Crisis Fines and Insider-Trading Puzzles

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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Citigroup.

It is August 2015 and here is the Securities and Exchange Commission fining Citigroup $180 million for selling bad structured credit products in 2007. I wonder when we'll see the last SEC fine for selling bad structured credit products in 2007. I have to say that this one feels a little limp; you can tell that the SEC has lost some of its enthusiasm for these cases. The mis-selling at issue here was of hedge funds called ASTA and MAT, which did municipal arbitrage (buy muni bonds, hedge rate risk by selling taxable bonds or through swaps, lever up the resulting hedged position), and Falcon Strategies, which "invested in ASTA/MAT and other fixed income strategies, such as CDOs, CLOs, and asset-backed securities." Here's the problem:

Financial advisers and the fund manager orally represented to investors that Falcon was a “safe,” “low-risk” investment, akin to a “bond substitute” or “bond alternative” that had the same risk profile as a municipal bond investment but with a slightly higher return. Internal sales pitches stated that Falcon “walks like a bond, talks like a bond, [has] cashflow like a bond” and described Falcon as a “better version of a bond.” Consistent with that marketing theme, Falcon was benchmarked against the Lehman Aggregate Bond Index, which is used to evaluate the performance of bond portfolios.

The SEC says: "The funds were not bond substitutes, and an investment in the funds carried significantly greater risk than a bond investment." I don't know what that means? In the event the funds did terribly -- as of February 2008, ASTA/MAT had lost 84 percent of their value -- but in 2008 a lot of bonds did terribly too. It's very old-fashioned to think that the word "bond" necessarily implies a particular level of safety, particularly to the relatively sophisticated rich investors who bought this stuff. "The funds used significant amounts of leverage that increased the risk of both margin calls and loss in value," says the SEC, and that is true, but so what? The idea of the strategy, as I understand it, is that you do a very safe thing -- long highly-rated munis, short taxable rate product -- and lever it up a lot. "Falcon and ASTA/MAT were managed in accordance with disclosed investment strategies, including leverage guidelines," so the leverage wasn't exactly a secret. As it happens the very safe thing turned out to be not so safe, so oops, but it is a little hard from the SEC order to understand what Citi did wrong. There are a few more concrete instances -- Citi apparently misrepresented the results of backtesting -- but most of what they said seems like vague puffery and salesmanship rather than actual fraud. Still, if you do this, I guess you have to expect an SEC fine one day:

By the fall of 2007, the fund manager was instructed by supervisors at CAI to begin selling ASTA/MAT assets in order to reduce the fund’s leverage. Despite the negative market conditions and instructions to begin reducing leverage, the fund manager continued to tell investors that the biggest risk to the fund was the adoption of a flat income tax by the federal government. The fund manager reassured investors just weeks before the fund collapsed that the risk of loss was minimal.

Amazon, etc. 

I realized that the thing that bugs me about the New York Times Amazon-is-full-of-meanies story is that its premise is not so much that Amazon's employees work too hard but that they care too much about things that they shouldn't care about. So the story is full of sneery references to what Amazon is working on: "ways to restock toilet paper at the push of a bathroom button," "providing 'Frozen' dolls in record time," "delivering swim goggles and rolls of Scotch tape to customers just a little quicker." But that premise is unexamined and also sort of demonstrably wrong. Amazon has a $250 billion market cap! Different people care about different things; those who care a lot work hard on them. Who doesn't cry at their desk? How many Times reporters work 40-hour weeks?

Now of course you can and should object to that broader culture of constant work. As Emily Peck says, "The bruising workplace described by The New York Times is basically a stand-in for the white-collar, always-on, male-centric workplace that many U.S. workers know all too well." And Alison Griswold points out:

The last, giant caveat that seems worth appending to the Times report is how it plays with and to some extent sensationalizes an expectations gap about workplace culture. We’ve been trained to think that “working at Big Tech Company” should equate to the rosiest description of “working at Google.” Free gourmet meals. Lavish benefits. In-office scooters. Puppies! Some of the things former Amazon workers tell the Times are truly awful, but half of the scandal comes from them being about Amazon, a Big Tech Company that doesn’t conform to the Google ideal. The sad, horrible fact is that similar anecdotes coming from ex-employees at Goldman, Skadden, Bain, or various fast-growing startups in Silicon Valley would probably be nonstories—that is, until someone actually dies.

But I think that Annie Lowrey's explanation for the culture -- "That's what the money is for" -- misses something. The tradeoff for Amazon engineers is not pointless misery for piles of cash. It's misery with a point, or at least misery in pursuit of something that they think is worth caring about. Plus piles of cash. Though of course no one could defend this description of Amazon's bathroom culture:

The most horrifying moment of my employment at Amazon was the time I was using the toilet and a coworker began talking from the stall next to me. He asked me why I had not responded to his very pressing email. I closed my eyes and pretended this wasn’t happening. 

Here are Justin Fox and Leonid Bershidsky here at Bloomberg View, and Matt Yglesias at Vox. Here is a former Amazon employee who doesn't like dogs. Elsewhere, startups like chartreuse.

Insider trading.

One of the many delights of last week's big hacking insider trading case is that it addresses one of the great unresolved questions of insider trading law, which is: Is it actually insider trading to hack into a computer and steal information and trade on it? I mean, the hacking is presumably illegal, but is it insider trading? Normally insider trading requires the use or disclosure of information in violation of some duty of confidentiality to someone. The hackers don't seem to have had any duties to anyone, though there's arguably a tort-law sense in which you have a duty to everyone not to go around hacking into their computers. It seems obvious that it ought to be insider trading, and there's a Second Circuit case finding that it is, but it's kind of a weird case that doesn't really fit with the rest of the law. Here is Peter Henning on this question. One possible solution would be for Congress to pass a law making insider trading illegal, but, you know, don't count on that.

Elsewhere in insider trading hypotheticals, here's a silly one (via Daniel Rubin): If a court sends its opinion to the lawyers and parties before releasing it publicly, can they trade on it? Do they have a duty of confidentiality? (To the court?) I vote (1) they can trade, (2) but don't be the test case, come on, and (3) this is not legal advice. Again, a law telling people what is and isn't criminal might be nice. And: "Insider trading law is a mens rea morass."

Capital relief.

Capital is a buffer for banks against risk. Banks are supposed to have an amount of capital commensurate with the size of their assets, adjusted for the risk of those assets. If they sell some of the risk of those assets, then they can have less capital, because they have less risk and need a smaller buffer. Here's a story about capital-relief trades. I love a good capital-relief trade. What you want in a capital-relief trade is something that reduces capital requirements without reducing risk, through sheer regulatory sleight-of-hand. (I mean, that's what want, for my personal entertainment. It's not what regulators want.) There are known examples of those trades. But everything I read about capital-relief trades these days is like "banks are selling off risks, isn't that risky?" No?

Regulatory personnel. 

Would it be fun to be an SEC commissioner? What about the Commodity Futures Trading Commission? Or a director of the Federal Deposit Insurance Corp.? Or the Federal Reserve's vice chairman of bank supervision? There are current or upcoming openings for all of those jobs and I am just saying that my e-mail address is at the bottom of every post I write here on Bloomberg View. In other personnel news, the Dallas Fed appointed former Goldman Sachs vice chairman Robert Kaplan as its new president and CEO, and I am just saying that I also used to work at Goldman Sachs, what a coincidence. And the Federal Reserve is going to review Janet Yellen's security; apparently she gets too much?

Some of Ms. Yellen’s neighbors last year complained about an “armed camp” established by her security detail in a Washington gated community. Among other things, they sought an evaluation by the inspector general.

Far be it from me to question Yellen's security needs, but I am just saying I could probably run the SEC without a squadron of gunmen following me around. 

Petco.

Petco, which strives "to be the trusted partner of choice for pet parents," filed for its initial public offering, led by Goldman Sachs, and what do you think the pitch meetings were like? Dog-filled and adorable, I hope. Disclosure: I used to work at Goldman. Disclosure: I spend a lot of time at Petco, where I sometimes buy Blue Buffalo dog food and where my dog enjoys staring at the rescue cats that are available for adoption. (Adopt a rescue cat, this is investing advice.) Disclosure: This sentence from the prospectus describes me uncomfortably closely:

As pet parents increasingly use social media as a means to personify and share their pets with others, we believe pet­-focused content in social media will continue to accelerate the humanization trend.

People are worried about bond market liquidity.

Here's the New York Fed on "Liquidity during Flash Events," looking at the May 2010 U.S. equities flash crash, the March 2015 Swiss franc crash, and the October 15, 2014 Treasury flash whatever. It is a bit of a shrug honestly: 

These events shared a number of important properties but also differed in significant ways. In particular, all three events exhibited strained liquidity conditions during periods of extreme price volatility but the Treasury market event arguably exhibited a greater degree of price continuity, consistent with descriptions of the flash rally as “slow-moving.” 

Okay. Here are Stephen Cecchetti and Kermit Schoenholtz on liquidity. Their analysis includes the sentence "We can separate claims about a loss of bond market liquidity into two fairly distinct categories: those about U.S. Treasury bonds and those regarding corporate bonds," so I like them already. I feel like 90 percent of what I read about bond market liquidity treats Treasuries and corporates interchangeably, and as far as I can tell those markets have opposite liquidity problems (too much decentralized trading of Treasuries, too little of corporates). No sensible conclusions can ever come from lumping them together. Anyway the rest of Cecchetti and Schoenholtz seems pretty sensible, e.g.:

Returning to the market for corporate bonds, here the absence of liquidity is chronic rather than abrupt and temporary. While this lowers the potential for systemic risk, it also diminishes wealth: illiquid instruments are worth less to their owners and raise the cost of finance to their issuers. The puzzle is why the issuers and purchasers of corporate debt have had so little apparent incentive over decades to make these bonds more liquid. Importantly, we note that since this illiquidity pre-dates recent reforms, it cannot be attributed to regulatory changes like the Volcker rule, which applies to corporates but not to Treasuries.

Elsewhere, big investors like Harvard are using exchange-traded funds "as a way to dabble in inefficient and opaque bond markets." And here is John Coates on the Volcker Rule and cost-benefit analysis.

Things happen.

Chinese stocks had a rough day. Carlyle's Claren Road is having a rough time. "Global banks are facing billions of pounds-worth of civil claims in London and Asia over the rigging of currency markets." "Four former Citigroup Inc. currency traders are suing the bank for unfair dismissal after they were let go amid a global probe into foreign-exchange rate rigging." It's hard for fast food restaurants to get real food. More on the bitcoin fork. (And.) Jesse Eisinger calls for more incarceration. Jia Tolentino on Carly Rae Jepsen. "We learned resoundingly that our customers want to come to Starbucks and have a glass of wine or a craft beer." This GQ profile of Stephen Colbert is the best thing I've read this month. Don't keep your money in your toaster oven, come on.

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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