Money Stuff

Founder Friendliness and Spoofing

Also algorithms, activism and flow derivatives.

Uber!

The next chief executive officer of Uber Technologies Inc., who will take on the difficult job of replacing ousted visionary co-founder CEO-bro Travis Kalanick, is definitely going to be Travis Kalanick:

The search for a new CEO started over 50 days ago. It was at the same time that Travis agreed in writing to modify the company’s voting agreement to ensure that the board was composed of independent, diverse, and well qualified directors. Despite agreeing in writing to sign these amendments, he has still not done so.

Travis’s failure to make good on this promise, as well as his continued involvement in the day-to-day running of the company, has created uncertainty for everyone, undermining the success of the CEO search. Indeed, it has appeared at times as if the search was being manipulated to deter candidates and create a power vacuum in which Travis could return.

That's from Benchmark Capital's open letter to Uber employees explaining why it decided to sue Kalanick now to try to force him off the board. ("Perhaps the better question is why we didn’t act sooner.") And that passage is the main justification for the lawsuit: As long as Kalanick is a powerful influence on the board, it's going to be hard to find a CEO to replace him. Meanwhile he'll hang around, looking sensitive, offering Uber a shoulder to cry on after each bad interview with a potential CEO, and eventually Uber will remember what it saw in him in the first place, and there'll be a dramatic reconciliation, and Uber will fall back into Kalanick's arms, and the credits will roll.

Or not, I mean, if Benchmark gets its way. Benchmark has other reasons for suing now, including (1) that there's apparently something unspeakably bad in the Holder Report on Uber's culture and (2) that, bizarrely, Uber lacks a chief financial officer, and somehow one board member suing another will make it easier for Uber to hire one? Meanwhile Kalanick is "disappointed and baffled by Benchmark's hostile actions," and is trying to force the case into arbitration, where it will be considerably less entertaining for the rest of us.

The Benchmark lawsuit has shocked a lot of people because venture capitalists are not supposed to sue the entrepreneurs they fund. Uber is obviously a special case: It is a giant multinational company that happens to still be owned by VCs, and its controversies have been larger and more public than those of most private companies. But there are those who see the lawsuit as signaling a broader shift. Here is Erin Griffith, in a column titled "The Era of 'Founder-Friendly' Startup Investing Is Over":

Investors are finally realizing they went too far with the “founder-friendly” thing. And founders may be realizing that if they want their companies to go public, they need to give up some control. The Age of Unicorns did these companies a disservice by allowing them to stay private and avoid scrutiny. The Age of Startup Sobriety suggests it’s time they grow up.

I am skeptical. I do not think that "founder-friendliness" among venture capitalists is an intellectual or psychological movement, one that they will get sick of and decide to reverse. I think that it is an essentially structural effect of contemporary global capitalism. Globalization and technology have created winner-take-all dynamics in which owning the leading company in a sector is more valuable than it used to be: You can, after all, start a taxi company and grow it to a $68.5 billion valuation in just a few years. And with modern technology, you don't especially need a lot of money to do it: The shares of the economy being spent on labor and capital are both declining; profits are going up as market power is growing. Uber is spending a lot of money, sure, but its core idea was to build a global transportation company without buying cars, just by writing a phone app. 

Meanwhile global capital markets and low interest rates have created a glut of money looking for investment opportunities. To me, the most important current story about founder-friendliness is not Benchmark's lawsuit against Kalanick, but SoftBank Vision Fund's billion-dollar investments in, um, everything. SoftBank is pushing up valuations and giving "fledgling companies more room to run, whether they deserve it or not." (It is currently trying to fling money at Uber, or Lyft Inc., whichever, and is also "a big investor in the three largest Asian ride-hailing companies.") Indiscriminate investors tend not to insist on strong governance terms.

It just does not feel like a dynamic in which venture capitalists are poised to take back power from founders. It feels like a dynamic where entrepreneurs have a lot of power and providers of capital don't, where a hot startup is a rare and valuable commodity while capital is basically free. Uber seems less like a sign of change, and more like an unusual exception to the continuing consolidation of founder power. Maybe not even an exception! After all, I'm still expecting Kalanick to come back as CEO.

Spoofing vagueness.

"Spoofing" is a crime, defined by the Dodd-Frank Act as "bidding or offering with the intent to cancel the bid or offer before execution." But that is a weird definition. Lots of people submit orders, in stock and commodity and futures and currency markets, that do not execute, and that they don't intend to execute. If you own a stock that trades at $100, and you enter a stop-loss order to sell it if it hits $80, you do not want that order to execute, and usually it won't. But no one thinks stop-loss orders are spoofing.

More controversially, if you are a high-frequency market maker bidding and offering for a stock on 10 different exchanges, and you bid $100 for 100 shares of stock on each of those 10 exchanges, and then you buy 500 shares for $100 on five of the exchanges, you might cancel your remaining orders, because you have all the stock you can handle right now thank you very much. (You might then resubmit them at lower prices, and the cycle might repeat.) As it happens, lots of people think that is spoofing, though they are wrong. That is just market making. But you can see the difficulty. High-frequency traders cancel a lot of orders in their ordinary business, and if you are canceling 98 percent of your orders, then at some level you can't have intended to execute all of them. Perhaps you had no clearly formed intent with any particular order, but statistically you had an intent to cancel some of them before they executed.

Michael Coscia was arrested and charged with spoofing in 2014; he was convicted in 2015 and sentenced to three years in prison. He appealed his conviction, arguing that the law against spoofing was too vague: If most orders are canceled, if stop-loss orders are fine, if high-frequency traders aren't all prosecuted for spoofing, then how could anyone know what spoofing is? How could he know that what he was doing was a crime?

It was not exactly a good argument. What he was doing -- entering big sell orders, moving the price down, canceling those orders before they executed, buying small amounts at the new lower price, then reversing the process to sell what he had bought -- was pretty clearly spoofing. But he is right that the statute doesn't do a great job of distinguishing it from legal behavior. So last week the U.S. Court of Appeals for the Seventh Circuit affirmed his conviction but tried to define spoofing a bit better. From the opinion:

Importantly, the anti‐spoofing statute’s intent requirement renders spoofing meaningfully different from legal trades such as “stop‐loss orders” (“an order to sell a security once it reaches a certain price”) or “fill‐or‐kill orders” (“an order that must be executed in full immediately, or the entire order is cancelled”) because those orders are designed to be executed upon the arrival of certain subsequent events. Spoofing, on the other hand, requires, an intent to cancel the order at the time it was placed. The fundamental difference is that legal trades are cancelled only following a condition subsequent to placing the order, whereas orders placed in a spoofing scheme are never intended to be filled at all.

Ehh! Sure, I guess? That does successfully distinguish spoofing from stop-loss orders, but it doesn't distinguish it from the ordinary practice of high-speed market making in which many orders are canceled as market conditions change. The court doesn't really try:

Mr. Coscia next contends that, even if the statute gives adequate notice, the parenthetical definition encourages arbitrary enforcement. He specifically notes that high‐frequency traders cancel 98% of orders before execution and that there are simply no “tangible parameters to distinguish [Mr.] Coscia’s purported intent from that of the other traders.”

This argument does not help Mr. Coscia. The Supreme Court has made clear that “[a] plaintiff who engages in some conduct that is clearly proscribed cannot complain of the vagueness of the law as applied to the conduct of others.”

Hmm yes but that is not particularly comforting if you are an electronic market maker who is canceling a lot of orders. Is your business model allowed only because no ambitious prosecutor has read "Flash Boys" and decided to go after high-frequency traders? 

It's actually fairly clear what spoofing means, though? It means bidding or offering with the intent to cancel the bid or offer before execution, and with the further intent of moving prices. That's how all market manipulation works: You do a thing that would normally be legal, but with the extra illegal intent of moving prices in your favor by deceiving other traders. That is always a bit definitionally weird -- manipulation is a fuzzy concept, and any time you trade, you hope prices will move in your favor -- but it works well enough. Certainly it describes the conduct that Coscia was convicted of; certainly it doesn't describe stop-loss orders; probably it doesn't describe most normal electronic market-making. It might have been better to write it into the statute.

Algos.

This is pretty much how you close a hedge fund in 2017:

"Algorithmic trading systems have increasingly come to dominate” and the trajectory of prices is chaotic, he said. “Investing in oil under current market conditions using an approach based primarily on fundamentals has therefore become increasingly challenging. It seems quite likely this will continue to be the case for some time to come.”

That's Andrew Hall closing his Astenbeck Master Commodities Fund II Ltd., but it could be anyone really. What could it mean? One possibility is that the algorithms are wrong, but big and growing, and they can remain wrong longer than you can remain solvent. The other possibility is that the algorithms are better at investing than you are, and cheaper too, so it's harder for you to outperform them. It is hard to distinguish between these possibilities in the moment. Perhaps in five years, all the algorithmic trading firms will go bust, and chastened investors will seek out retired charismatic intuitive investing gurus to say "we are sorry, we fell under the spell of the algorithms, but they deceived us, you were right all along." Or perhaps in five years everyone will be investing with algorithms, and it will seem weird to think that it was once possible to be famous, and make $100 million a year, just by guessing when to buy and sell oil futures. There are computers for that now, you know.

Activism defense.

I guess maybe the first lesson of activism defense is, when Bill Ackman sends you a cordial email about how he is excited to work with you to improve your company, and you are suspicious of his motives, and you forward his email to your general counsel to express your suspicion of his motives, make sure you are actually forwarding the email to your general counsel, and not to Ackman. Automatic Data Processing Inc. Chief Executive Officer Carlos Rodriguez messed that one up:

Two days later, Aug. 6, Mr. Rodriguez, apparently meaning to forward Mr. Ackman’s email about being “excited” to work with Mr. Rodriguez to ADP’s general counsel, sent it to Mr. Ackman, the filing said. In the email, Mr. Rodriguez said he didn’t find the email “credible” and that he had already told the activist he didn’t share his views, the filing said.

It's a little disappointing that he wasn't harsher: Misdirecting a critical email is just awkward; misdirecting a really mean email would be funnier. Though to be fair this story comes from Ackman's filing in his proxy fight with ADP, and perhaps he cleaned up Rodriguez's language. In any case, in his own account, he was polite about the error: 

In response to Mr. Rodriguez’s errant email, Mr. Ackman sent an email to Mr. Rodriguez in which he assured Mr. Rodriguez of the genuineness and good faith nature of his email and other communications to date, expressed his disappointment in the Company’s response, and stated his belief that Mr. Rodriguez, through the Company’s public statements, had unfairly characterized their interactions to date in an effort to make Pershing Square’s requests appear unreasonable to the rest of the Board and the investing public. 

Elsewhere in activism: "Activist Fund Corvex Targets ‘Undervalued’ Yogurt Maker Danone." And: "Blue Apron jumps after hedge fund that pushed Whole Foods into Amazon's arms buys a stake."

Goldman.

How will Goldman Sachs Group Inc. fix its disappointing performance in fixed income, currencies and commodities trading? The answer seems to be by getting investment bankers to pitch more vanilla derivatives to corporate clients:

If bankers can help out traders by selling the company an interest-rate swap or a currency hedging programme, the thinking goes, Goldman can broaden its client base, capturing more of the “flow” trading activity that has historically been the preserve of big commercial banks such as Citigroup, Bank of America Merrill Lynch and JPMorgan Chase.

Disclosure: I used to work at Goldman, pitching derivatives to corporate clients, and the relationship bankers did not ... always ... enjoy ... those pitches. "Here's a nerd with some charts," was often the tone of the handoff there. Investment bankers like to do big company-changing deals, not pitch flow interest-rate swaps.

The traders don't especially love vanilla swaps either, but what are they going to do:

Goldman used to look down at such humdrum “flow” business, preferring instead to craft complex derivatives for hedge fund clients that would earn the bank big fees. But that is changing, according to people familiar with the revamp, as patchy activity among hedge funds has forced the bank to rethink its business mix.

People are worried about stock buybacks.

It's okay, though: "U.S. Stock Buybacks Are Plunging."

Things happen.

Three CEOs Quit Trump Advisory Council After Charlottesville Violence. Man Arrested for Trying to Detonate What He Thought was a Vehicle Bomb at Downtown Oklahoma City Bank. Hopes for European ‘safe’ bonds lean on pre-crisis techniques. UK aims to retain customs deal for years after Brexit. Junk Bonds of the Financial Crisis Were the Decade’s Biggest Winners. Tudor and Brevan Howard abandon Mifid. Israeli Billionaire Beny Steinmetz Detained in Investigation. Judge Orders LinkedIn to Allow Startup Access to User Data. (Earlier.) Warren Buffett Cashes Out on GE, Cashing In on Crisis Loan. Hedge Funds Break Up With Long-Adored Apple and Facebook Shares. What are Hank and Wendy Paulson up to? Charlottesville white nationalist demonstrator fired from libertarian hot dog shop. "Sam isn't a boss hater or the Westeros equivalent of an entitled millennial." Art show for dogs. MTA accused of storing dead bodies in employee break rooms.

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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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