Trading Ahead of the News
(Bloomberg Opinion) -- Wilbur Ross!
Here’s an insider-trading hypothetical for you. Let’s say you are a prominent government official and a billionaire, and you own stock in a shady company. A reporter calls you up and says “hey I am working on a story about how you own stock in a shady company, care to comment?” You say “I’ll get right back to you,” hang up, dump your stock, and short the company. Eventually the reporter publishes the story, which details how shady the company is and implies that it is nefariously connected to prominent government officials. The stock drops. And you’re like “hahaha got you, actually I was short that company,” and you collect your profits.
Five days before reports surfaced last fall that Ross was connected to cronies of Vladimir Putin through a shipping firm called Navigator Holdings, the secretary of commerce, who likely knew about the reporting, shorted stock in the Kremlin-linked company, positioning himself to make money on the investment when share prices dropped. ...
A collection of international journalists were picking apart the Paradise Papers—a trove of documents showing relationships between some of the wealthiest people in the world and offshore entities they controlled. One of the most stunning findings of their investigation: The U.S. secretary of commerce still held a stake in a shipping firm named Navigator Holdings, which linked Ross to some of Vladimir Putin’s closest allies.
But according to Ross’ filings, he had already divested of funds that held Navigator stock a few days earlier, on October 25. Six days later, he opened a short position against the company. That meant that if shares of Navigator plummeted on the Paradise Papers news, Ross could presumably cash out with a gain. Navigator stock did not plummet immediately after the news hit, but it did trickle down 4% over the ensuing 11 days before Ross exited his short position, seemingly with a profit.
Is that … okay? I mean, leaving aside the rest of the story, about Ross's entanglements and his disclosure of them as he became commerce secretary. Just: If that reporter calls you up, can you go short that stock?
I think the answer is sure, why not. You have no inside information about the company, no nonpublic information at all other than the fact that a reporter is working on a story — and you have no duty to the reporter to keep that confidential. (If the reporter shorted the stock, he’d probably get in trouble, on the theory that he owed a duty to his paper not to misuse the information for profit.) I dunno, seems fine. (Not legal advice!) Better than fine, really. Impressive, in its way.
Are there applications of this? Let’s say you’re a prominent M&A banker or lawyer, and a reporter calls you up to ask “hey are you working on the XYZ/ABC deal?” If you are then of course you can't trade on it, but that was true even before he called you. But if you’re not — and you know that a reporter is about to put out a story saying that XYZ is buying ABC — can you buy ABC stock to profit from the story? It feels a little dicey — did you get that information in the course of your employment? does it belong to your bank? — but I am not sure what the right answer is. Or if you're a big shareholder of a company, and a reporter calls you up to ask if you want to comment on a report that your company is doing terrible things — can you dump the stock before the report comes out?
One reason that all of this is a bit unclear is that reporters and insider traders are to some extent in the same business. The basic job is you call up people at a company and try to find out stuff that the company doesn’t want to be public. If you are a reporter, you write it down and publish it; if you're an insider trader, you trade on it; but in either case the essential first step is to get someone at the company to tell you something that they're not supposed to tell you. Sometimes insider traders do this by handing the insiders sacks of cash, and sometimes reporters do it by appealing to the insiders’ consciences and desire to get the story out, but often the tools they use — flattery, friendliness, exchanges of information, social ties, buying drinks — overlap.
When a reporter gets that information, and then publishes it, it stops being “material non-public information,” so trading on scoops you read in the newspaper is fine. (What about trading on scoops you read in extremely expensive limited-circulation specialty investment publications?) But between the time the reporter gets the information and the time that he publishes it, it feels … insider-ish? If a reporter gets information from a corporate insider in breach of that insider’s duty of confidentiality to the company, and the reporter gives that information to you with some expectation of quid pro quo (e.g. that you’ll give him information), then there is something a bit unclean about trading on it.
Oh by the way Ross says it is a coincidence:
In a statement sent to the Financial Times, Mr Ross said the short position was unrelated to the article. Rather, it was part of the broader divestment of the Navigator stake he began after being appointed commerce secretary.
After beginning to sell Navigator shares in May last year, he discovered some he did not previously know he owned, which were in an account the company had opened for him “in electronic form”, he said. The short sale was the technical mechanism he used to sell out as soon as he realised he had them.
“I decided to continue selling those shares, but since I did not have physical possession of them in order to make delivery in the required time period, I technically sold them short and, when the shares were delivered by the agent on November 16, I delivered those shares to the broker to close out the transaction,” Mr Ross said.
I am not sure I fully grasp the mechanics there, but it has the ring of truth. Honestly shorting the stock because the reporter called him would be such a good move that, if he had done it, I’d expect him to gloat about it.
A disgruntled Tesla Inc. employee broke into the company’s manufacturing operating system and sent highly sensitive data to unknown third parties, according to an email Elon Musk sent to staff.
The worker, who had been denied a promotion, did “quite extensive and damaging sabotage” to Tesla’s operations, Musk wrote in the memo late Sunday.
Why did he do it? It seems to me that the parsimonious explanation would be that he was mad about the promotion, and that Tesla employs some number of people — possibly including its chief executive officer! — who love to take a grudge to extreme lengths. But there are other, darker possibilities. From Musk’s (truly spectacular) email to employees:
We need to figure out if he was acting alone or with others at Tesla and if he was working with any outside organizations.
As you know, there are a long list of organizations that want Tesla to die. These include Wall Street short-sellers, who have already lost billions of dollars and stand to lose a lot more. Then there are the oil & gas companies, the wealthiest industry in the world — they don't love the idea of Tesla advancing the progress of solar power & electric cars. Don't want to blow your mind, but rumor has it that those companies are sometimes not super nice. Then there are the multitude of big gas/diesel car company competitors. If they're willing to cheat so much about emissions, maybe they're willing to cheat in other ways?
Oh man, I want so badly for all of that to be true. I want the saboteur to have been getting paid off by Exxon, and Ford, and short sellers, and … the biased media that is always out to get Musk, and … Grimes’s ex-boyfriends … and … just ... I want like a “Murder on the Orient Express” situation. I want Ford’s saboteur to show up at the machine he wants to sabotage, and find a long line of other saboteurs patiently waiting their turns. I want Tesla’s workforce to be half die-hard Musk fanboys and half enemy spies.
“Please be extremely vigilant,” Musk told his employees; “this is when outside forces have the strongest motivation to stop us,” by sabotage, theft, leaks or just “dereliction of duty.” Dereliction of duty! If you take a bathroom break at Tesla, is it because you need to go, or because you are secretly in the employ of Big Oil and trying to slow down production? There is an email address for tips, but sadly no mention of hastily convened tribunals and summary executions for saboteurs. Musk has been tweeting trollishly about Marx, but I hope that is just a distraction, and that really he's been reading up on Lenin.
Human vs. machine.
Oaktree Capital Management's Howard Marks has a new client memo out titled “Investing Without People,” which is a pretty standard take on passive investing, quants, artificial intelligence, etc. It is a good introduction to the issues, if you have never given passive or quantitative investing much thought, but if you have then it is mostly stuff you have read many times before. Bond ETF liquidity illusions! (“I think one of these days, this investor may want to execute a trade that wouldn’t be doable in the ‘real’ high yield bond market, and he’ll find that it can’t be done via ETFs either.”) How much passive is too much! (“But where between 40% and 100% will prices begin to diverge enough from intrinsic values for active investing to be worthwhile? That's the question. I don’t know ….”) Et cetera. Here is a Wall Street Journal summary.
Here is the passage where I usually part ways with these arguments:
Most quantitative investing is a matter of taking advantage of standard patterns (the factors that have been correlated with outperformance) and normal relationships (like the usual ratio of one stock’s price to another’s or to the market).
Quants invest on the basis of historic data regarding these things. But what will happen if patterns and relationships are different in the future from those of the past?
I found it to be a life-changing, liberating epiphany to realize that all of that is true of human investors too. Humans do not have an enzyme that tells them which stocks will go up. They try to spot patterns, see which stocks have gone up in which circumstances in the past, and use those patterns to predict which stocks will go up in the future. When the patterns change, the people who invested based on the old patterns ... lose money! And then they — or different people — learn the new patterns and invest based on them. If your argument against quantitative investing is that it is based solely on historical patterns, well, so is all investing. I do not think it is implausible to object that quantitative investing is naively or blindly or over-simplistically based on historical patterns — I mean, more so than regular investing — but it is not obvious why that would be a permanent situation. When humans started trading stocks they were pretty naive about it. Then — maybe? — they got better.
Of course I might be wrong, and there may be some extra-statistical residue that only humans can bring to investing. “Until computers have creativity, taste, discernment and judgement, I think there’ll be a role for investors with alpha,” writes Marks. But I tend to find the examples of this a bit unconvincing. “Can they sit down with a CEO and figure out whether he's the next Steve Jobs?” asks Marks. “Can they listen to a bunch of venture capital pitches and know which is the next Amazon?” These are awkward sentences to write the week after Elizabeth Holmes was charged with criminal fraud for allegedly bilking sophisticated investors out of hundreds of millions of dollars by wearing black turtlenecks. Here I will write the pseudocode for you:
IF CEO.Outfit == BlackTurtleneck AND CEO.Education == CollegeDropout THEN CEO.NextSteveJobs = Yes
It’s not that that algorithm is right; it’s that it at least matches human performance.
I don’t mean to say that Marks is wrong. “Importantly,” he writes, “the trends toward both quantitative investing and artificial intelligence presuppose the availability of vast amounts of data regarding fundamentals and prices,” which exist in public stock markets but are hard to find in “many of the things Oaktree and other alternative investors are involved in,” like “distressed debt, direct lending, private equity, real estate and venture capital.” I am sure that the road to total robot dominance of investing will be long and winding and filled with creepy moments of instability, and that some of the boldest claims about the superiority of machines will turn out to be wrong.
My point is only that some of the boldest claims about the superiority of humans will also turn out to be wrong. And they’ll be wrong because they are made by the humans. If you are an investment manager who has outperformed the market due to a lifetime of correctly spotting trends and patterns, it is tempting to mythologize that ability, to describe it as a matter of creativity and innate judgment rather than just statistical success based on familiarity with patterns. And maybe it is! But you’re not the right person to judge.
Winton, one of the largest quantitative investing firms in the world, is spinning off its big data analytics unit, as the demand for tools to analyse unstructured data booms in the investment world.
The company, Hivemind, is seeking to tap into the need to clean up and analyse reams of complex and unstructured data sets for everything from geolocation details to consumer trends and sentiment analysis.
“Companies today are grappling with the growth in unstructured data, such as text, video or images,” said Daniel Mitchell, who ran a team of data scientists at Winton and has been appointed Hivemind’s chief executive officer. “Hivemind’s cloud-based platform efficiently structures this data so that companies can process and analyse it.”
The social purpose of investing is to allocate capital to good businesses. Quantitative hedge funds make the world better — they hope, you should hope — because they send price signals that tell businesses where to invest and where to cut back. But if the hedge funds’ models are good enough they could just tell the businesses that directly, rather than sending them coded messages through the stock price. Perhaps one reading of Hivemind is that that’s what it's doing.
“Another point that I believe my opponent made is that there are more important things than space exploration to spend money on,” the machine said during its lengthy rebuttal. “It is very easy to say there are more important things to spend money on, and I dispute this. No one is claiming that this is the only item on our expense list.”
Welcome to Twitter, IBM Debater, you will fit right in.
Is it securities fraud to send lies to your customers about a security that you're pitching, if your boss wrote the lies and you forwarded them without reading?
That is a question that the Supreme Court will consider in the case of Francis Lorenzo, who was barred from the investment industry by the Securities and Exchange Commission for passing along fraudulent emails from “the owner of the brokerage firm where he worked — which he described as a boiler room.” (Here is a more detailed summary of the case.) If the Supreme Court is taking the case, I guess the answer is unclear, and we’ll know in a year whether or not this is fraud. You can see why it wouldn't be: If you’re a salesman at a bank, you are constantly forwarding prospectuses and research notes and trade ideas to customers, and you can't be expected to fully diligence every one of them yourself. The line between an accomplice to fraud, and a salesperson entitled to rely on someone else’s work, is not entirely clear. Still, not as a matter of legal advice, but purely as a matter of, like, career management, I would urge you not to go work at a boiler room and uncritically forward all of your boss’s emails to customers.
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