Money Stuff

SEC Hacking and Secret Accounts

Also Equifax options, AIG SIFIness, Valu, unicorns, Trix and Braden's proxy fight.

Edgar hack!

Look, it doesn't rise to the level of a Law of Insider Trading, but really, if you can insider trade by hacking into the computer systems of the Securities and Exchange Commission itself, without being caught, then ... I am not saying that you should do that, of course, but it would be pretty cool if you did.

I have my doubts though. Here is a "Statement on Cybersecurity" from Jay Clayton, the Chairman of the SEC:

In August 2017, the Commission learned that an incident previously detected in 2016 may have provided the basis for illicit gain through trading. Specifically, a software vulnerability in the test filing component of our EDGAR system, which was patched promptly after discovery, was exploited and resulted in access to nonpublic information. We believe the intrusion did not result in unauthorized access to personally identifiable information, jeopardize the operations of the Commission, or result in systemic risk. Our investigation of this matter is ongoing, however, and we are coordinating with appropriate authorities. 

Eh, it's the test filing system; how much can you get from that? Bloomberg News explains:

Among the few details that the SEC has shared about the intrusion is that it hit a corner of Edgar where companies can submit dummy filings. These forms, which are never meant to be released publicly, allow startups to get comfortable with using the database. Well-established corporations also use test filings to make sure their announcements format correctly on Edgar and to solicit feedback from the SEC.

"Preliminary filings regularly include data that could move share prices, and are submitted so companies can engage in a back-and-forth with SEC staffers." 

One obvious lesson here is: Don't store your sensitive information on other people's computers. Don't send your press releases to newswires hours before they're supposed to be released. Don't test-file a 4:05 p.m. earnings 8-K on Edgar at 2 p.m. (Test-file at 4:01 p.m.!) I suspect a lot of companies already knew this -- at least after the newswires were hacked and the hackers traded on thousands of confidential press releases  -- and so I'd be surprised if hackers did too much insider trading on the SEC breach. 

But people are angry at the SEC:

“There is treasure trove of information at the SEC and I want people to understand this isn’t some kind of victimless crime,” Rep. Bill Huizenga (R., Mich.), who chairs a House subcommittee that oversees the SEC, said in an interview. “This is an important thing for confidence in the markets.”

I mean, on the one hand, yes, the SEC gets lots of important confidential information from the brokers that it regulates. On the other hand the SEC's Edgar system is a disclosure system. Companies mostly send things to Edgar so they can immediately become public. Hacking Edgar is bad, but I would not assume that hackers got a "treasure trove of information" by getting into the test-filing system of Edgar. I sometimes wonder if politicians' overreactions to stories like this do more to undermine "confidence in the markets" than the stories themselves.

Elsewhere in insider trading.

Here's a fairly normal, though entertainingly brazen, insider trading case in which Peter C. Chang, the founder and board chairman at Alliance Fiber Optic Products, allegedly "generated more than $2 million in illicit profits and losses avoided by trading on nonpublic information and tipping his brother ahead of two negative earnings announcements and the company’s merger."

Chang allegedly concealed his insider trading by doing it in the accounts of family members (a violation of the spirit, if not the letter, of the Fourth Law of Insider Trading), though he also did it "from his work computer after attending board meetings where confidential information was discussed," which makes his concealment somewhat less cunning. Also -- many insider traders seem not to know this -- but after a merger, the Financial Industry Regulatory Authority will put together a list of people who traded ahead of the deal and send it to the people involved in the deal to ask "hey, do you know any of these people?" This can lead to awkward moments. We talked a while back about an alleged insider trader who didn't recognize his father's name -- which happened to be the same as his own name -- on one of those Finra lists. Oops! Here, similarly, Chang allegedly missed his wife's name on the Finra lists.

My favorite part is this, about Chang's alleged trading in an account that he allegedly opened in the name of his brother, Daniel Chang:

On or about May 1, 2015, Chang placed a phone call to T. Rowe Price. Chang was inquiring of the brokerage firm as to why a hold had been put on the account related to his AFOP position.

During the May 1 phone call, the T. Rowe Price representative asked the caller what his name was, and Chang responded falsely: “Daniel Chang.” The T. Rowe Price representative explained that the hold had been placed on the account pending clarification as to whether the account owner, “Daniel Chang,” was related to “Peter C. Chang,” the “Chairman of AFOP.” The representative stated that if the account owner was related, T. Rowe Price would not be able to complete the request, as the clearing broker would prohibit it. With confirmation that they were not related, T. Rowe Price would complete his request.

In response, Chang stated to the T. Rowe Price representative that a large percentage of Chinese people had the last name “Chang.” This response was evasive and misleading. The representative indicated his understanding that the account owner was not related to Peter Chang and informed Chang that a note would therefore be made to the account confirming that the account owner was not related to Peter Chang. Chang did not correct this misimpression.

Well! He didn't lie!

BROKER: Are you related to Peter Chang?
PETER CHANG: You know a lot of Chinese people are named "Chang."

That's not a no! I don't know that this is much of a defense to anything, but I guess I appreciate the effort.

Still elsewhere in insider trading.

Every time a big thing -- a merger, a scandal, whatever -- happens at a public company, people notice that a lot of options were traded just before the thing happened, and that the person who bought those options probably made a lot of money. "Aha," they think: "insider trading!" But the way options work is typically that one side of the trade (the buyer or the seller) initiates the trade because he wants to buy or sell options, and the other side of the trade is just a market-maker who gets the order, fills it at a price, and then goes and hedges her exposure.

After the big thing happens, everyone assumes that the buyer of the options -- the one who made a lot of money -- initiated the trade, either out of unusual luck or because he had inside information. But most of the time it seems like it was the other way around. Here, for instance, is a Bloomberg News story about a big trade in put options on Equifax Inc. that occurred right before Equifax announced that it had been hacked. That trade could have made the lucky buyer about $10 million, raising suspicions of insider trading -- except that the trade was probably initiated not by the lucky buyer but by the unlucky seller:

In the case of Equifax, data compiled by Bloomberg show that almost 2,700 puts changed hands on Aug. 21, the most for any day since 2005, including two blocks of 1,250 September $135 puts each. At the same time, some see evidence those contracts were “sold” -- that is, a seller approached market makers and asked the options be “written” and purchased from him.

What evidence? Mainly that the two blocks of options changed hands at 70 cents and 75 cents, or near the “bid,” the market price set by a buyer (the options had a bid/offer spread of 70/95 cents). Normally, when a seller initiates a transaction, he must do it at his counterparty’s terms.

Those September puts expired on September 16, with the stock at $92.98, meaning that the seller of the puts, if he was un-hedged and didn't cover his position, lost about $11 million. That hardly looks like insider trading. Meanwhile the buyer -- presumably a market-maker who bought the puts to facilitate the seller's transaction -- probably was pretty pleased when Equifax's stock plunged, but not $11 million worth of pleased: She probably hedged the puts by buying stock, and so much of her gain on the options was eaten up by her loss on the stock.

Elsewhere: "Hackers roamed undetected in Equifax Inc.’s computer network for more than four months before its security team uncovered the massive data breach, the security firm FireEye Inc. said this week in a confidential note sent to some Equifax customers." And: "Equifax Has Been Sending Consumers to a Fake Phishing Site for Almost Two Weeks." 


Part of the point of designating companies as "systemically important financial institutions," and imposing higher capital and regulatory requirements on them, is to make them stop being systemically important. "Break up the banks," people say, and one way to break up the banks is by making life difficult for the ones that stay un-broken-up.

And so a SIFI designation -- and also more generally its painful hangover from the financial crisis -- seems to have driven American International Group Inc. to divest businesses, shrink itself and improve its capitalization. "This company has dramatically changed its risk profile and controls since the financial crisis," says its chief executive officer. That's good! That was the point! And AIG has shrunk and transformed so much that now the U.S. Financial Stability Oversight Council is considering removing AIG's SIFI designation.

That's also ... sort of good? SIFI regulation is generally considered a second-best outcome: You'd prefer not to have any systemically important financial institutions whose failure could crash the economy, but if that's not possible, you should at least keep a close eye on them. If keeping a close eye on them encourages them to stop being systemically important, you should reward them for their progress. Giving firms a realistic off-ramp from SIFI status encourages them to shrink and become less systemic. If doing that doesn't get you out of SIFI status, then every existing SIFI will have no incentive to shrink, and every incentive to get bigger.

On the other hand, you know, it's AIG. It was at the center of the global financial crisis, as an under-regulated non-bank that took on massive risks whose implications were not well understood by regulators or the rest of the financial system. It would not be totally unreasonable to say that its punishment for that should be to remain a SIFI for the rest of eternity.

Blockchain blockchain blockchain.

Sure whatever fine:

The 23-year-old, who dresses up as anime characters and bunny girls, is one of 60,000-plus users on a Japanese startup called Valu Inc., a cross between a trading platform and crowdfunding site. “I plan to use the funds to buy expensive clothes that I couldn’t afford before, and enter international cosplay events,” said Numano, which isn’t her real name.

Anyone -- from fishermen and YouTube celebrities to pastry chefs and social-media mavens -- can sell shares to raise funds in a manner similar to an initial public offering. They attract buyers by offering gifts and services; for example, a blogger may offer exclusive posts that can only be viewed by shareholders, or a cosplayer may share signed photos.

With just a handful of rules, tokens -- known as VA and exchangeable (unsurprisingly) with bitcoins -- are bought and sold like real securities. 

There are market-manipulation and pump-and-dump scandals (bloggers "accused a group of YouTubers of buying each other’s shares and coordinating to sell them off"). I guess this seems a bit more like novelty crowdfunding than like people selling equity in themselves, but sure, in the future, everyone will finance their educations and homes and cosplaying by doing initial coin offerings. 

Meanwhile, elsewhere in non-traditional home finance, here is a lawyer arguing that "Loftium Unwittingly Forms General Partnerships with Homebuyers." (We talked about Loftium, the startup that funds people's home down payments in exchange for a cut of their Airbnb rental income for the next three years, the other day.) And elsewhere in bitcoins: "Jamie Dimon lays into bitcoin again, says it’s ‘worth nothing.’" 

People are worried that people aren't worried enough.

My Bloomberg View colleague Tyler Cowen interviewed Larry Summers, who is not that worried about the lack of worry reflected in the CBOE Volatility Index:

The volatility of the market moves very much with the level of the market. The reason is that if a company has $100 of debt and $100 of equity, and then the stock market goes up, it’s 50/50 levered.

If the stock market goes up by $100, then it has $100 of debt and $200 of equity and it’s only one-third levered. So when the stock market goes up, its volatility naturally goes down. And the stock market has gone way up over the last 10 months. That’s a factor operating to make its volatility go significantly down.

This is sort of a soothing insight: The more the market goes up, the less likely it is to go down, because all the companies have such big safe equity cushions. I suppose it does not apply if the companies use the rising market to borrow a lot more money though.

People are worried about unicorns.

Here is a claim that the rising market power of giant companies is casting a cloud over the Enchanted Forest, creating a "start-up funk" in which it is unusually hard to start and grow a new business:

Many economists say the answer could lie in the rising power of the biggest corporations, which they argue is stifling entrepreneurship by making it easier for incumbent businesses to swat away challengers — or else to swallow them before they become a serious threat.

“You’ve got rising market power,” said Marshall Steinbaum, an economist at the Roosevelt Institute, a liberal think tank. “In general, that makes it hard for new businesses to compete with incumbents. Market power is the story that explains everything.”

One story that I like to tell about stock buybacks is that big profitable slow-growing public companies generate a lot of cash that they don't need, and that they'd probably just waste if they spent it themselves, so they instead hand it back to shareholders to invest more productively in smaller, faster-growing, more innovative companies. But that only works if the smaller companies can grow and innovate and compete with the big ones. 

Meanwhile in Uber: "Uber Loses Its License to Operate in London." "Top Uber Investor Resists SoftBank Deal." "Tangle of cross-shareholdings links Uber and its rivals." "Uber has a lot of reasons to settle the lawsuit with Alphabet." And: "Uber Is Sorry for ‘Wife Appreciation Day’ Promo."

Food Stuff.

I can never resist a good Wall Street Journal food marketing story, and here is a great one,  about how consumers rebelled when General Mills Inc. introduced a new all-natural version of Trix. One woman "said in an interview Thursday she likes the way the artificial colors and high-fructose corn syrup look and taste." And then there's this guy:

“It’s basically a salad now,” said 35-year-old Justin Storer of the new Trix. The Chicago lawyer said he gets most of his lunches from the 7-Eleven across the street from his office while his co-worker eats “weird vegetable chips from Trader Joe’s and puffed kale.”

Bless his heart. General Mills relented and is bringing back Classic Trix.

"Unlocking Braden's Potential."

I would not have expected to laugh repeatedly at a parody activist proxy fight pitch deck, but Zoe Piel's "Unlocking Braden's Potential" is spot-on and I recommend it highly. "Quonset Point Capital L.P. ('QPC') specializes in improving underperforming children," it begins; "QPC is sympathetic to parents, but prepared to nominate replacements when necessary." It then mounts a compelling case against Braden's entrenched management team:

Elsewhere, here is Marty Lipton on "the State of Play in Activism."

Things happen.

Goldman Sachs slumps to its worst ever position in IB ranking. Goldman on back foot over $7.25bn Avantor debt sale. Puerto Rico's Economic Crisis Grows in Maria's Wake. Puerto Rico judge advises legal issues be put on hold after Maria. Mexico Earthquakes Test Plan for Investors to Absorb Government Disaster Costs. Wall Street’s Newest Puzzle: What Passive Buying and Selling Means for Individual Stocks. Alibaba and Tencent Set Fast Pace in Mobile-Payments Race. Mnuchin’s Incomplete Treasury Staff Could Be a Risk in Crisis. From Ugly Duckling to En Vogue: Commerzbank Luring Suitors. Cristiano Ronaldo Is Hawking One of the World’s Riskiest Derivatives. "The Grand Duchy of Luxembourg has won a hard-fought battle against a landowner in the central region of Bissen, whose refusal to sell a small plot of potato farmland had threatened to scupper its efforts to woo Google for a billion-euro investment." How to Help an Employee Who Rubs People the Wrong Way. "Billionaires build spaceships and collaborate with the government to spy on the populace, while working-class people live out of shipping crates and drink poison water." Wall Street's chess teacher. "The pasta rule is funny, but this is what the game is about. Just doing tedious calculations all the time."  The history of paperweights

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