Slouching Towards Wall Street… Notes for the Week Ending Friday, 20 May 2011
Fans of Gilbert & Sullivan will recall the scene from “The Mikado” where the lovelorn Nanki-Poo expresses “modified rapture” at learning that his beloved Yum-Yum — destined to be married to another — does not love her arranged husband-to-be. Sometimes we must take what we can get.
Your humble Scrivener appears to have missed the boat, despite having received an e-mail from the Office of Transport (no kidding) advising that we were short-listed as “nominated candidates for the impending Rapture.” Among items flagged in our file were possible “agnostic views,” which are “only borderline,” and thus not sufficient to prevent us being short-listed for the Rapture. If you are reading this Screed — and as we have written it — clearly we have both missed the Heavenly boat.
This is perhaps the most publicity-worthy item that did not turn out as anticipated this week. Here’s another:
Scientists don’t always get it right. The latest issue of New Scientist magazine (21 May, “When Science Gets It Wrong”) says we keep coming across things we thought we knew, and have discovered we did not. We won’t dwell on the whole fascinating article, but a side note (“Flaw Detected In Extinction Rates”) observes that “the destruction of nature is driving species to extinction — but perhaps not as rapidly as has been thought.” Scientists at UCLA, and at Yat-sen University in Guangzhou, China, believe they have come up with a more accurate method of measuring species extinction rates than the one commonly relied on. The article points out that, unlike in climate change studies, there exists no intergovernmental scientific advisory panel on biodiversity and conservation.
The researchers performed extinction rate projections for certain well-documented species. Using their new approach, they found that the traditional measurement “gave extinction rates that were between 83 and 165 percent higher than those their method produced.” The policy implications of this type of scientific inquiry become increasingly important as the volume of pure science around us diminishes. With the belt now so tight that it restricts breathing, one is tempted to question all scientific research.
As Hedgeye’s star healthcare sector analyst Tom Tobin pointed out in last week’s “Healthcaster” (19 May, “Deficit Dialogue: NIH Hits the Debt Ceiling”) government funding of basic biomedical research is “holding well below the run rate for 2009 & 2010,” and “commentary from NIH-funded scientists regarding the grant approval process continues to deteriorate.” It appears that funding is now only provided to the top 8% of ranked new grant applications — a 20% decrease in government funding to the basic research that drives medical advances.
In this environment, we are tempted to ask not, what did the funded research discover, but what were the researchers setting out to prove, that enabled them to win funding? Clearly, the more restrictive government funding for basic research becomes, the more the process is subject to political pressure. We have all read the articles about medical professionals — and even retired military top brass — selling their opinions to corporate America. In today’s world one no longer needs to be a conspiracy theorist to believe the government is telling scientific researchers what they must prove in order to receive funding.
The article quotes one Danish scientist saying scientists working for conservation groups use a standard model which they know gives high estimated extinction rates. This puts science at the beck and call of warring political agendas. The stakes may be unacceptably high — in the case of getting conservation science wrong, we risk losing polar bears and dolphins. In the case of getting climate science wrong, we risk destroying ourselves. Broad scientific consensus is that human activity has a measurable effect on the global environment. To reject this notion out of hand is quite literally to risk the future of the human race. Which is why we can not comprehend economic arguments that say we should allow industry to continue polluting the environment until we get “proof.” As any scientist will tell you, scientific consensus, broadly accepted principles, and robust workable theories are the foundation of much of what goes on in both research and the applied sciences. Scientific proof, though, is highly elusive. Ultimately, the only proof that we are destroying the environment will be when the last living organism dies. At least then we will know what policies to adopt.
Developments in the news this week include the Carlyle group engaging in what we consider some justified whining (Financial Times, 16 May, “Carlyle Founder Defends Strategy On Troubled China Investments”), and the no doubt shocking (to himself, anyway) discovery that former trader Zvi Goffer is actually a person of interest.
As we observed last week, the Carlyle Group’s involvement in what looked like questionable Chinese investments was on a small dollar scale, relative to the Group’s overall portfolio. This is as good an opportunity as any to remind our readers that regulation is based on a notion of Reasonableness: what should a firm reasonably be expected to do to protect its investors? What procedures are reasonably designed to prevent improper activity? In that light, it is reasonable for a portfolio manager with $100 million under management to be extremely diligent about an $80 million investment. It is less reasonable to expect the same degree of scrutiny when the $80 million is part of a $3 billion portfolio — and less reasonable still when set against total assets under management of $106 billion. (A correction is in order: last week we wrote that Carlyle has over $90 billion in assets under management. Strictly speaking, $106 billion is “over $90 billion.” We apologize for using an outdated figure.)
We agree with Carlyle founder David Rubenstein’s assessment: the investments in question represent a small part of their Asia portfolio. Carlyle’s plans in China include additional investments, as well as two yuan-denominated funds — a $100 million joint venture fund in Shanghai, and a Beijing-based fund targeted to grow to 5 billion yuan (China Business Daily, 17 May, “Carlyle’s Presence to Increase”). Rubenstein states emphatically that their overall performance in China has been very satisfactory, and we submit the blip in these two small companies demonstrates that the Group has managed to limit its losses while, says Rubenstein, enjoying returns “higher than the average 30 per cent it has made on its investments throughout the world.” Rubenstein noted that 95% of Carlyle’s investments in China have been profitable. Articles about Carlyle’s Chinese losers may be providing the Group the best free advertising they have enjoyed in years.
Elsewhere in the China trade, free publicity may not be as welcome. With the small, for them, Carlyle losses making headlines, we have taken another look at Halter Financial Group, a firm that advertises itself as “Reverse Merger Experts” — their website is “reversemerger.com” — and built a substantial business in merging Chinese companies into US-listed shell corporations. Its website prominently displays a photo slide show of the Halter Financial Summit, held in Shanghai in April, 2010, featuring keynote speaker George Bush, Jr., followed by former Treasury Secretary John Snow and other American and international luminaries. It is too early to tell whether Halter’s operation has been well or poorly managed, or whether the problems in the firm’s client companies are common to companies in this market sector — but it’s not too early to delve into what’s going on behind the scenes.
In the latest development, a Halter company is the target of securities fraud litigation. The company, Shengdatech, filed an SEC form 8K on Friday announcing that it was being delisted from the NASDAQ market for failure to maintain listing requirements. Shengdatech is in the business of manufacturing and marketing nano precipitated calcium carbonate products in China. A profile in Bloomberg BusinessWeek lists Tim Halter, chairman and CEO of Halter Financial, as former chief executive of Shangdatech. While some investor websites continue to tie him to the company, we would not find Halter’s name on current filings.
Investor class action law firm Milberg LLP has filed a class action alleging that “ShengdaTech’s management team did not disclose to shareholders that it was operating with material deficiencies in the system of internal control over its financial reporting.” This is apparently not an isolated incident, as reported earlier this year (Barron’s, 4 March, “Halters Agree To SEC’s Cease And Desist”) the shell corporation banking operation was linked to a company called Stock Transfer Corp, “providing services for many China companies funded by Halter Financial.” Tim Halter’s father and brother ran Stock Transfer. Halter senior allegedly stole $2.7 million in client company funds — a theft that was discovered by his son, who fired his father and repaid the clients. The SEC sanctioned the firm, and Halter, Jr. for failure to properly safeguard client funds. The firm agreed to the sanction and paid a small fine.
Stories keep appearing about problems with small-cap Chinese stocks, and the Halter Financial name keeps hovering at the periphery. This is partly because Halter has created and promoted indexes of Chinese stocks. But a large number of the companies in these indexes are Halter clients. On closer scrutiny, these indexes raise further questions. As we wrote almost two years ago (“Slouching,” 21 August 2009, “The China Syndrome”) Halter’s indexes are accessible to investors through ETFs, and because of the way ETF portfolios are reported, it may be impossible to determine how much Halter-spawned stock is held in these ETFs at any given time. Or, for that matter, whether ETF trades are the primary reasons for trading in these stocks. Or the only reason.
In other news, after telling an alleged co-insider trader that “they are only looking at the higher-ups,” and he had nothing to fear from the Galleon arrests (Wall Street Journal, 16 May, “Insider Trial Set To Begin”) Zvi (“Octopussy”) Goffer finds himself in the unenviable position not only of being a target of federal prosecutors, but of having his name routinely mispronounced in media reporting. For the record, Mr. Goffer’s first name, Zvi, is pronounced “Tsvee.” It’s a Hebrew name that means “Deer.” Mr. Goffer may wish he were as fleet of foot, now that hunting season is in full swing.
As to the hunters, in its effort to keep up with rulemaking as required under Dodd-Frankenstein, the SEC has proposed a change to Rule 205-3 definition of Qualified Investors. The proposed change — which is decades overdue — would raise financial suitability standards for individuals who invest in hedge funds and private equity funds. One change would double the amount required to be invested — from $1 million to $2 million — before a manager can charge a management and success fee. Hedge fund managers’ altruism extends to getting their names on hospitals and middle schools, but not to investing poor people’s money for free. This rule change would pare back cash available to private fund managers. This is legitimate regulatory push-back against the retailization of complex and opaque investment vehicles. This rule change may be partly intended to shrink the hedge fund industry, though we think it more likely that funds and their legal counsel have already planned alternative ways of getting paid something approaching their 2 and 20.
In the rule proposal, the SEC gets into the nitty-gritty of the investor’s asset mix. The proposal also excludes the value of the investor’s primary residence from the net worth calculation. We find it frankly astonishing that an investor’s residence was ever included in the mix. As we have pointed out in past Screeds, retail brokerage managers review customer accounts to make sure they are not using home equity to finance stock purchases. If buying an instantly disposable and price transparent liquid asset (a NYSE-listed common stock) is considered so high that individual’s house must be protected, what social policy philosophy allows the same investors to risk that house to fund a capital call from their private equity investment?
Needless to say, industry practitioners have submitted the usual comments to the SEC complaining that private investors will be disadvantaged by being shut out of this market. (In case you are new to the Screed, what is really being disadvantaged is fund managers’ ability to earn fees.) But the comments we have seen are half-hearted. Many of the Americans who used to be small investors are no longer homeowners. And with the outlook for home prices now dismal to dreadful, many would-be retail investors are facing flat to negative homeowner equity. The SEC’s proposal at this point is tantamount to shutting the barn door after the farm has been repossessed. Is this the aggressive face of the “new SEC”?
The Rajaratam verdict is being hailed as a sea change in financial regulation and being touted as the first major Wall Street case to make extensive use of the tools prosecutors have traditionally employed in going after organized crime. These same tools — wiretaps and photo surveillance — were employed when the FBI surveilled small brokerage firms in the 1990’s. This was directly in connection with investigations into organized crime and resulted in convictions of a number of “crossover” Wall Street figures — organized crime types who fronted as Wall Street salesmen and executives. One of the more visible headlines was the conviction of Stuart Winkler, former CFO of New York brokerage firm A.S. Goldmen, who was found guilty of putting out a contract on the Manhattan Supreme Court judge overseeing his case.
Jailed on stock fraud charges, Winkler reportedly enlisted a fellow inmate to kill judge Leslie Crocker Snyder because she refused him bail. The two were roommates at the Manhattan Detention Complex, a downtown holding facility known affectionately as “The Tombs.” Unfortunately for Winkler, the inmate was taping their conversations, after striking a deal with law enforcement.
As part of their broader investigation of Russian mob activities in the financial sector, the FBI reportedly ran wiretaps on a number of small brokerage offices that were reportedly staffed by large numbers of unregistered and highly aggressive telephone salesmen. We have to imagine that listening in on the sales calls would have provided Probable Cause in a number of cases. There were brokerage offices where one or two people actually had brokerage licenses. The General Securities Representative license is awarded upon passing the “Series 7” examination. In the 1990’s this was administered by the NASD, the self-regulatory organization that was the forerunner to FINRA. Since the Series 7 required a fair amount of knowledge — and a modest command of the English language was an unspoken prerequisite — there were a few individuals who earned a nice living by taking the licensing exams for other people, a cottage industry that ran successfully well into the 1990’s.
We are trying to imagine the reaction of FBI agents listening in while thirty or forty different voices — with accents ranging from the Outer Boroughs of New York, to Hispanic, to Eastern European — introduced themselves using the same name as they made thousands of cold calls every day.
Today the issue seems to be, not that the Feds have finally gotten tough on Wall Street, but they have returned to the ineluctable conclusion that there’s crime going on here! Was Rajaratnam gearing up to have someone bumped off? We may never know whether there was anything bigger and nastier going on here than financial skullduggery, though as skullduggery goes, we have to say the Rajaratnam case skullduggered a host of major leaguers. If ever there were a Skullduggerers’ Hall of Fame, a number of the players in this matter would clearly make it on the first round.
Still, at the end of the day we think Rajaratnam is a sideshow. Zvi Goffer was right — “they” typically don’t care about folks who only steal a few million, and with what’s going on in the world, the Galleon Follies look like small potatoes. Rajaratnam took every deal that came his way and announced he was greedy for more. Phone transcripts and emails we have seen in the course of the trial make it look like Rajaratnam was running a national advertising campaign in his quest for inside information. He was only slightly less discreet than Vince, the “ShamWow!” salesman. If only he had financed some of these companies, instead of betting against them, he could have had the government declare his hedge fund Too Big to Fail. Instead of looking at jail time he would have been handed a billion or two out of TARP. Rajaratnam appears to be stupider than we thought.
Now For A Really, Really Big Number
Can you imagine if Barack Obama had taken office and deliberately educated and taught the American people about the nature of the financial catastrophe?
Elaborate and well-coordinated misdirection programs — what we call “the Lookaway” — are a standby of governments, who are more likely to change the grammar of national disaster than to address root causes.
One of Latin America’s most important journalists is Brazilian multimedia reporter and commentator Miriam Leitao. Leitao, a daily featured columnist in Brazil’s leading newspaper O Globo, was honored with the Columbia Journalism School’s Cabot medal in 2005 for her “outstanding example of explanatory journalism.” Her new book “Brazilian Saga” is a history of Brazil’s currency and successive governments’ attempts to control inflation. For Americans this may seem an odd topic, but residents and observers of Latin America are used to periodically waking up to a Brave New Currency, just as they often don’t know who will be in the Presidential Palace from one day to the next. Leitao’s book says that between the start of the Cruzado Plan in 1986 (named after the newly introduced currency), and the Real Plan in 1994 (named after another new currency), Brazil’s currency changed its name five times. Our CEO, Keith McCullough, has quoted F.A. Hayek saying governments manipulate people by taking old words and changing their meanings. The flip side is when a government pushes off a crisis by changing what they call it. Masked by the successive name changes, Leitao says Brazil’s currency lost nine zeroes during those years. The Plano Real was introduced in 1994 under President Cardoso — Lula’s predecessor — and finally established longer-term control over inflation. In the course of the fifteen years preceding the Plano Real, Leitao says Brazil suffered cumulative inflation of over thirteen trillion percent. 13,342,346,717,617.70 per cent, to be exact.
Over to you, Mr. Bernanke. In God we trust.
Wish We’d Thought Of This Before They Got DSK
In a rare show of bipartisan unity, New York Republicans Michael Grimm and Peter King have joined with Democrat Edolphus Towns to introduce ground-breaking foreign policy legislation.
House Resolution 1826, if passed into law, will “establish appropriate procedures and sanctions to ensure that unpaid parking fines and penalties owed to New York City by foreign countries are paid.” The proposed mechanism would be to withhold it from assistance funds designated by the US, as reported in the New York Daily News (12 May, “New York Pols Want Cut Of Foreign Aid Withheld From Countries With Outstanding Parking Tickets.”)
Noting that “there’s no such thing as ‘diplomatic immunity’ from paying parking tickets,” the Representatives point out that 289 foreign missions have combined unpaid parking tickets in excess of $16 million. A pretty penny — or euro, as the case may be.
In fact, federal law permits the government to withhold designated foreign aid dollars to cover up to 110% of a foreign government’s unpaid parking tickets in New York City and the District of Columbia. The catch is that the withheld funds are not remitted to the cities, but remain in the federal government’s pocket. We are not sure where this saga will end, but we’re not eager to get into a fight with Vladimir Putin over a parking spot on Second Avenue.
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