Wachtell Lipton

Financial markets are basically about information asymmetries, real and imagined, and financial regulation is largely about limiting those asymmetries to socially acceptable kinds and quantities. A general rule for trading success – perhaps the only useful rule for trading success – is: if you know something that nobody else knows and that will increase the value of a stock, then you should buy that stock! Afterwards, you should tell people. If you know something that will decrease the value of a stock, same thing, but with selling. If you don’t know anything that nobody else knows, index.

If you follow that rule too closely, though, you will end up in jail, as one does. So the trick is to know what kinds of secret information it’s okay for you to trade on, and what kinds it’s not okay for you to trade on. This is actually much harder than most people think it is,* which is why Doug Whitman is on trial.

My favorite category of nonpublic information that it’s maybe okay to trade on is your own intentions. If you wake up and say to yourself “I’m going to buy J.C. Penney stock today,” then right there you have an information advantage: you know something that no one else does.

Of course, who cares? In expectation, (1) you’re poor, so you’re not buying enough JCP stock to push up the price, and (2) you’re stupid, so your opinion of JCP won’t change anyone else’s view on the fair price. But occasionally you – not you you, but the “you” in this sentence – are rich and smart, and then your intentions are actually valuable information. One way you know that they’re valuable information is that stealing them is illegal: if Warren Buffett is secretly planning to buy Lubrizol, and his deputy knows about it, the deputy probably can’t go around buying Lubrizol. Another way to know: when Warren Buffett or Bill Ackman announces a position in a stock, the stock usually goes up.

So: is it okay for Bill Ackman to profit from his knowledge that he wants to buy J.C. Penney stock? Or does he need to tell everyone about his plans before he executes them, so that everyone can adjust their price in light of the knowledge that there’s a big buyer? Obviously you can’t arrest Ackman for insider trading because he traded on his knowledge that he was going to trade. (There are degenerate cases where you can come close.**) But you can argue about whether he owns that information and should therefore be able to profit from it, or whether instead that information should be public so he can’t take advantage of it at the expense of unwitting public investors who would have held out for a higher price if they’d known he was the buyer.

Harvard professor Lucian Bebchuk has a column in DealBook today about how the SEC shouldn’t prevent activists from secretly buying shares in companies. Read more »

There are two competing theories of how companies should be governed; one says that management should have a lot of leeway to do what it thinks is best and shareholders should keep quiet and, if they’re unhappy, maybe sell their shares; the other says that shareholders own the company and anything that stands in the way of their replacing inept or corrupt management is bad. The pro-shareholder side has I guess been having a good run lately, what with Chesapeake bowing to Carl Icahn’s demands to be less evil, and with the performance of the Facebook IPO giving evil governance a bad name, but the let’s-say-anti-shareholder position is pretty well entrenched. And the leading exponents, or at least my favorite exponents,* of that view are the law firm of Wachtell Lipton, which invented the poison pill so that managers wouldn’t have to lose their jobs just because someone else wanted to buy their company and their shareholders wanted to sell it.

So let’s say you’re a CEO, and you want to buy a company, and you negotiate to buy that company for stock so your shareholders have to approve the merger. And let’s say juuuuuust hypothetically that, after you agree on the deal and mail the proxies and set up the vote and are about to complete your grand plan, you find out that the company you’re buying is sort of a piece of shit, and that you didn’t know that when you agreed to buy it. Embarrassing for you. What do you do?

Well presumably you ask your lawyers and when those lawyers happen to be Wachtell Lipton they tell you their favorite thing to tell you, which is, “you have lots of options but FOR GOD’S SAKE LEAVE THE SHAREHOLDERS OUT OF IT.” And if you were Ken Lewis in late November / early December 2008, that’s what you did. You can read here his [new lawyers’] defense of his decision not to tell Bank of America shareholders that Merrill had some massive upcoming losses before they voted to approve the acquisition of Merrill; it basically goes like this: Read more »

  • 23 Jan 2009 at 12:23 PM

Hunting The CDS Demons

Lewis Michael 2.jpgThe latest quest for financial weapons of mass destruction (hint: try looking in Syria) has a concerted push against Credit Default Swaps. Michael Lewis, cranky former banker turned cranker former writer slaps them with a left handed insult or two in The Atlantic last week, and random blogs ranging from The Market Ticker to Deal Journal to the electronic memo press at Wachtell Lipton Rosen & Katz regularly throw up missives bemoaning the very existence of the CDS market.
This from The Market Ticker:

“Naked” CDS, that is, swaps written or purchased not to hedge a bond or other business relationship but instead to speculate on the firm’s fortunes are effectively the same thing as a naked short, in that there are NO boundaries on how many CDS contracts can be written against a firm and by having them cash-settle they amount to nothing more or less than a gambling contract with no limit as to the leverage that can be employed.

We tend to be highly skeptical of any efforts to reduce pricing information. That is effectively what this is. Short selling bans and CDS bans only really reduce information available to the market. It is amazing to argue that credit default swaps (about the only counter balance to the insanity that was rating agency analysis) in the hands of evil hedge funds somehow precipitated the destruction of firms that were otherwise on the soundest of footing. Returning to Mark-To-Myth accounting and abandoning “What My Assets Are Really Worth At The Time Of This Writing” accounting amounts to the same insanity. Anyone who claims that such marks are “unrepresentative because they are at fire sale prices” is merely imposing their long-term price forecasting on accounting policy. We’ve seen how well these long-term forecasters predict prices, so we’d like to pass on that plan, thanks.
What most anti-short, anti-CDS proponents miss is that a firm with sufficient capital, a reputation for transparency and limited spin doctoring shouldn’t have to worry about short-sellers or credit default swaps- or should use the dip caused by such panic to buy back shares and move on. If pricing information on a thinly traded CDS contract somehow swings equity prices in dramatic ways it is because the market gives the disclosures offered up by management and ratings agencies almost no weight. This is exactly as it should be. When you are in a leveraged business, credibility is absolutely essential. Lehman didn’t fail simply because it was heavily leveraged. It failed because no one believed Erin Callan anymore and even a seriously interested party like David Einhorn was so obviously making so much more sense than Erin and the Lehman PR apparatus. Does anyone still doubt that the Lehman at $0.00 was the wrong price for that firm at the time?
Time to face facts. Propping up failed firms by artificially inventing prices (we are looking at you, Treasury) and then removing any ability of the market to contest those marks is Fantasy-Capitalism. We are all for a rich fantasy life. (Without it we wouldn’t have Marcus Schrenker). This said, we’d like it kept out of our Capitalism Cheerios, ‘kay, thanks. The CDS market is effectively the only market that was getting it right in the second half of 2007. Gutting it is a bad, bad idea(tm).