Bonuses, Discounts and Taxes

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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Bonuses and ethics.

A fairly straightforward idea in executive compensation is that you should pay your chief executive officer well for good performance, and less well for bad performance. If things are terrible, he probably shouldn't get a bonus. In practice, though, if things are terrible, he's probably all that's keeping them from getting even worse, and you probably want to give him a bonus. Then it is up to him, as a show of exemplary morality, to renounce the bonus.

Weirdly that's a trend in banking. Richard Handler at Jefferies, Antony Jenkins at Barclays, and Stephen Hester and Ross McEwan at Royal bank of Scotland have all handed back bonuses, and now Tidjane Thiam of Credit Suisse has announced that he has "asked the board of directors for a significant reduction in my bonus." It feels like the next evolution in holding bankers personally responsible for their actions: They shouldn't just be penalized financially if things go wrong, they should volunteer themselves for those financial penalties. That's how you know the culture has changed. 

Elsewhere, Gretchen Morgenson writes about how to encourage better banker behavior. And: "Quaker bankers: building trust on the basis of sincerity, reciprocity and charity." And did you know that risk-weighted capital regulation of banks was invented in Germany in the 1930s?

Discounts.

Here is a BuzzFeed article by Sapna Maheshwari about lawsuits against retailers who have too many sales:

In the J.C. Penney case, filed in 2012, a consumer named Cynthia Spann allegedly believed she was saving 40% to 50% on a bunch of $14.99 and $17.99 blouses made for J.C. Penney with an “original” price of $30. Spann claimed she wouldn’t have bought the blouses if she didn’t believe she was getting a deal, and argued $30 wasn’t their “prevailing market price” in the 90 days before her purchase.

So she sued J.C. Penney for ... like ... $15? No, of course not, she's the named plaintiff for a class action lawsuit brought by plaintiffs' lawyers. J.C. Penney agreed to settle for $50 million, and the lawyers are asking for $13.5 million of that. There is an obvious ridiculousness to the lawsuit: The blouses were advertised at $14.99 or whatever, she thought $14.99 was a fair price, she paid $14.99, she got the blouses. What is the problem? But you can see her point. That $30 "original" price was (allegedly) a lie. And if J.C. Penney didn't think that that $30 "original" price would be material to her shopping decision, why advertise it?

It all reminds me of Jesse Litvak, the former Jefferies bond salesman who sold customers residential mortgage-backed securities by telling them imaginary little stories about how much he'd paid for the bonds. At his fraud trial, Litvak didn't argue that the stories were true. Instead, he argued that they didn't matter, because (1) the customer was buying the bonds at a price the customer thought was fair, independent of Litvak's stories, and (2) nobody believes anything bond salesmen say anyway. 

Those are pretty much the retailers' defenses too:

“Let’s say I see a sweater that I really like and it says it’s $40 and it has a ‘compare at’ price — or ‘former’ price or ‘previously listed at,’ or whatever language you want to pick — saying it was $75,” said Stephanie Sheridan, a partner at Sedgwick and the head of its retail practice group. “At the end of the day, the consumer is making a voluntary decision to part with $40 of their money for the purpose of buying that sweater. There is an argument, too, that to you, you’ve decided that sweater is worth that amount.”

And:

The lawyers went on to cite research presented by the shoppers’ side, saying it supported Kohl’s position because “it shows that consumers often do not believe the ‘regular’ price and therefore would not be deceived by a false ‘regular’ price.”

Obviously there are differences. (You're probably not reselling the blouses, so knowing the prevailing market price is less material to your decision than it is to a bond investor's.) Still, I think a lot about Bernie Sanders's maxim that "the business model of Wall Street is fraud." The business model of sales is ... you know ... this sort of stuff. There's just a lot of salesmanship on Wall Street. 

The Vanguard tax thing.

We've talked before about the Vanguard tax thing, in which a former Vanguard tax lawyer and purported whistleblower claims that Vanguard should have been charging its investors higher fees and paying taxes on those fees. The idea is that Vanguard's taxable investment advisor is selling its services to Vanguard's non-taxable mutually-owned funds at cost, while it should be selling them at market prices that include a profit margin. It seems crazy, but no one really thinks that it's wrong. Jeff Sommer at the New York Times examined the conflict this weekend, and quoted the whistleblower:

Mr. Danon has a conflict: Now unemployed, he could receive a whistle-blower’s bonus of up to 30 percent of any funds collected by the I.R.S. in the claim. But he says he is fighting for a principle: “I felt I had to become a whistle-blower because I believe I’m right, and the law is the law, and I couldn’t convince anyone at Vanguard about it.”

Hmm. (I, like Sommer and many other people, have my own conflict, which is that I'm a Vanguard investor, so I stand to lose some money if Vanguard changes its model. Danon stands to make billions.) The weird part is that Vanguard's "average expense ratio is only 0.16 percent annually," but if it loses that "could raise average annual mutual fund shareholder fees by no more than 0.09 percentage point." So the at-cost price is 16 basis points, but the market price is 25? So the "right," arm's-length, market profit margin for an investment adviser is 56 percent?

Hedge funds.

On Friday, I wrote about a possible conflict at the top of Bridgewater Associates. That conflict seems to have been resolved with baffling inefficiency:

The company’s equity holders were then asked to review a series of recordings — about eight hours’ worth — to decide on the dispute. Stakeholders in the investment firm voted on, and resolved, the matter.

I mean, not baffling if you buy my mostly-joking model that Bridgewater is run by a computer that sets the human employees tasks to distract them from meddling with the investment process. Making all the senior employees listen to eight hours of tape to vote on what was said on the tape: quite a distraction! In any case, Greg Jensen, Bridgewater's co-chief executive officer, co-chief investment officer, and heir apparent to founder Ray Dalio, "is to step back from his current role as co-chief executive" and focus more on the investing side. Dalio once described Jensen as "in possession of the best package of character attributes I have seen in any human being," which is not how humans talk.

In other hedge-fund news, "BlueCrest Capital Management is being investigated by a U.S. regulator over possible conflicts posed by an internal fund that manages money for the firm’s partners," which can't be a huge surprise. We talked about that internal fund back in December, when I called it "not the best of all possible looks," insofar as the employee fund was up about 60 percent in three years, versus about nothing for the regular fund. That is the sort of discrepancy that attracts attention from the Securities and Exchange Commission.

Elsewhere, "Credit Suisse Asset Management plans to cherry pick profitable concepts from hedge funds with the launch in Europe of a 'best ideas' strategy." Last year was one of the worst years to invest in the best-performing asset classes. And Lynn Tilton's "Patriarch Partners LLC is stepping down from its role as collateral manager at the investment funds that feed liquidity to her portfolio of troubled companies."

Market structure.

Here is the sad story of foreign exchange traders who are being replaced by computers:

“The business has to be downsized,” said Keith Underwood, a foreign-exchange consultant who ended a 25-year trading career, including at Lloyds Banking Group Plc, in 2014. But it’s not easy “for people who have been in a market for many, many years to see that they’ve been replaced by an algorithm.”

At least it's happening now, while the multibillion-dollar fines for FX rigging by human traders in chat rooms with names like "The Cartel" are fresh in everyone's minds. In equities, it is popular to say that the markets are rigged because of all the algorithms, but the FX market knows what real rigging looks like. Elsewhere, the Chongqing Casin Enterprise Group of China is buying the Chicago Stock Exchange, which Bloomberg Gadfly's Gillian Tan says is "not that big of a deal." And after some dark-pool troubles, Investment Technology Group Inc. has "made progress in rebuilding trust and was on the cusp of a strategic review that will result in a narrower focus on its core brokerage business."

Insider trading.

Nothing here is ever legal advice, and I want to be particularly careful not to give illegal advice. The law of insider trading is unsettled, and my vague sense of where it will shake out is that obvious intentional cheating will continue to be criminal while gray-area hedge-fund research will be more protected. Still, when the Securities and Exchange Commission and the Justice Department bring charges against a corporate vice president of tax for allegedly insider trading in his own company's stock, in his own Charles Schwab account, on the basis of not-yet-released quarterly earnings numbers, I think: At least give that information to your brother-in-law, you know? At least create some sort of issue, some argument that you didn't get a personal benefit from the trading, to help out your defense. I guess that doesn't help much if you need the money.

Shkreli, etc.

I found myself getting annoyed at Congress last week for yelling at Martin Shkreli instead of trying to improve the system of drug pricing. At the New Yorker, Kelefa Sanneh is eloquently annoyed:

Even so, Cummings acted as if Shkreli were the only thing preventing a broken system from being fixed. “I know you’re smiling, but I’m very serious, sir,” he said. “The way I see it, you can go down in history as the poster boy for greedy drug-company executives, or you can change the system—yeah, you.” Cummings has been in Congress since 1996, and he is a firm believer in the power of government to improve industry through regulation. And yet now he was begging the former C.E.O. of a relatively minor pharmaceutical company to “change the system”? It seemed like an act of abdication.

And at Bloomberg Gadfly, Max Nisen writes that "Congress seemed more interested in a bit of righteous on-camera yelling -- and revealing some remarkable ignorance about the health care system -- than in root causes." 

In other health-care news, "the Justice Department is investigating what authorities suspect is half a billion dollars in health-care fraud linked to specialty creams used to treat pain and other ailments," including one hawked by Brett Favre.

What time is the financial crisis?

I wrote last week about how all the Super Bowl financial-services advertisements might just be a sign of a top, and particularly how the ad for Quicken Loans Rocket Mortgage -- "you could get a mortgage, on your phone" -- looked like a sequel to "The Big Short," with its focus on economic growth driven by leveraged housing investment. Well, the Super Bowl happened, and the "Big Short" comparisons were popular. I tend to be in the history-doesn't-repeat-itself-but-it-often-rhymes school of thought, though, and that Rocket Mortgage ad is a little too on-the-nose to worry about. The next financial crisis won't be a precise repeat of the last one except on phones.

On the other hand, the SoFi ad, in which a disembodied voice follows people around as they go about their business, declaring whether or not they are "great" (i.e., can get access to credit), strikes me as everything people worry about in algorithmic peer-to-peer lending. Elsewhere: "The Rich Are Already Using Robo-Advisers, and That Scares Banks."

People are worried about unicorns.

Honest Co., the Honest Unicorn co-founded by Jessica Alba, "is working with Goldman Sachs Group Inc. and Morgan Stanley on an initial public offering," and people are worried:

The recent rocky market for tech IPOs will be a factor in when Honest Co. decides to go public, said one of the people, who requested not to be named because the plans are private.

I don't really understand what makes Honest Co. a tech company, but with a $1.7 billion valuation and investors including Fidelity and Wellington, I think it is enough of a unicorn for our purposes.

People are worried about stock buybacks.

Not at private equity firms, though: "The world’s largest private equity companies are coming under increasing pressure to buy back their own listed shares after the downturn in both the credit and stock markets hit the value of their portfolios." I suppose at a private equity firm everyone is pretty much on the same page about capital structure optimization, and it's not like the money would otherwise be spent on capital expenditure or research and development. Elsewhere: "After a tough end to 2015, big companies are starting the new year with a tight rein on capital spending, and in some cases layoffs, as they seek to cope with sluggish industrial demand and uncertainties about the continued resilience of the American consumer."

People are worried about bond market liquidity.

I kind of thought they'd stopped, but oh no, the New York Fed's Liberty Street Economics blog announced today that it "will publish ten blog posts that illuminate how market liquidity has evolved since the financial crisis." The announcement is titled "Continuing the Conversation on Liquidity," and if you have occasionally dreamed about ending that conversation, this is not your week. (Neither is next week.) Today's installment is "Has MBS Market Liquidity Deteriorated?" (meaning agency mortgage-backed securities), and the evidence is, of course, mixed:

Some measures of agency MBS trading activity, such as trade size, trading volume, and the turnover rate, indicate a decline in market liquidity. Analysts attribute this trend to myriad factors, including increased regulation, which has made it more costly for financial institutions to take on risk; a rise in agency MBS ownership among buy-and-hold investors; and a decline in issuance. However, measures of transaction costs and price impact suggest that liquidity conditions have been relatively stable since 2011. It will be interesting to monitor liquidity conditions in this market as monetary policy is normalized, especially given the planned introduction of a single security designed to improve liquidity.

And here is a story about hedge funds who are betting against investment-grade bonds

Things happen.

China’s Forex Reserves Plunge to More-Than-Three-Year Low. Shipowners in financial distress as dry bulk crisis deepens. Tim Geithner, who once loaned JPMorgan $25 billion, is borrowing from JPMorgan to invest in Warburg Pincus funds. "The marginal utility of consumption is unlikely to be correlated with the outcomes of sporting events, so we can test some propositions of finance theory without having to worry much about those risk factors." Asness on Fama on momentum. 2015 Year-End Activism Update. Ponzi Scheme in China Gained Credibility From State Media. Bernie Madoff Sleuth Harry Markopolos Warns of 3 New Ponzi Scams. Why Is the U.S. Still Sitting on $4 Billion in Madoff Money? Thicket of London towers brings down criticism on developers. "I picked over parts of Newsweek and Time and Harvard magazine and reread them while I ate about a dozen leftover fish sticks. (Cold.)" Rage roomLehman Brothers Scotch has "a contrite, bereft peatiness."

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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:
James Greiff at jgreiff@bloomberg.net