Sovereign Immunity and Public Hangings

(Bloomberg View) -- Allergan.

Sovereign immunity is the principle that sovereign states can't be sued in court for actions that they take in their capacity as governments. This is an ancient and fundamental right of sovereignty, but it is 2017 and so of course people have figured out a way to slice it up and sell it. The least-cost producers of sovereign immunity in the U.S. tend to be American Indian tribes, and they have become volume sellers. So for instance American Indian tribes will rent their sovereign immunity to payday lenders, who then can't be sued for violating state usury laws. (Or can they?) And on Friday the Saint Regis Mohawk Tribe got into the pharmaceutical patent sovereign-immunity-rental business:

Allergan plc (NYSE: AGN), a leading global pharmaceutical company, and the Saint Regis Mohawk Tribe today announced that the Tribe now owns all Orange Book-listed patents for RESTASIS® (Cyclosporine Ophthalmic Emulsion) 0.05%, and that Allergan has been granted exclusive licenses in the patents related to the product. The Tribe, a recognized sovereign tribal government, is filing a motion to dismiss the ongoing inter partes review (IPR) of the RESTASIS® patents based on their sovereign immunity from IPR challenges.

Drug companies don't like the relatively streamlined inter partes review of the validity of drug patents, and Allergan apparently decided that Restasis, a dry-eye drug that "brought in $336.4 million in revenues in the second quarter of 2017," was too important to subject to the risk of review. So it ... I guess you could say it sold the drug to the tribe and then licensed it back? But the cash flows -- Allergan pays $13.75 million to the tribe up front, and then $15 million a year as long as the patents are valid -- suggest that the simpler description is just that the patents are staying where they are, and that the tribe is renting its sovereign immunity to Allergan for a modest annual fee. And then it is using that rented immunity to get the inter partes review dismissed.

One thing to say here is that the current list of sovereign-immunity-rental businesses -- payday lending, drug patents -- is short and random, but if this works you can imagine it branching out. It seems unlikely to branch out to good places. There is no particular reason to rent sovereign immunity if you are just doing stuff that you are otherwise allowed to do and that does not subject you to any liability; you rent immunity because you expect you'd otherwise have trouble in court. "Do you think Indian sovereignty covers insider trading, too?" asked reader Jon Zhou by email. 

Another thing to say about this is that it is really a symptom of the financialization of everything: If you have a legal right, someone will figure out a way to value it, monetize it, slice it into tranches and sell it to financial investors. By 2018 sovereign immunity will trade on the blockchain. But sovereign immunity is really not supposed to be rented; it works for essentially non-economic reasons. It is supposed to be an inherent property of the state, not something that can be infinitely reproduced and sold to the highest bidder. Why should anyone follow any laws? American Indian tribes could set the price of immunity just below the costs of compliance, and watch the cash roll in.

Principles.

Ray Dalio's book "Principles: Life & Work" comes out next week, and he's celebrating with another round of articles about how Bridgewater Associates is a weird place to work. (Because of those Principles, which make Bridgewater sound less like a financial institution and more like an intense group therapy session.) This one is from the New York Times, and in addition to the usual anecdotes about "public hangings" and "baseball cards," it contains a brief meta-analysis about whether all the articles about how weird Bridgewater is are bad for Bridgewater:

These incidents have spilled into public view over the past year, leading to concern about the firm’s image. The impact on recruiting has become a topic of discussion within the firm, according to an internal document reviewed by The Times. One manager wrote in the document that Bridgewater had become “a place that is difficult to hire for and lukewarm to join.”

But, as is generally the case with these articles about Bridgewater's weirdness, this one doesn't answer the main question I have, which is: Does Bridgewater ever analyze whether its culture of constant self-examination and radical transparency is actually good for its investing? I don't know exactly how you'd do a controlled experiment, but presumably you could at least examine Bridgewater's returns at periods of greater or lesser Principles enthusiasm, and perhaps compare those returns to those of other hedge funds with more traditional cultures. Or you could just introspect about it, but I never even really read about that. It's never "our culture of constantly rating each other on iPad apps leads to better investment returns," always "our culture of constantly rating each other on iPad apps leads to better ratings on the iPad apps." I am always left with the sense that the group therapy is the point, that the investor returns are a happy accident that subsidize all the introspection, and that Bridgewater is an odd little eddy in financial capitalism that uses investor money to fund the pursuit of personal enlightenment.

Oh, I mean, you might just assume it is intuitive that constant introspection and examination would lead to better investment outcomes, but I am not so sure. There is a lot of this sort of thing:

Meetings occasionally last for hours, sometimes simply because of a debate over why certain subjects are on the agenda or the quality of an employee’s presentation. Workers described being publicly berated for not completing homework assignments related to the firm’s culture or, sometimes, for “below-the-bar thinking.”

In one of the firm’s more memorable case studies — videotaped episodes of events at Bridgewater that employees review and analyze — a female employee burst into tears during a group interrogation. “I have never seen so many smart people in a room who never get anything done,” Mr. Bradley said.

I have joked before that Bridgewater's business model is that it has a computer that does its investing, and that the computer uses the personal-rating games to distract the human employees so they don't interfere with the investment process. If you spend all your meetings debating what the meetings should be about, then sure, you're probably not going to have time to monkey with the investment algorithms.

There's one other anecdote that I keep reading in the Bridgewater-is-weird pieces and that surprises me each time, about Dalio's early years at a Wall Street brokerage firm:

Mr. Dalio didn’t last long. He punched his boss in the face and brought a stripper to a corporate event. He was fired and then formed Bridgewater in 1975, working out of his two-bedroom Manhattan apartment.

One aspect of Bridgewater's weirdness is that it maintains a library of tapes of old meetings and conversations, so you can go back and, I guess, see if you could have done a better job. I hope that they are building a retroactive virtual-reality role-playing episode in the Bridgewater game in which you can go back and watch (a reenactment of) a young Dalio punching his boss and bringing a stripper to a work event, and then sit him down and ask him about what he was feeling and how he could have handled those feelings better. I am sure there is a lot of valuable data to be extracted from this episode.

Elsewhere: "Bridgewater Associates LP is poised to amass a huge investment fund in China, giving its founder, Ray Dalio, the kind of clout that has largely eluded Western financial firms in the world’s second-largest economy." 

Research.

One thing about Mifid II, the European regulation requiring "unbundling" of sell-side research from trade execution, is that in equity trading that unbundling already happened a long time ago, and for purely economic reasons. In the olden days, stock trading commissions were really high and fixed, and bid/ask spreads were wide, and stock trading was really profitable and not price-competitive, and so banks competed by giving customers free research to attract their lucrative trading business. And then trading was electronified and became essentially free, and bid/ask spreads tightened as electronic market-makers took over the market, and now if you want to trade stocks you don't really have to pay much of anything for the execution services. You still can overpay a big bank for execution, if you want the research, and in fact investment funds still usually do pay banks for research as part of an execution bundle, because they can pass that execution-bundle cost on to their investors. (This is what Mifid II is supposed to change.) But if you just want to trade stocks without getting any research, there are plenty of brokers who will execute your trades cheaply. The bundle is now a way to pass on costs to end-user investors, not a structural feature of the market.

Meanwhile in fixed-income trading, that mostly hasn't happened: For all the talk about declining dealer balance sheets and all-to-all electronic trading, most corporate bonds still trade through relatively concentrated networks of big dealers who are compensated not with commissions but with bid/ask spreads on the bonds they buy and sell. The basic business of fixed-income dealing is still pretty lucrative, and it is not easy to compete by offering lower execution costs. 

This makes it tricky to figure out how to unbundle fixed-income research from fixed-income execution: Everyone kind of already knows the price of equities execution without research, but bare-bones fixed-income execution isn't really a product that exists yet. And so if you're going to continue to pay a lot for fixed-income execution, shouldn't the research still be free?

Several banks, including BBVA, NatWest, Credit Suisse, ING and Daiwa, are preparing to provide some or all of their fixed income research for free in preparation for new EU rules, under “Mifid II”, requiring fund managers to pay directly for analyst research, instead of the current practice that includes it with other costs such as trading commission.

But another camp, led by the biggest US banks, says that making research available for free could be risky and does not make commercial sense. They also say they will not defy the “spirit” of the rules, which they believe is that research should be paid for.

It is a puzzle: If you charge for research, and don't lower the price of execution, then you are not really "unbundling" so much as you are "increasing your prices." On the other hand, if you don't charge for research, and continue to subsidize it out of the costs of execution, that really does seem to defy the spirit of the rules. I suppose the compromise is to charge, but not that much:

Earlier this year, banks were quoting Olivier de Larouzière, head of interest rates at Natixis Asset Management, an annual fee of as much as €300,000 for his firm to have unfettered access to fixed-income research and meetings with analysts. Since then, most banks’ prices have plummeted, he said, to around €70,000 on average, though some are still trying to charge about €150,000.

Juicero.

The basic business model of a tech startup in 2017 is to offer a product or service at negative gross margins, and then talk in messianic terms about how powerful entrenched interests are trying to sabotage your world-changing disruption. Here, for instance, is a postmortem on the demise of Juicero Inc., which made a $400 machine to squeeze juice out of bags and lost $4 million a month doing it until it shut down earlier this month. You might think, um, charge more for the juice bags, or produce the juicer more cheaply, or something, and to be fair Juicero did think that. ("Juicero began working on a cheaper press, called V2, that the company planned to release in 2018"; it also cut some of its 232 employees.) But this is Silicon Valley, where my negative gross margins are always proof of your moral failings, and "several investors also say they felt Juicero was a victim of an anti-elitist political and media climate." Meanwhile at least Juicero founder Doug Evans had a good time:

Some employees say Evans’s passion for wellness was overwhelming. The founder mostly ate raw and vegan foods, and would sometimes scold non-vegan employees who ate yogurt or drank milk at team meetings, according to three former employees. He occasionally referred to dairy products as “cow pus,” they say. For a time, he also refused to allow employees to expense work meals at non-vegan restaurants, the ex-employees say.

Blockchain blockchain blockchain.

China, having washed its hands of initial coin offerings last week, is getting rid of bitcoin exchanges this week:

China plans to ban trading of bitcoin and other virtual currencies on domestic exchanges, dealing another blow to the $150 billion cryptocurrency market after the country outlawed initial coin offerings last week.

The ban will only apply to trading of cryptocurrencies on exchanges, according to people familiar with the matter, who asked not to be named because the information is private. Authorities don’t have plans to stop over-the-counter transactions, the people said.

"Too much disorder was naturally a basic reason," said one person about the decision, and I continue to applaud China's efforts to stop everyone from talking about bitcoins and ICOs all the time. 

Elsewhere, here is David Adlerstein on "The ICO Governance Deficit":

The ICO space is already learning that securities laws exist for reasons that should have been evident since 1929.

Unfortunately, many less-discerning ICO investors will learn the hard way that long-established corporate governance norms exist for a reason as well.

Maybe! But that is the cryptocurrency-is-about-re-learning-basic-financial-lessons hypothesis; on my more controversial cryptocurrency-is-about-un-learning-those-lessons hypothesis, initial coin offering investors won't learn that governance norms matter, ICO governance will keep getting worse, and eventually ICOs will be run by hereditary dynasties of absolutist monarchs who derive their power directly from God.

People are worried about unicorns.

Eh no everything is fine in initial public offering markets; the exits from the Enchanted Forest are functioning nicely:

US listings were up from 2016, which marked the one of the weakest periods in years. According to Dealogic, 112 IPOs have priced year to date, versus just 63 at this time last year. Issuance volume has more than doubled to $31.6bn.

Two-thirds of this year’s deals are trading above their issue price. On average, 2017’s class of US IPOs have risen in value by about double the S&P 500, at 20 per cent, according to Renaissance Capital, which runs IPO-focused exchange traded funds.

Meanwhile in the dark side of the Enchanted Forest, "VC fund investors struggle to react to Valley’s gender issues." And: "Employees of Fintech Firm SoFi Allege Women Are Treated Improperly."

Things happen.

Private Equity Prowls for Young Bankers Early in Frenetic Ritual. China Is Striving to Contain Its Once-Diving, Now-Thriving Yuan. Wall Street Is Turning on China’s ‘Perfect Buyers.’ Short Sellers Take Fight Against Chinese Companies to the Big Screen. Do Sanctions Prevent Venezuela From Restructuring CAC Bonds? Pimco’s Ivascyn Conquers Europe Too as Global Fund Attracts Cash. Klarman's Baupost Plans to Return Some Investor Money. Goldman Sachs to take on UK retail banks. European Banks Top the World in Dress Sense. Do negative interest rates make banks less safe? "In fact, however, one share-one vote is not the historical norm. To the contrary, limitations on shareholder voting rights in fact are as old as the corporate form itself." Methods for pricing options in the 19th century. "What the Bank of England?"

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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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.

To contact the author of this story: Matt Levine at mlevine51@bloomberg.net.

To contact the editor responsible for this story: Brooke Sample at bsample1@bloomberg.net.

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