Money Stuff

Forbidden Activists and Closet Indexers

Also BDCs, GSEs, taxes and bitcoins. And swap spreads.


There is a standard list of shareholder rights that you expect at public corporations. Free transferability of shares, shareholder democracy with one vote per share, fiduciary duties of management to investors, that sort of thing. That list has evolved as a pretty good general default for how to run a company, but one thing that has happened in recent years is that it has become more optional, and companies have experimented with, say, multi-class share structures or reduced fiduciary duties or just raising many billions of dollars without going public. And I generally think that's fine. If an entrepreneur wants to sell low-vote stock to people, and people want to buy it, who am I to complain. Or if a company wants to go public with protections against shareholder activism, or limits on who can buy its stock, well, that's the sort of thing that investors should be able to price and deal with.

But this is a little weird:

When Concordia Healthcare Corp. agreed to issue a 14 percent stake to a private equity firm, the Canadian drug manufacturer tucked into the deal several layers of protection from shareholder activists.

The agreement in October bars the buyout firm, Cinven, from transferring or reselling its Concordia shares to a list of almost 60 activist firms, including those run by Bill Ackman, Carl Icahn, and Dan Loeb, according to a regulatory filing. To make sure it didn’t miss anyone, Concordia also blocked Cinven from transferring its shares to anyone on the SharkWatch 50, a roster of the largest activists compiled by FactSet Research Systems Inc.

You can make a case that banning activists protects the company (against short-term pressures and disruptions), though many people would say that it mostly protects management (against shareholder scrutiny). But here no one is really making the case either way. When Facebook went public with a charter that limited public shareholders' voting rights, Mark Zuckerberg was free to argue that it was good for the company rather than just good for him. And investors could decide whether or not to buy. But when management of an already public company  negotiates a deal with a single new investor, and places a large friendly block of stock with that investor with a guarantee that it can't be sold to activists, it does feel like shareholders are a bit cut out of the loop. "A restriction on who can buy the stock really just smacks of retrenchment by the management team and the board," says an activist, and he is not entirely wrong.

Closet indexing.

Here is a fascinating article, and a related study, about closet indexing, in which an investment manager just closely tracks her index but charges big active-management fees. In some parts of the world -- especially Sweden and Poland, but also Canada, Finland and Spain -- this seems to be particularly prevalent. The article focuses on scandal and regulation; here's "Carl Rosen, chief executive of the Swedish Shareholders Association":

It should be easy to get rid of this gigantic mis-selling phenomenon. [Regulators should] ban all active funds that charge more than 0.8 per cent in fees, have a tracking error of below 4 per cent and an active share [a measure of how closely a fund follows its benchmark] of below 40 per cent.

Sure. More interesting to me are the study's findings that "actively managed funds are more active and charge lower fees when they face more competitive pressure from low-cost explicitly indexed funds," and that "the average alpha generated by active management is higher in countries with more explicit indexing and lower in countries with more closet indexing." 

Non-traded BDCs.

Here is a very, very crazy Bloomberg story about a Massachusetts Securities Division complaint against Realty Capital Securities LLC. (Here is the complaint.) The story is about a business development company called Business Development Corporation of America, which was marketed to investors by a broker-dealer named Realty Capital Securities, both of which were part of the network of American Realty Capital, a sponsor of non-traded real estate investment trusts controlled by Nicholas Schorsch. BDCA had a special meeting of shareholders to vote on matters relating to a proposed deal with Apollo Global Management. RCS served as proxy solicitor for that meeting, in charge of getting BDCA shareholders to vote with management. RCS's proxy solicitation techniques were ... unconventional. From Bloomberg:

To lock in the vote, employees of a Boston-based company also linked to Schorsch -- Realty Capital Securities LLC, a subsidiary of RCS Capital -- fabricated proxy votes, the complaint alleged. Posing as shareholders, the employees at times adopted “contrived” accents to fool a proxy company into accepting the votes, it said.

As in, like, two RCS employees would call together, and one would pretend to be the shareholder, and pretend not to speak English so, I guess, he wouldn't be asked too many questions? You are not supposed to do that. The complaint quotes one RCS employee:

I'm not really sure what it is, but, I mean, it was almost sort of indentured servitude to the point where, you know, these -- you know, I ... would just say, "No, I'm not coming in Saturday. I'm not coming in Sunday," but these other poor kids would just -- you know, 22-year-olds would just be forced to come in and work Saturdays and Sundays and just have no summer. You know, I don't know -- I don't know if they all cracked or if they couldn't get it done so they were told to just do it this way.

This is terrible and ridiculous, but let's not lose sight of the bigger picture. "According to the BDCA Prospectus," says the complaint, "an investment in BDCA included fees as high as seven percent to soliciting broker-dealers and fees as high as three percent to RCS." Ten percent fees! That's worse than the vote stuff.

Fundamental laws of tax.

My tax professor in law school was Michael Graetz, and he taught me the two fundamental laws of tax, which are, first, that it is always better to make more money than less money, and second, that it is always better to die later than sooner. Here is Josh Barro on Carly Fiorina's plan for a three-page tax code, which, like all presidential-election-related tax proposals, is ridiculous. But Fiorina's has the special distinction of repealing the first fundamental law of tax:

”The minute it’s passed, I’m going to call my dean and tell her to pay me only in goods,” said Michael J. Graetz, a tax professor at Columbia Law School. “Buy me a house, buy me some groceries every week, buy me meals.” That’s because the three-page plan avoids complex rules about fringe benefits by saying noncash compensation is tax-free.

Fannie and Freddie.

Here are three things that I think I think:

  1. The government's effective nationalization of Fannie Mae and Freddie Mac in August 2012, when they were returning to profitability, was unfair.
  2. This is not, in the grand scheme of things, something to get especially worked up about.
  3. In particular, it is not the sort of winning public-opinion issue that will force the government to return Fannie Mae and Freddie Mac to the hedge funds and others who own its now-mostly-worthless shares.

I could be wrong about any or all of these things, but in any case no one else seems to hold all of those opinions at the same time. Here is Roger Parloff at Fortune, who seems to be a #1 kind of guy.


Here is Bloomberg's Zeke Faux on bitcoin's continued association with hacking, drug dealing and Ponzi scheming, including "an online pyramid scheme that’s promising returns as high as 100 percent a month" founded by Sergei Mavrodi:

His latest pitch: convert your bitcoins to another online currency called mavros and see your account balance grow. “The financial apocalypse is inevitable,” he said in a video posted on Nov. 8. “Together we change the world!” 

Super. "Scammers seem to be the biggest bitcoin users partly because of the volatility: Few others are ready to conduct their business in a currency that can lose a quarter of its value overnight," says Faux. Elsewhere, probable bitcoin inventor Nick Szabo gave a presentation at an "Ethereum" (crypto-smart-contract-whatever) conference in London. The presentation featured Ayn Rand and Friedrich Hayek on the same slide, and also this:

The logic is that "wet code" (as he describes traditional law) has huge drawbacks: It's vague, expensive, varies from jurisdiction to jurisdiction, and is "based ultimately on the threat of coercion." But "dry code" — AKA computer code and Ethereum — has none of these problems. It's precise as only computer code can be, cheap to deploy after initial outlays, is universally constant, and its security is based on the blockchain.

People are worried about swap spreads.

"Debt Market Distortions Go Global as Nothing Makes Sense Anymore" is the headline here, but the thing about negative swap spreads is that they are weird without obviously being scary. Bond market illiquidity might cause a big market crash, and stock buybacks might cause the death of capitalism or whatever, but I feel like negative swap spreads mostly cause people to be, like, huh, swap spreads are negative, how 'bout that. "Everybody in the fixed-income market should care about this," says an interest-rate strategist, though.

People are worried about stock buybacks.

Here is Bloomberg View's Justin Fox making the point that it's pretty cheap to start a new tech company. Three of the five biggest shareholder payouts in 2014 came from tech companies (the other two were oil companies). If your model of stock buybacks is that big companies give money back to investors and the investors invest it in new ideas, the point here is that the investors can invest less in new ideas, because it's getting cheaper to commercialize new ideas. (Because of tech!) So perhaps you shouldn't worry about stock buybacks.

People are worried about bond market liquidity.

One somewhat counterintuitive bond-market-liquidity worry is that trade reporting can cause illiquidity: If I sell you a big lot of bonds, and we tell everyone how many bonds I sold you and at what price, then everyone knows that you have a lot of bonds to get rid of and is less likely to buy them from you at a high price. So there is an argument that delaying the public reporting of large trades will improve liquidity. There is a counter-argument that more transparent markets are fairer and more trustworthy, which perhaps improves liquidity but which is in any case a regulatory good in itself. Like, whatever the right answer is on the liquidity point, it is hard to imagine U.S. securities regulators deciding that markets need less transparency. Anyway, "The world’s biggest corporate-bond investors are coming up short in persuading regulators to loosen trade disclosure rules, a measure they have argued is key to easing the market’s liquidity woes."

Elsewhere, "Senior MP warns Bank of England on bond market liquidity" is the headline here, and I have to say that it makes me a bit envious. In the U.S., our politicians mostly worry about stock buybacks.

People are worried about FX market liquidity.

I mean, why not.

Things happen.

Stock Traders Reap Promotions and Pay as Bond Brethren Laid Low. Europe’s Small Banks Brace for Bonus Rules. Marriott Buying Starwood in Deal Valued at $12.2 Billion. On Capitol Hill, Another Banking Battle Brews. Efforts to Rein In Arbitration Come Under Well-Financed Attack. Clinton's Wall Street Donors Say More Than 9/11 Built Their Bond. After Outcry, Ireland Adjusts Its Corporate Tax Draw. China Bond Investors Bet on Bailout. What to Do with All the Business Cards from Your Last Conference. "Qu’elle est belle, la devise de Paris." David Brooks did a stunt. Journalists are smarter than CEOs. (Counterpoint.) Hello, Gadfly. Kangaroo detector. Flavortown wine.

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    Matt Levine at

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