Hedge Funds, Blockchains and Indestructible Wealth

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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Adage.

Here is a very sweet story about an actively managed stock mutual fund that charges a 50 basis point management fee and a performance fee of 20 percent of returns above the S&P 500 index, though it rebates some of that fee if it misses the benchmark the next year. Except that the fund, Adage Capital Management, isn't technically a mutual fund, even though it is an equity fund that tracks the S&P by keeping its sector breakdown equivalent to the S&P's. It's a "hedge fund," which means it can't raise money from the general public, but which makes it easier for it to charge that performance fee (and give the rebate) and to short stocks (though "Adage holds far more bullish bets than bearish ones").

But the real benefit of the "hedge fund" title is in framing. So those fees seem reasonable for an actively managed mutual fund, but they are dirt cheap for a hedge fund, where the stereotyped fees are 2 percent for management and 20 percent of all profits, not just those above the benchmark. And Adage has $28 billion under management, which would make it a nice-size equity mutual fund (but no comparison to, e.g., the Fidelity Contrafund, which has $106 billion), but instead makes it "the world's largest stock-focused hedge fund." Most of all, calling Adage a hedge fund allows its founders, who came from Harvard's endowment, "a chance to refashion themselves as symbols of frugality after years of criticism for their pay." What kind of symbols of frugality are they? One of them is so frugal that when he flies to his vacation home on Nantucket, he only sometimes flies private. That's a frugal hedge fund manager!

Blockchaaaaaaaaaaains.

Have you heard that the blockchain will be big in finance? Here is more about that. We've talked about it before, and my view is basically that, yeah, there should probably be some sort of cooperation to build agreed-upon electronic databases of ownership and transactions in markets where they don't exist, and yeah, blockchains seem like an appealing technical solution to that problem. But there have long been other totally plausible technical solutions to that problem (you know, databases), which may not be quite as spiffy as blockchains but would basically be fine. And to the extent that a market hasn't adopted some sort of cooperative electronic database solution, it's probably not because of technical deficiencies in the existing database architecture. It's because cooperation is hard. Perhaps the blockchain, with its spiffiness and cultural cachet, will make cooperation easier. It's a social technology as well as a cryptographic one.

SEC enforcement.

The Securities and Exchange Commission came back from its summer vacation refreshed and ready to go, and yesterday was busy. Let's start with "a father, son, and friend in Northern California" charged with insider trading on merger news. The father's "on and off" girlfriend worked at Clarient, which was taken over by General Electric, and told the father in advance of the deal. He then bought stock and told his son and a friend to buy stock. This case is civil rather than criminal, presumably because it is super small potatoes (the total profits were about $64,000; the son made just $3,288) and super unsophisticated: Nobody thought to use short-dated out-of-the-money call options or cover up their trading; it's almost like they didn't know it was illegal. Anyway the defendants agreed to settle by paying about $170,000 back to the SEC.

Then there's a $2.1 million settlement with auditing firm BDO USA for "dismissing red flags and issuing false and misleading unqualified audit opinions about the financial statements of staffing services company General Employment Enterprises." The tale is convoluted, but in the SEC's telling about $2.3 million went missing from GEE, the auditors asked about it, the controlling shareholder lied about it and wired the money back so that the convicted felon who was allegedly really controlling the company "could eventually carry out his plan to enrich himself by using GEE to purchase other companies for his benefit." The auditors signed off on this questionable series of events, which I suppose they shouldn't have.

Then there are the "fraud charges and an asset freeze obtained to halt an ongoing real estate investment scheme being conducted by a trio of business associates in California accused of stealing investors’ money while promising them 'indestructible wealth.'" Also there are "fraud charges against a Maryland-based financial services firm and its founder/CEO accused of grossly inflating the amount of managed assets and exaggerating the investment returns actually obtained for customers." The founder/CEO is Dawn J. Bennett, who allegedly "frequently touted to customers and more broadly on her paid radio program that highly profitable investment returns generated by Bennett Group Financial Services placed it in the 'top 1 percent' of firms worldwide without disclosing that the returns were calculated for a model portfolio and not based on actual investor performance." The radio program was called Financial Myth Busting With Dawn Bennett, because of course it was. (Remember: Even if someone has convinced you not to trust the fundamental institutions of modern society, or at least some financial myths, that doesn't mean you have to trust her!) Anyway the actual SEC order is full of pleasantly silly nit-picking about exactly how many assets Bennett managed or advised; she claimed that she was counting short-term cash management advice to some corporate clients, but the SEC disagrees:

When Bennett first testified during the investigation in December 2013, she said that, during weekly telephone calls between 2005 and 2011, she gave advice to the Chief Financial Officer of Company A’s U.S.-based business unit (“CFO”), about how to manage over $1 billion in Company A cash. However, CFO had left Company A in February 2006. Upon testifying a second time in January 2015, Bennett changed her story and said that she actually provided the advice to CFO’s successor (“Successor”). This iteration of Bennett’s story was also false and was undercut by Successor’s testimony that he never received such advice from Bennett or anyone else at Bennett Group.

Good catch. Meanwhile over at the Justice Department, the president of Choice Office Solutions LLC was arrested for wire fraud and aggravated identity theft for, among other things, allegedly producing "a forged authorization letter from the New York Mets purportedly signed by Jeffrey Wilpon" as part of some sort of office-equipment swindle. 

Apple did some things.

Here's a summary. There are like Harry-Potter-style photos on the new iPhone, and you can touch it hard if you want, and there's a new TV product (but not an actual TV, pace Carl Icahn), and there's a giant iPad, and "Hermès is making a new line of bands for the watch." Cool cool. Here's a live blog. Here are analyst reactions. Here is the Internet -- no link, it is all around you -- which probably has more information about yesterday's Apple event. 

People aren't worried about bond market liquidity.

"Corporate bond sales are surging after nearly a three-week hiatus," with about $28 billion of agency and corporate investment-grade U.S. issuance yesterday, and demand was strong. The article dutifully notes that "there are some warning signs," with leverage rising, default rates up a bit, year-to-date returns negative and rates set to rise eventually. But liquidity doesn't even make the list. It may soon be time for this section to go to its well-earned retirement. On the other hand: "The dark side of foreign exchange liquidity."

Me yesterday.

I wrote about Yahoo's Alibaba/Aabaco spinoff, which has hit a tax snag. Here is Victor Fleischer on the "blood bath" that would result if the spinoff goes through and turns out to be taxable.

Things happen.

The Justice Department wants to imprison more nonviolent first-time offenders. Treasurys Trading Is Focus of Probes. Puerto Rico Lays Out 5-Year Plan for Restructuring Its Debts. For China Brokerages, the Market Rescue Hurts More Than It Helps. "Inside a deeply suspect mortgage-relief operation in L.A." The EB-5 visa program leads to a lot of luxury tower construction. Jefferies's upcoming earnings may show what Wall Street would have been like without the Volcker Rule. "We statistically identify institutional investors who persistently report holdings of the most underpriced IPOs." What else is code? Intel to End Sponsorship of Science Talent Search. Order your Big Mac "Derrida-Style." How the High Times Bonghitters Became the Yankees of New York Media Softball. K-Cup soup. Homeopathy conference ends in chaos after delegates take hallucinogenic drug. 

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

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