Injured Bankers and Merger Votes

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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Wells Fargo.

Yesterday Wells Fargo & Co. Chief Executive Officer John Stumpf testified before the Senate Banking Committee, and I guess he got beaten up before the hearing? Or broke his hand punching a wall? In any case, his swearing-in produced what may be the defining image of the financial industry in the 21st century:

Photographer: Win McNamee/Getty Images

The official explanation is that he "injured his right hand while playing with his grandchildren," but whatever it was, it was probably less painful for him than the actual hearing. Highlights included Elizabeth Warren calling him "gutless," demanding that he resign and telling him that he should be in prison. No one exactly piped up to disagree.

The other day I wrote some dumb rhymes and offered them as my qualifications to be the CEO of a big bank. I take it back! I don't want that job; it seems terrible. Sometimes you get yelled at by senators and have to just sit there and take it. Whenever I watch congressional hearings, I am struck by how much time is spent on a search for personal villainy, for a rich banker to blame and yell at and maybe imprison, and how little time is spent on developing an understanding of systemic problems that can be addressed by carefully crafted legislation. Oddly, many of the Republican senators who lit into Stumpf yesterday also want to get rid of the Consumer Financial Protection Bureau.

Meanwhile in personal villains, former Wells Fargo consumer-bank head Carrie Tolstedt was the absent villain at yesterday's hearings, with lots of demands to claw back her compensation. But "Clawing Back Bankers’ Pay at Wells Fargo Is Harder Than It Looks": For Tolstedt, probably only her $19 million of unvested stock awards can be clawed back, not the nine figures of lifetime total compensation that senators mentioned during the hearing. I mean, $19 million is not nothing, but it's hard to imagine the Senate being satisfied with it either.

Merger voting.

We have talked a bunch around here about the potentially anti-competitive effects of mutual-fund cross-holdings, the idea being that investors who own shares in multiple companies in the same industry may not care too much for vigorous margin-reducing competition in that industry. And we talked a bit yesterday about the effects of cross-holdings on merger votes, the example there being that shareholders of Tesla might vote for its acquisition of SolarCity not so much because the deal is good for Tesla, but because it is good for SolarCity, and those shareholders are also SolarCity shareholders. But here is a pretty amazing passage about the SABMiller/AB InBev deal that combines both themes:

Bankers advising SABMiller and AB InBev are monitoring the situation, but remain confident the deal will get approved, according to people familiar with the matter.

Part of the reason for that confidence is that several of SABMiller’s large shareholders, including BlackRock Investment Management (UK) Ltd. and State Street Global Advisors Ltd., also own stakes in AB InBev and Molson Coors Brewing Co., according to FactSet data.

That raises the likelihood they will vote in favor of the deal, because AB InBev and Molson Coors are due to acquire SABMiller assets. The BlackRock and State Street funds combined own roughly 2.8% of SABMiller shares, according to FactSet.

Voting against the deal “would be the equivalent of shooting yourself in the foot,” said Stifel analyst Mark Swartzberg.

SABMiller's big public shareholders -- diversified funds at BlackRock and State Street -- may vote for the deal not (solely) because it is good for SABMiller (the target), but also because it is good for AB InBev (the acquirer) and Molson Coors (a third party that will buy some assets to meet antitrust requirements), and they are shareholders of those companies too.

From a merger-strategy-and-governance perspective, that is, you know, an interesting data point. (If you are a director of SABMiller, how should you think about your fiduciary duties to those shareholders? Should you care at all about their broader interests, or just focus on getting them the best deal as SABMiller holders?) But from an antitrust perspective, it is pretty disturbing. We are talking here about the combination of two of the biggest beer companies in the world, with some of their assets being offloaded to a third beer giant. And some shareholders may want this because they own stakes in all three companies. They are in effect just shifting their assets from one pocket to the other in a way that optimizes their total return; it is not too hard to believe that some of that return will come out of the pockets of beer drinkers. I have always been a little skeptical of the mechanisms by which diversified shareholders could actually cause industries to be less competitive, but I am becoming more convinced.

By the way, several people pointed out yesterday that this sort of analysis of cross-holdings and votes is a bit too simplistic. When I say that Fidelity owns 11.62 percent of SolarCity and 13.95 percent of Tesla, that doesn't really mean that it should vote all those shares one way. Fidelity is not just one big pot of money: Different Fidelity funds can own different amounts of the two companies, and Fidelity's obligations are to the investors in individual funds. A Fidelity fund that owns Tesla shares but no SolarCity ones might vote differently from a Fidelity fund with big holdings of both. I assume, without checking, that there's a lot of overlap even at the fund level -- if you like Elon Musk, why not collect all the Elon Musk companies? -- but, yes, in general, shareholder overlap may be less important than it looks.

Asset management.

Did you know that people used to buy stocks? Like, regular people, doctors and lawyers and plumbers and teachers, would call up their brokers and say "get me 100 shares of Amalgamated Brass Steam Fittings Ltd.," and then they'd own shares in that particular company, and have to decide on their own when to sell and what else to buy. This still happens even today, but to me, as an investor in diversified mutual funds, it seems quaint and alien. I mean, people used to pull out their own decaying teeth with a string and a doorknob. Then dentistry was invented. You know that you can get a professional -- or even an index provider -- to pick the stocks for you, right? It seems so strange to pick them yourself, but I guess everyone needs a hobby.

I am being perhaps a little hyperbolic here, but what do you make of the news that Harvard, with an endowment of $37.6 billion and an investing staff of more than 200 people, seems to have decided that picking investments is a job best left to professionals?

Harvard University has zeroed in on two leading candidates to helm its $37.6 billion endowment, the biggest in higher education, according to people familiar with the matter: N.P. ‘Narv’ Narvekar, who oversees Columbia University’s endowment and Amy Falls, who stewards Rockefeller University’s and is on Harvard’s investment committee.

Both prospects have relatively small staffs and farm out their money to the best managers they can find, the approach favored by Yale endowment chief David Swensen, whose investment performance has outstripped Harvard’s. By contrast, Harvard has long hired in-house investment pros, including some swashbuckling Wall Street types with eight-figure paychecks.

And:

A primary question facing the next chief executive will be Harvard’s unusual “hybrid” investment model, these people said. The endowment gives money to outside managers but also employs its own traders, who wager on assets such as stocks and bonds as well as overseeing holdings such as real estate. That model differs from rivals such as Yale, where nearly all endowment assets are farmed out to outside managers.

Keeping or expanding the hybrid model is still on the table, but Harvard has underperformed Yale and other rivals over the past decade as they have outsourced and it has stuck with running a lot of its own money. And it is, on first principles, a little hard to understand why a university would be better at asset management than an asset management company. But you can see the appeal. It's a smart university, with lots of smart alumni who run asset management companies. Surely it can just hire some smart people and make some smart stock investments? And it's not like professional active asset management has that great a reputation these days. Why not do it yourself? And yet, no, professional specialization still seems to work better than doing it in-house.

Meanwhile in hedge funds, "investors pulled nearly $10bn from multi-strategy hedge funds in the three months to July." In mutual funds, "MFS Investment Management, which created the first mutual fund in 1924," continues to be a throwback in that its actively managed stock funds are still attracting new money from investors. And in pensions, "Reckoning Comes for U.S. Pension Funds as Investment Returns Lag."

Exxon.

You could have a simplistic model of oil-company accounting that is like:

  1. You spend $X to pump oil out of the ground.
  2. You sell the oil for $Y.
  3. Your income is $Y - $X.

But that, of course, is not quite how accounting works. An oil company's economic health is not measured just by how much it got for the last few barrels it pumped out of the ground. It is also, critically, measured by how much it will get for all the barrels it will pump out of the ground in the future. Which makes the accounting not just an exercise in counting actual past sales, but also an exercise in estimating future prices and costs. That is much harder -- estimating the far future is always harder than observing the recent past -- but it is also much more politically controversial. Anyway, "the U.S. Securities and Exchange Commission is investigating how Exxon Mobil Corp. values its assets in a world of increasing climate-change regulations":

The SEC’s probe is homing in on how Exxon calculates the impact to its business from the world’s mounting response to climate change, including what figures the company uses to account for the future costs of complying with regulations to curb greenhouse gases as it evaluates the economic viability of its projects.

The SEC is also looking into "why the world’s largest energy explorer by market value has been immune from the multi-billion dollar writedowns that have afflicted rival oil and natural gas producers" as oil prices have dropped, though "Exxon also has defended its practice of not writing down the value of assets, saying that it is extremely conservative in booking the value of new fields and wells, which lowers its need to reduce the value of those assets if falling prices later affect the reserves’ value." 

There are a lot of subjective judgments involved in oil-company accounting, or any accounting. And those judgments are quite properly subject to oversight by the SEC and other agencies, to make sure that they are made in good faith and without fraud. But there is also an inevitably political component to the judgments. (The judgments involved here are in part about politics: The carbon costs that Exxon needs to consider in valuing its reserves include the costs of future regulations imposed by governments.) And Exxon's financial disclosures have already, weirdly, become controversial not just for their accounting accuracy but also for their substantive views on climate change. It's a bit of a weird debate to have about accounting. But in a financialized world, where every important issue is discounted into the stock prices of publicly traded companies, maybe everything really is accounting.

Cornerstones.

Here is an article about how the Postal Savings Bank of China, "a sprawling state-owned lender that is one of the country’s biggest," priced its $7.4 billion initial public offering in Hong Kong with the help of other state-run Chinese companies that bought most of the shares in the deal: 

The big I.P.O. is shining a light on the practice, called cornerstone investing, of inviting big investors to buy up big chunks of shares before a company goes public. Though it is less common in other markets, it has been increasingly used by Chinese state firms going public in Hong Kong, where government-controlled companies buy up growing numbers of shares to ensure a smooth offering.

One fun thing about IPO-structure worries is that they are often about two opposite problems. So: What is the problem with cornerstone investors? One possibility is that they are bad for regular investors because they overpay for deals, since they are not always motivated by purely price-based concerns. So the article cites a 2014 report by the Hong Kong Financial Services Development Council, which found that "the aftermarket performance of companies with a significant cornerstone component in their IPOs often proves to be sub-optimal," as cornerstone investors overpay, get shares that they can't sell for six months, and then drag down the price when those lockups expire.

The other possibility is that cornerstone investors are bad for regular investors because they underpay for deals, getting access to hot IPOs in preference to regular investors. The article says that marketing to cornerstone investors "has come under criticism in the past because it can give plugged-in investors preferential access to new offerings." I suppose both of these worries can be true -- sometimes cornerstone investors get a bad deal, sometimes they get a good one -- but if you are worried about both of them equally then, in some sense, you should stop worrying. The IPO market is a dynamic process, and if IPOs sometimes go up and sometimes go down, then that means the system is working.

People are worried about unicorns.

Theranos, the Blood Unicorn (Elasmotherium haimatos), has produced tens of thousands of inaccurate blood test results and operated a lab that regulators found to "pose immediate jeopardy to patient health and safety." It also raised hundreds of millions of dollars from investors who may never see that money again. But Nick Bilton has found another victim in the Theranos saga, perhaps the most tragic one of all:

I heard from a friend about a young girl in Silicon Valley who has a blood deficiency and who, after reading many of the glowing stories about Holmes, had come to idolize her. In fact, the little girl was so taken by Holmes that she was planning on dressing up as her for Halloween. For now, the friend told me, her parents don’t really know what to do. Do they want to deliver devastating news to their daughter about her idol, or let her roam through the streets of Silicon Valley asking for candy by impersonating someone who has been under review by the Securities and Exchange Commission, Federal Bureau of Investigation, and Food and Drug Administration, among others?

I mean people dress up as actual vampires for Halloween. Or witches. Or pirates. Or Pizza Rat. Halloween costumes don't have to express moral approval. Anyway, the point is that Elizabeth Holmes is a good and cool Halloween costume, though going as a Blood Unicorn would be even better. 

People are worried about stock buybacks.

Well, a survey of corporate directors found that they are not worried about stock buybacks:

The two most common criticisms of buyback programs are that they jeopardize corporate growth and that they lead to large, unjust pay packages for senior managers. Some directors saw merit in these criticisms; most did not.

"Indeed, some embrace buybacks out of fear that companies would otherwise squander capital by chasing uneconomic growth." We talked the other day about short-termism as a core governance problem: Managers prefer long-term projects for the job security, but shareholders might rationally prefer lower-return short-term projects over higher-return long-term ones, just because the short-term ones are easier to monitor. The directors serve essentially as the shareholders' agents in monitoring the managers. On the one hand, you'd hope they'd have better luck than the shareholders in monitoring even long-term projects. (They can ask for status updates at board meetings or whatever.) On the other hand, the directors know the managers pretty well, and if they don't trust the managers to choose good long-term projects, they should definitely be handing money back to shareholders.

Elsewhere: "Microsoft Plans Another $40 Billion Buyback, Boosts Dividend."

People are worried about bond market liquidity.

The Bank of Japan announced changes to its monetary stimulus approach, "leading the world into a new era of central banking" by "essentially making long-term interest rate, 10-year Japanese government bond yields a focal point in its central banking platform instead of negative interest rate policy." You can read more about the policy framework here, and you can read the bank's "Comprehensive Assessment" here, and of course it worries about bond market liquidity:

Regarding liquidity in and the functioning of the JGB market, many liquidity indicators suggest that there has been a decline in liquidity in the JGB market since the introduction of "QQE with a Negative Interest Rate." Given that the Bank's large-scale JGB purchases aim to lower interest rates by compressing term premiums, the impact on liquidity is a necessary consequence of the intended effect of JGB purchases. Moreover, so far, the Bank has faced no specific difficulties in carrying out JGB purchases. However, as the Bank will continue with unprecedentedly large-scale JGB purchases, it will continue to carefully monitor developments in liquidity in and the functioning of the JGB market.

Elsewhere, companies increased "issuance of mega-sized bonds of $5 billion or more to a record $330 billion in 2015," and are on pace for even more in 2016.

Things happen.

Deutsche Bank’s Low Capital Makes It No. 1 for Risk in Study. Central-Bank Rescues Prove Profitable. "California is the capital of American business." Mylan CEO's mother used position with education group to boost EpiPen sales nationwide. "It seems that the sharing economy was a transitional state from private ownership to corporate ownership." Banks Test Blockchain Network to Share Trade Data. SWIFT hopes to thwart fraudsters with detection system in wake of bank heist. Inside the Pipeline That Transfers 2.7 Billion Euros a Minute. Hedge funds warned of crowding risks. People are worried about duration. Warren Buffett on the declining marginal utility of money. J.P. Morgan Chase Names Berkshire Hathaway Investment Manager to Board. SEC Issues $4 Million Whistleblower Award. Christian Laettner Reaches Deal to Repay Investors. Trump used $258,000 from his charity to settle legal problems. Woman Drives Into Oncoming Traffic to Avoid Going to New Jersey. China's richest dog has 8 new iPhones. Endless shrimpHamdog. Smart candle. Yale is auditioning for a new bulldog mascot, Handsome Dan XVIII, who "will have a 'live Bulldog cam' and may be available for regular petting hours."

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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