Plunges, E-Mails and Insider Trading

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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Crash boom bang.

"Chinese Stocks Crash Again to Extend Biggest Plunge Since 1996" is the Bloomberg headline, so that is super, but as of 8 a.m. Europe and futures are up and perhaps the worst is over. In China, the Shanghai Composite was down 7.6 percent on the day and "22 percent in four days since Aug. 19," with more than 700 stocks limit down today. The People's Bank of China cut interest rates, though, which might help.

I wrote yesterday about some reasons to look on the bright side of the market rout. I suppose there are others. "The Stock Market Plunge Is Great News for Walmart," so that's great news, if you're Wal-Mart. On the other hand one piece of good news that I mentioned was that at least some hedge funds seem to have positioned themselves for the crash. Of course I need hardly tell you that the hedge fund industry contains multitudes and that others were less well positioned:

What is clear, however, is that the numbers rolling in for August from the hedge fund industry do not look good. Hedge funds went into the sell-off bullish, with $1.5 trillion in long positions — bets that stocks will rise in price — compared with $684 billion in short positions, bets that stocks will decline in price, according to an analysis of the industry by Goldman Sachs.

Actually that's not too bad? Better than being 100 percent long, like you would be if you were in an index fund. But "hedge fund hotels" had a particularly rough week.

Market structure news is similarly mixed. On the one hand I feel like the equity markets did not cover themselves in glory, as the S&P 500 flirted with market-wide circuit-breaker levels and as General Electric lost $50 billion in market cap briefly for no obvious reason. "Anatomy of '1,000 flash crashes'" says the headline on this CNBC story about the 1,278 stock and ETF circuit breakers that triggered yesterday. The VIX "fear index" was too fearful to index, as erratic trading made it impossible to calculate for about 30 minutes. And exchange-traded funds did particularly poorly, with some trading far away from net asset value at times. On the other hand Virtu Financial, previously criticized for never losing money, "was on track to have one of its biggest and most profitable days in history Monday," and I feel like maybe you keep quiet about that?

And here's Izzy Kaminska with a thing that Scott Skyrm wrote last week:

And here’s another date to watch ‐ August 24th, which is the second G‐SIB capital surcharge calculation date (in addition to July 31 and September 30) We should expect some type of funding pressure and/or Repo market distortion on Monday. 

Did regulatory capital surcharge methodology cause banks to cut back on their short-term wholesale funding yesterday and provide less funding to the market, accelerating the crash? Or is it a coincidence? Who knows. Elsewhere, Donald Trump has a succinct Instagram ("China's taking our jobs, they're taking our money. Be careful, they'll bring us down. You have to know what you're doing," etc.). Pat Robertson blamed the crash on abortion. The Onion has a take. And what exactly has Nav Sarao been up to since he got out on bail?

Apple's e-mail.

One weird thing that happened yesterday was that Apple CEO Tim Cook e-mailed CNBC host Jim Cramer to tell him that everything was fine and to preview strong growth in China in July and August. Intraquarter earnings guidance is not something that Apple is particularly known for, and while it seems to have helped the stock it also puzzled people.

The puzzle is: If you are the chief executive officer of a public company, can you e-mail Jim Cramer with material information that you have not previously made public? The argument for "no" is that the Securities and Exchange Commission's Regulation FD prohibits selective disclosure of material nonpublic information to certain investors and analysts, and that Cramer "co-manages a portfolio, Action Alerts PLUS, that has a long position in Apple," so he might be covered by the rule. The argument for "yes" is that Jim Cramer is on television, and CNBC publicized the letter, and it would be pretty odd (and unconstitutional!) if the SEC's rules mean that companies are not allowed to talk to the press. "I’m sure Cook was well aware that Cramer would share it with his viewers and it would therefore quickly become public," says an analyst. I think that's right, and enough to make the e-mail okay, but discuss among yourselves.

Meanwhile in insider trading.

I like to tell people that everything is wire fraud: Lying on the Internet, if there's money involved, might be wire fraud, and who among us doesn't lie on the Internet? So if prosecutors want to put you in prison, they can, more or less at their discretion, so you should be nice to them. Peter Henning has this troubling story about a man, Steven Slawson, who was charged with insider trading not under traditional insider trading law but under Section 1348, a Sarbanes-Oxley securities fraud law patterned after the wire fraud law. Slawson argued that if the government wanted to imprison him for insider trading it should have to prove that he knowingly insider traded. But:

The government argued in response that the law was intended “to enable prosecutors to reach a greater array of securities-related misconduct, and to enable the government to avoid the technical complexities and nuances of the traditional securities laws that were often exploited by defendants and their lawyers.”  In other words, the benefit requirement imposed by the Supreme Court in the Dirks case no longer applies because Congress adopted Section 1348 to “avoid” such cumbersome requirements.

The court agreed, though the jury acquitted him anyway. If this is right, Henning says, "then the problems caused by the decision in the Newman case magically disappear by simply using Section 1348 in future insider trading cases." You don't need to prove the elements of insider trading to imprison someone for up to 25 years. You just have to prove an act "to defraud any person" over a security. 

It seems to me that fraud is not self-defining, and that insider trading is only "fraud" because courts have defined it that way. (Perhaps it seemed that way to Slawson's jury, too.) It also seems to me that it should be "cumbersome" to put people in prison for years, but never mind that. Lots of people think that Congress should write a law defining and criminalizing insider trading -- perhaps even a law that lowers some of the Newman requirements and makes it easier to get convictions. But it is very weird for prosecutors to claim that Congress already did that without noticing. If Section 1348 is a magic law to make it easier to get insider trading convictions, why doesn't it mention insider trading?

Banks as tech companies.

Here is a story about banks becoming tech companies that features JPMorgan building an educational tracking system for the LeBron James Family Foundation ("The bank’s tech workers donated about 4,000 hours of coding time to create the software") and Wells Fargo helping "a mall operator improve its app to schedule holiday visits to Santa Claus." Why not? Banks employ tons of software engineers, and as I said previously about this sort of thing, "The whole business of financial services is about flinging free things at clients in the hopes that they will give you some extremely overpriced paying work." I suspect this is particularly likely with software engineering, because the managing director with the client relationship probably knows from his own experience how hard it will be to do a leveraged buyout analysis or an activism defense review, but has no idea how long it will take to build a Santa app. It's a lot easier to over-promise outside your area of expertise.

Tech companies as banks.

Meanwhile Facebook filed for a patent application for "a tool that could be used by lenders to accept or reject a loan application based on the credit ratings of one’s social network." The Pacific Standard article is scandalized:

You could be denied a loan simply because your friends have defaulted on theirs. It’s the kind of digital redlining that critics of “big data” collection have been warning of for years. It could make Facebook a lot of money, and it could make the Web even less safe for poor people.

It also says that "modeling based on one’s social network only presents more opportunities for discriminatory and inaccurate conclusions," but of course if the conclusions are broadly inaccurate then Facebook will have trouble selling them. The problem of big-data Internet credit evaluation is not that it might be inaccurate. That is a simple problem! The problem is: What if it's more accurate than anything else, while still being discomfiting and discriminatory and generally creepy? That is a harder problem.

People are worried about bond market liquidity.

But, as I said yesterday, you can stop: Now there is evidence! If the recent crash doesn't dislocate the bond market -- and I suppose we'll need a few days to be sure -- then what will be the argument for continuing to worry that a crash will dislocate the bond market? I don't want to say that there's none; perhaps a crash driven by U.S. credit conditions, or by the Fed raising rates, will more directly implicate bond market structure than one that seems to come from China. Still. Elsewhere here is Pimco with "A Look at Bond Market Liquidity," and it's a pretty cheerful look, arguing that "there's a lot of transactional liquidity" and that "if you’re a long-term investor, then lower liquidity is often an opportunity to add alpha because the market gets irrational and moves more than it should."

Things happen.

Matt Klein defends risk parity. The New York Fed on Rethinking Mortgage Design. ISDA on capital relief trades. 20 Predictions for the Future of the Market Structure Crisis. Research: For a Corporate Apology to Work, the CEO Should Look Sad. H&R Block snuck language into a Senate bill to make taxes more confusing for poor people. Japanese whisky shortage. I'm 23 and dressed as royal baby Prince George for a week. Animals are getting fat. Happy National Duck Out For A Drink Day.

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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