Whistle-Blowers and Good Activists

(Bloomberg View) -- Come on Wells Fargo.

The infamous number is that 5,300 Wells Fargo employees were fired for setting up fake customer accounts to meet sales quotas, but it is important -- and difficult -- to try to put that number in context. For instance: How many employees were fired for not meeting sales quotas because they didn't set up fake accounts? I don't know, and Wells Fargo couldn't tell me when I asked, but the number matters. If 5,300 people were fired for setting up fake accounts, and 20,000 were fired for not setting up fake accounts, then that tells you something about the overall incentive structures for Wells Fargo employees.

Maybe the worst thing I've seen yet about the Wells Fargo scandal is that at least four people were allegedly fired for telling Wells Fargo about all the fakeaccounts:

"They ruined my life," Bill Bado, a former Wells Fargo banker in Pennsylvania, told CNNMoney.

Bado not only refused orders to open phony bank and credit accounts. The New Jersey man called an ethics hotline and sent an email to human resources in September 2013, flagging unethical sales activities he was being instructed to do.

Eight days after that email, a copy of which CNNMoney obtained, Bado was terminated. The stated reason? Tardiness.

"CNNMoney spoke to a total of four ex-Wells Fargo workers" who think they were fired for whistle-blowing, and "another six former Wells Fargo employees told CNNMoney they witnessed similar behavior." That is presumably a sample rather than an exhaustive list, and you can begin to construct a hypothetical list of the incentives facing Wells Fargo consumer bankers:

  1. Open fake accounts to meet sales goals: Maybe get fired.
  2. Don't open fake accounts, miss sales goals: Probably get fired.
  3. Tell executives about all the fake accounts: Definitely get fired really fast.

Look, setting up 2 million fake accounts for customers is bad, sure, but setting up a fake whistle-blowing line -- telling employees they could safely report misbehavior internally, and then firing them for doing it -- is astonishingly, cynically, horribly worse. "It is clearly against the law for any company (or executives of such companies) to try to suppress whistleblowing," says former Securities and Exchange Commission Chairman Harvey Pitt, but that doesn't begin to capture the problem. The problem is that you have to try to get it right. You have to want to follow the law and do the right thing, and if your employees tell you that you're not doing that, you have to try to fix that. You want a culture that responds to problems by fixing them. You don't want a culture that responds to problems by firing the people who noticed them. That sort of culture is how you end up with, you know, 2 million fake accounts and 5,300 people fired for creating them.

Meanwhile, here is Adam Levitin comparing this Wells Fargo scandal to its 2011 fine for "falsifying borrower income and employment information in order to sell debt consolidation, cash-out refinance mortgage loans at sub-prime rates," in that both seem to have been driven by an overly aggressive sales culture. Here is Gretchen Morgenson comparing this scandal to Wells Fargo's mortgage-foreclosure troubles. And here is James Kwak on Wells Fargo's culture of customer focus:

For Wells Fargo, as for any megabank, “the customer” is not a person—it’s a dataset, with means, medians, correlations, and metrics, like “cost of acquisition” and “churn rate” and “marginal profitability of product X.” Yes, customers matter, but in the generic sense that applies to all businesses: customers are where the money comes from.


Banks like to talk about the advantages of “one-stop shopping,” but in the age of technology there really aren’t any. You can set up automatic payments from one institution to another, and that’s that. Cross-selling is one of those strategies that generates profits not by providing better tacos to taco lovers, but by taking advantage of existing customers’ limited attention to sell them mediocre products that they wouldn’t have chosen otherwise.

And here is John Gapper:

Wells Fargo stood for cross-selling and, if it stops selling, it is left with a strategic hole. That is not only a problem for his bank, but for all those that tried to do the same. The model for making banking like retailing has run aground on the reputational hazard its sales culture created.

Is activism good?

One fun thing in writing about finance is that there are heated and decades-long academic disputes over whether some basic types of financial events are Good or Bad. Like, mergers: Are mergers good or bad? People keep writing papers about it -- here's a recent Gretchen Morgenson column about one -- and no one has reached a definitive answer. High-frequency trading. Hedge funds. In some sense it's weird that there are no answers: Like, financial goodness and badness are expressed in objective numbers, prices and returns and so forth, so you'd think you could just measure goodness and badness definitively. But on the other hand, the measurement is never quite as objective as you'd want: Maybe mergers are good for acquirer returns over one year, but bad over three, or whatever -- which do you pick?

Also, more importantly, these are weird topics to treat as aggregates. Mergers may on average be good, or they may on average be bad, but either way that tells you only a very little bit about whether any particular merger is good or bad. Academic studies can tell you the average outcome, and they can even give you tips about what characteristics make a merger more likely to be good or bad, but they're unlikely to give you a definitive answer for the next deal. And so no chief executive officer persuades shareholders to vote for a deal by saying "mergers are Good, haven't you heard," and no disgruntled shareholder argues against the deal by saying "no, actually, they are Bad."

Anyway, people have been debating Is Activism Good or Bad forever, and here are a fun paper and related blog post from Edward Swanson and Glen Young finding that in fact Activism Is Good:

We find that short-window returns around the public announcement are significantly positive and do not reverse in the post-intervention period; analyst recommendations decline prior to the intervention but increase significantly afterward; and short interest declines significantly in the post-intervention period. These favorable reactions are supported by significant improvements in target firms’ accounting fundamentals. 

The most fun point may be this:

Activists’ critics allege that shareholder activism causes managers to be myopic, to adopt policies that favor short-term performance at the expense of long-term value creation. If true, one would expect institutional investors with a long-term investment horizon to decrease their ownership and those with a short-term horizon to increase their position. The study finds the opposite, however. Ownership by long-term or “dedicated” investors increases following an activist intervention, and ownership by short-term or “transient” institutional investors declines. These ownership changes are inconsistent with activism encouraging managerial short-termism.

I keep thinking about Richard Thakor's "Theory of Efficient Short-Termism," in which shareholders prefer short-term projects because they give the shareholders more opportunity to monitor managers. That notion of "short-termism" has nothing to do with shareholders' holding periods: You can own a stock forever, and still not trust the company's managers to go off and do 20-year projects with no supervision. You could read Swanson and Young's results to mean: Long-term investors like companies where someone is keeping an eye on management, and activists are good at playing that role. Sometimes they play it by demanding stock buybacks, sure, but you have to look at the bigger picture.

Elsewhere, "Activist Investors Double Chance of CEO Exits, Study Shows." And here are some reflections by a finance professor who submits shareholder proposals to companies.

Equity capital markets is bad.

So far this year, banks have taken in just $3.7 billion in fees from U.S.-listed equity deals, which besides initial public offerings include share sales for companies that are already public and convertible-debt issues, according to Dealogic data this week.

That’s the lowest since 1995, when the business generated $2.6 billion up to this point in the year, or $4.1 billion after adjusting for inflation. At the height in 2000, it was a $9.1 billion business year to date, or $12.7 billion adjusted for inflation.

There are all sorts of reasons. With debt financing more or less free, fewer companies are all that jazzed to issue more expensive equity. With "being a unicorn" replacing "having a hot IPO" as the goal of tech entrepreneurs -- and with startups like Uber able to raise unlimited cash in the private markets -- IPOs are way down from last year, which in turn was way down from 2014. And block trades -- in which banks bid to buy shares for their own risk, and generally make a pretty thin spread on reselling them, instead of taking no risk and being paid a fat fee -- have become more popular, making up 44 percent of follow-on equity offerings. 

It is all pretty gloomy. There's that recent Natasha Sarin and Larry Summers paper about how banks have actually gotten riskier since the financial crisis, because of "declining franchise value" in their businesses. You can see a bit of that here. The equity capital markets business is, let's face it, a great business. Fees are high and not especially competitive, and, traditionally, the bank doesn't put much of its own capital at risk. The banks use the value of the franchises that they've built up -- the sales networks that allow a few banks to dominate the equity offerings business -- to extract profits. And now that's declining: There's less value to extract, and what there is now requires banks to take risks with their own balance sheets. 

Vegan mayo market structure.

The story of Hampton Creek, the vegan mayonnaise almost-unicorn, is perhaps best read as a story of market structure. We've talked before about allegations of mayo spoofing, in which Hampton Creek allegedly sent employees to buy up a lot of its Just Mayo product to make retailers and investors think there was a lot of demand. But here is a new, fascinating article about Hampton Creek's struggles that features the story of Ali Partovi, an angel investor who invested in Hampton Creek and then went to work there as an executive. "He lasted nine days before objecting to Tetrick’s sales projections and telling the board the CEO was deceiving investors." He quit, and the board looked into it and "concluded that 'no further action was warranted.'"

But Partovi still owned shares. And he eventually sold them. As a former executive who resigned because he thought that the company was deceiving investors, that put him in an odd spot, no? Hampton Creek is a private company, but that is the sort of inside information that you'd be uncomfortable not disclosing. So he did. Maybe.

Eight months later, Partovi sold his shares to Benioff at a profit. Two people familiar with the transaction say Partovi told Benioff he believed Tetrick had been dishonest with investors. Hampton Creek says Partovi “made no allegations of fraud” when he sold.

The private startup market is just weirder and more fun than the public market. You don't just go to the exchange and anonymously dump your shares; you're more likely to have to actually look the buyer in the eye. And if you think you know something bad about the company, you might even feel obligated to tell him.

Bro's club.

Megan Messina, the former Bank of America managing director who sued the bank for gender discrimination because her boss ran a "subordinate 'bro's club' of all-male sycophants," has settled with the bank and withdrawn her lawsuit. Messina's allegations were wide-ranging and scandalous, and not only about gender discrimination. Messina accused Bank of America of front-running clients, overcharging them, violating the Volcker Rule, mis-marking bond positions, and generally following all the stereotypes of misbehaving bond traders. Now that she's dropped her lawsuit, I wonder if anything will come of those accusations. Presumably the customers who were allegedly harmed won't be bringing their own lawsuits, though I hope some of them have at least sent nasty e-mails to their Bank of America contacts. 

Influential finance people.

Here's Bloomberg's list of the 50 people with "the most power in financial markets." Number 50 is John Oliver. The top 4 are political leaders -- Theresa May, Donald Trump, Hillary Clinton and Xi Jinping. The top-ranked person employed more or less in the financial industry is Warren Buffett at 8; the top asset manager is Bill McNabb of Vanguard Group at 12; the top banker is Jamie Dimon at 13; the top hedge fund manager is Paul Singer at 32. (Carl Icahn, sort of a hedge-fund-manager emeritus, is number 20.) It is not, all in all, a list that is heavy on people who are actually "in finance." That seems about right. Between regulations making the financial industry less fun, scandals making it less respectable, poor performance tarnishing the big-name investors, and markets being increasingly dependent on political conditions and central-bank decisions, why would you expect anyone working in finance to have much influence in finance? There was a time when finance controlled the rest of the world, but in 2016 it is the opposite.

Elsewhere in influential finance people, here's an article about Burton Malkiel.

Volkswagen shareholder lawsuits.

If a public company does a bad thing, and everyone finds out about it, that will cost the company money. Maybe it will lose customers, or have to spend a lot of money fixing the problem, or have to pay a fine, or, as in the case of Volkswagen's emissions scandal, all of those things. But the company's money ultimately belongs to the shareholders, so when it pays those fines or whatever, the shareholders are harmed. How can they be compensated for their damages? Well, obviously, they will sue. Whom will they sue? Well, obviously, the company. What will they sue for? Well, obviously, money. Where will the money come from? Well, obviously, the shareholders.

I mean, some of it might sometimes come from insurance, and a lot of it will go to the shareholders' lawyers, but it is a constantly puzzling circularity. Part of the reasoning behind fining a big company a lot of money for doing bad stuff is that the fines will incentivize shareholders to do a better job of monitoring their managers and preventing bad stuff from happening. (Another part of the reasoning is, sometimes, that the bad stuff unjustly inflated profits, and that the shareholders never really deserved to have the money in the first place.) But the reasoning behind the shareholder lawsuits is that the managers kept the bad stuff so secret that the shareholders could never have known about it, and that they should be compensated for their losses by taking money from the current shareholders. Who, I guess, should have done a better job of monitoring the managers.

Anyway, "Volkswagen Shareholders Seek $9.2 Billion Over Diesel Scandal."

People are worried about unicorns.

Hey they've found the way out of the Enchanted Forest:

For the first time in six quarters, the number of venture-backed companies that went public or were acquired for at least $1 billion exceeded the number of start-ups that joined the billion-dollar club in the private market, according to CB Insights.

Er, sort of. There were five billion-dollar exits, and only four new unicorns. This is not just about a rise in exits but also about a decline in ... yes, I suppose the term is "unicorn births": "Unicorn births have been on a downward trend since Q4'15, and reached a 6-quarter low in Q2'16." 

People are worried about bond market liquidity.

The center of bond market liquidity worrying these days is the market for Japanese government bonds, given the Bank of Japan's focus on longer-term rates. People are worried:

The Bank of Japan has been forced to shift its monetary focus from quantity to interest rates in the face of persistent deflationary pressures. But a looming liquidity crunch in the Japanese bond market is making the status quo less tenable by the day, meaning that structural economic reforms from the government will need to complement the easy-money policy.

Me yesterday.

I wrote about the Leon Cooperman insider trading case. What I didn't realize yesterday is that Ed Cohen, who controlled Atlas Pipeline, the company that Cooperman is accused of insider trading, is also "an adjunct professor of classical studies at the University of Pennsylvania," has a book out with Oxford University Press about Athenian prostitution, and "has a penchant for speaking in Latin on earnings calls." As a classics-major-turned-finance-guy myself, I of course endorse this approach.

Things happen.

Fed Stands Pat, but Says Case for Rate Increase Has Strengthened. Bill Gross: I'm hardly able to speak after Fed decision. Central Bank Tools Are Losing Their Edge. Anthem and Cigna Accuse Each Other of Breaching Merger Deal. Trading Halts Could Last Longer in Extreme-Volatility Events. Mylan’s Chief Is Chastised by Lawmakers Questioning EpiPen Pricing. Mark Zuckerberg pledges $3bn ‘to end all illness.’ A New Active ETF Puts the Manager’s Money Where His Mouth Is. Another Breakfast RuinedOxford Tops List of World’s Best Universities. Apple in talks on McLaren supercars takeover. Three Brothers Seek to Overtake Tesla With Souped-Up Plug-In Cars. Get Ready for Freeways That Ban Human Drivers. What makes Google's digital assistant nostalgic? If You Want to Be a Slob, Be a Slob. Robot lawyers. Magnises still exists. Dalmatian puppy plays to stereotype. Man punches beaver.

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

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