(Bloomberg Opinion) -- The corporate police.
We have talked a few times recently about what it means to control a corporation. There are many theories: “Shareholder primacy” views shareholders as the owners of the corporation and directors and officers as their agents; “board primacy” views directors as the stewards of the corporation as an entity; modern “founder friendly” theories treat many corporations as the creation of entrepreneurs who can do what they like. But I keep coming back to a dumber and more practical theory, which is that if you have the keys to the front door—not in the sense of abstract ownership or entitlement, but in the sense of, the actual keys are in your actual pocket—then really you control the corporation. If the shareholders and directors and officers stand outside pounding on the door, and you don’t let them in, then what good does all their theory do them?
Here (via Francis Pileggi) is a pretty wild Delaware court case. A Delaware company called ZST Digital Networks, Inc., owns a British Virgin Islands company with the amazing name World Orient Universal Limited, which owns another British Virgin Islands company called Global Asia Universal Limited, which owns a Hong Kong company called EverFair Technologies, Ltd., which owns a mainland Chinese company called Zhenzhou Technology Company Limited, which is “engaged in supplying digital and optical network equipment to cable system operators in the Henan Province of China.” All except the last one are basically empty shells: Practically speaking, ZST is a complicated American wrapper for a Chinese company, a wrapper that allowed that Chinese company to more easily raise money in the U.S. And so ZST went public in the U.S. in 2009, listing on the Nasdaq Global Market and selling almost $30 million of stock. Its two main shareholders were Bo Zhong, the chairman and chief executive officer, and Lin Zhong, his son and the chief financial officer; both are Chinese nationals. In 2011, ZST’s auditors resigned because “the Company had obstructed their efforts to verify its cash and account balances,” which is never a great look, and ZST soon delisted, de-registered its stock, and sort of vanished from the American markets.
This was inconvenient for the U.S. shareholders who owned its stock. One of them, a guy named Peter Deutsch, sued, in 2012, demanding first that ZST tell him what’s up and show him its financial statements, and then, when it ignored those demands, that it buy his shares back from him. The Delaware Chancery Court—the leading court of U.S. corporate law—ordered it to buy his shares back (for about $2 million), and ZST ignored that too. The Chancery Court appointed a receiver to seize ZST’s assets to pay Deutsch back, and ZST ignored that too. So the receiver went and seized ZST’s assets, at least in an abstract corporate-law sense:
The receiver next began the difficult process of exercising control over the BVI Subsidiaries, the Hong Kong Subsidiary, and the Operating Company. The boards of directors of the BVI Subsidiaries resisted, necessitating efforts to replace those individuals with directors who would cooperate with the receiver. To facilitate these efforts, the receiver sought an order confirming his authority to vote the shares of the Company’s direct and indirect subsidiaries, including to effectuate changes to their respective boards of directors. By order dated April 19, 2013, I confirmed that the receiver had this authority.
Exercising his authority, the receiver replaced the directors of the BVI Subsidiaries and sought an order from a British Virgin Islands court confirming the validity of his actions. On May 31, 2013, Bo filed a lawsuit in the same court contesting the receiver’s actions. The British Virgin Islands court rejected Bo’s efforts, and on July 25, the Eastern Caribbean Supreme Court dismissed his challenge.
The receiver next caused the second-tier BVI Subsidiary to exercise its voting power as the sole stockholder of the Hong Kong Subsidiary to remove Xue Na, the sole director of the Hong Kong Subsidiary, and appoint new directors. Na refused to recognize the legitimacy of these actions. To confirm their validity, the receiver caused the Hong Kong Subsidiary to convene an extraordinary general meeting at which Na was removed and new directors appointed.
It’s all a lot of work. You have to go to the Virgin Islands, and Hong Kong, and vote to get rid of the original people and replace them with the court-ordered people, and get local court orders confirming that you can do what you’re doing, and so forth. And each time you do that, you peel back a layer of wrapping, and get a little closer to the actual business. Notionally. In a corporate-law sense. But in a practical sense, the people with the keys to the actual business—Zhenzhou Technology in China—kept ignoring all of this.
The receiver came up with the clever plan of selling the Hong Kong company—“he engaged Aegis Capital Corporation to act as financial advisor in connection with the sale,” “sent teasers to over forty potential bidders,” got five interested parties, and ultimately got “a letter of intent offering to acquire the Hong Kong Subsidiary for $15 million, subject to due diligence and other conditions.” One small hitch:
One condition required negotiations with Bo, Lin, and other members of the Operating Company’s management team.
In violation of the Cooperation Paragraph in the order appointing the receiver, Bo, Lin, and the management team did not cooperate with the receiver’s efforts. They refused to grant any physical access to the Operating Company’s facility or to provide the bidder with additional financial information. In the face of this resistance, the potential buyer withdrew.
You can't sell the company if the people with the keys won’t let the buyer in.
This kept going on forever, and it is entertaining throughout, but at this point I will skip ahead to the current situation, which is that Deutsch and the receiver got fed up and asked the Chancery Court—the Delaware state court in charge of corporate law, remember—to arrest Bo and Lin Zhong. The Chancery Court … did not say no. Its opinion last week basically ordered ZST one more time to do the stuff that it had previously ordered it to do, and said that if it didn’t do that then the Zhongs will be arrested. (Delaware courts don’t actually have the power to arrest people in China, but they do have the power to order the arrest of people anywhere in the U.S., and the Zhongs apparently travel to the U.S. frequently.)
Ultimately, of course, this is what it means to own a corporation, or to own anything. It means that if you want the corporation to do something, and the people with the key to the front door won’t do it, then you can get the police to kick down the door; it means that you can enlist the power of state violence to exert your control over your property. Everyone knows this; it is the deep theory that underlies all theories of corporate control and property rights generally. It’s just that you never really see it in corporate law. Usually the superstructure of corporate theory is enough; failing that, usually at least a court order is enough. It’s rare to have to actually call in the cops.
Here is a story about how traditional asset managers—Neuberger Berman Group LLC, AllianceBernstein Holding LP, that sort of place—are going out and hiring a lot of quants and data scientists:
Many of these traditional stock- and bond-picking firms are now paying up to hire mathematical and computer experts. They want these recruits to dive into pools of data—and the machine-learning tools that harness that data and other information—in search of trading ideas and blind spots.
There are two ways to think about “data science” (and machine learning and big data and an assortment of related buzzwords) in investing. One view, which seems quite popular, is that there is something fundamentally different about this stuff, and that there is a sharp dividing line between “quant” firms that hire data scientists to build computer models to pick investments, on the one hand, and traditional “fundamental” investment managers that hire humans to pick stocks, on the other. You see this view in many critiques of algorithmic/quant/etc. investing, which treat human insight and quant models as totally distinct domains of knowledge. On this view, there is something weird and desperate about traditional firms going out and hiring quants: The quant firms have such an advantage, as technically sophisticated first movers and as places with good quant-dominated cultures, that it is a bit hopeless for the traditional investors to think they can beat them at their own game.
The other view is that data science is like, you know, Excel. Lots of people traded stocks before computer spreadsheets were common. Some of those people were high-tech computerized investors who built their own custom financial modeling software. Some of them were low-tech hardworking investors who built financial models by hand, with paper and pencils. And lots of them were low-tech not-so-hardworking investors who were like “this stock looks like a steal given its P/E ratio” or “I visited this company last week and the executives all had firm handshakes” or whatever, and never bothered building models at all. And then Excel became popular, and time passed, and now the baseline expectation of anyone who goes to work at a traditional asset manager is that she will be able to build financial models quickly in Excel. The technological and quantitative sophistication of the whole industry went up, gradually over time, not because the old-line paper-and-pencil firms were supplanted by the new more powerful spreadsheet firms, but because the new technology became standard at the old firms. Excel modeling is not some weird fancy arcane special province of a few computer geeks; it is a core part of modern financial competence.
I am not sure that “data science” will ever quite get to that point, where coding machine-learning models will be a baseline expectation of every first-year analyst. But you could easily imagine it getting close, to the point that every reasonably sophisticated investment firm will have a data-science department, and every reasonably competent analyst will at least be able to formulate useful questions for those departments and make good use of the answers. And then—it will be a while—people will just sort of stop talking about “data science,” or about "quant firms,” and it will vanish like Excel modeling into the general category of financial competence.
Everybody won in the Hovnanian trade.
Mary Childs at Barron’s reports a curious fact, which is that Solus Alternative Asset Management—the hedge fund that sold credit-default swaps on Hovnanian Enterprises Inc., was blindsided when Blackstone Group’s GSO Capital Partners engineered a quickie default by Hovnanian to trigger the CDS and a strange new bond to enhance the CDS payout, sued GSO and Hovnanian over it, and ultimately settled when GSO decided that the trade was too embarrassing to stick with—actually made money, overall, on its Hovnanian position: “The trade contributed 218 basis points, or 2.18%, to the performance of the fund so far this year,” and that is apparently “net of 2017's trading losses.”
Meanwhile GSO, which was on the other side of the trade, also made money, at least on its CDS positions; it lost some money—as intended, frankly—on the very favorable refinancing that it did for Hovnanian, but a spokesman says that “the net outcome across our debt, equity, and CDS positions was financially immaterial to GSO.” (It is not obvious whether it was immaterially negative or immaterially positive.) And of course Hovnanian did great; it got favorable financing from GSO without, in the end, actually having to default on any debt.
And there are other beneficiaries. So many lawyers, I suspect, made so much money. And, not least, all of us got to observe it, and marvel at the elegance of the trade and the twists and turns of the dispute. GSO and Solus basically teamed up to make art and gave it away to us for free.
So … who did lose? Credit derivatives are zero-sum, you know; both sides can’t really be up. It’s possible that Goldman Sachs Group Inc., which was also on Solus’s side of the trade and which settled with GSO earlier, didn’t do as well. It’s possible that others who piggybacked on either side of the trade got burned; for instance, if you copied GSO’s trade after it was public—and after CDS prices had widened—then you spent more money than they did, and if you got out of the trade after GSO settled with Solus—at which point Hovnanian CDS prices collapsed—then you did worse than them. Also of course there were more abstract losers—confidence in the CDS market, that sort of thing—though it is hard to see how those sorts of losses could generate the actual cash to pay back GSO and Solus.
But this shouldn’t obscure the main points, which are that Solus and GSO did this trade against each other, and they both had a lot of fun, and we all had a lot of fun, and somehow they both apparently made money. They should do it again sometime!
A trainee day trader in France is suing a British brokerage for an amount comparable to almost its entire annual revenue after it seized the €10m profit he made using what he initially thought was a demonstration version of its platform. …
He was practising trading at home on what he believed to be the demo version — placing €1bn of orders for European and US equity futures — before realising that it was the live platform and he had run up a loss of more than €1m. He continued trading, eventually building up a $5bn position in US equity futures and turning the loss into a profit of more than €10m.
The brokerage, Valbury Capital, is trying to keep the money; it “told him he had breached his contract and his positions were ‘void and cancelled’.” On the one hand, somehow I don’t think that, if he’d ended up with 10 million euros’ worth of losses, Valbury would have just written those off as “void and cancelled.” On the other hand, in that case, I kind of doubt they’d have gotten much of that money back? There is some practical justice in saying “you know what, fine, you really were trading on the demo version, let's just write it off as a demo.”
Square Inc. and Twitter Inc., which both count the tech titan as chief executive officer, are on the brink of boasting 100 percent gains this year. The firms are now worth more than $62 billion combined, surpassing the market value of Tesla Inc.
In the past, investors have expressed skepticism about Dorsey’s ability to effectively run both companies at the same time. It seems some shareholders have put those concerns on the backburner.
My Bloomberg colleague Joe Weisenthal tweeted that Dorsey “is having probably one of the most amazing years of any executive ever,” though by sheer dollars of value-add, Jeff Bezos has had better days. But leaving aside that, and whatever concerns you might have about Twitter as a … business and an … influence on the world … just imagine that Dorsey actually possesses a special skill that allows him to double two companies’ stock prices each year. What, if you are a corporate board of directors, should you make of that? If you are the board of Twitter (or Square), should you offer Dorsey billions of dollars to quit Square (or Twitter) and focus all of his magic on quadrupling your stock price? Or would that be bad; does the magic come from the multitasking itself? Conversely, how much should a third company offer him to come in and run them too? Like why couldn’t Dorsey be CEO of Uber while he’s at it? If he can double two companies' values, where is the limit?
People are worried about bond market liquidity.
I am sorry but I am going to keep making fun of this worry when I read things like “A Trader Just Sold $321 Million of an EM Local-Currency Bond ETF”:
The VanEck Vectors J.P. Morgan EM Local Currency Bond ETF, or EMLC, absorbed a single, massive block sale of almost 19 million shares, worth $321 million, at 10:28 a.m. in New York Wednesday. The trade helped push its daily volume to a record $399 million as of 12:21 p.m., about 13 times the average daily turnover during the past three years.
Local-currency emerging-market bonds sound like they’d be pretty illiquid. Packaging them into an exchange-traded fund might make them seem more liquid, but if someone wanted to get out of a big ETF position all at once, they might find that the liquidity isn’t there. By selling the ETF they’ll cause a fire sale of the underlying bonds. Right? That is the worry that we have discussed endlessly around here for years and years now. And we could keep going; Howard Marks put out a version of it just this week.
And every actual event undermines it! The bond index underlying EMLC was … um … up 0.45 percent yesterday. Obviously a $321 million bond trade is not a particularly big one, but still, it’s a record for this ETF, and it just didn't have a whisper of an impact on bond market liquidity.
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