Expert Networks

The KMPG partner at the heart of today's Herbalife/KPMG fiasco was unknown for several hours, until finally his name resurfaced. Per Reuters: "Scott London, a partner at accounting firm KPMG, was the lead auditor for Skechers USA Inc who resigned after allegedly leaking insider information to traders, said Skechers Chief Financial Officer on Tuesday. In an interview, CFO David Weinberg said he was surprised to learn late on Monday from partners at KPMG that London had admitted to the allegations and was leaving the firm."

Oil? Financials? Aerospace? When someone asks who the biggest sources of lobby dollars for DC's politicians-for-purchase are, these are the three usual suspects that come to mind. Some may, therefore, be surprised to learn according to the database kept by OpenSecrets between Pharmaceutical and health product industry, hospital and nursing homes, health professionals and health services, HMOs, or more broadly Pharma/Healthcare/HMO, the total lobby dollars spent between 1998 and 2012 was a staggering $5.3 billion, or nearly three times greater than the second most generous industry: insurance, and well above Oil and Gas at $1.4 billion, and Securities and Investment at $1.0 billion. Is it becoming clearer why the US government has few qualms about unsustainable taxpayer funded healthcare spending, especially when there are so many current benefits accruing to the politicians who see so many billions in benefits from passing lobby-friendly laws now (by which we mean generous taxpayer funding, the bulk of which benefits the healthcare industry's bottom line)? As for the costs: who cares - just dump them on future generations. It's not like anyone expects the $16.7 trillion in US debt to be ever repaid.

You know how we feel about special order-types and expert networks.  I'll save you the long-winded paragraph so you can keep selling AMZN.  Here is an HFT infographic

"They say this is not massive money printing, but first they are wrong; and second, monetary authorities in the United States did not see the crash coming and the unsoundness of the financial system. In fact, right up until the crash they were saying that nothing like what happened could ever happen... This monetary policy, $3 trillion of bond buying in the United States, $3 trillion in Europe and another $2.5 trillion to $3 trillion in Japan, is unprecedented. ... If and when people lose confidence in paper money because of repeated bouts of quantitative easing and zero-percent interest rates—it could happen suddenly and in a ferocious manner in the commodity markets, in gold, possibly in real estate—interest rates could go up at the long end by hundreds of basis points in a very short time. I’m quite concerned as a money manager that we have to manage money, not just for the boundaries of what’s in front of our faces—maybe we’ll have a little tax increase or not, the fiscal cliff, or the stock market might go up or down 10% or 15%—but for a basic shift. The thing that scares me most is significant inflation, which could destroy our society."

Curious why stocks suddenly took on extra water in the past few minutes? This:

• SAC CAPITAL SAID TO PLAN INVESTOR CONFERENCE CALL TOMORROW - BBG
  

As a reminder, SAC is and has been for the past 10 years arguably the largest buyside market maker, and the firm which now that it has no more Expert Networks to lead to "excess alpha" is forced to slam stops in the market, primarily to the upside, and crush all shorts during times of peak shorting. Should SAC be forced to scale its operations lower, one thing is certain: the farce formerly known as the market will look very different than it does now.

Over two years ago, on November 5, 2010, weeks before news broke out that the SEC had caught hedge funds in a massive insider trading scheme involving expert networks, and before the phrase expert network was even mentioned in places away from hedge funds, we wrote an article, titled "Is The SEC's Insider Trading Case Implicating FrontPoint A Sting Operation Aimed At S.A.C. Capital?" that predicted everything that has transpired with SAC since then: we said expert networks would be exposed as the root of virtually all "information arbitrage" alpha by Steve Cohen, more importantly, we exposed various biotech stock trading patterns, where the informational benefits from easily bribable doctors would result in immediate profits courtesy of advance knowledge of Phase 2, 3 and NDA results. Today, we discover not just how deep the SAC insider trading schemes went, but that the profit from such information abuse amounted to hundreds of millions in standalone cases. Adding these together and one can see why Steve Cohen - whose knowledge of these epic inside trading scheme is of course never implied by us: after all, that's what the DOJ, the SEC and the various DA offices are for - was generating 20% returns year after year and able to pocket 3% and 50%.

Slowly, the fund that made "information arbitrage" a household name, and almost singlehandedly created the expert network industry (first exposed on Zero Hedge in 2009 before the broader public had ever heard of them up on Part 1, Part 2 and Part 3 and all of which was summarized in Are Expert Networks About To Be Exposed As The Ringleader In The Biggest Insider Trading Bust In History?) only to watch it go up in insider trading flames (as we warned years prior), and which no regulator had dared to touch for decades, is coming unwound. The latest details in a story which once again began on the pages of Zero Hedge in 2010 come from Bloomberg, where we learn what everyone already knew, namely that when working for Stevie Cohen "it was “understood” that those assigned to give their best trading ideas to founder Steven A. Cohen would provide him with insider information." Because one doesn't generate 10-20% 'Alpha' (a term which no longer has any meaning in a market exposed to have been driven exclusively by insider trading in the pre-New Normal, and entirely by central planning in the post-New Normal era) year after year and charge 3 and 50 for being just smarter. Being first apparently counts too, but cheating beats all.

Every now and then we prefer to sit back and let some of the smartest money speak, especially when said smart money agrees with us. In this case, we hand the podium over to none other than Paul Singer's Elliott Management, which after starting with $1.3 million in 1977 was at $19.8 billion most recently. No expert networks, no high frequency trading, no "information arbitrage", no crony capitalism and pseudo monopolies of scale, and most certainly no bailouts: Singer did it all the old fashioned way: by picking undervalued assets and watching them appreciate. The timing is opportune because while Elliott has much to say about virtually everything in their latest 20 pages Q2 letter, it is the billionaire's sentiment vis-a-vis US Treasury debt that may be most critical, and may be the catalyst that resulted in today's abysmal 10 Year bond auction. To wit: "long-term government debt of the U.S., U.K., Europe and Japan probably will be the worst-performing asset class over the next ten to twenty years. We make this recommendation to our friends: if you own such debt, sell it now. You’ve had a great ride, don’t press your luck. From here it is basically all risk, with very little reward." There is little that can be misinterpreted in the bolded statement. And while many have taken the other side of the Fed over the past 3 years, few have dared to stand against Paul Singer because if there is one person whose opinion matters above most, certainly above that of the Chairsatan, it is his.

Two weeks ago we highlighted the dismal performance (and massively over-crowded momentum factor tilt) of the 2-and-20 crowd relative to a passive equity ETF investment over the past few years. The reality is, in a Central Bank systemically-driven, high correlation, low dispersion world, the herding of hedge fund cats (with expert networks now dead) leaves them massively over-exposed and chasing the same relative returns as their mutual fund index-tracking peers - for fear of the career-limiting (Tilson-esque) miss of the great bull market's next leg. Apropos of this, Goldman's index of the most-widely-held stocks by hedge-funds is back to levels not seen since March 2009 and down a whopping 7.2% in Q2 of this year as all that momentum fades. Interestingly JNJ is the most widely held (by $ amount) short among hedge funds and of course Apple is the most widely held long.

The second Barclays announced its $450 million Libor settlement, it was all over - the lawyers smelled not only blood, but what may be the biggest plaintiff feeding frenzy of all time. Which is why it was only a matter of time: "State attorneys general are jumping into the widening scandal over whether banks tried to manipulate benchmark international lending rates, a move that could open a new front against the top global banks. A handful of state attorneys general said they are looking into whether they have jurisdiction over the banks, and are starting preliminary discussions to determine what kind of impact the conduct involving the Libor rate may have had in their states."

Much has been said about the evil crony capitalism inflicted upon America as a result of PAC, SuperPACs, corporate donations, and just general bribery on behalf of America's corporations in broad terms, and Wall Street in narrow (and Private Equity firms in uber-narrow) terms. But is there an even bigger destabilizing force of "cronyness" in America? According to the WSJ, there well may be: labor unions. Yes: those same entities that are so critical for Obama's reelection campaign that the president abrogated property rights and overturned the entire bankruptcy process in the case of GM and Chrysler, to benefit various forms of organized labor at the expense of evil, evil bondholders (represented on occasion by such even more evil entities as little old grandmas whose retirement money had been invested in GM bonds), appear to have a far greater impact in bribe-facilitated decision-making than previously thought.

Two days ago we made a simple observation: back in September 2011, Weinstein's firm SABA Capital hired one of the key JPMorgan prop traders - Maitland Hudson - who "ran JPMorgan’s proprietary trading of derivatives tied to commercial-mortgage bonds" and whose future job at Saba would "focus on relative value trades" - such as, perhaps, IG9 10 Year versus a basket of tranched trades... Our suggestion was that instead of being a brilliant credit trader as he has been called by Bill Ackman, and his antics while in charge of the DB prop desk certainly put theory in jeopardy, perhaps Weinstein is merely a wonderful headhunter: one who knows just whom to hire and when (kinda like Steve Cohen hiring key Pharmaceutical company R&D personnel in a perfectly legal transaction now that expert networks are done, but that is a topic for another day).

The dream of virtually anyone who has ever traded even one share of stock has always been to generate above market returns, also known as alpha, preferably in a long-term horizon. Why? Because those who manage to return 30%, 20% even 10% above the S&P over the long run, become, all else equal (expert networks and collocated flow-frontrunning HFT boxes aside), legendary investors in the eyes of the general public, which brings the ancillary benefits of fame and fortune (usually in the form of 2 and 20). This is the ultimate goal of everyone who works on Wall Street. Yet, ironically, what most don't realize, is that these returns, or Returns On Investment (ROI), are absolutely meaningless when put side by side next to something few think about when considering investment returns.

Namely lobbying.

One thing is for certain, the litigation is beginning to shift from minor players to major players at the core of the Financial Crisis. Investors take note, this is a major shift and needs to be monitored as it will have major implications for market dynamics going forward.

You know, just in case that whole investment banking, equity research, high frquency trading, hedge fund thing does not work out, Citadel always has a plan B - to become an executive headunter. From Ken Griffen's annual letter: "We actively follow the careers of countless individuals across the competitive landscape in the interest of finding people who will strengthen our team and enhance our performance. Our talent database contains over 150,000 resumes, of which approximately 25,000 were added in the past twelve months. When recruiting for a given position, we often construct our short list from a pool of more than 100 highly qualified candidates. The decision making process for new hires often extends beyond the traditional interviews."And in case that fails, the company will become a certified travel agent: "Consider these statistics: in 2011, the Global Equities team traveled more than 3,500 days, on more than 1,600 trips, conducting 9,000 meetings with 2,000 different companies." Impressive stuff, and just shows you what one has to do when "expert networks" are no longer part of the picture. Then again the "whole hedge fund thing" may work for just a little bit longer: "We are pleased to report that Citadel Wellington LLC (“Wellington”) and Citadel Kensington Global Strategies Fund Ltd. (“Kensington”) have generated net returns in excess of 20 percent for 2011." Which means that Citadel has passed its high water mark for the first time since after 2007 and can actually collect performance fees and pay bonuses for a terrific job well done: victory!