Mayo Spoofing and Earnings Hints
My favorite market structure story of 2016 so far may be this one, about Hampton Creek, the food company that makes Just Mayo:
Hampton Creek executives quietly launched a campaign to purchase mass quantities of Just Mayo from stores, according to five former workers and more than 250 receipts, expense reports, cash advances and e-mails reviewed by Bloomberg. In addition to buying up hundreds of jars of the product across the U.S., contractors were told to call store managers pretending they were customers and ask about Just Mayo. Strong demand for a product typically prompts retailers to order more and stock it in additional stores.
Putting in fake orders to buy something, when you are actually a seller, to create an illusion of demand so that others will buy and you can sell? Normally when we talk about that around here, we call it "spoofing." And normally it is done in high-speed electronic trading markets for financial instruments. Not in supermarkets, for mayonnaise. (Or, I mean, vegan quasi-mayonnaise.) But the principles are the same.
Now, this is not just a spoofing story. For one thing, the contractors actually bought a lot of mayo, which is not traditional in spoofing; perhaps it's more like mayo wash trading. Hampton Creek itself "says the primary purpose of the purchases was to check the quality of the mayonnaise," though if that's true it's a little odd that contractors would buy 20 jars per store and then just throw them away. Hampton Creek raised a funding round after doing these buybacks; you might wonder about its revenue accounting when you consider that some portion of its sales -- the company says under 0.12 percent -- were to itself.
But I like to think of this as a market structure story. People get incredibly angry about the spoofing and other bad stuff that goes on in the anonymous electronic markets for stocks and futures. Books are written about it. It seems to me that what upsets people about electronic-trading misbehavior is simultaneously its visibility -- any misbehavior is deterministic, built into code in black and white, impossible to explain away as quality control -- but also its invisibility: The trading is so fast, so automated, that it's hard for a human to really grasp, and easy to believe that a shadowy conspiracy of unseen deception can hide in the electronic markets. But really there is spoofing, bluffing, deception, manipulation, front-running everywhere -- in old-fashioned human trading, in mayo, everywhere.
Anyway, don't miss the mayo ouroboros gif.
Here is a fun story about how companies beat research analysts' earnings estimates so consistently: They call up the analysts and talk them into lowering their estimates until they're just below what the company will actually report. Then the company reports and, surprise! Earnings beat.
Quarter after quarter, about 75% of companies in the S&P 500 index meet or exceed analysts’ earnings forecasts, a statistic that has held up in good times and bad. One reason for such consistently impressive results is that some companies quietly nudge analysts’ numbers, almost always lower.
A federal rule bars companies from selectively disclosing material nonpublic information but doesn’t prohibit private conversations in which companies can gently push analysts in helpful directions.
It's possible that the market for U.S. public-company stocks is sillier than the market for vegan mayo. Some morals of the story:
- Is this ... good? Like, the analysts are in the business of telling the market what the companies' earnings will be. If the analysts' estimates are more accurate, then the market will be better informed and more efficient. As the quarter goes on, the company has a better sense of what the earnings will be than the analysts do. So it ... just ... tells them. (I mean, I am highly stylizing the process here, but that's basically right!) And then their estimates get more accurate, and the market is better informed. That's all good, right?
- "Then the company should just put out guidance publicly and constantly update it," you say, "so everyone gets the same information at the same time." Come on. If a company was constantly putting out press releases saying "last week we thought our earnings for this quarter would be around $500 million to $550 million, but now we think they'll be $490 million to $545 million," it would constantly be getting it wrong, and would constantly get blamed or sued for its over- or under-estimates. Filtering it out through analysts is a way to inform the market without taking responsibility for the numbers.
- What is Regulation FD even doing? That's the one that "bars companies from selectively disclosing material nonpublic information but doesn’t prohibit private conversations in which companies can gently push analysts in helpful directions." Your "gently push analysts in helpful directions" is my tell them what earnings are going to be. What about that is not "material"? And yet Regulation FD enforcement actions are exceedingly rare -- though there was one against Office Depot in 2010 for basically this sort of thing.
- The flip side of Regulation FD is insider-trading law, and here I'll remind you that prosecutors tried to send Todd Newman and Anthony Chiasson to prison for years because an investor-relations employee at Dell gave some helpful hints about Dell's upcoming quarterly earnings announcements to (a guy who gave it to some guys who gave it to) them. But giving helpful hints about upcoming quarterly earnings announcements is apparently rampant, and legal, among investor-relations employees. (Ultimately Newman and Chiasson got off.)
- What is the role, and what are the incentives, of the analysts here? Who provides more value to investors: an analyst who believes the company is a Sell, rates it a Sell, is spurned by management, and doesn't get helpful hints about earnings -- or an analyst who believes the company is a Sell, rates it a Buy to ingratiate himself with management, and gets an inside line about how earnings will come in? Remember: If your model of sell-side research analysts is that they're just supposed to know which stocks will go up and tell you to Buy them, you will always misunderstand sell-side research.
"New York’s top banking regulator asked Goldman Sachs Group Inc. to supply more information about its work for a Malaysian investment fund amid investigations into whether any money laundering, sanctions violations or other misconduct occurred," and good lord how fun would it be to be a regulator investigating Goldman's dealings with 1Malaysia Development Bhd.? I imagine Goldman is having a lot of conversations like this these days:
Regulator: Wait you underwrote $6.5 billion of bonds for this sovereign-ish fund, and then $3.5 billion of the money disappeared?
Goldman: [shrugs helplessly]
Regulator: Did you ... like ... notice that anything weird was up?
Goldman: [grins sheepishly]
Regulator: Honestly what was the due diligence like there, I am super curious.
Goldman: [slumps in chair]
Regulator: And you got paid $593 million in fees? That's unusual! Was there a ... reason for that?
Goldman: [hides under table]
Regulator: [bursts out laughing]
They should televise it. Disclosure: I used to work at Goldman, and if I had ever brought in a bond deal that made the firm $593 million I would long ago have retired to my giant mansion, which is apparently just what Goldman's 1MDB banker has done.
Well here's a story about how "online lender Prosper Marketplace Inc. is in advanced talks with a group of investment firms to sell them roughly $5 billion worth of loans over the next two years," but it might be giving away at least a little bit of the store to do so:
The loans would be bought at face value, but the firms are also in discussions to receive equity warrants in Prosper as they make the purchases, the people added. The potential buyers are also talking to banks about borrowing money to support their loan purchases, and a deal could wrap up in the coming weeks, they said.
I feel like you don't see a lot of banks giving away equity warrants in themselves in order to, like, attract deposits? (There was that time T-Mobile gave away stock in itself to attract customers?) "Prosper’s deal to sell loans at face value would provide a measure of validation of investors’ confidence in its underwriting ability," but that would depend on how many warrants they get, no? I guess it doesn't matter that much. If you just buy Prosper's loans at par, then that suggests confidence in its underwriting ability. If you buy them at par in exchange for a big slug of warrants in Prosper, then that at least suggests enough confidence in Prosper that you want to own its equity.
LendingClub Corp., looking to bolster demand for the consumer debts it arranges online, is in talks with Western Asset Management Co. to set up a fund that would purchase as much as $1.5 billion of loans over time, people with knowledge of the matter said.
"The real question is," says an analyst, "what does LendingClub have to give up in exchange for that firm commitment?"
Meanwhile in the traditional banking sector:
Bank of America Corp., which spends about $1 billion a year handling cash, will save money and require fewer employees as more customers make payments electronically, Chief Executive Officer Brian Moynihan said.
Is that a lot? It sounds like a lot, but I mean, you have to pay people to fill the ATMs and whatever. Bank of America's non-interest expense last year was $57.2 billion; less than 2 percent of that was spent on that oldest and piggy-bank-iest of bank activities, handling cash. Anyway, Bank of America is excited for what the technological future will bring.
Speaking of piggy-bank activities, here is a delightful story about how "Just three lenders now handle the bulk of the global 'bank notes' business: Bank of America Corp., Bank of Ireland in Europe and United Overseas Bank Ltd. in Asia":
Banks get paid fees based in part on the weight of the money they move, and they don’t get paid a lot. Bank of America typically handles hundreds of millions of dollars a day for about two hundredths of a percentage point of the face value, people familiar with the process said. At that rate, shipping $100 million only brings in about $20,000. Bank of America’s total global revenue from the business is about $100 million a year, these people said.
I always feel a little bad for (accused) insider traders like this:
The SEC alleges that Dr. Edward Kosinski of Weston, Connecticut, traded in advance of two negative news announcements by Regado Biosciences, which was pursuing a drug called REG-1 to regulate clotting in patients undergoing coronary angioplasty. Kosinski, who served as principal investigator of the drug trial, got advance notice that patient enrollment in the trial was being suspended because patients had experienced severe allergic reactions. He allegedly sold all 40,000 shares of his Regado stock the following day to avoid approximately $160,000 in losses when the news became public and the stock price dropped.
I mean, he wasn't supposed to have the stock in the first place -- he allegedly bought it without disclosing to Regado, despite signing an agreement saying he would -- but still. If you own a ton of stock in a company, and you get secret bad news about that company that will crater the stock, it is tough to just sit on that news and wait for your stock to go down. Loss aversion is a powerful thing. I don't feel too bad for him, though; after he was out of the stock, he allegedly went and bought short-dated out-of-the-money put options to make some more money when the company disclosed that its drug had caused a patient's death. (He made about $3,291 on that one.) He has also been charged criminally.
Speaking of criminal charges, here's a Manhattan federal indictment of 46 people accused of being in La Cosa Nostra. The alleged mob crimes range from health-care fraud to instructing an associate to "keep the pipes handy and pipe him, pipe him, over here [gesturing to the knees], not on his head." Plus a little gun trafficking:
During this recorded meeting, Mastrovincenzo asked CW-1 and ZINZI how many guns he should get, and ZINZI told Mastrovincenzo, “at least a hundred.”
The alleged mob nicknames range from "Anthony Vazzano, a/k/a 'Tony the Wig,' a/k/a 'Muscles,'" to "Bradley Sirkin, a/k/a 'Brad.'"
People are worried about unicorns.
Hootsuite Media Inc., one of Canada’s few unicorn tech startups worth $1 billion dollars or more, says efforts to shore up operations -- including cutting staff and hiring a new chief financial officer -- have helped it become cash-flow positive. The news is a welcome bright spot after a tough year and could help pave the way for a public offering.
It's been tough for the narwhals, I guess, but now that Hootsuite is cash-flow positive it can lead them out of the Enchanted ... Northwest Passage? ... and into the public markets.
People are worried about stock buybacks.
People are worried that BlackRock, which is worried about stock buybacks, is not sufficiently worried about stock buybacks:
Despite their CEO's strong views, funds run by BlackRock side with company management on questions tied to stock buybacks most of the time, according to filings analyzed by research firm Proxy Insight for Reuters.
"Larry Fink’s letters demonstrate that leadership," says an AFL-CIO official. "We hope it's not all posturing." I have bad news for you! Not only does BlackRock vote with management on most buyback questions -- even though Fink, its CEO, worries about buybacks as a symptom of short-termism in corporate America -- but BlackRock itself does lots of buybacks. What if ... what if worrying about stock buybacks really is all posturing?
People are worried about bond market liquidity.
Here's Alexandra Scaggs on the difference between equity markets -- which rapidly and (relatively) easily electronified and disintermediated the big banks in the 1990s, with day-traders and "SOES bandits" leading the way -- and debt markets, which are big and institutional and are now having a hard time dealing with the retreat of big bank intermediation:
That risk has been pushed off of banks’ balance sheets — and into the hands of institutional investors.
Those institutions could hardly be more different from the disruption-friendly SOES bandits. They’re the Old Guard, with legacy relationships, compliance requirements, and good old-fashioned (non-digital) social networks.
Elsewhere, the Bank of England will be buying corporate bonds, so get ready for more articles about how the European Central Bank's corporate bond-buying program is dangerous for liquidity, only with the BOE swapped in for the ECB.
Goldman Questions How Quickly It Can Unload Private-Equity Holdings. RBS posts £1bn loss as it ditches Williams & Glyn spin-off. China Moves Toward Launching Credit-Default-Swap Market. Crude Slump Sees Oil Majors’ Debt Burden Double to $138 Billion. Apple Can Sell Power as Tech Giants Boost Energy Investments. Shocker! Facebook Changes Its Algorithm to Avoid ‘Clickbait.’ Can Twitter Fit Inside the Library of Congress? Tesla’s Grand Plans for SolarCity Burn a Key Israeli Solar Tech Firm. James Stewart on Tesla/SolarCity. Izabella Kaminska on the Bitfinex hack. Goldman Sachs just promoted its first round of ‘power 22 year-olds.’ The Fed's interns are tweeting. Harvard Republican Club Will Not Support Party Nominee Donald Trump. This Summer, Cut Your Watermelons With A Flaming Sword. Man leaves casino, robs bank, returns to casino, police say.
If you'd like to get Money Stuff in handy e-mail form, right in your inbox, please subscribe at this link. Thanks!
To contact the author of this story:
Matt Levine at firstname.lastname@example.org
To contact the editor responsible for this story:
Brooke Sample at email@example.com