Money Stuff

Proxy Fights and FX Fixes

Also Larry Fink, Portland, Arjun LP, public embarrassment and poetry.


This is just conjecture, but I get the sense that Arconic Inc. Chief Executive Officer Klaus Kleinfeld didn't especially like spending time with the activist investors at Elliott Management Corp. Even back when relations were cordial, before Elliott launched a proxy fight and called for Arconic to get rid of Kleinfeld, this happened:

Elliott asked for another meeting to discuss concerns about the profit forecasts. Mr. Kleinfeld said the only time he could spare was at the World Economic Forum, the annual summit of global elites in Davos, Switzerland, that he attends regularly.

That is going to be my all-purpose brush-off from now on. "Sorry, I'm not free for lunch this week, but I think I'll have a spare 20 minutes at Davos this year, want to meet up then?" It accomplishes so many goals, so efficiently.

I would never want to be the CEO of a big public company, but it seems like the tradeoffs are pretty straightforward. On the plus side, you get paid a lot, and you get to boss a lot of people around. On the minus side, as Lucy Kellaway points out, it is stressful, and "you spend your life in two of the most depressing spaces on earth — meeting rooms and aeroplanes." And certain natural human behaviors are just closed off to you. For instance, when a famously mean hedge fund calls for your board to fire you, and mounts a big public campaign criticizing your leadership, you can't send them a nasty abusive threatening private response, no matter how much you want to.

I mean, you can do it. Kleinfeld did! You just have to stop being CEO shortly afterwards. Kleinfeld did! "Mr. Kleinfeld stepped down as Chair and CEO by mutual agreement," Arconic announced yesterday, "after the Board learned that, without consultation with or authorization by the Board, he had sent a letter directly to a senior officer of Elliott Management that the Board determined showed poor judgment." Honestly that seems like a fair trade? Sending a nasty letter to a shareholder you don't like -- Elliott says it "read as a threat to intimidate or extort a senior officer of Elliott Management based on completely false insinuations" -- is a pretty satisfying way to stop being CEO. (Better than how Kleinfeld left Siemens AG, anyway, "as the company worked to recover from a bribery scandal.")

It is not ideal for the company, though. Elliott's proxy fight continues. "Importantly," says Arconic, "this decision was not made in response to the proxy fight or Elliott Management’s criticisms of the Company’s strategy, leadership or performance." Still, I mean: Elliott said the CEO had to go, the board disagreed, and then it turned out that the CEO really did have to go. How could you not score that as a point for Elliott? They certainly do:

This letter cannot be viewed in isolation. It is simply the latest debacle in a pattern of conduct in which the Board has repeatedly excused, endorsed, and participated in Dr. Kleinfeld’s poor leadership and attempts to entrench himself and his allies on the Board. When such conduct manifests itself in a pattern as it has here, it is not a CEO problem. It is a Board problem.

Honestly I'm mostly disappointed that neither side has chosen to publish Kleinfeld's letter. It must be pretty good!

The London Fix.

Remember the foreign-exchange trading scandal? Basically reference foreign-exchange rates were set during one-minute "fixing" windows every day, and clients would ask to buy currencies at those fix rates, and the banks would agree to sell to them at those fix rates, and the banks would take the risk that they could actually execute -- actually buy the currencies -- at those rates. That is a risk for the bank, which means that it comes with a reward: If they could buy at better rates than the fix rates, they could make a profit on the trade. There were various ways for the banks to do that, some pretty illegal (sharing customer order information with each other) and others not especially illegal but still sort of ugly-sounding if you haven't thought about them. For instance, banks that knew they would have to sell euros to customers at the fix would buy a lot of euros sloppily in the minute leading up to the fix, pushing up the fixing price, since they knew that the customer was on the hook to buy them. That was fine! That was the point of the fix, really: The customer got the convenience of being able to buy at a fixed price; the bank got the ability to "pre-hedge" to manage its risk, and the pre-hedging moved the price in the direction of the customer's demand. 

Anyway the banks were all fined a lot of money, mainly for the illegal collusion, though there was a lot of non-binding regulatory huffing about the legal-but-ugly stuff. Then the banks all sent out notices to customers apologizing for the collusion, and half-apologizing for the legal-but-ugly stuff, and also quietly informing them that the legal-but-ugly stuff would continue. But here is a National Bureau of Economic Research working paper from Takatoshi Ito and Masahiro Yamada looking into the banks' actual behavior after the settlements (and some related changes to the FX market, like widening the fix window to five minutes and trying to limit customer-flow conflicts of interest). The results are kind of what you'd expect: Banks cut back on some legal-but-ugly behavior, which led to increased risks and costs for them, which led to increased costs for their customers.

Third, after the reform, trading volumes prior to the fixing window became subdued. The trading volumes suddenly jumped at the beginning of the fixing window, and the trading volumes stayed at a constant level during the window, as opposed to a volume spike in the beginning of the window before the reform. These observations are evaluated in two analyses. Fourth, we conjecture that banks changed their behavior to avoid any appearance of taking advantage of private information from customer orders by placing a constant amount during the fixing window, which is consistent with the third observation. However, this behavior created profit opportunities for non-bank participants. Fifth, the calibration of an optimal execution model indicates that the extension of the window did not reduce the transaction cost, but increased the risk for fixing traders. The total liquidity during the fixing window did not increase despite the longer fixing window. The optimal execution model resulted in pre-hedging, which was discouraged after the reform.

Particularly fun is that, early on, the banks played too nice, and got picked off by other traders:

The evidence is consistent with the hypothesis that the reform made banks behave naively to avoid the appearance of collusion or of the use of private information about customer fixing orders; moreover, that behavior must have taken advantage of by non-bank participants. Banks corrected their behavior, so that predictability disappeared after less than a year.

A basic problem in financial markets is that you want to do transactions with people who are good at doing transactions, because they will do a good transaction for you. But if you do transactions with people who are too good at doing transactions, they will do a good transaction to you. If you are a customer looking to buy euros from a bank whose trader is an idiot, you may end up getting a bad price, because she will overpay for euros and pass the cost on to you. But if you buy euros from a bank whose trader is a genius, you may also end up getting a bad price, because she will find ways for you to overpay her for euros. It is not obvious how to address this dilemma with regulation. It seems like post-scandal FX market reform has, in effect, made the banks dumber, but it's not obvious that that's better for the customers.

Larry Fink.

Quick question: If someone called you "the most powerful man on Wall Street," would you consider that (a) a compliment or (b) an insult? If you chose option (a), BlackRock Inc. Chief Executive Officer Larry Fink agrees with you

Erik Schatzker: You’ve been described as the most powerful man on Wall Street. Are you?

Larry Fink: I’m not on Wall Street, so the framing of the question is wrong.

ES: Let’s define Wall Street in a writ-large way—finance, financial markets.

LF: That’s fair. I have no objection to that phraseology. I would say I really take it as a compliment, not as a negative.

If you chose option (b), I kind of want to hear from you? Who would take it as a negative? Anyway Schatzker's interview with Fink is interesting throughout, though the highlight for me might have been learning that Fink is responsible for Maroon 5:

The first artist we signed was a band called Kara’s Flowers. We worked with them and changed their name to Maroon 5. We were the label Maroon 5 used for, I think, their first five albums. We made a lot of money on that record company—in a depression! Think about what happened to the record industry at that time.

In more financial news, here is Fink on exchange-traded funds:

One thing you have to understand related to the growth of ETFs is that a large component of the growth is not people seeking beta; it’s active managers navigating beta for alpha. They’re doing asset allocation. It’s cheaper; it’s more efficient; you have less idiosyncratic risk than in any one stock. So I actually believe one of the unknown secrets about the growth of ETFs is that they’re heavily used by active managers.

This is a generally useful way to think about financial markets: As you build new tools to do a basic thing more efficiently, people don't just keep doing that basic thing more efficiently. They use those tools to move to higher level of abstraction; they build more complex strategies that use the basic thing as inputs. 

This has implications for fees. The paradigm I often think about is cheap electronic trading of stocks, which destroyed banks' profit margins on trading cash equities, but which led to huge new profit opportunities in derivatives trading and structuring that wouldn't have been possible if the banks couldn't trade stock efficiently. Similarly with ETFs, if the model is "everyone will just index now and pay a few basis points," then the asset management industry's profit margins are in trouble. If the model is "now active managers have cool efficient new ways to do asset allocation and 'navigate beta for alpha,'" then there are a lot of opportunities for active managers to make money. 


This story so perfectly takes city-council divestment efforts to their logical extreme that at first I assumed it was a parody:

Portland's City Council had originally considered adding Caterpillar, Wells Fargo, JP Morgan Chase and six other companies identified by a volunteer committee on socially responsible investing to a so-called "Do Not Buy" list, but the council was unable to come to an agreement on which companies to blacklist from the city's investment portfolio. Instead, in December, they voted to place a temporary halt on all new corporate investments until permanent decisions could be made.

After activists organized rallies and packed council meetings with hours of testimony, the council agreed last week to end corporate investments altogether.

But no, it is real. Portland "will likely see a drop in revenue of $4.5 million a year when the $539 million now invested in companies is moved to federal bonds and other places." "We can rest assured in Portland that our money won't be funding prisons, pipelines and the occupation of Palestine," says an activist named Amanda Aguilar Shank, who is going to be disappointed when she learns what federal bonds are used for. "There is no ethical consumption under capitalism" is a phrase that comes up surprisingly often in this financial newsletter, but really, if you want to divest from modern capitalism, just getting rid of corporate securities is not going to cut it. Any securities -- any financial assets -- are suspect. You have to start paying city retirees in local assignats, or compost, or bitcoins.

A good hedge fund.

Arjun LP is a hedge fund run by Joseph A. Meyer that is distinguished by (1) never losing money, (2) guaranteeing investors that they will never lose money, and (3) explaining how it makes its money by saying things like "I’ve got a spreadsheet that did the calculations" and "All it does is look at the last trade and calculate trades that would be equivalent of, 'What if this security increases 50 percent in value in the next three seconds.'" Sadly, the Securities and Exchange Commission is now investigating Meyer, Arjun, and Statim Holdings Inc. (Meyer's firm), after Georgia regulators found "multiple irregularities." Statim's lawyer explained to Bloomberg's Simone Foxman, Matt Robinson and Margaret Newkirk that it is all a misunderstanding, and their fault:

“The SEC and the GA Securities Division are conducting what appear to be a routine investigation of Arjun LP, Statim Holdings, Inc. and Joseph Meyer in part based on misstatements of fact made by you in your Bloomberg article,” Sadow said in an emailed statement. “All financial records and information sought in the inquiry have been disclosed and show no fraud or illegal activity whatsoever. Mr. Meyer has and will continue to cooperate in full with both agencies.”

I'm sure that this will all blow over once the SEC sees the spreadsheet. 

"The worst thing that happens is that I lose some money and maybe make a public idiot out of myself."

That's a quote from Doug Derwin, who is spending some of his venture-capital wealth to buy billboards urging Elon Musk to stop hanging out with Donald Trump. So he means it in a very straightforward literal way. But it would also be a good motto for an activist hedge fund, or any hedge fund, or any investor really. Certainly for Portland's city council. It should be the first risk factor in every initial public offering prospectus. Of course it is an extraordinarily optimistic statement. Neither of those things is particularly bad. Really it is a good aspirational motto for the utopia of late capitalism. We should all dream of a world where the worst thing that happens is that we lose some money and maybe make public idiots out of ourselves. 

People are worried about equity compensation.

Look, it is a bit of a cheat for me to have all these recurring section headings like "People are worried about ____," as though it's unusual or noteworthy for people to constantly have the same recurring worries about a bunch of different things. People worry about stuff! That is the nature of financial markets, and of humanity, really. If I started a section called "People are worried about adorable puppies," I am sure I could find material to fill it every day. (Important note: Please do not send me material for this hypothetical section; I will block your email address.) There just aren't too many news stories that couldn't be headlined "People Are Worried About ____." Anyway though here is a post from Mercer Capital's Financial Reporting Blog that is actually headlined "People Are Worried About Equity Compensation." I'm sure they are!

People are worried about unicorns.

I get nervous about linking to fake news here, so in an abundance of caution I will remind you that Clickhole is not real, but anyway here is a Clickhole article titled "Getting Out Ahead Of This One: Uber Has Apologized In Advance If Anyone Finds Out About Something Called ‘Project Judas,’" and that one feels like it'll be real in a week or two. Meanwhile in real news, "Theranos Inc. and its founder pledged to stay out of the blood-testing business for at least two years in exchange for reduced penalties from federal health authorities, in an agreement that resolves a year-long regulatory impasse." And: "Scientists find giant, elusive clam known as ‘the unicorn of mollusks.’"


Here's a poem about Tax Day from Fortune's Jen Wieczner, if you're looking for pretty esoteric last-minute ways to put off filing your taxes. It has a sort of political theme. "Plus, it had also become harder / To convince some people it was fair / That they had to file their tax returns / When the President's were God knows where." Elsewhere, Anthony Lane wrote a poem about "The Fate of the Furious."

Food Stuff.

Mermaid toast, sure.

Things happen.

Goldman Sachs Falls Short on Earnings, Revenue Estimates. (Earnings release.) BofA Beats Estimates on Surge in Trading, Higher Interest Income. (Earnings release, presentation, supplement.) Trump to Nominate Quarles for Fed's Top Regulatory Post, Source Says. Paul Volcker stands tall against attacks from banking industry. Bank Brexit Exodus Seen Hastened by Close Regulator Scrutiny. U.S. top court mulls time bars for SEC recovery of ill-gotten profits. Silver Lake Raises $15 Billion Fund for New Tech Deals. Google Makes Nevada Land Grab for Data Center. United, Facing Uproar Over Passenger Treatment, Says Earnings Beat Expectations. United Air removes couple traveling to wedding from plane. This Italian Bank Accepts Wheels Of Parmesan Cheese As Collateral For Loans. Coachella 2017: Man Arrested for Stealing Over 100 Phones. The Stink Highway. This is how the facial hair of university grads has changed since 1898. Journalist wins beauty pageant she was sent to cover. Egg sandwiches

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