Insider Traders and Whistle-Blowers

Also mental models for sell-side equity research and for whatever makes people become bank CEOs.

Some insider trading.

In 2010, the Federal Bureau of Investigation raided Level Global Investors, Diamondback Capital and Loch Capital looking for insider trading. All of those funds ended up shutting down, and while several Level Global and Diamondback employees were convicted of insider trading, the convictions of the two who went to trial, Todd Newman and Anthony Chiasson, were recently and notably reversed. The New York Times got the FBI's 2010 Level Global search warrant unsealed yesterday, and it is a fascinating read. The warrant affidavit  transcribes conversations between company insiders and the "fight club" ring of insider traders that included Diamondback and Level Global analysts. And those conversations show how general market research tips over into insider trading: Analyst X talks to Insider Y at Company Z for broad insight into the semiconductor industry, and Y says that he has good insight into "capital expenditure from the outside world as we see it" -- meaning (I think?) general market color about the industry, not material nonpublic information about Company Z -- and then X hints that things might be slowing down in the industry, and Y says "Yeah so hopefully you are hearing that news from our competitors, because I am not seeing it the same way," and now X knows something about Company Z that he's not supposed to know. But reading the conversations there's -- mostly -- no clear moment where it tips over from general market discussion to inside information; I, at least, would have a hard time going through this warrant affidavit and highlighting the illegal sentences. Of course that's the idea.

Meanwhile, David Ganek of Level Global, who was never charged with a crime but who did see his hedge fund disappear, decided yesterday to sue U.S. Attorney Preet Bharara over the 2010 raid. He's claiming prosecutorial misconduct because Bharara authorized the raid, and also invited the news media to the raid. Ganek will never in a million billion years win this lawsuit -- this is not the sort of lawsuit that you win -- but I suppose harassing prosecutors in court is a reasonable way to soothe the pain from being harassed by prosecutors. And what's Roomy Khan up to?

Some whistle-blowing.

Eric Schneiderman, the New York attorney general, sort of wants to supplant the Securities and Exchange Commission in securities regulation, because securities regulation is fun and also because, unlike the SEC, he's got the Martin Act, the New York state law that says that everything the light touches is securities fraud. One battleground between Schneiderman and the SEC is the war for whistle-blowers: If you're going to squeal on your company's misdeeds for cash, you want to squeal to whoever pays you the most. So Schneiderman -- who was already attracting whistle-blowers by moving faster than the SEC -- now also wants a New York law "allowing him to pay and protect whistle-blowers," so there can be a proper free market in squealing. From his press release:

Attorney General Schneiderman’s bill -- the Financial Frauds Whistleblower Act -- would provide financial compensation to whistleblowers who voluntarily report fraud in their industry, and whose tips lead to more than $1 million in penalties or settlement proceeds. The bill would also guarantee the confidentiality of the whistleblower’s information, and make it illegal for any employer to retaliate in response. The rewards paid to whistleblowers will be drawn from monetary recoveries paid by those who commit wrongdoing, and not out of state funds, making this a cost-free way to increase the government’s ability to detect frauds and obtain recoveries.

"Cost-free," huh? It's a cliché to say that money is fungible, but people keep forgetting it when it's convenient for them. This is the guy who wants to be your market structure regulator.

Some predictions.

I enjoyed this post from Eoin Power about how sell-side financial research works. It starts with the job advertisements:

There’s often an expressed desire for “creative thinkers” or people capable of “outside-the-box analysis”, which has always struck me as a little odd. Like, there are only so many ways for Lockheed to generate income over the relevant timeline of a DCF, and there are only so many things that can affect its bottom line. If you’re a money manager, how much do you really want a creative analysis? “Lockheed could do well marketing GPS solutions to farmers” might be true, but that seems like the kind of idea that’s more useful if you work at McKinsey than if you work at Fidelity. Basically, [the broadcast TV movie dubbing would be: forget] creativity -- you  just have to be right. And most of the time being right is boring and straightforward. 

His model:

It is better to be mostly wrong, but in creative individuating ways, so that when you are right, it is in a way that nobody would have ever seen coming. Being right 99% of the time and missing the shockingly unexpected calls along with everyone else provides no value to clients.

He figures that clients can mostly figure out the boring straightforward answers themselves, ascribes the value here to "the embedded impetus to at least consider an investment thesis you hadn't thought of before." Simple entertainment strikes me as a plausible (partial) explanation for the same phenomenon. Which, by the way, one shouldn't overstate: It's not like sell-side analysts are actually paid or expected to be wrong 99 percent of the time, or to spend most of their time clowning around outside of boxes or whatever. That's mostly just a thing that sounds good in advertising for smart boring people.

Here is a story about some analysts who say that "the stage is set for another financial crisis to unravel years of relative calm in debt markets."

A happy British bank.

Yesterday had a lot of bad news, so it's nice to see that "The Lloyds Banking Group said on Friday that it returned to a profit in 2014 as it prepared to pay its first dividend since the lender was bailed out by British government during the financial crisis." Lloyds is still 23.9 percent owned by the U.K. government, and last had a full-year profit in 2009, so as we discussed with RBS yesterday it's a little funny that capital return is the first priority. But I guess if you put money in British bank shares you'd be pretty keen to get it back too. Elsewhere, RBS's retreat from global investment banking won't be good for Stamford. And here is more on Bill Winters, the new chief executive officer of Standard Chartered and yet another disciple of Jamie Dimon to end up running a financial company:

For Mr. Dimon, leader of the largest U.S. bank by assets, his firm’s emergence as a top breeding ground is both a blessing and a curse, highlighting his firm’s ability to develop talent as well as the uncertainty surrounding J.P. Morgan’s succession plan.

I will never fully understand the psychological drives that lead someone to become a bank CEO, but a rough model would be that if you're the sort of person who is ideally suited to be a bank CEO:

  1. You don't want to quit once you're the CEO, and
  2. You don't want to wait around for your boss to quit if you're not the CEO.

So you can only have so many of those people at once.

A valuation.

Here is a story about a guy who spent $18,000 on advertising to win a recruiting contest in which the prize was 100,000 shares of stock in, according to Bloomberg Businessweek, is "part Costco, part mall, and all anti-Amazon," and will somehow put Amazon out of business and make a trillion dollars. (The trick is even lower margins than Amazon.) Those 100,000 shares "could be worth between $10 million and $20 million if everything goes according to plan," and Jet has raised money at around a $600 million valuation, so my ballpark guess would be that there are around 6 million shares outstanding, with the last raise at a value of around $100 per share. And this guy got in at 18 cents a share. Does that mean he got an incredible deal? Does it mean that the investors in the last round got an incredibly bad deal? (At 18 cents a share, the company would seem to be worth about $1 million, though that's not a fair valuation -- this was a contest, so Jet got more value for its shares than just this guy's $18,000 worth of advertising. It got, like, some other people's similarly cheap advertising.) What have we learned? There's that T. Boone Pickens line about how sometimes it's cheaper to drill for oil on the floor of the stock exchange than in the ground. Sometimes it's cheaper to drill for startup stocks at "so-called 'reward advertising' sites like Swagbucks and Gifthulk" than via venture capital investing.

How to do your taxes.

Here is a story about Gilead Sciences, which in 2014 had $8.2 billion in foreign income before taxes, but less than $7 billion in foreign sales, for a pre-tax profit margin of over 100 percent. How do you have more profits than sales? The answer is simple: volume. No, I'm kidding, the answer is that pharmaceutical companies move their intellectual property to low-tax jurisdictions and then attribute much of the income from their U.S. sales to that intellectual property, lowering their overall tax rate.

Things happen.

Here's a Planet Money episode about spreadsheets that I enjoyed immensely, even though I appear in it. Art market manipulation! John Lanchester on robots, labor and capital. Matt Klein on inflation breakevens. Taylor Swift is good at economics. Bed Bath & Beyond is good at merchandising. It's good to run the Carlyle Group. Buy This Saudi Prince’s Upper West Side Pad For $48.5 Million And He’ll Throw The Third Panic Room In For Free! Playboy or Cat Fancy? Hipster ipsum. Vox can't explain a dressYesterday's llamas set to "Yakety Sax," and The New Yorker on the llamas. Condom maker's shares surge after South Korea legalises adultery.

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    Matt Levine at

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