Streetwise Professor

August 22, 2009

Sergeant Schultz Sees Something!

Filed under: Derivatives,Economics — The Professor @ 5:35 pm

About 10 months ago I wrote about a massive squeeze on VW stock, associated with the revelation that Porsche had accumulated an immense options position on the larger company’s stock. For a brief time, the squeeze made VW the largest capitalization firm in the world.  The only comparable event in historical record that I am aware of is the Northern Pacific corner of 1901.

The German financial regulator, Bafin, investigated.  But, apparently channeling its inner Sergeant Schultz, it concluded: “I see nuthink!  I know nuthink!”  Disregarding the obvious evidence of a massive manipulation floating before it very eyes, Bafin declined to proceed against Porsche, stating  “We didn’t find any indications for a share manipulation.”  I am speechless.  No indications?  Did you, like, you know, look at the stock chart?  Just what exactly caused that massive spike in price?  That is all, Sergeant.

But, apparently either Sergeant Schultz was sent to the Eastern Front at long last and replaced by a more vigilant overseer, or the threat to do so finally caused him to open his eyes.  For German prosecutors, acting on a referral from Bafin, dramatically raided former Porsche CEO Wendelin Wiedeking’s home, and the home of Porsche’s former CEO:

German prosecutors are investigating Wendelin Wiedeking, Porsche’s former chief executive, and other people close to the sports car maker, alleging market manipulation and the leaking of inside information in the failed takeover attempt of Volkswagen.

Prosecutors in Stuttgart yesterday raided the headquarters of Porsche, which recently agreed to merge with VW after an attempt to acquire the much bigger rival had pushed it to the brink of bankruptcy.

. . . .

Claudia Krauth, a prosecutor at the regional court in Stuttgart, said the investigation had been launched after a complaint from Bafin, Germany’s financial regulator.

Bafin launched an investigation into market manipulation this year after a German press report suggested that Porsche had misled markets about its ambition to take over VW.

Actually, changes in political fortunes are the best explanation for Bafin’s change of heart.  Porsche’s wild gambit failed this summer, resulting in the acquisition of the company by VW, and the ouster of its CEO  Wendelin Wiedeking.  When Wiedeking was riding high, and was still a power in Germany, Bafin had little appetite to take him on:

Last month, VW’s shares rocketed after Porsche unexpectedly disclosed that through the use of derivatives it had increased its stake in VW from 35 to 74.1 per cent, prompting Bafin, Germany’s financial regulator, to launch a formal investigation into possible market manipulation.

But analysts blamed Bafin for allowing Porsche’s use of options to secure secretly a dominating stake in VW.

Investment bankers said Bafin felt little appetite for pursuing an investigation of Porsche as it lacked political support for such a move. [Emphasis added.]

So, Wiedeking is on top–no manipulation.  Wiedeking is down:  Into the cooler!

I guess late is better than never, but this correlation between Wiedeking’s power and the posture of German regulators and prosecutors is unseemly, to put it mildly. There can be little new information about the squeeze itself that would explain the timing; Wiedeking’s precipitous fall seems the most salient development.  It hardly inspires confidence in Bafin’s independence and probity to observe this pattern of conduct.  It strongly suggests that financial regulators in Germany are captured by those whom it is supposed to regulate.  Not that this phenomenon is limited to Germany, but on its face this is a particularly egregious example.

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  1. Since the regulator is such a problem position everyplace on earth, it is best to replace individuals by programs. A public key cryptosystem enabled virtual regulator is the need of the hour.

    Comment by Surya — August 22, 2009 @ 9:06 pm

  2. You’re onto something, Surya. In fact, I could probably design a virtual regulatory system to identify market manipulations. There are already systems out there that companies use to identify compliance problems.

    Human regulators, especially in big money finance, are often overmatched intellectually and subject to political intimidation by the big players.

    Although I usually have very little nice to say about trial lawyers in the US, I think private legal actions against big malfeasors can play a very constructive role in the financial markets.

    The ProfessorComment by The Professor — August 22, 2009 @ 9:37 pm

  3. Thanks Professor. I even thought of a title for a paper “Regulating without regulators”. I wasn’t thinking so much about market manipulations, but it would be cool to see how one can design a secure manipulation detection system. I was thinking more along the lines of the usual 10K audit process. One can remove the dependence on a specific auditor paid for by the company if there is a virtual Fed auditor.

    Fed would publish an open source audit methodology for Mtm valuation of derivatives, etc, etc. There are ways to map this into machine readable schema with very little overhead. We can use this machine readable framework to valuate the general ledger data which again is in an electronic framework thanks to SAP and Oracle accounting systems. The output would be a standard 10-15 pages report resembling a 10K.

    The question is then one of security. The company doesn’t really want to disclose all its position data and the Fed doesn’t want its valuation system to be tampered by the company. Through a judicious use of public key cryptosystem we can solve this problem elegantly. Is there any grant money for such proposals? I am thinking that the direct virtual auditing by the Fed would even help companies reduce compliance costs significantly and they need not be scared about paying millions to auditors everytime a new regulation is introduced.

    Comment by Surya — August 23, 2009 @ 12:34 pm

  4. Actually, don’t the SEC and the NYSE already have computer programs for tracking market manipulations? I thought they already did.

    Comment by elmer — August 23, 2009 @ 5:34 pm

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