Money Stuff

Researchers, Traders and Energy Funds

Also financial transaction taxes, Jamie Dimon, ICOs, stock buybacks and unicorns.

Research insider trading.

We have talked before about the Securities and Exchange Commission's case against Gregory Bolan and Joseph Ruggieri, two former Wells Fargo Securities employees. Bolan was a research analyst, and Ruggieri was a trader, and sometimes Ruggieri would buy a stock shortly before Bolan would put out a Buy recommendation on that stock, and the SEC concluded that was suspicious insider trading. Or, rather, the SEC's Enforcement Division concluded it was insider trading. But it brought the case in one of its own courts -- before an SEC administrative law judge -- and that SEC judge concluded that it was not insider trading. (By Ruggieri; Bolan settled.) And then the SEC appealed, and the way that the SEC appeals from its own courts is by appealing to the SEC -- like, to the actual commissioners of the SEC. And so the SEC heard the SEC's case, and concluded that the SEC was wrong. Just barely: Only two SEC commissioners heard the case, and one (Kara Stein) agreed with the Enforcement Division, but the other one (Michael Piwowar) didn't, and the tie went to Ruggieri. So: not insider trading.

When we first talked about the case, I pointed out the essential oddity of the research analyst/trader relationship. The analyst is supposed to know stuff about stocks. The trader is supposed to buy and sell stocks. They are colleagues, on the same team. Of course the trader should call up the analyst and ask him "hey will this stock go up?" before buying the stock; that is just common sense. On the other hand, the analyst's Buy/Sell/Hold rating on the stock, between the time he formulates it and the time he publishes it, is material nonpublic information, and he is not supposed to share it with the trader before he shares it with everyone. So the analyst can tell the trader to buy the stock any time, but he can only tell him to Buy the stock if he has a public Buy recommendation. Or something like that.

That nuance is easy to miss. The SEC Enforcement Division pointed out that Ruggieri traded ahead of Bolan's ratings changes on four occasions, and that Ruggieri and Bolan talked by phone before each of those trades. Sounds suspicious! But as Commissioner Piwowar points out:

Bolan and Ruggieri talked almost every day during the year and a half that they overlapped while at Wells Fargo, in accordance with Wells Fargo policy that encouraged active communication between traders and analysts. Thus, phone calls occurring before a trade would not have been unusual.

The policy is to encourage active communication between traders and analysts, but also to make sure that traders don't know about analysts' recommendation changes before they are public. You can see how that might be difficult to police.


Here is the story of EnerVest Ltd., a private equity fund that bought producing oil and gas wells, levered them up with fund-level debt, and used the proceeds to return 30 percent annual profits to its investors. Until it raised a $2 billion fund in 2013, oil prices crashed, and that fund went roughly to zero, "wiping out investments by major pensions, endowments and charitable foundations," and perhaps marking "the first time that a fund larger than $1 billion has lost essentially all of its value." Oops! 

“We are not proud of the result,” John Walker, EnerVest’s co-founder and chief executive, wrote in an email to The Wall Street Journal.

No, I mean, I can see how you wouldn't be. But I sympathize. There is a tension, in thinking about investment returns, between the obvious purpose shared by every investment fund and the specific purpose of any individual fund. Every fund is supposed to make money; making more money is better than making less money, and losing all your money is very bad. On the other hand, EnerVest's pitch to pensions and endowments and charitable foundations wasn't "we're going to try to make money somehow, preferably without losing all of it." It had a specific mandate. Those institutions wanted levered exposure to U.S. oil and gas wells, in 2013, when oil prices were north of $80 per barrel. That turned out to be a bad thing to want, or get. In some sense that is EnerVest's fault; no doubt EnerVest was also pretty jazzed about the oil-well-investing opportunity in 2013, and pitched it enthusiastically to investors.

But pensions, endowments and charitable foundations aren't investing in funds like this out of pure trust in the funds' absolute returns: They wanted a specific mix of exposures in their overall funds, and they decided that some of their risk should be allocated to oil, and that EnerVest was a good way to get exposure to oil prices. And it was! It was an extremely efficient delivery mechanism for what turned out to be a bad risk. But that is not EnerVest's fault. You can't compare every alternative fund's performance to the S&P 500 Index, or even to, you know, zero. EnerVest gave investors what they wanted, oil exposure, even if it didn't give them what they really wanted: money.


At a very high level, there are two opposing ways to think about finance:

  1. Finance is bad and should be treated with suspicion; or
  2. Finance is good and should be coddled and loved.

I am old enough to remember when the financial transaction tax was not just a way for governments to raise revenue, but also a symbolic way for governments to express suspicion about finance. Aren't there just too many financial transactions? Aren't they too high-frequency, too speculative? Don't they lead to constantly recurring crises, for which the financial sector doesn't pay its fair share? Shouldn't we tax all those transactions, to discourage them and slow them down and ground finance in the real world of social obligations?

Apparently not:

French Finance Minister Bruno Le Maire said earlier this month that Brexit could bring “thousands of jobs to Paris,” an opportunity that could be lost if the tax were imposed. His German counterpart, Wolfgang Schaeuble, said that “quite a bit speaks in favor of the French argument to look first at how the Brexit negotiations are going.”

Ahahaha. The financial sector is so important and attractive that France and Germany are vying desperately to attract banks from the U.K. after Brexit. Taxing financial transactions doesn't exactly fit with that message; that was more of a six-years-ago approach.

"Jamie Dimon tells financial journalists to stop writing about finance."

That is the excellent Financial Times headline, about Jamie Dimon's fun speech on JPMorgan Chase & Co.'s earnings call last Friday:

The USA has to start to focus on policy which is good for all Americans and that is regulation, tax, education, we have to get those things done… You guys (journalists) should be writing a lot more about that stuff. That is holding it back and hurting the average American citizen if we don’t do it. It’s not a Republican issue, it’s not a Democrat issue.

Why you guys don’t write about it every day is totally beyond me, who cares about fixed income trading in the last two weeks in June. I mean seriously?

As someone who has spent years making fun of worrying about bond market liquidity, I have some sympathy. But the weird thing here is that Dimon was supposedly offered the job of Treasury Secretary in the Trump administration, and turned it down to focus more on fixed income trading and yelling at journalists. I gather that a big part of the job of being Treasury Secretary is getting regulation and tax things done, while running a global investment bank involves a lot of fixed income trading. And yet: revealed preferences.

Blockchain blockchain blockchain.

Guys there is such an amazing efflorescence of initial coin offerings that I can't really keep up. My current favorite ICO might be The SAFE Token:

The SAFE Token is the first “anti bubble” bitcoin derivative created by an ex-partner at Goldman Sachs to protect you against cryptocurrency price declines, while maintaining an upside in the Cryptocurrency market.

The alleged former Goldman partner "would like to stay anonymous," though there's a video at that link where you can maybe hear him talking in a computerized voice. Anyway the point of the SAFE Token is that its price is based on "square root of bitcoin mining difficulty." (There's a white paper.) How does that ... work? The white paper doesn't say! One interpretation is that it is a bitcoin derivative, sold to you by a person, that pays off based on that formula. But it is also ... an ICO? They are doing an offering of SAFE Tokens, which will then be a tradable thing. "As the SAFE is a healthy structure, much less volatile than Bitcoin, it will become the 'safe heaven' and will have a preferable supply/demand structure as it becomes a favored asset as Bitcoin prices fall." (Yes, it repeatedly says "safe heaven.") But who will pay cash for the SAFE token at the formula price? I don't know! The point is that we're all having fun.

Or there is this:

InvestFeed, a community-powered stock trading network, is making the ambitious move to drop U.S. equities from its platform and to replace them with high-performing, highly-liquid digital currencies.

Cool, definitely, a platform for talking about and trading stocks is worthless garbage here in 2017, while a platform for talking about and trading cryptocurrencies is the future. "Cryptocurrencies, especially newer alt coins, suffer from lack of exposure," says the InvestFeed white paper, implausibly. But why does it have to come with an ICO? InvestFeed is not just a data and discussion platform; it is also a coin:

In investFeed’s system, FEED Tokens (IFT) will play a key role in providing economic incentives so that the rational behavior of individuals results in common good. Unlike in Twitter where volunteers must donate their time to contribute and validate information, on investFeed’s platform, contributors will be rewarded for their work and incentivized to continue increasing the value of the community ecosystem.

Part of the original cryptocurrency dream was that it would enable micropayments: If you can easily and instantly transfer money using bitcoin, then you can pay people to comment on your blog, or pay them not to comment on your blog, or charge them for commenting on your blog, or whatever. It is a nice currency-ish function for bitcoin. But the new ICO dream seems to be a million different currencies for a million types of micropayments. Now, you can set up a blog, and set up a currency to pay/charge people for commenting on your blog, and then sell that currency for cash, and as your blog gets more popular the currency gets more valuable. As a way to fund blogging, it ... I guess it provides economic incentives so that the rational behavior of individuals results in common good? And yet it seems like a step backward in the division of labor. Now, to set up a website, you don't just need to have technical skills and good content. You also need to reinvent the notion of money, but for your website.

Meanwhile Tezos, the biggest ICO to date, has raised $230 million to build a blockchain that is more decentralized than the other decentralized blockchains. And: "The price of the digital currency bitcoin fell over the weekend, dropping below $2,000 and farther away from its June highs, part of a broad selloff in dozens of cryptocurrencies, including ether." And: "A Brief History of Blockchain: An Investor’s Perspective."

People are worried that people aren't worried enough.

"Washington is in gridlock and the White House faces scrutiny. Valuations are at the highest levels since the financial crisis." Guess where this is heading? Of course: "The CBOE Volatility Index ended at 9.51, a 24-year low, falling 15 percent." People, measured by the VIX, are as unworried as they have been since 1993. I remember 1993. 1993 did not feel like 2017, except VIX-wise I guess.

People are worried about unicorns.

"What's the absolute maximum number of dog collars you'd like to buy this year," asks Adam Ozimek. "Probably less than twelve?" And yet Good Day Dog offers a monthly dog collar subscription service. One of the bubblier features of the modern tech market is how the basic function of putting basic physical goods in a box and mailing them to your house is now somehow thought of as "tech."

As I guessed, there appears to be six subscription toothbrush services. I mean maybe a toothbrush subscription is a good idea, but will you really buy it from a startup entrepreneur? Or will you just get it from Amazon when they decide to wipe this market out? Or maybe just straight from Crest. Either way, right now there are probably 20 to 30 people employed at toothbrush subscription startups, most of whom will be unemployed within the next few years at best.

Meanwhile in the business of chopping fruits and vegetables, putting them in a bag, and mailing the bag to your house, where you can squeeze juice out of the bag with your hands or, if you are feeling tech-enabled, with an internet-connected machine, Juicero Inc. "is undergoing a 'strategic shift' to lower the cost of its $399 machines and juice packs filled with raw fruits and vegetables on an accelerated timeline." The strategic shift involves laying off a quarter of its staff.

Elsewhere, Elon Musk is worried about artificial intelligence:

Speaking Saturday at the National Governors Association meeting in Rhode Island, the chief executive of electric-car maker Tesla Inc. and rocket maker Space Exploration Technologies Corp. laid out several worst-case scenarios for AI, saying that the technology will threaten all human jobs and that an AI could even spark a war. “It is the biggest risk that we face as a civilization,” he said.

It feels sort of appropriate that the two big risks to the tech industry are (1) that many tech startups are essentially unambitious repackagings of low-tech grocery-delivery businesses and (2) that tech firms will build robots so advanced that they will take over the world and destroy human civilization.

People are worried about stock buybacks.

Gretchen Morgenson is worried about stock buybacks, particularly at pharmaceutical companies, many of which spend more on buybacks and dividends than they do on research and development. I tend to take an accounting view of things like this: A pharmaceutical company wants to have revenue that exceeds its expenses to make a profit for its investors. Revenue is revenue. Research and development are expenses. Buybacks and dividends are not; they are just ways to return profits to investors. If the pharmaceutical companies took all the money they spent on buybacks and dividends, which are not expenses, and instead spent it on research, which is, then their expenses would (say) double. Then they'd need to (say) double their revenue to make an acceptable profit for their investors. Perhaps the extra research would yield such great drugs that they'd easily double their revenue. But remember these are companies that are already spending billions of dollars on their most promising research opportunities. If they spent billions more dollars on their less promising opportunities, presumably those opportunities would be ... less promising. So what do you do when your expenses grow but your revenue does not? I gather that if you are a drug company, you raise the prices of your drugs.

Morgenson also discusses a recent study about companies who have bought back more than their entire current market capitalizations:

Fifty companies have spent more inflation-adjusted capital buying back stock than their businesses are currently worth in market value, the study found. Companies on this list include HP Inc., J. C. Penney and Sears Holdings.

J. C. Penney! Sears Holdings! The way you get on this list is by (1) buying a lot of stock and (2) having low or negative growth. The implication is that (1) causes (2), but (2) could equally easily cause (1). What do you think Sears Holdings Corp. (current market capitalization: $865 million, market capitalization 10 years ago: over $20 billion) would be worth if it hadn't done any buybacks? Would it have invested in research, automation, new business models? Would it have built itself into a viable competitor to Amazon? Or is it possible that profitable companies in dying industries should take their profits and give them back to shareholders to re-invest in growing industries?

Things happen.

Trian to Launch Proxy Fight Against P&G. (Trian proxy statement.) New U.S. Subprime Boom, Same Old Sins: Auto Defaults Are Soaring. U.K. Regulator to Probe $650 Billion Investment Platform Market. In Urban China, Cash Is Rapidly Becoming Obsolete. China Blocks Big Banks From Lending to Dalian Wanda. "Peter, vomiting, unable to sit up, slipping in and out of consciousness, had managed, somehow, to dial into a conference call." Tensions between Bill Gates and Prince al-Waleed over Four Seasons Holdings Inc. Oil Giants Make a Play For Millennial Hires. The Plan to Make Chip Credit Cards Less Annoying. Lucy Kellaway: How I lost my 25-year battle against corporate claptrap. Game of Thrones API. How HBO’s Silicon Valley built “Not Hotdog” with mobile TensorFlow, Keras & React Native. Australian senator of 9 years resigns after finding out he's from New Zealand. Dog rides horse

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