(Bloomberg Opinion) -- CS FCPA.
Imagine you are a 22-year-old hired at a big investment bank as a first-year analyst, straight out of college. You show up at the introductory training class, where the bank teaches new analysts how to do discounted cash flow analyses and format working-group lists. But you don’t come alone. For some reason Warren Buffett is with you. Just hanging out, going to your training classes. You are inseparable for the whole program. “Oh yeah, that’s my buddy Warren,” you tell your fellow analysts. “I just like talking about deals with my young friend,” he explains.
At the end of the program, there is a multiple-choice exam testing your knowledge of financial concepts. You do very poorly on the exam. Here is my question: Does the bank care? Are your bosses like “I am sorry but this person does not know much about finance or WGL formatting, which are the essential skills for any first-year analyst”? Or do they throw your exam in the garbage, invite you out to dinner, and suggest that you bring your friend Warren along to talk about a few deal ideas they have?
Decades of investment banks hiring top students from top universities, training them in financial modeling and working them all the time has created the misleading impression that the essential job of an investment banker is to be smart or hard-working or an expert in financial modeling. But the essential job of an investment banker—the thing she gets paid for—is to convince corporate executives to hire her investment bank to do deals. It is a sales job, a relationship job, a people job. Being smart and hard-working and an expert in financial modeling are tools that are often useful in achieving the main goal, and that are probably essential in sustaining the business in the long term. But if you can do the main thing, then you can skip a lot of the instrumental stuff.
Yesterday the Securities and Exchange Commission and federal prosecutors fined Credit Suisse Group AG and its Hong Kong subsidiary $77 million for violating the U.S. Foreign Corrupt Practices Act by hiring the relatives of government officials and executives at state-owned enterprises in Asia. The SEC’s and prosecutors’ theory in these relative-hiring cases—we have talked about others before—is that these job offers were a form of bribery that the bank gave to the officials and executives in order to win business. They definitely were! From the SEC order:
Credit Suisse maintained spreadsheets that listed “referral hires” or “relationship hires.” These spreadsheets included information identifying the referring client or relationship when the relationship was with a government regulator. Some of these spreadsheets identified the “[c]ontribution” of the referral hire, including in at least three instances, deals specifically attributable to the relevant relationship. In an email to colleagues, a Credit Suisse employee explained: “Relationship hires have to translate to $” or “the relationship is worthless to our organization.”
But another part of the regulators’ case is that the kids who were hired to please their powerful relatives were not qualified to be hired. I assume that the vague but unstated premise here is that if they were qualified—if they were geniuses of financial modeling and pitchbook formatting who would be assets to the bank no matter who their parents were—then regulators wouldn’t be able to prove that they were hired as bribes. (Even with the spreadsheets?)
And so the SEC order and Justice Department statement of facts describe in loving and hilarious detail the career paths of some of those relatives, of whom the best may be “Referral Hire A,” the daughter of an important official (“Foreign Official A”) at a Chinese state-owned enterprise (“SOE A”). Her hiring was unorthodox:
After stating “not too many interviews,” and explaining that Referral Hire A was “a princess [who was] not used to too many rounds of interview,” Employee A proposed “giv[ing] her the offer letter asap,” at which point Employee A would “push her mum [Official A].” In order to make Referral Hire A’s application appear more presentable, Credit Suisse HK bankers drafted a resume for her requiring them to be a bit “creative” in filling in the details.
Her performance in training was unorthodox: “Credit Suisse employees complained that she failed to attend a mandatory boot camp, brought her mother to training events, and left early.” Her multiple-choice quizzes were abysmal: “She filled in a pattern of 5As in a row, 5 Bs in a row, etc. on the answer key.” She was “the most famous intern ever.” She was given a full-time job offer anyway.
Her performance in that job was unorthodox:
During Referral Hire A’s employment with Credit Suisse, Referral Hire A’s mother accompanied her to Credit Suisse trainings in New York, traveled with her on Credit Suisse business trips, approved a list of client deals for her to work on, and requested that she be promoted by Credit Suisse.
And her employee reviews were unorthodox. “I’m wondering if we can explain that she’s a special situation and there’s no need to give feedback,” one Credit Suisse employee wrote to another. Another emailed to say that he was “at a complete loss as to what to write for” her review, and suggested ideas like “Pls come to the office more often — we would like to see more of your smiling face” and “Come to the office, answer your phone, don’t be rude.” She was promoted to associate after two years.
It is all unorthodox, yes, but it is slowly becoming less unorthodox. She is sort of aging into appropriateness. Hanging out with a major client (her mother, fine) and never showing up at the office is weird in a trainee analyst. Doing it as an associate is still unusual. But by the time you’re a managing director, if you show up at the office every day you are doing something very wrong. You can’t do your job from your office! Your job is to get out in front of clients, understand their needs, build relationships with them, pitch deals to them. The closer your relationships are with the bank’s biggest clients, the better you are at your job. It is generally difficult to make those clients your mother, but if they are already your mother then that’s a pretty strong relationship.
And then there is this:
Credit Suisse employees took steps to attribute credit for certain deals to Referral Hire A, even where she did not contribute any work to those projects. … Employee A emailed other Credit Suisse employees to alert them to another email from Referral Hire A regarding an SOE A block trade. Employee A advised them to respond to Referral Hire A that, “[W]e know you made this deal possible for us.”
Well, but what is “work”? The whole point of the SEC’s case is that she did make the deal possible for Credit Suisse. Not by burning the midnight oil building spreadsheets and formatting pitchbooks, but … look, in my experience, it is somewhat unusual for the analysts and associates who do build the models and format the pitchbooks to get congratulatory emails saying “We know you made this deal possible for us.” (It does happen sometimes; some people are just polite.) Because everyone knows they didn’t. The pitchbook formatting isn’t what wins the deal. The relationship is what wins the deal. If Referral Hire A had formatted pitchbooks perfectly but had the wrong mother, her contributions to winning the deal would have been marginal. Instead she left the formatting to others and did the really valuable work of having been born to a powerful executive of a state-owned enterprise that needed a lot of investment banking work.
Look this is all stupid but it’s understandably stupid. When banks hire senior bankers from their competitors, they don’t quiz them on Excel shortcuts; they hire them for their Rolodexes, their books of business, their reputation and relationships with clients. When they hire junior bankers into analyst programs, they do care about the Excel stuff. Someone really does need to build the models and format the pitchbooks. But the hope is that some small minority of those analysts will develop into senior bankers, will be able to transition from building models to building books of business. If you find an analyst who is already connected with powerful clients—who brings the powerful clients to the office every day!—then she is in some raw but relevant sense a good analyst.
Oh and sure hiring her is absolutely an illegal bribe! (If the client is a government official; if she’s a private company executive things are murkier.) There is no doubt that the SEC and the Justice Department are right about that! But their argument that she is also a bad investment banker—that she is unqualified—seems to me to claim too much, to misunderstand what banking is, to assume that there is some objective measure of investment-banking qualification that is separate from the ability to win and execute deals. A good investment banker is one who helps her bank make money. And that’s what these referral hires did.
Preparations for the public listing of Saudi Arabia’s state oil company, a centerpiece of the government’s plan to open its economy, have stalled, leaving government officials and people close to the process doubting that it will go forward at all. ...
Saudi officials say they have been careful to avoid publicly acknowledging how badly the IPO process is going to avoid damaging relationships with banks and other advisers. … Bankers and other advisers have stationed dozens of employees inside Saudi Arabia to help the kingdom and Aramco prepare for more than two years, taking minimal fees in the hope of a huge payout when the IPO actually happens.
We talked yesterday about one explanation for the size of investment banking fees, which is that those fees are earned not only for the actual work on any particular deal but for all the uncompensated work that the banks did to win the deal, and make up for all the uncompensated work that the banks did to win other deals that never happened. Bank fees are always at risk and frequently vanish, and the banks need to make up for it by overcharging on the deals they actually complete. How much, at this point, would you want to charge for executing the Saudi Aramco initial public offering if it does eventually happen?
Icahn v. Dell.
When Michael Dell took his computer company Dell Inc. private in 2013, Carl Icahn fought quite hard to prevent the deal. He bought a billion dollars’ worth of Dell stock. He went on television to call the buyout “almost grand theft.” He raised billions of dollars of financing commitments, and then put in a strange offer to the board to do a leveraged recapitalization of the company instead of selling it to Michael Dell. And he tried to convince other Dell shareholders to vote down the deal, even after Michael Dell had raised his offer. It didn’t work, but it was a good effort, and Icahn did make a profit from it.
An important aspect of this fight was that Michael Dell, the founder and chief executive officer of Dell, owned a little less than 14 percent of its stock. Icahn owned about 4.6 percent, and Southeastern Asset Management, which joined his efforts to block the deal, owned 8.3 percent. So they were evenly matched, and the rest of the stock was owned by public shareholders who were, in theory, persuadable by the best arguments and the best price. Icahn lost, but he lost a fair fight. And Michael Dell did raise his bid. He had to convince, not only a special committee of Dell directors who were tasked with determining that the merger was fair to shareholders, but also the shareholders themselves, who could always refuse to vote for the deal. And even after the deal went through he had to convince the Delaware courts that the deal price was fair. (The Chancery Court said no, but eventually the Supreme Court said yes.)
On the other hand now that Dell is going a bit more public again through a swap of its regular stock for its VMWare Inc. tracking stock, Icahn still disapproves, but there’s not much he’s going to do about it:
Mr. Icahn thinks lobbying for a better deal could be an uphill battle and it could be a challenge to gather the necessary votes and commit to a drawn-out fight with Mr. Dell, who founded Dell and is its CEO, the people said. But he also thinks investors are being asked to exchange an interest in fast-growing VMware, which makes virtualization software, for a position in a company he believes has a less promising outlook, the people said. And he wonders whether investors in the tracking stock will want to hold Dell stock, they said.
It is worth noting here that if Icahn managed to win 100 percent of the tracking-stock shareholders to his position, he would end up with 4 percent of the total voting power of Dell’s stock. The tracking stock is a low-vote stock, and most of the voting power belongs to Michael Dell (45 percent) and his private equity backers at Silver Lake Partners. That will be true after the exchange, too, since the tracking stock will be exchanged for low-vote common stock, leaving Michael Dell in control.
Now this exaggerates Icahn’s powerlessness. Dell does need to be fair to the tracking-stock holders; a special committee of its board negotiated and approved the transaction terms on their behalf, and the deal is conditioned on a vote of the unaffiliated tracking-stock shareholders. But those protective formalities are not quite the same as actually having the majority of the company’s voting power up for grabs. Icahn could conceivably round up enough votes to block the deal, but he can’t round up enough votes to, say, install his own slate of directors, or force through an alternative deal.
Activism works best in regular public companies with regular voting rights. But those rights are rather passé these days, as founder-CEOs worry about the likes of Carl Icahn and try to structure their companies to render him powerless. Sometimes that works exactly as intended!
Elon Musk superhero stuff.
“Elon Musk Sends Team to Thailand to Help in Cave Rescue” is the headline here, but the team is not what I expected. I expected the team to be a Boring Co. intern with a big drill, who would just point it at the trapped Thai soccer team and dig them right out. Is that not the point of (1) having a big tunnel-drilling machine and (2) fancying yourself a comic-book superhero? But no:
Musk’s tunneling startup Boring Co. could potentially make available its massive drills or excavation expertise, but such an approach could be too dangerous for this mission.
What’s Fabrice Tourre up to?
“What if we created a ‘thing’, which had no purpose, which is absolutely conceptual and highly theoretical and nobody knows how to price,” Fabrice Tourre once asked a friend over email. Then you’d be a finance professor! Ha ha ha no seriously then you’d be a derivatives structurer at Goldman Sachs Group Inc., as Tourre was when he sent that email, and when he helped build the Abacus synthetic collateralized debt obligation that got Goldman fined $550 million and Tourre himself fined $825,000. Now he’s a post-doc in financial economics at Northwestern University.
I suppose that in any society you will have people who are drawn to the idea of creating highly theoretical financial structures out of pure aesthetic enjoyment. Of course I am one of them. Traditionally those people become derivatives structurers at Goldman Sachs, as Tourre did, and as I did. (Oh right, disclosure.) Perhaps the question for society is, do you want those people:
- Designing their conceptual “things” at Goldman Sachs, actually building them, and then selling them to clients with, perhaps, less refined aesthetic sensibilities; or
- Designing their conceptual “things” in the academy, writing papers about them, never actually building them—but instilling the ideas, and the aesthetic sensibility, into a new generation of finance students; or
- Rerouted elsewhere, to cancer research or manual farm labor or whatever?
I can see arguments for all three options. Also: Is writing a financial newsletter more like option 2 or option 3?
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