Bad E-Mails, Hazy Lines and Anomalies

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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Don't do this.

You know how, when you start a new job, human resources gives you a sort of tepid warning not to use your work e-mail for personal reasons? And you nod, and stick to business for a few days, but then one day you slip up and use your work account to e-mail your significant other that you'll be home late? And you realize that it did no real harm, and is more convenient than Gmail, so you start using your work account more regularly to make dinner plans with her? And then your e-mails, from your work account to hers, get a little less work-appropriate, and you try not to think about the fact that the compliance team is undoubtedly giggling at the steamiest bits of your personal correspondence? And then, for some reason, you e-mail her material nonpublic information about a deal that you're working on so she can do some insider trading?

Yeah, this is not exactly legal advice, but don't do that. Colin Whelehan and Sheren Tsai know what I mean:

Whelehan was on the deal team that had access to Apollo’s data room containing key financial information about the transaction. He sent the tip about the deal from his work e-mail account to hers, according to the complaint.

Whelehan's firm was working on a deal with Apollo, allegedly tipped "his live-in girlfriend and romantic partner, Tsai," about the deal, and she traded in the target's stock, generating profits for herself and a relative of $23,914.44. But through dogged police work and subtle interrogation techniques, she and Whelehan were soon brought to justice:

Tsai was caught just three days after the deal was announced on Feb. 16, when her firm’s chief compliance officer asked her why she had bought the ADT shares in January. She initially claimed she invested because she thought it was a good company, until confronted with the e-mails with Whelehan on her work account.

Tsai and Whelehan settled with the Securities and Exchange Commission without admitting or denying the charges; Tsai has agreed to pay back the money with interest and another $23,914.41 fine. She and Whelehan have also agreed not to insider trade any more. Seriously, they "have each consented to the entry of judgments permanently enjoining them from violating those provisions of the federal securities laws." Sometimes insider traders are prosecuted and sent to prison, and other times they are barred from the securities industry, but in particularly silly cases of insider trading the penalty is that they have to promise the SEC that they won't do it again. I assume the SEC can't quite believe that they really meant to insider trade like this in the first place.

Research versus leaks.

Elsewhere in insider trading, here is an article about the chilling effect the SEC's case against Leon Cooperman might have on other investors:

Hedge funds have long depended on developing relationships with company management as a critical part of the research they do when they evaluate which companies to invest in or bet against. The public website for Citadel, for instance, boasts that it had 12,500 such meetings last year alone.

Since the financial crisis, however, the SEC and federal prosecutors have cracked down hard on investors and corporate insiders whom they believed have crossed the line between doing research and stealing or leaking secret company information.

People really think there's a line; "crossing the line" is a popular metaphor not only among journalists but also among prosecutors and regulators. But there is no line. There is a blur. You go talk to a company's executives and ask them questions. You are asking the questions because you want to know the answers, because you are an investor and the answers will inform your investment decisions. There is a popular belief that there is some category of questions -- "are you about to be acquired," say, or "what will next quarter's earnings be" -- that you can't ask, or that they can't answer, because those answers are obviously "material" and so trading on them is obviously cheating. But the materiality standard is actually far lower and squishier than that, just information that "would have been viewed by the reasonable investor as having significantly altered the 'total mix' of information" available. Anything that investors ask in a meeting could plausibly be characterized as "material": If they didn't think the answer mattered, why would they ask the question? (Why would they trade after getting the answer?) And in fact the most important recent insider trading case, the Newman criminal prosecution, involved fairly nuanced information from a Dell investor relations employee -- not an upcoming merger or an earnings surprise, but vague and not-all-that-useful predictions about margins. Anything can, in hindsight, be material.

There are other efforts to draw the line that are perhaps more successful than "materiality," but they are still imperfect. If you bribe the insider for information, instead of just asking him, then that probably crosses a line. But prosecutors have brought cases claiming that giving career advice, or just general sociability, can count as enough of a bribe to cross the line, rendering that one more or less meaningless. (Courts don't always agree.) Or if, as alleged in the Cooperman case, the executive has reason to trust you not to trade on the information, and you trade on it anyway, then you have crossed the line. Certainly if you've signed a confidentiality agreement promising not to trade, you shouldn't trade, but the evidence for that trust is often -- as in the Cooperman case -- considerably vaguer and more disputed than that. Again: not a line, but a blur.

People think there's a line because they want there to be a line, because insider trading is often prosecuted as a crime. They want there to be a clear moral distinction between the bad evil cheating hedge-fund manager who criminally seeks out illegal inside information, and the good noble useful research analyst who diligently researches companies by interviewing their managers 12,500 times a year. But those activities are identical. The idea that there's a line, and that it's objectively observable when someone has "crossed the line between doing research and stealing or leaking secret company information," is just a fiction to help us feel better about the sometimes arbitrary choice to send people to prison.


"The fact that obvious information should be incorporated into the price of a stock seems … obvious," begins this blog post perfectly, but markets seem not to incorporate obvious earnings seasonality into prices. So "the fact that ice cream producers generate more earnings in summer and snow blower shops generate more earnings in winter would strike most people as obvious to the point of being trite," and yet when ice cream shops announce higher earnings in the summer than they did the previous spring, markets always seem surprised:

The paper hypothesizes that the effects of seasonality are due to investors overweighting recent earnings when forming estimates of future earnings. If an upcoming quarter has positive seasonality, the level of earnings in the three most recent announcements was likely lower than the announcement four quarters prior. If investors suffer from a recency effect, whereby recent information is easier to recall than is old information, they will be more likely to overweight recent lower earnings compared to the higher earnings from the same quarter in the prior year. This would cause them to be overly pessimistic about the upcoming announcement and would lead to greater positive surprises.

So if you buy seasonal stocks just before their predictably best season's earnings -- if you buy ice cream stocks just before they announce summer earnings -- they tend to surprise to the upside, and you can make abnormal returns. Here is the related paper, "Being Surprised by the Unsurprising: Earnings Seasonality and Stock Returns."

One thing to think here is that people complain all the time that public markets are irrationally short-term-focused. If that's true, you should be able to make money from it. There should be an arbitrage. This is apparently one such arbitrage: If public markets are so dumb that they can only remember the last three quarters, then you should be able to make money by remembering that every fourth quarter is a summer.

Elsewhere, here's another anomaly, about mean reversion around earnings. And here's one about female chief executive officers:

Female CEOs do tend to outperform according to data compiled by Bloomberg. Of the 16 female CEOs in the S&P 500 index who have held the job for at least three years, 75 percent have outperformed the index since they took over.

It's a small sample, and there are confounding effects from the "glass cliff," where the companies that hire female CEOs have a tendency to be in trouble. ("A 2015 Utah State study found that of the 52 female CEOs of Fortune 500 companies appointed between 1955 and 2014, 42 percent took over during a crisis or market downturn," versus 22 percent for males.) But like the short-termism anomalies, the basic idea is that you can profit from the market's irrationality: If companies are biased against appointing female CEOs, so that the standards for women are higher than those for men, then there should be a way for you to make money from that fact.


A while back, I characterized the difference between the traditional financial industry and its new financial technology challengers this way: "Tech is an industry of moving fast and breaking things. Finance is an industry of moving fast, breaking things, being mired in years of litigation, paying 10-digit fines, and ruefully promising to move slower and break fewer things in the future." That suggests a natural division of labor in which fintech startups dream up new ideas about how the financial world could work, and then stay up all night playing air hockey and coding those ideas into an app, and in the morning they give their app to a bank, and the bank sends it to be slow-roasted by a platoon of lawyers for six months. It is not a perfect division of labor -- there will be cultural and technological clashes on all sides -- but it seems to be where things are heading:

Seventy-two startups demoed their products at Finovate, in real time, to an audience of investors, bankers, payment companies, and potential customers. After listening to almost nine hours of bright-eyed startup founders talk about the future of the finance, it struck me that they all had one thing in common.

These startups weren't trying to take the place of established players; they were looking to sell to them.

Almost all of the startups that presented were looking to sell their technology to existing players in the industry to add their programming expertise to the vast networks that banks already have.

If you want to disrupt laundry, go ahead and launch a laundry app to the public. But if you want to disrupt banking, it's harder to just launch a banking app. You'll probably need a bank.

Elsewhere: "SoFi Plans to Offer Life Insurance by End of Year." And here is Izabella Kaminska on "Breaking insurance models with big data."


Here is the story of an industry that provides essential infrastructure for global business. The industry is consolidated into a few big global players of systemic importance, and those players tend to be pretty leveraged and to have pretty opaque finances. There are not a lot of buffers or wiggle room in the business: If a big firm fails, it could be immediately disruptive to a wide swath of global trade. Failure is also unpleasant to think about because the relevant bankruptcy rules don't match up well with the practical realities of unwinding a firm in this industry, so actually invoking the legal bankruptcy process is likely to cause huge disruptions. All of this leads the market to rely on an "assumption of continuing government support" for the over-levered firms in the industry, and sometimes governments do in fact bail out failing firms. But the assumption has recently proved false, and people are now talking about a "black swan event" with the possibility of "systemic effects on the global shipping industry." Oh, right, the industry that we're talking about here is shipping. What did you think it was?

Penny stocks.

Here is the story of a man named Chris DiIorio, who spent 13 years "as an institutional equity trader and research analyst" on Wall Street, and who then decided to put $100,000 of his own money into a penny-stock company that supposedly made computer chips. ("I bought this company on hype," he says.) The company then announced a reverse merger with a travel company, because that is how things go in the penny stock world; corporate identities are pretty fluid. The stock soared, and then lost almost all of its value. "DiIorio took a loss from the peak stock value of well over $1 million," though I am not sure why you'd measure his losses that way. "DiIorio prided himself on being a savvy trader," for some reason that passes human understanding, and while he "initially saw it as a classic 'pump-and-dump' scheme," he apparently came to believe that something even weirder was going on. This is Part 1 of an eight-part story, so I suppose we'll find out what it was. For now, I have ... questions. 

Bit Bastion!

Oh my, here's a website for Bit Bastion, which "uses leading cryptographic protocols such as Bitcoin and Ethereum as stepping stones to create a new truly innovative protocol," specifically "a universal registry protocol with a main focus of decentralizing governance, creating independent states and hosting other lands on the Bit Bastion Blockchain." Oh yes. There are plans for an independent state ("We have identified some small nations in the world which are willing to partner with Bit Bastion and become sovereign nations with a commitment to a technologically advanced society"), for "distributed autonomous organization" governance by smart contract, for a seastead ("Our ship will be 12 nautical miles from the coast of San Francisco, in international waters"), and of course for a casino ("Crypto gambling has been huge, possibily being the most profitable industry this technology has brought us"). There is also a Slack channel, and can you imagine if this thing actually becomes a real country? The U.S. has its Constitution and Declaration of Independence, but children will grow up in the Distributed Autonomous Republic of Bit Bastion memorizing its founding Slack emojis. Anyway I don't know how real any of this is, but "real" is so rarely a relevant criterion for judging blockchain projects, so just enjoy it.

People are worried about unicorns.

People who work for Uber, the Ubercorn, have some reason to worry; here's a Vice video about "What Uber drivers think about their robot replacements." (They don't all love them.) Meanwhile, "Airbnb Inc. said it has raised $555.5 million in new funds." Also "Airbnb is allowing some employees to sell stock, which will total about $200 million," because unicorns are basically public companies these days and their shareholders need some way to cash out. 

People are worried about stock buybacks.

I may have to retire this section because, while people still seem to worry about buybacks, fewer companies are actually doing them:

The number of S&P 500 companies with buybacks over $1 billion dropped to a 3-year low in the second quarter of 2016, according to data released by FactSet this week. Overall, fewer companies were opting to buy back any stock at all, marking the lowest participation rate since the end of 2010.

People are worried about bond market liquidity.

Here's some classic bond market liquidity worrying:

The institutional investors participating in the Greenwich Associates 2016 U.S. Bond ETF Study are experiencing longer execution times, increased execution costs and more difficulty sourcing fixed-income securities and completing trades—especially large ones.

These challenges have become so pronounced that they are causing institutions to alter their investment processes. Not only are institutions adding resources and upgrading systems, but they are also increasing the importance of liquidity when assessing an investment. Furthermore, institutions are looking beyond individual bonds to alternative vehicles that can provide required fixed-income exposures.

Bond ETFs are emerging as an important alternative for institutions implementing trades and adjusting portfolios. Growing numbers of institutions are incorporating ETFs into their investment universe, using them as tools to rotate sector allocations, increase or reduce risk levels, and adjust duration.

Elsewhere: "The Selloff From the Recent Bond Shock Is 'Mostly Completed,' Says JPMorgan's 'Wizard.'" And "renewed central-bank commitments to easy policies sharply curtailed investors’ fear of a selloff similar to the 2013 'taper tantrum.'"

Things happen.

JPMorgan May Face New Scrutiny in China Hiring Case. CBOE Said in Talks to Buy Exchange Operator Bats Global. Caesars’ Bankruptcy Brawl With Creditors May Be Near the Finale. Yahoo Says Information on at Least 500 Million User Accounts Was Stolen. Facebook Says It Gave Advertisers Inflated Video Metrics. Tesla’s Short Sellers Are Paying Through the Nose. The Ted Spread Is Dead, Baby. OFR Monitor Shows Accelerating Shift to Government Money Market Funds. KKR is trying to be more family-friendly. "Despite the prominent role that discounted cash flow valuation methods play in academic finance courses, few PE investors use discounted cash flow or net present value techniques to evaluate investments." Hedge fund managers haven't dropped fees much despite investor pressure. "What people really want is good alpha producers and cheap beta providers." Deutsche Bank Woes Sparks Concern Among German Lawmakers. The Man Who May Inherit the Mess at Wells Fargo. Matt Klein on Sarin and Summers: "If banks provide real value in their ability to identify portfolios of worthwhile credit investments, they can still survive without the subsidies extracted from the rest of us. And if not, too bad." Harvard Endowment Loses 2% in Fiscal 2016. "Terry’s legal filings are peppered with quotes allegedly taken from the recordings, which include Highland President James Dondero calling his investors 'jackasses.'" The W train is coming back. Income-sharing commune. Toilet whisperer. "Well, I have wanted to work at McKinsey since I was a kid, but now I don’t know why, and I think I may have been brainwashed."

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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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Matt Levine at

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