Clawbacks, Buybacks and Bankruptcy

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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Clawbacks. 

Here is Andrew Ross Sorkin with the case against the Securities and Exchange Commission's new clawback rules. I count about five objections:

  1. Companies will raise pay to compensate for the clawback risk. As I've said before, the key meta-rule of executive pay is that all executive-pay rules have the effect of increasing executive pay.
  2. Companies will stop paying executives for meeting objective financial targets (which, if they're restated, can lead to clawbacks) and start paying based on "subjective or operational metrics." This is also inflationary; if your bonus target is "be a good guy" then you will probably get your bonus.
  3. The rules seem to modify existing employment contracts, which raises legality issues.
  4. The rules have "nothing to do with the origins of the financial crisis and affects Main Street businesses that are not even part of the financial services sector," according to SEC Commissioner Michael S. Piwowar, which seems to me like a silly objection -- for how long must rulemaking be addressed only to the 2008 mortgage crisis? -- but there you go.
  5. It's not fair:

“Imagine a senior leader of a sales unit who falls within the scope of the proposed rules and is subject to a clawback because of an honest but material error committed by the accounting department or even the outside auditors,” Jones Day posited. “This is not a far-fetched situation. If a driving force for the clawback rules is to improve financial reporting, then it is at a minimum unclear how imposing strict liability on an executive officer with no role over financial reporting will further that goal.”

I mean look. First of all, it's a bit rough for the sales leader to have to give back her bonus when they find the accounting error, but on the other hand she really didn't earn the bonus -- she just thought she did, because of the accounting error -- so it's not entirely fair for her to keep it either. But second, why would the "driving force for the clawback rules" be "to improve financial reporting"? That is just a thing that lawyers and accountants say. Very obviously, the driving force for the clawback rules is to take away un-earned executive bonuses. They're driven by a dislike of bonuses, not by an appreciation for good financial reporting. Elsewhere, a Miss USA contestant would not cap executive pay

Bankruptcy.

Puerto Rico had what sounds like a pretty uninformative meeting with creditors in New York yesterday:

As a few dozen protesters outside chanted “you broke it, you fix it,” Government Development Bank president Melba Acosta addressed about 300 representatives of investment funds, insurance companies and other creditors gathered at Citigroup Inc.’s Park Avenue headquarters Monday. While she pressed the case for easing the fiscal burden on the commonwealth, she said it was “premature” to discuss which debt may be affected until officials develop a plan to turn around its finances.

Wait were the protestors, like, angry investors? Or were they telling the investors to fix it? Or what? Anyway some sort of bankruptcy protection remains very much on the agenda (well, the debtors' agenda), and here is an argument for extending Chapter 9 protection to Puerto Rico's public sector entities.

Meanwhile, Trump International Golf Club Puerto Rico Seeks Bankruptcy, and you'd have to say that was a bit overdetermined. Speaking of Donald Trump, "Trump Proves Being Openly Racist Is Bad for Business" was only the second-meanest thing said about him on Bloomberg yesterday; here is "Krugman: Trump Is a 'Belligerent, Loud-Mouthed Racist.'" (The third-meanest, incidentally, was "Kravis Says ‘Scary’ Trump Would Ask Him to Be Treasury Chief.") And elsewhere in celebrity bankruptcy, 50 Cent, whom you may remember for his $155 million net worth two months ago, filed for bankruptcy, greatly pleasing Twitter.

Greece. 

Here's Dan Davies with an optimistic case for Greece. Here is gloom from Yanis Varoufakis ("point blank refusal to engage in economic arguments," also "The project of European integration has, indeed, been fatally wounded over the past few days"), Wolfgang Münchau ("a toxic fixed exchange-rate system, with a shared single currency, run in the interests of Germany, held together by the threat of absolute destitution for those who challenge the prevailing order"), David Einhorn ("the grand goal of the European negotiators appears to be to discourage other countries from electing populists"), and Felix Salmon ("'Convertibility risk', in the language of Wall Street, is now a very real thing" for peripheral Europe), as well as meta-gloom from Joe Weisenthal. The IMF is in a position of once again lending into what it considers to be unsustainable debt, against its rules, without any real commitment from European leaders to write down Greece's debt. Franco-German relations are frayed. And Greece's parliament still has to approve the deal.

Bank risks.

Here's a new NBER working paper (free version here), by Juliane Begenau of Harvard Business School and Monika Piazzesi and Martin Schneider of Stanford, trying to measure "U.S. banks' exposure to interest rate and credit risk" over time. Some findings:

Interest-rate risk exposure rose substantially after the repeal of the Glass-Steagall act as larger banks increasingly engaged in trading activities, including interest-rate derivatives. For large banks and those with a lot of trading business, credit risk exposure rose more slowly but then spiked to peak together with interest rate risk exposure around the financial crisis in 2008. In smaller banks and those with more traditional business, both risk exposures built up less before the crisis, but instead increased in its aftermath. This is true especially for credit risk in the loan portfolio. More generally, the cross section of banks shows considerable heterogeneity in bank risk taking as well as the role of derivatives.

Here are some summary charts; one thing to note is that virtually all of the exposures are from classic banking (loan credit risk and loan interest-rate risk) and "safe" securities (rate risk on Treasuries, agencies and other AAA bonds).

Source: Begenau et al., Bank Risk Exposures, page 28.

Also of interest to me:

Our estimation finds that most banks’ interest-rate derivatives trading works like a portfolio of pay-floating swaps: banks pay their counterparty a floating rate and receive a fixed rate in return. As a result, most banks gain on their derivatives positions when interest rate rates fall so the floating rate they pay adjusts downward. In particular, we observe large gains for many banks when the Fed lowered interest rates during the 2001 recession and more recently during the financial crisis.

One thing I like to ponder is how much money banks made or lost on their various market-manipulation frolics over the last few years. The above would suggest the conclusion that Libor manipulation -- which went both ways but tended to manipulate Libor mostly down around the time of the financial crisis -- was mostly profitable for banks.

Post-it insider trading.

One of my favorite insider traders, Frank Tamayo, who achieved undying fame after he "met the stockbroker near the clock at the information booth at Grand Central and chewed up or ate post-it notes or napkins after using them to show the stockbroker the ticker symbol of the company that would be acquired," has settled with the SEC. "For his extensive cooperation in the SEC’s investigation" -- how else would they have caught his co-conspirators after he ate the evidence? -- "Tamayo will not face a monetary penalty from the SEC," though he will have to "disgorge more than $1 million of his ill-gotten gains." He will not have to disgorge the Post-its, as far as I know. He pled guilty in the parallel criminal case and is awaiting sentencing, though one assumes his cooperation will be rewarded there too. Elsewhere in SEC news, the median fine against individuals has more than doubled over the last 10 years, from $60,000 in 2005 to $122,500 so far this year, but the median fine paid by firms is down.

People are worried about bond market liquidity.

"For months everyone in financial markets has been talking about liquidity," says Antonio Weiss of Treasury, and don't I know it! Weiss's op-ed, defending U.S. regulation against charges that it has dangerously reduced bond market liquidity, was sort of a preview for the Joint Staff Report on the Treasury flash crash/rally of October 2014, which I wrote about here yesterday, and which is also fairly chill about bond market liquidity. Throw in BlackRock's papers from Friday (which we discussed yesterday) and it seems like we're in the midst of a mini-backlash to the worries about bond market liquidity. In fact: "The world is awash with unprecedented excess liquidity," says a guy, though he's talking about a different kind of liquidity. On the other hand, "Junk-Bond ETFs Show Just How Desperate Traders Are for Liquidity."

People are worried about stock buybacks.

Look I'm not going to pretend that Hillary Clinton's economic policy speech was mostly about stock buybacks -- it was mostly about Uber -- but it was a little about stock buybacks:

I will also propose reforms to help CEOs and shareholders alike focus on the next decade rather than just the next day. Making sure stock buybacks aren’t being used only for an immediate boost in share prices. Empowering outside investors who want to build companies but discouraging 'cut and run' shareholders who act more like old-school corporate raiders.

Is changing the time horizons of investors a valid purpose for the federal government? Should it be? I don't really have a view, and I think it's an interesting question, though I certainly hope that the 2016 election doesn't come down to the Rule 10b-18 safe harbor.

Things happen.

JPMorgan earned $1.54 a share, beating earnings and revenue expectations. Samsung C&T's merger proxy solicitation: "Even a single vote entrusted to us would be of great help." (Previously.) Gundlach vs. Morningstar. "Regulatory scrutiny has been acting as a disincentive for FX sales traders to provide the market color that clients continue to clamor for." The Fed and Congress don't get along, and Congress is investigating. Calpers missed its return target. Hedge funds are losing enthusiasm for China. Dexter Filkins on the death of Alberto Nisman. Mark Zuckerberg's legal battle with his neighbor remains strange. "Bipolar individuals earn 43 percent less on average, but they are 8 percent more likely to enter the 90th percentile of the wage distribution." Here comes the Schneiderman. "55% of Americans would rather have naked pictures of themselves leaked online than have sensitive financial details or their Social Security number stolen." Nouriel Roubini’s 10-Person Roof Deck Hot Tub Is Back In Business. Sharkcano.

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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 on this story:
Matt Levine at mlevine51@bloomberg.net

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