Company Isn’t Sure If It Fired Its CEO
(Bloomberg Opinion) -- Dueling 8-Ks!
Who controls a company? Its managers? Its chief executive officer? Its board of directors? Its shareholders? “The night watchman controls the company, sort of,” I wrote last week, “if he can change the locks overnight and not let the managers and directors and shareholders in the door the next morning.” Control of a company is fractured and elusive, because “a company” is fractured and elusive: It is not an identifiable coherent object, but a set of people and decisions and pronouncements and products and web pages and filings. If you have influence over any of those things then to some degree you control the company.
In the cleanest form of corporate-finance theory, some hierarchy of control flows up from the night watchman to the managers to the CEO to the board to the shareholders, and the people at each level of the hierarchy have tools to make sure that the people below them in the hierarchy can do what they want. But in the actual world, people sometimes … just … do … stuff.
Rockwell Medical Inc. is, let’s say, a company. It trades on the Nasdaq Global Market under the ticker RMTI, it has about a $300 million equity market capitalization, and it “manufactures, markets, and delivers dialysis solutions, powders and ancillary products to hemodialysis providers,” according to Bloomberg. But this week it seems to have fissured into two companies, each with the same name, business, assets and shareholders, but with different, let’s say, metaphysical statuses. At one of them—call it RMTI-A—the board of directors met on Tuesday and decided to fire Chief Executive Officer Robert Chioini, at which point he resigned from the board; it also appointed a special transition committee of three directors to oversee the company while it searches for a new CEO. We know this because RMTI-A put out a press release and 8-K about these developments on Wednesday morning.
At the other Rockwell Medical Inc., call it RMTI-B, Chioini remains the CEO and is still on the board. He is however aware of the goings-on at RMTI-A, and he’s not happy about them. For instance the directors who fired him at RMTI-A are, at RMTI-B, in the doghouse. (They tried to fire him at the board meeting at RMTI-B, too, but “as that action was not the purpose of the special meeting, the determination of the non-conflicted independent directors was that the termination was not effective.”) Those directors are, at RMTI-B, the subjects of “an internal investigation in response to [a shareholder] demand letter requiring immediate initiation of an investigation of alleged breach of fiduciary duties by various directors and other possible violations of federal securities laws,” and Chioini “through counsel has notified the SEC of the action taken by the directors whose conduct is discussed in the demand letter that gives rise to the investigation.” We know this because RMTI-B also filed an 8-K about these developments on Tuesday night.
But this fissure is so far purely metaphysical. No one has told the Securities and Exchange Commission about it, for instance, and so RMTI-A and RMTI-B share a single account—Rockwell Medical Inc.’s—on the SEC’s Edgar system. At 9:27 p.m. on Tuesday RMTI-B’s 8-K, announcing that Chioini is still the CEO, arrived at Edgar; at 6:05 a.m. on Wednesday, RMTI-A’s 8-K, announcing that no he isn’t, arrived. Because late-evening Edgar filings don’t actually become public until the next day, the two filings ended up hitting the Bloomberg terminal news feed five minutes apart on Wednesday morning. Confusing!
Obviously each side thinks that it is the real Rockwell Medical Inc., and that the other company (and its 8-K) is an impostor. “Following the May 22, 2018 Board meeting and without authorization, Mr. Chioini and Thomas Klema, Vice President, Chief Financial Officer, Treasurer and Secretary, filed a Current Report on Form 8-K making certain assertions regarding the independent directors who voted in favor of Mr. Chioini’s removal,” says RMTI-A’s 8-K (emphasis added). Well, without whose authorization? Certainly without the authorization of RMTI-A’s board of directors. (Certainly also without the authorization of RMTI-A’s CEO, since at that point RMTI-A didn’t have a CEO.) Certainly, though, with the authorization of RMTI-B’s CEO, and perhaps even with the authorization of its board.
Oh also RMTI-A fired its chief financial officer and RMTI-B didn’t, so there’s that. (“I have no information to suggest the governance requirements to call such a meeting were followed,” says RMTI-B’s CEO about RMTI-A’s board meeting to fire the CFO for conspiring in the RMTI-B 8-K.)
I don’t even have a point here. I just wish all corporate governance was like this. What will happen? How will it end? Who cares! It’s so wonderful. I mean, no, obviously it will end with everyone suing and with a court eventually deciding which of RMTI-A or RMTI-B is “really” Rockwell Medical Inc., but how boring that will be.
The good outcome would be if this goes on forever—if RMTI-A and RMTI-B just continue to coexist, with the same assets and buildings and employees and, crucially, Edgar identifiers, but with some slight non-overlaps among their directors and executive officers. Everyone should keep coming to work, and glaring at each other, and asserting that they run the company. (I said much the same thing about CBS Corp., which is stuck in its own quantum superposition, last week.) “Get to work on manufacturing that dialysis solution,” the RMTI-B CEO will say to a lab technician. “No, no, grind that powder instead,” the RMTI-A special transition committee will say. The technician will shrug and, I don’t know, pick a side I guess? Try to please both sides? Do what people in any office do to manage the conflicting demands of different bosses and tricky office politics, but more so? Meanwhile RMTI-A and RMTI-B will take turns issuing 8-Ks, all of them about “Rockwell Medical Inc.,” but increasingly disconnected from each other. “Rockwell Medical Inc. announces that it is considering strategic alternatives,” one 8-K will say, followed minutes later by one saying “No it most certainly is not.” Every day will be an adventure.
And why not further splintering? Yesterday’s drama gives us a clue that Rockwell’s CFO (well, RMTI-B’s CFO anyway) has the Edgar access codes, since he was involved in Chioini’s 8-K. He should issue his own 8-K late one night declaring himself CEO. Really if you are the assistant corporate secretary at any large public company, and you happen to have the Edgar keys so you can make routine filings, why not throw in an 8-K declaring yourself CEO? Give yourself a huge stock award while you’re at it. Who’s to say what’s real anyway?
The basic problem in modern banking is, if a bank loses money, whose money does it lose? Who is on the hook for a bank’s losses? I can think of at least six options:
- Its depositors. This is a bad outcome for lots of reasons—the point of a banking system is really to have risk-free deposits—and so in practice it is not a realistic option in any but the direst circumstances.
- Its shareholders. This is a good outcome for lots of reasons: It forces the owners of the bank to internalize its risks, it puts risk on securities that are meant to bear risk and on holders who can afford it, it matches with expectations about how corporations work, etc. And so in practice this is the favored option of bank regulators and commentators in almost all circumstances. On the other hand the shareholders don’t like it. Specifically, banks want to have as little capital—as much leverage—as possible, so that they can make more profits for shareholders while putting less shareholder money at risk.
- Taxpayers. This is the one that everyone complains about. This is “government bailouts.” It is obviously bad. The thing to realize is that it is in some sense inevitable in the limiting case. Banks cannot have infinite equity, and can always find a way to lose more than all of their equity. Then someone is on the hook. Depositors are not a good option. The government—or the central bank, etc.—is the inevitable option of last resort. Banks are in essence a public-private partnership to turn risk-free deposits into risky loans; you cannot cut the public risk in that partnership to zero. You can minimize it! (With more equity, etc.) But you can’t make it zero.
- Its creditors. This is fine—banks can issue bonds meant to bear losses—but conceptually it is simplest to think of a bank as being made up of (1) deposits and (2) capital. Some of a bank’s non-deposit debt (repo loans, etc.) will be functionally deposits: It is supposed to be risk-free, and if it bears losses then that is systemically unattractive. Some of the bank’s non-deposit debt (“total loss-absorbing capital” bonds, etc.) will be functionally equity: It will be issued with a high coupon and specific provisions describing how it will bear losses, and people who buy it ought to internalize the bank’s risk. So this category—non-deposit bank debt—is really just a combination of categories 1 and 2. People argue over the specifics of how risk-bearing debt compares to equity, or how risk-free the non-risk-bearing debt is supposed to be, but for our purposes, never mind.
- Its employees. This is a clever one and people talk about it occasionally; it has some obvious appeal (make the people who take the risks internalize them!) but it doesn’t seem practically important for loss absorption. If a bank loses a billion dollars you’re not really going to get the billion dollars back from the employees who lost it.
- Someone else who agrees to take the risk. Like, if you are a bank and you make loans, you can buy credit-default swaps on those loans from someone else. An insurance company, or a pension fund, or whoever. And then your losses are its problem. This can be great (you’re offloading credit risk from a flighty deposit-funded bank to a pension fund with a long time horizon) or terrible (you’re offloading credit risk from a prudent regulated bank to some weird short-term-funded shadow-banking entity), but whatever it is is in some sense no longer the bank’s problem. The bank has dealt with its risk; now the risk is elsewhere.
The basic dance of bank regulation is that banks want to minimize (2)—they want as little equity as they can get away with—while regulators want to minimize (3)—they want as little taxpayer risk as they can manage. This is mostly a simple game: The more equity is at risk, the less taxpayers are at risk. But finance is a creative industry, and people are constantly looking for an outside-the-box escape from this dilemma. What if there were some way to put less equity at risk, without putting taxpayers more at risk? (Or, if you are a bank: What if there were some way to put less equity at risk, without regulators noticing that taxpayers are more at risk?)
If you look at my list, category (1) is not a real solution; no one wants depositors to bear risk. Category (4) is a popular one, and there is some probable arbitrage where banks think that their bonds are not bearing risk while regulators think that they are. Category (5) is not an especially meaningful solution. But category (6)—sure, yes, absolutely, that works. That makes everyone happy. If the banks can offload risk to some willing third party, then the banks can have less equity while the taxpayers have less risk too. It’s a good trade. Everyone views everything with suspicion, so it’s not like this trade is universally embraced, but the general category of “capital relief trades”—where a bank finds a way to offload risk to a third party to minimize its capital requirements—is a fruitful one.
This, though, is delightful:
The trades typically work like this: The bank bundles loans—usually to companies—and calculates the capital it needs to hold against potential defaults on that portfolio. The bank then pays a fee to an investor, such as the EIF, a hedge fund or pension fund, to insure against a chunk of the future losses.
If the underlying loans default, the bank can claim compensation from the investor up to a predefined amount. Investors insist the bank also takes the risk of some loss on the loans to ensure they aren’t being handed dud credits. The attraction for the investor is often a double-digit yield on assets it can’t normally access.
Once blessed by regulators, the sale allows a bank to reduce the amount of capital it uses to back those loans.
I mean, all of that is just a standard description of capital-relief trades, except for one clause: “such as the EIF.” The EIF is the European Investment Fund, “a public-private partnership between the EU, commercial banks, and other financial institutions.” Get it? This trade looks like (6): It looks like the bank transfers its loan risk to some willing third party, finding a way out of the shareholder-versus-taxpayer dilemma. It’s just that the third party is a taxpayer-backed fund. The way out of the dilemma is to give the risk to taxpayers, but in a weird form. “Taxpayers Are on the Hook in Banks’ Financial Engineering” is the Wall Street Journal’s headline.
“The concern is that banks are creating an illusion of transfer of risk,” said Michael Osnato, a partner at Simpson Thacher & Bartlett LLP.
If European governments want to recapitalize or subsidize the banking sector, then they should just inject equity or other loss-absorbing capital, not use complex structures, said Peter Hahn, professor at the London Institute of Banking & Finance. “At least it’s more visible and you know what the real exposure is.”
Yeah but that is … that is like the opposite of the point of finance. The point here is to make it less visible, to create an arbitrage, to make everyone feel like they’ve gotten a win, to find a way out of the zero-sum shareholders-versus-taxpayers dilemma, or at least, a way out of thinking about it as a zero-sum dilemma. This trade is what banking is all about; this is the heart of how finance works; this is what the creativity is for. If you don’t like this trade then you don’t really like finance. Which is perfectly reasonable of you!
Weisenthal applies the lessons of Peter Bernstein’s book “The Power of Gold: History of an Obsession” to thinking about cryptocurrency:
My takeaway from the book is that if you were an early state or a king or something, then the holding of gold was essentially an embedded proof that you had all the skills needed to wield power.
In other words, when you have gold you’re communicating all the different things you’re capable of (mastering supply routes, commanding an army, scientific endeavor, marshalling labor etc.). Gold, then, is a very specific proof of work. If you can get gold, you’ve proven that you have the ability to run a state or some state-like entity.
So what seems like a gigantic waste is actually an extensive demonstration of skills. … Throwing this forward to cryptocurrency mining, people often decry all the waste involved, and the extraordinary lengths people will go to do seemingly pointless computations. But looking at gold’s history shows there’s a reason people go through all this trouble. It communicates a lot when you demonstrate all of the various technical skills you’re capable of.
Does it? Like, having gold, as a pre-modern king, meant that you were good at king stuff. Does having Bitcoin, as a 21st-century … very online person … mean that you are good at modern very online stuff? There is definitely an argument that it does. Seen in one positive light, amassing a lot of cryptocurrency by mining demonstrates some facility with computer engineering and programming and math, those essential 21st-century skills. There is an argument that it also demonstrates access to efficient electricity: Cryptocurrency mining rewards those who can generate (or purchase) electricity most efficiently; the waste involved in mining, on this view, is only apparent, and really incentivizes the development and use of more efficient sources of energy. (And: “Bitcoin is a colossal battery that absorbs energy and then releases it anywhere, whenever.”) And there is an argument that it rewards essentially pro-social behavior: Bitcoin mining is the process by which Bitcoin transactions are confirmed, being a miner means maintaining the system for everyone else, and mining rewards contributors to the greater good.
The alternative view is that Bitcoin mining can be done by purchasing pre-built hardware and running it so loudly that it annoys your neighbors, or by using malware to hijack other people’s computers to mine for you, or just by buying space on someone else’s commercially available mining rig. This view might note that the “math” done by miners is just brute-force guessing of numbers, and that the intellectual sophistication required to invent Bitcoin has nothing to do with what’s required to mine it. It might add that, besides mining Bitcoin, other well-known ways to amass a lot of it include selling drugs online, hacking other people’s Bitcoin wallets, or just being early to the Bitcoin party and buying when the price was low. I once joked that Bitcoin is “the world's first economic system that allocates wealth basically for hanging around on Reddit,” and there is a kernel of truth to that. Bitcoin’s proof-of-work mechanism is definitely proof that you’ve done something, but it might take a few thousand more years before historians are really sure of what it is.
Elsewhere: “The Justice Department has opened a criminal probe into whether traders are manipulating the price of Bitcoin and other digital currencies,” focusing on things like possible spoofing and wash trading. It will be interesting to see the legal theory that the Justice Department uses to prosecute Bitcoin spoofing. Bitcoin, after all, probably isn’t a security, or a commodity futures contract, or anything else that is commonly monitored by the sorts of regulators who care about spoofing. If you are spoofing Bitcoin you are surely not committing securities fraud, or violating the Dodd-Frank prohibition on spoofing in commodity markets. (Not legal advice!) On the other hand you are using a computer to do self-evidently naughty things, so the Justice Department has a pretty good argument that you are committing wire fraud.
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