Insider Trading and Tech Buybacks
When the U.S. Court of Appeals for the Second Circuit ruled in the Newman and Chiasson case last year that people who trade on inside tips have to have known about the corrupt source of those tips to be guilty of insider trading, it threw into doubt a number of convictions other than those of Todd Newman and Anthony Chiasson. They had been convicted of trading on tips from some Dell and Nvidia insiders, but the Second Circuit ruled that those tips were not corruptly obtained -- the insiders had never gotten any personal benefit in exchange for their tips -- and that, even if they had been, no one as far removed from the tips as Newman and Chiasson could possibly have known about it.
This was good news for former SAC Capital portfolio manager Michael Steinberg, who had been convicted of insider trading on essentially the same set of facts as Newman and Chiasson, and whose conviction was obviously going to be reversed. It was also arguably good news for the half-dozen people in the chain between the Dell and Nvidia insiders and Newman/Chiasson/Steinberg. Those people had pled guilty and cooperated with prosecutors, and unlike Newman/Chiasson/Steinberg, they did not have a strong argument that they didn't know what the insiders were up to. But the Second Circuit had ruled that the insiders hadn't done their tipping corruptly, so the whole thing wasn't a crime, so no one should be guilty, plea or no plea. "If there's no crime there, that's a good reason to withdraw your plea," said one of their lawyers.
That was almost a year ago, and I figured that prosecutors would put up a bit of a fight on all of this, but their odds never looked good. And in the intervening months the Supreme Court declined to help them out. So yesterday U.S. Attorney Preet Bharara caved, and "moved to dismiss the charges and convictions of seven people," including Steinberg and six cooperators who had pled guilty. This is not particularly a surprise: Prosecutors clearly wouldn't win an appeal in the Steinberg case, and the "decision to dismiss the pleas of cooperators was consistent with the 'desire that cooperators never do worse than defendants who go to trial.'"
Still it marks the anticlimactic end to the sweeping crackdown on insider trading at hedge funds. Bharara had expanded the law to mean, in essence, that if you worked at a hedge fund and traded on nonpublic information, whatever the source, you ran the risk of going to prison. That theory seems to be dead, and we're back in a world where it's only illegal if you know that you're insider trading.
Yesterday was a big day for all the big tech companies. Amazon announced what seems generally to be referred to as a "surprise" profit, because Amazon's thing has historically been not making a profit. But this quarter it is "bucking a trend that until recently saw nearly every dollar it generated put back into the business," and made $79 million on $25.4 billion of sales. That net income number is in the sixth paragraph of the press release.
Alphabet’s plan to repurchase nearly $5.1 billion of its shares was a surprise. Alphabet has nearly $73 billion in cash and analysts and investors have been pushing the company for years to return some of that to shareholders.
Hahahaha "nearly $5.1 billion," you wish. "The board of directors of Alphabet authorized the company to repurchase up to $5,099,019,513.59 of its Class C capital stock, commencing in the fourth quarter of 2015," and that number is the square root of 26, times a billion. When Google became Alphabet, one big question was whether the reorganization would make it easier for Google/Alphabet/whatever to reinvest its massive profits in human immortality and other moonshot projects, or whether the increased clarity would make it harder to resist Wall Street demands for capital discipline and share buybacks. So this buyback is ... a data point? But, you know, it is not a regular buyback, it is a fun quirky buyback! It's a weird number! The square root of the number of letters in the alphabet! For some reason! To prove that Alphabet isn't all about capital discipline! It's still a place for engineers to have fun! Or at least people who own calculators. One worry about stock buybacks is that if you're doing a buyback it means you are out of other ideas, but what does it mean if you are spending time optimizing the aesthetics of the buyback authorization amount?
Twitter's earnings are next week, but it had its own surprise yesterday, when chief executive officer Jack Dorsey announced (by tweet) that he is giving away about one-third of his Twitter stock ("exactly 1% of the company") to the company's employee equity compensation pool. "His decision to give away shares may increase employee morale after recent staff cuts and help Twitter expand the pool of stock used to compensate employees without dilution." On the other hand, it is kind of weird that Twitter's CEO, who is also the CEO of Square, is reducing his equity stake in Twitter at the same time Square is going public? And it is kind of weird that Twitter is so hard up that it can't afford to issue stock to pay employees, and needs its CEO to chip in personally to pay them? In stock?
Lunch with Bernanke.
Martin Wolf had lunch with Ben Bernanke, and it was good. On the argument that the Fed's program of low interest rates and quantitative easing has increased inequality:
"If people are unhappy with the effects of low interest rates, they should pressure Congress to do more on the fiscal side, and so have a less unbalanced monetary-fiscal policy mix. This is the fourth or fifth argument against quantitative easing after all the other ones have been proven to be wrong. And this is certainly not an argument for the Fed to do nothing and let unemployment stay at 10 per cent."
And on the optimal number of financial crises (not zero!):
"My mentor, Dale Jorgenson [of Harvard], used to say — and Larry Summers used to say this, too — that, ‘If you never miss a plane, you’re spending too much time in airports.’ If you absolutely rule out any possibility of any kind of financial crisis, then probably you’re reducing risk too much, in terms of the growth and innovation in the economy."
That seems like the sort of thing that it's easier to say once you've left office.
What's Greg Smith up to? Well, the guy who wrote a book about why he left Goldman Sachs (derivatives, ping-pong) is now the president of Blooom (sic!), which "uses proprietary technology to assesses average Americans’ readiness for retirement and then helps them improve their asset allocation and reduce their fees." I feel like there are a lot of these demystifying-investing startups, and they all combine good ideas and nonsense in hard-to-evaluate proportions:
In the process, Blooom tries to help workers understand what they have invested and how in plain language. It uses the image of a flower to let them know how they’re doing on their savings — “Is your plant healthy or withered?” is easier to understand than “Do you have adequate, diverse, low-cost investments?” For this service, it charges a flat fee: $1 a month for workers with less than $20,000 and $15 a month for workers with more than that.
The flower stuff is just terrible; all financial metaphors are terrible. But the flat fee for unconflicted advice -- Blooom doesn't manage the money itself -- is kind of nice. "It is a far cry from the derivatives desks on Wall Street," writes Annie Lowrey, but as a former Goldman derivatives salesman myself, I think I see where he's coming from. The thing about selling derivatives is that you are in the business of giving clients complicated advice about how to solve their financial problems, and then selling them the solutions. It is a hopelessly conflicted business: You want to give them the best solution, but you also want to charge them as much as possible, and your fees tend to be baked into the economics of opaque trades rather than being clearly stated up front. Half your job is helping clients navigate complexity; the other half is using complexity to make money off of them. Smith is not the first derivatives salesman to atone for his sins by going into a non-conflicted, transparent-flat-fee-based advisory business. That sort of thing is a magnet for disgruntled derivatives guys who like giving advice but hate hiding the ball.
I don't really know what to think of the Valeant situation though, as I said yesterday, I found Valeant's rebuttal to recent criticisms pretty terrible, on a strictly aesthetic level. The problem is that the interesting criticisms of Valeant's specialty pharmacy relationships are about their opacity, their legal issues, their compliance with insurance and Medicare rules, etc. The Citron Research note was focused on the possibility that the specialty pharmacies were used to accelerate revenue recognition, and Valeant has answered that charge, but that charge does not seem like the really important one? Valeant will hold a conference call on Monday to say more, but Monday is kind of a long time from now.
Meanwhile, here is ProPublica with a further investigation into Valeant's "pharmacy relationships in California," where Philidor, a Valeant-related pharmacy, was denied a license. Here are some analyst reactions, including one downgrade from a longtime bull at BMO Capital Markets who "cannot defend the specialty pharmacy structure." Here is the Wall Street Journal with a profile of Andrew Left of Citron Research. And here is Left on Bloomberg Television, in a bizarrely compelling 22-minute segment that is partly about Valeant but mostly about financial media and how we construct narratives around investing theses.
Elsewhere, Theranos is in a "pause period."
Fortune has a good story about exactly how Uber optimizes its taxes by using multiple Dutch subsidiaries, one of them wholly untaxed, and intellectual-property-licensing arrangements to defer U.S. taxes on most of its income abroad. The story is very clear, and a useful-and-possibly-shocking introduction to international tax structuring for the uninitiated, though I don't think there's anything particularly unusual about Uber's structuring? "Our corporate tax structure is probably the least innovative thing about Uber," says Uber. "It’s the standard approach adopted by most multinational companies." That's true! If you can avoid taxes with IP licensing, you do! And it's not like the Objectivists at Uber are less interested in reducing taxes than the average soulless multinational.
Elsewhere, Nasdaq acquired SecondMarket because, as I keep pointing out, the private markets are the new public markets. And: Magic Leap, the virtual-reality-or-wearables-or-something startup whose CEO once said "you see investment bankers and VCs ... almost crying and having these revelations, like Gandalf is real," "is close to inking a $1 billion financing round." Like, $1 billion of financing (at a $4.5 billion valuation), not a $1 billion valuation. And: Startup founder sends rude note to venture capitalist, but by snail mail? That is what Yik Yak is for, come on. And: "Investors' honeymoon with unicorns of Silicon Valley coming to an end," though they'll always cherish the memories of their honeymoon, with unicorns. And: Day-trading Uber driver.
Here is Anna Gelpern on "A Flash of Federal Ambition" for Puerto Rico, whose finances are a mess that will not be easy to sort out even with federal help:
The insanely convoluted debt structure includes bonds whose priority repayment is guaranteed by Puerto Rico's constitution, bonds governed by New York law, bonds secured by sales tax revenue routed to the creditors by statute, bonds secured by other revenue pledges that could be more easily diverted, and bonds payable if the legislature appropriates the money. There are also pensions and other government obligations to its citizens, which have their own constituencies and protections. It seems like three-quarters of the creditors believe they are senior to someone, like the above-average children of Lake Wobegon.
Puerto Rico's bond investors are not loving the Obama administration proposal to give "the commonwealth unprecedented authority to restructure its entire debt burden through bankruptcy protection." A Senate panel was unimpressed too.
Meanwhile in actual-sovereign default, "Argentine Front-Runner for President Is Expected to Resolve Standoff With U.S. Hedge Funds." And: "Was This Hedge Fund Billionaire's Epic Argentina Clash Worth It?"
People are worried about the debt ceiling.
Here's a story about the struggles of the House Republicans to pass any sort of debt-ceiling increase bill, even one that would include "large cuts to spending on social safety-net programs" and "force a vote on a balanced-budget pact and freeze all new federal regulations through July 1, 2017." Here is Barclays on investor worries about short-end Treasuries. Here is Pimco worrying about the debt ceiling. Here is me saying: Debita impendiorum maximorum vendenda sunt.
People are worried about bond market liquidity.
So they are particularly bummed that Credit Suisse "shook Europe’s bond markets by deciding to drop its role as a primary dealer across the continent":
“This is a dramatic move for Credit Suisse, and a step back for bond-market liquidity,” said Christopher Wheeler, an analyst at Atlantic Equities LLP in London. “This is probably designed to reduce costs and capital tied to its investment bank business. I hope it’s not a shape of things to come for the bond market.”
It is, in fact, very difficult to know whether liquidity conditions are deteriorating in bond markets. Standard measures, such as bid-ask spreads, are of little help because historically narrow bid-ask spreads can widen suddenly in a liquidity event. Some commentators have pointed to the post-financial-crisis behavior of the 22 primary dealers, who play an important role as market makers for bonds. In fact, primary dealer inventories in corporate bonds have declined from over $250 billion in 2007 to about $50 billion in 2015. Since 2007, the supply of U.S. corporate bonds has increased from about $3.2 trillion to almost $5.0 trillion (see graph above), so that the dealer inventory relative to outstanding debt has dropped precipitously. Moreover, prior to 2007, dealers were net long in corporate bonds and net short in U.S. Treasuries. Dealers are now net long in Treasuries. This, together with their reduced holdings of corporate securities, suggests that dealers’ willingness and/or ability to take on risk has diminished greatly since 2008.
Deutsche Bank May Slash Bonuses by Almost One-Third. Large Money Managers Suffer Bruising Quarter. New Rule Adds a Layer of Protection to Swaps Trades. Draghi's Signal Adds $190 Billion to Negative-Yield Universe. Inside Swiss Banks’ Tax-Cheating Machinery. No Honeymoon Likely for SEC Chair, New Commissioners. Credit Suisse, Barclays Could Pay up to $150 Million to Settle ‘Dark Pool’ Claims. Important charts. Predatory Management Buyouts. Sexy Pizza Rat. Pet trusts. House Fund. Deep voices. Big meat. Golf ban. Sky bridge. Wicked Bible. "If You Feel Left Out at Work, Visualize Money."
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