Merger Lies and Ferragamo Bribes

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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M&A etiquette.

Guy Hands's lawsuit against Citigroup continued in London yesterday with my favorite sort of cross-examination, the kind where Citi's lawyers asked Hands if he was lying, and he said no, and they asked if he was sure. "Guy Hands Testifies He Did Not Make Up Claims Against Citigroup," is the headline here. In a TV murder drama they'd ask him a few more times, but louder, and he'd break down and confess.

But the testimony did feature one insight into the M&A process. Remember that Hands bought EMI in 2007 in a 4 billion-pound deal that worked out very poorly for him and his private equity firm, Terra Firma. Now he is suing Citi, which was EMI's sell-side adviser, because he claims that Citi lied to him. Specifically he says that a Citi banker, David Wormsley, misled him about competing interest in EMI from Cerberus, causing him to bid more than he otherwise would have because he thought the auction was competitive. (In fact he ended up being the only bidder.) Citi's lawyers asked him, in effect: Well why did you think it was okay for Citi to share Cerberus's secret bidding information with you?

On Wednesday, Mr. Hands also said it was “market practice” for information to be shared by agents of selling companies about the price other bidders were willing to pay in a confidential auction, even when there was a confidentiality agreement in place between the parties.

It happens “on an everyday basis in the City,” Mr. Hands said, referring to London’s financial center.

And:

It would have been "obvious to you that if Mr. Wormsley had approached you in the way you suggest he did that the other bidders were being deceived," Howard replied. "I put it to you it wasn’t a level playing field, it was tilted in your favor. In fact, it was entirely loaded in your favor."

"Do you think that’s an honest way to approach business?" Howard asked.

"In my experience, it’s the way auctions are conducted," Hands said.

The bank lawyer continue to press Hands: "Is it honest or not?"

"Sitting here today, it doesn’t sound very nice," the financier replied.

You get the point. In his version of the story, Hands knew that Citigroup was lying. He thought it was lying to Cerberus about its (written, contractual) promise to keep Cerberus's information confidential. It turns out (according to him) that it was lying to him about Cerberus's bid. He thought Citi was being dishonest in his favor, but it was really being dishonest in its client's favor. (Which, I mean, you can see why he'd object, but after all Citi's responsibilities were to its client.) 

There is a view, in post-crisis financial enforcement, that there is one universal standard of honesty applicable in all situations, financial and otherwise. ("It is no answer to the question to say this was regarded as honest by other bankers," said a prosecutor in a Libor case this week.) But this view seems obviously false to me. Standards of honesty are socially conditioned. The poker table and the witness stand demand different levels of candor. Your response to the question "how are you?" will depend on whether you're talking to your boss or your therapist. And reasonable market expectations of who is lying to whom really should inform who is allowed to lie to whom. Here, Hands claims, he thought he was getting normal dishonesty, and he was actually getting abnormal dishonesty. He might be wrong -- both about what's normal and about what he was getting -- but surely those categories do exist.

Platinum and Ferragamo.

"If you are stuffing cash in a gym bag," I said recently, "or receiving a gym bag stuffed with cash, something has gone wrong in your life." The maxim can be extended: If you are stuffing cash in a Ferragamo bag, or receiving a Ferragamo bag stuffed with cash, then something has gone expensively, ostentatiously wrong in your life. New York Correction Officers' Benevolent Association President Norman Seabrook allegedly knows what I'm talking about:

Before meeting SEABROOK on December 11, 2014, CW-1 went to Salvatore Ferragamo ("Ferragamo"), SEABROOK's favorite luxury goods store in Manhattan, and purchased an expensive bag for SEABROOK. CW-1 then placed $60,000 in cash in the Ferragamo bag and met SEABROOK several blocks away from the Ferragamo store. When CW-1 told SEABROOK how much money was in the bag, SEABROOK was angry that it was not as much money as he was initially promised.

That's from the federal criminal complaint against Seabrook and Murray Huberfeld, a co-founder of, and investor in, a hedge fund called Platinum Partners. "CW-1" is apparently Jona Rechnitz, a real estate developer who has pleaded guilty in this case and is now a cooperating witness; he introduced Huberfeld and Seabrook. At the time, Platinum Partners got investments mostly from rich individuals, not institutional funds, and was experiencing outflows and looking for new investors. Seabrook, meanwhile, was in charge of investing the correctional union's pension fund and cash account:

One night during either the November or December 2013 trip to the Dominican Republic, after he had been drinking, SEABROOK complained to CW-1 in CW-1's hotel room that SEABROOK worked hard to invest COBA's money and did not get anything personally from it. SEABROOK said that it was time that "Norman Seabrook got paid."

A light bulb went off, Rechnitz allegedly talked to Huberfeld (who allegedly "responded, in substance, that compensating SEABROOK would not be a problem"), and Seabrook invested $15 million of COBA money in Platinum. Then came the alleged cash in the alleged Ferragamo bag, which was allegedly invoiced to Platinum Partners as being for Knicks tickets at $7,500 per game. The complaint snarks that the Knicks were 4-20 at the time, but the point here is that taking a potential investor to a Knicks game is (sometimes) legal bribery, while giving him a bag of cash is not.

We've talked about Platinum Partners before. It is a weird little hedge fund. Here's an article from last October pointing out that it "has gained an average of about 17 percent annually" since 2003, "on a par with the world's best-performing hedge funds." Here's an article from this April saying that it "has racked up returns that are the envy of the industry," and has never had a down year. But neither article is what you would call unqualified praise. As I said at the time:

The word "prison" appears three times in the article. Sub-headings include "Strategies and Schemes," "Early Scandal," and "Black Elk Blow-Up." And "many big money investors who have looked at Platinum have walked away." There are some risks -- perhaps not easily expressible as "beta" -- that those investors don't like. 

So, I mean, look, on the one hand, it is bad to accept bribes to invest your union's pension in a possibly somewhat shady hedge fund. On the other hand, Seabrook invested his union's pension in one of the best-performing hedge funds in the world. Many pension fiduciaries, even the ones who don't accept bribes at all, or who only accept genuine Knicks tickets, invest in hedge funds that charge high fees for disappointing returns. Seabrook may have picked the sort of hedge fund that, you know, pays bribes, but on the other hand it gets results.

Spreadsheets.

How much was Dell worth at the time of its 2013 management buyout? Michael Dell and Silver Lake paid about $13.75 per share after a sales process that, while not perfect, seems to have done a reasonable job of drawing out the highest available bid. Last week, though, Delaware Vice Chancellor Travis Laster ruled that Dell was actually worth $17.62 per share, by doing discounted cash flow analyses based on two different sets of predictions and then averaging the results. So the company has to pay the extra money to the (relatively few) shareholders who objected and sued successfully for appraisal. But this week those shareholders pointed out a small boo-boo:

As described in the attached affidavit (“Cornell Affidavit” or “Cornell Aff.”), and at the request of Petitioners, Professor Cornell employed the same forecasts, the same inputs, and the same assumptions as the Court described in its Opinion. Although Professor Cornell’s calculations confirmed the Court’s calculations using the adjusted Bank Case, Professor Cornell’s calculation using the adjusted BCG 25% Case, and the same inputs that were adopted by the Court and applied to the adjusted Bank Case, produced a per share value of $16.90. Compared to the Court’s calculation of $16.43 per share, Professor Cornell’s check yielded a per share value that is $0.47 per share higher. Weighting $18.81 and $16.90 per share values equally (per the Court’s Opinion) produces an implied fair value of Dell of $17.85, a $0.23 per share increase over the Court’s calculation of $17.62.

Here is the affidavit. Without the underlying spreadsheet I can't tell you who's right, but, you know, if I were a lawyer who had just won a big appraisal case, I wouldn't submit a follow-up motion telling the judge that he got the math wrong unless I was really really sure about my own math. So I will go ahead and assume that the spreadsheet error was Vice Chancellor Laster's, and that it undervalued Dell by 23 cents a share. (That's about $400 million, though it works out to only about $1.3 million for the appraisal plaintiffs.)

The moral of the story might be "hahahaha lawyers can't do math," though even real live mergers and acquisitions bankers sometimes make big Excel errors that land them in court.

Databases.

I hadn't been paying super close attention to the Galen Marsh case, but I had sort of assumed that Marsh, who worked as a client service associate and then as a financial adviser at Morgan Stanley Smith Barney in New York, had gone in one night, downloaded a ton of customer data, and then brought it home, where it was stolen by hackers and put up for sale on the internet. (He pleaded guilty to stealing the data last year, saying that "I was using it to be better at my job" and that he never meant to sell it.) That is almost right, except replace "one night" with "thousands and thousands of times":

Although the Portal should have restricted Marsh to accessing only customer data associated with the FAs whom he supported, Marsh noticed that he could run this report for all MSSB customers, including those outside his group. A programming flaw in the authorization module for the FID Select Portal caused the module to not interface properly with the employee data entitlements database applicable to that Portal. As a result, a CSA like Marsh was able to access customer data for any FA group throughout MSSB.

Marsh repeatedly exploited this programming flaw by first entering a branch ID number other than his own — numbers that were generally available throughout MSSB — and then entering various possible FA or FA group numbers until he discovered a combination that worked. At that point, Marsh was able to and did run reports containing PII of all customers of that FA or FA group. ... From October 2013 through December 2014, Marsh conducted approximately 4,000 unauthorized searches of customer data using the FID Select Portal.

There wasn't, like, a big ol' customer list that Marsh just copied onto a thumb drive. He laboriously constructed the customer list by basically guessing every other financial adviser's identification number and then downloading their customers' information, over and over again, for more than a year. Yesterday Morgan Stanley agreed with the Securities and Exchange Commission "to pay a $1 million penalty to settle charges related to its failures to protect customer information."

By the way, the denouement of all of this is that Marsh put the data on his home server, where it was promptly stolen by a (still unknown) hacker and "posted to at least three Internet sites along with an offer to sell a larger quantity of stolen data in exchange for payment in speedcoins, a digital currency." You often see blockchains and cryptocurrencies touted as a solution to information-security problems, but it's worth noting that so far they have been involved mostly in causing those problems. If you hear the word "speedcoin," your data has already been stolen. 

CFPB vs. FOIA.

Here's a fascinating little story about the Consumer Financial Protection Bureau's response to Freedom of Information Act requests. Basically there's a newsletter called Probes Reporter, which sends thousands of FOIA requests about companies to federal agencies to see if the agencies might be investigating the companies. If they are, Probes Reporter tells its paying subscribers, who can then trade on the information. The agencies won't necessarily respond "oh sure here is everything we have in our investigation into XYZ Co.," but even if they deny the request with a form FOIA response -- that the request could "reasonably be expected to interfere with enforcement activities" -- then Probes Reporter can guess that, you know, there are enforcement activities afoot.

The CFPB won't even give it that. Instead, the "agency says it can 'neither confirm nor deny' the existence of the requested record, a step that lawyers and academics said is supposed to be reserved for cases in which officials determine that even acknowledging a document in its files could compromise national security or damage someone’s privacy." As a journalist I suppose I am obliged to be a FOIA maximalist, and be mad at the CFPB for this broad interpretation of its right to conceal information. But I see where it's coming from? Why should hedge-fund subscribers to a newsletter get (and trade on) information about CFPB investigations before everyone else does? As a matter of administrative secrecy it's annoying, but for an agency whose mission is leveling the financial playing field it kind of makes sense. 

People are worried about swap spreads.

They are, from time to time, but as a recurring heading this one never really took off. Arguably it should be folded into bond market liquidity. But today the Treasury Notes blog series on bond market liquidity -- sorry, on "fixed income market dynamics" -- takes up the issue of swap spreads, and why they have gone negative:

The GSEs’ retained portfolio of mortgages, which is often hedged with net pay-fixed positions, has declined since 2008. Over the same period, the Federal Reserve, which does not hedge its portfolio with interest rate swaps, has substantially increased its holdings of Agency Mortgage Backed Securities (MBS). Separately, corporate issuance, which is often hedged by receiving the fixed leg of an interest rate swap, has increased to record levels. All else being equal, structural declines in demand for net pay-fixed positions and increases in demand for net receive-fixed positions will help to move swap spreads lower.

In any case, Treasury's "judgment is that the tightening of swap spreads does not reflect a deterioration in Treasury's funding costs."

People are worried about non-GAAP accounting.

And where else to start but with Valeant:

Valeant’s decision to play up so-called Generally Accepted Accounting Principles in its quarterly earnings Tuesday -- showing a loss of more than $1 per share -- follows a six-month letter-writing campaign by U.S. officials. Beginning in December, the Securities and Exchange Commission challenged Valeant’s practice of playing down GAAP results in favor of its own adjusted pro-forma numbers, a method of reporting that critics say paints an unrealistically rosy picture of the drug-maker’s financial health.

I have repeatedly expressed skepticism about this worry. Generally accepted accounting principles are just one set of conventions, not a true reflection of objective reality. And market efficiency implies, at a very minimum, that investors can read a whole press release, not just the non-GAAP numbers in the headline. Also Valeant had a lot of other problems besides its accounting. Still it does test my skepticism to see that a company whose stock is down 91 percent from its peak -- and down 75 percent from the time of SEC's December 4 inquiry -- is an epicenter of non-GAAP accounting worry. Maybe there's something to that worry after all.

People are worried about unicorns.

I don't know, I worry:

Uber CEO Travis Kalanick rocked up at the Axel Springer NOAH Berlin tech conference in the back of a comical yellow car on Wednesday.

The entrepreneur was driven a short distance in a roofless Trabant (a popular car in East Germany before the Berlin wall came down) that happened to resemble a taxi.

Kalanick was one of three people in the vehicle, which parked up alongside the stage as the Rocky theme tune ("Eye of the Tiger") was played was played in the background.

Also he doesn't have a driver's license.

People are worried about stock buybacks.

The basic stock-buyback worry is that public companies, driven by short-term-oriented activist shareholders, will spend all their money on buybacks and not on innovation. But here is a blog post about a new academic paper on activism and innovation, finding that the relationship isn't so simple:

We find that R&D spending drops significantly in absolute amount (but not relative to the total assets) during the five-year post-event window. Interestingly, there does not appear to be a reduction in output from innovation—measured by patent counts, citation counts per patent, and quality of the citations. Therefore, target firms’ innovation efficiency improves in the post intervention period.

Elsewhere, though, here is a new Roosevelt Institute report called "Untamed: How to Check Corporate, Financial and Monopoly Power." As the name suggests, it covers a lot of ground, but it does include stock buybacks:

Share repurchases, also known as buybacks, have become one of the main outlets through which cash leaves firms—and thus one of the primary building blocks of short-termism—with corporations spending roughly 100 percent of their profits to buy back stocks or pay out dividends. 

People are worried about bond market liquidity.

Deep down, worries about the decline of the single-name credit default swap market are bond market liquidity worries. Or possibly vice versa. Anyway:

Some hedge funds with large exposures to the energy sector say that during the first quarter, the absence of a broadly-traded single-name CDS market inhibited their ability to cut exposure as bond prices tumbled.

Investors instead turned to other products, focusing on CDS indices and exchange traded funds that aim to track bond markets.

No but the way to cut exposure to X as prices for X tumble is to sell X. That's how people have cut exposure to everything in every financial market for the entire history of humanity, with a few shining rare exceptions that we call by the name "derivatives." The derivatives are nice. They are local peaks of human civilization. But they're not the only way to cut exposure to things. You can sell bonds. It is allowed. It is just so hard, though, because of the liquidity.

Elsewhere, BlackRock continues to push back on the popular idea that herding in bond mutual funds will lead to runs and fire sales. The European Central Bank has been buying corporate bonds, and pushing around the prices of those bonds significantly (because of the liquidity). "Foreign Demand for Treasurys Just Hit an All-Time High." And here's a Deutsche Bundesbank discussion paper on "High-frequency trading in the Bund futures market":

The results suggest that liquidity-taking HFTs trade in the direction of the market trend and are more active in phases of high volatility. Accordingly, they are also more active around the release of macroeconomic news than usual. In these situations, HFTs benefit from their speed advantage and trade according to the news surprise in a fraction of a second and immediately realize their trading profits. Their trades improve the price discovery process. However, the faster reflection of news in prices comes at the cost of short-term excessive volatility, which increases the risk of market disruptions. Moreover, my results show liquidity-providing HFTs increasingly withdraw from markets when volatility rises, either expectedly following macroeconomic news or unexpectedly due to rising risk aversion.

Things happen.

Commerzbank looks at locking up spare cash in vaults. A Bearish George Soros Is Trading Again. Dark Days at the Folly as Nomura Traders Join Europe’s Jobless. UBS Will Cut Recruitment of New U.S. Brokers by 40%. Weighted by Debt, Puerto Ricans Divided Over Federal Oversight. REIT Surprise: How Real Estate Crushed the Stock Pickers. "About 73 percent of job postings that specified compensation and included a reference to the CFA designation offered a salary below $100,000." The secret to investing in hedge funds: avoid almost all of them. Hedge Funds Buckling Under Fee Pressure, LP Apathy. Prosper Shuts Off Borrowers From Two Loan-Marketing Sites. Welcome to Larry Page’s Secret Flying-Car Factories. Google shareholder calls exec a 'lady CFO,' Twitter erupts. FINRA Sanctions Oppenheimer & Co. $2.9 Million for Unsuitable Sales of Non-Traditional ETFs and Related Supervisory Failures. SunEdison Reshaped Boards in ‘Friday Night Massacre,’ Suit Says. Whiskey ETF. "There are seven words I am not permitted to utter in front of my kids: Stife, Clutch, Fire, Dope, Swag, Fo’ Shizzle and Chill." An Anti-Corporate Capitalism Art Collective of Hippos. Drone dancing. Are exotic dancers independent contractors? What does it mean to have sex "with" someone?

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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