Wednesday, December 21, 2016

Happy-Holiday Synopsis

What a year it has been!  We sign off for 2016 with a short brief on the wave of activity that has occurred in recent weeks, wishing our readers a happy holiday season and a terrific 2017.

The main new stories of the year have been the escalation of ERISA retirement plan litigation and the unfolding conundrum that is Wells Fargo.  Meanwhile, some of the other ongoing litigation has expanded, including with FX cases being filed abroad.

But here are some of the main happenings over the last 2-3 weeks.

Actions & Settlements

Gold & Silver Fixings Class Actions [1], [2]: The court approved Deutsche Bank’s settlements of $60 million and $38 million, respectively. Meanwhile, plaintiffs’ attorneys filed documents highlighting electronic communications provided by Deutsche Bank that they argue demonstrate alleged manipulation and collusion across banks. Deutsche is the only bank to settle so far. 


  1. Goldman Sachs settled ISDAfix manipulation class action allegations for $56.5 million. (Class action claims against seven banks/brokers remain outstanding.)
  2. Meanwhile the CFTC took an enforcement action, its third in regards ISDAFIX, against Goldman Sachs -- the others being against Barclays and Citibank. The ISDAFIX penalty brings the CFTC's tally to over $5bn in fines (across 18 actions) relating to FX, LIBOR, EURIBOR and ISDAFIX misconduct.
Euribor: The European Commission fined Crédit Agricole, HSBC, and JPMorgan Chase a total of €485 million (~$520 million) for manipulating the Euro Interbank Offered Rate (Euribor).

Dark Pools: Deutsche Bank settled with New York State for $37 million and FINRA for $3.25 million over its equities order routing practices.


  1. PIMCO settled for $20 million SEC allegations that the asset manager misled investors about the performance of its Total Return ETF (ticker: BOND) by failing to disclose that a significant factor in BOND’s outperformance was its strategy of purchasing odd-lot positions at discounts and then immediately marking them up to the round-lot prices.
  2. The DOJ charged executives at hedge fund Platinum Partners with fraud, alleging Platinum fraudulently overvalued its illiquid assets to stoke high returns, as well as for other problematic practices.  The SEC filed similar civil charges.

Happy holidays!

[1] In re: Commodity Exchange, Inc., Gold Futures and Options Trading Litigation (1:14-md-02548)
[2] In re: London Silver Fixing, Ltd. Antitrust Litigation (1:14-md-02573) 
[3] Alaska Electrical Pension Fund et al v. Bank of America Corp et al (14-cv-07126)

Tuesday, November 29, 2016

Not ... Just ... Yet ... Wells, Fargo

If Wells Fargo didn't already have enough to worry about, last week things got a little bit more “interesting” with the filing, against Wells, of a class action complaint filed by employee-participants in its $35 billion retirement plan.

Wells is busy dealing with the aftermath of its fake accounts scandal.  It has paid the CFPB a $185 million penalty, but the reputational fall-out is ongoing, as outsiders seem to show more empathy towards the (former) employees at the heart of the scandal, and less with the company itself. Hundreds if not thousands of Wells' employees were let go over a period spannin years, accused of fraudulently opening 2 million customer accounts ... enough to cost former Chairman and CEO John Stumpf his job.  He fell on his sword last month. 

Much has been made of  the culture at Wells Fargo that may have enticed (or even compelled) thousands of employees to conclude that it was better to conjure up fake customer accounts than to fall short of sales quotas, especially after some of the 5,300 workers fired for the scandal decided to sue for wrongful termination that they allege was in retaliatory.  (With a nod in Wells Fargo's direction, the CFPB put out a bulletin yesterday on "Detecting and Preventing Consumer Harm from Production Incentives.")

The complaint filed last week  alleges that Wells Fargo enriched itself at the expense of its employees by engaging “in a practice of self-dealing and imprudent investing of Plan assets by funneling billions of dollars of those assets into Wells Fargo’s own proprietary funds.” The plaintiffs argue that Wells Fargo’s proprietary funds, specifically its target date funds (which were a default investment option), charged higher fees than, and under-performed against, comparable funds. 

It is a familiar tune that we have heard from employee plaintiffs at other financial services firms, such as Morgan Stanley and Putnam Investments, two of several financial services firms recently accused of self-dealing through its employee retirement plans. Similar cases have already been settled (e.g. Ameriprise for $27.5 mm and Mass Mutual for $31 mm). Self-dealing asset managers are not the only alleged culprits – 2016 has seen at least two dozen lawsuits over retirement plan fees and offerings, including twelve by university employees.

Pat Bagley, Salt Lake Tribune; licensed by PF2

A primer on the ERISA litigation can be found here.

The case is: Meiners v. Wells Fargo & Company et al (16-cv-03981) 

More on issues of corporate culture at financial institutions, here

Friday, November 18, 2016

FX Settlements Up and Up-dated

It has been a little over a year since we last visited the state of currency markets litigation.

For the main benchmark rigging allegation issue, overall settlements have now surpassed $12.2 billion, primarily in fees imposed by global supervisory authorities.  North American private actions account for over $2 billion, but many of the defendants are yet to settle.  Since our last update, we have seen three, albeit relatively small, settlements by defendants in the Canadian class action.

Outside of the main case, there have been settlements by custodians State Street ($530 mm) and Bank of New York ($714 mm) in cases alleging they failed to provide, as promised, "best execution" on FX conversions on standing orders.  Separately, Barclays has settled with regulators and a private litigant over issues concerning its backing away from live quotes, implementing a potentially one-sided "last-look" approach.

Here is the current status of the settlements in re potential benchmark rigging.  It is noteworthy that counselors representing the class actions have pursued, and often exacted large settlements from, parties that have escaped regulatory fines.

Friday, September 16, 2016

The Influence of Short-Termism on Corporate Culture

Our first piece on corporate culture at financial firms is up and ready (click here).

We managed to grab the first bit of news in the ongoing Wells Fargo saga, but there should be further developments next week Tuesday, when Wells' CEO, John Stumpf, appears before a Senate Banking Committee hearing.  He will face some tough questions.

(Meanwhile the House Financial Services Committee announced today that it too will be investigating the allegedly illegal activity by Wells Fargo employees, and says it too will summon CEO Stumpf to testify later this month.)

We don't want to give it away, but here's a short blurb, enticing you to read the piece.  We hope you'll dig in!


Bank of America is cutting costs. Its headcount has decreased by roughly 15,000 employees annually over the last three years. Things are moving fast. CEO Moynihan recently explained that: "We're driving a thing we call responsible growth. You've got to grow, no excuses." 

Meanwhile, it has become known that numerous Wells Fargo's employees have been creating unauthorized accounts for their clients. Millions of accounts. More than 5,000 employees are said to have been fired. 

Perhaps growth has its costs. 

Short-Termism and its Potent Influence on Corporate Culture at Financial Firms tries to frame the issue: how and to what extent can short-term thinking patterns hurt the long-term goals of a firm?

The financial firms are under pressure, including from increased regulatory oversight (and non-compliance risk) and the renewed focus on cultural issues within financial firms.  

We analyze some of the problem zones and propose a framework for tackling short-term thinking patterns and the associated cultural concerns -- appreciating that the mindsets, incentive structures, and personality types at financial firms can make matters all the more challenging. 

In addition to Wells Fargo, we include examples and thought-pieces from: 
  • Credit Suisse Citigroup 
  • Green Tree Financial 
  • JP Morgan 
  • Platinum Partners 
  • Société Générale 
  • Visium Asset Management
As always, all feedback is welcome and appreciated!


Monday, August 15, 2016

Buy-Side Pricing Alerts

The money center banks have for years been heavily criticized for their pricing operations going awry. 

Many of these issues occur in the fixed income or over-the-counter (OTC) markets, where transparency is limited, secondary market liquidity near invisible, and pricing discrepancies sometimes easily and innocently explained away.

The banks have had their troubles and issues with consistent pricing across different divisions.  The "London whale" saga at JPMorgan was one of the big ones.  

Anybody who watched The Big Short recently will remember the palpable frustration in the air as the "shorts" waited anxiously for RMBS and CDO price depreciation, which lingered endlessly, much to their frustration, despite the obvious downward change in fundamentals.  In the book, Scion Capital’s Michael Burry is quoted as saying: 
“Whatever the banks’ net position was would determine the mark,” ... “I don’t think they were looking to the market for their marks. I think they were looking to their needs.”
Pricing Concerns ... Coming to a Fund Near You

In the Big Short, the focus on pricing was on banks' failure to lower prices quickly enough.  But pricing concerns are more typically focused in the other direction: asset price inflation. And nowadays the buy-side is taking the brunt of the investigative interest ... with the focus being drawn on their valuation of private companies.

First, let's step back.  Everybody who owns a computer (even a smartphone) can see where Apple's stock trades.  Yes there are off-exchange venues (including dark pools) but generally there is plenty of price transparency for liquid large-cap stocks.  

Importantly, all institutions would hold Apple stock at the same value on their balance sheets, whether they're long or short, expecting it to rise or fall.  Each institution's opinion doesn't matter: the market dictates.

In OTC and private company's equity valuation worlds, there isn't necessarily a ready instead of marking-to-market the world more generally marks-to-model.  Each firm can hold the same security at a different price.

But the problem is, well, funds charge fees based on performance.  Higher asset prices translates into better performance.  Ergo, mark your assets higher and you'll make more money.  Voila!  Next, funds advertise their performance.  Higher marks therefore means better performance; marketing of stronger performance can translate into higher capital inflows from investors, which means more money under management, which means more fees.  Brilliant!

So that's the problem (the incentive/motivation is too compelling!).

The news pieces are coming in thick and fast.

On Friday, Reuters published a piece called: U.S. mutual funds boost own performance with unicorn mark-ups which explained that:
"The Securities and Exchange Commission (SEC) has been asking mutual fund companies how they value their stakes in companies like Uber, Pinterest Inc and Airbnb...  The regulator is worried investors could get hurt in case of a sharp tech downturn, according to two people familiar with the SEC's queries."
The WSJ had written a similar piece back in November 2015: Regulators Look Into Mutual Funds’ Procedures for Valuing Startups, noting that:
"According to a Journal analysis of data provided by fund-research firm Morningstar Inc. of startups worth at least $1 billion, there were 12 instances over the past two years in which the same company was valued differently by more than one mutual fund on the same date."  
And BloombergBusinessweek, back in March 2015, had put together perhaps the most entertaining read of all:  We Tried to Re-Create JPMorgan’s Mutual Fund Returns and Gave Up: "The bank’s impressive mutual-fund-group performance figures come with little explanation ."


We're keeping a close eye on asset pricing issues, especially in the credit space.  If you notice anything we're missing, let us know.  Click here for a compilation of pricing issues we have seen recently, including specific investigations.

Tuesday, July 5, 2016

Student Loan ABS Update & Ratings Mismatches

We've kept a look-out on the National Collegiate Student Loan Trust (NCSLT) shelf we inspected more fully in January this year.

At the time, we commented on the nature of all outstanding notes, originally rated AAA by Fitch or S&P, being currently rated junk (sub investment grade) -- and often in deep junk territory.  

In January, S&P had some of those notes on watch for upgrade, but those have since been attended to by S&P.  As we revisit these notes, none of those notes on watch for upgrade was upgraded by S&P into investment grade territory (BBB- or above).  And, due to a technical dispute having arisen in respect of a servicing agreement, some of the Moody's-rated investment-grade notes were placed on downgrade watch.

This shelf really shows the difference between rating agencies' approaches.  The ratings performance may say more about the viewer than the viewed.   

Just have a look at the currently ratings for each note outstanding that was originally rated AAA by Fitch/S&P or Aaa by Moody's.  For each rating agency, there are roughly 55 notes described in the table below. Moody's has roughly half of their outstanding notes, originally Aaa still in investment grade territory.  Fitch and S&P have none.

Meanwhile the following, originally AAA, note successfully paid off in full in November 2015, at a time that it was rated C by Fitch, CCC by S&P and Aa1 by Moody's. (Moody's subsequently upgraded it in December, after it had been paid off, but this was probably just due to an administrative or technical shortcoming on their side.)

The next one is a good example, too.  Originally AAA it was downgraded to CC by Fitch in 2013 and has remained there since.  Then in 2014 Moody's upgraded it to Aa1 and then in December 2015 back to Aaa, its original rating.  But in May 2016, while Moody's had just upgraded this note to Aaa, S&P took it off watch for upgrade, and left it at CCC.

Your AAA, is my CCC, is my CC...

Ratings history snapshots, above, courtesy of Bloomberg LP.

Friday, July 1, 2016

A Rocky Start to Q3

It's been a week since the Brexit vote.  And silver, not gold, has been taking off.

Usually in lock-step with gold, silver has outperformed gold by roughly 9.2% over the last 4 days.  Gold has been up 1.3%.  Silver, on relatively high volume, has gone up more than 10%.

This graph shows silver in green, each day adding to its gains over gold, in white (both were normalized at 100 for the comparison).  And we're again pointing out the suspicious volume, in red, at roughly 3:33 pm yesterday in SLV, which we commented on yesterday, almost a half hour before the day's close, (which was importantly also quarter-end).  

By yesterday, silver had moved 4.5% relative to gold.  Today, it moved another 4.5%, after opening again far higher on high volume.

Silver futures, too, show similar patterns to the ETF, and volume spikes.  Our hunch is that a bigger play was at large here behind the scenes, possibly involving or culminating in the squeezing our of some silver shorts.  Certainly, if it were a drive purely to protect against economic concerns, pertaining for example to Brexit, we would have expected to see the gold markets move in similar fashion.

Thursday, June 30, 2016

Silver is Golden ... or Gold has Lost its Luster (for today)

The last 2 days have been pretty good to silver's ETF (SLV) and pretty ordinary for gold ETF (GLD).  
Gold and silver, often joined at the hip, have disconnected from a price perspective ... and there's some interesting trading at the center of it.  Overall, silver is showing gold who's boss, disconnecting from gold for a 4.6% gain over the last two days.  

Is somebody (or some firm) keen on silver and not so keen on gold, or might a barrier have been tested on an option expiring at quarter-end?

We just moved into quarter-end, and both GLD and SLV moved slightly higher into the 4 pm close, on some synchronized, high volume (right around 3:59 pm).  

But perhaps the 3:33 pm move, unique to silver, (on high volume) is interesting.  Silver hits a peak at 3:33 pm, so perhaps a barrier was tested, say on a knock-in knock-out option.

You can see the additional volume spike in the lower silver graph -- but not in the gold above -- just before the close.

And this graph zooms in on the price movement (up) on the very short infusion of interest in the silver market at 3:33 pm today. It then losing some of its gains before pushing higher again into the close at 4 pm.

Graphs courtesy of Bloomberg LP.

Thursday, June 23, 2016

Bank Stress Tests and the Problem of Ignoring Reality

“Too large a proportion of recent "mathematical" economics are mere concoctions, as imprecise as the initial assumptions they rest on, which allow the author to lose sight of the complexities and interdependencies of the real world in a maze of pretentious and unhelpful symbols.
                                                                                        - John Maynard Keynes

The 2011 European Bank stress tests were largely held in disregard.  They had managed to assume away the implications of a chief risk held by the banks being tested – that countries within the EU could default – culminating in several banks easily passing the tests, only to fail soon thereafter.

The results were released in July 2011, with Dexia and Bankia and the Cypriot banks passing and sometimes easily passing the tests. Dexia failed in October 2011. Bankia survived a little while longer, before being nationalized in May 2012. The Cypriot banks never triggered any kind of concerns among the key monitoring agencies, the EU, EBA, IMF or BIS, well, not before the Cypriot banking collapse.

The editorial board at Bloomberg View just put out a piece on why the US Fed's bank tests lack credibility.  Same problem, here: a lack of basis in reality:
"...the simulation [being run] is a far cry from what happens in a real crisis. It doesn't fully capture how contagion can afflict many of a bank's counterparties at once, magnifying losses many times over. It also assumes that a thin minimum layer of equity capital -- just $4 per $100 in assets -- would be enough to maintain the market's confidence in a bank's solvency. These flaws make a passing grade almost meaningless."
Reality is very different, and modeling behavior in a stressed environment is necessarily a different process from modeling a normal environment, as what was previously uncorrelated or even inversely correlated can suddenly become correlated ... as the economic principles break down and legal rules change.

We're not saying this is easy – but there's little comfort to be gained in performing a test if that test fails to capture the harsh reality that, in times of crisis, our (joint) behavior itself will compromise the predictive value of the theoretical process we're modeling.  

Perhaps a picture will say it best:

Tuesday, June 21, 2016

GFC 2.0 – Could it Happen Again?

We returned recently from an enjoyable and enlightening trip to Australia.

This post covers some of the recurring themes that emerged from our discussions Down Under. Given NY’s central positioning in the "GFC" (Australia’s initialism for the Global Financial Crisis) and so many of the subsequent reform efforts, the Aussies were curious to hear our view on whether it can happen again. 

With assistance from some graphics and helpful references, we are going to try to answer this question in a short-ish blog. 

A recent post by Bruce MacEwen over at Legal Business does a solid job of summarizing a number of indicators suggesting that economies across the globe are failing to respond to monetary stimulus efforts as central bankers would have hoped, and we were asked about many of these same issues. MacEwen ends his post: “I submit that we have positive confirmation of that hypothesis [Growth is Dead] and that our attention has to turn now, if it hasn't already, to the 'Now What?’” 

Rather than focusing on what might precipitate a GFC 2 – Mohammed El-Erian recently posted some thoughts on this here – we focus on what has been happening, and whether we might be particularly vulnerable to a shock, major or minor. 

In short, the Fed’s response to the first GFC was to expand the monetary base in support of financial asset prices: the "Greenspan Put" which has been handed down to Bernanke and then on to Yellen: 

The emerging narrative is that Central Banks around the globe have in quick succession reduced borrowing costs to record lows (over $10 trillion in negative-yielding sovereign debt), stimulating monetary supplies as a temporary measure to buy time and allow economies to recover from the shock of 2008. However, politicians have typically not had the stomach to implement the structural fiscal reforms required for sustainable economic growth … and have simply used the liquidity injection from central banks to borrow additional cash to fund deficits rather than cut benefits or restructure meaningfully. 

Furthermore, the other (some would say main) engine of economic growth – private-sector corporations – have more generally retreated from capital investment that would normally be conducive to economic growth. This pullback can be attributed to a range of reasons, from repairing their own balance sheets to an uncertainty in the economic environment that has culminated in their being conservative in their capital planning. The net effect has been an increase in system-wide leverage, with global debt rising to ~240% of GDP at the end of 2014 (from ~200% pre-GFC).

US corporate debt has climbed as earnings have stagnated: 

Over at Casey Research they highlight that (non-financial) corporate debt growth is outpacing GDP growth and has now eclipsed the debt-to-GDP ratios seen in each of the past three US recessions. This is not to say it makes another GFC imminent, as the lead time between the increase in corporate debt relative to GDP and previous recessions has varied.  Rather, it simply highlights that not much has improved from previous cycles with regard to the amount of leverage in the system. 

Now, one might argue that the increase in leverage / debt loads would be sustainable if sovereigns or corporations were taking advantage of record low yields to invest in growth via infrastructure projects or R&D, which would likely be the policymakers’ preference. 

However, instead of capitalizing on low borrowing costs to invest in growth, borrowing cheaply has allowed them to maintain a certain level of politically "easy" spending, enabling them to delay making the hard choices.   As for corporations’ use of their increased borrowings, Bloomberg’s Matt Levine will often tell us that “people are worried about stock buybacks”... This suboptimal use of borrowings, at least from the perspective of driving revenue growth, has been among the factors leading ratings agencies to downgrade their assessments of corporations’ ability to repay their increasing debt burdens.  Only two companies remain with AAA ratings from S&P.

Some may then argue that since the GFC, regulators have learned the lessons of what precipitated the crisis. They have worked to stabilize the financial system through increased scrutiny of banks’ activities, such as the Volcker Rule, and capital planning through annual stress tests such as CCAR – and this rather looks to continue to increase bank’s market risk capital requirements by roughly 40% from pre-crisis levels. However, John Kay’s “Other People’s Money” argues that while the extent of regulation has increased, it is an expansion of a flawed methodology and does not address the fundamental issues within the banking sector: so these capital increases are unlikely to save us. 

Further, even if regulators do get the house in order for individual banks, Adair Turner’s “Between Debt and the Devil” argues that one should think of debt as a negative externality akin to pollution. That is, while it may be rational for an individual borrower and lender to come to terms, one must consider the overall amount of leverage in the system, which is not something we are aware of regulators explicitly controlling (yes, the Fed has attempted to limit US banks from underwriting / syndicating leveraged loans where resulting leverage would be greater than 6x EBITDA, though that has simply pushed the underwriting to shadow banks / foreign regulators banks such that the impact on overall system leverage is doubtful). We have only seen individual bank stress tests, and some macro-prudential initiatives around housing markets from our Antipodean friends – so even if banks are individually well capitalized, which we previously said they may not be, it is the overall leverage across the system that should concern us. 

With tepid growth across most of the developed world, corporate and government balance sheets more levered than any time before, and interest rates already at historic lows, central banks may have few levers left to battle any further deterioration in economic performance, regardless of the drivers. And drivers there are, from consumer debt growing in worrisome fashion, to debt being sold to insure banks against rogue trades, to one-off securitizations being done to the tune of $6 billion. And the list goes on, in addition to El-Erian's factors mentioned above.

If we agree that our central banks may not be well positioned to play as formidable a role, we would have to hope that structural reforms are in place to allow private institutions and individuals to step in.  And that, too, seems hardly to have been corrected since the GFC with, among other things, self-perpetuating vicious cycles still being a problem – in the pricing and rating of securities – during a stressed environment or a liquidity event.  

Outside of the central banks, we don't seem yet to have a functioning correction mechanism.  So, when asked whether it can happen again, our response has been: "We hope not, but what could possibly go wrong?”