Third Point - Letter to Investors Q3 2013

Additional Color on “Whatever that guy is buying, I want to short it”

Yesterday, the Securities Exchange Commission (“SEC”) announced fraud charges against collateral manager Of CDO (better late than never, right?). I re-read the sections in The Big Short , dedicated to Harding Advisory and Wing Chau. I’ve included the relevant sections (I’ve bolded a few lines for emphasis). Enjoy:

Eisman took his assigned seat between Greg Lippmann and a fellow who introduced himself as Wing Chau and said that he ran an investment firm called Harding Advisory. When Eisman asked exactly what Harding Advisory advised, Wing Chau explained that he was a CDO manager. “I had no idea there was such a thing as a CDO manager,” said Eisman. “I didn’t know there was anything to manage.”

Later Eisman would fail to recall what Wing Chau looked like, what he wore, where he’d come from, or what he ate and drank-everything but the financial idea he represented. But from his seat across the hibachi, Danny Moses watched and wondered about the man Lippmann had so carefully seated next to Eisman. He was short, with a Wall Street belly-not the bleacher bum’s boiler but the discreet, necessary pouch of a squirrel just before winter. He’d graduated from the University of Rhode Island, earned a business degree at Babson College, and spent most of his career working sleepy jobs at sleepy life insurance companies-but all that was in the past. He was newly, obviously rich. “He had this smirk, like, I know better,” said Danny. Danny didn’t know Wing Chau, but when he heard that he was the end buyer of subprime CDOs, he knew exactly who he was: the sucker. “The truth is that I didn’t really want to talk to him,” said Danny, “because I didn’t want to scare him.”

When they saw that Lippmann had seated Eisman right next to the sucker, both Danny and Vinny had the same thought: Oh no. This isn’t going to end well. Eisman couldn’t contain himself. He’d figure out the guy was a fool, and let him know it, and then where would they be? They needed fools; only fools would take the other side of their trades. And they wanted to do more trades. “We didn’t want people to know what we were doing,” said Vinny. “We were spies, on a fact-finding mission.” They watched Eisman double-dip his edamame in the communal soy sauce-dip, suck, redip, resuck-and waited for the room to explode. There was nothing to do but sit back and enjoy the show. Eisman had a curious way of listening; he didn’t so much listen to what you were saying as subcontract to some remote region of his brain the task of deciding whether whatever you were saying was worth listening to, while his mind went off to play on its own. As a result, he never actually heard what you said to him the first time you said it. if his mental subcontractor detected a level of interest in what you had just said, it radioed a signal to the mother ship, which then wheeled around with the most intense focus. “Say that again,” he’d say. And you would! Because now Eisman was so obviously listening to you, and, as he listened so selectively, you felt flattered. “I keep looking over at them,” said Danny. “And I see Steve saying over and over, Say that again. Say that again.”

Later, whenever Eisman set out to explain to others the origins of the financial crisis, he’d start with his dinner with Wing Chau. Only now did he fully appreciate the central importance of the so-called mezzanine CDO-the CDO composed mainly of triple-B-rated subprime mortgage bonds-and its synthetic counterpart: the CDO composed entirely of credit default swaps on triple-B-rated subprime mortgage bonds. “You have to understand this,” he’d say. “This was the engine of doom.” He’d draw a picture of several towers of debt. The first tower was the original subprime loans that had been piled together. At the top of this tower was the triple-A tranche, just below it the double-A tranche, and so on down to the riskiest, triple-B tranche-the bonds Eisman had bet against. The Wall Street firms had taken these triple-B tranches-the worst of the worst-to build yet another tower of bonds: a CDO. A collateralized debt obligation. The reason they’d done this is that the rating agencies, presented with the pile of bonds backed by dubious loans, would pronounce 80 percent of the bonds in it triple-A. These bonds could then be sold to investors-pension funds, insurance companies-which were allowed to invest only in highly rated securities.

It came as news to Eisman that this ship of doom was piloted by Wing Chau and people like him. The guy controlled roughly $15 billion, invested in nothing but CDOs backed by the triple-B tranche of a mortgage bond or, as Eisman put it, “the equivalent of three levels of dog shit lower than the original bonds.” A year ago, the main buyer of the triple-A-rated tranche of subprime CDOs-which is to say the vast majority of CDOs-had been AIG. Now that AIG had exited the market, the main buyers were CDO managers like Wing Chau. All by himself, Chau generated vast demand for the riskiest slices of subprime mortgage bonds, for which there had previously been essentially no demand.

This demand led inexorably to the supply of new home loans, as material for the bonds. The soy sauce in which Eisman double-dipped his edamame was shared by a man who had made it possible for tens of thousands of actual human beings to be handed money they could never afford to repay.

As it happened, FrontPoint Partners had spent a lot of time digging around in those loans, and knew that the default rates were already sufficient to wipe out Wing Chau’s entire portfolio. “God,” Eisman said to him. “You must be having a hard time.” “No,” Wing Chau said. “I’ve sold everything out.” Say that again. It made no sense. The CDO manager’s job was to select the Wall Street firm to supply him with subprime bonds that served as the collateral for CDO investors, and then to vet the bonds themselves. The CDO manager was further charged with monitoring the hundred or so individual subprime bonds inside each CDO, and replacing the bad ones, before they went bad, with better ones. That, however, was mere theory; in practice, the sorts of investors who handed their money to Wing Chau, and thus bought the triple-A-rated tranche of CDOs-German banks, Taiwanese insurance companies, Japanese farmers’ unions, European pension funds, and, in general, entities more or less required to invest in triple-A-rated bonds-did so precisely because they were meant to be foolproof, impervious to losses, and unnecessary to monitor or even think about very much.

The CDO manager, in practice, didn’t do much of anything, which is why all sorts of unlikely people suddenly hoped to become one. “Two guys and a Bloomberg terminal in New Jersey” was Wall Street shorthand for the typical CDO manager.The less mentally alert the two guys, and the fewer the questions they asked about the triple-B-rated subprime bonds they were absorbing into their CDOs, the more likely they were to be patronized by the big Wall Street firms. The whole point of the CDO was to launder a lot of subprime mortgage market risk that the firms had been unable to place straightforwardly. The last thing you wanted was a CDO manager who asked lots of tough questions.

The bond market had created what amounted to a double agent-a character who seemed to represent the interests of investors when he better represented the interests of Wall Street bond trading desks. To assure the big investors who had handed their billions to him that he had their deep interests at heart, the CDO manager kept ownership of what was called the “equity,” or “first loss” piece, of the CDO-the piece that vanished first when the subprime loans that ultimately supplied the CDO with cash defaulted. But the CDO manager was also paid a fee of 0.01 percent off the top, before any of his investors saw a dime, and another, similar fee, off the bottom, as his investor received their money back. That doesn’t sound like much, but, when you’re running tens of billions of dollars with little effort and no overhead, it adds up. Just a few years earlier, Wing Chau was making $140,000 a year managing a portfolio for the New York Life Insurance Company. In one year as a CDO manager, he’d taken home $26 million, the haul from half a dozen lifetimes of working at New York Life.

Now, almost giddily, Chau explained to Eisman that he simply passed all the risk that the underlying home loans would default on to the big investors who had hired him to vet the bonds. His job was to be the CDO “expert,” but he actually didn’t spend a lot of time worrying about what was in CDOs. His goal, he explained, was to maximize the dollars in his care. He was now doing this so well that, from January 2007 until the market crashed in September, Harding Advisory would be the world’s biggest subprime CDO manager. Among its other achievements, Harding had established itself as the go-to buyer for Merrill Lynch’s awesome CDO machine, notorious not only for its rate of production (Merrill created twice as many of the things as the next biggest Wall Street firm) but also for its industrial waste (its CDOs were later proven to be easily the worst).“He ‘managed’ the CDOs,” said Eisman, “but managed what? I was just appalled that the structured finance market could be so insane as to allow someone to manage a CDO portfolio without having any exposure to the CDOs. People would pay up to have someone ‘manage’ their CDOs-as if this moron was helping you. I thought, You prick, you don’t give a fuck about the investors in this thing.” Chau’s real job was to serve as a new kind of front man for the Wall Street firms he “hired” investors felt better buying a Merrill Lynch CDO if it didn’t appear to be run by Merrill Lynch.

There was a reason Greg Lippmann had picked Wing Chau to sit beside Steve Eisman. If Wing Chau detected Eisman’s disapproval, he didn’t show it; instead, he spoke to Eisman in a tone of condescension. I know better. “Then he says something that blew my mind,” said Eisman. “He says, ‘I love guys like you who short my market. Without you I don’t have anything to buy.'” Say that again.
“He says to me, ‘The more excited that you get that you’re right, the more trades you’ll do, and the more trades you do, the more product for me.'”

That’s when Steve Eisman finally understood the madness of the machine. He and Vinny and Danny had been making these side bets with Goldman Sachs and Deutsche Bank on the fate of the triple-B tranche of subprime mortgage-backed bonds without fully understanding why those firms were so eager to accept them. Now he was face-to-face with the actual human being on the other side of his credit default swaps.

Now he got it: The credit default swaps, filtered through the CDOs, were being used to replicate bonds backed by actual home loans. There weren’t enough Americans with shitty credit taking out loans to satisfy investors’ appetite for the end product. Wall Street needed his bets in order to synthesize more of them. “They weren’t satisfied getting lots of unqualified borrowers to borrow money to buy a house they couldn’t afford,” said Eisman. “They were creating them out of whole cloth. One hundred times over! That’s why the losses in the financial system are so much greater than just the subprime loans. That’s when I realized they needed us to keep the machine running. I was like, This is allowed?”

Wing Chau didn’t know he’d been handpicked by Greg Lippmann to persuade Steve Eisman that the people on the other end of his credit default swaps were either crooks or morons, but he played the role anyway. Between shots of sake he told Eisman that he would rather have $50 billion in crappy CDOs than none at all, as he was paid mainly on volume. He told Eisman that his main fear was that the U.S. economy would strengthen, and dissuade hedge funds from placing bigger bets against the subprime mortgage market. Eisman listened and tried to understand how an investor on opposite ends of his bets could be hoping for more or less the same thing he was-and how any insurance company or pension fund could hand its capital to Wing Chau. There was only one answer: The triple-A ratings gave everyone an excuse to ignore the risks they were running.

Danny and Vinny watched them closely through the hibachi steam. As far as they could tell, Eisman and Wing Chau were getting along famously. But when the meal was over, they watched Eisman grab Greg Lippmann, point to Wing Chau, and say, “Whatever that guy is buying, I want to short it.” Lippmann took it as a joke, but Eisman was completely serious: He wanted to place a bet specifically against Wing Chau. “Greg,” Eisman said, “I want to short his paper. Sight unseen.” Thus far Eisman had bought only credit default swaps on subprime mortgage bonds; from now on he’d buy specifically credit default swaps on Wing Chau’s CDOs. “He finally met the enemy, face-to-face,” said Vinny.

It is unclear whether Merrill Lynch and/or other parties face charges. Given Merrill and others seem equally, if not more culpable than Harding Advisory/Wing Chau, it would seem appropriate.

Daniel Loeb and Third Point LLC: Recruiting Criteria (?) - Weekend Reading

I was doing some background research on a completely unrelated matter, and ran into this famous Daniel Loeb email exchange (from 2005) with a London-based gentleman (At Third Point, like the financial markets in general,”one’s place in society” does not matter at all. We are a bunch of scrappy guys from diverse backgrounds (Jewish Muslim, Hindu etc) who enjoy outwitting pompous asses like yourself in financial markets globally) It seems Loeb and Third Point strive to embody the American promise and dream (at least as of 2005). Also, harkens back to  Dr. Martin Luther King’s famous, “I have a dream that my four little children will one day live in a nation where they will not be judged by the color of their skin, but by the content of their character” :

—–Original Message—–
From: Alan Lewis
Sent: Tuesday, March 22, 2005 11:34 AM
To: Daniel Loeb
Subject: CV

Daniel,

Thanks for calling earlier today. Enclosed is my cv for your review. I look forward to following up with you when you have more time.

Best regards,

Alan

Alan D. Lewis
Managing Director
Sthenos Capital Ltd.

—–Original Message—–
From: Daniel Loeb
Sent: 27 March 2005 23:08
To: Alan Lewis
Subject: RE: CV

what are your 3 best current european ideas?

Daniel Loeb
Managing Member
Third Point LLC

—–Original Message—–
From: Alan Lewis
Sent: Monday, March 28, 2005 1:03 AM
To: Daniel Loeb
Subject: RE: CV

Daniel,

I am sorry but it does not interest me to move forward in this way. If you wish to have a proper discussion about what you are looking to accomplish in Europe, and see how I might fit in, fine.

Lesson one of dealing in Europe, business is not conducted in the same informal manner as in the U.S.

Best regards,

Alan

—–Original Message—–
From: Daniel Loeb
Sent: 28 March 2005 09:50
To: Alan Lewis
Subject: RE: CV

One idea would suffice.

We are an aggressive performance oriented fund looking for blood thirsty competitive individuals who show initiative and drive to make outstanding investments. This is why I have built third point into a $3.0 billion fund with average net returns of 30% net over 10 years.

We find most brits are bit set in their ways and prefer to knock back a pint at the pub and go shooting on weekend rather than work hard. Lifestyle choices and important and knowing one’s limitations with respect to dealing in a competitive environment is too. That is Lesson 1 at my shop.

It is good that we learned about this incompatibility early in the process and I wish you all the best in your career in traditional fund management.

Daniel

—–Original Message—–
From: Alan Lewis
Sent: Monday, March 28, 2005 4:08 AM
To: Daniel Loeb
Subject: RE: CV

Daniel,

I guess your reputation is proven correct. I have not been in traditional fund management for more than eleven years. I did not achieve the success I have by knocking back a pint, as you say. I am aggressive, and I do love this business. I am Half American and half French, and having spent more than half my life on this side of the pond I think I know a little something about how one conducts business in the UK and Europe.

There are many opportunities in the UK and Europe, shareholder regard is only beginning to be accepted and understood. However, if you come here and handle it in the same brash way you have in the U.S. I guarantee you will fail. Things are done differently here, yes place in
society still matters, where one went to school etc. It will take tact, and patience (traits you obviously do not have) to succeed in this arena.

Good luck!

Alan

—–Original Message—–
From: Daniel Loeb
Sent: 28 March 2005 10:23
To: Alan Lewis
Subject: RE: CV

Well, you will have plenty of time to discuss your “place in society” with the other fellows at the club.

I love the idea of a French/english unemployed guy whose fund just blew up telling me that I am going to fail.

At Third Point, like the financial markets in general,”one’s place in society” does not matter at all. We are a bunch of scrappy guys from diverse backgrounds (Jewish Muslim, Hindu etc) who enjoy outwitting pompous asses like yourself in financial markets globally.

Your “inexplicable insouciance” and disrespect is fascinating; It must be a French/English aristocratic thing. I will be following your “career” with great interest.

I have copied Patrick so that he can introduce you to people who might be a better fit-there must be an insurance company or mutual fund out there for you.

Dan Loeb

————————————————

From: Alan Lewis
To: Daniel Loeb
March 28 2005

Hubris.

————————————————

From: Daniel Loeb
To: Alan Lewis
March 28 2005

Laziness.

Sources and Further Reading:

http://www.120467.com/2007/10/daniel-loeb-recruit-email.html

http://www.newyorker.com/archive/2005/04/18/050418ta_talk_mcgrath

In Memory of the Hero Who Helped Expose Enron & Other Frauds: Doug Millett Former Partner of Kynikos Associates

Sad News out of HF land: Doug Millett, former COO of Kynikos and a veteran l/s, lost a battle with cancer this pm. A nice man, RIP.

— Roddy Boyd (@BoydRoddy) September 22, 2013

“In several phone calls Jim Chanos and his chief operating officer Doug Millett, pitched her (Bethany McLean) the Enron story. The company, they said, was nothing more than a hedge fund sitting on top of a pipeline. But despite having the risks of a high-stakes trader, it had the returns on investment of a car company.” - Conspiracy of Fools, a True Story

” ‘I had been in touch with Doug Millett, who worked for James Chanos.’ She (Bethany McLean) reported that Millett suggested she look at Enron’s financial figures.” - The Inside Stories of Modern Political Scandals

“in the memorable words of Doug Millett, Kynikos’ chief operating officer-it simply didn’t make very much money.” - Why Enron Went Bust Start with arrogance. Add greed, deceit, and financial chicanery. What do you get? A company that wasn’t what it was cracked up to be. http://money.cnn.com/magazines/fortune/fortune_archive/2001/12/24/315319/index.htm

I’m told by a gentleman familiar with Doug Millett, that Millett also helped uncover many other frauds, fads and failures, especially of the dot com variety.

Not to mention, Marc Cohodes, who helped uncover the frauds formerly known as Lernout & Hauspie, Aremissoft, Novastar, and many more,  had this to say:

Lost a comrade today . They broke the mold when they made him . Rest in Peace Doug, will be seeing you along the way.

— Marc Cohodes (@AlderLaneeggs) September 22, 2013

Rest in peace.

The United States of America vs. Anthony Davian (a.k.a. @hedgieguy)

This is not the SEC complaint (which is to come, or so I believe), but a complaint filed few weeks ago as the US seeks to seize Davian’s property in hopes of compensating his victims.

::UPDATED with the SEC complaint below::

Short Sellers - according to Kathryn Staley

“Short sellers are odd people. Most of them are ambitious, driven, antisocial, and singleminded. As individuals, they are not very likely to own a Rolex watch or a Presidential springer spaniel or any other symbolic trapping of success; they are likely to have a wry, slightly twisted sense of humor. As a group, short sellers like to disagree, and they like to win against big odds. Typically, they have an axe to grind, a chip on the shoulder. As in the general population, some of them are cretins and some are not, but they are all smarter (most of them, in fact, are intellectual snobs) and more independent than most people.  Contrary to popular wisdom, they do not form a cabal and bash stocks senseless. They normally are secretive and slightly paranoid. And they are frequently irreverent in their regard for business leaders and icons of Wall Street. Dana L. Thomas summed up the breed in this statement:

Professional short sellers usually have a zestfully unbiased attitude toward men and affairs. They are often men of biting humor. After all, their stock in trade is an ironic transubstantiation of values - a satiric commentary on the standards of men.” 

— The Art of Short Selling by Kathryn F. Staley

If Kathryn Staley’s description of short sellers is apt, these characters seem far more compatible with the hedge funds of the 1980s-1990s, then they do with the sterilized, institutional counterparts that prevail today… in fact, I’d venture to say that short sellers are more culturally similar to the characters found in Silicon Valley…

Is Anthony Davian a.k.a. @hedgieguy Twitter’s 1st Ponzi Schemer? A Follow-up to Roddy Boyd’s Expose

On Monday, July 15,2013, Roddy Boyd of the Southern Investigative Reporting Foundation published an excellent piece (worthy of a prize, if you ask me; PLEASE READ IT if  you have not already) about a certain Anthony Davian (a.k.a.  @hedgieguy), and what looks like the first twitter-originated  ponzi scheme.  I’ve been tracking @hedgieguy, on and off, for the last 2-3 years, and would like to provide the public with my take. I privately expressed my concerns about @hedgieguy with several people, over the last 1.0-1.5 years (even as others shared their concerns about Davian with me as well). Sometime in Q2 of last year, I told my friend:

me: I actually don’t understand why that guy sells newsletters, if he’s managing $100-200 million. something doesn’t make sense. It doesn’t add up.
XXX: Who are you referring to you. Mr Ching (our nickname for Davian who often tweeted “CHING CHING” sound of cash register) ?
me: Yes, Mr Ching.
XXX: That can’t be right and I will tell you why…

I only wish we looked into his operations more closely…  who knows, maybe we would have been able to save some people their money. Maybe not. Rather than tell you “I saw this coming” or “I knew it” after the fact, the below shows you exactly what I and few others said before Roddy Boyd’s exposé. This post is intended to complement Mr. Boyd’s exceptional work.

WHY @HEDGIEGUY SEEMED TOO GOOD TO BE TRUE, BEFORE THE FACT (PRESENTED CHRONOLOGICALLY)

To start off, a few disclosures: I’ve never met with Mr. Davian, nor have we spoken over telephone. We exchanged a few e-mails, twitter direct messages, and public tweets. That is the extent of my correspondences with Davian. I’ve never had any business ties with Davian (or his affiliates). I never purchased nor tried any of his (or affiliates’) goods or services.  Finally, I never recommended any of his (or his affiliates’) goods or services to anyone.

I started following @hedgieguy on twitter sometime in 2011 (I believe in Q2 or Q3). I was largely focused on shorting Chinese reverse merger stocks at the time, and followed  @hedgieguy because he seemed interested in them as well. I eventually unfollowed him sometime in 2012. The below summarizes my experience with @hedgieguy , and shows how I came to believe his claims of managing $100-200 million were simply too good to be true:

(XXX refers to several different individuals)

Q3 - Q4 2011: @hedgieguy and I start corresponding publicly via twitter in Q3 2011. Friendly dialogue about stocks. We were probably both in good spirits, as the Chinese reverse merger shorts were working exceedingly well. In Q4, my well timed short GMCR call (pure luck, as the call was made pre-David Einhorn’s now famous October presentation, “GAAP-uccino”) got many people’s attention; @hedgieguy seemed to benefit from that trade as well. He started promoting me via Re-Tweets, etc. Our correspondences remained largely cordial through Q4 2011.  That said, I started getting concerned by the fact  he seemed perfectly fine going long (and even promoting) complete fraud stocks, just for possible short squeezes, even as he had vocally spoken out against the fraudulent Chinese reverse merger stocks. It seemed completely hypocritical to me.

11/14/2011: XXX: Very competitive bloke (hedgieguy), funny though. He always gets it right every week. He must be making a fortune for his partners.

Q1 2012: The red flags concerning @hedgieguy start growing noticeably, even as his flattery towards me increases (starts getting uncomfortable).

1/9/2012: XXX: Wow this guy hedgieguy unfollows me for RT’ing something from XXXX. Don’t want to talk to someone who ignores b/c u r friends with someone.

1/9/2012: “He is what is wrong with the business”:

me: you are now the 2nd person to now express (legitimate) ill feelings lol. it’s not even a single thing.

XXX: nope. he is a ___ and a stock pumper

me: it’s hard for me to disagree

XXX: he is what is wrong with the business

Q2 2012:  Davian gets nasty towards me and others; certain behavioral red flags become increasingly apparent. By the end of Q2, I suspect that @hedgieguy is too good to be true.

5/4/2012: Hedgieguy has the gall to ask XXX to connect on LNKD, after publicly insulting one of XXX’s friends

XXX: so that HedgieGuy asked to connect on LNKD after getting mad about my friendship with XXXX

me: he acts like the very pump n dumpers he shorts, etc.

5/28/2012: Hedgieguy makes fun of people who tweet on a Friday night (and then tweets 10 times later that Friday night)

me: It’s even worse. For example, yesterday he tweets, ”Judging from what I see. Only no life geeks post a lot of tweets on the weekend. Get out of mom’s house guys!”

XXX: oh geeze. so you responded to that?

me: No I did not. He made fun of of other people tweeting on a Friday night, and then he proceeds to tweet ten times on a Friday night.

me: He also tweeted: “‘To wall st/financial types: no one gives a fuck about your CFA studying. As hard as you try to high jack this holiday, it’s not about you!’

XXX: oh boy, you can appreciate memorial day and still study for the CFA. They’re not mutually exclusive.

6/17/2012: I explain why Hedgieguy is too good to be true

me: I actually dont understand why that guy sells a newsletters, if he’s managing $100-200mm. something doesn’t make sense. doesn’t add up

XXX: who are you referring to you. Mr Ching?

me: yes, Mr Ching

XXX: That’s can’t be right and I will tell you why

me: that tells me he doesn’t.  right, we’re in agreement, I want to hear your reasoning.

XXX: In October 2011, he said he made 20% for the month. Do the math, Its bullshit

me: I’m with you. I think if there’s any truth to what he’s claimed, it’s that the 100 million is not hedge fund/LP money. stuff I don’t understand, but is NOT under the 2/20 structure.

XXX: Did he say on the stream he manages 100mm. Or through your sources

me: I don’t remember, sorry

XXX: Let me tell you something. Its a “no no” to disclose your AUM on twitter to begin with.

me: I would think so, unless it’s already out there. if you are Bill Gross or John Paulson, your information is so public lol

XXX: Maybe so, however, that’s promoting your fund. Its illegal.

me: good point, no marketing of your fund, right

XXX: Yes. I have not done any research on this guy, because one look at his website, and I said, yeah whatever. Unprofessional website. 

Q3-Q4 2012: Davian insults David Einhorn’s friends/fans … and then proceeds to cheer on and compliment Einhorn.

me: he was quite something. I couldn’t believe my eyes. You know what he said? So few days ago, he was making fun of people cheering david einhorn (he’s at the Vegas poker tournament).  Then the next day.. the next day!!! he talks about how nice a person einhorn is, and that he hopes einhorn wins the tournament! Is hedgieguy on drugs?? The guy makes fun of other people for doing x, and then does x the next day! 

XXX: What a fuckwit

Q1 2013:  “another one to be careful of is @hedgieguy”

me: so it angered me seeing this guy behaving just like the very ppl he writes so passionately against.

xxx: yep. happens to some shortsellers…they flip. b/c easier to promote.

me: right. i’m lucky i’ve been “yolked” with straight shooters

xxx: indeed. ok thx

me: Another one to be careful of is @hedgieguy 

 

HOW THE FRAUD WORKED AND HOW IT WAS MADE POSSIBLE - MY TAKE

Based on Roddy Boyd’s piece, it would seem criminal charges are likely forthcoming for Anthony Davian. The question then is, how exactly did Davian end up committing fraud/theft in the first place? Mr. Boyd’s work focused on how the malfeasance was uncovered, not how we got there in the first place.  I will discuss how I believe Davian ended up committing fraud and stealing money.

I do not think Davian was breaking the law (or intending to break the law) from the beginning. He may have exaggerated performance, assets under management, and/or credentials early on (the legal implications of these actions are not entirely clearly, even though the moral implications are crystal clear), but I don’t think he was in ponzi scheme / theft mode until sometime in 2012/2013.

THE SUCCESS OF THE CHINESE REVERSE MERGER TRADE ENHANCED HIS (APPARENT) CREDIBILITY

In 2010/2011, shorting microcap stocks - particularly of the Chinese reverse merger variety - worked out very, very well. For those who are unfamiliar with the Chinese reverse merger trading opportunity of 2010/2011: a very smart hedge fund manager presciently summarized the opportunity to me, before the fact (sometime in 2010): “shorting the Chinese reverse mergers is like shooting fish in a barrel.” He proved to be quite right, as they were collectively down 50-80% in that period of time.

My guess is that Davian wasn’t the intellectual horsepower behind those trades (to his defense, he often credited @Dasan on the trade). I mean, a guy who publicly insulted Carson Block and Muddy Waters Research (these guys were at the forefront of uncovering these frauds) in Q4 2010 was probably not exactly the most informed participant. I wonder if Davian even realizes today that he should be grateful to Muddy Waters, given MW benefited everyone who was involved with the Chinese RTOs. The other thing is, I don’t think Davian was a true short seller; he did not subscribe to the mission that most short sellers adhere to, namely “speaking truth to power”. Nor am I aware of him/them ever producing any original, investigative research. I don’t think they had the knowledge or financial means to do the kind of work real short sellers do. In fact, he more resembled the very pump and dump stock promoters short sellers revile, the kind who spend 100% of their time on promoting and manipulating stocks.

The @Dasan character and possibly a few others, were likely the actual brains behind Davian’s investment research/idea generation, while Davian was the street smart promoter. This arrangement worked out well for them, so long as the short chinese reverse merger trade remained profitable (which it did through 2011).

HOW AND WHEN THINGS WENT WRONG

2012 is where I think things started to go wrong for Davian. Shorting (anything) got much more difficult in 2012. In fact, if you take a look at the performance of the short books of funds that short the kinds of names that Davian’s Gravity fund purported to, there was no way they would’ve been up 28% in 2012, with the kinds of  assets under management, sharpe ratios, and diversification they claimed. The only way they could’ve delivered 28% is if (1) AUM was much, much lower (2) sharpe ratios were much lower (3) greater portfolio concentration .

Take for example the performance of the short book of a well respected short seller I know. They were DOWN -x% in 2012 (while up x% in 2011); I believe that Davian might’ve performed positively in 2011, but +28% in 2012 ? He started to fabricate returns, is my best guess (if he wasn’t doing so earlier on).

Just as actual performance was souring, his operating expenses started rising (he hired a few analysts), and investors started pulling out money. So he did what many other desperate people in his situation have done in the past: He started stealing client money, to cover personal and operating expenses. Why else would a guy claiming to manage $100-$200 million a.u.m. start a $29.99/month subscription service? Why else would he approach strangers who he had never met or spoken to over the phone, to post research on his websites? He was desperate for cash.