Nobody Pays Attention to FX Fees
(Bloomberg Opinion) -- AmEx FX.
Oh man, this story about American Express Co.’s foreign-exchange business is so elemental, so basic, it ought to be a business-school case study, or an ethics question on financial licensing exams:
Here’s how it worked, according to current and former employees: Salespeople would often tell potential clients that AmEx would beat the price they were paying banks or other financial institutions to convert currency and send money abroad. The salespeople didn’t inform customers that the margin, a markup that AmEx tacks on to the base currency exchange rate, was subject to increase without notice, they said. Prospective clients with certain AmEx cards also were accurately told they could earn points for the transactions, they added.
Some time later, salespeople would increase the margin without informing the customers, the current and former employees said. To spot the change, customers generally would have to log in to their accounts and compare the rate AmEx was offering to the market exchange rate at the time of the transaction. As recently as this year, they said, some customers had margins increased anywhere from 0.05 to 0.25 of a percentage point. In earlier years, margins rose by as much as 3 percentage points, according to former employees.
When clients did notice a change and inquired, AmEx salespeople sometimes would blame a glitch or other technicality and lower the margin, according to current and former employees and emails reviewed by The Wall Street Journal.
Can you do that? Sure why not. I mean, AmEx apparently did it. And their spokeswoman was like yeah, what about it:
AmEx said it doesn’t have contractual pricing arrangements with most of its foreign-exchange customers. “We have training, control and compliance oversight and believe that our transactions are completed and reported in a fair and transparent manner at the rates which the client has authorized,” said spokeswoman Marina Norville.
It just has everything, every tension in financial services wrapped up into one simple schematic fact pattern. The customers thought that they were in a relationship with AmEx; AmEx thought that it was just doing a series of trades at independent prices. The customers thought that AmEx was looking out for their best interests; AmEx thought that it was charging arm’s-length counterparties the price it wanted to charge them. The customers thought AmEx would tell them what it charged; AmEx figured that if customers wanted to know what they were paying they could always compare their prices to the market price and back out AmEx’s margin.
Simplest of all, AmEx knew what the market price was, and the customers, in the first instance, didn’t. (“Current and former employees say the division targeted smaller businesses in part because they’re less likely than large corporations to have employees who closely track forex transactions.”) You read sometimes about banks bamboozling their customers using “opaque derivatives,” but opacity is in the eye of the beholder, or non-beholder, and basically every financial thing is more opaque to the customers than it is to the bank. Like, you’re supposed to know the FX exchange rate? That’s what you hired the bank for!
And there is the deepest tension, the one between getting and retaining and pleasing customers, on the one hand, and pumping every cent out of them, on the other:
Current and former employees describe an environment focused on bringing in as many new clients as possible and squeezing revenue out of them before they depart. Employees were told that the average forex customer did business with AmEx for around three years, they said.
"Who cares if they come or go? Let’s make money while we have them,” one current employee said, referring to the attitude within the division.
You can almost imagine AmEx as a victim here, as a grimly resigned participant in a market that has settled into a bad equilibrium. Doing foreign exchange transactions for smaller businesses just doesn’t lend itself well to being a deep relationship business. The customers don’t know if they’re getting good prices, and can’t be bothered to find out, so just doing a good job for them won’t necessarily retain them (what if someone else pitches a lower introductory price? Or just gives them a new toaster for switching?) and won’t build a reputation that will lure in other clients (who pays attention to this stuff?). You are going to face high costs of customer acquisition and retention, and good service and low fees won’t really reduce those costs. On the other hand, gouging the clients will at least recoup the costs.
I consider myself a bit of a connoisseur of stories about financial fraud, but I have never read anything quite like this Jeff Maysh story about a syndicate that ripped off McDonald’s Corp.’s Monopoly game back in the 1990s. It’s not just that it’s so good, but that it seems to come from another dimension, a place where the laws of reality are subtly bent. Like here’s a throwaway passage:
[Amy] Murray was a quick-thinking Midwesterner who had risen through the ranks at McDonald’s, and was often the public face of the company during any drama. She was the “McQueen” of McDonald’s, said Joe Maggard, a disgraced Ronald McDonald actor who was convicted of making harassing phone calls while posing as the clown.
That two-sentence character sketch of a minor player in the story comes from an interview with a disgraced clown. The disgraced clown never appears again. It’s just the sort of story where a disgraced clown pops up and disappears. Why not? Or here’s how one character’s arc in the story ends:
Then, just before the judge announced her sentence, Robin Colombo caught a glimpse of her lawyer’s paperwork, and saw she was going back to prison. She screamed and made a desperate dash for the exit, and reached an outer corridor before marshals overpowered her. She was sentenced to 18 months. Behind bars, she discovered the Bible and wrote her life story, From a Mafia Widow to Child of God. She was later reunited with her son, Frankie, who did not join the mob.
There are tons of crazy things in that paragraph and they are all totally tangential to the actual story, almost all of which is crazier than that. The basic story is that McDonald’s ran a promotional game for years where it gave out Monopoly game cards, with lots of cards that gave you a free burger or whatever and a few cards that carried very valuable prizes, including $1 million giveaways. For years, the guy in charge of hiding the valuable pieces inside of McDonald’s products (“Uncle Jerry” Jacobson) instead stole virtually all of them, giving them to his buddies in exchange for a cut of the proceeds. (A female auditor followed him around to make sure he didn’t steal the game pieces, so he’d slip into airport men’s rooms to do it.) Eventually the ring was brought down by a massive FBI operation led by an agent named Richard Dent:
Dent opened an official investigation, naming it Operation “Final Answer,” after the “Who Wants to Be a Millionaire?” McDonald’s game. The operation would involve 25 agents across the country, who tracked 20,000 phone numbers, and recorded 235 cassette tapes of telephone calls.
You know, I read that passage and it raised my hackles a bit: Why did the FBI devote so many resources to protecting the integrity of a giant corporation’s marketing stunt? That’s a complaint that I have about a lot of stories like this, because I am a boring curmudgeon, but in this story, where everything is insane, here’s the payoff:
The colorful court case, held in Jacksonville, Florida, started September 10, 2001, the day before terrorists crashed planes into the World Trade Center, the Pentagon, and a field in Pennsylvania. ...
Baker recalled that one of the FBI’s top agents, known as the “human lie-detector,” interrogated him, and added that if the FBI had focused on surveilling terrorists not McDonald’s winners, 9/11 might never have happened
In addition to … causing … 9/11 … ????? … the McDonald’s operation had another problem, which is that the FBI told McDonald’s that its game pieces were being stolen, and who was stealing them, and how, but then spent months investigating so they could catch everyone and get everything on tape and generally wrap their sting up nicely. But that was a bit hard on McDonald’s:
Knowing that the game was compromised, Golden Arches executives considered canceling the whole thing. But Dent insisted he needed one more game to gather enough evidence. Jack Greenberg, the McDonald’s CEO, had a big decision to make. To run the game knowing it was corrupt could invite lawsuits and damage McDonald’s reputation.
Everything, I like to say, is securities fraud. Is knowingly running a rigged promotional game, in order to help the FBI catch its masterminds, securities fraud? I dunno, why not? I would love to see that lawsuit. (McDonald’s eventually paid out more money—shareholder money—to customers to make up for the rigged game.) But here is the actual aftermath:
McDonald’s sued Simon Marketing, who counter-sued. A group of Burger King restaurants tried to get a class act lawsuit together, so did a group of unhappy McDonald’s customers in Canada. The Monopoly game had demonstrated the evils of chasing riches at the expense of others, but the saga also proved that strange things happen when people conspire to cheat fate. Gennaro Colombo won a car using a stolen prize ticket and died in a car wreck. And when lady luck regained control of the McDonald’s competitions, she handed winning tickets to a man wearing a full Pizza Hut uniform; a Taco Bell owner; and a former homeless man who was later charged with beating up his fiancée–a PR nightmare.
If you had told me that McDonald’s shareholders had sued over this, I’d be like, “yep, everything is securities fraud.” But I don’t know what to do with the information that a group of Burger King restaurants sued over this. What? Just … what?
MoviePass is a service where you pay them a monthly fee that is less than the price of a movie ticket, and in exchange they will buy you all the movie tickets you want, at full price, and make it up on volume somehow. For a while the market’s reaction to that business model was along the lines of “I don’t understand how that works but whatever the new economy is pretty interesting,” but then eventually the reaction shifted to “hahaha well that can’t work.” As public perception shifted, MoviePass’s parent company, the unpromisingly named Helios and Matheson Analytics Inc., announced that its financial situation was fine because it had an “equity line of credit” that could cover its cash burn. An “equity line of credit” is a somewhat head-scratching notion, and it turned out that Helios and Matheson was just referring to a program where it could try to sell stock from time to time, and maybe someone would buy it.
This is conventionally called an “at-the-market offering,” and unlike a line of credit, it doesn’t really guarantee any funding. For instance, one problem with it is that the more stock you sell, the more you drive down your stock price, and the more stock you need to sell to raise the same amount of money. (Similarly, the worse your business gets, the more money you need, but the lower your stock price is.) Helios and Matheson’s stock is down about 98 percent for the month of July so far. It did a 1-for-250 reverse stock split on Wednesday so its stock price wouldn’t be too comically low. Its equity market capitalization, as of 10 a.m. today, was about $2.1 million. It is hard to raise millions of dollars selling stock when your market cap is $2.1 million. Also it’s in trouble with its payment processors, and “service went down Thursday after the processors stopped clearing payments for MoviePass.”
So it got a loan. For $6.2 million. The terms have a payday-loan severity:
Investment firm Hudson Bay Capital Management can demand repayment of more than $3 million of the loan on Aug. 1, and the rest on Aug. 5. Proceeds from a planned stock sale must also be used to repay the debt.
If Helios and Matheson Analytics fails to pay, it will be subject to a 15 percent annualized late fee until it makes good on the obligation. If the company is 48 hours late in its payment, Hudson Bay can require the company to repay the debt at 130 percent.
It’s a strange loan. (Here are Friday’s 8-K and the promissory note.) Hudson Bay paid Helios & Matheson $5 million for the $6.2 million note, meaning that even if it gets paid back on time—with no late fees or penalties—then the company is paying 24 percent interest to borrow money for like a week. Not 24 percent annualized; 24 percent for the week. Normal public companies do not pay that sort of rate to borrow $6.2 million for a week.
But you can see the logic. Helios & Matheson wants to sell stock, to pay for its operations and, now, to pay off that Hudson Bay note. (The proceeds of the at-the-money offering have to be applied first to pay off the note.) Once the payment processors shut off MoviePass and the business seizes up, there is really no more selling of stock. But if you can borrow money for just a little while, you can keep the business going and sell a bit more stock, and then … I dunno … maybe things will turn around?
I am not sure why anyone would buy the stock in that scenario, but then it’s not like anyone is. The stock is down about 80 percent since the loan was announced. The plan, as far as I can make it out, seems to have been to get a little money to stabilize things so that the company could sell more stock. It didn’t work.
You know what is a financial-markets story that I have never read? I have never read a story like This Hedge Fund Has Had 50 Percent Returns for the Last 10 Straight Years and Its Manager Is Desperate to Deploy More Capital but She Just Can’t Raise Enough Money From Investors. You never see that, for some reason. No, I kid, the reason you never see it is that markets are efficient enough that if someone runs a wildly successful hedge fund, it is closed:
Multibillion-dollar funds operated by Renaissance Technologies LLC, PDT Partners, WorldQuant LLC, Two Sigma Investments LP and other computer-driven “quant” firms have generated market-beating returns for years, according to people close to the firms, sparking heated investor interest. Renaissance’s Medallion fund, for example, has averaged annual gains of more than 35% since 1990, and was up about 10% this year through July 20, the people say.
There is a catch, however.
These funds are generally available only to employees, early clients and a few lucky others, part of an effort to limit their size and keep them nimble enough to continue racking up gains. For pension funds, endowments and other big investors, being shut out of these exclusive funds is a bit like peering into a hot nightclub that allows only VIPs inside.
The conventional form of the efficient markets hypothesis says, roughly, that nobody can reliably beat the market. But the much more straightforward and intuitive form of the efficient markets hypothesis says that you can’t beat the market. And if somebody else can beat the market, why would they do it for you? Either they’ll charge you their entire outperformance (and then some) in fees, or they’ll just turn you down flat.
Congrats DJ D-Sol.
Here’s some news of the end times from Billboard:
New York City-based DJ D-Sol (aka David Soloman) – and, in his day job, Goldman Sachs COO – debuts at No. 39 on Billboard's Dance/Mix Show Airplay chart (dated July 28) with "Don't Stop." The remix of the 41-year old Fleetwood Mac classic (the original peaked at No. 3 on the Billboard Hot 100 in September 1977) is the DJ/business executive's first Billboard chart entry.
So yes that’s the next chief executive officer of Goldman Sachs Group Inc., David Solomon, making the Billboard charts for his electronic dance single. And having his name misspelled. And being described as a “DJ/business executive.” That’s my favorite part. First because “business executive” is so pleasingly vague; certainly when I was growing up I dreamed of being a business executive. But also because of the order: “DJ/business executive,” not “business executive/DJ.” Obviously the DJ part is more relevant to Billboard. Billboard doesn’t chart high-yield bond league tables.
There is a popular perception of Solomon that he is a powerful investment banker with a curious outside hobby as an electronic-music DJ, a hobby in which he happens to be doing surprisingly well. (“David's always believed that having a wide range of outside interests leads to a balanced life and makes for a better career,” says Goldman spokesperson Jake Siewert.) But what if that’s wrong? What if he is fundamentally an electronic-music DJ who, like so many artists, has to work a day job to support his practice? Other musicians bartend to make ends meet; Solomon just happens to run Goldman Sachs. Now that his single has charted, will he quit and devote himself to music full-time? (No, is the answer, I am pretty sure, but go with me for a second here.) In New York there is often an expectation that waiters and baristas “really” do something else, that they are just working in the service industry until their artistic careers take off. But maybe that’s true of investment banking too. If someone tells you that he is a senior executive at Goldman Sachs, perhaps it’s polite to inquire “but what do you really do?”
Disclosure, I worked at Goldman Sachs until my career as a writer took off, so I may be biased.
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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Matt Levine is a Bloomberg Opinion columnist covering finance. 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 3rd Circuit.
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