an expert working group obtained by Bloomberg News last week suggests holders of AT1 securities, also known as CoCos, deserve “particular protection relative to the other stakeholders concerned.”

While dividend stoppers are permitted by all major jurisdictions outside the European Union, they are banned by EU regulations. That may force European regulators to stop short of a stopper and instead issue guidance that AT1 coupons should be paid before other optional payments are made.

The idea of banning the stopper -- of the dividend stopper stopper -- is that a dividend stopper would make it too hard for banks to stop paying their coco coupons even if they really need to conserve capital. On the other hand, if banks really need to conserve capital, maybe they should cut off the common dividend?

Elsewhere, UBS sold $1.5 billion of AT1s at a 6.875 percent yield. 

Asset management.

Here is an interview about "how to get a job at Steve Cohen's Point72" that attempts to answer a question that I find genuinely mysterious: Why would you work at a family office in a certain amount of unpleasantness with the Securities and Exchange Commission when you could work at, you know, a real hedge fund? This answer is a model of turning lemons into lemonade:

We have a very stable capital base. We essentially have one investor – Steve Cohen. When you’re a fund with multiple investors, you’re susceptible to capital withdrawals, which can be very destabilizing and even an existential threat. We think our greater stability is a significant advantage. The lack of outside investors also helps keep our portfolio managers free of the additional demands and distractions that come with a large investor base.

Nobody is worried about Point72 liquidity, I guess. Also, "on almost any day, you can walk onto our trading floor at Stamford Connecticut and see Steve Cohen sitting at his desk in the middle," which has its own appeal. On the other hand:

What’s your favourite interview question?

I’m not a believer in silver bullet questions, but I do like to ask candidates at the campus level to describe the way they spend their time in terms of a pie chart. – How did they split their time in the past week?

What’s the worst answer you’ve ever had?

I would generally advise against any answer that has the word ‘fraternity’ in it.

I am not sure Steve Cohen would agree?

Elsewhere, Bill Gross's lawsuit against Pimco survived a motion to dismiss, which honestly I found surprising. When we last talked about the lawsuit, I may have called it "barely a lawsuit"; Gross is suing because Pimco fired him in violation of his employment contract, but (1) Pimco didn't fire him, he quit, and (2) he didn't have an employment contract. I found both of those objections pretty persuasive, and Gross's responses to them struck me as a lot of emotive hand-waving, but a judge "said late Sunday that Mr. Gross provided enough facts to go to court," so to court he will go.

Elsewhere: "Fortunes of individual asset managers have been more varied than at any point since the crisis." BlackRock bought a lot of shares in the SPDR Gold Trust, a competitor gold exchange-traded fund, when its own iShares gold exchange-traded product briefly ran out of shares to issue. And hedge funds' top 100 short stocks "were up 4.59 percent in February, outperforming their top 100 longs by the most since BofAML began tracking the data some five years ago."

RVPlus.

Here is a Securities and Exchange Commission enforcement action charging "a microcap company CEO for falsely claiming to have a lucrative relationship with the United Nations and billions of dollars in clean energy contracts with foreign governments." The SEC's complaint gives some insight into the mechanics of microcap stock promotion; the defendant, Cary Lee Peterson, bought the company, RVPlus Inc., from someone else, and was allegedly annoyed that he couldn't immediately use it for pumping and dumping ("No more hiccups. You guys are killing my awareness campaign that I have set up when you do that.").

But the billions of dollars of foreign energy contracts are the real delight: According to the SEC, Peterson set up a fake UN-affiliated charity, and then convinced actual government agencies in Nigeria, Haiti and Liberia to sign contracts with RVPlus in which RVPlus would provide services to those countries and the fake charity would pay RVPlus. So he actually signed real, or real-ish, contracts with the foreign governments, though RVPlus didn't do anything under them and the foreign governments weren't on the hook for any payments. Aat one point Peterson allegedly e-mailed a Liberian official to explain that RVPlus hadn't done anything under the contract because "Liberia forget [sic] to make public notice from government and many people as the investors and sponsors did not take the MOU [Memorandum of Understanding] serious or legitimate [sic] when it was published on record with US federal government."

It all just seems like a lot of work, honestly, but I have to respect the craft of a man who, instead of just pretending to have a multimillion-dollar contract with a Nigerian state environmental agency (who would check?), allegedly went to the trouble of tricking the agency into signing that contract. Also here is a funny little anecdote:

On December 18, 2012, Peterson informed RVPlus’s new auditor firm (“Auditor A”) that Peterson believed RVPlus’s financial statements should reflect over $250 million in accounts receivable.

In response, Auditor A emailed Peterson certain accounting literature for revenue recognition specifying that “[i]n order for the Company to recognize revenues, all the criteria have to be met:
• Persuasive evidence of an arrangement exists.
• Delivery has occurred or services have been rendered.
• The price is fixed or determinable.
• Collectibility is reasonably assured.”

Peterson replied to Auditor A: “You and I know goods not deliver [sic] and contract just start.”

That day, Auditor A resigned from the RVPlus audit.

Activists and reputation.

This is fun:

Keusch also found a clever way to measure how activists impact CEOs’ reputations, by tracking their positions on outside boards. Over the five years following an activist intervention, CEOs who manage to keep their jobs end up holding fewer outside board seats. Those that get replaced do take on more board seats, but significantly fewer than is typical for departing CEOs. “These findings are consistent with a severe reputation penalty for CEOs who depart from their positions in a way that is unlikely to be face-saving,” writes Keusch.

I’ve argued before that the backlash against activists represents a battle between two visions of capitalism, one led by managers, the other by shareholders. But Keusch’s paper paints activists as less opposed to the interests of management so much as opposed to the interests of bad management.

Obviously one would like to untangle cause and effect a bit there: Is the reputation penalty because activists are good at identifying bad managers, or just because they are noisy about it? 

Happy Valeant "So, What's Up With You?" Call Day.

That call started at 8 a.m., and was preceded by this announcement of preliminary results and updated guidance. First-quarter "Adjusted EPS (non-GAAP) expected to be $1.30 - $1.55 from previous guidance of $2.35 - $2.55." Pre-market trading was ... not good

Donald Trump is worried about non-GAAP accounting.

I mean, he isn't, but:

In June of 2002, when the SEC brought the landmark action against Trump Hotels and Casino Resorts, the agency said it pursued the Trump case—its first for this type of abuse—because it provided a “stark illustration of how pro-forma numbers can be used deceptively and the mischief they can cause.” The agency accused Trump Hotels of using “fraudulent” reporting used to “tout purportedly positive results.”

I have given up on my quaint hopes that the 2016 election might be about the Rule 10b-18 safe harbor, but even a little discussion of generally accepted accounting principles and pro forma accounting would class things up these days.

People are worried about unicorns.

I assume -- I hope -- that none of these companies are unicorns, but this list of names of on-demand valet parking startups is a delight:

Turns out it’s hard to make money parking cars. Two startups (Caarbon and Vatler) quickly imploded and three more (Luxe, Zirx and Valet Anywhere) are shifting away from the on-demand model.

You'd be an unstoppable Scrabble force with those names!

"Uber became huge so people felt everything needed to be on-demand," says Ryan Sarver, an investor at Redpoint Ventures and a Luxe board member. "Then people went out of business because it doesn’t have to be."

But actually I feel like parking does have to be? Luxe now "prompts drivers to say what time they want their car back; if they still opt for on-demand service the app pushes them to request the car 15 minutes ahead of time in San Francisco and a full hour ahead of time in New York." It is enough to make you say "zirx!" The unicorn dream is about magically transforming the world, turning a hassle into a seamless delight -- not about waiting an hour to get your car back. You might as well just call an Uber.

People are worried about bond market liquidity.

"I believe certain investment strategies -- such as those focused heavily on distressed debt -- may be more suitable as closed-end or private funds, rather than as funds that are subject to daily redeemability," says David Grim, the SEC's director of investment management. On the one hand, it is probably not quite right to think that liquid products can only be built on top of liquid underlyings; one important purpose of financial innovation is to create liquidity, and it seems inarguable to me that, for instance, bond exchange-traded funds have added to the overall liquidity available in bonds. On the other hand, I mean, sure, there are ways to create liquidity other than daily redeemability, and distressed debt probably does work a bit better in a closed-end fund.

Elsewhere, some investors in energy bonds are "Shorting Oil to Hedge Credit," "because the previous mechanism for hedging oil-company debt, through contracts known as credit default swaps, is much less active, and the bonds have been hard to sell without taking steep losses." What sort of oil derivative is a junk-rated energy bond? You are sort of short a put, right? Meaning, in particular, that you have to sell more oil as prices get lower? On the other hand: "Investors have renewed appetite for energy bonds."

Things happen.

Bangladesh central bank governor quits over cyber heist. Stanley Fischer and Lael Brainard Are Battling for Yellen’s Soul. J.P. Morgan Readies Mortgage-Backed Deal. Lenders Are Getting Choosier When It Comes to Risky Real Estate Deals. The Koch Brothers Have Started a New Family Office to Quietly Invest Their Fortune. Institutional Investors Sue Volkswagen Over Fall in Share Price. Two Coal Barons, One Overdue Bond Payment and the End of an Era. Lehman's Derivative PortfolioSEC backs DOL in BP stock-drop case. Prosecutors are trying to take Tom Hayes's house. Prominent Silicon Valley investor denies he kept a sex slave for 13 years. Kellogg Says There Is A Criminal Investigation Into Assembly Line Peeing Incident. Trump Has Tiny Hands PAC ordered to change its name. Theranos CEO Elizabeth Holmes Is Holding a Hillary Fundraiser With Chelsea Clinton. Bankers for Bernie. An economic analysis of game 4 of the Lee Se-dol/AlphaGo match. Google's AlphaGo AI beats Lee Se-dol again to win Go series 4-1. Corporate law is terrible. Prime patterns. Hashtag robber. Badger theremin. Bony-eared assfish. Horse with suit.

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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Matt Levine at mlevine51@bloomberg.net

To contact the editor responsible for this story:
James Greiff at jgreiff@bloomberg.net