Two law professors claim Sullivan & Cromwell put its own interests before that of FTX’s stakeholders, reviving criticism over the law firm’s role in the bankrupt cryptocurrency exchange’s rise, collapse and unwinding.

The firm’s “apparent conflicts of interest permeated FTX’s bankruptcy filing and every aspect of the case”, Jonathan Lipson of Temple University and David Skeel of the University of Pennsylvania wrote in a paper published online earlier this month.

The two academics focused on the 20 M&A and regulatory assignments that S&C worked on for FTX, for which it earned just under $10mn in the months leading up to the exchange’s November 2022 bankruptcy filing.

Through that work, “S&C knew, or was in a position to know, that FTX was co-mingling customer assets”, the professors contended, referring to FTX founder Sam Bankman-Fried’s misuse of account holder funds.

The paper comes ahead of a hearing on Thursday at which Bankman-Fried is set to be sentenced after being convicted of masterminding the looting of FTX customers’ accounts.

The criminal case will not be the final word on FTX’s collapse: earlier this month Robert Cleary, a former federal prosecutor, was appointed as an independent examiner in FTX’s bankruptcy to provide a detailed report on the events leading up to its implosion, including the work of its advisers.

John Ray, the chief executive appointed to oversee FTX, said in a statement on behalf of the company and its advisers: “The paper is simply not research but uninformed and unsupported allegations,” which “grossly mischaracterises the facts”.

The involvement of S&C, which represents the FTX estate, has been controversial from the start. S&C lawyers had assisted the company in the chaotic days leading up to its bankruptcy filing — including preparing its petition and appointing Ray, a restructuring expert its lawyers knew well, as its new chief executive. A former S&C partner, Ryne Miller, was FTX US’s general counsel.

The office of the US Trustee, a part of the Department of Justice which represents the public interest in bankruptcy cases, initially objected to S&C’s retention, arguing that the law firm had failed to properly disclose the full extent of its connections to FTX. Several US senators also voiced concern.

But the trustee eventually lifted its objection after the law firm provided more details of its previous work, and the court approved S&C’s hiring. According to court filings, S&C has reaped a total of $184mn in fees, including billings and reimbursements, between November 2022 and January 2024.

The professors criticised business decisions made by FTX during the course of the case including the failure to revive the FTX exchange, selling the LedgerX unit for what they deemed an inadequate amount and choosing not to sue Binance for withdrawing $2bn from FTX in the fall of 2022, a move that helped precipitate FTX’s bankruptcy.

The professors further contended that “S&C may have violated ethical duties of confidentiality, candour, and loyalty by reporting allegations of these crimes to prosecutors . . . by duping Bankman-Fried into giving control of FTX to Ray”.

“For well over a year, S&C and Ray had free rein to marshal and manage conflicting claims about the public and private interests at stake as they saw fit,” the professors wrote. “These conflicts appear to have reduced recoveries, even as they have enriched S&C.”

People close to S&C and FTX noted that all the company’s actions had to be approved by the bankruptcy court with the consent of the US Trustee and creditors, and pointed out Bankman-Fried had several lawyers personally representing him in November 2022. Moreover, they said account holders could potentially receive the full amount of their claims by the time the bankruptcy is finished.

Lipson and Skeel said they ran into each other last fall during oral arguments before an appeals court over the examiner’s appointment. They decided afterwards to collaborate on the article about the duties of lawyers, which is to be published in the Stanford Law Review.

They said there was a “firewall” in place so Bankman-Fried’s parents, who are Stanford law professors, had no knowledge of the article prior to submission. Skeel said he had no interaction with the Bankman-Frieds and handled all interactions with the Stanford publication. The pair did not call S&C or FTX prior to publication but said they welcomed any feedback.

Lipson said while he was not friends with the Bankman-Fried’s parents, “I have spoken to Sam and his mother, Barbara [Fried], on a number of occasions, which is how we came by much of the material we have”.

“Candidly, I was pretty sceptical of [Sam] Bankman-Fried’s claims at the time, and it was only after a fairly sustained effort of putting pieces together — some from them, but most in public — that it came to appear that S&C may have some problems,” Lipson said.

A spokesperson for Bankman-Fried declined to comment.

thanks... do you know what is their carry trade formula and base rates they used?

sg and my have quite close rates, so 5.72% is much higher than the rate differential i was expecting... just wanna understand the numbers...

The writer is an FT contributing editor

Passive funds are, by construction, price-insensitive bundles of financial securities, weighted to replicate the performance of market indices. But the indices themselves are not entirely passive. And decisions made by index providers are increasingly shaping capital allocation.

By the time Tesla was included in the S&P 500 index, it had already become the sixth-largest US company by market capitalisation. Tesla’s stock had been left out of the S&P 500 despite satisfying each of the published criteria in the index methodology, but the Index Committee had used its discretion not to include it until December 2020.

Rob Arnott — founder of Research Affiliates — estimates that between the committee’s announcement and index rebalance day a month later, index funds needed to buy about $78bn of Tesla stock. A frenzy of activity saw almost a quarter of outstanding Tesla shares trade on the final day of the period, by which time its price had increased by 57 per cent.

The use of discretion by index committees such as S&P Dow Jones’s is rare. Most large providers have an almost algorithmic approach to membership decisions. But the rules themselves are not static.

In 2019 the JPMorgan index committee, following a consultation process, changed rules that had prevented high-income gulf states from having their sovereign bonds included in the EMBI Global range of benchmarks. Debt issued by Saudi Arabia, Qatar, Bahrain, Kuwait and the United Arab Emirates was phased into the index, and by the end of the year constituted almost 12 per cent of the benchmark. These countries’ bonds were transformed into assets that passive funds would be compelled to buy, and on which active managers would need to spend large amounts of portfolio risk to avoid. At around the same time, FTSE Russell changed its recognition of Saudi equities, moving them into the FTSE Global All Cap index — a popular global equity index. Absent these moves it is unclear whether investors would have actively chosen to allocate in size to Middle Eastern sovereigns and companies.

Perhaps most striking have been the series of index changes that have driven capital flows to China in recent years. Between 2018 and 2020, MSCI and FTSE Russell began to include portions of the onshore RMB-denominated A-Share market in their global and emerging market stock indices. Over the same period China’s sovereign debt entered the Bloomberg Barclays Global Aggregate Index, one of the most tracked bond benchmarks. And since 2021 a phased inclusion of Chinese debt into the FTSE Russell World Government Bond Index has been in train.

The IMF estimates that these benchmark changes will have cumulatively driven about $380bn of capital flows into China. They expect that portfolio investments attached to index inclusion are likely to become an important source of financing for Beijing’s current account in the future as its current account surplus turns to deficit.



Index providers are naturally exposed to political scrutiny. Last summer, the House of Representatives Select Committee on the Chinese Communist party launched an investigation into MSCI, arguing that “as a direct result of decisions made by MSCI . . . Americans are now unwittingly funding PRC companies that develop and build weapons for the People’s Liberation Army”. But in the US the providers sit in regulatory limbo.

Gregory Campbell, a financial services assurance partner at PwC, tells me that while EU regulators believe index providers should operate as independent, objective data providers, their US counterparts have questioned whether this is even possible. Given the providers look after index methodologies, they are indirectly responsible for directing investment flows. In 2022 the SEC consulted on whether the providers should be regulated as investment advisers. Since then, they have made no overt move to regulate them.

With the seemingly perpetual growth of passive investing, the importance of index committees grows every day. In the UK, The Investment Association estimates that passive accounts for a third of all assets under management, and index fund assets eclipsed those in actively managed funds in the US market at the end of last year. Decisions as to which securities this money tracks have huge mechanical consequence given their price insensitivity.

The idea of creating a neutral index representing the market is seductively simple. In reality, the challenge of describing and then policing the perimeter of a market is significant. As arbiters of the rule-books defining a market, index committees have become among the most powerful allocators of capital in the world. They deserve scrutiny in accordance with this position.

The Russell 2000 small-caps index has now lagged behind the S&P 500 large-capitalisation index since its inception at the end of 1978, overturning a century of return data across multiple countries.

These are admittedly price returns, since no total return indices go back this far. But including dividends wouldn’t change the picture. Larger companies tend to be more generous with their dividends, so it would probably only worsen the small-cap underperformance. And it looks even more stark if you start in 1984, when the Russell 2000 was actually born (with data going back to the late 70s).

It’s tempting to dismiss this as merely the result of the powerful momentum currently enjoyed by the 10 biggest US stocks, which are thumping even the S&P 490. And notably, this isn’t happening internationally, where small>big largely still holds true.

Milo about to become more expensive in Malaysia...

https://www.sinchew.com.my/news/20240422/nation/5552438

As a clever-clogs analyst a long time ago, I remember ripping a friend’s new business venture apart. Why would you touch such a horrible industry? The profit margins are barely in to double figures! But when revenues passed eight digits, his earnings were a million pounds per year. He realised before I did that money is absolute, whereas my financial models were full of percentages and ratios.

Relativism is not only a cultural problem. It is also rife in finance — as my friend demonstrated — as well as economics and politics. We are constantly bombarded with comparisons which make no sense at all.

Take the news that the UK plans to increase its defence budget to 2.5 per cent of gross domestic product by the end of the decade. What on earth does military spending have to do with the final value of goods and services produced in a country in one year? Even Nato believes its 2 per cent of GDP guideline “serves as an indicator of a country’s political will to contribute”. 

No it doesn’t — the denominator has nothing to do with politics. If anything should be calculated bottom-up on an absolute basis it’s national defence, assessing risk versus capability. In any rational world, how many 155mm artillery shells are needed should be independent of consumer confidence (the biggest driver of GDP). Armies should not starve if artificial intelligence fails to boost low productivity.

Carbon intensity metrics used to judge corporate greenness are another example of relative hogwash. Our atmosphere needs lower emissions, period — not having them increase less than revenues. Plus you can end up with a ridiculous situation in which companies are praised when sales outpace emissions solely because of inflation.

The hot topic of unemployment also suffers from wayward denominators. America has its jobless claims data, but the rest of the world rarely mentions the actual number of real human beings out of work. Mostly we talk about the unemployment rate, expressed as a percentage.

But these are a fiction — usually dividing an arbitrary definition of unemployment by a worse estimate of the number of people who are economically active. If someone feels worthless the day a survey hits their door mat, they may tick the “currently not actively seeking work” box. Hey presto, they aren’t included in the unemployment rate.

And therein lies the appeal of ratios and percentages, I suppose. They are one step removed from having to face unpalatable truths in either the numerator (how many tanks do we actually have compared with Russia) or the denominator (better optics on defence spending are merely due to a recession).

The inequality debate is another case in point. Those on the left prefer to throw around comparisons between the rich and poor. Meanwhile the right tends to focus on the numerator only, showing how much wealthier the poor are in absolute terms.

You may think markets are above spurious relativities. And to their credit (and, often, my shame) they frequently are. For example, no one cared that Amazon or Tesla had negative margins for years. Investors knew the revenue line was the only thing to watch.

Likewise, for decades markets have not been spooked much by soaring public debt ratios. Rich country public sector liabilities are now 100 per cent of GDP on average. This may yet prove disastrous. However, so far government bond owners have been right not to panic.

That said, investors still do things every bit as silly as comparing defence budgets to national incomes. We rank companies by their price-to-earnings ratios, say, despite the fact every company and sector measures their net profits differently.

Strategist reports are also devoured. These mostly consist of charts of variables which seem to move together (such as solar flare activity and year-on-year Nasdaq returns). Causation is claimed when the two numbers are merely correlated — if even that.

Perhaps our most common investment mistake is comparing today with the past. To be sure there are ratios that do revert to a mean — returns on equity for example. But extrapolating historical relationships is often ruinous, as many a failed hedge fund — Long-Term Capital Management springs to mind — will tell you.

Absolute numbers can mislead as well, of course. Sure, Alphabet’s market cap rose by a headline grabbing $200bn on Friday — but it’s a big company. Similarly, it was wrong during Covid to quote cases and deaths by country with no reference to population size.

We must all be more careful not to take relative or absolute facts as given. But the former are especially dangerous; inaccuracies can lurk in two numbers. And very often these shouldn’t even be compared at all.

stuart.kirk@ft.com   

The pages of the Financial Times are not usually a place for legends about ancient gods, but perhaps I can be indulged in sharing one with a lesson to teach us all.

More than a century ago, Odin, All-father, greatest of the Norse gods, went to his wayward fellow god Loki, and put him in charge of the stock market. Odin told Loki that he could do whatever he wanted, on condition that across each and every 30-year period, he ensured that the market would offer average annual returns between 7 and 11 per cent. If he flouted this rule, Odin would tie Loki under a serpent whose fangs would drip poison into Loki’s eyes from now until Ragnarök.

Loki is notoriously malevolent, and no doubt would love to take the wealth of retail investors and set it on fire, if he could. But when faced with such a — shall we say binding? — constraint, what damage could he really do?

He could do plenty, says Andrew Hallam, author of Balance and other books about personal finance. Hallam uses the image of Loki as the malicious master of the market to warn us all against squandering the bounties of equity markets.

All Loki would have to do is ensure the market zigged and zagged around unpredictably. Sometimes it would deliver apparently endless bull runs. At other times it would plunge without mercy. It might alternate mini-booms and mini-crashes; it might trade sideways; it might repeat old patterns, or it might do something that seemed quite new. At every moment, the aim would be to trick investors into doing something rash.

None of that would deliver Loki’s goals if we humans weren’t so easy to fool. But we are. You can see the damage in numbers published by the investment research company Morningstar; last year it found a shortfall in annual returns of 1.7 percentage points between what investors make and the performance delivered by the funds in which they invested.

There is nothing strange about investors making a different return from the funds in which they invest. Fund returns are calculated on the basis of a lump-sum buy-and-hold investment. But even the most sober and sensible retail investor is likely to make regular payments, month by month or year by year. As a result, their returns will be different, maybe better and maybe worse.

Somehow, it’s always worse. The gap of 1.7 percentage points a year is huge over the course of a 30-year investment horizon. A 7.2 per cent annual return will multiply your money eightfold over 30 years, but subtract the performance shortfall and you get 5.5 per cent a year, or less than a fivefold return in 30 years.

Why does this happen? The primary reason is that Loki’s mischievous gyrations tempt us to buy when the market is booming and to sell when it’s in a slump. Ilia Dichev, an economist at Emory University, found in a 2007 study that retail investors tended to pile into markets when stocks were doing well, and to sell up when they were languishing. (Without wishing to burden the long-suffering reader with technical details, it turns out that buying high and selling low is a bad investment strategy.)

One possible explanation for this behaviour is that investors are deeply influenced by what they’ve seen the stock market doing across their lives so far. The economists Ulrike Malmendier and Stefan Nagel have found that the lower the returns investors have personally witnessed, the less they are likely to put in the stock market. This means that bear markets scare investors away from their biggest buying opportunities.

Another study, by Brad Barber and Terrance Odean, looked at retail investors in the early 1990s, and found that they traded far too often. Active traders underperformed by more than 6 percentage points annually. Slumbering investors saw a much better performance. The sticker price of making a trade has plummeted since then, of course. Alas, the cost of making a badly timed trade is as high as ever.

Morningstar found that the gap between investment and investor returns is largest for more specialist investments such as sector equity funds or non-traditional equity funds. The gap is smaller for plain vanilla equity and smaller still for allocation funds, which hold a blend of stocks and bonds and automate away investor choices. That suggests that the investors who are trying to be clever are the most likely to fall short, while those who make the fewest possible decisions will lose out by the smallest amount.

I am always hearing that people should be more engaged with investing, and up to a point that is true. People who feel ignorant about how equity investing works and therefore stick their money in a bank account or under a mattress, are avoiding only modest risks and giving up huge potential returns.

But you can have too much of a good thing. Twitchily checking and rearranging your portfolio is a great way to get sucked into poorly timed trades. The irony is that the new generation of investment apps work the same way as almost any other app on your phone: they need your attention and have plenty of ways to get it.

Recent research by the Behavioural Insight Team, commissioned by regulators in Ontario, found that gamified apps — offering unpredictable rewards, leader boards and badges for activity — simply encouraged investors to trade more often. Perhaps Loki was involved in the app development process?

I’ve called this the Investor’s Tragedy. The more attention we pay to our investments, the more we trade, and the cleverer we try to be, the less we will have at the end of it all.

Deutsche Bank’s asset manager DWS inflated the amount of money it won from clients by billions of euros through an accounting approach that it failed to disclose for years, and which fed into executive bonus calculations. 

Quarterly results for the Frankfurt-listed company, in which Deutsche Bank holds an 80 per cent stake, last month showed for the first time how it included so-called advisory mandates in its overall assets under management and annual flows. 

Advisory mandates are a low-margin business, where an asset manager gives a client its view on matters such as asset allocation but the client makes its own independent investment decisions, and are distinct from higher-margin “assets under management”, where the company makes investment decisions on the client’s behalf.

DWS did not expressly disclose that its assets under management also included assets managed by third parties until late 2022 — months after former chief executive Asoka Wöhrmann was ousted — and that changes in the market valuation of advisory assets were counted in its flows. Even then, the practice was only referenced in a footnote. 

The size of DWS’s advisory assets has grown disproportionally in recent years, according to the new disclosures and people familiar with historic data.

Three people with direct knowledge of DWS’s internal discussions told the Financial Times that the asset manager started to place significant emphasis on the acquisition of new advisory mandates when Wöhrmann took the helm in late 2018, months after the company floated.

Since its IPO, bonuses for executives and other staff have been directly linked to net flows.

DWS’s pay policy tasked executives with lifting net inflows as a percentage of assets under management by 3 to 5 per cent a year as one of four targets in their long-term incentive plans. In 2021 — the first year for which data is available — DWS management achieved 150 per cent of their inflow target. 

DWS told the Financial Times that “advisory asset inflows, and in particular the inclusion of market movements when calculating them, have not had a material impact on executive compensation in any year.” 

It is the second time since its 2018 IPO that DWS has faced questions about disclosure. Last year, DWS paid $19mn to settle charges with the US Securities and Exchange Commission about greenwashing, and an investigation by Frankfurt prosecutors into the allegations is ongoing.

The asset manager last month reported for the first time that advisory mandates made up 3.5 per cent of total assets excluding cash in 2023, up from 3 per cent a year earlier. In the same year, however, the disclosure shows that advisory assets represented 27 per cent of all net inflows excluding cash. 

DWS has not disclosed data for advisory inflows for years before 2022.

But FT calculations based on data provided by insiders show that advisory assets accounted for at least a fifth of all DWS non-cash inflows between June 2018 and March 2024 — a breakdown not previously made public.

Advisory assets more than tripled to €29bn in that period, while total assets under management excluding cash rose 36 per cent to €856bn.

According to people familiar with the historic data, advisory assets lifted DWS’s reported net flows in all years since 2018.

In 2020, almost all of the €10.8bn in reported non-cash inflows were linked to advisory assets, the people said. That was mainly due to a multibillion mandate from Siemens which had been erroneously treated as an active multi-asset one, and was reclassified as an advisory mandate in late 2022, they added.

The overall impact on flows was “immaterial” in all other years, the people said.

After DWS restated the data for 2023, a €4.4bn inflow into the asset manager’s high-margin flagship “active multi-asset” strategy became a €1.7bn outflow when stripping out an advisory mandate for another German blue-chip.

Irene Rossetto, an asset management analyst at Keefe, Bruyette & Woods, told the FT that including changes of the value of advisory assets, including currency effects and market performance, in flows was “uncommon” and “does not appear to be in line with industry practice”. 

DWS told the FT that despite changes to the definitions of net flows and assets under management in its financial reports, its internal definitions had “been consistent since prior to the initial public offering”, adding that “our annual reports and financial disclosure were always accurate”.

The group said that changes in disclosure since late 2022 were intended to “provide more transparency into the nature of our AUM and flows”. 

Wöhrmann declined to comment through a lawyer. Deutsche Bank declined to comment.