Tax Fights and Research Changes

Also share repurchase, whistle-blowers, blockchain for guns, Swiss stock buying, etc.

Apple tax.

Honestly I am very confused by the U.S. political reaction to yesterday's European Commission ruling that Apple owes Ireland $14.5 billion in back taxes and interest:

Democrats, Republicans and U.S. corporate groups all criticized the commission on Tuesday, with the Business Roundtable, a group of major-company chief executives, calling the decision an “act of aggression.”

“Countries ought to be working in partnership to prevent tax evasion and crack down on the unfair practices that have eroded tax bases in the U.S. and around the world, but today’s ruling could make that kind of partnership more difficult,” said Ron Wyden of Oregon, the top Democrat on the Senate Finance Committee.

The essential insight here is that Apple is really a U.S. company, and its profits really belong in the U.S., so Ireland's decision not to tax Apple's European profits and attribute them instead to the U.S. was correct. Apple Chief Executive Officer Tim Cook's letter explains it well: 

At its root, the Commission’s case is not about how much Apple pays in taxes. It is about which government collects the money.

Taxes for multinational companies are complex, yet a fundamental principle is recognized around the world: A company’s profits should be taxed in the country where the value is created. Apple, Ireland and the United States all agree on this principle.

In Apple’s case, nearly all of our research and development takes place in California, so the vast majority of our profits are taxed in the United States.

Right, right, I am totally with everyone so far. Apple, Ireland and the U.S. all agree that Apple's European profits mostly belong in the U.S., so they all agree that they should be mostly taxed in the U.S. So Ireland mostly doesn't tax them. And the U.S. ... hang on a minute, the U.S. also doesn't tax them:

Until Apple changed its structure in 2015, the company used subsidiaries that slid neatly between U.S. and Irish tax laws. According to a 2013 U.S. Senate investigation, Ireland saw the companies as resident in the U.S., because they were managed and controlled from California. The U.S. considered them foreign entities not subject to immediate tax because they were registered in Ireland.

The clearest explanation is still the European Commission's great diagram yesterday: Apple's European profits were allocated, not to the U.S. for immediate taxation, but to a cloud floating over the Atlantic, with a tax rate of zero. So the essence of the U.S. response is something like: Hey, Europe, you can't tax Apple's Irish profits, because we already have dibs on not taxing them. 

Now yes of course the U.S. system is to tax profits of U.S. companies even when they are earned abroad, so Apple's European earnings are taxable in the U.S. (And the taxes it pays in Europe are deductible against those U.S. taxes.) But they're only taxable when they're repatriated from the Irish subsidiaries back to the U.S., and Apple, with its massive cash pile abroad and limitless ability to borrow in the U.S., is in no hurry to do that. If the U.S. moved to a more normal corporate tax system -- taxing profits based on where they're earned and immediately, rather than globally but not yet -- then this controversy would have less sting. But the U.S. is no hurry to do that, either.

Meanwhile, Apple may have to stump up the $14.5 billion to Ireland while it appeals, but, like, what else is it doing with its massive pile of money? Honestly investing $14.5 billion with a European sovereign at zero interest is pretty good these days. 


I sometimes like to say that "the whole business of financial services is about flinging free things at clients in the hopes that they will give you some extremely overpriced paying work," and among the most-flung free items in the financial world is sell-side research. A bank hires some smart analysts, they write some smart stuff, they send it to the salespeople, and the salespeople blast it out to the clients saying "see how smart we are? Now do some trades with us." And the salespeople collect commissions. And the analysts get paid out of those commissions, and bask in the vague glow of knowing that they helped out the team in some nebulous way.

Helping out the team in a nebulous way is great! Having specific attributable revenue lines, with targets that you have to meet, is no life for the lady or gentleman of taste and discrimination. But Europe's upcoming anti-bundling rules, which will essentially require banks to charge directly for their research rather than "bundling" it into the costs of trading, are taking the fun out of research, and forcing UBS's head of research to do stuff like this:

He has used psychologists to help analysts think about their topics differently, and pinpoint more precise and insightful research questions. Words such as “risky” are discouraged, because Mr Perez said research showed “risky” could be interpreted as a risk of failure of between 10 and “80 something” per cent to investors.


“It’s not just to avoid the word risky,” he added. “[It is] to try to break down the big questions, like ‘what is the future of the bank into testable propositions’ that can have an incontrovertible answer.”

They are also using a Question Bank to cultivate questions from clients directly, although not all are considered. “An analyst or economist can ask you a question for which you have no answer, or the answer is incredibly difficult to find,” said Mr Perez. “For example, a huge problem that we don’t consider solvable within our domain of expertise is the implications of climate change.”

One day you are effectively your own boss, thinking about the big questions, writing about the things that you think matter. The next day there's some psychologist looking over your shoulder, editing your word choices, telling you to focus only on questions that your clients have asked and that have incontrovertible answers. 

It is all a little reminiscent of the media business, which was built on vague unattributable cross-subsidization, and where technology then developed to the point where it was easy to figure out exactly how much economic value each article gives to its publisher. The effects of that have not been entirely good.

Equity-financed equity repurchase!

One thing that I used to do in my old job was help companies issue convertible bonds to buy back stock. It's a bit of a weird business: Issuing the convertible is kind of like issuing stock, so it feels a little like the company is just issuing stock to buy back stock, while its bank takes a fee. But it's not really like that; the instruments and payoffs are different, and you can draw a little cost of capital chart and show how it benefits the company, especially if the stock goes up. Still, it can be awkward. One approach is to embrace the awkwardness. When coverage bankers called to ask for suggestions for companies in rough situations, the idea of the "equity-financed share repurchase" sometimes came up. The trick was to advise the bankers, with a straight face, that the company should issue common stock and use the proceeds to buy back its common stock. What fun we had.

Come to think of it, the basic long-term story of the U.S. public equity markets is companies issuing stock and using the proceeds to buy back stock, though not usually as a single trade.

Anyway here is Ronald Barusch scratching his head at the question: "Why Did Signet Jewelers Sell Equity to Buy Equity?" The equity that it sold (to Leonard Green & Partners) was a voting convertible preferred, so perhaps Signet had some cost-of-capital reason for it, but probably Barusch is right that the basic answer was a governance one: Leonard Green has agreed to vote its new preferred (which is voting stock, and controls 8 percent of the vote) along with management, and the deal provides Signet "validation of its value proposition and sound counsel in troubled times for the company, as well as its expertise in the retail industry as it faces a complex decision on what to do with its credit business." Selling equity to a big private equity investor, and using the proceeds to buy back equity from dispersed public holders, is actually sort of a plausible trade, economics aside.


It is sometimes interesting to keep track of what sort of commission is viewed as reasonable in different markets. In the equity markets, if you make 3 cents on a trade of a $50 stock -- 0.06 percent -- you are living pretty high on the hog. Residential mortgage-backed securities traders would apparently lie to customers to get paid something like 2 percent of the bond's value. The going rate for smallish initial public offerings is 7 percent. Hedge fund managers often get 20 percent of their investors' profits, plus 2 percent of their assets. And Securities and Exchange Commission whistle-blowers seem to be averaging about 21 percent:

More than $107 million has been awarded to 33 whistleblowers, with the largest being more than $30 million. (see Top Ten list)

Because of the information and assistance provided by these whistleblowers, the SEC was able to bring successful enforcement actions where more than $504 million was ordered in sanctions, including more than $346 million in disgorgement and interest for harmed investors.

I don't think that even counts the whistle-blower award that Eric Ben-Artzi rejected

Blockchain blockchain blockchain.

This is not a blockchain story at all, but it is a story about the National Tracing Center, the federal agency that traces guns used in crimes, which is not allowed to have a computer database due to a 1986 federal law. So they look through records on paper, and microfilm, and eventually non-searchable PDFs, to find guns. It seems ... terrible.

Obviously a better system (for the users of the database, anyway) would be to combine The Blockchain and The Internet of Things, embed a chip in every gun, require transfers to be registered on a blockchain, and then have an immutable auditable searchable ledger of all gun transactions that could quickly tell you the history of each gun. But just typing the records into Excel would also be a pretty big improvement over the status quo. The determining factor is not technological, it is social and legal and contextual. The problem is getting people to agree that a database is desirable and to work together to build one; the actual database architecture is, relatively speaking, trivial.

I think this way about a lot of blockchain-for-banking discussions. Sure, fast computerizing syndicated loan settlements would be good. Maybe do it on a blockchain, whatever. But the key problem to solve is getting the participants in the market to agree to work together to improve settlement mechanics, not the technical problem of what the best computer system for settlement would be. 

Elsewhere in technical problems with computer systems for settlements:

SWIFT, the global financial messaging system, on Tuesday disclosed new hacking attacks on its member banks as it pressured them to comply with security procedures instituted after February's high-profile $81 million heist at Bangladesh Bank.

In a private letter to clients, SWIFT said that new cyber-theft attempts - some of them successful - have surfaced since June, when it last updated customers on a string of attacks discovered after the attack on the Bangladesh central bank.

"SWIFT told banks Tuesday that it might report them to regulators and banking partners if they failed to meet a November 19 deadline for installing the latest version of its software," which sounds like something Adobe would say to me. Oh and here is a Bank of Canada working paper "On the Value of Virtual Currencies."

Swiss stock buying.

If you are worried about stock indexing pushing up stock prices without regard for fundamentals, and eventually leading to communism, what do you think about the Swiss National Bank's stock purchasing?

The Swiss National Bank has become a multi-billion-dollar equity investor due to its campaign to hold down the Swiss franc.

It is now the world's eighth-biggest public investor, data from the Official Monetary and Financial Institutions Forum show

And: "The SNB does not comment on the details of its strategy, but says it does not pick stocks, investing instead in companies according to their weight in various indices." That is not so different from Vanguard, which owns vastly more stocks than the SNB does, but the fact that the SNB is buying stocks for monetary policy rather than retirement savings creeps people out a little:

"The SNB creates Swiss francs out of thin Alpine air," said James Grant, publisher of Grant's Interest Rate Observer, a U.S. financial markets journal.

"Then they go and call their broker and go on a tour of the U.S. stock exchange," he told Finanz und Wirtschaft newspaper. "They get involved in important companies from the S&P which create real profits, and they do that with money which has been created out of nothing."

I mean, fiat currency is a weird and vertiginous concept, but it's been around for a long time now!  You gotta get used to it at some point.

A finance anecdote.

It's from Max Abelson and Zachary Mider in Bloomberg Businessweek, and it's about Steven Mnuchin, Donald Trump's national finance chairman. Here you go:

Mnuchin drove a Porsche in college, two friends say. His classmate Michael Danziger, an heir to a pharmaceutical fortune, says he was also tapped to join Skull and Bones but turned down the secret society. “You’re going to live to regret this,” he recalls Mnuchin saying. Danziger, who knew his classmate was headed into finance, says he answered: “You put the ‘douche’ in fiduciary.” Mnuchin says the exchange never happened.

I tend to believe Mnuchin here; that doesn't even make sense as a comeback.

It's so boring.

Everything is so boring that I feel like I keep reading the same article about how boring it is:

By some measures, the S&P 500 has been trading in its narrowest range in decades, a sign of just how muted market activity has been. In the 17 trading days through last Thursday, the S&P 500 moved less than 0.75% between its daily high and low. That is the most consecutive days with such a narrow trading range in records that go back to 1970, according to Ryan Detrick, senior market strategist at LPL Financial.

But: "September Could Be Huge for Markets All Around the World."

People are worried about unicorns.

Really why wouldn't you worry about In-Q-Tel, "a venture-capital firm in Virginia funded by the Central Intelligence Agency"? I mean, first off: unicorn spies! That just seems alarming. But also, that name is easily a bottom-decile venture-capital fund name. I honestly can't think of a worse VC fund name, though I am looking forward to your nominees. What does it say about the U.S. national security apparatus that it can only barely manage to name a venture-capital fund? Also there are potential conflicts of interest:

Nearly half of In-Q-Tel’s trustees have a financial connection of one kind or another with a company In-Q-Tel has funded, a Wall Street Journal examination of its investments found.

In-Q-Tel’s hunt for promising technology has led the firm, on at least 17 occasions, to fund businesses that had a financial link of some sort to an In-Q-Tel trustee.

Elsewhere, "Google is moving onto Uber Technologies Inc.’s turf with a ride-sharing service to help San Francisco commuters join carpools." The problem with Uber seems to be that its drivers are paid too much, so Google "has said it aims to make fares low enough to discourage drivers from operating as taxi drivers." It's the sharing economy, but with pay capped at a place where it feels like actual sharing.

Oh, and needless to say Theranos's Zika test is a disaster:

Theranos Inc. withdrew its request for emergency clearance of a Zika-virus blood test after federal regulators found that the company didn’t include proper patient safeguards in a study of the new test, said people familiar with the matter.

People are worried about stock buybacks.

"Kiss it goodbye, the great buyback boom is on the wane." This recurring section started because people worried that there were too many buybacks, that they are a symptom of corporate short-termism that deplete research and development and harm the economy. But I guess they are going away now. 

People are worried about bond market liquidity.

Here is Michael Hyland with a fun idea to improve Treasury market liquidity by expanding the ability to reconstitute Treasuries from STRIPS:

Changing the Treasury Department’s STRIPS reassembly rule to allow for reconstitution of any outstanding security, rather than just the original security, offers an easy-to-implement opportunity to increase on-the-run Treasury liquidity and revitalize the off-the-run portion of the market.

The idea of "Separate Trading of Registered Interest and Principal of Securities" is that, say, a 5 percent 10-year Treasury bond can be disassembled into 20 semiannual 2.5 percent interest coupons, and one zero-coupon 10-year principal repayment, and the interest and principal bits can trade separately. Or you can put them back together, but only in their original form. Hyland's idea is that if you have, for instance, 10 years of 6.75 percent interest lying around from an off-the-run 10-year bond, and also the stripped principal of that bond, you can reassemble them into (1) a new on-the-run 10-year bond with a 1.5 percent coupon and (2) the leftover interest STRIPS. So you have transformed an off-the-run 10-year into an on-the-run one (plus some extra interest), improving its liquidity by careful slicing and blending. What's not to like? 

Things happen.

Cryan Shoots Down Merger Report as Deutsche Bank Shrinks. Icahn: Ackman is the one backed into a corner on Herbalife. The Gamble of Tronc’s ‘Just Say No’ Defense. Banking Regulators, Facing Criticism, Seek to Dispel Myths on Money-Laundering Rules. BCG's 2016 M&A Report. How's Neuromama doing? (Earlier.) FDIC Fund Climbs to Postcrisis High. Italy's Monte Paschi may swap bonds for shares to ease cash call. Visium Hedge Fund Informant Recorded 125-Plus Conversations. Caesars wins lawsuit shield to pursue 'uphill' appeal. Goldman Sachs Said to Have Lost $1.8 Billion U.S. Property Deal. Capitalism and democracy: the strain is showing. "If you act the way Trump talks you’re going to pull down a 70-year-old system that got us out of the Great Depression and helped the U.S. become the strongest economy in the world." In Donald Trump, Gold Bugs See a Kindred Spirit. Driverless cars to display road etiquette with emojis. Bank of America: These Stocks Will Surge When Millennials Start Making More Money. Generation Z Will Out-Earn and Outwork the Rest of Us. This teen programmer built a robot lawyer that helps poor people. Happy Burning Man I guess. Indie crosswords. A theater review. Scary clowns. Dogs are geniuses

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