Money Stuff

Uber's Board and the Fiduciary Rule

Also Snap, Blue Apron, email etiquette, gold suspicions, the VIX and tripping unicorns.

Uber!

In June 2016, Travis Kalanick, then the chief executive officer and a major shareholder of Uber Technologies Inc., persuaded the other big shareholders to amend Uber's governing documents to give him the right to appoint three members of the company's board.  Then in June 2017, Kalanick was pushed out as CEO, but he exercised his right to appoint himself right back onto the board. This apparently makes for some awkward board meetings, which Benchmark Capital Partners VII, L.P., one of the big shareholders, decided to make much more awkward by suing Kalanick for fraud yesterday in an effort to force him off the board.

Benchmark's complaint alleges a strange sort of fraud. The basic point is that Benchmark voted to give Kalanick more board seats because it thought he was a good CEO, but that he was secretly concealing the truth, which is that he was a bad CEO. And it is true that, after those June 2016 amendments, a lot of rotten news about Uber, and about Kalanick's management style, has come out. Benchmark focuses on four items: Waymo's lawsuit claiming that Uber stole some of its self-driving car technology, stories that Uber executives looked at the medical records of a woman who was raped during an Uber ride in India, stories about Uber's culture of sexual harassment and gender discrimination, and stories about "Greyball," Uber's program to hide from law enforcement in markets where Uber's presence was restricted.

Benchmark's theory is that Kalanick knew this stuff was real bad, and hid it from the board while trying to cement his power:

Upon information and belief, Kalanick knew Benchmark never would have approved the amended Certificate of Incorporation or the Voting Agreement as to the three new Board seats if Benchmark had known the truth about Kalanick’s prior conduct. Kalanick also understood that these matters, once revealed, would likely force him to resign as Uber’s CEO, and thus sought to grant himself a way to play an ongoing leadership role at Uber once the truth came out. Kalanick therefore knowingly concealed these matters from Benchmark and Uber’s Board to obtain, for his personal benefit, the unilateral right to pack the Board with three additional directors of his choosing. In doing so, Kalanick acquired a disproportionate level of influence over the Board, ensuring that he would continue to have an outsized role in Uber’s strategic direction even if forced to resign as CEO.

Of course it would be amazing if this lawsuit turns up, like, a journal entry from Kalanick saying "I know I am going to be fired as CEO because I've done so much bad stuff, so I need to trick shareholders into giving me board seats before they find out." But it seems unlikely that anyone actually thinks that way. More likely, Kalanick failed to tell the board that he was a bad CEO, not as part of a devious fraud, but because he genuinely -- and with some justification! -- thought he was a good CEO. "Kalanick repeatedly touted his abilities and management of Uber and Uber’s achievements to date" when talking to Benchmark partner Bill Gurley. He neglected to add "hey by the way I also preside over a bro-ish culture of sexual harassment and gender discrimination," presumably because he thought that culture was fine

Similarly, the shareholders gave him the extra board seats because they thought he was a good CEO. Perhaps they were somewhat deceived in this, in that they didn't know the details of Greyball or the Waymo lawsuit or whatever. But, look. When the Greyball thing was first reported, it was genuine news. But you would not call it "out of character," for Uber, exactly. Uber's response to the Greyball revelations was basically "yeah, what about it?" The reason that Uber had a program for evading law enforcement in markets where it was not allowed is that Uber had a longstanding pattern of going into markets where it was not allowed. Going into new markets without permission, and fighting with regulators once it got there, was kind of what Uber was known for. The board members, in 2016, were definitely cool with fighting with regulators. Greyball was just a tactical tool in that fight.

Really Kalanick's abrasive and controversial management style seems to be exactly what the shareholders signed up for. They wanted a brilliant difficult visionary, someone who would break all the rules to make Uber a success, a living embodiment of the "move fast and break things" culture. Even after Kalanick resigned, Gurley tweeted that "there will be many pages in the history books devoted to" him, and that "very few entrepreneurs have had such a lasting impact on the world." But if you want a CEO who'll break all the rules, you look a bit silly when you later complain that he broke a few rules! "The board looked the other way for years while Travis engaged in all sorts of unethical and even illegal behavior," says Steven Hill about this lawsuit. "He is their monster."

Anyway, Uber's CEO search, absurdly, is still ongoing. Imagine coming in as the CEO now, with an active fraud lawsuit about who gets to be on the board? I assume that the lawsuit will drive away more of Uber's dwindling pool of candidates, and move us one step closer to the inevitable announcement that Kalanick's replacement as CEO will be Kalanick.

Oh and in other Uber news, "Ryan Graves, Uber's first employee and original CEO, has resigned from his current post as VP of operations." At this point Uber has so many senior vacancies that "X is leaving Uber" is less newsworthy than "Y is still employed at Uber." So here is a Quartz article literally reporting who is still employed at Uber

The fiduciary rule.

A good rule of thumb about financial regulation is: Most new financial regulation turns out to be good for incumbent banks. It is easy to forget this rule, because after all the incumbent banks tend to fight bitterly against all new financial regulation. And it is not always true. Still, it is true eerily often. For instance, there is the Department of Labor's fiduciary rule:

Financial firms decried the restriction, which began to take effect in June, as limiting consumer choice while raising their compliance costs and potential liability.

But adherence is proving a positive. Firms are pushing customers toward accounts that charge an annual fee on their assets, rather than commissions which can violate the rule, and such fee-based accounts have long been more lucrative for the industry. In earnings calls, executives are citing the Department of Labor rule, known varyingly as the DOL or fiduciary rule, as a boon.

It does make sense that charging customers a fixed annual percentage of their assets would be more lucrative than constantly calling them up and suggesting that they do trades that can make you money. It might even be better for them, too! (Maybe they shouldn't have done all those trades.) Or not; I mean, there is a brute zero-sum accounting where if the financial industry is making more money, then that means its customers are spending more money, and it is not a priori obvious that they're getting more for their money.

One thing you might wonder about is the political economy of this: Why do the banks always resist new regulation, when it so often turns out to be good for them? One answer might be conservatism: Most regulations work out well, but some don't, and you can't be sure in advance that any new regulation will be good for you. A related answer would be laziness: Sure you'll make more money with the new rule, but you'll have to change all your systems and procedures to get there, and it'll be a big pain. But another possible answer would be correct opposition. Sometimes banks oppose regulations because they think they are bad policy, even if they will be good for the banks. It's possible that some of the financial industry's objections to the fiduciary rule -- that it would raise costs for customers -- were meant sincerely, and were driven by concern for customers rather than the firms' bottom lines, and were correct. 

Blue Snapron.

Snap Inc. and Blue Apron Holdings Inc., which had "two of the most prominent technology initial public offerings of 2017," both reported earnings yesterday, and they were pretty bad. ("Blue Apron Stock Is Now Worth Far Less Than One of Its Meals.") Here is a simple dumb model of corporate finance in 2017:

  1. You have an idea.
  2. You raise as much money as you need from venture capitalists to make that idea a success.
  3. You build your business by making it as popular as you can.
  4. One you have reached a peak of popularity, you go public.
  5. You cash out the venture capitalists, and yourself, in the IPO.
  6. Then, you know, whatever.

A couple of comments on that model. First of all, item 4 -- top-ticking your maximum popularity to go public -- is probably the most important thing. Snap and Blue Apron did it exactly right: Blue Apron's popularity declined in its first quarter as a public company; Snap's daily active users keep growing, but at declining and disappointing rates. This is reflected in their stock prices: Blue Apron closed yesterday at $5.14, after IPOing at $10 per share; Snap closed at $13.77 versus a $17 IPO price. Better to sell at $10 now than $5.14 later! 

Second, the model has little to say about profitability. The way you make money as an entrepreneur, and the way you reward your original venture-capitalist investors, is in the stock market, not by returning cash to them that you generate in the business. And the stock market, for buzzy tech-enabled businesses in 2017 (or 1999), rewards popularity, not profitability. Both Blue Apron and Snap lost money last quarter. The goal in steps 3 and 4 is not to build your business until it is profitable, and then sell out; it's to build it until it is popular, and then sell out and let the public shareholders worry about monetization.

Third, this model doesn't ... really ... work? Like, for one thing, Snap's and Blue Apron's founders and venture capitalists are still big shareholders. Blue Apron's IPO was entirely primary, meaning that the private shareholders didn't actually cash out at all in the IPO, and it might need even more money. (Snap's was mostly primary, and its lockups on big shareholders expired only recently.) If you go public at the peak, but keep your own shares into the decline, what was the point of going public? Also, of course, if this really is the model, then eventually public investors are going to catch on: Blue Apron and Snap are not exactly getting investors excited for the next round of popular-but-unprofitable IPOs. 

Email!

So one thing -- and this is not legal advice -- but one thing is, don't put this in email:

“Transmar consistently submits inaccurate borrowing-base reports to the banks, the discovery of which is an existential threat to our company,” the younger Johnson wrote in the body of the message, according to the filing.

I mean, don't do it, fine, obviously it is better not to defraud your banks, but if you are going to defraud your banks don't write it explicitly in an email. But then another thing is, if you must write it in an email, make the subject line, like, "borrowing-base reports" or "bank relationship" or "10 a.m. tee time" or "u up?" 

A bad subject line would be: "VERY CAREFUL -- DO NOT FAT FINGER FORWARD." But that is the subject line that Peter B. Johnson used on that email, which he allegedly sent to his father Peter G. Johnson, the president of Transmar Commodity Group Ltd. Sure, with that subject line, the recipient is going to read it. (And not fat finger forward it!) But eventually, when things go wrong (and if you're consistently lying to your banks, they've already gone wrong!), lawyers will find an email with a subject line like that, and it will be awkward to explain, and you might have to do that explaining in criminal court:

Peter G. Johnson, 68, Transmar’s founder, and Peter B. Johnson, 38, who ran the company’s European operation, were arrested Tuesday morning at their New Jersey homes. Thomas Reich, 59, Transmar’s vice president of finance, later turned himself into the U.S. Federal Bureau of Investigation. 

"'I didn’t do it,' Peter B. Johnson told reporters Tuesday after he and the others appeared in Manhattan federal court."

Gold conspiracy theories!

Here is a Wall Street Journal article about people who believe that the Federal Reserve Bank of New York doesn't really have 6,200 tons of gold in its vaults, or maybe it's been selling or lending out the gold, or maybe it's "gold-plated tungsten, which would weigh almost the same," or whatever. My favorite complaint is this one:

“All you see is the front row of gold bars,” said James Turk, co-founder of Goldmoney, a gold custodian. “There’s no way of knowing how deep the chamber is or how many rows there are.”

It is such a nice metaphor for modern financial life. I have some savings. All I see is the front page of a financial institution's website. It tells me I have $X, and practically speaking, I can convert that number on a web page into $X worth of actual spending power in fairly straightforward ways. But it is a little vertiginous to just look at a number on a web page and be like "yep, that is all my money in the world." It is just some electrons. What if the bank was hacked, or its computers broke, or it just decided to change the number on the web page for fun? 

You can sympathize a little with the people who want physical certainty. Just get a big stack of gold bars. They're so ... concrete. But the doubts quickly return. You can only look at the bars from one angle! How do you know how far back they go? Even if you can look at them all at once, how can you know they're real? Even if you can weigh them, how do you know they're not tungsten? Even if you do a chemical analysis, how do you know they're not hypothecated? The point of holding gold is a certain kind of psychological certainty, but in life, true certainty is impossible. Once you succumb to the need for certainty, you can never really be satisfied. There's no way of knowing how deep the chamber is or how many rows there are. 

People are worried that people are worried.

On Tuesday, Donald Trump casually threatened nuclear war with North Korea, which briefly caused the Chicago Board Options Exchange Volatility Index to rise from its recent lows as investors finally started to expect some volatility. But then the market remembered that it wasn't reacting to political news anymore, and volatility subsided. And then yesterday Trump said something to the effect of "hey look I can keep threatening nuclear war until you start paying attention, I've got nowhere else to be, frankly I kind of enjoy it," and the market finally started to freak out. I mean, some:

Stocks fell the most since May on Thursday, extending a decline that began when President Donald Trump warned North Korea over aggression. The S&P 500 fell 1.5 percent, while the CBOE Volatility Index jumped 44 percent to bring its three-day rise to 62 percent. It was the first close above 16 for the VIX since the day of the U.S. election.

That VIX jump was 4.93 points, from 11.11 to 16.04, still below the VIX's historical average, but a change from the months of discussion about how low VIX levels combined with high levels of geopolitical weirdness meant that investors were complacent. They're a bit less complacent now, anyway. And here is a Ray Dalio LinkedIn post about complacency and volatility.

Blockchain blockchain blockchain.

"Initial coin offerings have raised $1.2 billion and now surpass early stage VC funding." "Coinbase Inc., the digital currency exchange that in the past two months suffered a trading crash and upset customers over how it handled the bitcoin split, received a $100 million investment from a group led by IVP." And here's a story about a cryptocurrency party:

“If somebody gives you a chance to jump on a rocket ship that’s taking off, you don’t say no,” said Tricia Lin, a 35-year-old from New Jersey who recently quit her job at Morgan Stanley to pursue a future in digital currencies. Bouncing around from one idealistic conversation to another, she added: “It’s so different from the finance industry.”

People are worried about unicorns.

How does the Enchanted Forest maintain its enchantment? Possibly through small quantitites of acid! The unicorns are tripping, or at least microdosing. Here is an article about "How Silicon Valley rediscovered LSD" that includes this endorsement of a project-management app:

Paul, a start-up founder in New York, says he and his employees are less stressed since they started microdosing. But he couldn’t be absolutely sure about the cause and effect: he thinks it may have also been the project-management app Asana, which they started using at the same time, to keep organised.

"Asana: a productivity app that's so good, you'll confuse it with psychedelic drugs" would be a good slogan.

Things happen.

Credit Suisse Bans Trading in Some Venezuelan Securities. A Battle Over Goldman’s Hunger Bonds Is Being Waged in Florida. "Russia's largest oil producer Rosneft said on Tuesday it had made around $6 billion in pre-payments to Venezuelan state oil company PDVSA and had no immediate plans to make any further advance payments soon." Embattled Wells Fargo Board Plans Shake-Up. The Quant Fund Robot Takeover Has Been Postponed. Parked Electric Cars Earn $1,530 Feeding Power Grids in Europe. Britain Bans Betting in Soccer, but Not for ‘The Lizard.’ Knife robber beaten with mops during two different shop raids. 

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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

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