Snap (SNAP) and Tencent (0700:HK)

Yesterday, as part of its disappointing quarterly earnings announcement, SNAP revealed that Chinese internet giant Tencent has acquired a 12% stake in the company.

This is considerably less than it seems, however, for three reasons:

–US securities law requires that an acquirer make a filing–called a 13D–declaring its intentions once it has built a 5% voting interest in a publicly traded company.  It must also report every +/- 0.5% change in its ownership interest as long as the total holding remains at 5% or above.  Based on this rule, a quick reading of the Tencent headline suggests the Tencent move up came in at least one large chunk and fairly recently.  Not in this case, however.  SNAP has issued only non-voting shares.  So the SEC filing requirement doesn’t apply.  In fact, Tencent says it has acquired the stock in the open market over a lengthy period.  Therefore, the 12% stake is not a this-week vote of confidence by Tencent in the SNAP management.

–the stake was acquired in the open market, not from SNAP directly.  Therefore, the large amount of money Tencent spent on SNAP shares did not go into the company’s coffers.  It went to third-party holders exiting their positions.  So, yes, Tencent took out sellers who might otherwise have put downward pressure on SNAP’s share price.  But SNAP did not receive the benefit of a substantial cash injection.

–also, the fact that these were open market transactions does not signal the strong commitment to SNAP that a direct purchase of a block of shares from SNAP would have.  Tencent could disappear from the share register just as easily as it appeared.

’tis the season to be jolly, but…

At the end of last week I wrote a bit about one of my pet peeves, the inconsistent way in which the SEC treats inside information.  As one of my former colleagues, an SEC investigator hired by my employer at that time to advise analysts and portfolio managers how to stay on the right side of the law, once told me, “Inside information is whatever the SEC decides it is on a given day.  The cardinal rule is never to do anything that catches the SEC’s attention.”

Not very helpful counsel, is it?    …although it does accurately describe the Eliot Spitzer school of law enforcement.

Don’t get me wrong.  Honest professional investors don’t want inside information.  It taints their own research efforts and prevents them from trading on hard-won insights.  And I applaud the SEC’s efforts to shut down peddlers of stolen company information and the people who buy it from them.  What I don’t like–and what may be changing now–is the inability by the SEC so far to separate legitimate research from theft.

a second peeve

On now to my second pet peeve…selective release of information by publicly traded companies.  Yes, it still goes on, despite the fact that Regulation FD is supposed to have made this practice illegal.

Again, I’m all for a level playing field.  And I’ll admit that when I was a large shareholder by virtue of representing my money management clients I didn’t worry too much about how companies treated the average individual investor.

Even in those days, however, I saw the tremendous preference that long-established companies gave to brokerage house analysts.  Many held private meetings for sell-side analysts only (owners of the company’s stock excluded) in which they provided detailed descriptions of their operations and offered informal access between sessions and over lunch/dinner to top technical and management employees.  This still occurs (Adobe has a similar kind of get-together that everyone can come to.  It costs $1,500 or so, however, which is probably what it costs ADM+BE to host the function and which is fine with me.).

Waht bothers me is that the firms in question givelots of  important information to brokers, that brokers turn around and charge me to get.  So I’m an owner and the only way I can obtain data about my company is to be forced to pay for it from a third party.  That’s crazy. Sometimes, too, the message gets garbled in the retelling.  At least have a broadcast of the proceedings on the company website.

Since I’ve retired I’ve also found that the Investor Relations and Public Relations departments of older, stodgier firms are much less responsive to my requests for information than they were when I ran large portfolios.  Now they sometimes ignore my repeated phone calls or emails, whether I identify myself as a shareholder, an analyst in a (small) money management firm, or a financial blogger.  Either that or they respond with a big time lag.

In a way, this lack of response is valuable information in itself.   Big, stodgy, unresponsive to owners = stay away.  In cases when new management comes in to shake up the walking dead, this is a sure sign that the turnaround hasn’t gotten as far as top management thinks.

On the other hand, I’ve also had many enjoyable conversation with CFOs or CEOs of mid-sized companies who, to my mind, get it that the idea of responsibility to their owners isn’t simply a legal fiction.  My experience is that firms of this sort tend to do better in a fast-changing world.

economy performance vs. stock market performance

Th financial media often talk about the prospects for the stocks market as closely liked to the prospects for the overall economy.   Is this right?

in a general way, yes

The most important investors in developed markets tend to be citizens, or at least residents, of the country in question.  This is partly because doemstic securities are the ones individual investors feel most comfortable with and can easily get the most information about.  It’s also partly because institutional investors like pension funds or insurance companies both want to match their domestic liabilities with domestic assets, and because they are most often legally required to do so.

When a country is booming, employment is high and wages are rising, money tends to flow into stocks.  When times are bad, not so much.  In particular, it’s been my experience as a global investor that stocks in high GDP growth countries tend to do better than very similar stocks headquartered in low GDP growth nations.

looking a little more closely, no

This is the easiest to see in Europe.  Switzerland has annual GDP of about $650 billion.  Germany’s is six times that.  Yet, the two countries have stock markets of just about the same size.  How so?

Two reasons:

–the Swiss market is dominated by international pharma and financial companies.  Only a tiny amount of their business is done in Switzerland.

–large chunks of Germany’s very important export-oriented industrial sector are unlisted.  The German stock market leaders are banks, public utilities and the autos.

In neither case–tiny country with enormous multinationals, or big countriy without many domestice companies listed on the stock exchange-os there a strong relationship between economy and stock market.

the US

–The US is the country where, thanks to the SEC, the most information about the geographical breakout of earnings is available.  Slightly over half of the companies in the S&P 500 provide geogrpahical earnings data.  If we assume that the structure of the rest of the index mirrors that of the reporting companies (a whopper of a leap, but I’m not sure what else we can do), then the earnings of the S&P break out about as follows:

US      50% of reported earnings

Europe  25%

Rest of the world    25%.

–Large parts of the US economy, like construction/property and autos have minimal representation in the S&P 500.  In the former sector, lots of companies remain private.  In the latter, a lot of the activity is by foreign companies.

significance?

If we just look at likely GDP growth for the US in 2015, we’d probably be predicting a pretty good year for stocks.  GDP may be up by 3% real, 5% nominal.  Money will likely flow into stocks.  The Fed will probably be careful not to rock the boat by raising interest rates too quickly.

However, we have two other issues to factor in:

–economic activity in the EU, Japan and emerging markets may not be so great and the dollar has been strong vs. foreign currencies.  This may mean that US-domiciled multinationals may not look so good, especially after their foreign results are translated back into dollars.

–In addition, we have to consider how we can find publicly traded stocks that are tied to potential hotspots for 2015 growth.

 

the “dark pool” investigation

Someone with a Dungeons and Dragons background must have named them “dark pools.”  But they’re neither mysterious nor scary.  Dark pools are just off-exchange automated trading networks for stocks.

They exist for two reasons:

–the old school method of having a trader in a money management firm call up a broker and place a buy or sell order by phone is expensive.  And money managers have a legal obligation to obtain the lowest cost execution of their orders on behalf of clients.  So they have a positive obligation to seek out cheaper ways of doing business–which automated networks are.

–brokerage house traders won’t keep a money manager’s order secret unless the manager is exceptionally diligent.  This is a real hassle, and very time-consuming for the  money manager’s trading room.  But if you don’t pay extraordinary attention, your secret trading plans–which, after all, are your stock in trade–will be all over Wall Street in a nanosecond.

Automated trading networks have one–no, make that two–defects:

–they can be relatively illiquid, so that very large positions may not be able to be moved quickly, and

–many of the biggest of them are run by investment banks/brokerage houses.

This second characteristic is the reason for the current SEC investigation.

In a recent post, I wrote that Fidelity was exploring the possibility of forming its own automated trading network with other money managers, cutting out brokers altogether.  Its reason, I thought, was that computer=based high frequency traders were able to deduce Fidelity’s trading plans by analyzing dark pool data–and that Fidelity wanted to create a venue where they’d be banned.

It appears I may have been too high-tech in my approach.  The SEC investigation appears to focus on two possibilities, both of which are decidedly old-school brokerage behavior and both of which would violate the guarantees the automated network operators give to clients:

–the first is that the operators may have taken undisclosed fees from high-speed traders to allow their buys and sells to have priority over other order–essentially letting them front-run or scalp other participants

–the second is that operators may have taken the supposedly anonymous trading activity of high-profile participants and sold its details to others.  I say “sold” but in my experience, the compensation for such information would normally not be in cash but either in increased trading volume or higher per-trade fees.

Personally, I don’t think dark pools themselves are the issue.  I view them as part of the solution to a problem with how traditional brokerage/investment banks are run.  And the fact that the old system is breaking down makes these firms even less willing than normal to give clients an even shake.

It will be interesting to see how the SEC investigation progresses.

 

 

Fidelity’s dark pool proposal–why?

Recently, Fidelity, one of the largest money managers in the world, has been sending feelers out to its peers to form a private “dark pool” in which they could all trade anonymously.

What’s this all about?

I’m not sure who made up the name “dark pool.”  But it glamorizes a pretty mundane operation.  A dark pool is a computer-driven trading network where professional investors buy and sell securities with each other in a low-cost anonymous way.

They’re meant to solve two problems that every large investor like Fidelity who’s subject to SEC regulation in the US has:

–in trading securities for their clients,money managers are required to obtain the lowest cost in making any trade as well as the best execution of the order.  Best execution, which I take to mean the most favorable price, given the circumstances at the time of the trade, is a rather vague and contentious concept.  But lowest cost, meaning the lowest commission or bid/ask spread paid to get the trade accomplished, is relatively clear.

It’s also very clear that dealing with a third-party broker isn’t the lowest cost way of doing business.  Dealing directly with another institution through a computer trading network may cut commission/spread costs in half.  As a result, increasing amounts of trade is being done through dark pools so institutions can establish that they’re working to fulfil the lowest-cost legal mandate.

–any money manager wants to keep his trading activity as secret as possible.  After all, no one wants others to be freeriding on investment ideas that a manager has developed after long and expensive research efforts.

This is a particularly pressing issue for managers with large amounts of money under management, since such a manager will often have orders that are so big they can take, say, a month to execute–sometimes longer.  The trickiest part of such trading is keeping the manager’s activity secret for as long as possible.

Again, brokerage house trading operations for third parties are not a great way to go.  They tend to leak like sieves.  Part of this is a function of order size.  The broker may approach potentially interested parties.  As/when the size of the order becomes apparent, the other party may be able to guess the identity of the institution the broker represents.

There’s mre than that, however.  Information is also a valuable resource.  In my experience, most important clients of a broker–and the broker’s own proprietary trading desk–would know the general outlines of a Fidelity order within minutes of its being placed.  The broker might not use the Fidelity name, but the description ” a large institution in Boston” would leave little to the imagination.  The idea is that smaller clients will regard this as valuable information and will compensate the broker with increased trading commissions in return for continuing access.  (My tendency would be to do less business with a broker who acts this way, but apparently I’m in the minority.)

Dark pools, though sometimes illiquid, are one solution to this problem.

It turns out, though, that the dark pools also have their issues.  One that I find interesting is that to obtain liquidity dark pools may allow high frequency traders to participate.  And, it turns out, they have found “big data” ways to figure out which orders are Fidelity’s–and to use this information to trade against them.

Fidelity’s response is to try to form a dark pool that will consist only of institutional investors, without high frequency traders.  Such a setup might have issues of its own.  If there are only, say, four major members it may be that the trading intentions of the others will be obvious to all.  But, in Fidelity’s view at least, that would be better than the current situation.

 

 

accredited investors and the JOBS Act

“accredited” investors

When you open a brokerage account in the US, you fill out a form that requests information about your income, risk tolerances and investment knowledge.  From what I can see, it gets only superficial scrutiny.  But saying that you have some money and understand the risks of investing in various types of publicly traded securities does two things.  It gets you a seat at the table and it protects your broker from customer lawsuits claiming they lost money because they didn’t understand what they were getting into.  In a sense, passing this vetting process makes you accredited–but that’s not what the term “accredited” usually means.

Instead, it refers to the same kind of vetting process, but for private placements–purchases of securities not registered with the SEC and not sold through the traditional (expensive and time-consuming) IPO process carried out by the big brokerage houses.

For individuals, “accredited” means you have $1 million in assets, not including your principal residence, or you earn at least $200,000 a year.  (There’s a different criterion for institutional investors who want to trade in non-registered–usually foreign–securities.  To be accredited in that sense means having $100 million in investable funds under management.)

The bottom line:  “accredited” means either you’re in the top 1% or pretty close.

not good enough for the 21st century

In the pre-internet, pre-JOBS Act, pre-Mary Jo White world, that was ok.  Private placements were restricted to a very small number of individuals, whose main characteristic is that they can afford losses they might incur in buying risky securities.  The wealth criterion also effectively preserved the near-monopoly on public issuance of securities of the big brokerage houses on Wall Street.

That’s all changing.

the new order

There are already special rules to allow crowdfunding sales of securities.

For the JOBS Act (which allows smaller, early stage companies to raise funds with only limited disclosure) to be truly effective as a  capital raising vehicle for business startups, the pool of investors has got to be larger than just the usual “accredited” suspects.

Interestingly, at the same time as the newly active SEC is saying it sees some merit in things like bitcoin, the agency is also preparing to overhaul the definition of what an accredited investor is.

The new emphasis appears to be on accrediting people who have knowledge, training or experience that gives them insight into the risks and rewards of investing in a startup rather than just being able to take their lumps if an investment goes south.

I don’t know whether this is a good thing or not.

But Washington passed the JOBS Act last year to make it much easier for startups to raise money.  And, contrary to Mary Shapiro’s foot dragging, Mary Jo White is certainly going to set rules of procedure to allow the Act to function.  And that means opening this class of investments to more potential buyers.

do think, however, that this will turn out to be another instance of a new internet-based business model undermining an older higher-cost pre-internet one.  It will be interesting to see how–and if traditional brokerage/investment banking firms will adapt.  I suspect that this change will have far greater ripple effects than anyone now expects–maybe even momentous ones.

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bank investigations finally beginning

Until recently, one of the key aspects of the financial wrongdoing that led to the Great Recession, one bemoaned by mid-level investigators/regulators, has been that virtually no one has been prosecuted.  This contrasts sharply with what occurred during the savings and loan collapse of the early 1980s and the junk bond debacle later in that decade.

One obvious difference between the latter and today is that the perpetrators in the former instances were tiny fish in the financial pond–either owners of small S&Ls or the rogue financier Michael Milken, who worked for the US subsidiary of a Belgian bank.  No one systematically important.  No big sources of political patronage.

Just what any cynic would have thought.

But what appears to be proving most important, in my view, is who is serving as head of the SEC.

President Obama’s appointment in 2008 to chair the regulatory agency was Mary Shapiro. Her previous job?   …head of the National Association of Securities Dealers, now known as FINRA (Financial Industry Regulatory Authority), the trade group representing the investment banking industry.  In other words, Ms. Shapiro was the chief publicist/lobbyist for the big commercial/investment banks.  According to Wikipedia, FINRA paid her $9 million in her final year in that post.  Talk about the fox guarding the henhouse.

Now that Ms. Shapiro has been replaced by a tough veteran prosecutor, Mary Jo White, investigations are suddenly far more extensive.  And the SEC efforts now have teeth.  No more consent decrees without admission of criminal behavior.  And it’s finally ok to investigate the systematically important banks.

I think this new effort to clean up Wall Street is a huge plus for all portfolio investors, and particularly for individuals like us.

A perverse part of me just can’t accept a gift horse, though.  I keep wondering what led to Mr. Obama’s change of heart.  I’m thinking that the contrast between Shapiro and White (Elisse Walter, another FINRA alumna, served as SEC chairperson for a few months between the two) is so great that there must have been a reason.  Could Mr. Obama just have been that clueless?  Does he no longer need political donations?  I can’t imagine what.  Any thoughts?