Mirrors, Odd Lots and Tick Sizes

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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Deutsche Bank in Russia.

Here is a story about the rise and fall of Tim Wiswell, the youngish American who ran equities trading at Deutsche Bank in Moscow and may have done a few billion dollars of mirror trades to help wealthy Russians move money out of the country. (He was also allegedly "a bit of a 'himbo.'") It's hard to tell quite how bad the mirror trading was, or even what was bad about it (sanctions violations, one assumes?), but you get the sense that no one at Deutsche Bank in Moscow cared all that much:

One thing to appreciate, say those who have worked in banking in Russia for any length of time, is that Moscow isn’t like Wall Street or the City of London, where rules are more clearly defined and enforced. To thrive in such an environment requires you to adapt.

Front-running—placing personal side bets using knowledge gleaned from your job—was so commonplace among the fast-living expat crew Wiswell ran with that it was considered a legitimate way to bump up your pay, two of Wiswell’s former colleagues said.

This has become such a cliché about pretty much every emerging market that I wonder if it's part of the official orientation package. You show up on your Moscow trading desk, fresh out of Colby College, and a grizzled Moscow hand pulls you aside and shows you a PowerPoint that says: "Look kid. I know you come over here with your fancy 'rules' and 'laws' and 'fiduciary duties' and 'calculators,' but it's not like that out here. Out here, it's a lawless hellscape where we live by our wits. Now, go front-run some clients." The thing about these informal orientations is that they have, as far as I can tell, absolutely no legal effect. When you are arrested in the U.S. for violating sanctions, and you tell the court that you thought Russia was a rules-free zone, no one is going to be all that sympathetic. Anyway here's this guy:

“They expect us to take clients out, to outcompete with the local brokers in showing them a good time,” Hammond wrote in his memoir. “We’re essentially the black ops. We’re the ones putting our livers at risk. We’re the boots on the whorehouse ground that our organization is not supposed to be in.”

Great, super, we salute your liver's sacrifices.

Deutsche Bank in Italy.

Are the rules clearly defined and enforced in Italy? I guess we'll find out:

A judge in Milan on Saturday charged 13 former and current executives at Banca Monte dei Paschi di Siena SpA, Deutsche Bank AG and Nomura International PLC with a number of alleged financial crimes, people familiar with the matter said.

The decision by judge Livio Cristofano follows an investigation lasting more than 1½ years by Milan prosecutors into two complex financial transactions that Monte dei Paschi arranged with Nomura and Deutsche Bank, as well as other transactions that allegedly helped Monte dei Paschi misrepresent its financial situation.

There is a sort of qualitative difference here in that the Russian mirror trades were dirt simple: You buy a stock in Moscow, you sell it in the Caribbean, you've moved money offshore. The Monte dei Paschi deals were at least a bit more complicated, involving derivatives that helped the bank's finances look better than the reality. You could build a general model of financial shenanigans in which the complexity increases as you get closer to core markets: At the far periphery, it's just front-running and bribery and simple money laundering; closer in, it's complex derivatives to obtain desired accounting results; and in New York and London themselves, it's nefarious transactions of such ineffable subtlety that no one can yet figure out what they are. On the other hand Wells Fargo opened millions of fake accounts with e-mail addresses like "noname@wellsfargo.com," so that rule of increasing complexity is not inviolable.

Deutsche Bank elsewhere.

Meanwhile in ineffable subtlety, on Friday "Deutsche Bank AG jumped the most in almost six months after a media report that the lender is nearing a $5.4 billion settlement with the U.S. Department of Justice, less than half the amount initially requested," but that may have been a bit optimistic:

The talks are moving forward, but they have not progressed to a degree that a proposed deal has reached senior-level review at the Justice Department or with Deutsche Bank’s supervisory board, people familiar with the matter said.

Meanwhile here is German deputy chancellor Sigmar Gabriel on Deutsche Bank's complaints about last week's wild market moves:

“I didn't know whether I should laugh or be furious that a bank which turned speculation into a business model now declares itself the victim of speculators,” Mr Gabriel said. “I'm really worried about the people employed at Deutsche Bank.”

Odd lots and stock splits.

Two years ago, when Apple did a stock split, we talked about why anyone would care. I suggested one technical reason having to do with round-lot trading. If you bid $10 per share for 100 shares of a stock on a national stock exchange, then your bid is "protected": Under the rules of the national market system, no one is supposed to sell shares to someone else at a lower price without selling to you at $10 first. But "odd lots" of fewer than 100 shares are not protected: If you bid $10 per share for 99 shares, and the highest bid for 100 shares is $9.99, then people can sell 100 shares -- or 99 shares -- at $9.99 and ignore your bid. (It seems like it would be irrational for them to do that, but in practice this means that a wholesaler can buy from a retail customer off the exchange at $9.99 instead of at your best-in-the-market $10 price.) Lower stock prices, the theory went, encourage more round lots, which means that more trades will take place at the "real" best bid or offer, and fewer will take place at worse prices that bypass odd-lot best bids or offers.

This was all fairly hypothetical, but now three academics -- Robert Battalio, Shane Corwin and Robert Jennings -- have written a paper, forthcoming in the Journal of Trading, finding that this is a real thing:

We identify time intervals with an unprotected odd lot limit order at a price better than the protected quote and examine trades during those intervals for ten high-priced stocks during one week in 2015. We find over 406,000 intervals representing 37% of sample stock trading time where an odd lot order betters the protected quote. Examining trades within these intervals, we find nearly 55,000 cases in which the trade price is worse than the odd lot price. In total, the price disimprovement in our ten stocks is $554,675 for the week examined. This is a previously undocumented trading cost associated with the corporate decision to not split a stock’s price in a market in which odd lot orders are excluded from the protected quote.

So there you go. Meanwhile Jason Zweig reports that "this year is on track to be the third-lowest for stock splits in modern history," and that the average stock price "has risen to a near-record $86 a share—after decades of remaining in a range between $25 and $45." He is pretty cheery about this development -- "It is a sign that the investing world may finally be learning the distinction between the price of a stock and the value of a business" -- and quotes some corporate executives saying things like "There's no compelling business case to do it" and that it "wouldn't change the intrinsic value of the company and doesn't provide any real benefit." Ah, yes, but you see, there's the odd-lot thing. 

Happy tick size day.

It's here:

Shares in some small companies will start trading in five- rather than one-cent increments Monday, in the first adjustment to “tick” sizes since the decimalization of the U.S. stock market 15 years ago.

The reasoning behind the tick-size pilot is so strange:

Supporters of the pilot program say forcing small-cap stocks to trade at five-cent increments will make it more profitable for investment banks to make markets in such securities, leading them to pursue more research about small companies, which could generate interest in the companies’ shares. The ultimate hope is that widening tick sizes will boost liquidity, or the ability to place orders without moving the price.

No but see. There are lots of brokerages that make a bit of money executing orders on small stocks, and also publish research on those stocks. And there are lots of electronic market makers that trade small stocks, and could make more money with wider tick sizes. But those are different firms. The small research brokerages tend to do agency trades and so don't make money from wider spreads; the electronic market makers don't publish research because they tend to be like two people and a room full of computers. Paying electronic market makers more won't encourage agency brokerages to write more research, and it certainly won't encourage those market makers to get into the research business.

Still this is better than the reasoning that we talked about last time we discussed the tick size pilot, which was that it would somehow encourage more initial public offerings. Anyway, the actual point is that the bigger tick size may encourage market makers to provide more, and more robust, liquidity in small-cap stocks, and that is fine too. Or it isn't, it's a pilot program, we'll see.

Insider trading.

Nobody really likes how insider trading law works, so lots of people think they can do better. Here's an effort from Zachary Gubler of Arizona State, arguing "that we should replace the classical theory with the misappropriation theory of insider trading." The "classical theory" is that corporate executives owe a fiduciary duty to their shareholders, and so shouldn't trade with those shareholders while possessing material nonpublic information. But this doesn't apply to, for instance, a company's lawyers, so courts have developed the "misappropriation theory" to cover them. 

Courts have historically applied the misappropriation theory only to cases of insider trading involving corporate outsiders, but there is no reason why it couldn’t also be applied to the classic case of insider trading. After all, when an insider trades in his own corporation’s stock based on material non-public information, he misappropriates that information in breach of a fiduciary relationship owed to the corporate entity.

The practical consequences of this don't seem enormous -- "the misappropriation theory would lead to liability for insider trading in debt securities," that sort of thing -- but he argues that it "would do a better job explaining what courts actually do in these cases." Essentially, when a corporate executive insider trades, we'd say that it's bad not because he violated his duties to shareholders by trading with them, but because he violated those duties by misappropriating their information. That does make more sense. For instance, it explains tipper liability -- cases where the insider doesn't trade, but gives information to a friend who trades and gives the insider a personal benefit -- a lot more clearly than the classical theory.

On the other hand, here is Michael Guttentag of Loyola Law School arguing that courts should get rid of the personal benefit test and "go back to the underlying statutory prohibition against deceptive conduct." This way, I think, madness lies. Remember, there is no actual law against insider trading. There is a law against using "any manipulative or deceptive device or contrivance" in trading stock, which has been interpreted to include insider trading. But insider trading is not obviously deceptive. The guy on the other side of the trade never meets you; you are not telling him lies about the company. You know something he doesn't -- but that's often true in trading. If diligent research on the company's earnings isn't a "deceptive device," why is calling up a corporate insider to ask about those earnings a "deceptive device"?

Meanwhile in actually existing insider trading law, Vladimir Eydelman -- whom you may remember as the guy who insider traded based on information written on Post-It notes or napkins that his tipper would then eat -- was sentenced to three years in prison. I suppose eating the napkin does sort of look like a "deceptive device."

That guy with his taxes.

Look, the thing is, losing $916 million in one year doesn't mean that you didn't pay taxes for the subsequent 18 years. That is literally a made up number, an exercise in hypothetical arithmetic:

Although Mr. Trump’s taxable income in subsequent years is as yet unknown, a $916 million loss in 1995 would have been large enough to wipe out more than $50 million a year in taxable income over 18 years.

He could have had substantial income in the subsequent years, as his fortunes rebounded. Or he could have had cancellation-of-indebtedness income, unless debt parking was involved. You get 18 years by just making up an income figure -- $50 million -- and assuming Trump had exactly that much income every year until his 1995 tax loss was wiped out. (And that he had no other tax losses.) It would be pretty weird if that was the case.

And yet Trump didn't deny the report. (In fact his response never mentions that he's ever paid income taxes.) Ezra Klein:

Trump still isn’t releasing his returns. And here’s what that means: whatever is in his returns is worse than what the New York Times is telling the world is in his returns. The Trump campaign has decided it prefers the picture the Times is painting — a picture where Trump didn’t pay taxes for 18 years — to the picture Trump’s real records would paint.

Also don't forget the first law of tax, that it is always better to make more money than less money. Did Trump?

It can be smart to avoid paying taxes if you’re using tax breaks encouraged by the government or exploiting gaps in the system. It isn’t necessarily smart if a $0 tax bill results from actually losing money or not following the law.

Elsewhere, Trump had an odd night in Pennsylvania. The Commercial Finance Association had to apologize for Rudy Giuliani's racial remarks at its "40 Under 40" dinner. And Justin Wolfers argues that the stock market "appears to assess the consequences of a Trump victory as a bit worse than 9/11, and roughly comparable to the onset of the Iraq War." And: "Donald Trump Pointed to 9/11 Attacks in Asking SEC for Leniency During Fraud Probe."


Here is Larry Wall of the Federal Reserve Bank of Atlanta on financial technology companies, sharing-economy companies, and their different approaches to avoiding regulation:

The approach taken by many firms of asking for forgiveness rather than permission has not proven to be very effective for fintech firms. Most financial regulations are less vulnerable to being overridden because the primary purpose of these regulations is not incumbent protection. Further, the regulators generally require fintech firms to comply with the regulations, making it difficult for firms to obtain the scale and popularity needed for political clout.

I like to say that "tech is an industry of moving fast and breaking things," while "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." Uber's approach of ignoring regulation until it goes away seems to be working out for them, but it doesn't translate as easily to fintech. Elsewhere: "Big banks make insufficient use of fintech, says research."

Are index funds communist?

Here is a near-future dystopian short story by Keith Quinton, previously published on Seeking Alpha, called "The Last Active Investor." If you like speculative fiction about index funds -- and what the past few months have taught us is that everyone does -- then maybe check it out.

People are worried about unicorns.

The other day I allowed that Blue Apron "is clearly a unicorn even though its technology consists mostly of chopping vegetables and putting them in a bag for you." I assume it will come as no surprise to you that (1) that technology consists of humans and (2) the humans are not particularly happy about it:

In the 38 months since Blue Apron’s facility opened, the Richmond Police Department has received calls from there twice because of weapons, three times for bomb threats, and seven times because of assault. Police captains have met twice with Blue Apron to discuss the frequency of calls to the police. At least four arrests have been made due to violence on the premises, or threats of it. Employees have reported being punched in the face, choked, groped, pushed, pulled, and even bitten by each other on the job, according to police reports. Employees recalled bomb scares, brandished kitchen knives, and talk of guns.

I sometimes think of the Enchanted Forest of the Unicorns as sort of "The Ones Who Walk Away from Omelas," but with the numbers adjusted: It's a paradise of perfect happiness for a few founders and venture capitalists, but that happiness depends on keeping a thousand people in a refrigerated manufacturing facility, biting each other. Elsewhere: "Venture Capitalist Threatens To Quit If Taxes Are Raised."

People are worried about bond market liquidity.

"Over the past few years there has been a tremendous amount of interest, discussion and analysis around decreasing liquidity in the fixed income markets," writes Prashant Sharma of J.P. Morgan Asset Management. Maybe you've heard.

Things happen.

"Henderson Group Plc agreed to buy Janus Capital Group Inc., creating a $320 billion money manager as both companies seek to boost profit and assets." U.K.’s Theresa May Pledges to Set EU Divorce in Motion by End of March. What’s Derailing Greece’s Plan to Sell State Assets? Its Own Government. Clinton to Decry Wells Fargo Fraud, Propose Curbing of Forced Arbitration. Illinois to Suspend Wells Fargo From Bond, Investing Work. Cash Floods Into Fed Repo Facility. New junk bond investors put safety first. Base Metals Are Back in a Bull Market. Sam Wyly to Pay $198.1 Million to Settle SEC Legal Battle. (Earlier; even earlier.) Scottrade’s Riney Becomes a Billionaire as Firm Shops for Buyer. "There are synergies, both from being near clients and it’s a cool neighborhood." This 20-year-old says he dropped out of NYU to start his own hedge fund. Hedge Fund Data Revisions. "The leverage ratio acts as a backstop to the risk-sensitive capital requirement: it is a tight constraint during a boom and a soft constraint in a bust." The Cobalt Pipeline. The Difference Between Rationality and Intelligence. Mall Suspends Security Robot After It Clobbered a Toddler. This Florida Millionaire Accidentally Married His Granddaughter.

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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