Judge Rules AT&T Merger Will Be Fine

Also RMBS markups and Bitcoin manipulation.


Shortly before 4 p.m. yesterday, a bunch of lawyers, media executives, journalists and other interested parties—some of whom had paid $860 to be there—were locked into a federal courtroom in Washington D.C. with no electronic devices. No one was allowed to leave, announced the judge, except “on a gurney.” That judge, Richard Leon, then delivered his decision in the Justice Department’s antitrust case against AT&T Inc.’s deal to buy Time Warner Inc. To them. And no one else. It was a magical event, a gap in modernity’s space-time continuum. An important thing had happened, in a sealed room, but no one tweeted it. In a sense, had it happened at all? I don’t know what else they did in that room. If I were Judge Leon I would have had a party, or led a séance, or just let everyone talk quietly among themselves for a while. Being in a big room with all your friends, with your phones turned off! Amazing.

Eventually they got out of the room, of course, and started tweeting. Time Warner’s stock crept up into the close and in after-hours trading, while they were in the room, before shooting up a few points when the ruling—a complete victory for AT&T and Time Warner, allowing the merger to close with no conditions—finally became public at about 4:40. If you were trading Time Warner stock at, like, 4:20 p.m. yesterday, I would love to know why. Like, what was your edge, after the judge had started announcing his ruling but before anyone outside the room knew what it was? Did you use ESP to figure out what he was saying? Did you finally get around to reading some research notes and briefs in the case, 20 minutes before it was over? Did you get some unrelated piece of positive Time Warner-related news and decide that it increased your valuation of Time Warner, regardless of the merger outcome? Continuous markets are kind of weird.

AT&T’s acquisition of Time Warner is a vertical merger: AT&T mostly owns pipes (DirectTV, cellular networks) that bring content to consumers, while Time Warner mostly owns studios (Time Warner) and networks (HBO, the Turner networks) that produce and package that content. By combining the two, they can achieve some efficiency benefits that should work to lower prices for consumers. For instance, by combining AT&T’s data on its wireless customers with Time Warner’s advertising inventory, they can introduce more targeted ads, which “will lead to higher ad revenues that will alleviate pressure on the programing side and lower the price of video distribution to consumers,” according to Judge Leon’s opinion. In modern antitrust law, more targeted advertising is a consumer benefit. There are those who think that modern antitrust law is bad.

Against these benefits, the government argued that the combined company would have so much market power that it would actually be able to raise prices. This is an unusual argument in a vertical merger—and vertical mergers are rarely challenged—because the merger won’t make AT&T any bigger in any of the businesses it (or Time Warner) is already in. Instead, the government’s theory is that AT&T can use its Time Warner content to bully competing distributors (other cable companies, video-on-demand companies, etc.). Right now, Time Warner makes its money by signing big high-stakes deals with content distributors who want to carry its content. If they don’t reach a deal, then everyone loses: Time Warner doesn’t get paid, and the distributor’s customers get mad that they can’t watch HBO and start thinking about switching cable companies. And so in practice they generally work out a deal; long-term blackouts are very rare.

But once AT&T owns Time Warner, the government argued, its incentives will shift: If it fails to reach a deal with Comcast or whoever, then it still won’t get paid for Time Warner’s content, and Comcast’s subscribers will still get mad and think about switching providers, but now they might switch to AT&T. (To DirecTV, or to some AT&T wireless video product, etc.) Blacking out Time Warner’s networks on a competing distributor will now be good for AT&T’s distribution business, which will give Time Warner more leverage to demand higher prices for its content in those negotiations with distributors. Or that is the government’s theory, which it argued based on some intemperate public statements from AT&T, some worries from its competitors, and the expert testimony of antitrust economist Carl Shapiro.

Judge Leon didn’t buy it. He noted that an AT&T expert witness looked at previous content/distribution vertical mergers and found that “There’s absolutely no statistical basis to support the government’s claim that vertical integration in this industry leads to higher content prices.” And he noted that, even after the merger, it will be in AT&T/Time Warner’s interest to distribute Time Warner’s content as broadly as possible, so it won’t really have that much leverage to demand higher prices:

Indeed the evidence showed that there has never been, and is likely never going to be, an actual long-term blackout of Turner content. Numerous witnesses explained, and Professor Shapiro acknowledged, that a long-term blackout of Turner content, even post-merger, would cause Turner to lose more in affiliate fee and advertising revenues than the merged entity would gain. Given that, there is insufficient evidentiary basis to support Professor Shapiro’s contention that a post-merger Turner would, or even could, drive up prices by threatening distributors with long-term blackouts.

The discussion gets into some odd theory-of-the-firm moments. Several of AT&T’s witnesses were people who had negotiated these content deals at other vertically integrated cable/content companies: “Madison Bond, who has served as a lead negotiator for NBCU during the past seven years when the company has been vertically integrated with Comcast,” for instance, and several Time Warner executives who “testified similarly about their time at the company when it was vertically integrated with Time Warner Cable.” All of these witnesses said the same thing: They never used their ownership by a distributor as leverage in negotiation with other distributors.

When questioned by defense counsel about his prior negotiations on behalf of NBCU, Bond testified that he “never once took into account the interest of Comcast cable in trying to negotiate a carriage agreement.” Consideration of potential Comcast gains during an NBCU blackout “doesn’t factor at all” into his negotations, Bond continued, nor has anyone from Comcast “ever asked” him “to think about that.” Bond’s statements were similar to testimony given by Comcast’s chief negotiator, Greg Rigdon, who testified that he has never suggested, or seen a Comcast document suggesting, that NBC “should go dark on one of [Comcast’s] competitors because then [Comcast] might pick up some subscribers” or that NBCU should “hold out for a little bit more in affiliate fees because that will harm” Comcast’s competitors.

(Citations omitted.) Similarly, a Turner executive said, “I’ve been in Turner when we were a vertically integrated company and had a sister company called Time Warner Cable. And I can tell you that at no time during my tenure there did anyone ask me to consider in my negotiations and how I dealt with other distributors the outcome and impact at Time Warner Cable.”  

So basically everyone with experience of negotiating these deals, who had the leverage that the government claims AT&T/Time Warner will have, said: Nah, it never even occurred to us to do that. But the government’s economist testified that of course they would have that leverage and use it. “Indeed, this opinion by Professor Shapiro runs contrary to all of the real-world testimony during the trial from those who have actually negotiated on behalf of vertically integrated companies,” wrote Judge Leon. So he asked Shapiro about it, and got this fun answer:

No, I am aware of that testimony. And so I think there’s a very serious tension between that testimony and the working assumption for antitrust economists that Professor Carlton and I share; that the company after the merger will be run to maximize their joint profits.

Isn’t that sort of lovely? An economist testified about how companies should operate. Actual operators testified about how the companies do operate. The answers were different. “There's a very serious tension,” said the economist. It is really all you could ask for in an antitrust trial: An economic theory of corporate behavior was proposed, it was confronted with the practical reality of the people actually doing the corporate behavior, and the economic theory shrugged and melted away. 

Judge Leon is surely right that the tension isn’t as serious as Shapiro thinks:

That profit-maximization premise is not inconsistent, however, with the witness testimony that the identity of a programmer’s owner has not affected affiliate negotiations in real-world instances of vertical integration. Rather, as those witnesses indicated, vertically integrated corporations have previously determined that the best way to increase company wide profits is for the programming and distribution components to separately maximize their respective revenues. … In the case of programmers, that means pursuing deals “to be on all the platforms,” rather than undertaking a “series of risks” to threaten a long-term blackout.

Part of how you combine different businesses is by getting them to work together: If Time Warner is good at selling ads, and AT&T is good at mining customer data, then you smush them together so that AT&T/Time Warner will be good at selling ads based on customer data-mining, which is where the money is. But part of how you combine different businesses is by leaving them to work separately: If Time Warner’s business model is selling programming to every distributor, then changing that model so that it only sells to AT&T, just because AT&T bought it, would be a mistake. Which is which—when you should combine businesses, and when you should leave them to make their own profit-maximizing decisions—is a complicated question, and you can certainly try to answer it with game theory and economic modeling. But sometimes you can just ask companies what they actually do! It is not perfect evidence of what they should do. But it’s pretty good evidence of what they will do.

Excessive markups!

A thing that used to happen a lot in the market for non-agency residential mortgage-backed securities was:

  1. A trader at a bank would buy a thinly traded RMBS for, like, 60 cents on the dollar.
  2. He would turn around and try to sell it to a customer for, like, 70 cents on the dollar.
  3. He’d put on a big dramatic show about how he had paid 69.75 for it and was barely making any money selling it at 70.
  4. The customer would pay 70.

We know that this happened a lot because quite a few RMBS traders were prosecuted for it. Federal prosecutors decided that lying to your customers about the price you had paid for bonds is fraud, and that people should go to prison for it. It is really no surprise that they would think this. What is surprising is that a lot of judges and juries seem to have disagreed, and recently several of these traders—who indisputably lied to customers about the prices they had paid for bonds—were either acquitted of fraud, or had their convictions tossed out by judges after juries had convicted them.

Still, you probably shouldn’t lie to your customers about the prices you paid for bonds. That's not legal advice or anything, and the law does seem murky, but in any case, your bank doesn’t want you to do it. Here is a Securities and Exchange Commission enforcement action against Bank of America Corp.’s Merrill Lynch, Pierce, Fenner & Smith Inc. unit, which agreed to pay more than $15 million because its traders lied about RMBS prices to customers from 2009 through 2012. Obviously it does not want that to happen any more.

Here is another thing that happens from time to time in the market for non-agency residential mortgage-backed securities:

  1. A trader at a bank would buy a thinly traded RMBS for, like, 60 cents on the dollar.
  2. He would turn around and try to sell it to a customer for, like, 70 cents on the dollar.
  3. The customer wouldn’t ask him what he had paid.
  4. He wouldn’t volunteer it.
  5. The customer would pay 70.

That is a very different situation. There is no lie there; no one was deceived; the trader just charged as much as he could get away with. The whole point of the bond-lying prosecutions was the actual lying; if bond traders just don’t say what they paid, and no one asks, then the problem goes away. That is certainly the lesson that banks seem to have taken from those cases. “Many salespeople no longer reveal how much their banks paid for a bond they’re trying to sell customers, as a matter of firm policy”: If you don’t tell customers what you paid, you won’t be tempted to lie to them about how much you paid.

But here’s a passage from that Merrill Lynch enforcement order:

At times during the Relevant Period, Merrill traders also charged customers markups that bore no reasonable relationship to the prevailing market prices.

In one instance, Merrill purchased $15,621,000 original face amount of a bond at a price of 1.86. Later that day, a trader, through a salesperson, sold the bond to a Merrill customer at a price of 4.00. The 4.00 price represented an intra-day mark-up of 115.1% and profits to Merrill of approximately $334,289.

In another instance, Merrill purchased $8,278,000 original face amount of a bond at a price of 34.6125. Later that day, a different trader, through another salesperson, sold the bond to a Merrill customer at a price of 40.00. The 40.00 price represented an intra-day mark-up of approximately 15.6% and profits to Merrill of approximately $388,182.

That’s just selling the bond for (much) more than Merrill paid for it. There is no lying at all. But the SEC still thinks it’s fraud:

Merrill traders did not disclose the excessive mark-ups charged to Merrill customers. Information about those mark-ups would have been important to the investment decisions of those customers. By failing to disclose the excessive mark-ups, Merrill traders acted knowingly or recklessly. Under these circumstances, their conduct violated antifraud provisions of the federal securities laws

The SEC adds in a footnote (citations omitted):

Under the “shingle theory,” a broker-dealer “creates an implied duty to disclose excessive markups by ‘hanging out its professional shingle.’” When a broker-dealer, without disclosure, charges a customer a mark-up that results in a price that is not reasonably related to the prevailing market price, the broker-dealer commits fraud. 

The rule here is not that you have to disclose your markup. The rule is that you have to disclose—or, preferably, avoid—excessive markups. What makes an excessive markup is a bit in the eye of the beholder: “The examples of excessive mark-ups in paragraphs 11. and 12. above of the Order are not meant to suggest that mark-ups below the levels reflected in those examples could not be excessive,” says the SEC, but it is not obvious to me that Merrill’s markups here of 2.1 and 5.4 points on thinly-traded (and yes, fine, well-below-par) bonds were actually excessive. (There is a popular though not especially binding rule of thumb that a markup of more than 5 percent is excessive.) “Can bond traders lie to customers” is a murky area of law, but “can bond traders overcharge customers” is even murkier.

But the key point here is that the lesson that banks took from the bond-trader-lying cases was wrong. The lesson is not “don’t disclose the price you paid for bonds, because then you won’t be tempted to lie about it”; it's not “you can charge whatever you get away with as long as you don’t affirmatively lie about anything.” You can see how the banks would have thought that. Here's how the court of appeals described their business in one recent decision:

The broker-dealer acts solely in its own interest as a principal. ... It seeks to profit from transactions in the securities by buying low and selling high. … A broker-dealer is not, therefore, an agent for its counterparties in these trades and owes them no special or fiduciary duty. … The counterparty has no legitimate expectation of purchasing a bond at the price paid by the broker-dealer. Rather, the broker-dealer and counterparty each have their own price ranges in which they will consummate their ends of the transactions. The final price is determined in an arms-length negotiation .…

Not so fast, says the SEC! A broker-dealer doesn’t act solely in its own interest as a principal; it does have some (not fiduciary, but some) duty to the counterparty; the counterparty does have an expectation of purchasing a bond, not at the price paid by the broker dealer, but at some price with some reasonable relationship to the price paid by the broker-dealer, at least if the broker-dealer bought it that same day. Lying to customers may or may not be illegal, but even just keeping quiet is not perfectly safe.


John Griffin and Amin Shams of the University of Texas, whom you may remember as the professors who argued that the VIX is manipulated, have a new paper out arguing that Bitcoin is manipulated:

This paper investigates whether Tether, a digital currency pegged to U.S. dollars, influences Bitcoin and other cryptocurrency prices during the recent boom. Using algorithms to analyze the blockchain data, we find that purchases with Tether are timed following market downturns and result in sizable increases in Bitcoin prices. Less than 1% of hours with such heavy Tether transactions are associated with 50% of the meteoric rise in Bitcoin and 64% of other top cryptocurrencies. The flow clusters below round prices, induces asymmetric autocorrelations in Bitcoin, and suggests incomplete Tether backing before month-ends. These patterns cannot be explained by investor demand proxies but are most consistent with the supply-based hypothesis where Tether is used to provide price support and manipulate cryptocurrency prices.

If you spend any time thinking and writing about cryptocurrencies, this is a theory that you run into: that Tether, a cryptocurrency that is allegedly but nebulously pegged to the U.S. dollar, is actually used to prop up the price of Bitcoin and other cryptocurrencies. The idea is that when the price of Bitcoin drops, manipulators will buy more of it, pushing up its price in dollars—but they’re not actually buying more Bitcoin using dollars, they’re buying more Bitcoin using Tether, which can be created out of thin air by a company (also called Tether) with links to a Bitcoin exchange (Bitfinex).

I do not personally claim enough expertise to evaluate this theory, though Griffin’s and Shams’s paper seems quite careful. I will say, though, that of these two explanations— 

  1. Bitcoin’s rapid and sustained rise is due to the fact that it satisfies a real economic need in an elegant way, and people have responded to that; or
  2. Bitcoin’s rapid and sustained rise is due to a magical fountain of fake dollars that everyone just decided to treat as real dollars, and that can be used to manipulate its price any time it’s in danger of falling— 

the second is possibly more impressive. Like, creating billions of dollars’ worth of value by building a useful thing is relatively straightforward. Creating billions of dollars’ worth of value with a ridiculous perpetual-motion fake-dollar-printing machine is a real innovation.

Things happen.

Investors Are Betting on the Next Big M&A Deal After AT&T’s Win. LBO Volume Surges as KKR, Others Put $1 Trillion Cash Pile to Work. ZTE Dives After Agreeing to $1 Billion Fine and Major Revamp. Wall Street Firms Face a New $15 Billion Hurdle in China. Foreign banks push US Federal Reserve to relax capital rules. Credit Suisse Wins Narrowing of $11 Billion Suit, Martin Act. Tesla Cutting About 9% of Global Workforce. “Notably, the baby’s parents transferred Asahd’s right of publicity to a company ATK Entertainment at some point during his infancy.” Fyre Festival’s Billy McFarland Arrested on Fraud Charges As He Awaits Sentencing for Fraud Conviction. Raccoon Vs. Skyscraper: The Summer Blockbuster You Never Knew You Needed.

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