| I guess there are two ways of thinking about merger arbitrage as a hedge fund strategy. One is: “Merger arbitrage is a bet on which mergers will close.” If you are a merger arbitrageur, your job is to look at merger deals that are announced, figure out how likely they are to actually close, and then bet money on the ones that the market underprices. Company X is trading at $35 per share, and then it announces that it has signed a merger agreement to be bought by Company Y for $50 per share. The stock trades up to $46. You look at the deal and think “this deal is ironclad, there are no regulatory problems, it will definitely close in six months, and I can make 8.7% in six months by buying today at $46 and selling at closing at $50.” You are playing a game of skill against other traders, trying to buy the deals that will close and avoid (or short) the deals that won’t. In reality nothing is certain, so you will try to pick the deals where you think the probability is good and the reward (the spread between the deal price and the current stock price) is worth the risk. The other way to think about it is: “Merger arbitrage is a low-margin form of liquidity provision.” Company X is trading at $35 per share, and then it announces that it has signed a merger agreement to be bought by Company Y for $50 per share. Investors in Company X would like to turn their attention to something new: Their job is providing capital to interesting business ideas, not figuring out whether and when mergers will close. Merger arbitrageurs come in to provide a service: They go to all the Company X investors and say “hey instead of waiting an indefinite amount of time for this merger to close and pay you $50, just sell us your shares today for $46, and we’ll deal with all the hassles on the back end.” And this is a useful service for which the merger arbs charge, you know, $4. They are making markets somewhat more convenient and efficient for everyone else. They are offering a simplifying abstraction — “when a merger is announced, that merger will happen” — over the messy legal complexities of the market. These descriptions are not mutually exclusive; they are both true, and the difference is a matter of emphasis. In the first, merger arbitrage is about being smart and taking on risk to earn gains; in the second, merger arbitrage is about being careful and limiting risk to earn a modest spread. The first description is about finding alpha; the second is about charging for a service. I once argued that the current US antitrust enforcement regime, under Lina Khan’s Federal Trade Commission, is in a sense good for merger arbitrage. Sure sure sure Khan tries to block a lot of deals, and sometimes succeeds, but often she fails; there is just more variability than there once was. I wrote: The returns to skill — to reading FTC complaints and using your expertise to know which mergers will close and which will be blocked — go way up. You buy the deals that will close (and double down when the FTC sues and the stock drops) and avoid the deals that won’t; you use skill to generate alpha, rather than just being a passive index investor in every deal. … If you are good at merger arb you want some dispersion in outcomes.
That was in the context of the FTC’s failed attempt to block a drug company deal, in which merger arbs were able to buy low (on the FTC’s lawsuit) and sell high (when it lost). “Because of the FTC’s lawsuit, we have had the ability to take something that would have made tens of millions of dollars and instead make many, many times that amount,” said the head of Pentwater Capital Management, a fund that made a killing on the trade. But that is all very much the first way of looking at merger arb, and the second way — “we collect a modest fee for moving the market along” — would argue otherwise. In that view, merger arb is basically a pennies-in-front-of-the-steamroller strategy, and in that sort of trade the main thing that you want is no steamrollers. Earning modest profits on five deals and getting blown up on one is, in this view, very bad; you do not want a dispersion in outcomes. You want to earn your steady fees. Anyway good news for merger arb: In recent months, numerous high-profile acquisitions have either struggled to close or failed, including a plan to unite Tapestry and Capri Holdings, the companies behind Coach and Michael Kors. The pileup has ripped through the hedge-fund world, leading to unexpected losses and several top traders losing their jobs. Now however, the new president’s pro-business, lighter-regulation agenda “means a pro-merger environment that will embolden companies to get bigger through acquisitions; it is as simple as that,” said Orkun Kilic, a London-based arbitrager. “I am very excited for the next four years.” A hostile deal environment has largely kept Kilic on the sidelines since December, he said, and he now expects to become more active with Trump’s election.
So now there will be tons of mergers, and they will all go through, and the spreads might be more modest but they’ll be a lot safer. A big problem, or perhaps opportunity, in crypto is: - There are a lot of crypto tokens with very large, somewhat fake “market capitalizations.” Anyone can launch a new crypto token, say “there are 10 billion of these tokens,” give herself 5 billion of them in two different wallets, and then sell one token from one wallet to the other for $1. Voilà, the token has a market cap of $10 billion, and her stake is worth $5 billion. If she tried to sell all of it at once she would probably be able to get, in round numbers, $0. But mechanically multiplying her stash of tokens by the last sale price will tell you that her stash is worth $5 billion.
- There are, or were anyway, a lot of places — leveraged crypto exchanges, crypto lending platforms, decentralized finance protocols — where you could borrow, non-recourse, against a fairly arbitrary list of crypto tokens. You show up with $100 worth of Bitcoin and the platform will lend you $50, or $100, or $200 even. You show up with $100 of A Shiba Inu Token, But Not The Ones You’ve Heard Of, and the platform will lend you $10, or $20, or maybe $50 or $99: The haircuts might vary based on the token’s popularity or liquidity or volatility, but a lot of places would lend you something against all sorts of nonsense.
- Those two facts combine straightforwardly into “find (or create) some nonsense, push up its price, plop it into a lending platform, borrow as much real cash as you can against it, and then walk away whistling as it collapses.”
The most elegant description of this problem/opportunity probably comes from Sam Bankman-Fried, the co-founder of crypto exchange FTX, who explained it to me on Bloomberg’s Odd Lots podcast in 2022: You start with a company that builds a box and in practice this box, they probably dress it up to look like a life-changing, you know, world-altering protocol that's gonna replace all the big banks in 38 days or whatever. Maybe for now actually ignore what it does or pretend it does literally nothing. It's just a box. … This box is worth zero obviously. … But on the other hand, if everyone kind of now thinks that this box token is worth about a billion dollar market cap, that's what people are pricing it at and sort of has that market cap. Everyone's gonna mark to market. In fact, you can even finance this, right? You put X token in a borrow lending protocol and borrow dollars with it. If you think it's worth like less than two thirds of that, you could even just like put some in there, take the dollars out. Never, you know, give the dollars back. You just get liquidated eventually. And it is sort of like real monetizable stuff in some senses. And you know, at some point if the world never decides that we are wrong about this in like a coordinated way, right? Like you're kind of the guy calling and saying, no, this thing's actually worthless, but in what sense are you right?
In many senses! Let me quickly mention two famous examples of this phenomenon — “you put X token in a borrow lending protocol and borrow dollars with it,” “never, you know, give the dollars back” and “just get liquidated eventually.” One is the Mango Markets exploit: A guy named Avi Eisenberg pushed up the price of MNGO tokens, borrowed against his MNGO futures position on the Mango Markets platform, and walked away whistling with $110 million, though now he is in prison. The other is, of course, FTX: FTX collapsed a few months after that podcast, and Bankman-Fried is also in prison. A stylized description of part of what went on in FTX’s collapse — not all of it, but an important part — is: - Alameda Research, a crypto trading firm also started and owned by Bankman-Fried, had billions of dollars’ worth of tokens, many of which were “Samcoins,” tokens with names like FTT and Serum and MAPS, which were affiliated with FTX in some way and largely owned by FTX/Alameda. Their market capitalizations were large and, it seems fair to say in hindsight, not entirely real.
- FTX is a leveraged crypto exchange, and Alameda was able to borrow against those positions on FTX, in part to buy other crypto stuff and in part to pay for stadium sponsorships, political donations, real estate, etc.
- Then those tokens went poof, Alameda owed FTX billions of dollars, and the money wasn’t there.
- So ultimately FTX’s other customers took Alameda’s losses: FTX was loosely speaking a platform that made loans against dodgy crypto tokens; it loaned its customers’ money to Alameda secured by its weird tokens, and when those tokens went poof so did the customers’ money.
I will say: I sort of assumed that this was unique to Alameda. That is, FTX generally advertised that it had good risk management that would prevent this sort of thing from happening, that it wouldn’t just lend a ton of its customers’ money to someone who showed up with a random inflated token. Alameda, though, was subject to many exceptions, and could sort of borrow from FTX whatever it wanted. But last week FTX’s new management went on a tear of suing people who took money from FTX under its old management. Bloomberg’s Bill Allison and stacy-marie ishmael report: FTX filed a lawsuit against Anthony Scaramucci and his hedge fund SkyBridge Capital as part of a broader effort to claw back money for creditors of the bankrupt company. The lawsuit against the former White House communications director is one of 23 filed in the bankruptcy court of Delaware on Friday. Defendants also include digital-asset exchange Crypto.com and political groups such as the Mark Zuckerberg-founded FWD.US, according to court documents. FTX alleges that during the crypto winter of 2022, founder Sam Bankman-Fried engaged “in a campaign of influence-buying throughout the year and making lavish and showy ‘investments’.”
There’s also a lawsuit against Binance, arguing that, when FTX paid Binance $1.76 billion to cash it out of its stake in FTX in 2021, that $1.76 billion was largely stolen and Binance should give it back. But also, Coindesk reports: Among the lawsuits filed last week by the FTX estate is a 32-page document listing eight counts against Humpy the Whale, the crypto trader who earlier this year attracted attention for a governance attack on Compound DAO. Naming him as Nawaaz Mohammad Meerun, a Mauritian citizen, the suit filed in the U.S. Bankruptcy Court for the District of Delaware alleges that between January 2021 and September 2022, Meerun “orchestrated a series of massive market manipulation schemes and defrauded hundreds of millions of dollars from FTX.” It also claims Meerun had connections to organized crime groups. Meerun dismissed the allegations.
Here is the complaint, which describes the standard approach, e.g.: In January 2021, Meerun began laying the groundwork for to perpetrate a fraud on FTX by accumulating a massive position in an illiquid token (“BTMX”). He eventually cornered more than half of the total BTMX supply, driving BTMX’s price up by 10,000% over three months. Meerun knew that the notional value of his BTMX holdings had been massively (and artificially) inflated by his manipulative trading, and used that inflated value to exploit a flaw in FTX’s margin trading rules, “borrowing” tens of millions of dollars from FTX using his BTMX holdings as “collateral.” Meerun knew that as soon as his manipulation stopped, BTMX’s price would crash and he would be required to return all of his “borrowed” assets.
“I have always operated within the parameters set forth by FTX exchange,” Meerun told Coindesk, and I suppose “operate within the parameters set forth by FTX exchange” and “exploit a flaw in FTX’s margin trading rules” could be different ways of saying the same thing. Anyway the complaint also has some good FTX internal exchanges: Bankman-Fried, [Ryan] Salame, [Gary] Wang, and Nishad Singh, Director of Engineering at FTX, were left scrambling to catch up with Meerun’s actions. On March 27, 2021, Salame asked “do we want to restrict his trading until he replies?,” adding that “it almost feels like a competitor exchange trying to screw us? idk that sounds dumb lol.” … As of the morning of March 28, 2021, Meerun’s manipulated BTMX position had a paper value of nearly $1 billion, and Meerun had withdrawn a total of $450 million from FTX, which included more than $150 million withdrawn on March 27 alone. That same day, Bankman-Fried pointed out that he had “realized we forgot to block withdrawals [face with tongue emoji]” on Meerun’s account. Salame responded: “ooof i didnt realize how insane the account had gotten.” Concerned that Meerun would attempt to circumvent the limits they had placed on his account, Bankman-Fried directed Wang and Singh to “treat the account as flagged so we’ll catch if it tries to feed another account.” Singh replied that Meerun had “already done some stuff with a new account kingofthepudding@protonmail.com . . . which now has blocked withdrawals.” Bankman-Fried reported that he had “messaged him threatening to freeze/liquidate.” Salame bizarrely responded that it “would be cool to keep him as a friend though since he’s like 50% of our margin platform lol.”
Ultimately they liquidated him, Alameda took on his positions, and Alameda (and, thus, eventually FTX) lost somewhere between $400 million and $1 billion on the trade. “Realized we forgot to block withdrawals [face with tongue emoji]” is not the most embarrassing internal FTX communication about an oopsie — that would be “hidden, poorly internally labeled ‘fiat@’ account” — but it’s not the best emoji to have in a court filing. Anyway you can read all of this as a dress rehearsal for FTX’s collapse a year later. There will probably be a few more of these in the next three months, but then what? The Securities and Exchange Commission [Friday] charged Invesco Advisers, Inc. for making misleading statements about the percentage of company-wide assets under management that integrated environmental, social, and governance (ESG) factors in investment decisions. The Atlanta-based registered investment adviser agreed to pay a $17.5 million civil penalty to settle the SEC’s charges. According to the SEC’s order, from 2020 to 2022, Invesco told clients and stated in marketing materials that between 70 and 94 percent of its parent company’s assets under management were “ESG integrated.” However, in reality, these percentages included a substantial amount of assets that were held in passive ETFs that did not consider ESG factors in investment decisions. Furthermore, the SEC’s order found that Invesco lacked any written policy defining ESG integration. “As stated in the order, Invesco saw commercial value in claiming that a high percentage of company-wide assets were ESG integrated. But saying it doesn’t make it so,” said Sanjay Wadhwa, Acting Director of the SEC’s Division of Enforcement. “Companies should be straightforward with their clients and investors rather than seeking to capitalize on investing trends and buzzwords.”
We have talked about this sort of thing before. For a while, it was obviously good marketing for investment managers to say “our ESG Fund always considers ESG factors in making investment decisions,” because (some) customers wanted ESG. Sometimes the managers did not in fact always consider ESG factors in making investment decisions for the ESG Fund, and the SEC would occasionally audit the funds, find some decisions that were made without writing a memo about the ESG factors, and impose a fine. Once it did this for biblical investing too. The Invesco case is a bit different because the SEC’s objection here is not about Investo’s marketing of its ESG funds. Rather, it’s about Invesco’s marketing of its whole business. The alleged greenwashing here is not “Investo said that its ESG funds always considered ESG, and sometimes they didn’t.” Rather it is “Invesco said that up to 94% of its assets were in ESG funds, but actually that was an exaggeration because it counted purely mechanical non-ESG index funds.” It wasn’t that much of an exaggeration — Invesco said things like “investment teams responsible for managing approximately 85% of Invesco’s AUM have attained the ESG integration level defined as minimal but systematic integration” — but it was an exaggeration, so Invesco had to pay up. Here, though, there is no suggestion that Invesco tricked investors into investing in its ESG funds by exaggerating their ESG approach. Rather, the point here is that, way back in “between approximately April 2020 and July 2022,” Invesco thought it was a good idea to tell potential customers that every part of its investment process was infused with ESG. ESG, Invesco was saying, was not just a part of how it ran designated ESG funds; it was part of Invesco’s DNA and its culture. Imagine saying that now! We talked last week about “greenhushing,” the idea that, now, if you want to integrate any ESG factors into your investment decisionmaking, you have to do it quietly, because otherwise Republican lawmakers will come after you. (There’s some chance that, in the next four years, considering ESG will be a crime.) Gary Gensler’s SEC has a few months to bring its last greenwashing cases, but after that, I assume the next SEC will be bringing greenhushing cases? “Invesco said in its marketing materials that it does not boycott fossil fuels, but in fact it runs some ESG funds that own no fossil-fuel stocks, so it has to pay up.” Get them coming and going. Early in Donald Trump’s first term as president, there was a funny fight over who was the acting director of the US Consumer Financial Protection Bureau. One theory was that it was Leandra English, who was a holdover from the Obama administration; the other theory was that it was Mick Mulvaney, who was named to the job by President Trump. It kind of feels like, in the long run, the person running a federal executive agency is going to be the one picked by the president, but in the short term, with the acting director, weird stuff does happen. But Mulvaney won the fight early on, by showing up at the CFPB on his first day and bringing doughnuts. For some reason the court battle stretched on for a year and a half before English gave up (and President Trump nominated a permanent director), but as far as I can tell, Mulvaney was running the CFPB for most of that time. “To me,” I wrote, “the person who is acting as director of the CFPB is the acting director of the CFPB. If Mulvaney tells CFPB people to do things and they do it, then he is the acting director; if English does, then she is.” The doughnuts, I argued, were essential, as a matter of legal realism, to persuading the relevant stakeholders that he was actually in charge. But the CFPB is an odd agency; it was created during the Obama administration and has no real Republican support. Mulvaney called it a “sick, sad joke.” He could have accomplished a lot of his goals, as acting director of the CFPB, by padlocking the front door and going away. He did not bring the doughnuts as the first step toward rallying the troops to conquer new heights in the battle against consumer financial fraud. “The CFPB can’t do any regulating for a year while we fight this out in court” would have been, for the Trump administration, fine. I bet Jerome Powell has been scouting good doughnut shops: When a frustrated Donald Trump flirted with removing Federal Reserve Chair Jerome Powell in a dispute over interest rates back in 2018, Fed leaders privately readied a break-glass-in-case-of-emergency response: a legal challenge against the president to protect the integrity of America’s central bank. … Six years later, Trump is heading back to the White House and the dormant drama of his fraught relationship with Powell is back on display. When asked last week whether he would resign if asked to do so, Powell offered a one-word reply: “No.” He gave the same answer when asked if the president had the authority to dismiss him. … “If the president were to succeed at this, that would mean every future chair is subject to removal at the whim of the president,” said Scott Alvarez, who served as the Fed’s general counsel from 2004 to 2017. “I don’t think that’s a precedent Jay would want to set, and that’s why I think he would fight it. This is a humongous precedent.”
He has been thinking about this for a while: “I will never, ever, ever leave this job voluntarily until my term ends under any circumstances. None whatsoever,” he told a visitor [in 2019]. “It doesn’t occur to me in the slightest that there would be any situation in which I would not complete my term, other than dying.” At the time, Fed leaders decided that if Powell’s status as chair of the Fed’s board was called into question, the central bank’s separate interest-rate setting body, the Federal Open Market Committee, would close ranks by meeting to immediately re-elect Powell as its chair. ... The upshot is that attempting to remove Powell would provide little practical benefit because Powell would likely continue to lead the institution until any litigation is resolved, which could extend beyond Powell’s term.
Yes if the rest of the Fed thinks you’re the Fed chair then that does kind of make you the Fed chair? What if there are two Fed chairs, though? Powell, with the support of the FOMC, saying “the Fed Funds rate is 4.75%,” and a Trump appointee saying “actually it’s 2%”? What would the short-term interest rate be? I feel like the plausible answers are “20%” and “0%.” It has to be something! It’s not like the CFPB; doing nothing, even for the Trump Fed, is not an option. Or is it? Hours after Powell implied last week he would fight any dismissal, Sen. Mike Lee (R., Utah) posted a news article with a comment suggesting the Fed should answer to the White House. “Yet another reason why we should #EndTheFed,” he wrote on X.
There is definitely a view in government that padlocking the front door of the Fed and going away would produce better monetary policy than the Fed does. That does not seem to be the dominant view in Trump’s circles, but you can’t quite rule it out. On the other hand, elsewhere in Trump’s circles, there is a school of thought that actually having two Fed chairs would be fun: Scott Bessent, an investment manager who is currently an adviser to Trump [and potential Treasury secretary], last month suggested Trump should announce whom he plans to select as Powell’s successor so that this “shadow” chair could try to undercut Powell, making him a lame duck. In an interview last week, Bessent said based on recent criticism of the idea, he no longer thought it was worth pursuing.
It would be funnier to name, like, three shadow Fed chairs and have them going around making wildly different pronouncements about monetary policy, and then at the end pick the one who got the most attention. Or have a bunch of different Fed chairs for different points on the interest-rate curve; “when I am Fed chair in two years and nine months, let me tell you what I am going to do to rates.” Anyway at Credit Slips Adam Levitin argues that “realistically, if President Trump were to fire Powell for any reason, no matter how ridiculous (e.g., ‘I don't like his tie’), the effect would be to render Powell's position untenable,” but Powell has made it clear that “untenable” is not a problem for him, and it doesn’t seem to be a problem for Trump either. Bonuses Set to Grow Across Wall Street for First Time Since 2021. Key Advisers to Trump Back Bessent for Treasury Secretary. The Outsider Trying to Restore Citi to Investment-Banking Glory. Elliott Amasses $5 Billion-Plus Stake in Honeywell. BlackRock Targets Money-Market Fund Business in New ETF Push. Levered Bond ETF That’s ‘Broken Many Hearts’ Sees Record Inflow. Shell Overturns Dutch Court Order to Slash Emissions Faster. How oil and gas companies disguise their methane emissions. SoftBank Rainmaker Exits Vision Fund After Tumultuous Tenure. Mattel Apologizes for Porn Site Misprint on ‘Wicked’ Toy Packaging. If you'd like to get Money Stuff in handy email form, right in your inbox, please subscribe at this link. Or you can subscribe to Money Stuff and other great Bloomberg newsletters here. Thanks! | 
