Rigged Chapter 16

"Brainstorm"

by

Ross M. Miller
Posted August 2, 2004

I can remember hands that I played and theorems that I proved more than a decade ago, but what happened on our retreat from the conference room to world outside remains hazy. We (with the possible exception of Zero) were in a collective state of shock.

There was no way that I was getting right into the car that Roland had sent for me, so all four of us traipsed around the block across from Lowell’s building.

“The phone call back there was my invitation to lunch,” I said to my crew once we were a safe distance from the other pedestrians.

Randy then asked me the obvious question, “So, what does this all mean?”

“I don’t think it matters at this point. The hive doesn’t appreciate any kind of deception—intentional or unintentional, legal or illegal. Our evidence doesn’t show that they ever conspired to execute trades that helped their rock star at the expense of everyone else and I’m not sure that it even matters. All I’ve done is open the window for them, now they’re going to jump out of it.”

“How do you figure that?” Tara asked.

“Simple,” I said. “I’d bet anything that right now they are on the phone and furious. Their problem is that what they see as bad behavior in their world is normal operating procedure for their new parent. Once Roland ascertains that I didn’t do anything terrible—meaning something that could cost the company money—he’ll want to know what set them off. That’s when their trouble begins, especially given what was blurted out. For the moment, I’m just killing time so that I can arrive for lunch after the initial round of fireworks.”

“What about us?” Zero wanted to know. “Should we pack our bags?”

“Not yet,” I said, “though we may well have worn out our welcome here in Boston. And, before I forget to tell you, congratulations on the great work. While I’m off, you can go back to the hotel, have a nice lunch, and figure out what else is going on. I was hoping that our morning psychodrama would shake more loose than it did, but it’s a start. It’s obvious that there’s something big here.”

“Agreed,” said Tara, “Planet X is surely out there.”

“And it’s up to us to find it,” I said. “Well, give it your best and I’ll be in touch.”

My three colleagues headed toward the hotel and I went back to catch my ride over to Roland (wherever he might be). The car and driver were familiar from the ride to the airport. As the driver opened the door for me, he said, “You’re getting to be one popular guy with Roland.”

“I hope that’s a good thing,” I said back to him, still uncertain of how things shook out with Lloyd and company. Once we were on our way, I replayed the morning meeting in mind and thought about what I would tell Roland and the sort of questions that he might ask me. The possibilities were so far beyond my ability to comprehend, that I zoned out after a few minutes, knowing that I could always trust my instincts whatever happened.

There was a time when I could pull one allnighter after another with few ill effects, but over the last several years I had gotten used to six hours of shuteye. Anyway, I never let something like sleep deprivation or nondebilitating illness bother me. I had been in math competitions since junior high and had become accustom to competing under highly suboptimal conditions. Something would always seemed to go wrong—from power outages to food poisoning—but I learned not to let any of it faze me.

My heart was still pounding from the encounter with Harvey as the car sped through tile-walled tunnels and then out into the daylight near Beacon Hill. We passed by the State House, its gold dome shining opulently in the sun and its sidewalks crammed with demonstrators. They were carrying a Babel of signs, one of which looked like it read: “Save the Sacred Cod.”

We ascended the hill through narrow streets with vehicles parked everywhere. Several buildings were encased in scaffolding, while others had ladders leaning against them. Noise and clutter aside, it was a captivating place that gave one a peek at a time long past.

When we turned onto Mt. Vernon Street, it dawned on me that I really should know where I was being taken. (I was in the right car, wasn’t I?) I had expected to be dropped off at a restaurant, not driven into the heart of a residential area. The streets were a red-brick patchwork and what I took to be ersatz gaslights were planted at regular intervals along them. The architectural motif was dominated by black wrought-iron fences, black shutters, and red doors with distinctive brass knockers. I felt like I was really in Boston now. I slid open the partition and asked the driver, “Where are we going?”

“Louisburg Square. We’re almost there.”

That rang a bell. Among Lowell’s substantial real estate holdings was a Louisburg Square townhouse. At seven million and change, it was difficult to forget.

Someone who was not looking for the Square could easily miss it. It was a patch of green with flowers, benches, and an old statue. The greenery was surrounded by a tall fence with daggers on top of it and signs that read “Private Parking Trespassers Will Be Towed” spaced evenly along it. If there was a gate in the fence, I could not see it. A short stretch of cobblestones ornamented the ground in front of the park. Elsewhere, the cobblestones were relegated to the gutter and ordinary blacktop was the pavement of choice.

A crowd of Japanese tourists were taking turns immortalizing one other holding the knocker to 10 Louisburg Square. The black script on the matching yellow T-shirts that the tourists wore resembled the Kana on my old pachinko machine and on the back of my old GFF business card. Fortunately, we were headed to the odd side of the square.

Cars were virtually bumper-to-bumper along both sides of the square and a large truck was parked at the far end. My car stopped in front of a four-story townhouse where men were taking equipment—lights, tripods, and cameras—out the front door, down the street, and onto the truck.

The men carrying the last of the equipment squeezed by me as I walked up the front steps and looked into the open front door. An attractive woman in her late thirties or early forties—nicely proportioned, pleasantly blond, meticulously coiffed, and tastefully made up—was there to greet me.

“We’ve been expecting you,” she said. “Please come in and do excuse the mess.”

Judging by the looks of my hostess, I could not believe that we shared a common notion of what constitutes a mess and was surprised to discover that we did. The air was heavy with gypsum dust. Drop cloths and masking tape obscured most of the foyer.

While I struggled not to cough, she filled the conversational void. “I’m glad that they’ve finally left. They were shooting the ‘before’ pictures, but things are chaotic enough without those men all over the place. Some of them were truly horrid.” She gave me a look that under different circumstances I would have considered suggestive before she shifted into a more formal gear. “Oh, I’m terribly sorry, I haven’t introduced myself, I’m Caroline Bennett.” I thought about Simon, but had enough sense left not to ask if she had ever been celebrated in poem or song.

I started to introduce myself as we entered the dining room when Roland interrupted with a hearty, “Doc, glad you could make it. I see that you’ve met Caroline. It’s been a madhouse here. GNN is trying to beef up their Saturday schedule so they’re doing one of those home makeover shows starting next spring and we’ve been chosen as their first victim.”

Much of the dining room was still visible and the furnishings were more modest than I had come to expect from The Lowell Group. But then everything I know about antiques I learned from PBS. Nothing exotic, nothing fancy, just a long table with ten uncomfortable chairs, four of them occupied. Roland was in his usual spot at the head of the table and the others were familiar faces from GFF. I had seen enough movies to know that the occupying forces had not only taken the royal palace, but had begun to redecorate it.

Roland launched into the unnecessary introductions. “Doc, you remember Artie Feingold and Kelly Ames from yesterday and, of course, you know Joe Conway from our visit to White Plains . . . now when was that? Just grab a seat anywhere. I hear you made quite an impression at Lowell today. Simon was irate to say the least. Great job.”

Roland sat down flanked by Artie and Kelly while Joe sat at the far end. I considered confusing everyone by sitting next to Joe, but thought better of it and sat next to Kelly.

“Here’s the agenda for the rest of the day,” Roland said. “Doc can fill us in during lunch and then we’ll have a brainstorming session for as much of the afternoon as it takes.”

Lunch, which was waiting on a side table, came from a Charles Street bistro. “If you think this is a mess, you should see the kitchen,” Roland said, apologizing for our having to tough it out on salad and sandwiches. I was long past the point of caring about food. I did not recall eating anything for breakfast and I did little more than pick at lunch while speaking to the assembled group.

Once everyone had settled down with something to eat, I began. “We’ve been looking over Lowell’s databases, paying special attention to the Lowell Aggressive Growth Fund.” Roland and Joe were hanging on my every word while Artie and Kelly only looked up briefly from their salads. “We still have a vast amount of data to sift through, but the pattern that is emerging from what we’ve already found is fascinating. Our analysis, which is still preliminary, shows that some of Ken’s exceptional performance before the acquisition can be attributed to favorable trades made with other Lowell funds, particularly those managed by Harvey Anderson. Soon after being acquired by GFF, these trades shifted from favoring Ken to favoring Harvey and the others. This doesn’t explain everything that is going on with Ken’s fund, but it’s a start.”

“And by favorable trades, you mean—” Roland said.

“Although I didn’t see any mention of this in the briefing materials that you gave me, The Lowell Group has the ability to cross trades among their own funds. For example, if Harvey is buying a stock that Ken is selling, they have a computer system that let’s them—actually, their traders—exchange the stock without going through a broker or sending an order to an exchange. They say that it’s perfectly legal—and perhaps it is—but my group has come up with a way to game the system and, based on their trades, so have they.”

Roland turned to Artie and Kelly to get their input. Artie spoke first, “As long as the accounts are kept separate, I don’t see any accounting problems here. Commingling the funds or deciding at the end of the day which shares go into what fund could be a problem—that’s what Hillary’s brokers were caught doing—but trades among funds that are properly accounted for at the time of the trade should be fine.”

“And what about the legality?” Roland said, looking at Kelly.

“There are numerous issues that can arise here.” Kelly said. “However, it is easy for Lowell to deal with them all proactively. As long as they get a waiver from the appropriate regulatory authority, pretty much any trading arrangement is legal if they are careful to color within the lines.”

Kelly came across as disarmingly confident and I was impressed. (Maybe going to law school was not such a bad idea.) I looked straight at her and said, “Lloyd Perkins claims that they’ve done all of that and I see no reason not to believe him. They were, however, trying to hide something from someone. It might be reasonable to conclude that they kept the trades between their funds small in order not to attract attention.”

“So what’s the issue with Ken’s fund trading with one of Harvey’s funds?” Kelly asked. “I can’t imagine that the SEC would let them trade except under highly restrictive terms.”

“The terms are certainly restrictive—the only price that they are allowed to trade at is the midpoint of the current bid and offer. And while that may be an appropriate price for a few hundred shares, Ken and Harvey traded a lot more than that, even if they cut them into bite-size pieces.”

At this point, Artie chimed in, “A hundred shares or a million shares. I don’t see a problem. From an accounting point of view, a stock’s price is its price.”

I could tell that this wouldn’t be easy. I turned to Artie and said, “The problem is that The Lowell Group is large enough that it cannot get into or out of a stock without moving the price in an unfavorable direction. Let’s suppose that Ken wants to sell some shares in a company that he holds. If he sells them on the open market, the mere action of selling the stock will depress the price of the shares, especially if the market suspects that Ken is the one doing the selling. The market’s reaction not only reduces the price that Ken gets for any shares that he is able to sell, but any shares that remain unsold become less valuable and more difficult to sell. The way around this problem is for Ken to sell his shares to Harvey. This allows Ken to receive the going price for the stock and Harvey is left holding the bag—any markdown necessary to move the shares hurts the performance of his funds and not Ken’s fund. Not all at once, mind you, but in a flurry of small trades spread out over a day or two. Similarly, Harvey’s funds can maintain inventories of shares that Ken is interested in buying. Ken can then buy from Harvey at the going price inconspicuously and then profit when Harvey drives the stock price up by replenishing his inventory in the open market.”

“This is all very interesting,” Roland said. “But what does it have to do with the recent change in Ken’s fortunes?”

“Everything that I described to you happened before GFF acquired Lowell. Soon after the acquisition, things have been going in the opposite direction, hurting Ken and helping Harvey.”

Joe Conway finally jumped in. “What you say sounds plausible, but I don’t see how it could make all that much of a difference, certainly nothing like the dramatic swing in Ken’s performance of late.”

“That’s a good point. This strategy only accounts for some of Ken’s superior returns. Still, this consistent edge has been enough to nudge it into the top tier of growth funds. There’s something else going on that’s bigger, but we just haven’t been able to isolate it.”

“At the pension fund, we’ve noticed some strange goings-on in the stock market ourselves. While I cannot claim that our in-house portfolio managers are doing anything particularly sophisticated, one of the hedge funds that we invest with has racked up some impressive gains over the last few quarters. They are highly secretive, but I think they’re onto something.”

With Ken losing big, it made sense that someone else was winning big. “Can you tell me more about this hedge fund,” I asked Joe.

“They’re down in Florida. On Sanibel Island. It’s one of several islands near Fort Myers.”

“Can’t say I’ve ever been there.”

“It’s a very nice area, especially in winter. Great golf and awesome fishing, not to mention that the Sox take spring training nearby. Some people visit just for the seashells. As for the hedge fund, it’s run by Muir Konin. He’s a delightfully eccentric man. He manages a billion dollars—one hundred million of which is ours—and he has been returning us over fifty percent for the last couple of years and has already doubled our investment this year. His performance is even more impressive when you consider that Muir gets to keep half of all the profits for himself. He’s a wonderful guy, I think you’d like him.”

Joe seemed to enjoy the role of matchmaker. People always thought I’d like their strange friends and acquaintances and sometimes they were right.

“Any chance of getting Muir to come up here?” I asked.

“No way,” Joe replied. “Muir insists that everyone come to him. Even Mike, who used to visit him on his way to Boca, has to go to Muir. I make it a point to see him once or twice every winter. He won’t talk to just anyone and he’s not always forthcoming. You just have to take your chances.”

The topic of Muir Konin caught Roland’s interest. “Doc, unless you have a better idea, why don’t you go down to see Muir tomorrow? We can take a break after lunch and set things up for you. I’m sure your people can manage without you. Not to mention that we’re running out of time. I don’t see how we can proceed until you deal with this.”

It seemed best to go along, so I implicitly agreed to the plan by asking Roland, “Just how much time do we have?”

“We’re all getting together back at the hive at ten o’clock Thursday night to prepare for Friday’s conference call. Anything we don’t know by then doesn’t matter.”

I knew not to ask who was included in the “we” that were meeting at the hive. Mike was a possibility and so was I.

“What else is going on?” Roland asked me.

“I noticed someone suspicious who might have been following us. He rode with me on the water taxi back from the airport. It’s probably nothing, but I thought I’d mention it.”

“Thanks. Our lobbyists tell us that something is coming out tomorrow; something we may have to deal with in the conference call. The feds are known for wanting to spoil the party. Just be careful, that’s all.”

“Anything else?”

“No, that’s it.”

Roland then turned to Kelly and said, “I’m wondering if what Doc has turned up could in some way be construed as fraudulent activity on Lowell’s part. We might not have paid nearly as much for them if we knew that they were juicing up Ken’s performance.”

Kelly perked up. “First, there’s the issue of intent. If these trades just happened, then it’s not fraud.”

Roland asked me, “Do you think this was intentional?”

“Yes, almost certainly,” I replied. “Harvey did everything but flat out admit it. At some level, he knows what’s going on, but I don’t see how we’d go about proving some kind of conspiracy.”

“The audit team has spot-checked the tapes of the traders’ phone calls and hasn’t found anything,” said Roland. “Maybe they should dig deeper.” I took the audit team’s absence from these meetings with Roland to be a good sign.

“It’s up to you,” I said. “But all the trades in question were done by computer and if the traders were part of a conspiracy, I’d credit them with enough intelligence not to discuss it on a line that they know is being recorded. I realize that everyone slips up from time to time, but the only evidence of impropriety that we’re likely to find is an occasional call that begins with a trader asking someone what she’s wearing.”

Roland had heard enough from me and looked to Kelly for input.

“If there was a conspiracy and Lowell defrauded GFF,” Kelly said, “it also defrauded the investors in Lowell’s funds.”

“With what implications for us?”

“Anything we might recover from Lowell’s former partners is likely to pale in comparison with what we could owe in a class action judgment against us as Lowell’s new parents.”

“The curse of deep pockets,” Roland said with an exaggerated sigh.

“I wouldn’t worry too much,” Kelly replied, “Again, conspiracy or no conspiracy, if the regulators allow it, it’s not fraud. And Lowell has what I would assume are accurate records of all crossing trades; they were made available to us now and I would hope that they were available for due diligence prior to the acquisition.”

Roland looked annoyed. “They were, but we were mainly concerned with the accuracy and integrity of the trading and portfolio systems. They all checked out, so we left it at that. Even if we had discovered the pattern of trading that Doc did, I’m doubt that we would have given it a second thought. And, let’s face it, after the GNN deal panned out so well, our confidence was running high and we probably should have looked at everything more closely.”

Any problems traceable to the due diligence process would become Roland and Joe’s problems. Whatever Mike’s reasons for acquiring Lowell, he would have called the deal off without the green light from both of them.

Artie, no doubt feeling neglected, jumped back into the conversation. “And let us not forget that there are any number of perfectly legitimate ways that Lowell has at its disposal to shift money around among its funds. The trustees of Lowell’s funds determine how expenses are allocated to each fund. If you want to give a fund that you are promoting a boost, it’s easy to assign it a smaller share of the expenses at the same time that you are dedicating more of your resources to developing and promoting it. To me, what Lowell is doing is an extreme case of favoring one fund over another. The only reason that we are here today is that when GFF entered the picture something unusual happened. Something that may not even be Lowell’s fault. And then, of course, there’s the whole issue of soft dollars.”

“What about soft dollars?” I asked. I remembered seeing something about them in the binder, but no one at Lowell had mentioned them.

Joe was happy to give me an explanation: “A fraction of the commissions paid to brokers are designated as soft dollars. This slush fund, if you will, can be spent on a variety of services that are loosely categorized as research. This research includes a vast array of goods and services ranging from computers to airline tickets.”

“Computers and airline tickets are research?”

“A research database could require a new computer to house it and attendance at a research conference could require an airline ticket to get there.”

Having just authorized the purchase of two servers for “research purposes,” I thought it was best not to press this. Instead, I asked, “So what’s the problem with soft dollars?”

“You’ve obviously never been to one of our industry’s research conferences,” Joe said, with both arms stretched over his head. “More time is spent on the golf course or tennis courts than in meeting rooms. But that’s a relatively minor abuse of the system. Having all the soft dollars in a single pot allows you to cover the expenses of one fund with the commissions generated by another. Ken could, in essence, buy his people computers with Harvey’s money. And no matter how you allot them, soft dollars make a fund’s expenses look smaller than they really are. Those computers and airline tickets are now buried in commissions rather than being included as an expense. Congress or the SEC occasionally makes some noises, but nothing ever comes of it. It’s just how business is done. Many of the better investment managers act responsibly, but amazing stories abound.”

“So, in the bigger scheme of things, what we found at Lowell might not be that significant?” I asked, looking up and down the table for a response.

Roland held out his hand while he finished chewing his salad and then said, “It’s significant, alright. There’s no question that it’s significant. It’s larger than anything they could achieve by juggling expenses.”

Our meeting was interrupted by the arrival of dessert from Lowell’s bakery. I thought about all the soft dollars that could be going to crullers. Roland led the parade to the pastry tray and granted us a twenty-minute break so that we could check in with our offices. With a brownie in one hand, I phoned the hotel and got hold of Randy.

He started by asking, “Are we still in business?”

“You are, but I’m being shipped off to Florida tomorrow.”

“Too bad. Take sunscreen.”

“I hope I won’t need any, I’ll only be down there a few hours.”

“Do the rest of us get to go down with you?”

“Not that anyone’s told me.”

“You never take me anywhere.”

“I’ll send you a postcard.”

“Better yet, bring me back a manatee.”

“Any progress?”

“Some. During lunch we created a new series of snapshots for the portfolio database and Tara’s looking over it.”

“Well, keep digging. Who knows what you might find?”

“Our destiny?”

I was happy to learn that things were okay at the hotel. I checked voice mail back at Alaska and the place was humming along without me. I would now have the pleasure of an afternoon of brainstorming with four of GFF’s finest.

Brainstorming had a long tradition at GFF, although to my knowledge nothing useful—certainly none of its major products—ever emerged from one of these sessions. Although some brainstorming sessions are entirely freeform, most are designed to address a specific issue or question. The topic du jour was: “What do we do about Lowell?”

A brainstorming session is like any of the thousands of meetings held throughout GFF on a typical day except that the food and location are better and meeting facilitators are barred from it. I’m not sure where they came from, but word of these facilitators filtered back to Alaska, not that we had any use for them. A consultant must have done a study showing that meetings were being run inefficiently and the way to make them more efficient was to have people trained in running meetings there to move things along. The idea of a brainstorming session is to get everyone’s uncensored thoughts, which is harder to do with someone trying to facilitate things. (Because meeting facilitators want repeat business, I am not aware of disposable facilitators who can be eliminated when you’re done with them.) Of course, there was the time back at the old lab that one of Roland’s underlings suggested that GFF get into the crack cocaine business during a brainstorming session. He soon separated from the company.

One thing that brainstorming sessions have in common with any high-level meeting at GFF is that no one keeps notes. You can write all you want on whiteboards during the meeting, but once it’s over everything is erased. No one can subpoena something that vanishes without a trace.

Roland arranged to have four whiteboards wheeled into the room and Artie was assigned the task of maintaining them. He was the natural selection considering that women, minorities, and technologists (at least at the higher ranks) were exempt from anything that resembled secretarial work.

Like every brainstorming session that I had previously attended, this one made no discernible progress toward its stated goal. I had already said more than my share for the day, so I assumed my usual role of paying careful attention to what everyone else was doing. On two occasions someone turned to me and uttered the familiar “Doc, you’ve been awfully quiet, what do you think?” (This is the leading candidate for my epitaph.) I dodged these inquiries, provided bland answers to the mandatory questions that went around the table, and otherwise said nothing. The implied pot odds just weren’t attractive. Roland and Joe did most of the talking with Kelly and Artie speaking up on legal and accounting issues, respectively. I followed a suggestion that Randy once gave me for getting through meetings and pretended the whole thing was a cross between avant-garde theatre and performance art.

Not one to beat around the corporate bush, Roland asked us each point blank whether GFF should keep Lowell or sell it. The vote was unanimous to keep it—for now. Artie, tallying up the potential cost savings, brought up the possibility of merging Lowell’s operations with Joe’s pension fund. “Over my dead body” was Joe’s response, said in a way that elicited laughter from the table. “I’d spend from now until my retirement trying to fit the two businesses together.” GFF had learned from a series of misadventures in the days before Mike that synergy rarely worked as intended; indeed, the mere mention of the word in front of someone from the hive was a major-league faux pas. Any deal that required “synergy” to make its numbers, was a deal that would be scotched long before it reached Mike. If Lowell had anyone at GFF to fear, contrary to what Kenneth Paine believed, it was not Joe Conway.

Much of the session revolved around what might best be described as the general theory of mutual funds. Time was spent figuring out what mutual funds were all about, what the perfect mutual fund company would look like, and how to get Lowell to better fit that mold. I resisted the temptation to launch into Jungian archetypes and Platonic caves though I suspected that the others at the table would have gobbled it up. As lunch began to divert more blood from our brains to our stomachs, ideas that included golf tournament sponsorships and advertising blimps surfaced.

The meeting broke up at a quarter to five. Roland was happy with the results but said that we should keep thinking about things and get back to him with any ideas. While Joe, Kelly, and Artie continued talking, Roland escorted me to the front door of the townhouse. I got the impression that I was to leave now and that something was going on later with the rest of them. Maybe just a ride to the airport, maybe something else.

“Alice has made the arrangements for you to visit Muir tomorrow,” Roland said. “All the details have been e-mailed to you. If there are any problems, let her know.”

“Great,” I said, trying to sound enthusiastic.

Roland then put his arm around me, a gesture that he reserved for special occasions. “I cannot tell you how much I appreciate what you’ve done here. I think that we can have a lot more visibility moving forward.”

This was more hivespeak. Every previous time I had heard him say “visibility,” it was in the context of aviation. Anyway, I already had too much visibility.

“You’re welcome,” I said.

“Your return flight will have you coming into Westchester ahead of the Thursday night meeting at the hive. We’ve booked a room for you overnight at the conference center and we will get you back to Boston first thing Friday morning.”

“Great.”

“Finally, here are two tickets to the Celtics—there’s a preseason game tonight against the Pistons. They’re for GFF’s luxury box. I wish I had enough for the four of you, but several of our customers will be there. If any more tickets materialize, someone will call you at the hotel.”

“Thanks, Roland. I’m sure that we can put them to good use.” Everyone knew that Mike was a rabid Celts fan and rumor had it that he wanted to acquire the team after his mandatory retirement from GFF.

I saw no one waiting for me after Roland smiled, turned around, and shut the door hard enough to jiggle the knocker. For the second day running, I would make my way back to the hotel alone.