Shells, Inversions and Speed Chess

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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Panamania.

I have to say I am a bit sympathetic to the argument of Ramon Fonseca, of Mossack Fonseca, who said in an interview not only that his Panamanian law firm has done nothing wrong in setting up offshore companies for wealthy people, but also that it "has fallen victim to 'an international campaign against privacy.'" I mean, I was sympathetic to Apple in the iPhone hacking case, too, and it seems to me that setting up an offshore shell company is a little like strong encryption, but for your financial affairs. It's certainly possible that you are doing bad stuff with your offshore shell company -- as it is certainly possible that you are doing bad stuff with your encrypted iPhone -- and it might be good if governments and reporters could crack that encryption. But then again, if you care about your privacy, you might prefer it if they couldn't. Or, as Pakistani Information Minister Pervez Rasheed put it in discussing the prime minister's family's alleged offshore companies:

"Every man has the right to do what he wants with his assets, to throw them in the sea, to sell them, or to establish a trust for them. There is no crime in this in Pakistani law or in international law," Rasheed said.

If the Panama Papers leak really does lead to a crackdown on offshore companies, perhaps undersea companies will be the next frontier. 

Meanwhile, Bloomberg's Blake Schmidt interviewed Fonseca and his partner Jurgen Mossack last week, and honestly they sound delightful? Here is Fonseca's story:

He boasts that his friends have labeled him “a da Vinci man” for his interests in politics, law, business, letters and philanthropy. He’s penned a half-dozen novels over the years, and for a while as a young man had considered becoming a priest.

It was during his time as a bureaucrat at the United Nations in Geneva, where he was surrounded by international lawyers, that Fonseca said he was lured by the mysterious world of offshore businesses. “One day it occurred to me that I could do it too,” he said. “I created my little office and left the UN and started with one secretary to create and sell companies.” He’d join up with Mossack soon thereafter.

I realize that a lot of children grow up idolizing pop stars or basketball players or the President, and a few of them eventually achieve the dream of becoming their heroes. But my favorite stories are the ones of quieter inspiration, where U.N. bureaucrats are seduced by the mysteries of international tax law and eventually achieve the dream of creating and selling offshore companies themselves.

Elsewhere in Panama Papers, I was pleased to see some healthy skepticism about claims that they are "history's biggest data leak," which is apparently measured by metrics -- like file size and numbers of documents -- that don't even really quantify the amount of information leaked, never mind its explosiveness. It seems to me that one Abu Ghraib photo is bigger, in its way, than a terabyte of scanned LLC agreements of celebrities who want to conceal their ownership of Manhattan apartments. But here is a Wired story about "How Reporters Pulled Off the Panama Papers, the Biggest Leak in Whistleblower History," that goes heavy on the terabytes:

“How much data are we talking about?” Obermayer asked.

“More than you have ever seen,” the source responded, according to Obermayer.

I hope that dialogue ends up in the movie.

Elsewhere, it seems somehow fitting that the one U.S. person so far named in connection with the Panama Papers is a "financial writer and life coach." And here is an article about Brazilian senator Delcídio do Amaral's "accounts of colossal bribes, back-room oil deals and desperate cover-ups" in the Petrobras scandal.

Inversions.

The Treasury Department announced new rules relating to tax inversions yesterday, and as tax analyst Robert Willens put it, "They’re pretty much taking all of the juice out of inversions." The biggest juicing involves earnings stripping:

The Treasury Department also took aim at another feature of these so-called corporate inversion transactions: complicated internal loans that effectively move profits of United States-based businesses overseas. This tactic, known as earnings stripping, involves the American subsidiary borrowing from the parent company and using the interest payments on the loans to offset earnings — a cost that is not reflected on financial statements but lowers the tax bill.

Monday’s rules classify this intra-company transaction as if it were stock-based instead of debt, eliminating the interest deduction for the American subsidiary.

It is worth distinguishing two reasons for tax inversions. One reason is just that the U.S. has a relatively high corporate tax rate on worldwide income earned by U.S. corporations, which creates an incentive for international companies not to be located in the U.S. This will pretty much always be true as long as the U.S. taxes worldwide income this way (and as long as other countries don't); even if you ban "inversions," foreign companies will still have an advantage in acquiring U.S. ones for just this reason.

The other reason to invert is because inverted companies can structure their U.S. income to avoid paying U.S. income taxes, by creating a lot of deductible expenses (interest, licensing payments) that are paid to subsidiaries abroad. That is more or less gamesmanship, and is more or less solvable by rules. The solutions are difficult, but Treasury seems to be pretty serious about finding them.

Spoofing and speed chess.

I would say that a good general rule of thumb is that when someone tells you that he "has exceptional reasoning skills -- in the 99th percentile," you probably should stop listening to the rest of what he has to say. That goes double if it's his lawyers telling you that. But I have a soft spot in my heart for Igor Oystacher, who has been accused of spoofing in the futures market by the Commodity Futures Trading Commission, just because I find the CFTC's case against him strangely unconvincing. On the other hand, the CFTC's best argument is just that Oystacher put in a lot of orders where he changed his mind half a second later, and that is a really short time in which to change your mind -- unless he was just spoofing and never really meant the first order to execute. Oystacher's responses so far have been along the lines of "If we click quicker than most, it is a skill," which, like, sure, I don't know. But now his lawyers have fleshed that argument out a bit, and it is a joy:

Outlining his defense for the first time in an April 1 court filing, lawyers said that Oystacher, a competitive speed chess player, has exceptional reaction-time skills and a customized computer mouse that make him faster than most humans at executing trades.

If he clicks quicker than most, it is a skill (honed by speed chess), but it is also a special mouse. The perfect combination of man and technology. I love it.

Speaking of changing your mind quickly.

Here's a story about Southwestern Energy, which "disclosed that it drew $1.55 billion on its credit agreement on March 30, only to repay the full balance two days later." Guess what happened on March 31? That's right, the first quarter ended, and Southwestern calculated its balance sheet for the end of the quarter -- a balance sheet that had $1.55 billion more cash than it did the previous day. Also $1.55 billion more debt, but "having the cash on its balance sheet on the last day of the first quarter increases the amount of secured debt that it can borrow in the second quarter, per its indentures and credit facilities," by about $232 million. 

People get mad about the weirdest things in finance. Like this is in some ways a story of Southwestern pulling a fast one -- literally! -- on its lenders. But not really. It's all disclosed. It's not dishonest, or trickery. It is, I think it is fair to say, gamesmanship: It is using a literal reading of the rules (here, the debt contracts) to get a result that Southwestern likes but that is perhaps a little counterintuitive, that maybe even violates the spirit of those rules in some way. But of course debt contracts don't have spirits. They just say what you can and can't do, and if you can do it, you can do it. There is no further appeal to spirit or generosity or patriotism to block you from doing what you're otherwise allowed to do. This trade is fine, a non-event; Southwestern's creditors will, I assume, shrug and say "yeah, you got us." But there are plenty of other scenarios where companies do what they are allowed to do under a literal reading of the rules, and nonetheless get in trouble for it. (Tax inversions, and offshore shell companies, perhaps come to mind.) And if you're used to doing this sort of literal gamesmanship, it can be hard to stop when it's no longer appropriate.

The Brothers Meyohas.

When last we talked about Sarah Meyohas, the financial artist who manipulated some micro-cap stocks (but for Art!), she had lost her Charles Schwab account for, you know, doing that. But not everyone in the Meyohas family trades retail: Sarah's brothers, Marc and Nathaniel Meyohas, "two little-known financiers who hope to revive the 'British Steel' name," run a private equity firm called Greybull, and are looking to "buy the Scunthorpe steelworks from Tata, pumping £400m into the struggling plant and saving a total of around 9,000 local jobs." (Also: "The wealthy brothers' father made his fortune in the private equity industry in the United States.") In my imagination, they are a whole family of finance artists, and once they acquire the steel plant they will cover it in elaborate murals and earthwork art, and will use it to fabricate complicated sculptural allegories for the ravages of global financial capitalism. (Their sister is on the same page, and e-mailed me: "large scale sculpture if you ask me!") But realistically they're probably just buying it to make money

Bill Gross.

I have previously expressed skepticism about Bill Gross's lawsuit against Pimco claiming that it fired him in breach of his employment contract, because "(1) Pimco didn't fire him, he quit, and (2) he didn't have an employment contract." But a California judge did not share my skepticism and allowed Gross's suit to go forward, and now Pimco has filed a response arguing that Gross knew he'd lose his bonus if he quit, and quit anyway, leaving "a handwritten resignation note the next morning." 

The filing has some amazing exhibits, including the resignation note itself, as well as Gross's alleged notes of a phone conversation with Reuters reporter Jennifer Ablan ("what he claimed were contemporaneous handwritten notes of his phone call with Ms. Ablan, taken in his car while he was pulled over on the side of the 405 freeway," as Pimco's lawyers put it), in which Gross told Ablan that former Pimco Chief Executive Officer (and Bloomberg View contributor) Mohamed El-Erian was undermining him, and that El-Erian had Ablan "wrapped around his little finger like everyone else."

Star analysts.

I have written before about two models of sell-side equity research. In one, the job of a research analyst is to know what stocks will go up, and tell her clients. In the other, the job of the analyst is to get her clients access to corporate managers, and her research reports are more or less beside the point. I am biased toward the second model, but of course they can coexist, and probably the real world reflects a mix of both. For instance, you could easily believe that some analysts are good at predicting which stocks will go up, and so investors care very much about their actual Buy and Sell recommendations; other analysts are mostly there for the access. Anyway here's a summary of a study finding that "a downgrade by a star analyst causes tremendous valuation changes, which are not offset by the CEO's reputation," unlike downgrades by non-star analysts.

Bitcoins and blockchains.

Here is a Bank of Canada Staff Working Paper that certain segments of the Money Stuff audience may enjoy:

This paper imagines a world in which countries are on the Bitcoin standard, a monetary system in which all media of exchange are Bitcoin or are backed by it. The paper explores the similarities and differences between the Bitcoin standard and the gold standard and describes the media of exchange that would exist under the Bitcoin standard. Because the Bitcoin standard would closely resemble the gold standard, the paper explores the lessons about how it would perform by examining the classical gold standard period, specifically 1880–1913. The paper argues that because there would be virtually no arbitrage costs for international transactions, countries could not follow independent interest rate policies under the Bitcoin standard. However, central banks would still have some limited ability to act as lenders of last resort. Based on the experience during the classical gold standard period, the paper conjectures that there would be mild deflation and constant exchange rates under the Bitcoin standard. The paper also conjectures how long the Bitcoin standard might last if it were to come into existence

It's mostly about macroeconomics, though; someone should really write a more sociologically oriented paper about a world in which countries are on the bitcoin standard. How did we get there? What else has changed? Elsewhere: "Microsoft and R3 Partnership to Accelerate Adoption of Distributed Ledger Technologies by Global Banks."

People are worried about unicorns.

I joked the other day that one day ambitious parents will worry more about their children's startup incubator applications than about their college applications, but you can more or less combine the two by applying to Minerva, "a San Francisco start-up aiming to offer an Ivy League-level education at half the cost of elite US colleges" that "has accepted a smaller fraction of its applicants than Harvard or Yale in its third year of operation." Minerva, which has $70 million in venture capital funding, took 306 students, who will "move between California, Berlin, Buenos Aires, Seoul, Bangalore, Istanbul and London while studying a largely online curriculum" and paying about $28,000 a year. Somehow it is not called Unicorn University, which feels like a missed opportunity, though the Minerva Unicorns would be a good name for the football team. Except there is no football team. Quidditch team, probably.

Elsewhere, I always sort of think of the Enchanted Forest as a socialist utopia, at least when it is not busy being a Randian utopia, so I am not surprised that "Bernie Sanders Is Still Outraising Hillary Clinton Among Tech Workers." And here is a story about co-working startup WeWork and its new ... co-living ... concept ... called WeLive. "A walk through WeLive feels like a stroll through a millennial office worker Narnia," says the article, because everything in this section of Money Stuff inevitably turns into children's fantasy literature.

People are worried about stock buybacks.

Here is Cullen Roche, sensibly, on those worries:

Corporations are buying back shares because their profits are near record levels and their resulting cash flows are high. Equity prices are high because future profit expectations are accordingly high.  Buybacks are a procyclical result of this and do not necessarily reflect manipulated stock prices, but are merely the result of record high profits and cash flows.

Elsewhere: "In the battle between the barons of buybacks and the divas of dividends, the divas are getting out to an early lead."

People are worried about bond market liquidity.

If you are worried about bond market liquidity, perhaps you should consider convertible bonds, which are in an entirely other market with its own liquidity dynamics:

Finding a way to lure investors is crucial at a time when raising capital has been tougher across asset classes, especially for companies with lower credit ratings. Stocks have been on a roller-coaster ride, at the same time as wary credit market investors have driven up the cost of issuing debt for some firms.

About $7.4 billion in convertible securities have been issued in the U.S. this year, according to data compiled by Bloomberg. While that’s down 31 percent from this time in 2015, convertible issuance has been relatively healthy compared to other asset classes. Junk bond issuance plunged 57 percent so far in 2016, the worst start to a year since the recession in 2009, according to the data.

Disclosure: I used to structure and market convertible bonds, so I am always happy to see them doing well. Another disclosure: I couldn't find much real bond-market-liquidity news this morning. That just means there'll be a ton of it tomorrow.

Me yesterday.

I wrote about activism and antitrust.

Things happen.

Merrill, Other Brokerages Prepare for Fiduciary Rule. Fourteen asset managers sue Portuguese central bank. Hedge Funds Sue to Block Payment by Puerto Rico's Development Bank. A profile of Pierre Andurand, who is good at trading oil. A profile of Andrea Smith, who's in charge of stress testing for Bank of America. Are Stress Tests Still Informative? Online Lenders Enlist Silicon Alley to Avoid Next 'Big Short.' Bearer securities are still a thing. Twitter Said to Win NFL Deal for Thursday Night Streaming Rights. Marissa Mayer and Yahoo Media. There's no such thing as a free dinner. "Some guy scaled the building and used his elbow to break in" to the Bureau of Labor Statistics. Money for Nothing: The Lucrative World of Club Appearances. When a New Cell Phone Almost Ruins Your Relationship. Taliban app. Is CERN summoning demons?

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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