Magic Tricks and Vanishing Directors

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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Art and magic.

Here is a U.S. patent application for a "Computer Assisted Magic Trick Executed in the Financial Markets." Here's the trick:

The magic trick is a methodology of identifying a number of securities of publicly traded companies which are ideal targets for short selling. The process starts with utilizing a computer system to scrape publicly available information on the internet about a company. The system then searches for social connections between a target company and a company which has been previously successfully targeted for a short selling campaign. Evidence which would cause a change in the perceived value is collected and disseminated. A magic show is performed where the perceived value of the target company is first increased and then sharply decreased. 

So the trick is ... a short-selling campaign? A pump-and-dump? But: for Art? Or: for Magic? The people behind it appear to be two Stockholm-based artists, and one of them apparently used the trick as his Ph.D. thesis. Here is more:

Zero Magic was developed by covertly infiltrating a secretive hedge fund specializing in short selling, and reverse engineering its methods. In brief, the hedge fund’s trading strategy is based on identifying suitable short selling targets through analyzing networks of corruption, and then framing critical newsworthy stories about these target companies that can be anonymously distributed among journalists. Profit is gained when a target company loses in value. Rigorous measures are taken by the fund never to be identified as the source of a negative campaign.

Access to the hedge fund was gained through the art world. The founder and co-director routinely supports artists and art institutions and is said to have gotten the idea for his fund when looking at a Mark Lombardi drawing (an artist known for mapping networks of power and corruption). It is hard to tell whether the founder’s engagement with art merely entertains personal vanity, or if it functions more strategically as a means of “secret publicity” for the fund; giving access to investors, while staying under the radar of more mainstream public relations. Covert techniques such as hidden recordings and proxy researchers were used to uncover the fund’s methods.

Huh. Here is a PDF of the trick, which really does look for all the world like a short research report about a small drug company that trades in the over-the-counter market. There are no cryptic runes invoking the power of the dark arts, or lush oil paintings of the stock chart; it's just a research report. As with Duchamp's "Fountain," the art consists in calling it art. The magic consists in convincing people that it's magic. The financial manipulations themselves are art, and magic, even though they are also the typical financial manipulations that lots of micro-cap short sellers use. The deep lesson here is that the world of finance is everywhere enchanted, that it is suffused with the values of art, and that its simplest components can be carried over to the art world unchanged and get you a Ph.D. They should put synthetic collateralized debt obligations in the Louvre.

Anyway the trick allegedly was performed on April 21 of this year, and the stock did in fact go up a bit, and then down by some 33 percent, over the next three weeks, so there you go.

I have no idea what parts of this are real, or what "real" even means any more. My investing advice to you is: If you are planning to manipulate the stock market, make sure you have art-gallery representation first. (Probably legal representation too!) I have had a couple of occasions recently to mention my favorite stock-manipulating artist, Sarah Meyohas, who traded small-cap stocks to "delineate intention" and then painted the results. I said:

Sometimes I hope there are more artists like her out there, founding and marketing and inflating multibillion-dollar companies not because it is profitable to do that, but because it is beautiful. Or at least funny.

Good lord are there. Some of them do it to get Ph.D.'s in Sweden, but even the regular pump-and-dumpers are, in their way, making art.

Corporate elections.

Yesterday Keith Meister's Corvex Management launched an absolutely delightful proxy fight against The Williams Companies, the gas pipeline company whose proposed merger with Energy Transfer recently fell apart. Meister had actually been on the Williams board until June, but then he and five other directors "resigned from the Board following a fundamental disagreement with the remaining directors over the future leadership of the Company." Now he wants back on. In fact, he wants to replace the whole board. So he is running a proxy fight to put 10 new world-class directors on the board. The only problem is that today is the deadline that Williams has set to nominate directors, and Meister hasn't picked his directors yet. He's sure they will be awesome, but it'll take a little time to find them. So he's nominating some placeholders:

Corvex has today submitted to Williams the names of ten Corvex employees, reflecting the number of directors expected to be up for election in November. These individuals will, in effect, act as placeholder nominees. They will seek election as the entire Williams Board at the 2016 Annual Meeting. These Corvex employees are not intended to be the permanent directors for Williams, but their nomination satisfies the August 25th nomination deadline and gives us time to select a slate of long-term directors.

Over the next several weeks, Corvex will identify new, independent director candidates who it envisions would serve as long-term directors of Williams. Corvex will disclose this list of nominees to comprise the Williams Board for the long-term (the “Stockholder Selected Board Members”), and full information on those nominees and their qualifications will be provided in the Corvex proxy statement well in advance of the Annual Meeting.

If the placeholders are elected, they'll appoint the real directors to the board, and then resign.

Is that legal? I mean, I don't know, it seems legal-ish. Corporate law allows all sorts of weird formalities (like that August 25 deadline) that are stacked against shareholders, and my general view is that, if shareholder can come up with a plan that technically satisfies the weird formalities, it shouldn't matter too much that the plan is ridiculous. Ronald Barusch analyzes the question; he too seems cautiously optimistic. There are skeptics, though; Kirkland & Ellis told clients that "the Corvex tactic is untested and may not survive a court challenge."

Corporate democracy is a more flexible -- though less democratic -- instrument than regular democracy. I sort of like the idea of people running for election with a promise to resign and appoint someone more qualified if they win. More elections should work like that.

Warren Buffett convertible arbitrage!

Here is a fun story about Berkshire Hathaway's investment seven years ago in Dow Chemical convertible preferred stock. That stock will automatically convert into common stock -- cutting off Berkshire's juicy preferred dividend -- if the common stock trades above $53.72 for 20 out of any 30 trading days, but the stock is weirdly stalled just below that cutoff, and Dow thinks it knows why:

Dow believes someone is selling the stock short—or betting that its price will fall—to keep it from rising above $53.72, according to people familiar with the matter.

Mr. Buffett declined to comment on whether he or his company have been shorting Dow’s shares as a way to exert downward pressure on the stock and avoid triggering the conversion.

One (probably unrelated) thing to say here is that people sometimes confuse convertible arbitrage with stock manipulation, since they really differ mostly in intent. Berkshire bought a convertible security in Dow. There is a classical way to trade convertible securities; books have been written about it, and it is quite popular. It is called "convertible arbitrage." The convert-arb way to trade a convertible preferred is to short common shares against it, to hedge your stock-price risk. There are Black-Scholes-ish formulas to help you decide how many shares to short; generally, the number is between zero and the number of shares that the preferred stock can convert into. And the number goes up as the stock approaches the mandatory conversion price: A way out-of-the-money convertible preferred is mostly a fixed-income instrument, but a preferred that is about to convert is mostly equivalent to common stock, so you should be short pretty close to 100 percent of the underlying shares as a hedge. So if the stock is at $45, you'd be short some stock, and then as it goes up to $53 you'd short more stock, and that would have the tendency to push the stock down. So just by doing a regular convertible arbitrage strategy, you automatically dampen volatility, especially near the automatic conversion price, and so you automatically reduce your chances of conversion.

To a convertible arbitrageur, this looks like the most natural thing in the world, but to the issuer of the preferred it can look like manipulation. Especially if the issuer is sick of paying the preferred-stock dividend.

Back when I built convertible bonds, I never knew Berkshire Hathaway to engage in much convertible arbitrage, and I'd be pretty surprised if it does so now! Seems a little fancy for Warren Buffett. But you never know.

Some Glass-Steagall.

Here are a bunch of people musing at The Atlantic about whether Congress should bring back Glass-Steagall, and what that would mean. I do not expect Glass-Steagall to come back, despite the fact that both major U.S. political parties purportedly support it, in part because these days "bring back Glass-Steagall" seems to be almost as empty a slogan as "Make America Great Again." It just means that you want to express distaste for big banks, without any particular regulatory content. Bringing back something like the old Glass-Steagall Act -- a law separating commercial and investing banking -- does not strike me as a great idea, but there seems to be widespread political consensus that we have to do something dumb about financial regulation, and among the dumb financial-regulatory things we could do, bringing back Glass-Steagall seems relatively harmless.

Anyway this jumped out at me, from Sheila Bair's contribution:

It is important to understand that not all supporters of reinstating Glass-Steagall are financial reformers. There is some (quiet) Wall Street support as well. I think their hope is that by forcing investment banks to separate from commercial banking, the investment banks would once again be free of prudential oversight by the Fed.

That strikes me as not wrong, but also kind of a weird hope? Like, in 2008, there were big investment banks that were separate from commercial banking and free of prudential Fed oversight. One of them was Lehman Brothers. (Two more were Goldman Sachs and Morgan Stanley, which soon flipped into Fed-supervised banks.) It didn't ... go great? Like if your hope for a new Glass-Steagall is to separate deposit banking from investment banking, and then have huge systemically important investment banks doing shadow-banking activities free of Fed oversight, then ... I mean that is a perfectly reasonable thing to want, if you are an investment banker with lots of clever risky ideas who feels hampered by regulation. But it's a weird thing for a financial reformer to want.

Meanwhile banking is about borrowing at low rates and lending at higher rates, even when the bank is Goldman Sachs

Private equity fees.

Here is a very boring Securities and Exchange Commission private equity fee allocation case, this one against WL Ross & Co. Basically WL Ross charged portfolio companies transaction fees, and then offset (a portion of) those fees against the management fees that it charged its funds that invested in those portfolio companies. But sometimes WL Ross would invest in a portfolio company alongside co-investors -- with, say, 40 percent of the money coming from WL Ross funds, and 60 percent coming from co-investors -- and the company would pay a transaction fee to WL Ross. Then WL Ross would apply (say) 40 percent of that fee to the management fees it charged its own funds, and just keep the other 60 percent, because it's not like it charges the co-investors management fees. That seems ... fair-ish? Like, debatable, but not obviously crazy? Apparently it was not particularly well disclosed, though.

Anyway eventually WL Ross itself decided it was bad, and refunded $10.4 million of fees (plus $1.4 million in interest) to its investors, and came to the SEC to apologize, and the SEC fined it $2.3 million, because the SEC is really not a fan of non-transparency in private equity fees. "This resolution reflects a proactive approach to handling the matter and our commitment to exceeding the expectations of today’s private equity market," says a WL Ross spokesperson, but the SEC seems to think that that's a pretty low bar.

Elsewhere in bad disclosure, here are 71 (!) SEC cases against municipal-bond issuers for having bad disclosure. Or, strictly, for having bad disclosure about their previous bad disclosure:

Minnesota, for example, told investors that it hadn’t failed to comply with disclosure requirements in bond issues in 2011 and 2013, when in fact it had failed to file required audit reports in 2008 and 2010 for previous bond issues, according to the SEC’s order.

The 71 issuers agreed to knock it off.

Corporate culture.

Hey guess what, companies have ruined "Office Space":

The message behind “Office Space,” which eviscerates soulless American corporate culture, is being newly embraced as companies plan employee retreats around printer bashing.

At Alamo Drafthouse theaters across the country, companies clamor to book “Office Space” viewing parties. Employees watch the movie with work-themed props in hand—think tiny staplers for all—before taking a printer out back and crushing it. Whoever wins the best-excuse-to-get-out-of-work contest gets to take the first swing.

I think that is the worst thing I have ever read. "Yeah I'm gonna need you to come in tomorrow for an 'Office Space'-themed team bonding exercise." Nope! The lesson is that corporate culture is powerful enough to appropriate any criticism for its own use.

People are worried about unicorns.

Here is a joke about Soylent, or I guess it's a real story about Soylent, who even knows:

Rob Rhinehart, CEO and co-founder of the Los Angeles-based meal-replacement startup, arrived in a white truck emblazoned with the company’s logo, alongside the actor Josh Brener, who plays the character Nelson Bighetti, or Big Head, in Silicon Valley. The truck, too, was an inside joke: cartoon Soylent trucks appear in the show’s opening credits, and Rhinehart said that inspired him to make one in real life.

The entrepreneur and actor were touring California’s actual Silicon Valley to pitch Soylent’s latest products, out this month: Coffiest, bottled nutrient sludge combined with coffee, and Food Bar, a caramel-flavored slab of soy protein, algal flour, and isomaltulose.

Okay fine but I don't understand why the bottled nutrient sludge is called "Coffiest" and not "Bottled Nutrient Sludge." That would be great branding! Apparently? 

People are worried about stock buybacks.

No, today the role of stock buybacks will be played by dividends:

Dividends are playing an unusually large role in the stock market’s run to record highs, adding to investors’ concerns about stretched valuations and soft corporate earnings.

The five-year rolling correlation between S&P 500 companies’ dividend yield and the index’s performance has been at 0.80 or above for the five quarters through June, according to S&P Global Market Intelligence. That is the highest since 1993 and up from an average of minus-0.1 dating back to 1941.

Buying stocks instead of bonds, because the stocks yield more, is "a strategy that some analysts warn could expose buyers to the risk of large capital losses that could wipe out years of income."

People are worried about bond market liquidity.

This section achieved self-referentiality yesterday, for at least the third time (the first two involved Guy Debelle), and it has gotten so boring that I am tempted to raise the degree of difficulty. Like, from now on, I should only have to have a "people are worried about bond market liquidity" section if the people worrying about bond market liquidity also cite this section of Money Stuff in worrying about bond market liquidity. Is that too much to ask?

Probably! Anyway here's a Kroll Bond Rating Agency report about "Low Rates, Low Growth & Falling Market Liquidity." It doesn't mention me. Also: "Are traders allowed to front-run customer orders in the Treasury market?"

Me yesterday.

I wrote about communism. It sort of spiraled off into absurdity about algorithmic investing solving the socialist calculation problem for capital allocation. At which point, I asked, "what do you need markets for?" I had an answer ("freedom"), but James Grimmelmann pointed out that another one is "to elicit accurate preferences." Quite right! My socialist-calculation fantasy was really just about financial markets -- the markets for allocating capital among businesses -- rather than about markets for real goods and services. In financial markets you probably don't need to worry as much about different people's different preferences. Some people like apples and some people like bananas, but as a first cut it seems reasonable to assume that everyone likes higher returns and lower risks. (Or almost everyone.) Though obviously in our real world different people have different ways of balancing those preferences too.

Things happen.

America’s Biggest Banks Have a New Name for Their Venmo-Killer: Zelle. U.S. Regulators Step Up Scrutiny Around Swift. Hedge Funds See Biggest Redemptions Since ’09 as Returns Lag. Disarming Holdouts in Sovereign Debt Restructurings. Regulators Approve Hemp Derivatives Exchange. We’re Paying CEOs All Wrong. Investors Renew Appetite for Europe’s CoCo Bonds. Bond Traders Are Desperate for Direction From Yellen in Jackson Hole. China’s Central Bank Moves to Clamp Down on Speculation. High-Speed Trader IMC Under China Stock-Index Futures Probe. Izabella Kaminska on blockchains and real-time gross settlement. At BlackRock Even a 40% Gain Can’t Save ETFs From the Trash. One of Peter Thiel's fellows created a new startup that will fund your lawsuit. Putnam Adds Ex-Morgan Stanley Executive Greg Fleming to Board. Is the Securities Industry Cleaning Up Its Hiring Practices? Nope. Duke University Makes Claim on Estate of Aubrey McClendon. Meet the matchmaker who sets up dates for Goldman Sachs bankers for a £9,000 annual fee. "Martin Shkreli on the death of Harambe." Guy Who Spent 16 Years Marinating In Jim Simons’ Second-Hand Smoke Seeking Fountain Of Youth In Toilets. Whisper whiskies. Happy National Duck Out for a Drink Day!

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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