Flash Crash Rights and Wrongs

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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More on the flasher.

"Flash Crash Arrest Lays Bare Regulatory Lapses at All Levels" is the Bloomberg News headline and, I mean, yeah? Like what even is this:

It turns out regulators may have missed Sarao’s activity because they weren’t looking at complete data, according to former CFTC Chief Economist Andrei Kirilenko, who co-authored the report. He said in an interview that the CFTC and SEC based their study of the sorts of futures Sarao traded primarily on completed transactions, which wouldn’t spotlight the thousands of allegedly deceitful orders that Sarao submitted and immediately canceled.

I feel like "ooh all those canceled orders must be up to no good" is one of the most popular criticisms of modern market structure, and regulators just decided not to look at them at all? So they missed Sarao, who was allegedly, at times on the day of the flash crash, more than 20 percent of the order book, just because his orders didn't execute. There's a lot more that's weird, though. Sarao was a guy in a tracksuit trading out of his house with his personal money, but his clearing brokers -- MF Global, at the time of the flash crash -- let him place orders for hundreds of millions of dollars worth of futures? It seems like there were risk management as well as regulatory failures.

Yesterday I wrote sympathetically about spoofing bans, but here is John Cochrane, who is bracingly unsympathetic. ("Why is Mr. Sarao being prosecuted and not all the people who wrote badly programmed algorithms that were so easily spoofed?") On the other hand, while I can see the arguments for banning spoofing, I can't see any good reason to send Sarao to prison for many years for doing it. If he's extradited and convicted, "one of the biggest single determinants" of his sentence will be the amount of loss he caused -- which, if he's blamed for the flash crash, could be huge. This seems like an egregiously unnecessary and cruel result, given that his crime is basically fiddling with algorithms. Jim Whitman writes that, in contrast to America, Europeans have a stronger tradition of state power, and so 

they are able to treat some offenses as merely forbidden, rather than as evil -- as mala prohibita rather than mala in se. The contrast with the United States is strong: our liberal, antistatist tradition leads us to conclude that nothing may be forbidden by the state unless it is evil; otherwise the state would have no right to forbid us to do it. Indeed, we still have much of the quasi-Christian attitude that David Rothman identified in describing the prerevolutionary American world: "The identification of disorder with sin," he writes, "made it difficult for legislators and ministers to distinguish carefully between major and minor infractions."

If fiddling with algorithms in a certain way is illegal, it must also be evil. If I were a judge in England I'd be looking hard for a way to avoid extraditing Sarao.

Nice one Argentina.

I don't necessarily root for Argentina in its fight with its holdout-creditor hedge funds, but that doesn't mean that I can't cheer when Argentina pulls a fast one on those funds, just out of sheer impartial love of sport. The game of gamesmanship is the winner here:

The country, which is blocked by U.S. courts from paying its foreign debt until it settles with disgruntled creditors, issued $1.4 billion of bonds under local law Tuesday through a one-day auction, raising three times the amount it targeted. Hedge funds led by billionaire Paul Singer’s Elliott Management scrambled to challenge the move, but the quick-hitting nature of the sale didn’t give them enough time to stymie the offering.

The deal was a reopening of 2024 U.S. dollar bonds at a yield of 8.96 percent, and one holdout creditor "on Wednesday notified creditors and financial institutions that participated in the offering that the sale may constitute fraud and that the company may have the right to pursue relief." I said yesterday that this deal works "only if Argentina has been incredibly careful and clever about avoiding even the most glancing contact with New York," and we'll see if that's the case, but apparently at least some bond buyers are feeling pretty good about their chances of getting repaid.

Haha whoops Scott Stringer.

Remember how New York City Comptroller Scott Stringer was shocked, shocked, to find out that New York's pension funds pay investment management fees to "Wall Street"? Which includes paying a few basis points to traditional stock and bond managers, and one or two hundred basis points to "alternatives" (private equity, real estate, etc.) managers? Welp:

Only a few months ago, Stringer was pushing Albany lawmakers to pass a bill that would have allowed an additional 10 percent of the city's $160 billion pension system -- or $16 billion -- to be invested in alternatives. Assuming the industry standard 2 percent management fee on such investments, that shift could have generated more than $300 million in new Wall Street fees every year.

Stringer championed the bill following a 2013 election campaign that saw him benefit from an influx of campaign contributions from financial executives after former Wall Street prosecutor (and former governor) Eliot Spitzer jumped into the race for comptroller. During the campaign, Stringer declared that he wanted the city to consider moving more pension money out of low-risk bonds and into Wall Street firms.

Upon taking office in 2014, he argued that the existing law prohibiting more than a quarter of the city's pension fund from being invested in alternatives was too restrictive.

Just put it all in index funds, man.

What's Deutsche Bank up to?

Apparently it is "set to decide against a complete exit from retail operations and instead opt to spin off its Postbank business and make big cuts in its investment bank." This is not quite a retreat from investment banking though:

Rather than seeking to become a “European Goldman Sachs”, Deutsche’s top executives see JPMorgan Chase as the rival with the closest model to its chosen strategy -- combining investment banking with commercial lending and retail units.

JPMorgan is still pretty investment-bank-y. But I guess this leaves the title of "European Goldman Sachs" open; maybe it's Credit Suisse's for the taking? In other Deutsche Bank news, there's a big Libor settlement

What principles should companies have?

I don't understand anything about Paul Tudor Jones's push to improve companies, but I love it:

JUST Capital, which has a 7-figure operating budget provided mostly via Mr. Jones, is in the process of polling 20,000 Americans on what corporate practices are most important to them. By September 2016, the group expects to release a ranking of 1,000 of the top multinational corporations based on how they fare on that to-be-determined criteria.

A partial list of bafflements:

  • When I hear the words "just capital," I think about, you know, a focus just on capital, not all the social-responsibility stuff.
  • But then I read those words and wonder why JUST is in all caps. Is it an acronym? What does it stand for?
  • Is its mission really, like, "we think companies should follow important principles, but we don't know what they are yet, so we'll take a poll and get back to you"?

Also the board members include "holistic-health guru Deepak Chopra, Huffington Post founder Arianna Huffington, Tom’s Shoes founder Blake Mycoskie and former Goldman Sachs Group Inc. partner Paul Scialla."

Compliance whistleblower.

Here's a compliance officer who will get paid "between $1.4 million and $1.6 million" for reporting noncompliance to the Securities and Exchange Commission. How should you think about those incentives, generically? On the one hand, you do want compliance officers with backbone, who won't back down when management overrules their compliance calls, and $1.6 million buys a certain amount of backbone. On the other hand, you'd prefer compliance officers who, you know, persuade their managers to comply, rather than letting those managers misbehave and then going to the SEC for a reward. "This compliance officer reported misconduct after responsible management at the entity became aware of potentially impending harm to investors and failed to take steps to prevent it," says the SEC, but how can you be sure that the compliance officer did all he or she could to persuade management to take those steps? Elsewhere, here is William Cohan asking, "Can Bankers Behave?"

Why tax structuring is fun.

Bloomberg's Zach Mider on why reporting on it isn't:

To the extent that there is tension or drama, you don’t really get to see the other side. Companies plan to arrange their affairs to avoid taxes. But the ultimate victims are the federal government and tax revenue, indirectly all of us who pay taxes in America. There’s not like a person you can go interview who lost the money that some company would have paid. So it’s hard to find a way to make the story human.

It's good to arrange your affairs so that you don't have an identifiable "victim."

Hedge fund documents.

This is not new, but it was new to me, and a fun resource: a collection of hedge fund offering documents (via). "These documents were obtained from PACER," the electronic database of documents filed in U.S. federal court cases, and if your hedge fund documents are on PACER you know something has gone badly wrong. 

Things happen.

Investment banking leads to private wealth management leads to investment banking. Abbott Labs is pretty pleased that it took Mylan stock in exchange for its generic drug unit. Size versus certainty in M&A fees. PE ratio frequency and forward 12-month returns. Petrobras "wrote off 6.2 billion reais ($2.1 billion) due to alleged graft and another 44.6 billion reais for overvalued assets," and "graft" is not a great line item to have on your income statement. Meet the guy (allegedly!) causing all the earthquakes in Oklahoma. It's weird that people sometimes think that Google searches for X are an indicator of X's popularity. "A Bay Ridge couple is having the loudest sex in the city," according to city records. Ray-Ban Bans Rand Paul’s Ray-Bans over Brand Ban. Don't swim in the Gowanus Canal, come on.

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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:
Matt Levine at mlevine51@bloomberg.net

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