Hand Sanitizer and Speed Bumps

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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Banker conduct.

Maybe the most shocking piece of financial news in 2016 so far is that you can drink hand sanitizer. I mean, don't. (This is medical advice.) But if you do, you'll get pretty drunk? It's apparently how one Wells Fargo employee got through the day:

One morning, before meeting with a customer, in which I knew I was going to have to sell unneeded services, I had a severe panic attack. I went to the bathroom and took a drink of some hand sanitizer.

This immediately reduced my anxiety. From that point, I began drinking the hand sanitizer all over the bank.

In late November 2012, I was completely addicted to hand sanitizer and drinking at least a bottle a day during my workday.

Okay! That's part of a "Voices From Wells Fargo" piece in which former bankers and tellers talk about the pressure they were under to sell unnecessary banking products to customers, like "opening travel checking accounts for customers by convincing them that it was unsafe to travel without a separate checking account and debit card." A related article describes these desperate, demoralized, hand-sanitizer-addicted Wells Fargo employees as "like lions hunting zebras," picking prospective customers who were "the weakest, the ones that would put up the least resistance" to unnecessary products. "We had customers of all ages, but the elderly ones would at times be targeted, because they don’t ask many questions about fees and such," said one teller. 

The initial story of the Wells Fargo scandal was about unauthorized fake accounts. But these stories are about authorized real accounts -- accounts that customers agreed to open because Wells Fargo bankers convinced them that they were necessary, and because the customers were not sophisticated enough to push back. "Customers would be told that they needed separate accounts for such purposes as traveling, grocery shopping and saving for an emergency." That strikes me as ... not great advice? But you can see why Wells Fargo's $185 million settlement was addressed only to the fake accounts, not the real ones. It is very easy to agree that opening a savings account without a customer's permission is fraud. Opening three checking accounts with the customer's permission is a grayer area. The customer may not have entirely understood what was going on, and the banker's recommendation probably wasn't the same advice she would have given her own mother, but you can't be sure it was a lie. There is some plausible reason to have multiple checking accounts for multiple purposes. In the aggregate it is all tawdry and gross, but a regulator just can't be sure that every customer with multiple checking accounts was duped into opening them. 

There were a lot of fake accounts, and some did real harm, but I suspect that most customers never noticed their fake accounts, or paid any fees for them. And it would have been relatively easy for management to crack down on the fake accounts. Many of them were opened with e-mail addresses like "noname@wellsfargo.com"; you could just have your computer system reject those.

But the real accounts are a much harder problem. Wells Fargo really did want its bankers to pitch more accounts. It has now backed away from rigid sales goals, but it seems straightforward enough that a bank will expect salespeople to sell products. The line between "sell customers products" and "open fake products for customers without their consent" is relatively easy for a bank, or a regulator, to monitor. The line between "sell customers products that they understand and need" and "sell customers products that they don't understand and don't need" is much fuzzier and harder to police. The fake accounts make for a neat story, but in some ways they distract from the bigger and harder issue.

Meanwhile the New York Fed is holding a conference on behavior and culture in the financial industry. Here are New York Fed President William Dudley's opening remarks, which cite this cultural checklist from Ignazio Angeloni of the European Central Bank:

  • Are you doing what you promised to do?
  • Are you using your best knowledge and intention in doing it?
  • Are you doing what public authorities, superiors, colleagues and business partners expect you to do, and if not why?
  • Are you conforming to the mission and the values of your company, as they are publicly stated?
  • Will your actions enhance public confidence in your company and in the financial sector?
  • Finally, and crucially, would you behave similarly if your actions were publicly observed?

One central cultural issue is that there are places and times in the financial industry where you are not supposed to do what people expect you to do. (Imagine applying that checklist to a poker game.) Being unpredictable, disguising your intentions, keeping your private information to yourself -- those things can be essential in, for instance, negotiating a merger, or building up an activist position, or trading bonds. They are obviously terrible in selling checking accounts to senior citizens. A lot of the issues in "the culture of finance" are just about getting everyone to agree on when banks are supposed to act like fiduciaries, and when they're supposed to act like poker players.

Speed bumps and SIPs.

The origin story of IEX, the Investors' Exchange started by Brad Katsuyama and immortalized in Michael Lewis's "Flash Boys," is something like:

  1. Katsuyama would see 100,000 shares of XYZ stock available for sale at $10 on various stock exchanges.
  2. He'd try to buy all the stock for his client, but high-frequency traders would see him buy 25,000 shares on one exchange and race ahead of him to other exchanges to buy up all the stock, "front-running" his client and pushing up the price to $10.05.
  3. So he built IEX with a 350-microsecond speed bump, so that you could buy 25,000 shares on IEX and then go buy the rest of your shares on other exchanges before the high-frequency traders even knew about your trade.

This is a good, clear, reasonably comprehensible story. But it is no longer true! As part of IEX's process of getting approved by the Securities and Exchange Commission as a national stock exchange, it had to give up that particular advantage: It still has a speed bump, but now its router sits outside the speed bump. So if you want to buy 100,000 shares, you can't just send the order to IEX, buy 25,000 shares, and then race to the other exchanges to buy the rest before anyone finds out about your trade. If you did that, you'd be slowed down by 350 microseconds too, so you wouldn't have any head start on the high-frequency traders who are trying to "front-run" you. Instead, what happens now is that you send your 100,000-share order to IEX's router, and the router figures out how many shares are available on different exchanges, and then it tries to send your order to all those exchanges in parallel, so that you get your 25,000 shares on IEX at the same time you get the 25,000 on Nasdaq and the 25,000 on BATS and so forth. If the router does a good job, you still get your 100,000 shares, but that's on the router. The speed bump no longer gives you a head start. 

Anyway here is a story called "A Nasdaq Speed Upgrade Is Threatening IEX." The issue here is that IEX's 350-microsecond speed bump has always applied to the direct data feeds that it gives to its members, but not to the consolidated "securities information processor" feed that everyone in the market gets. The SIP is the official regulatory feed, and IEX has to report to it immediately. This didn't matter when the SIP was very slow -- "trades took 480 microseconds to be posted by the SIP" -- because, even with the speed bump, IEX's direct feed was still faster than the SIP. But now Nasdaq, which runs the SIP, is upgrading it, to shrink that time down to under 20 microseconds. It used to be that high-frequency traders got news of an IEX trade with a 350 microsecond delay from IEX's direct feed, or 480 microseconds from the SIP. (This oversimplifies by ignoring location differences.) Now they will get that news in 350 microseconds from IEX, or 20 microseconds from the SIP, meaning that the speed bump won't delay them and they'll be able to race ahead of IEX's customers to buy more shares on other exchanges.

Except, again, that that's not how IEX works any more! The update to the SIP really would have been a threat to IEX back before the SEC approval process. But in becoming a stock exchange, IEX sort of abandoned the speed-bump mechanism that was such a big part of its origin story. It's just taking a while for people to catch up to that.

Subscription line financing.

Well this is fun:

Willis Towers Watson, the world’s largest adviser to pension schemes, has accused private equity managers of employing a little-known financial engineering technique that flatters their investment returns and helps them claim lucrative performance fees.

The investment consultancy and a number of the world’s leading finance-focused academics are increasingly concerned about private equity managers using bank loans, rather than clients’ capital, to pay for their investments in companies.

This seldom-discussed technique — known in the industry as subscription line financing — enables private equity managers to charge higher performance fees because their internal rates of return are sensitive to when an investor’s cash is put to work.

Here is a stylized example: If you buy a company with $100 of investor capital, and sell it for $130 two years later, you have made 30 percent over two years, which Excel tells me is an annual internal rate of return of about 14 percent. But if instead you buy the company with $100 borrowed from a bank, draw down $101 in investor capital six months later to pay back the bank with interest, and sell the company for $130 at the end of the two years, you have made your investors call it 29 percent over 18 months, or an internal rate of return of about 18 percent. By shortening the period in which you are using investor capital, you make your returns look better. It has the effect of leverage, but the leverage is applied to the timing of the cash flows rather than their amount.

Isn't that neat? Some people object because it "could be adding inappropriate levels of leverage to mergers and acquisitions," though that seems implausible to me; the subscription line financing is just a short-term loan bridging to a draw on the limited partners' committed capital, and will only default if the limited partners refuse to stump up the money. Others object because this is a "trick," but "trick" is a loaded word. It really does increase the internal rate of return! It gives investors back roughly the same amount of money, but it uses their money for a shorter time, which is arguably good for them. "The costs are relatively minor and I think generally investors feel the benefits outweigh those costs," says a guy. 

There is a general lesson here, which is: Be careful how you measure performance, because whatever you measure might be gamed. If you really want to maximize IRR, go ahead and pay your agents for maximizing IRR. If you get annoyed at "tricks" that maximize IRR without increasing absolute economic returns, then maybe you should measure something else.

How are things for hedge funds?

Let's ask Howard Fischer:

“It’s miserable, miserable,” the 57-year-old manager of $1.1 billion Basso Capital Management says of hedge fund returns over the past few years. “If that’s the normal expectation, I don’t have a business.”

Sounds bad! But this is in some ways worse:

“Many investors seem to gradually be coming to a realization that what they think they know may no longer matter,” Jordi Visser, who runs investments at $1 billion hedge fund Weiss Multi-Strategy Advisers, wrote in a June paper. “It appears to be a feeling of being trapped in an investing world that no longer makes sense.”

It's not just a business problem, an inability to beat markets or raise money or whatever. It is existential: The thing that defined you as a person, your ability to pick winning investments, may no longer exist, or matter. It's gloomy stuff. Here is Fischer's advice for his fellow hedge fund managers:

“They can be convinced not to be an a--hole for the rest of their lives,” he says.

Wow, harsh. And not ... immediately responsive to the existential questions?

Elsewhere: "Hedge Fund Managers Expect ‘Massive’ 34% Pay Cut, Survey Says." "Hedge fund industry assets hit a new record in the third quarter, according to new data from Hedge Fund Research, but they did so entirely on the strength of performance gains as net redemptions totaled the largest quarterly outflow since 2009." And: 1.5 and 17.5 is the new 2 and 20, but it "doesn't roll off the tongue in the same condescending way."

Meanwhile Dimensional Fund Advisors, which focuses essentially on clever passive management, is "the fastest-growing major mutual-fund company in the U.S." High-fee clever active management is having a crisis of faith; low-fee clever passive management is doing great.

Swiss banks.

The U.S. government has cracked down on a lot of bad cross-border banking activity -- money laundering, terrorist financing, etc. -- with the predictable but unintended result that U.S. banks are overly cautious about providing financial services to foreigners. So banks have avoided charity financing, and providing services to embassies, which has been a little embarrassing for the government, which did not really want to shut down charities and embassies. But the U.S. government has also cracked down on another kind of bad cross-border activity: Tax evasion by U.S. citizens using Swiss bank accounts. With this predictable but unintended result:

Many Swiss banks have frozen out US clients, and even closed down existing accounts, in the wake of a damaging legal battle with the US Department of Justice (DoJ) over tax evasion. Banks have not only dropped links to tax cheats, but many have also shunned all US citizens, as the paperwork builds up along with the potential penalties for letting a rotten apple slip through the net.

So "several Swiss banks have received a letter from the United States Ambassador to Bern, Suzan LeVine, asking them not to shun US citizens who want to open accounts in Switzerland." It's all fun and games when the U.S. uses its global financial hegemony to enforce its own criminal laws on foreigners, but it can sometimes be inconvenient for Americans too.

Elsewhere:

Other policy makers have expressed concern that strict crackdowns on banks’ lapses in carrying out anti-money-laundering regulations have led banks to nearly cut off several emerging markets from the global financial system, damping their economies. The International Monetary Fund, in particular, has sounded that alarm repeatedly this year and held a conference highlighting the issue at its annual meeting in early October.

Art.

Here is Alexandra Scaggs on "the emerging genre of regulatory filings as performance art," focusing on a Form 4 filed by artist Antonio Lee's YNoFace Holdings Inc. purporting to own several billion shares -- roughly half the shares outstanding -- of Bank of America. One assumes that YNoFace does not own half of Bank of America? So why make a Securities and Exchange Commission filing saying that it does? Here is Scaggs:

Reuters compares the filing to other SEC-filing scams like the fake Avon Products takeover bid, but we think it fits into a colourful trend of oddball regulatory filings meant to make a statement, not a profit.

It's true, the stock didn't budge on the filing. (One lesson for artists and scammers: If you want to move a stock, file a fake Schedule 13D or Schedule TO; a fake Form 4 is more of an ethereal thing, and people might not notice. I guess I should say that this is neither legal nor financial nor aesthetic advice?) But while that may be good evidence that the filing had no fraudulent intent, it does not exactly clear up what its artistic intent was. The last time we talked about financial art, I said:

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.

I suppose that just filing an SEC form might strike an artist as such a strange and performative act that it becomes art on its own.

People are worried about unicorns.

The pain continues for Theranos, the Blood Unicorn (Elasmotherium haimatos), with an article titled "Agony, Alarm and Anger for People Hurt by Theranos’s Botched Blood Tests." There is perhaps a reason why social networking is the dominant form of company in Silicon Valley these days: A "move fast and break things," minimum-viable-product ethos makes a lot more sense with, like, tweets, than it does with critical medical tests. You really should try to get those right before you ship. 

Elsewhere: "Don’t plan on using your autonomous Tesla to earn money with Uber or Lyft."

People are worried about bond market liquidity.

"Regulators Should Help Treasury Market Evolve, Citadel Says," specifically:

Membership in the clearing system operated by the Depository Trust and Clearing Corp., which facilitates the transfer of cash for bonds, needs to be expanded, White said, speaking on a panel at a Futures Industry Association conference in Chicago. In August, Direct Match Holdings Inc. had to abandon its plan to offer asset managers anonymous, exchange-style trading when it couldn’t secure access to the DTCC through State Street Corp. after an initial agreement with the bank fell through.

Things happen.

Credit Suisse Revamp Takes Shape, but Doubts Remain. BAT Offers to Buy Rest of Reynolds American for $47 Billion. AT&T Discussed Idea of Takeover in Time Warner Meetings. Morgan Stanley in Line for $120 Million Payday in Bayer-Monsanto Deal. U.S. credit union regulator paid law firms $1 billion to sue banks. London, "soft power" and Brexit. Lawyers Are Thriving Because of Brexit. Fight Between Goldman Sachs and Libyan Fund Shadows Lawyer. SEC Sharpens Focus on Registered Investment Advisers. U.S. Treasury official urges move away from Libor. Online Lenders Seek to Shape Industry Before Regulators DoDeutsche Bank shares back above pre-DoJ level, up 14% this month. A Tesla short-seller. High Frequency Scalping Strategies. Snoopy Has Been Fired by MetLife. "Ernst and Young struggle to account for Trump." Hipster coffee boom sends buyers to conflict zones. "Twitter, where hackneyed phrases go to die a slow, repetitive death." Ranch dressing is backSuperyachts. Taser dronesDumpster fire. Woodpecker adorably pecks away at animal control officer's neck.

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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