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. Read more opinion SHARE THIS ARTICLE Share Tweet Post Email

Bribes

We talk a lot around here about insider trading. One thing that I often say is that insider trading is not about fairness, it is about theft. Whenever an insider trading case is announced, the prosecutors will make a little speech about how financial markets have to be a level playing field, and how the insider traders are cheaters who got the answers before they took the test, but it is all nonsense. Financial markets are not a level playing field; some people will always have faster computers or better resources or more money to spend on research than others, and they should have incentives to find out information that other people don’t have. But more important, the level-playing-field stuff is just not the law. The law doesn’t say that any time you trade on material nonpublic information it’s illegal. The law, to oversimplify a complicated area, makes it illegal to trade on material nonpublic information that you obtained in violation of a duty to someone: It’s illegal for corporate executives to trade on corporate information for their private gain, or to give that information to their buddies in exchange for a personal benefit, or for outsiders to obtain information in confidence and then betray that confidence by trading on it. The real issue is never whether the trading was unfair to the people on the other side; it’s whether the information was misappropriated from its rightful owners.

People continually find this odd, but it is not really an oddity of insider trading law. It’s pretty normal. The deep point here is that the law is pretty good at protecting property interests, but not so good at protecting fairness. If there’s a thing, and someone owns it, and you take it, the law can deal with that: It’s relatively straightforward to figure out what happened and explain why it was wrong and identify the victim and assign blame to the perpetrator and so forth. Fairness is a much harder concept to pin down and enforce; my “unfair advantage” might be your “deserved reward for hard work and innate skill.” What’s odd is not that insider trading law is about theft; what’s odd is that it almost looks like it might be about fairness, and that people think it is.

Yesterday federal prosecutors brought a big criminal case against a bunch of wealthy people accused of paying bribes to get their children into colleges. They were clients of a college counselor named William Rick Singer, whose services included (1) bribing SAT and ACT exam administrators to let someone else take the kids’ exams for them and (2) bribing coaches and administrators “to facilitate the admission of students to elite universities under the guise of being recruited as athletes.” The clients would give money either to the coaches personally or to their athletic programs, all disguised as donations to Singer’s fake charity, and in exchange the coaches would pretend to want the clients’ kids on their teams and pull strings to get them admitted. The FBI investigation was code-named “ Operation Varsity Blues.”

Here is one thing that U.S. Attorney Andrew Lelling said in announcing the charges:

“There can be no separate college admissions system for the wealthy, and I'll add that there will not be a separate criminal justice system either.”

Level playing field! Here is another thing he said less than a minute later:

“We’re not talking about donating a building so that a school’s more likely to take your son or your daughter. We’re talking about deception and fraud.”

There can be no separate college admissions system for the wealthy, except for the extremely well-known one where you donate a building in exchange for getting your kid in! “Lol just donate a building like a real rich person,” the U.S. Attorney almost said. Josh Barro’s analysis on Twitter is exactly right:

The admissions slots were stolen from the colleges and resold on the black market. Which is a crime, for good reason. We don’t have to act like there wasn’t a legal, primary market for the admissions slots already. I think the key is not to understand this as a crime against other applicants, or the public, or “fairness.” It’s a crime against the schools.

It is not about fairness; it is about theft. Selective colleges have admissions spots that they want to award in particular ways. They want to award some based on academic factors; they want to award others based on athletic skill; they want to award others in exchange for cash, but—and this is crucial—really a whole lot of cash. Buildings are not cheap. Here’s education journalist Dana Goldstein on Twitter:

A few months ago I was interviewing a college admissions coach who told me the following about how big of a donation it takes to get a child into an Ivy no questions asked: "There’s a certain magic number. It’s way higher than people think: $10 million.”

The numbers in the criminal complaint are way lower than that—generally hundreds of thousands of dollars —and of course they went to corrupt coaches and test proctors and counselors, not to the schools themselves. Also, even when colleges award admissions spots in exchange for cash, they’ll never say they’re doing that; the parent’s generous financial support is one input into a holistic evaluation of etc. etc. etc., not a direct quid pro quo. Like so many things, it is an aristocratic economy of gifts and relationships, not a grubby transaction. The bribery scheme devalued the asset not only by stealing it and re-selling it for less than it was worth, but also by being so explicitly commercial.

Or here’s how Singer described it to one parent:

Okay, so, who we are-- what we do is we help the wealthiest families in the U.S. get their kids into school …. Every year there are-- is a group of families, especially where I am right now in the Bay Area, Palo Alto, I just flew in. That they want guarantees, they want this thing done. They don’t want to be messing around with this thing. And so they want in at certain schools. So I did 761 what I would call, “side doors.” There is a front door which means you get in on your own. The back door is through institutional advancement, which is ten times as much money. And I’ve created this side door in. Because the back door, when you go through institutional advancement, as you know, everybody’s got a friend of a friend, who knows somebody who knows somebody but there’s no guarantee, they’re just gonna give you a second look. My families want a guarantee.

The back door—“institutional advancement,” i.e., giving colleges tons of money—is fine, not because it is “fair,” but because the owner of the asset gets to decide the conditions of its sale. (The fairness of the front door is debatable too, by the way.) The side door is wire fraud, not because it is “unfair”—Singer says here that it’s one-tenth the price of the back door, which kind of seems fairer—but because consultants and coaches are misappropriating the asset and selling it for their own benefit. The law doesn’t protect fairness; it protects property.

Anyway the complaint against the parents is 204 pages long and consistently hilarious and horrifying; the FBI tapped Singer’s phone and eventually got him to cooperate, meaning that there are just so many tapes. This might be the worst, with a prominent lawyer (!) named Gordon Caplan (“CW-1” is Singer):

CAPLAN It’s just you and me. Is that kosher? I mean, can we? CW-1 Absolutely, I do it all the time man. I do it all the time for families and then we take college classes for kids, you know, online to raise their GPA. Because again, it’s not, nobody knows who you are ’cause you’re, you don’t take a, there is nothing that, you know, is filmed when you take your test and everything, that’s what’s so great about it. So that’s why I asked. CAPLAN Is, let me put it differently, if somebody catches this, what happens? CW-1 The only one who can catch it is if you guys tell somebody. CAPLAN I am not going to tell anybody. CW-1 Well (laughing) CAPLAN (laughing) CW-1 Neither am I. And, neither am I.

Yeah you know who will tell someone? The FBI agent listening to that wiretap. (Laughing.) Also pretty bad is that, once Singer started cooperating, the FBI had him go back and call all his old customers and recap their crimes to them on tape:

CW-1 Okay. Excuse me. So my-- so my foundation is getting audited now. E. HENRIQUEZ Oh. CW-1 Uh-- E. HENRIQUEZ Well, that sucks. CW-1 Right. And they’re going back, like they always do. E. HENRIQUEZ Yeah. CW-1 Pretty normal. So they’re taking a look at all my payments. So they asked me about the large sums of money that came in from you guys. E. HENRIQUEZ Okay. CW-1 And so, essentially— E. HENRIQUEZ For all the good deeds that you do. CW-1 Absolutely. So, of course, I didn’t say anything-- you know, I’m not gonna tell the IRS that, you know, [CW-2] took the test for [your eldest daughter] or that Gordie— E. HENRIQUEZ Right. Yeah. CW-1 --or that Gordie-- you know, we paid— E. HENRIQUEZ Like-- Yeah. CW-1 --Gordie to help her get into Georgetown,right? E. HENRIQUEZ Right. CW-1 So I just want to make sure that you and I are on the same page— E. HENRIQUEZ Okay. CW-1 --in case they were to call. E. HENRIQUEZ So what’s your story? CW-1 So my story is, essentially, that you gave your money to our foundation to help underserved kids. E. HENRIQUEZ You-- Of course. CW-1 And— E. HENRIQUEZ Those kids have to go to school. CW-1 Absolutely.

So, one, never do a call like this. As Ken White tweeted: “WHEN SOMEONE CALLS AND SAYS ‘OH HAI REMEMBER THAT FRAUD WE DID LAST YEAR SHALL WE DO IT AGAIN’ YOU HANG UP.” But also, the way that Singer’s scheme worked was that the bribes were paid to his fake charitable foundation, which had the benefit not only of disguising what was going on but also of letting the parents take tax deductions for their bribes. I suppose this is objectionable, but it’s worth pointing out that if you donate a building to a college that is also tax-deductible. You did it out of pure philanthropy and no goods or services were exchanged for the donation. Certainly there was no transaction involved.

SSG

If you had the ability to pick stocks that go up, what would be the best way to monetize that ability? The two main answers are:

Use it: Invest your money in the stocks that go up and then, when they go up, keep the money; or Sell it: Raise money from outside investors, invest their money in the stocks, and then, when they go up, give the investors the profits and take a fee for yourself.

Obviously in most cases the correct answer is “both”: You raise money from outsiders and charge them fees, and invest your own money alongside them, as almost all hedge fund managers do. But that’s mostly because, in most cases, you start with a finite amount of money. If you have $100 in your checking account and the ability to pick stocks, you are going to make more money by selling it than by using it yourself. (Assuming that you also have the ability to raise money, of course.) If you have $10 million in your checking account and the ability to pick stocks, that is probably still true, though now your own money will be more of a contributor.

But if you have $10 billion in your checking account and the ability to pick stocks, investing your own money will probably be more lucrative than investing for someone else. Doing both might still be more lucrative than doing only one, but maybe not: Maybe your particular stock-picking ability has capacity constraints (maybe you are only good at picking small-cap stocks or trading special situations), and so you can only work with $10 billion at a time. Maybe the hassle and compliance costs of dealing with clients aren’t worth the extra money it brings in. And so in fact you occasionally see really big and successful hedge fund managers close their funds to outside money: Their skill only works on a certain amount of money, and they can invest that amount of their own money, so why share the skill with outsiders?

Goldman Sachs Group Inc.’s special situations group (usually called “SSG”) isn’t really in the business of picking stocks, but the basic analysis applies. It’s in the business of sitting around and identifying weird ways to make money, and then going and doing them. It “has invested the bank’s own money in Asian property, African startups and troubled U.S. retailers, among other ventures,” it runs about $30 billion, “and it remains one of the most profitable businesses at Goldman.” If you had to pick any business at any Wall Street bank that has demonstrated actual skill at picking investments that go up, SSG would be high on the list. Also:

Goldman plans to raise outside money for its special-situations group, according to people familiar with the matter. Also under discussion is a broader reorganization of the firm’s various private investing activities into a new unit that would seek to raise new funds across a variety of strategies, the people said. ... “Based on our track record, there is an opportunity to raise additional third-party funds across equity, credit and real estate,” Goldman Chief Executive David Solomon told analysts earlier this year. “We have a world-class alternative investing franchise, which has generated strong returns over three decades [and] presents us with extraordinary opportunities to partner with clients to invest their capital alongside our own.”

It seems plausible—though hard to say definitively—that Goldman’s capacity to find “its own” money to invest in SSG is more or less unlimited (it has a $930 billion balance sheet), while the capacity of SSG’s actual strategies to use that money is limited (it’s all, you know, special situations). So this looks more or less like a choice by Goldman to monetize its skill in doing SSG investments, at least at the margin, by selling it instead of using it for itself.

Why would Goldman do that? (Disclosure, I used to work at Goldman, but I have no real idea what the answer is.) There is a simplest and worst and most cynical answer, which is something like: Goldman doesn’t really think that skill is very valuable—it doesn’t think that SSG will generate large reliable returns in the future—and so figures selling it (for fees) will be better than keeping it (for returns). There is a more sympathetic variant on that answer, which is that Goldman thinks that the skill is valuable but risky, and would prefer to hedge that risk by selling some of the upside and downside to clients. That’s a perfectly sensible thing to do; it is maybe more risk-averse than you’d expect given Goldman’s, and SSG’s, reputation, but perhaps it is part of Goldman’s transition from a firm run by traders to one run by more conservative and client-focused bankers like Solomon.

There are answers that involve client service. Maybe Goldman looked at SSG and said: Look, this skill is a good thing, and it is good that we have captured it for ourselves, but really we should sell it to our clients not because that is more lucrative—it is less lucrative—but because we want our clients to be happy. This could be a matter of pure client-focused altruism (implausible), or it could be a matter of holistic client service and cross-selling (“long-term greedy”): If you give your clients a good opportunity in the (lucrative but relatively small) SSG business, then they will be grateful and will award you more, like, mergers-and-acquisitions mandates or trading commissions or assets to manage in your other investing businesses.

There are regulatory answers, I guess? There is a widespread sense that managing money for clients is a good thing for banks to do, but “gambling with their own money” is a bad thing to do. Investing client money is certainly less capital-intensive. This analysis is complicated a bit by the fact that the Volcker Rule, which is meant to constrain banks from gambling with their own money, is a very strange rule: It actually gives banks more flexibility to do certain kinds of long-term merchant-banking-type activity with their own money than to run hedge funds and private equity firms with a mix of inside and outside money. Still one assumes that Goldman can figure this stuff out, and the overall environment does favor the shift.

There is a shareholder-value answer, which is that merging SSG and other investing groups into a client-facing asset-management business “will create a unit resembling a smaller version of KKR & Co. or Blackstone that executives hope will be better understood and more richly valued by shareholders”: “Shareholders today value steady, low-risk businesses like money management.” This is a variation on the risk-aversion answer: Even if Goldman, culturally, likes risk and thinks it can make more money investing its own money than someone else’s, the market will discount those activities differently, and Goldman would prefer a higher stock price (based on more reliable fee-based earnings) over higher but less certain future profits.

I don’t know! All of these things are plausible and of course it can be a mix. But they all have an end-of-an-era feel to them. There is a real pre-crisis feel to Goldman Sachs running a business investing its own money in strange and risky and unconstrained ways. SSG has always had a certain mystique, and you would not have described it as a “steady, low-risk businesses like money management.” But that seems to be its future.

Mafias

Hahaha data science:

Riley Newman, a former head of data science at Airbnb, set out in mid-2017 to raise a venture capital fund that would invest in a multitude of tech trends. But he quickly realized that potential investors were not interested in that kind of fund. Instead, all they wanted to hear about were his former Airbnb colleagues and whether they might start their own companies. “It was, ‘Yeah, all that stuff is fine, but Airbnb, right?’” Mr. Newman, 36, said. “Airbnb was where we had a competitive edge on the market.” So Mr. Newman and his partners at Wave Capital adjusted their pitch: They said they were creating a fund to invest specifically in Airbnb employees who were planning to leave the company to become entrepreneurs. It worked.

I like to imagine that the first iteration of this fund was, like, “with my vast experience in data science, I will apply cutting-edge statistical techniques to identify the factors that are most likely to predict success in a founder or business.” And the second was like: “If someone has ‘Airbnb’ on their resume I will give them money.” Which do you think is a better approach? If you were a data scientist at the top of your field, would you be a little annoyed about ending up with this, um, one-binary-variable model? “When you look at V.C., there is a lot of pattern matching and trying to act on that,” says a former Uber employee who had an easy time raising money for his new startup, “so if you worked at Uber, you must be O.K.” I dunno, “pattern matching,” to me, suggests matching on more than one trait; it seems a rather grandiose way to describe “looking for Uber on a resume.”

Those quotes are from this fascinating Erin Griffith story about “The Rise of Silicon Valley’s New Mafias,” the networks of alumni of the current generation of big tech companies that are going out and founding, or funding, or both, the next generation of startups. I particularly commend to you two historical photographs of previous generations of Silicon Valley mafias, one of the founders of Fairchild Semiconductor in the 1950s and the other of the “PayPal Mafia” in the 2000s. Both are all-male (pattern matching!), both display an astonishing variety of intense expressions, one (PayPal) displays an astonishing variety of outfits (tracksuits! vests! fedoras!) (the Fairchild guys are all in suits), and both are wonderful reflections of their eras.

Things happen

When Elon Musk Tried to Destroy a Tesla Whistleblower. Deutsche Bank Faces Merger Pushback as 30,000 Jobs Seen at Risk. Real-Estate Startups Try Their Hand at Private-Equity Investing. Speculators to be banned from market for biofuel credits. Regulator Slams Wells Fargo After CEO Testifies to Congress. A CDS orphaning. How GE Built Up and Wrote Down $22 Billion in Assets. MoviePass Owner Helios & Matheson to Restate Financial Results. Trump ponders ending case against Huawei’s Meng Wanzhou. Billionaire Nelson Peltz Joins Aurora Cannabis as Strategic Adviser. The ECB after Draghi: ‘You need an actor who can act fast.’ De Rothschilds to Take Swiss Bank Private in $98 Million Bid. America’s Most Hated Home Loan Is Staging a Comeback. German yachtsman inflates trousers to survive 3 hours in sea. How the Danish Justin Bieber Made It Big in China.

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