Death Arbitrage and Uber Battles
(Bloomberg View) -- Death arbitrage.
We talked a while back about Donald F. "Jay" Lathen Jr., a former Lehman and Citigroup investment banker who was laid off in September 2008, kicked around for a while, and in 2009 "discovered survivor's option bonds." A survivor's option bond (or certificate of deposit) is a bond (or CD) that can be held by two people in a joint account, and if one of them dies, the bond can be redeemed immediately at par. Many of these bonds traded at a discount to par, and Lathen had the bright yet also undeniably dark idea of finding terminally ill people (in hospices and nursing homes), buying discounted survivor option bonds jointly with them, and then redeeming them at par when the people died. This worked quite well, and Lathen ended up setting up a hedge fund to run the strategy using investor money.
The obvious first reaction to Lathen's strategy is that it was in poor taste, but as I said last time, "anyone who has ever walked around a trading floor knows that poor taste is not a violation of securities laws." Lathen was not accused of defrauding the terminally ill patients whose deaths he profited from: Everyone agrees that he explained the idea to them, that they "were encouraged to ask questions" before signing, and that he promised them $10,000 (and nothing more) for their signatures and promptly paid it.
Nor was he exactly accused of defrauding his hedge-fund investors: Again, he explained the idea to his investors, dealt with them honestly, and made them a lot of money. (He raised a total of about $5.85 million from about 15 investors, and his fund's "overall profits were between $7.5 and $9.5 million.") The SEC did accuse him of violating client-money segregation rules, because he bought the survivor option bonds in his own name, but those claims were kind of silly and the SEC judge sensibly dismissed them.
The SEC's main claim is that Lathen defrauded the issuers of the bonds, various big financial institutions, which were not really expecting to pay out these survivor-option benefits to a hedge fund. And in fact, when the institutions realized that they were paying out the benefits to a hedge fund -- because Lathen kept submitting redemption requests "in connection with different people who did not share his last name" -- they sometimes got mad and refused to pay.
And then Lathen got mad right back at them! For instance, Lathen got paid by Barclays Bank PLC after he made "a few threatening phone calls." He didn't get paid by Goldman Sachs Group Inc., so he "filed complaints against Goldman Sachs with the New York State Department of Financial Services and the Consumer Financial Protection Bureau." (Disclosure: I used to work at Goldman.) Given that approach, it doesn't exactly seem like Lathen was lying to the issuers, and the SEC judge concluded that he wasn't: "Lathen provided the issuers with what was required by their offering documents."
Still, there are more technical arguments that Lathen defrauded them, because Lathen and the terminally ill patients he recruited were not really joint owners of the account. For one thing, the SEC argued that Lathen wasn't really a joint owner: He was just holding the accounts as a nominee for his hedge fund, which was the real beneficial owner, and by claiming to be an owner he was deceiving the banks. The SEC judge dismissed this argument quickly, finding that the "real" beneficial owner was none of the banks' business.
But the SEC argued that the terminally ill participants weren't really joint owners either. In order to get the death benefit, Lathen and the deceased co-owner had to be "joint tenants with right of survivorship," under New York property law principles, in the account. To establish joint tenancy in a property, you need to have an intention to co-own the property while you are both alive, and for each of you to be able to inherit it when the other one dies. (So, for instance, if an elderly disabled person makes his niece a joint tenant in his bank account so she can sign checks for him, a court might decide that wasn't a real joint tenancy because he didn't intend her to have the money.) Neither, argued the SEC, was true here: Lathen's agreements with his terminally ill participants provided that they couldn't withdraw any money or have any other ownership over the accounts, and that if by some accident Lathen died first, his fund could withdraw most of the money rather than letting it pass to the participants.
This is a good argument, and the SEC judge addressed it at length, and seemed to have had a lot of fun doing so. But ultimately he concluded that he couldn't tell if Lathen's joint tenancies were valid: It's an unsettled issue in New York property law, and who is an SEC administrative law judge to decide it? But since this was a fraud case, and since Lathen seemed to be acting honestly and got a lot of advice from a lot of good lawyers, the judge concluded that, valid or not, the joint tenancies weren't fraud, and found for Lathen. That doesn't resolve the question of whether Lathen's strategy ought to have worked: The banks could have argued that his ownership wasn't valid. Perhaps they still will. But in any case the survivor-option loophole "has run its course," and the banks have modified their documents to cut it off by, for instance, limiting the survivor option to relatives. It was weird while it lasted, though.
Here is a story about how Travis Kalanick's relationship with Benchmark Capital, a big shareholder at Uber Technologies Inc., fell apart over time, leading to Benchmark's lawsuit trying to kick Kalanick off Uber's board. Benchmark partner Bill Gurley "privately cautioned Mr. Kalanick about overspending and overexpansion" and urged him "to hire a chief financial officer and think seriously about going public." This being Uber, Kalanick responded with nicknames and hazing:
Thanks in part to such fretting, Mr. Kalanick would sometimes reference the character Chicken Little, who always claimed the sky was falling, when speaking of Mr. Gurley, according to a person who spoke on condition of anonymity to describe the conversations.
(Kalanick's spokesman responded "that Mr. Kalanick never called Mr. Gurley Chicken Little.")
Here, meanwhile, is a very good Stratechery post by Ben Thompson about why Benchmark is suing. Actually first it is about why venture capitalists so rarely sue founders:
The entire point of venture investing is to hit grand slams, and that calls for more swings of the bat. After all, the most a venture capitalist might lose on a deal — beyond time and opportunity cost, of course — is however much they invested; the downside is capped. Potential returns, though, can be many multiples of that investment. That is why, particularly as capital has flooded the Valley over the last decade, preserving the chance to make grand slam investments has been paramount. No venture capitalist wants to repeat Sequoia’s mistake: better to be “nice”, or, as they say in the Valley, “founder friendly.”
Why did Benchmark break that norm in Uber's case? Uber is just so big:
Does it give the firm a bad reputation, potentially keeping it out of the next Facebook? Unquestionably. The sheer size of Uber though, and the potential return it represents, means that Benchmark is no longer playing an iterated game. The point now is not to get access to the next Facebook: it is to ensure the firm captures its share of the current one.
When we talked about this case earlier this week, I also argued that Uber is an outlier, and that the flood of capital into Silicon Valley will generally force venture capitalists to stay founder friendly: If you insist on strong governance rights and checks on entrepreneurs, those entrepreneurs can always get plenty of money elsewhere. But there is a counterargument: Perhaps Silicon Valley venture capitalists are unusually founder friendly, and the flood of capital into startups from investors who aren't traditional VCs (mutual funds, the SoftBank Vision Fund) will make startup governance norms more like normal public-company governance norms.
So Thompson describes the more-at-bats-for-more-grand-slams mentality of typical venture capitalists, but the mutual funds and sovereign wealth funds that are buying into late-stage unicorns at huge valuations don't share that approach: If you put a billion dollars into a startup at a $10 billion valuation, you're not as willing to just write that deal off as an early-stage venture capitalist is to write off a million dollars. And reader Alex Bakker points out in an email that there are other cultural factors at work:
A disproportionate number of SV VCs are populated with ex-founders themselves. ... I think they’re used to letting the founders drive, because they got to drive, and that worked for them. Other VCs who maybe got their start elsewhere, say PE, Banking, etc. might have had a drastically different experience with what governance is supposed to be and do, and greater awareness of when companies with poor/little/no governance have benefitted from improvement on that front.
Perhaps founder-friendliness is mostly an intellectual and cultural movement of Silicon Valley founders and venture capitalists, and more mainstream capital coming into tech unicorns will make their corporate governance more mainstream. If I had to bet though, I'd still take the other side: More money coming into startups has to be good for founders' bargaining power, even if that money does come with different expectations about governance.
Despite its economic and political crisis, Venezuela keeps paying its debts, meaning that the long and complex and horrible litigation over Venezuela's potential default keeps being deferred. But maybe not much longer. Venezuela pays its bond debts, yes, and its state-owned oil company Petroleos de Venezuela SA pays its bonds, but Venezuela also owes billions of dollars to foreign companies whose property it expropriated, because of arbitration awards given by the International Centre for Settlement of Investment Disputes. Those companies want to enforce their ICSID judgments, which Venezuela hasn't paid. Mark Weidemaier writes:
Enter Canadian mining company Crystallex, which has been trying to enforce a $1.2 billion arbitration award against Venezuela, so far without success. A few days ago, it tried a new tack--one with broader implications for any restructuring of Venezuela's or PDVSA's debt. Crystallex asked a federal court in Delaware to attach the shares of PDV Holding, Inc., a Delaware company that is the ultimate U.S. parent of CITGO petroleum. PDV Holding is owned by PDVSA, which, in turn, is owned by Venezuela.
Citgo is essentially the U.S. division of PDVSA, with lots of juicy assets in the U.S. that creditors could seize. Crystallex is trying to seize them. This creates two issues. First, it will push a court to determine whether PDVSA and Venezuela should be responsible for each others' debts, a key issue in any restructuring of those debts. Crystallex argues that they should be:
"PDVSA is so extensively controlled by the government that it is impossible to say where one ends and the other begins." To make the point, Crystallex has mined PDVSA's Twitter feed, noting that on at least 100 occasions, PDVSA has tweeted "PDVSA es Venezuela."
Second, if Crystallex has any likelihood of succeeding, it will make PDVSA's and Venezuela's other creditors nervous. They have big risky claims too, and they are also expecting to look to Citgo's U.S. assets to satisfy those claims. If Crystallex gets its hands on those assets first, the other creditors will be in trouble, and they might want to get to court themselves to forestall that risk.
Elsewhere, here are Lee Buchheit and Mitu Gulati on "Enforcing new Venezuelan public debt instruments," that is, "Maduro bonds" that might be issued by Venezuela's new and controversially-legal government. Surprisingly, despite the broad rejection of Venezuela's constitutional referendum by its neighbors and the U.S. government, it is not clear that a New York court would reject the validity of those bonds:
One can sympathize with the plight of a US federal judge confronted, as he or she may be, with battling banjo Venezuelan legal opinions about the validity of new Republic debt instruments under Venezuelan law. The most likely fact pattern for such a case would be the issuance of new debt instruments by the current administration, followed by a change of regime, followed by a refusal of the new administration to recognize the validity of those instruments. If the instruments are governed by New York law and the action to enforce the instruments is brought in a US court, it will ultimately fall to a US federal judge to decide between competing legal opinions about the state of Venezuelan law at the time the instruments were issued.
How often does Jeffrey Gundlach berate employees?
"Constantly?! Try NEVER":
That's part of Gundlach's reaction to a Wall Street Journal article about his firm, DoubleLine Capital, that hasn't been published yet. He's certainly creating high expectations for it, though:
Late Wednesday, DoubleLine analyst Loren Fleckenstein forwarded emails with a Journal reporter to Bloomberg, the Financial Times, New York Times and other news outlets. In the message exchange, Fleckenstein -- citing a reporter’s after-hours call to an employee’s spouse -- called the journalist a “coward,” then later said that “‘creep’ fits better.”
Blockchain blockchain blockchain.
I said recently that "every dumb joke about cryptocurrency has also actually happened," and I am increasingly convinced that that is a fundamental law. The other day I wrote the script for a fake ad for Blockstream's plan to put the blockchain in space so that bitcoins could be used in "a small hut on the side of the road in the Sahara Desert," as long as the hut had "a perpetual generator out back with a satellite dish, a raspberry pi by the generator, a local wi-fi hot spot, and the necessary software set up." I wrote:
A small plane crashes in the Sahara. The only survivor, a venture capitalist from San Francisco, treks for days in his Allbirds looking for water. Finally, he comes to a small hut. A young boy comes from the hut, sees the desperate tattered VC, thinks for a minute, and disappears back inside. A camel blinks in the sun. The boy comes back out with an ice-cold mug of Soylent and hands it to the VC, who drinks it gratefully. "That will be 0.02 bitcoins," the boy says. The venture capitalist breaks out in a broad grin. Finally, he realizes, he is home.
And then a Blockstream executive mocked up and tweeted my ad, and now my Twitter mentions are full of people saying things like "Whoever wrote this needs to be fired, it reads like a satirical comedy sketch" and "When I first saw this I thought it was a joke, but this is for real? The hubris that Blockstream has is astounding." There's a Reddit thread about it. "I'm glad the boy knows about surge pricing," commented Ethereum founder Vitalik Buterin, but that is of course an essential part of the joke: If the boy had charged a dollar for the Soylent, instead of approximately $87 at today's bitcoin price, the venture capitalist wouldn't have felt at home. Surge pricing is a part of his culture, a way to make him feel welcome and understood. Plus I assume it's not cheap to get Soylent to the middle of the Sahara.
Anyway the point of this story is that the set of parody blockchain projects is exactly identical to the set of real blockchain products. It is never appropriate to ask about a blockchain project, "is this a joke, or for real?" It can only be both, or neither.
People are worried that people aren't worried enough.
Nope, that's over! The Dow Jones Industrial average fell 1.24 percent yesterday, "ending a 63-day streak of sessions without moves of 1% or more in either direction. The Standard & Poor's 500 index fell 1.54 percent yesterday, though it broke its own similar 58-day streak last week. "Evidence is building that the market’s long stretch of tranquility is breaking," and soon instead of meta-worrying about how unworried everyone is, everyone might be able to just worry directly.
My Bloomberg View colleague Antonio Weiss on how to "Make the Treasuries Market Safe at Any Speed." Lee Cooperman is stepping up his attack against Bill Ackman. Jacob Wohl is "only 19 and has already been investigated by the U.S. Securities and Exchange Commission." Deutsche Bank, Bank of America settle agency bond rigging lawsuits. Former Harvard Money Manager Is Launching a Digital-Currency Hedge Fund. Prudential Is Plotting Its Escape From Fed's Tough Oversight. Shell of Old G.M. Surfaces in Court Fight Over Ignition Flaw. Missing Brexit Bankers in Dublin Trigger Political Blame Game. Blackstone Adds $10 Billion in Energy Assets With Harvest Deal. "Without Donald Trump, Twitter Inc. could lose almost a fifth of its value." Starbucks Baristas Are Forming Online Support Groups Ahead of the [Pumpkin Spice Latte]'s Launch. Revenge Against Robots. Are rich people presumptively bad?
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Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
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