Boardroom Battles and Car Washes
The Viacom drama.
What is the point of owning the majority of the voting stock of a public corporation if you can't make it do what you want? Sumner Redstone's holding company, National Amusements Inc., isn't so pleased with the management of Viacom Inc., a public company that it controls. (It owns only about 10 percent of Viacom's total stock, but 79.8 percent of its voting Class A shares.) In particular, National Amusements has fought with Viacom's board and management about the possibility of selling Paramount Pictures, which is owned by Viacom. The fight has gotten ugly, so yesterday National Amusements delivered a written notice that it was kicking out five board members, including the chief executive officer, Philippe Dauman. And those board members replied by saying: No, you can't get rid of us. The two sides are suing one another, hoping a court will figure it out.
Of course it is much messier than that little summary makes it sound. In particular, it is hard to know what National Amusements "really" wants, because it is hard to know what Redstone wants, because there is a lot of controversy around his mental competence. (He is "93 years old and in poor health," and Dauman and his allies claim that his daughter Shari Redstone is illicitly making decisions for him; his "doctor put out a statement saying Mr. Redstone was alert and in no distress during a recent examination, and that he knows what he’s doing.") So the directors can argue in court that the binding written consent of their majority shareholder, firing them and replacing them with new directors, doesn't really reflect the will of that shareholder and should be ignored. This is sort of a weird argument to make. If owning a company means anything, it means that when you fire the directors they go quietly without second-guessing what you mean.
But of course you don't really get to do whatever you want with a public company, just because you own a majority of the (voting) shares. Though you mostly do:
Lawrence Cunningham, a professor of corporate law at George Washington University, said in a recent interview that controlling shareholders have broad authority under Delaware law to make changes with or without cause. Viacom’s deposed directors could fight their removal by arguing that Mr. Redstone isn’t looking out for the best interests of minority shareholders or is mentally unfit.
Those directors that National Amusements is ousting have fiduciary duties to the shareholders -- all the shareholders, not just the majority shareholder. This puts them in a tough position: They have to make sure that Redstone really means to get rid of them; they also have to make sure that, even if he does mean it, he's not just planning to take over the company and burn it to the ground.
There's not much evidence that that's his plan. The stock closed up 6.75 percent yesterday. If you are a director of a company, and the controlling shareholder tells you you're fired, and the market rejoices, it's a bit awkward to go to court and disagree.
Some insider trading.
Oh man, here is a sad little insider trading case. The Securities and Exchange Commission charged Christopher Salis, an executive at SAP, with tipping his friend Douglas Miller about SAP's plan to buy Concur Technologies; Miller, his brother Edward Miller and their friend Barrett Biehl then allegedly "rushed to open online brokerage accounts and make risky, short-term trades in Concur call options so they could profit substantially when the deal was publicly announced." The Second Law of Insider Trading, as I often remind you in a not-legal-advice sort of way, is: Don't do that. But the Millers allegedly thought they were above the Second Law, or rather, below it:
Douglas and Edward Miller owned a car wash, and the two were struggling to keep the business afloat due to its poor financial performance and mounting debt. Douglas Miller viewed the Concur trading as their “possible savior.” At the same time, the Millers chose the amounts of their brokerage deposits carefully; they each deposited under $10,000 in the belief that their subsequent options trading would escape detection. As Douglas Miller later recalled in a text message to Edward Miller, “We all tried to fly under the radar of investing under 10k bro.”
The First Law of Insider Trading is, of course, don't insider trade. I guess that makes the Third Law: If you must insider trade, and you must do it by buying short-dated out-of-the-money call options in a merger target, at least don't text or e-mail about it. Come on.
There's a general over-eagerness in this case that makes it sort of touching. They were really in a hurry to get those trades done:
Douglas Miller urgently explained to a Scottrade representative on a recorded line that his family wanted to trade that day: “I have me and a couple of people. . . . Me, my brother, and my mom opened up Scottrade accounts. We were trying to do options. We got approved for options. . . . We were trying to do something today.” Douglas and Edward Miller spoke with multiple Scottrade representatives about the fastest way to fund their accounts. Douglas Miller stated that he was willing to bring cash to his local Scottrade branch office, but was informed that cash could not be accepted.
Having learned that Scottrade would not accept cash, Douglas and Edward Miller and their mother drove approximately 30 minutes to their nearest Scottrade branch office and presented cashier’s checks for deposit, which they had purchased earlier that day in amounts of $9,800, $6,000 and $8,000, respectively.
I don't know if it quite rises to the level of a Fourth Law, but if you are insider trading in short-dated out-of-the-money call options, you might want to, you know, play it cool when you're on a recorded phone line with your broker. Speaking of playing it cool, don't do this:
Hours before the announcement, revealing his knowledge of the upcoming but still secret merger announcement, Douglas Miller called Scottrade on a recorded line and asked for advice on how to sell his options positions. He asked, “I was just trying to prepare myself if something happened, how you would actually sell [options] in your account, like how you would actually go about doing that?” (Emphasis added.) He asked the Scottrade representative to explain certain options terminology, such as “sell to open” and “sell to close.”
If your short-dated out-of-the-money options suddenly become massively valuable because the merger you had inside information about is announced, you want to look surprised. "Wow, I had no idea this company was going to do a merger, what a lovely surprise, lucky me," you should say to your broker, with the casual laugh and shrug of a person to whom good things happen all the time. After the announcement. After.
I emphasize that none of this is legal advice, except the First Law; really you should not insider trade. But if you do, just, have some sprezzatura, you know? It may not keep you out of trouble, but you'll feel better about yourself.
Elsewhere in enforcement actions, the U.K. Financial Conduct Authority brought a case against the people who ran "four alleged 'boiler room' companies" with the most marvelous names: "First Capital Wealth Limited, Bishops of Mayfair Limited, Wallberg Dillion Reid Limited and Sterling Capital Corporation Limited."
We talked a while back about "The DAO," the "Decentralized Autonomous Organization" that runs on the Ethereum blockchain and that is supposed to revolutionize corporate structure by, like, being a partnership, but with computers. It has gotten a lot of attention, and has raised over $150 million (in ether, the Ethereum blockchain cryptocurrency) to invest in venture projects voted on by its members. Also, according to posts on the DAO forum, Slock.it's blog, Reddit, Hacker News, Tech Insider and some related blogs, it is now "under attack and is leaking eth in huge amounts." Oops!
The situation is fluid, I guess, but if the DAO really is being hacked and drained of its money, then that would be ... utterly unsurprising? The New York Times described a DAO vulnerability a few weeks ago. More generally, as the size and public profile of a blockchain project gets bigger, the likelihood that all of the money involved will disappear approaches one. "The libertarian rubes who think Bitcoin is anything but a way to get themselves robbed have gotten themselves robbed yet again," wrote Rusty Foster, several robberies ago.
And yet the blockchain is almost universally touted as the future of finance. Banks are falling over themselves to move their processes onto blockchains. It's so fast and modern and secure! I don't know. I mean, obviously, regular banks, and interbank transfer systems, get hacked. The blockchain is not unique in that regard. But there sure are a lot of blockchain thefts.
Elsewhere, here is a proposal (from Reddit via Tyler Cowen) for using public-key cryptography to conduct background checks for gun sales.
Is Microsoft too big to fail?
When we talked a while back about the Financial Stability Oversight Council's (unsuccessful) effort to classify MetLife as a "systemically important financial institution" subject to Federal Reserve regulation, I pointed out that the standards for being a SIFI were a little vague. I said:
A "systemically important financial institution" can't just be, you know, a big company with a lot of money. Apple has a lot of money.
But vague standards can be fun to play with. So here is Geoffrey Heffernan with "a fictitious designation statement by the Financial Stability Oversight Counsel" designating Microsoft as a systemically important financial institution. His imagined FSOC argues that Microsoft is "predominantly engaged in financial activities" because it "indirectly" enables third parties to engage in those activities by, like, providing them with Excel and Word and PowerPoint. And it argues that Microsoft is big, and a failure of Microsoft's products could pose a threat to the U.S. financial system, so it should be subject to Fed oversight.
Look, the actual FSOC's case for regulating MetLife, while not iron-clad, is a lot better than Heffernan's fictional FSOC's case for regulating Microsoft. But Heffernan's case isn't crazy, or I guess, it is crazy, but not obviously crazy. It looks, in vague outline, like a thing a real FSOC could perhaps say. His point here is of course not that Microsoft is systemically important and should be regulated by the Fed; his point is that the FSOC's standards for designating SIFIs are so vague that any big enough company could, with some creativity, fall under the FSOC's standards.
You may disagree. I don't care; my point here isn't that Microsoft is too big to fail, or that MetLife isn't, or that the FSOC's designation processes are imperfect. My point here is that someone wrote a work of fiction in the form of an imaginary FSOC designation letter! That's great. I don't throw around the word "Borgesian" every day in this newsletter, but this may be as close as we're going to get.
I realize that it is perhaps not intellectually rigorous to discuss all "hedge funds" as an aggregate, but if you do, the industry as a whole has a mystifying combination of
- mediocre performance,
- high fees,
- terrible press, and
- more or less consistently increasing size.
The existence of hedge funds disproves market efficiency: Either hedge funds beat the market and provide sustainable alpha, or else the large smart institutions that invest in them are being systematically fleeced. A perfectly efficient market wouldn't allow for either. But of the two possibilities, "systematically fleeced" is the more disturbing one. (It's not like no one mentions the high fees and mediocre performance! That's what the terrible press is!) But the mystery is getting a bit less mysterious, because the size of the industry isn't consistently increasing any more:
The hedge fund industry continued to shrink in the first quarter of the year, as uneven performance failed to reassure clients frustrated by high fees.
While 291 hedge funds shut their doors in the first three months of 2016, just 206 new funds started up, according to data from Hedge Fund Research.
Meanwhile at traditional asset managers, "Pacific Investment Management Co. cut its workforce by 68 people, or about 3 percent," as its "$1.5 trillion in assets under management are down 25 percent from a high of $2 trillion in the first quarter of 2013." And "Grantham Mayo Van Otterloo & Co., the money manager known for the bearish views of founder Jeremy Grantham, has cut about 10 percent of its 650-person staff in a retrenching that follows a sharp decline in assets."
Yesterday the Financial Accounting Standards Board issued new guidance "requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations." Basically the old rule was that banks had to record credit losses when they became "probable"; the new rule "requires an organization to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts." Here is the Accounting Standards Update, a summary of the costs and benefits, and a Q&A explaining the decision:
In the lead-up to the financial crisis, financial statement users were making estimates of expected credit losses using forwardlooking information and devaluing financial institutions before accounting losses were recognized. This highlighted that the information needs of users differ from what GAAP has required.
Similarly, preparers expressed frustration during this period because they could not record credit losses that they were expecting due to the fact that the probable threshold had not been met.
I'm a little skeptical that a lot of banks "expressed frustration" that they couldn't mark down their loans as fast as they wanted to in 2007, but let's leave that aside. One general thing you can say about financial markets is that they are supposed to be good about discounting the probability of future events into present prices, and that as time goes by and financial technology becomes more sophisticated, they should keep getting better at doing that discounting. One general thing you can say about banks is that they exist to some extent outside of that market system: They can fund long-term assets (like loans) with short-term liabilities (like deposits) precisely because they don't mark those assets to market every day. "The point of banking is to conceal risk." But the lure of modernity is hard to resist, and if everyone else is getting more sophisticated about discounting future events into present prices, banks will have to do that too.
People are worried about unicorns.
I guess it was inevitable that if Uber was working on a credit facility, its sharing-economy unicorn friend Airbnb would be too. It was: "Airbnb Inc. secured a $1 billion debt facility from some of the largest U.S. banks to help the home-sharing company develop new services and fund growth initiatives." And:
While Airbnb hasn’t announced plans for an imminent initial public offering, investment banks often arrange debt facilities for successful private companies in hopes of building relationships to win future business like underwriting an IPO.
Meanwhile, Parker Conrad, who founded Zenefits, the Unlicensed Insurance Broker Unicorn, and then resigned when all the unlicensed insurance sales came to light, "is working on another startup idea, according to a help-wanted ad posted briefly on Wednesday." "The ad didn’t say anything about what the company plans to do, but indicated ambitious plans, promising the potential recruit that 'you have a (small) shot at building a FB scale company.'"
But the most worrying unicorn is probably this $6,000 unicorn-shaped pool float "adorned with more than 10,000 Swarovski crystals, hand-applied in 14 shades of the rainbow." There are pictures. Here is one:
"It’s so special, only one will be made," so make sure to get it for the venture capitalist in your life.
People are worried about bond market liquidity.
Here is "The ETF liquidity mirage":
Instead of a hot market driven by nanosecond investors, the reliability of the pricing of ETFs is meant to derive from the arbitrage trade built into the structure: assets in the ETFs should be liquid enough for the APs to perform their pricing function. With the bond market, that just is not true… as the Wall Street machinery, in a profound irony, proudly touts as exactly the reason investors should pile in.
I should say that I disagree with this; I think that wrapping illiquid things into liquid traded securities is one of the most basic functions of a financial system, and that there's nothing particularly wrong with it. (Every stock is a liquid wrapper for its company's illiquid underlying business!) And I think that exchange-traded funds, which trade in a secondary market and whose redemptions are mediated by arbitraging authorized participants, are safer and more stable than regular old bond mutual funds that redeem out investors at net asset value. But the ETF-mirage view is certainly popular.
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