Disclosure, Transparency and Criticism
(Bloomberg View) -- Private companies are the new public companies.
A well-known fact is that there are fewer public companies than there used to be, and companies prefer to remain private for longer. One standard story is that public markets have become less attractive, what with increased disclosure requirements and evil short-termist high-frequency traders, but that story does not entirely fit the facts. Last month I argued that "a more interesting answer is that public markets haven't really gotten worse; instead, private markets have gotten better." The disclosure and nuisance of being public was always burdensome, but public markets used to be where the money was. Now that you can raise a lot of money in private markets, why bother going public?
From their inception, the federal securities laws proposed a simple bargain to U.S. companies: disclosure in exchange for investors. Companies that went public took on substantial disclosure obligations and, in return, were permitted to solicit the largest (and therefore cheapest) source of capital: the general public. Conversely, private companies were restricted to raising capital primarily from insiders and financial institutions, without publicity and subject to severe restrictions on subsequent transfers of their securities—effectively precluding any sort of market for private company equity. Over the last three decades, however, the disclosure bargain has largely been revoked. While maintaining (or increasing) substantial disclosure burdens on public companies, regulators have repeatedly and dramatically loosened the restrictions on private capital-raising. Today, private companies can raise ample, cheap capital with relative ease. Thus, public companies benefit significantly less from their disclosure obligations under the new regime and can justifiably complain of a regulatory bait-and-switch.
One mystery is: If disclosure is good, why don't private investors demand it too? Regulators don't require Uber to disclose audited financials to raise billions of dollars, but why don't Uber's investors require it? De Fontenay's answer "is that disclosure has material third-party effects or externalities," helping not just the particular company's shareholders but the market and society more broadly. Uber's investors get the optimal amount of information (not much!) for them, while, say, Apple's investors get the optimal amount of information for society. But it is an unstable equilibrium for Uber:
Private companies today can raise large amounts of capital while disclosing less than their public company counterparts in part by freeriding on the enormous volume of public side information, which makes private company valuation vastly easier and more accurate.
But if that's the case, then more companies should stay private, which will reduce the volume of public information, which will make fund-raising for private companies increasingly difficult. "Public companies have little reason to continue to provide this subsidy."
Here is a story -- on LinkedIn, of course -- about the time that a Bridgewater Associates employee named Jim Haskel sent an email to founder Ray Dalio saying "you deserve a 'D-' for your performance today in the meeting ... you did not prepare at all because there is no way you could have and been that disorganized." Of course Dalio loved it:
Dalio not only embraced this email, but shared it internally within the company and went on to show it to the more than 1,800 attendees of TED.
"Isn't that great?" Dalio said of the email, to laughs in the crowd. "That's great. It's great because I need feedback like that. And it's great because if I don't let Jim and people like Jim express their points of view, our relationship wouldn't be the same."
From the outside, it always seems to me like Bridgewater's radical transparency exists, as it were, in quotation marks. There is a lot of strenuous performance of openness and egalitarianism. The idea of this story is that Dalio has such natural, unpretentious, tell-me-anything interactions with his employees that they feel comfortable sending him harsh honest emails like this. Which is true. But also, when they send him those emails, he turns them into a TED talk. I never do that when my friends send me blunt emails. (Should I?) If you send your boss an email criticizing his performance, and he says "you're fired," that is one kind of power move. But if he says "ho ho ho, you old rascal, well done," and then tells a room full of chuckling TED listeners about his benign tolerance, that is a different kind of power move. I think I find it more intimidating? But I don't work at Bridgewater.
There is a well-known asymmetry in financial markets, which is that if you are short a company and say mean things about it, you might get sued or investigated or otherwise accused of manipulation and fraud, while if you are long a company and say nice things about it, no one will ever complain. Of course this is an asymmetry in life, too: If you say mean things about a person, he might sue you for slander, but if you say nice things about him, no one else is likely to sue you for inaccurate praise. That's not even a thing. Of course if you say nice things about a person, and someone dates or hires him on your recommendation, and he is terrible, then you have caused harm. But it is not the kind of harm that the law concerns itself with. Similarly, if you buy a stock and publicly announce "this is a great stock," and then it goes to zero, people will think you were dumb or unlucky. If you short a stock and publicly announce "this is a terrible stock," and it doubles -- or goes to zero! -- people will think that you were dishonestly trying to manipulate the stock for your own benefit.
Anyway shortly after the formation of the universe in the Big Bang, some hedge funds including SAC Capital Advisors LP shorted the stock of Fairfax Financial Holdings Ltd., and they said mean things about it, and Fairfax sued, and time passed, and generations of people were born and died, and empires rose and fell, and still that case is somehow going on. And yesterday a New Jersey appeals court said it could continue:
In a 156-page decision likening the 11-year-old case and its millions of pages of documents to a "fearsome" lion, Judge Clarkson Fisher said the trial judge was too quick to find no evidence of wrongful intent by SAC, whose trading "gave it financial goals aligned with the alleged conspiracy."
Yes, short selling will do that. Meanwhile, "a New York State Supreme Court judge dismissed a lawsuit by Highland Capital Management accusing one of the asset-management firm’s investors of libel."
If you have a world in which every big developed economy is run by globalist technocrats, they are going to agree on a lot. Bank regulations, for instance, will be harmonized, so that each country's banks can operate safely and efficiently in every other country. If, on the other hand, you have a world in which a lot of the biggest developed economies are run by nationalists who want to back away from international commitments and focus on their countries' interests above all else, then bank regulation could get weird:
This is how a race to the bottom can start. In Washington, President Donald Trump has vowed to roll back the financial regulations passed after the 2008 crisis. In London, Prime Minister Theresa May, facing a possible exodus of bankers as Britain quits the European Union, has said she might fight any “punitive” trade measures from the EU with tax cuts or policy changes to attract investors and companies. At the same time, some EU member states could consider relaxed rules to entice London-based firms.
Of course it doesn't have to go that way. You could imagine an anti-globalist government tightening bank regulation, rejecting international technocratic norms to be less generous to banks, rather than more. Having more banks might be good for a country, but having more bank failures is bad, and nationalists could, in the abstract, want to reduce the influence and danger of international banks in their countries. Contemporary nationalist populism is often described -- including by those nationalists! -- as a delayed reaction to the global financial crisis of 2008, and to the excessive power of global banks. And yet in practice the nationalists all seem to want more banks, and to reduce regulation to attract them.
I try not to write about, or link to, Donald Trump psychologizing or Kremlinology much around here, because that is what, you know, the entire rest of the internet is for. But I am going to make an exception for this excellent Gillian Tett column, because it has a financial angle. She points out that Trump's advisers (other than Rex Tillerson) "do not have the usual instincts of seasoned S&P 500 chief executives," but instead "have been shaped by the world of dealmaking and arbitrage":
This distinction matters. Financiers who build their careers by handling distressed assets are trained to make high-risk, high-reward trades, particularly if they can control downside risk. They scorn bureaucratic process and focus on results. They will pivot and cut their losses if a deal goes sour. They embrace brinkmanship and will often be ultra-aggressive at the start of a bid, but later retreat to cut a deal. Above all, distressed-debt players are opportunistic, not ideological: they are constantly hunting for value in assets and trades that are mispriced or widely scorned.
There is also an obvious zero-sum element to a lot of distressed dealmaking. The basic job of a corporate executive is to grow the pie, to find new markets and products and ideas to make people, and the company, better off. The job of a distressed dealmaker is, sometimes, to save the pie -- to find a way to keep a troubled business going -- but also often just to divide the pie, to identify the security or process or argument or trick that will give him the most leverage and the biggest chunk of a limited recovery.
Elsewhere in Trump psychologizing: "Trump says he thought being president would be easier than his old life." And here is Larry Summers on Trump's pretend tax plan: "I can only imagine how demoralized the Treasury tax staff — a group that rightly prides itself on its professionalism and analytic seriousness — must be." And elsewhere in distressed debt, here is a profile of Adam Savarese, the Goldman Sachs Group Inc. distressed trader who outperformed last year and underperformed this year.
Blockchain blockchain blockchain.
There are roughly three ways to think about blockchains in banking:
- The blockchain will be an open, trustless, permissionless system for facilitating financial transactions, which will allow new competitors to start new businesses and take on entrenched incumbents.
- The blockchain will be a universal architecture for financial transactions; everyone's data will live in one shared secured place, and financial decisions and transactions will be instantaneous and frictionless.
- The blockchain will be a way for big banks to update their databases and maybe share them with each other, making settlement of trades a bit faster.
Number 1 is the sort of bitcoin-utopian dream. Maybe it will come true! But not if the banks have anything to say about it. Most of the action in financial-industry blockchain initiatives is being led by groups of banks, and by traditional middlemen like stock exchanges and clearinghouses. Their dream is of a centralized, trusted, permissioned system that happens to use some of the technology of the blockchain.
Number 2 is the sort of Davos-y dream, in which "rather than to stay at the margins of the finance industry blockchain will become the beating heart of it." Maybe it will come true! But if it does, it will require an extraordinary level of cooperation. Banks, governments, corporations, individuals, whatever will all have to get on a single blockchain, or a system of blockchains that talk to each other seamlessly, in order to realize the benefits of a global architecture.
Number 3 is, like, some bank database programs are old, and need an upgrade. It's no one's dream. No one dreams about upgrading databases. But they actually do it, which is something.
Anyway here's a story about how JPMorgan Chase & Co. is quitting "the mammoth bank blockchain consortium led by New York-based startup R3 CEV"; other banks including Goldman Sachs Group Inc. and Morgan Stanley had previously quit, but a bunch of other banks remain. Also JPMorgan remains in a bunch of other blockchain groups:
The bank is a member of the newly formed blockchain consortium Enterprise Ethereum Alliance, and is an investor in blockchain startups Axoni and Digital Asset Holdings. It also participates in the Hyperledger Project, a cross-industry group led by the Linux Foundation.
I suppose all this fragmentation of blockchain initiatives could be just a hedging of bets, and one day one of them really will be the architecture of the entire financial system. Or more likely one consortium will build a settlement system for syndicated loans, and another will build the clearinghouse for one emerging-market stock exchange, and a third will build a blockchain for shipping companies clearing customs, and the world will continue much as it is, a bunch of different transaction types with a bunch of different processes, none of them particularly talking to each other.
We talked the other day about Wells Fargo & Co.'s shareholder meeting, in which an old-timey activist shouted an approximate movie quote while being removed from the hotel ballroom for violating Robert's Rules of Order. That is pretty classically how U.S. bank shareholder meetings go. Meanwhile in Switzerland:
Activists for environmental organization Greenpeace crashed Credit Suisse's shareholder meeting on Friday.
Two people rappelled from a catwalk above the stage, unfurling a banner with the slogan "Stop Dirty Pipeline Deals" as Chief Executive Tidjane Thiam delivered prepared remarks.
Yeah you don't see a lot of rappelling at U.S. shareholder meetings. Our meetings tend to be contentious, yes, but not particularly athletic. "When I moved here, I was told this is a quiet, mountainous country," said Thiam. "This is more excitement than I expected."
People are worried about unicorns.
Uber Technologies Inc. is interviewing candidates for the job of chief operating officer, whose responsibilities would include helping Chief Executive Officer Travis Kalanick to grow up. It seems challenging:
A Kalanick hallmark has been night jam sessions—“seshes,” in Uber parlance—that could last until 2 a.m. The CEO sometimes summoned employees with little warning, causing them to delay other projects and scramble to prepare for session topics such as how to capitalize on Uber’s size. A topic might be debated each night for a week.
Presumably the COO's responsibility would be to move the seshes to 9 a.m., and to draw up agendas in advance. I hope that Uber goes public soon, because I really want to read about this in its prospectus. "We make many of our decisions in late-night sessions, which we refer to as 'seshes,'" some junior lawyer will have to write. Meanwhile, here is a deep-dive investigation into claims that Kalanick "once held the world's second-highest score for the Nintendo Wii Tennis video game."
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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.
To contact the author of this story: Matt Levine at email@example.com.
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