Bailout Lawsuits and Trader Chats

Also: SEC trading, insider trading, worry worries and millicorn etymology.


In 2008, the U.S. government bailed out American International Group, Inc., and got back in exchange a 79.9 percent equity stake in the company. Eventually AIG got better, and some of AIG's previous shareholders, who saw four-fifths of their stakes effectively wiped out, thought that they had gotten a bit of a raw deal. The most aggrieved shareholder was probably Maurice R. "Hank" Greenberg, a former chief executive officer of AIG whose firm, Starr International Company, Inc., was one of AIG's biggest shareholders. Starr sued the government, and in 2015 it sort of won: A federal court ruled that the government had cut some corners (and violated the Federal Reserve Act) in crafting the AIG bailout. But it also awarded Starr no damages for the government's illegal taking, because if it hadn't happened, AIG would have gone bankrupt and Starr would have been left with nothing anyway. 

Everyone appealed, and yesterday Starr lost again, but in a different way. The judges of the U.S. Court of Appeals for the Federal Circuit agreed with the lower court that Starr shouldn't get any money because it hadn't been harmed by the bailout. But their reasoning was different: It wasn't about damages (that Starr would have been even worse off without the bailout), but rather about standing. The government, in the appeals court's reasoning, hadn't done anything to Starr, so Starr had no right to sue the government.

Oh of course the government had done something to -- or at least with -- AIG. AIG, if it didn't like its bailout, had standing to sue the government. (It chose not to.) But Starr, and Greenberg, weren't AIG. They were just shareholders. And the government hadn't taken any property from them. From the opinion (citations omitted):

We address Starr’s argument that its case for direct standing is particularly compelling because the Government’s acquisition of newly issued equity should be equated with a physical exaction of stock directly from AIG shareholders. Specifically, Starr urges us to view the equity acquisition as being “indistinguishable from a physical seizure of four out of every five shares of [shareholders’] stock.” To do otherwise, Starr submits, would be to “elevate form over substance.”  

We decline Starr’s invitation to view the challenged conduct as it wishes. There is a material difference between a new issuance of equity and a transfer of existing stock from one party to another. Newly issued equity necessarily results in “an equal dilution of the economic value and voting power of each of the corporation’s outstanding shares.” In contrast, a transfer of existing stock creates an individual relationship between the transferor and the transferee. Equating AIG’s issuance of new equity with a direct exaction from shareholders would largely presuppose the search for a direct and individual injury—e.g., the “separate harm” that results from “an extraction from the public shareholders and a redistribution to the controlling shareholder, of a portion of the economic value and voting power embodied in the minority interest.” We therefore do not equate the Government’s acquisition of equity with a physical seizure of Starr’s stock.

If you own 10 percent of a company, and the government takes over 80 percent of the company in the form of newly issued stock, then you will be left with 2 percent of the company. That will feel, to you, a lot like the government taking 8 percent of the company away from you. But to a federal court it feels very different. If the government took your stock from you directly, then you'd have a case to sue. But if the government took the stock from the company -- diluting your ownership rather than seizing it -- then that's not your problem; it's the company's. And so you can't sue.

Does this "elevate form over substance"? Meh, a little, probably. (That is a popular pastime in corporate law.) But it's important to understand the form at issue here, the corporation, which has powerful formal properties. I occasionally make fun of the notion that shareholders are the "owners" of a corporation: It is sort of true, and sort of not true, but it does not generally provide a useful guide to understanding the rights of shareholders. You cannot explain Snap Inc.'s non-voting shares, or the short-termism/long-termism/activism/buybacks debates, by pointing to notions of "ownership." Shareholders have certain rights in the corporation, dictated by contract and law and custom, but it is not as simple as saying that the shareholders own the corporation. For instance: If the shareholders owned the corporation, and the government took four-fifths of the corporation, the shareholders could probably sue! But in fact they usually can't. 

Trader chats.

My basic theory of post-crisis financial scandals is that the main illegal thing that traders do is send each other dumb emails and chat messages. So many of these scandals are hard to describe in objective terms. The Libor scandal was about submitting fake numbers in Libor surveys, but even non-scandalous Libor submissions were pretty fake, so the only way to distinguish the bad fakes from the good ones was by finding chat messages saying things like "LOWER MATE LOWER !!" What was scandalous in the foreign-exchange-fixing scandal was that banks traded ahead of customer orders, but that was also legal; what was illegal was the dumb chats between those banks sharing customer information. The chats and emails are evidence of substantive illegality -- illegal collusion, manipulation, etc. -- but also display an attitude. If they were written in dull legalese, they would have created much less of a reaction; regulators might not even have noticed the problem. But they weren't; they were filled with obscenity, slang, misspelling, and promises of Champagne, all of which tend to enrage prosecutors and juries and the public.

Anyway I enjoyed this story about the irreducible atomic unit of dumb trader chat:

A five-word message to a rival banker was enough to cost former Citigroup Inc. trader David Madaras his job as the bank fought to appease regulators probing the foreign-exchange scandal engulfing the industry.

Citigroup’s Timothy Gately disclosed the message on the first day of Madaras’s employment lawsuit in London Tuesday. The executive said the April 2011 chat constituted gross misconduct and firing Madaras was the only appropriate sanction.

"he’s a seller/fking a," Madaras told a rival trader who had just disclosed the identity of a client, Gately said in a filing prepared ahead of the hearing. That chatroom message "validated an external trader’s disclosure of a client name," Gately said in the filing.

The first three words -- "he's a seller" -- are substantive misconduct, disclosing a client's order to a competitor, and enough to get you fired in an atmosphere of heavy scrutiny of that sort of thing. The next two -- "fking a" -- are substantively superfluous, but you can't have a scandalous trader chat without obscenity and misspelling. You can't imagine a trader actually being fired for typing "he's a seller," but of course one was fired for typing "he's a seller/fking a."

This is partly a matter of psychological makeup -- how could the traders resist cursing? -- but it might also be a matter of technology. What search, what flags, brought that chat to the executives' attention? Does compliance monitor every time traders type "he's a seller"? (Presumably they type that a lot!) Or is there a search for "fking," and other variant spellings, that triggers review? 

Don't do this.

David Humphrey (1) traded illegally (2) using options (3) in his mother's account (4) while employed at the Securities and Exchange Commission, so he violated a plurality of my Six Laws of Insider Trading, or he would have except that he didn't insider trade. His trading was illegal just because he worked for the SEC, and so was restricted from some types of trading and required to report all his trading to the government. But it was not insider trading; Humphrey didn't use the information he gained as an accountant at the SEC to inform his trading. You can tell because he traded index options:

Humphrey initially employed this trading strategy by selling options in the NASDAQ-100 Trust and its successor, Powershares QQQ Trust Series 1 ("QQQ"), exchange-traded funds that track the Nasdaq-100 Index.

He eventually moved on to Citigroup Inc. and Under Armour, Inc., options, but he seems to have focused on writing uncovered options where he had no particular edge and, in fact, often lost money. It was not a particularly slick scheme. Nor was he particularly slick at concealing it: 

As part of his scheme, Humphrey provided misleading information to E*Trade. In 2012, Humphrey upgraded his E*Trade account. The account upgrade documents asked for his employer and business telephone numbers. Humphrey did not disclose that he worked for the SEC and he did not provide his SEC telephone number as his business number. Rather, Humphrey wrote that he worked for the "Federal Government" and he provided his cell phone number.

Also: "He largely conducted this improper trading strategy using his SEC computer during business hours." This went on for 14 years, from 2001 until Humphrey left the SEC in 2014, making this case perhaps not the SEC's most impressive enforcement coup. I mean, they didn't catch Bernie Madoff either, but Madoff didn't work for them. Anyway Humphrey "pleaded guilty in federal court in Washington to making false statements in government filings" and will pay back $108,600.

Insider trading. 

Mathew Martoma is the former SAC Capital Advisors LP analyst who paid two doctors thousands of dollars in consulting fees and got inside information from them about drug trials. He is currently serving a nine-year prison sentence for insider trading, but his lawyers have appealed his conviction, and every time I read about the appeal I am convinced that nobody -- not Martoma, not his lawyers, not the prosecutors, not the judges, and certainly not me -- understands insider trading law. What on earth:

A central question at Tuesday’s appeal was whether Mr. Martoma and the two doctors had a “meaningfully close personal relationship,” which Mr. Martoma’s lawyers argued was necessary to prove after the Newman decision.

The Newman decision said in order to uphold an insider-trading conviction, the government must prove the tipster and the trader had “a meaningfully close personal relationship that generates an exchange that ... represents at least a potential gain of a pecuniary or similarly valuable nature.”

This is insane. The legality of Martoma's trading doesn't -- shouldn't, anyway -- turn on whether he was good friends with those doctors, or just kinda friends with them. (Or on some even dumber distinction: "The judges asked whether a meaningful relationship means one that is ongoing, or whether a relationship can be considered close if only one party is pushing for the relationship to continue.") The issue is that Martoma (via SAC) paid the doctors thousands of dollars for the information. They didn't tip him because they were friends! They tipped him because he paid them! I mean, maybe they tipped him because they were friends, actually; maybe the consulting fees would have covered only legal information but for the additional fact of their friendship. But there's no reason to care about that; it's obviously illegal because he paid them. Someone should just go write an insider trading law so that courts don't get bogged down in this sort of confusion.

Meanwhile, Bill Ackman and Valeant Pharmaceuticals International Inc. are still getting sued over their alleged insider trading in Allergan Inc. stock, and it seems like they might have to pay up. ("Pershing Square has set aside $75 million for the case," implying a total settlement of about $200 million, but plaintiffs' lawyers think it should be meaningfully higher.) That lawsuit also drives me a little nuts, since it essentially accuses Ackman and Valeant of insider trading on their own intentions to buy Allergan. Nobody was harmed by their insider trading: If you were an Allergan shareholder who sold to Ackman before Valeant announced its offer to buy the company, you got a higher price than you would have without his trading, and his toehold is what allowed Valeant to make the offer in the first place. It is difficult to think of a plausible theory of insider trading's harms that would make this illegal. And yet someone did write an insider trading law -- Rule 14e-3 -- that (maybe) covers this situation.

A real estate bubble.

A good thing to do in financial journalism is to try to write headlines that will be remembered with fond irony after the crash. So here is: "Rich, Young Chinese Are Buying Overseas Properties on Their Smartphones." Really if you write that headline, the first letter of each sentence of the story should be an acrostic spelling out "What could possibly go wrong?"

People are worried that people aren't worried enough.

I am impressed by this worry, which, from a standing start a couple of months ago, has turned into an everyday popular worry with a constant supply of celebrities worrying about it. Here, Lloyd Blankfein:

"Every time I get accustomed to low volatility, like we were towards the end of the Greenspan era, and we think we have all the levers under the control ... something erupts to remind us that the idea that anybody is in control of everything is hubris," Blankfein told CNBC's "Power Lunch" from the sidelines of the company's director symposium in Chicago.

And Allison Schrager "recently asked a few traders if they believed lower volatility reflected less risk in the markets":

They laughed nervously and said, in essence, “a correction is coming and it will be ugly.” They expect a big group, eventually, will get nervous enough and pull out of the market—maybe institutional investors (pension funds, foundations, and the like) or recent retirees. Once this starts, more will follow. Then, one trader says, it will be “carnage.”

We have reached that magical state of markets in which the consensus of quotes is the opposite of the consensus of prices. Everyone who talks about equity index volatility is worried about it, but prices in actual trading markets keep getting calmer. 

People are worried about unicorns.

Yesterday I conjectured that a trillion-dollar company would have a thousand times as many horns as a billion-dollar unicorn, and would therefore, etymologically, be a millicorn. I do not actually think that "millicorn" is a good name for a trillion-dollar company. It's not just a thousandfold unicorn; it is a creature on an entirely different scale. You need a whole new mythic structure to accommodate it. A trillion-dollar company should be, I don't know, a Thor, or a World Turtle

But a number of readers wrote in with a different complaint, which is that a thousand-horned unicorn should be a "kilocorn." No. This is wrong. "Unicorn" is from the Latin words for "one" (unus) and "horn" (cornus), itself translating the Greek "monoceros." The Latin prefix for "thousand" is "milli-"; "millicorn" is a reasonable Latinate formation for a thousand-horned beast. The Greek equivalent would be something like "chilioceros." "Kilo-" is a modern formation, vaguely modeled on the Greek "chilio-," that you know as the prefix for "thousand" in the metric system. (Of course the metric system also uses "milli-" to mean "one thousandth," but we can't help that. The Romans did not spend a lot of time thinking in decimal fractions.) I think it is obvious that unicorns are not metric, that they live in a world of fortnights and fathoms and leagues and magic rather than one of nanoseconds and liters and kilometers and decimal precision. Oh sure billion- and trillion-dollar companies live in a world of decimal precision, but the point of naming them after mythic creatures is to abstract away from that precision, to make them seem magical rather than just big. Thus "unicorn" instead of "venture-backed billion-dollar private company," and thus, I'm gonna say, "World Turtle" instead of "kilocorn."

Elsewhere: "Scotland's Unicorn Hunter," Baillie Gifford.

Constant performance reviews.

I am skeptical about the new trend toward replacing annual performance reviews, which are terrible, with constant performance reviews, which are also terrible, but constantly terrible. But I am old, and the constant performance reviews are always justified by saying that the millennials, with their clicks and likes and faves and Snaps and desperate search for meaning in a cold joyless world of work, really want constant feedback. But this article makes it pretty clear that, no, everyone hates it except human resources managers:

It took Lumeris Healthcare Outcomes LLC two tries to get workers on board with a company-wide goal-tracking program by BetterWorks. Managers now use the tool to monitor employees’ workloads and progress, though not without some grumbling, according to Laura Lewis, a manager at the health-care solutions firm based in Maryland Heights, Mo.

“People have to overcome that negative of, ‘Why do I have to do this four times a year? Why isn’t once a year enough?’ ” she said.

Well, they're not wrong, are they? I love that the conventional human-resources wisdom is that, if everyone hates something, the solution is to just do more of it.

Things happen.

The $9 Trillion Question: What Happens When Central Banks Stop Buying Bonds? Carl Icahn Scrutinized for Shaping Policy That Helped Him Profit. Two Sigma to Buy Interactive Brokers' Options Trading Unit. Credit Suisse Adding Jobs in North Carolina as It Gets Tax Break. U.S. Asks Wal-Mart to Pay $300 Million to Settle Bribery Probe. J.P. Morgan Expands Investment in Detroit. French Insurer AXA Plans to List Shares in U.S. "A lot of the system seems to be price discrimination by pointless complexity, a disease that permeates contemporary America." Business Schools Take a Stand Against Academic Rankings. The psychological effects of growing up with an extremely common name. Jeffrey Gundlach is great at Twitter. Slack Doesn't Want People Using It for Romance. Prom coffin.

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