Mistakes happen. Things go wrong. It is how you handle them that matters.
This week’s observations follow on from last week’s post on rogue traders. Often, people will do silly things to hide mistakes and losses. A really famous case occurred at the Japanese house, Daiwa, in the nineties. A trader, Toshihide Iguchi, covered up a loss of some $70’000, struggled helplessly to compensate it and 12 years lated confessed as the loss ballooned to over $1 billion. For more, click here. Many will rush to say; “I am not a trader, so this does not apply to me.” And there you will be wrong; mistakes happen at many points in the value chain and it is important to have the right mindset. It happens in Operations too.
Rights issues are optional events associated with equities. Companies issue them when they need fresh capital and the “right” refers to the option given to existing shareholders to purchase additional shares in the company. The idea being you can keep the share of the company you own constant. But, they are rights, not obligations; you may buy the shares, which are often offered at a discount, or you may sell the rights. A lead manager is always appointed to coordinate these events, which can be quite complex when a stock is listed on multiple exchanges. Goldman Sachs was involved in one such complex issue in the early ’90’s.
Back in the day, the pharmaceutical company Ciba Geigy, which is today part of Sandoz, had just such a rights issue. There were rights on the bearer shares and the registered shares; Swiss companies at the time often had two and sometimes three kinds of share in circulation. Ciba also had ADR’s, American Depositary Shares, which traded on the New York Stock Exchange. The ADR’s were issued by an agent, Morgan Guaranty, now part of JP Morgan. When it came to the rights issue, regulation being what it is, and US regulation being the overly complex, prescriptive and proscriptive beast that it is, US persons were not allowed to take up the rights, so they were going to get cash from the agent, Morgan Guaranty (MGT). To get the cash, MGT sold the rights to Goldman Sachs. The rights were in two lumps, one each from the bearer and registered shares.
This was the typical type of block trade that Goldman was famed for; using the firm’s capital to intermediate. Taking risks, calculated ones. The deal must have been good, because the head equity trader of the day, one Xavier Rolet, who is now the CEO of the London Stock Exchange, agreed to pay cash up front. Something like a $2 million trade. A lot of money for the time and type of transaction. The rights were then sold on, making a decent profit. As an Operations guy, I had not been too aware of the trade. I did know we had a couple of trades to settle with Morgan Guaranty, receiving those rights as one big lot and then delivering them on.
One spring morning, I found myself in the office with my number two Marcel Estermann, sorting out reconciling items. Known as breaks, these are the staple diet of Operations folk. It was actually a bank holiday, but we were catching up as we had more breaks than we ought to have had or wanted to have. Unsolved breaks have a habit of biting you. The phone rings. Even though we are not officially working, we answer. A good friend of ours from London, George Liberopoulos is on the line. He starts to tell us about this terrible problem that Morgan Guaranty have with this rights delivery. It seems that an inadequate procedure has been followed at MGT. Their agent Euroclear, another division of MGT, has sold one lump of the rights, clearly in error and now can’t deliver the whole block to us. It seems that when some internal cut-off time was reached, the larger lump was sold with those responsible not realising that the issue was a failure to receive the smaller block of rights. George was in panic mode, I think reflecting the nerves round at MGT. The conversation developed into one where people are moving beyond asking for help and are almost making their problem, your problem, getting aggressive if you cannot solve things instantly.
We actually knew how to sort this, but could not sort it that day as the markets and the banks were closed. “George, there are three ways to solve this problem, but we will have to wait until tomorrow when the market is open. Here are the options. Call the client, sort out what they want and call us back before 12:00. It’s a holiday, we will leave when we are done cleaning up. Just tell us what the choice is so we can get on the job first thing. Option 1: We can sort it out. We’ll buy the rights back from the lead and tell MGT what it cost. Option 2: they phone the lead and sort it and Option 3: if we don’t do 1 or 2 we will all be spending a long time with the lawyers working out who owes whom how much. We have over 30 deliveries to make to deliver these shares. So decide and call back.” We finished our little clean-up exercise and were ready to go. No word from George. We called. Voice Mail. Left a message and a home number; this pre-dated Blackberries and mobiles.
Next morning, no messages, no instructions. So as soon as London opened, we were on the phone. The client asked us to get a price so they could get an idea of the damage. Now, the good news is that there was somebody to go to, the lead manager, to sort this. The bad news was that there was no way of being subtle about the problem. So we asked for a price for a specific number of rights, some 1’726 or so. “Zat zeems like a familiar number ja,” said the obviously white-socked trader round at Swiss Bank Corp. “Yeah, yeah. Forget the quips, just make me a price please.” “48 bid, indicative.” It was 09:00 in Europe. We passed on the info to MGT. They baulked at the cost, having clearly sold the rights somewhere below that. We told them to be quick. It took them a whole 90 minutes to call back and give us the ok. Meanwhile, Sod’s Law, the market had moved and was now at 49.50. Reluctantly, MGT gave the order to close out. Hesitation had cost something of the order of $150’000 or $100’000 per hour.
Lessons Learned: The procedures at MGT and Euroclear were clearly not adequate; they sold out the rights without knowing what was going on and then, when things went South, they did not know how to deal with a lead manager in a rights issue. In the scheme of today’s whale like problems at JPM, this is a bit of a prawn, but it serves up an appetising lesson on how to solve problems in Operations. When you encounter a mistake, there are three steps to getting things fixed: admit it, do not hesitate and close out the problem.
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