Shareholders, Directors and Traders

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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Corporate governance.

There is a social contract at most companies, partly explicit and partly implicit, that defines the roles and rights and duties of shareholders and directors and managers. And then Facebook has a different contract. For instance, at most companies, there's an annual meeting, and shareholders show up and vote on stuff, and if the shareholders are unhappy they can vote for changes, and while those changes aren't necessarily immediately self-executing, everyone has to at least pretend to take them very seriously. But at Facebook, Mark Zuckerberg has enough votes to approve whatever he wants, so the annual meeting is just for ineffectual shouting.

I feel like part of the contract at Facebook is, or really ought to be, that if you buy shares, you should not also complain about the voting structure that you bought into. But people do:

One shareholder spoke out to protest the new share structure, saying it wasn’t responsible to have one person having the most say in the company’s direction.

“It will continue to become impossible for outside shareholders to have any input on company decisions,” said Christine Jantz of Northstar Asset Management, which owns $5.4 million in Facebook common stock. “We are very concerned about governance risks.”

Now, to be fair, Jantz is complaining about the new share structure involving non-voting Class C shares, which is even more shareholder-unfriendly than the old one. She's not complaining about the voting structure she bought into; she's complaining about the even worse voting structure that will succeed that one. But the voting structure she bought into lets Mark Zuckerberg do more or less whatever he wants, without any shareholder input, including voting for a new and even worse voting structure. So the new, shareholder-unfriendly Facebook governance structure was in a sense contained within the old, shareholder-unfriendly Facebook governance structure. "It will continue to become impossible," Jantz complains, correctly.

I guess the point is, if you care about corporate governance, maybe just don't buy shares in huge companies that are controlled by individual founder-shareholder-CEOs? Certainly don't go to the annual meeting to complain; what does that get you? Elsewhere: "The strange genre of Mark Zuckerberg fan art." 

Oh also here is the weirdest corporate governance story I've read in a while, about Lululemon Athletica director Rhoda Pitcher:

So, the longest-serving director on the board of a $10 billion public company has a personal history that cannot be traced, no identifiable photo, a business that cannot be found, and a degree from an unaccredited entity with a residential street address.

Lululemon did not comment to TheStreet, which reported the story, or to Business Insider. Pitcher's biography on the Lululemon website says her degree is from "University Associates," which doesn't even have, like, the formal properties of a university name. This blog post calls her "a hugger" (and "one of the most amazing, inspiring and motivating people I have ever had the pleasure of meeting"). She is the chair of Lululemon's Nominating and Governance Committee. I do not know what to tell you, though I sort of like the idea that a private person without a fancy degree or much in the way of high-profile business experience can be a perfectly good, and long-tenured, director of a large public company. 

Market structure.

Here's a story about how, in the equities market, human sales traders "are in demand because they are proving more adept than computer programs at trading big chunks of stock, dubbed block trades." 

“A sales trader can do some very creative things,” said Rob Boardman, chief executive officer for Europe of Investment Technology Group Inc., an electronic broker and dark-pool operator. The firm employs sales traders and also develops buying and selling algorithms -- dubbed algos. “An algo is not going to make a phone call to the top five holders of a stock. It’s not going to call the CIO of a large institutional investor and say, ‘Do you fancy getting out of this?”’

Wait but. If you are trying to buy stock, calling the people who own a lot of that stock is not, you know, that creative. "Call the top five holders of a stock" is literally an algorithm. It is hard to make a robot chat application that can be convincingly human, but it's easy to make a robot chat application that can select the top five holders of a stock and message them "Ahoy friend, I see you own 5,000,000 shares of XYZ stock, do you fancy getting out of it? Good news, the Huskies won last night's game." 

This is probably good for the sales traders. Some of the jobs that are simplest to describe are the hardest to automate. "I spend my day calling people and asking them if they want to sell stock" sounds pretty straightforward, but it's all about nuance and relationship and subtle cues and knowing what sport the Huskies won at. It's hard for a computer to replicate the human warmth in those interactions. In complicated transactions with lots of moving pieces and intellectual content, a computer might have a substantive edge. But if the transaction is just buying a big chunk of stock, the humans have some hope.

Elsewhere in market structure, Larry Tabb is not happy that the Securities and Exchange Commission approved IEX's application to become a national stock exchange:

Investors will rue this day. Spreads will widen, retail investors will be hurt, large buy-side firms will be disadvantaged, market structure complexity will increase, sophisticated trading firms will profit, and the quality of the US markets will deteriorate.

Bank capital.

Bank capital debates are so weird. Here is a speech by Neel Kashkari on "Ending Too Big to Fail" that is, you know, whatever:

A policy analyst recently asked me if we really could resolve a large bank during a crisis. I responded by asking him if he thought we could dismantle an aircraft carrier in the middle of a hurricane. It’s not a perfect analogy, but he got my point. 

I guess his point was "no"? Anyway here is a long fascinating passage about Kashkari's opposition to contingent convertible debt as a bank capital instrument:

On one hand, regulators are saying believe us, contingent debt is as good as common equity in its power to absorb losses if a bank runs into trouble. We will really force bondholders to take losses.

On the other hand, the same regulators are saying investors will price these securities closer to debt than equity. But if these securities truly do face equity-like downside risk, (by the way, without the upside of equity), why would investors price them more like debt?

I see three possible explanations: (1) The securities aren’t really going to face losses, so they aren’t really capital. They will be cheaper than equity because they are really debt, which means they won’t provide much financial stability benefit. (2) The securities really are going to face losses, and investors will then price them more like equity, so there is little benefit for their added complexity, compared with banks just issuing more common stock. Or (3) investors will misunderstand the risk and underprice these convertible securities similarly to debt, while regulators will really make them face losses like equity.

This would make no sense at all if Kashkari were talking about regular companies. Every company that issues debt prices that debt like debt, not equity. And every buyer of that debt knows that, if the company runs into trouble, the equity will absorb losses, and then if there are losses left over, the debt will also absorb losses. Uber, which is still kind of a risky startup, is out raising a leveraged loan with a 4-handle coupon. That is a lot lower than Uber's cost of equity, but no one thinks that this is because Uber's equity is risky while its debt is guaranteed by the government. Uber's debt is cheaper than equity because the equity absorbs the first losses, and the debt is more senior. This is just what "debt" and "equity" mean.

Yet Kashkari's point isn't nonsense; there is a popular view that any losses on bank debts are somehow bad for "financial stability," and that any bank debt is therefore implicitly government-guaranteed just like retail deposits are. The trick, with contingent convertibles and other forms of loss-absorbing bank debt, is to break that association in the minds of investors, to separate out functional bank debt (deposits, repo) that needs to be risk-free for transactional and stability purposes, from just regular old financial debt (contingent convertibles, holding company senior unsecured bonds) that is a risky investment just like any other bond. I don't think that is an impossible goal, though it is hard, and perhaps made harder when Fed officials like Kashkari confuse the issue.

Elsewhere, "Credit Suisse Group AG Chief Executive Officer Tidjane Thiam said hedge funds are wrong to assume that the Swiss lender will have to raise additional capital." (Also: "Credit Suisse Chief Contends With Rising Tensions, and a Sinking Stock.") And are you excited for stress test week? Cancel your kids' birthdays; there is work to do:

"It is going to be all hands on deck," said Barclays bank analyst Jason Goldberg, who postponed his 11-year-old son's birthday dinner to focus on the stress test scores.

Blockchains.

Here's an explainer on the DAO hack. (Among other things, it mentions that the signature on the supposed message from "The Attacker" that I quoted yesterday isn't valid, which means that "it could be fake," though what else is new.) And here is Izabella Kaminska:

The Ethereum developers now ironically sit in the very same uncomfortable place that many regulators have sat before them. They can change the rules of the game to do what is morally right, or they can stick to the rules albeit at the cost of a systemic panic or collapse. Given that the very value of Ethereum’s system is based on not bowing to social pressure of this sort, unlike most regulatory systems which do allow for nuance in this decision process, they’re now damned no matter which way they go.

I feel like we are seeing a series of experiments with how much the "rule of law" should matter in financial regulation, with possibilities ranging from slavish adherence to the rules (Ethereum purists) through rough efforts at legitimacy and after-the-fact review (the U.S. during the crisis) up to, like, meh, whatever works (the Chinese stock market this winter). I suppose I have my biases, but neither extreme seems ideal. 

Meanwhile, here is a strangely timed story about how "Ethereum in recent months has become the next hot thing in cryptocurrencies." And in, like, Blockchain 1.0 news, "Bitcoin is the new safe-haven asset: Analyst." And "Craig Wright, the Australian who claimed to be the inventor of bitcoin, is attempting to build a large patent portfolio around the digital currency and technology underpinning it."

A little insider trading.

Here's a cheery little Securities and Exchange Commission insider trading action. "James Hannon was the Northeast Regional Vice President in 2012 – 2013 of retail chain T.J. Maxx," and "received daily emails from the finance division of TJX that contained consolidated daily comparable store sales." When the same-store sales were good, Hannon would buy some stock just before earnings, and sell just after earnings. This worked. It worked fine. Just fine. For instance:

July 3, 2012: Purchase of 5,600 shares just prior to the July 5, 2012 earnings announcement discussing a 7% increase in consolidated comparable store sales for June 2012. He sold the shares for a profit of $8,768.

That was his biggest profit, $1.57 per share (on a stock that closed at $42.50 on July 3, for about a 3.7 percent profit). His smallest was $1,100 on 5,500 shares -- 20 cents per share, 0.5 percent -- in February 2013. He did this five times for a total profit of $26,679. His settlement with the SEC requires him to give it back, with interest, plus another $26,679 for good measure.

Isn't that sweet? Hannon was not buying short-dated out-of-the-money call options on a merger target. He was day-trading his own company's stock to make small profits based on a small edge in inside information. He did a little bit of research, added a little bit of information to the market price, and made a little bit of money for his troubles. It's almost exactly what you're supposed to do, as a stock day-trader, except for the whole illegality thing.

People are worried about non-GAAP accounting.

No, again, this is a GAAP accounting worry:

Six Flags Entertainment Corp. and Tempur Sealy International Inc. have awarded millions of dollars in stock to top bosses and given the equity a unique value: zero. To use that figure, the companies set performance targets they said were unlikely to be met.

Six Flags twice met the impossible goals, leading to millions of dollars in share grants to the executives (and a sixfold increase in the stock price), as well as "significantly higher accounting charges" from expensing the stock grants when they were achieved rather than when they were first awarded. I have no particular problem with this, but it's another reminder that U.S. generally accepted accounting principles are a semi-arbitrary human system, not a perfect reflection of economic reality. If I offer you $50 million worth of stock if you can get earnings up by 12 percent, how much is that worth? The GAAP answer, in this case, is zero, which in hindsight looks wrong -- the executives met the target and got the awards -- but any other answer would have been pretty meaningless as well.

People are worried about unicorns.

Here is Andrew Ross Sorkin with a theory about Uber's constant fundraising, which is that Uber is raising all the money in the world so that no one else can have any:

Every time Uber raises another $1 billion, venture capital investors and others may find it less attractive to back one of Uber’s many rivals: Didi Chuxing, Lyft, Gett, Halo, Juno. In other words, Uber’s fund-raising efforts have seemingly become part of the contest: It’s not just a rivalry over customers and drivers; it’s a war of attrition, a mad scramble to starve the competition of cash.

It is sort of weird that the sharing-economy approach of, like, just building an app that lets riders connect with non-employee drivers using their own cars, would lead to an industry that is so focused on raising and deploying billions of dollars in capital to create moats and monopolies in individual geographic markets. Like if you had gone to venture capitalists and said "my plan is to buy like a million cars and create a giant global taxi company that is licensed and operates in hundreds of local markets, and by the way there'll be an app," no one would have been that into it. But Uber started with the app, and some hand-waving about the "sharing economy," so now no one is all that bothered by the massive capital intensity of the business. 

Elsewhere: "Europe’s tech unicorns are beating the US on this one key metric" (revenue). And Twitter bought Magic Pony, a startup that "specialises in creating algorithms that can understand pictures." Apparently the price tag was about $150 million, meaning that Magic Pony was not a unicorn. But it was a magic pony. Really "magic pony" would be a good diminutive for a startup with some unicornesque properties but a sub-billion-dollar valuation. It's smaller than a unicorn, and without the prominent horn, but it's still horse-like and magical.

People are worried about bond market liquidity.

All the worrying about bond market liquidity has alerted people to a basic underlying issue, which is that it's sometimes hard to sell bonds quickly, but bonds are often held in vehicles that might have to return money to investors quickly, creating the potential for a "liquidity mismatch" that would be bad. The main concern is about bonds held in mutual funds that offer daily liquidity, but hedge funds that offer, like, delayed quarterly liquidity have also gotten in on the act. This strikes me as a little weird -- surely you can sell most bonds in three months? -- but there it is. But while mutual fund managers downplay the liquidity mismatch, because demanding longer lockups from investors would hurt their business, hedge fund managers embrace it, because demanding longer lockups from investors will, you know, give them money that is locked up for longer. Anyway:

Investors are increasingly willing to commit money for five years or more as they eye the end of the credit cycle, when strategies touted by distressed hedge funds flourish as opportunities arise to purchase securities at depressed prices.

“You are going to see a lot more new funds with more restrictive liquidity provisions with long investor gates,” said Chris Acito of credit hedge fund of funds Gapstow Capital Partners.

This is not just about liquidity -- one investor mentioned "the involvement of having controlling positions in bankruptcy proceedings, or equity distributed after a reorganisation in which trading is restricted" -- but I do feel like all the liquidity worrying may have made it a bit easier for distressed fund managers to have frank talks about lockups with their investors. 

Elsewhere, Guy Debelle of the Reserve Bank of Australia gave his own frank talk about liquidity:

Globally the debate on bond market liquidity has been ebbing and flowing over the past couple of years. You can hear that it is simultaneously the best of times and the worst of times for liquidity in the bond market. Or to stick with the water analogy that is so prevalent in such discussions, the market is awash with liquidity at the same time as the tide is going out. As an aside, the water references in liquidity discussions are as pervasive as they are in Pixies' songs.

I cannot help but feel partly responsible for the first literary reference there. 

Things happen.

German Court Rejects Legal Challenge to ECB’s Bond-Buying Program. Hedge Funds Sense Profit in Europe Shock Waves After Brexit. George Soros: The Brexit crash will make all of you poorer – be warned. Ackman releases new Herbalife video; stock climbs. Fewer MBAs Want to Work For Hedge Funds. Hedge Funds Still Can't Figure Out a Way to Avoid a $25 Billion Tax Bill. Elliott and Private Equity Firm to Buy Dell’s Software Unit. Tencent, Partners to Pay More Than $8 Billion for ‘Clash of Clans’ Maker Supercell. Williams Cos. Gets Its Day in Court Over ETE’s Cold Feet. Martin Winterkorn, Ex-C.E.O. of Volkswagen, Is Under Investigation. Harvard Shifts More Investments to Outside Money Managers. European banks increase government debt holdings. Doctors Getting Free Meals Pick Branded Drugs More, Study Finds (earlier). Risky Business: Government Mortgage Insurance Programs. Philippe Dauman's Last StandWall Street donors seek to block Warren VP pick. Anthony Scaramucci tries to defend his Trump support. U.S. Economy Would Be ‘Diminished’ Under Trump’s Economic Plan, New Analysis Says. Kangaroo coins. Insect sting rankingsArtisanal Mayo Store Getting Priced Out of Prospect Heights, Owner Says. A 'Golden Girls'-Themed Restaurant Is Headed to NYC. Blue wine coming for millennials. 

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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