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The Hedge Funds Behaving Badly Edition
00:43:16
The panel and Sheelah Kolhatkar, author of Black Edge, discuss the turmoil at Bridgewater Management, how a hedge funder tried to take down Herbalife, and the insider trading allegations covered in Black Edge
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- [00:00]
Jordan Weissman
The following podcast contains explicit language.
- [00:10]
Felix Salmon
Hello, and welcome to the Hedge Funds Behaving Badly episode of Sleep Money. Is it an edition or an episode? I can never remember?
- [00:21]
Jordan Weissman
Edition.
- [00:22]
Felix Salmon
An edition. It's the Hedge Funds Behaving Badly edition. The reason we are going to talk about hedge funds, hedge funds and hedge funds is because we have the most special guest in the world right here. I am Felix Salmon of Fusion. I'm joined by Jordan Weissman.
- [00:38]
Jordan Weissman
Hello.
- [00:39]
Felix Salmon
Of Slate. I am also joined by the chief feature writer at Portfolio Rep magazine, Sheila Kolatka. Wait, that's not your job anymore?
- [00:52]
Sheila Kolhatkar
That's several jobs ago.
- [00:53]
Felix Salmon
Sheila and I used to work at Portfolio back in a million years ago.
- [00:57]
Sheila Kolhatkar
Pre financial crisis.
- [00:58]
Felix Salmon
Pre financial crisis.
- [01:00]
Sheila Kolhatkar
Different world.
- [01:01]
Felix Salmon
And then you went on to much grander things.
- [01:04]
Sheila Kolhatkar
As did you.
- [01:05]
Felix Salmon
So what are you up to now?
- [01:08]
Sheila Kolhatkar
I have been a staff writer at the New Yorker since July, and prior to that, I was at Bloomberg Businessweek for several years.
- [01:16]
Felix Salmon
And you recently, as in the past couple of weeks, came out in the New Yorker with a fascinating story about one of our favorite hedge fund managers, Mr. Bill Ackman. So definitely going to talk about that. And not only are you an expert on Bill Ackman, but you're an expert on our other favorite hedge fund manager, Mr. Stevie Cohen. You have a book. What's your book called?
- [01:45]
Sheila Kolhatkar
I do. It is called Black Inside Information, Dirty Money, and the Quest to Bring down the Most Wanted man on Wall Street.
- [01:53]
Felix Salmon
So we are going to find out in this podcast whether Stevie Cohen was brought down. Down. I think we know the answer to that one.
- [01:59]
Sheila Kolhatkar
Spoiler alert. Sorry.
- [02:03]
Felix Salmon
But first, I think what we're going to do, because there's no shortage of crazy hedge fund managers. And this is meant to be your guide to the business and finance news of the week. And there was some pretty interesting news about one of the crazier hedge fund managers. He might not be sort of criminally insane, but he's still insane.
- [02:21]
Jordan Weissman
No, he's like, he's harmlessly insane. Unless you happen to work for him. I think, like, that's sort of. That. That's sort of Ray Dalio.
- [02:28]
Felix Salmon
Who are we talking? Oh, Ray Dalio.
- [02:29]
Jordan Weissman
Yes, Ray.
- [02:30]
Felix Salmon
So Ray Dalio, he runs a hedge fund?
- [02:31]
Jordan Weissman
Yes. He is the. He's the king, the philosopher king of Bridgewater Associates, which is the world's largest hedge fund.
- [02:37]
Felix Salmon
It's a hedge. Now, the thing you learn about hedge funds and, or certainly I used to learn about hedge funds when I was writing about them, is that there are two different types of fund manager in the world. There's the hedge funds who run like, if they're successful, like three, five, $10 billion and make huge amounts of money with lots of risk. And then there's the big asset management companies who have like $100 billion and they're just like charge much lower fees and, and generally much more boring. Ray Dalio is basically the one person in the world who's managed to get like $100 billion of assets under management while also being a hedge fund.
- [03:17]
Jordan Weissman
Yeah. And he has, you know, people, when they write about him, make the distinction, it's like he is the biggest hedge fund firm and then there are funds within that which gigantic. And he runs with his own quirky system, which is sort of the kind of thing you'd expect almost like a 19th century intellectual to have come up with. And we can talk about that, but it's finally the news is he's stepping down.
- [03:38]
Felix Salmon
He is this not for the first time.
- [03:40]
Jordan Weissman
No, not for the first time. But he had come back, so he had kind of stepped down. He'd been trying to transfer out. He had this long transition plan and then he became co CEO and now he's decided he kind of wants to go back and chase his bliss and just be an investor.
- [03:53]
Felix Salmon
But he is. But the point is. Yeah, okay. And this is one of the things which we're going to talk about here. The hedge funds are nearly always associated with individuals. Bridge Watford is associated with Ray Dalio. Pershing is Pershing Square is associated with Bill Ackman and so on. And the problem is if you have an institution running $100 billion, you need to have some kind of institutional continuity. It can't just be Ray. And so for the past few years, Ray has been trying to install CEOs and he's gone through five of them just since the beginning of 2016.
- [04:27]
Sheila Kolhatkar
Well, this reminds me a little bit of a non hedge fund, but Pimco, the giant bond fund, very similar situation where the entire company, an enormous asset.
- [04:35]
Felix Salmon
Management company, was over a trillion, over $2 trillion.
- [04:39]
Sheila Kolhatkar
Yeah, I mean huge. Almost everyone has some money in a retirement fund somewhere buried in pimco. But Bill Gross, who was the, you know, the central figure of Pimco, could not, they just could not set up any kind of succession or, or power sharing or any sort of spreading around. And so many investors were there because of Bill Gross. So it reminds me a lot of this Bridgewater thing.
- [05:02]
Felix Salmon
Very similar. Ray Dalio is the, is the Bill Gross. And Bill Gross is also crazy. There seems to be a Sort of necessary condition for being a super successful investor that you're completely crazy.
- [05:14]
Sheila Kolhatkar
I prefer the word eccentric, but your word is also just appropriate, but also.
- [05:19]
Felix Salmon
Just pleasant on a sort of, on a sort of interpersonal dealings level. Like reading your book about Stevie Cohen. He's just a deeply, deeply unpleasant, thin skinned, angry man.
- [05:31]
Sheila Kolhatkar
I think their brains operate on another level and the conception of social nicety and how was your weekend and all that stuff just is not part of their brain chemistry.
- [05:41]
Felix Salmon
I mean they're totally focused on specifically with regard to Ray Dalio. Yeah, like tell us a little bit about these insane rules and the radical transparency and whatnot that this sort of clearly spectrum Y guy has instituted at Bridgewater.
- [05:56]
Jordan Weissman
So listeners may remember we've kind of Talked about Ray Mr. Dalio on past episodes and he has this eccentric management system where people are rated on this numeric scale and you're expected to constantly criticize yourself and others. And there's this whole concept of radical transparency where you were just, you know, supposed to lay into each other.
- [06:15]
Felix Salmon
Every meeting is recorded, is then available to everyone else in the company.
- [06:19]
Jordan Weissman
Exactly. You know, it's a bit of a panopticon. Everyone's sort of under surveillance. At one point, James Comey, which we all know as like the FBI director, he left and he was like, this is too intense. Like he was like, this was a really intense place to work. And this is the guy who now deals with Russian espionage for a living. So I mean that's what the management is like. But you know, speaking to this issue of continuity and you know, the problem of continuing a hedge fund when the person is associated, has stepped down or left, it seems like he's sort of trying to get around that with this kind of grand or has tried to get around this grand project. And this is where the 19th century inventor like weird intellectual thing comes into play, which is as the Wall Street Journal put it, he's for a long time been trying to build an algorithmic model based on his employees brains. Which is kind of a fancy way of saying what a lot of hedge fund managers do, which is they use algorithms. But he really has this intense, very developed like macroeconomic model. He kind of works from. That's very quirky. It's not something out of a box, it's something he has kind of come up with over the years on his own. And, and he's trying to, he's tried to kind of build this into the foundation of his fund. So theoretically maybe that could live on even when he's Gone, I think.
- [07:28]
Sheila Kolhatkar
Well, I think that's the idea. He's trying to make it sort of idiot proof and implement a system where it can persist beyond him and cease to be just a cult of personality, which is sort of what Bridgewater has been until now. But I think the fact that he's leaving in this sort of burst of.
- [07:45]
Felix Salmon
Controversy, quote unquote leaving, I mean, he's.
- [07:47]
Sheila Kolhatkar
Clearly leaving, stepping down.
- [07:48]
Felix Salmon
He's clearly not leaving. He's not gonna, he's not retaining the CEO title, but he's still going to.
- [07:53]
Sheila Kolhatkar
Hover, be hovering over the single most.
- [07:55]
Felix Salmon
Important person at Bridgewater for the foreseeable future. So, okay, so Sheila, you say cult of personality because he's managed to get these insane returns for investors. And like some of the other hedge fund managers we're talking about, he's charged enormous management fees, he's made huge amounts of money for himself. Do you think that's that can outlast him? Do you think he's managed to sort of create a black box which can continue to get these returns even once he's gone?
- [08:25]
Sheila Kolhatkar
Well, obviously, if you're an investor in Bridgewater, that is going to be your question. And imagine you're an investor who's a little older and you have a lot of money there and you are thinking about the next generation or your heirs or whatever. You have to make a long term decision about whether or not to leave your money and whether you think the place can continue to be as successful. Post Ray Dalio and I don't think we know yet what the answer to that is. But so many of these funds have this problem, like Pershing Square, which is Bill Ackman's fund, Dan Loeb's fund. Third point, I think it was true of SAC Capital, Steve Cohen's fund, when it existed. I don't think most of those investors would have put their money there and paid those insane fees year after year without the presence of the kind of superstar, you know, genius savant, weirdo who is running the whole thing.
- [09:14]
Felix Salmon
So, and so and so this is, this is Matt Levine's theory about Bridgewater is that what he's basically done is he's created this computer program which makes vast amounts of money. And then he's created a bunch of sort of busy work for his thousands of employees. So they spend lots of time running around reporting on each other and sort of psychoanalyzing each other and, and they spend so much time doing that that they basically forget to interfere with the computer program which makes all of the Money for the investors.
- [09:43]
Jordan Weissman
I mean, at some point, here's one risk I could kind of see, though, right? At some point, this computer program has to be updated. These algorithms aren't static for the most part. And so if Dalio's gone, you have to wonder how many people are really going to buy into his grand theories about the economy and what fuels this program over the long term. I mean, to give you a sense, his theory is that not only does the economy work like a machine driven by these, like, tectonic credit cycles that go over 70 years, but also, you know, that humans individually work as machines. And so he tries to model the little mechanistic people running around with the mechanistic credit cycles. And, you know, if it's left to someone who's not Ray Dalio to update the program, like, is it really going to keep looking like that long term?
- [10:25]
Sheila Kolhatkar
I think, as the great Cathy o' Neill would point out, algorithms are only as good as the people who, who design them and input the data. I mean, they're all about the inputs.
- [10:35]
Felix Salmon
So they are. And this is, this is my. You know, in this sense, Ray Dalio is a little bit like George Soros. They both love thinking grand thoughts about macroeconomic trends, and they both love writing long tomes about, like, how the economy works globally. And no one can take those tomes and monetize them in the way that they can. And they, to them, it's obvious, but it's also not obvious that George will put on the trade and then his back will start hurting and then he'll go, okay, now it's time to take off that trade. And there's only one George Soros spine. But this is the big macro kind of hedge fund is Ridgewater. And I feel like this is one of the reasons why he's been able to accumulate so much money, because institutional investors are comfortable with the idea that you can place bets on big macroeconomic outcomes. But what I want to talk about next is Bill Ackman, because he is much more focused on individual companies. And I feel that is where things start getting a little bit weird. So, Sheila, Bill Ackman is famously a guy who makes really high profile, concentrated bets on individual companies, some of which are spectacularly successful and some of which are spectacularly unsuccessful. Is that like, how's that working out for him?
- [12:11]
Sheila Kolhatkar
Well, he would describe himself as an activist investor. And the reason he's able to be an activist investor is because he has so much capital at his disposal that he can pick a company, a target. He wants to invest in. Usually he's making a long investment and he can really buy enough shares of that company that he can really become involved with the company. He can almost, he can make things happen and influence the fate of the.
- [12:36]
Felix Salmon
Company, place the board, that kind of thing.
- [12:38]
Sheila Kolhatkar
That's the idea. So they really get in there and in most cases, not always they are active. They, they're not a passive investor. Like they're just buying stock and just sitting back and waiting and studying the numbers from afar. They're like in there with the CEO, they might be recruiting a new CEO, they're suggesting changes to the company, they're telling the company to sell off units.
- [12:59]
Felix Salmon
He has this idea that he knows how to run the company better than the company does. And if the company only did what he thinks the company should do, then it would be worth more.
- [13:07]
Sheila Kolhatkar
Well, that is what activist investors generally do. They all come in and I mean the big critique of them is that they are very focused on a shorter term, you know, return to their investors. You know, they might be looking at a one year, six month, two year investment. The people running the company are thinking about the entire life of the company. But you often have these activist investors who go in there, they'll buy up 7% of the company and then they'll say, okay, we want you to lay off all these people, we want you to sell off these units. Oh, your stores are, you own the real estate under your stores. We want you to just sell all that and rent it back from someone else. Because they want to make short term.
- [13:44]
Felix Salmon
Financial engineering things, which make sense. So the classic example would be like Dan Loeb buying Yahoo, kicking out the CEO, bringing in a new CEO and doing a bunch of financial engineering, which basically allowed him to realize the value of Yahoo stake in Alibaba and then selling all of his shares and leaving the rest for scraps.
- [14:03]
Sheila Kolhatkar
Well, yeah, so a critic would say, well, they really don't care what happens to this company and its employees and its customers and the communities where it does business after they get out of their position. And there was, there was a sort of a funny example when David Einhorn bought up a stake in Apple, which is a very large company, one of the biggest companies in the world. Is it very hard to go and start telling Apple what to do? But he wanted Apple to sort of, they had a lot of cash sitting on their balance sheet. So he said, well, Apple, you should just give that all to us as a big dividend. And I don't think it really worked out well, for him, apple was sort of like, buzz off, you know, we're not interested. But if you. If you go after a smaller company and you have enough money, you can force that company to have to engage with you. And this has become a rising influence in the corporate america.
- [14:47]
Felix Salmon
Let's talk a little bit about herbalife. Because this is what your story was about. And this is the other thing that activist investors do, and specifically that bill ackman does, Is that he will make a very high profile short bet. And in the case of herbalife, he basically put a billion dollar short bet on herbalife, Saying, this is a fraudulent company and it's going to zero. And I'm going to give all of my money, all of my profits to charity. Because I'm that lovelier person. And. And this is activism of a different sort. And it's hugely dangerous, because for a short bet to work out, the. Obviously, the price needs to go down. The price also needs to go down sooner rather than later. Because if it goes up before it goes down, then you get squeezed and you can lose a lot of money. And more to the point, if you come out in public with a very, very large short bet, what you're basically doing is you're putting a huge kick me sign on your back for the rest of wall street, saying, hey, I'm squeezable. I can lose loads of money. And if I'm losing loads of money, you guys can make loads of money. Because this is a zero sum game. And so, please come and try and buy the stock and kick me. Why on earth would he do that?
- [16:03]
Sheila Kolhatkar
It is a bit of an insane thing to do. And I should say that bill ackman and his fundamental. They don't do this very often. They really only had done it once before, and it worked out well in that case. But they became.
- [16:17]
Felix Salmon
Although they got lucky with the financial.
- [16:18]
Sheila Kolhatkar
Crisis, well, the financial crisis really helped them out. But the fact is, with mbia, which is this huge company that was insuring bonds, they were right about mbia, you know, and then the financial crisis really forced everyone to acknowledge they were right.
- [16:31]
Felix Salmon
As every short seller will tell you, being right is about, you know, table stakes. It's necessary, but it's definitely not sufficient.
- [16:39]
Sheila Kolhatkar
Better lucky than smart.
- [16:40]
Felix Salmon
So anyway, so why. So explain how. Why is he. Why would he do this?
- [16:45]
Sheila Kolhatkar
So, herbalife, just to clarify what it is, it's a very large company. That sells protein shakes for weight loss. And protein bars. And just different herbal supplements and products for your health. And it is a multi Level marketing company, which is a kind of a controversial structure. Whereby they don't sell their products in stores. You cannot go to whole foods or a gnc and buy these products. You have to buy them through a distributor. So they have this independent network of salespeople. Who are selling the company's products to their friends, to their friends, friends, to their parents, to whoever they can find. And a bit like amway or avon or tupperware, and, you know, other companies that people have probably heard of. And the big controversy about these companies Is that there's always a question about who is actually buying the products and why are they buying them. And in many cases, the salespeople Are actually just really recruiting other salespeople. To also try and sell the products, who are having to buy the products to try and sell them themselves.
- [17:48]
Felix Salmon
And bill ackman's case here is that if it's, quote, unquote, a pyramid scheme versus a multi level marketing scheme. And the distinction is something which is, like, in the minds of lawyers, basically, Then it's illegal and should be shut down by the ftc.
- [18:05]
Sheila Kolhatkar
So a pyramid scheme is illegal. That is a company where basically, it relies on a constant inflow of new people at the bottom of the pyramid who are trying to become salespeople who are putting money in buying products. And the people at the very top of the pyramid who've been involved the longest, Are making money Based on the losses of this kind of endless flow of losers coming in at the bottom. And it's just not sustainable. And that is a pyramid scheme.
- [18:31]
Felix Salmon
Right. But herbalife has been around for quite a long time.
- [18:34]
Sheila Kolhatkar
It has.
- [18:35]
Felix Salmon
Which is, on the face of it, evidence that it is sustainable.
- [18:38]
Sheila Kolhatkar
And it's a large company. It was reporting around $5 billion in sales at the time that bill started to really look into it. And there was an outside researcher who did a huge amount of investigation into the company. And concluded that it was unsustainable. It was a pyramid scheme, this researcher said. And this person, she brought the idea to bill. And there are companies out there who do research on investments for hedge funds. You know, hedge funds are always looking for a good idea, A good, short idea. So independent researcher might come to you and say, okay, well, I think you should short the for profit education sector. You know, the government's gonna end up shutting it down. It's fraudulent. And actually, hedge funds have made a lot of money doing that. So.
- [19:19]
Felix Salmon
And they've been attacked for it. Because, as you mentioned in your book, there's this, like, visceral Hatred of short sellers. Among many different parts of the population, they're considered to be somehow like bad people.
- [19:33]
Sheila Kolhatkar
Well, they. They play a really important role. And they often end up exposing real frauds. Like enron is a very famous example. So I think they do play an important role. And there's a real problem in the stock market when you have everyone just boosting and pushing things up all the time. So short sellers can really expose problems. However, there's a lot of potential for abuse with short selling. And there is something a little icky about the idea that you can short a bunch of shares of a company. So that means you're borrowing the stock, you're selling it, and then you're. You're hoping it will go down so you could buy the shares back and repay your. Your borrow. They then will go out and publicize all this negative criticism and their critique of these companies. And if you're a company that's a target of a short, It's a little. I mean, it's just an existential crisis for you, because suddenly you have a prominent investor like bill ackman or david einhorn's, Another famous one, out there Publicly trashing and criticizing your company. And it can really. It can end up destroying a company, honestly.
- [20:33]
Jordan Weissman
So in the. I mean, I guess this saga hasn't really ended, but the most recent important chapter was that there was an ftc investigation in the end of herbalife. And they ended up getting slapped with a $200 million fine. They had to change their business model to some extent, but they weren't labeled a pyramid scheme. And so a lot of people feel like ackman's kind of lost. Like lost his bet. And what I.
- [20:53]
Felix Salmon
And on the mark to market basis, he certainly has lost his bet.
- [20:56]
Jordan Weissman
Well, and so what I want to. Assuming and you can challenge it. I mean, maybe you think he hasn't lost it. But is the issue here that just Ackman made the mistake of investing on politics, that he just misread the political situation that applies to multi level marketing firms so badly. Whereas the guys who were looking at the for profit industry Figured we can rely on the obama administration to eventually crack down hard on them? Multilevel marketing was just a totally different animal. I mean, is that. Is that the flaw?
- [21:25]
Sheila Kolhatkar
I don't think that was quite the problem, to be honest. I mean, as. As one rival hedge fund person who's involved in herbalife said to me, Bill ackman has been right about everything except the stock and the ftc's conclusions about Herbalife. Even though they did not use the label pyramid scheme. If you read the order that they produced as a result of this investigation, it is very critical of herbalife. And really mirrors what bill ackman's critiques were of the company. They basically said the company was misleading people. It was presenting these totally unrealistic, Inflated ideas. Of how much money you could make becoming an herbalife salesperson. They said the company would have to fundamentally restructure its business. And start operating legitimately, which is a pretty damning sentence about a company.
- [22:13]
Felix Salmon
This comes back to my question, right? If you can be right about everything about the company and it. And the stock price still goes up. And you have this big public short. Which is just basically asking everyone on. Everyone on wall street to kick you. Like, that's a really stupid bet to take, isn't it?
- [22:29]
Sheila Kolhatkar
Well, there are people who would say it takes a tremendous amount of sort of hubris and almost arrogance. To think that, especially with a company of herbalife size, you could kind of make all this happen. And to some extent, I think that was the error. I think bill ackman seems to have been proven correct. In many of his assertions about the company. But it was his. Maybe his belief that he could literally trigger its collapse Seems to have been off. It just has not happened. And the story is not over. You know, herbalife's earnings have. Have, you know, been showing signs of problems. And they are increasingly relying on growth in other countries, like china, to offset the decline, which seems to be starting in the US So there may end up being a situation where, if. If people in china decide to take a harder look at the company. And perhaps put more restrictions on it, that could really hurt them. But they do not seem to be. They are not. They do not seem to be imminently going to zero, which is what bill ackman predicted.
- [23:29]
Felix Salmon
The idea that, like, bill ackman is going to finally win his short. Because, like, the chinese version of the ftc Is going to crack down on herbalife. Seems improbable to me. We do need to wrap up this section. But I want to talk more about short selling. Because this is weirdly how the whole Stevie Cohen investigation started. So, back onto these short sellers. Stevie Cohen started as a good old fashioned trader, A tape reader. And he just had this kind of weird, Like, a bit like George soros's spine. He could. He kind of knew which way individual stocks were going. And he'd buy this one and sell that one. And hold the positions for, like, maybe 10 minutes or a couple of hours and he'd make lots of money. And then he eventually sort of graduated to holding overnight positions and bigger shorts and stuff like that. And one of the things that happened is there were a couple of companies who started accusing him of being a sort of mean and nasty manipulative shorter. And like, exactly what you were saying. And I want to sort of push you a little bit more on this because I want you to explain. Let's posit that short selling can and often is a good thing. When and how is short selling a bad thing? Because this is what he was accused of. This is when the FBI started to get interested in what he was doing. Eventually, that short selling investigation kind of morphed into an insider trading investigation. And we can get into that as well. But, like, why and when is short selling bad?
- [25:14]
Sheila Kolhatkar
Well, the particular example you're referring to is this company called Fairfax, which is a Canadian insurance conglomerate with very Byzantine, confusing accounting that I could not possibly begin to explain to you. But it basically became in the early 2000s, a target of short sellers. So a bunch of short sellers. It had a subsidiary that was trading in the US And a bunch of short sellers, of which SAC Capital was one. But there were a whole bunch. I think even Jim Chanos Fund was mentioned, possibly Dan Loeb's fund, a whole bunch of hedge funds started shorting Fairfax stock. And there were all these online chat boards and websites posting all sorts of rumors about how Fairfax was imminently going to collapse and it was committing all sorts of fraud. There were people comparing it to Enron, and they were just out there publicizing this, sometimes anonymously online. And Fairfax, of course, got very upset and said, well, wait a second, who are all these people who are out there spreading lies, what they. What they felt were lies about us and trying to make money from it. And you can understand why this was very upsetting to the people running Fairfax.
- [26:23]
Felix Salmon
And they okay, so let's assume that I'm someone who's spreading a lie about Fairfax, and I know that I'm exaggerating. I'm doing it anonymously. And I'm just doing it because I feel like if I spread enough lies, a bunch of people will sell the stock and then I'll be able to make money on my short. Is that illegal?
- [26:45]
Sheila Kolhatkar
If you are knowingly saying things that are not true about a company to enrich yourself, that is illegal. But what is not illegal, what is legal, is if you have a short position or a long position and you decide to honestly and openly express your True feelings about the, about your investment, that is protected speech. But if you are knowingly saying things that are not true, maliciously spreading disinformation, that is illegal. And the SEC will investigate that sometimes.
- [27:15]
Jordan Weissman
So, you know, the bigger theme of your book is about how everything from possibly spreading malicious information that may or may not be true to trading inside information or borderline inside information is maybe a lot more endemic to the hedge fund industry than we've all realized. And that this is a lot of what we think a lot of these guys, you know, 21st century masters of the universe types are maybe cheating or borderline cheating.
- [27:44]
Felix Salmon
This is the point where I need to explain. We're talking about Stevie Cohen, SAC Capital, another very big famous hedge fund. And this goes one step further in the sort of direction from Ray Dalio and the big macro stuff, Bill Ackman and his like long term bets on individual companies he's held, I mean Ackman's herbalife position is what, like two years old now?
- [28:05]
Sheila Kolhatkar
More than that. Four or five.
- [28:07]
Felix Salmon
Exactly. So he's been doing this for a while. You know, Cohen. What's the longest bet that Cohen's ever taken?
- [28:13]
Sheila Kolhatkar
I don't know, but definitely Cohen's fund was known as sort of a long, short event driven fund.
- [28:20]
Felix Salmon
So a few weeks at most maybe.
- [28:22]
Sheila Kolhatkar
Yeah, no, and some I think even months possibly. But they were, they were mostly trying to make trades based around events like a company's earnings announcement or a drug trial result. And there are many hedge funds. Citadel does this, Millennium does this. There are a lot of hedge funds that do this. And I always thought it was interesting that you would have all of these Ivy league educated, super overachiever, like really smart, ambitious, aggressive guys mostly working at these funds and they would spend all their time trying to figure out what Dell's earnings were going to be next quarter within a penny so they could bet on them.
- [29:00]
Felix Salmon
So what I just want to pick up on what Jordan said, like when, when we're talk, when you're talking in your book about like all of this borderline legal stuff which is going on in hedge funds in. Is it basically that bit of the hedge fund world? Not the HFT people, not the bill, not the activists, not the big macro people. But it's those sort of event driven long short funds. That's where the like dubious legality is sort of concentrated.
- [29:23]
Sheila Kolhatkar
Well, there are different problems and pros and cons around every type of hedge fund strategy. And there are thousands of hedge funds and they all have different strategies. So that being said this particular type of insider trading that was going on during the period I talk about in the book, it was most common at these long short funds that were trying to just make bets on stocks based on short term events. I mean, they were always looking for a catalyst. It wasn't, they were not typically saying, okay, you know, I've just got this new iPhone, I think this is gonna become a huge product. I'm gonna just go long apple and hold it for years as iPhone expands around the world. You know, it was not like that. They were always trying to set up a trade, you know, whatever. It was often tech stocks, and have in mind a catalyst, an event that would move the price, that would move the price in the way that they expected and that they were positioned to benefit from up or down, long, short, whatever it was, and then they would exit the trade. I mean, they were not in there, they were not long term value investors. So they had really no interest in the company's performance over time. They were interested in their event, you know, what is the next big move in the stock.
- [30:30]
Jordan Weissman
If you stop and think for just like a few minutes about this model and you're, some of these guys are glorified day traders and some of them are a little bit beyond that. But when you're managing billions and billions of dollars on these small trades, like, yeah, that's going to be conducive to things like entire trading. Because if you're trading on entirely public information, you're basically just betting that you're actually smarter than the entire market, which not that many people actually are.
- [30:53]
Felix Salmon
And the, and the story of the book basically is the story of the FBI trying to prosecute Stevie Cohen for insider trading and ultimately failing. The question which I have is, is this a useful and productive use of the FBI's time? I mean, how much damage does insider trading actually do?
- [31:15]
Sheila Kolhatkar
I think that's a fair question. I should start by saying they did become interested in this because they realized in the mid 2000s they just had not paid attention to hedge funds really at all. And the hedge fund industry, over the course of Steve Cohen's kind of career, had grown up into this huge part of Wall Street. In fact, hedge funds through the 90s really exploded. And by 2006, when this investigation really started, the government really had no idea what they were up to. And there were a lot of questions. They're lightly regulated, they're not transparent about what their holdings are. So at one point they were sort of like, what is going on? We need to kind of look into it. So the FBI did start to devote resources to this and slowly started to hear. And this was during the period leading up to the financial crisis. They started to hear through wiretaps and informants and, you know, just conversations with people that there was, you know, rumors of all sorts of bad stuff going on in these hedge funds, allegations of market manipulation, of this kind of short selling, you know, like disingenuous short selling, whatever you want to call it. Groups of hedge funds being accused of kind of colluding to drive stocks down so they can make money shorting them. People supposedly paying money to consultants who worked at tech companies to get intelligence from these people and trading on it.
- [32:36]
Felix Salmon
Yeah. And so the FBI basically starts looking at all of this. Why are they so interested in it? And, like, with hindsight, did it make sense for them to put that much effort into it?
- [32:48]
Sheila Kolhatkar
Well, I think that's a fair question, especially because what happened was, while they were in the middle of this investigation of all this insider trading spreading around the financial crisis, the financial crisis blew up. And we, as we all know, they did not bring the big cases that really the public wanted and demanded and deserve to see as a result of the widespread fraud of the financial crisis.
- [33:09]
Felix Salmon
And we can say quite clearly that the financial crisis, for all the blame is broadly spread around a million people, really was not the fault of hedge funds and was certainly not the fault of insider traders.
- [33:20]
Sheila Kolhatkar
Yes, the hedge fund stuff was not directly related to the financial crisis itself. However, I think it is a really important window into the time that led financial crisis, which was a period of time when we had serious deregulatory fever in Washington. The chair of the SEC during many of those critical years was this gentleman named Chris Cox, a Republican congressman who did not believe in regulation. They basically believed the market could regulate itself. And the SEC was actively discouraged from bringing any type of enforcement actions. They were. They were discouraged from bringing people in for depositions. They had to go through hoops to send subpoenas. So what did you have at the end of that? You had the financial crisis, and you had this huge spread of illegal activity among hedge funds.
- [34:06]
Felix Salmon
You see, I'm not sure I buy it. I think that what you're doing is you're conflating two very different things. One is the deregulation of the debt markets, which really did cause the financial crisis, and one is a bunch of sort of wild west activity in the equity markets, which had nothing to do with the financial crisis. And the FBI was spending so much time looking at the equity markets that they missed. What was the really important.
- [34:30]
Jordan Weissman
Well, the FBI, they should have been.
- [34:33]
Sheila Kolhatkar
Able to do all of it. They should have been able to do both.
- [34:36]
Jordan Weissman
Okay. But yeah, the FBI was. Would never have been tasked with dealing with what led up to the financial crisis. The sec, to some extent, but even them, I mean, they're not. They're not safety and soundness. That's more like the Federal Reserve's job or the ots. I mean, there are other regulators who failed in that respect. Frankly. The sec, what it sort of is positioned to do is go after individual assholes who are trading on inside information. I think. I don't think it's necessarily a bad thing to have someone taking the idea that markets should have some extent of an even playing field. I don't think it's a bad thing to have those people do that job. You can argue that maybe there are other things that they should be doing and better funded for, but as long as we believe the financial markets should be to some extent fair, that everyone should have the same, that that is just kind of a bedrock value I think that Americans have.
- [35:20]
Felix Salmon
Well, I mean, I will. I will. In a future episode, I will push back on. Well, and I don't think that the markets are fair.
- [35:26]
Jordan Weissman
I'm not saying that they're definitely not.
- [35:28]
Felix Salmon
They're not.
- [35:29]
Jordan Weissman
That's part of what your book gets at.
- [35:30]
Felix Salmon
And I don't think it makes sense for the SEC or anyone else to try and persuade the public that they are fair or to try and say they should be fair.
- [35:38]
Jordan Weissman
I totally disagree. I think that you can look at how. I mean, so your book does a wonderful job illustrating the extent to which information already is traded for a price on Wall Street. And the again, black edge is inside information. Gray edge is like on the edge. And how much of that flows around. You assume that if insider trading was just kind of ignored altogether by regulators or legalized, whatever ills come of that now are going to intensify. I don't think leaving it alone and letting everyone just run wild is going to make things better and just have people having a overriding sense of cynicism about the markets is also going to make things much better.
- [36:15]
Felix Salmon
Okay, we need to wrap this up, but I really want to finish by asking Sheila about this because it's really central to the sort of reason why you wrote this book in the first place. My feeling is that the harm done by insider trading is done to, like, the people who buy or sell or otherwise trade a stock before a piece of news happens, but when someone knew what was going to happen, that any sort of boring, sensible person who just has a buy and help put all of your money in index funds kind of strategy is never going to be harmed by insider trading, no matter how much of it there is. Jordan has a view that the insider trading does cause harm and that the more insider trading there is, the more harm it causes. Where to finish it? Do you fall on this spectrum?
- [37:06]
Sheila Kolhatkar
I think if we want to have a conversation about whether we should not bother considering insider trading a crime, it's fine to have that debate. But as long as you we're a society that professes to care about the integrity of the market and say it's a fair place and tell everyone that no, you're not going to have a defined pension anymore, you have to put your Money in a 401k and gamble your financial future in the market. As long as we're going to live in that world, I think the market having confidence in the market is actually really important. And I think the other I mean this is like a bigger picture question, but I just thought it was interesting researching this book that this is the job, this financial speculation job, information gathering job is the one of the, if not the most highly compensated job we now have in our economy. And the people who were good at this, including amassing black edge, have made the our generation's enormous robber baron level fortunes. And I'm just intrigued by the fact that we've decided as a society to compensate that job almost as highly as anything else. And why is that? Is that a valuable use of our societal resources? And that is part of the debate, I guess I would like people to have about this book.
- [38:21]
Felix Salmon
So let's have a numbers round to finish off. Sheila, did you bring a number?
- [38:24]
Sheila Kolhatkar
I did and it speaks very directly to what I was just ranting.
- [38:27]
Felix Salmon
Do you have an on topic number?
- [38:29]
Sheila Kolhatkar
I do. So My number is $13 billion, which is the aggregate amount of money that the top 25 hedge fund managers took home in compensation in 2015, which is the last year we have a full ranking. So $13 billion, the top 25 hedge fund guys, that's what they made.
- [38:52]
Felix Salmon
Jordan.
- [38:53]
Jordan Weissman
My number is not hedge fund related, but I felt like bringing it on anyway. My number is three. That's how many years in a row China has managed to reduce its coal use, which actually this might be the most important like economic environmental news of the week as far as I'm concerned. Just because in a world where China is successfully bringing down its Actual just total amount of coal it's using in its economy. That, that actually bodes well for, you know, our, you know, climate change, carbon usage worldwide. Whether or not the coal industry itself will kind of shrivel up and die like we, a lot of us hope it will maybe at some point. I mean it's, it's a good thing. Like without China continuing expanded use of coal, you know, you're not going to see mines in the US coming back to life and you're not going to see the industry kind of.
- [39:40]
Felix Salmon
Donald Trump promised me that I would get my coal mining job back.
- [39:43]
Jordan Weissman
Yeah, well, that's, that's another thing. I wrote a piece about that this week. It's just like how depressing it was hearing him talk about dying industries surging back to life during his faux State of the Union speech. I mean, that's just that that was kind of heartbreaking thinking of like a lot of people in those places who are just going to be so disappointed when they realize that it's not happening.
- [40:02]
Felix Salmon
My number I think is going to be 65 million because I'm not sure, somehow this got buried in all of the sort of Trump news. This is Obama news that Barack and Michelle Obama have sold a book apiece to Penguin Random House. We don't know exactly how much they were paid, but According to the FT, it was somewhere north of $65 million for the two books, which is, I mean, I'm old enough to remember that when you know, Bill Clinton got 10 million or 15 million or whatever it was for his book, that was just mind blowing amount of money. We have completely shattered the record for any kind of presidential memoir here.
- [40:44]
Jordan Weissman
So Laura Miller at Slate had a great point about this, trying to like rationalize it and it's that whereas like past presidential memoirs might be, you know, Christmas gifts in the US there is a legitimate case to be made that people internationally will buy the Obama's books because he is such an, in some ways even more popular globally than he is in the U.S. so you know, the publisher is going to have, you know, something it can sell in Britain and Sweden and wherever the heck else.
- [41:09]
Felix Salmon
And this, and this is true that we're not entirely comparing apples with apples here because most book advances, when you hear reported book advances, they're nearly always just for the US and this is a global one. So you have to take that into account. Still $65 million, a lot of money.
- [41:27]
Jordan Weissman
Yeah, he done good.
- [41:29]
Sheila Kolhatkar
Along with the hedge fund managers.
- [41:31]
Felix Salmon
Along with the hedge fund managers. I know some hedge fund managers who would be happy making $65 million.
- [41:35]
Sheila Kolhatkar
Yeah, that's pretty good.
- [41:37]
Felix Salmon
I think that's it. I think that's all that we have time for this week. I'm so happy that we managed to get Sheila onto this show. Sheila, number one, thank you for coming. Number two, what is the name of your book so that people can run out and buy it?
- [41:52]
Sheila Kolhatkar
It is called Black Edge. It is available at all fine booksellers.
- [41:56]
Jordan Weissman
It's.
- [41:57]
Felix Salmon
If you, if you walk into a physical bookseller, you can't miss it because.
- [42:00]
Sheila Kolhatkar
It'S bright yellow and it has a shark made of money on the COVID which I'm very proud of.
- [42:05]
Jordan Weissman
Is that a reference to Steve Cohen, shark?
- [42:07]
Felix Salmon
We are, we are talking, we were talking offline about whether Stevie Cohen spent $8 million or $12 million on his Damien Hirst shark. We are going to have to get to the bottom of this somehow. But, yes, thanks to Sheila. Thanks also to Ben Frisch, who produced this Week, Ben Frisch, also known as Benjamin Frisch in the world of podcast, to Zach Dynastein, who produces Most other weeks, to Steve Lichti and Andy Bowers who executive produced the whole thing, to the whole Panoply network at Panoply fm, and to you darling listeners who have to keep on emailing us because we love it when you email us. The email address, as ever, is slatemoneylate.com so drop us a note and we will talk to you next week on Slate. Money, who makes your money, who makes your money? Who makes your money, makes your money.
- [43:11]
Sheila Kolhatkar
Makes your money.