Tell Me Why (That Move Ain't Nothin but a Mistake)

Malt Liquidity 87

Yes, it’s time for that Elon discussion

A common warning I give out is to not ascribe narratives to stock moves (and caution against following people who consistently explain things after the fact because of course it was due to this and this). The system is too complex for the most part for there to be a definitive reason for every move. Proving causality of flows is notoriously hard and requires assumptions that defeat the purpose of ascribing a narrative — what is the proof that the stock moved due to X? It’s much easier to ascribe reasons to a trade. People buy a stock because they think it will go up. People sell stock for various reasons, including rebalancing, profit taking, and limiting exposure, but it still tells you something. People buy certain puts to hedge, etc. Most notably, insider trading convictions rely on the irregularity of the reason of the trade, not necessarily the outcome itself — it’s possible to lose money while insider trading! That being said, if someone’s buying a metric ton of short term OTM call options, they probably know something that other people don’t. Of course, the golden rule is don’t insider trade, but you’d think that when people do, they’d at least disguise their flow.

In a court of law, however, you do have to show causality between the act you claim harmed you and the losses you suffered. I do understand why this has to be the case legally — as I’m sure readers of Money Stuff know, “Everything is Securities Fraud”, so lowering the standards for “wronged investor” lawsuits would put every bit of rumor and news that’s later corrected at risk of being actionable against — but man I feel bad in some senses. Take the case of NKLA and its pathologically lying former CEO Trevor Milton:

Nikola Corp. and its founder, Trevor Milton, have escaped, for now, a securities lawsuit alleging Nikola misled investors about its hydrogen fuel cell technology and business prospects for its electric trucks.

Milton made various questionable statements, including in 2020 when he said that Nikola doesn’t “build on speculation; we build on orders,” Judge Steven Logan in the US District Court for the District of Arizona found. The “orders” Milton referred to were actually expressions of interest that could be canceled, Logan said in an opinion filed Thursday.

But Nikola Investor Group II, in its lawsuit, hasn’t shown an adequate connection between Milton’s alleged misrepresentations and their financial losses when Nikola’s stock dropped, Logan said.

NKLA was one of the more obvious fraudulent SPACs that got utterly torched by activist shorts (and then interest rate hikes.) But this is why I highlight the difference between the priorities of fundamental investors and traders — intraday movement is obviously not tied to a constant assessment of company financials!

The vast majority of money that moves in and around the market is based on the philosophy that whatever is invested in will create future cash flow rewarding current shareholders, who hold a right to their share of the output. When this money sloshes around, it creates market impact, which in turn creates trading opportunity. Note that these investors generally operate with a philosophy that they don’t want to react to day-to-day market movements. They are in it for the cash flow created over time and the movement in share price that will reflect that.

There are correlations as to how things work, obviously, but sometimes stock moves genuinely just don’t make sense. Take, for example, the day that Amazon’s acquisition of Whole Foods was announced — a classic merger arb trade is to long the target and short the acquirer, because of the difference in the cost of up-front capital for the acquisition versus the eventual forward cash flows of the absorbed company. But AMZN’s stock rose more than the valuation they were paying for Whole Foods!

And ultimately, Amazon and its investors may have gotten an even sweeter deal: Amazon stock rose more than 3% after it announced the deal, boosting the online retailer’s market value by about $14.5 billion—even more than the what it is spending to own all of Whole Foods

Not only do you have to show causality, but you also have to show intent on the part of the person who made the statement:

Securities fraud allegations against various Nikola executives and directors were also dismissed. Although company regulatory filings may have included misleading statements, including about the development of the Nikola One semi truck, investors failed to show the individuals intended to deceive the public, Logan said.

Again, it is decidedly correct on a judicial economy basis to not punish executives for incorrect prognostication. But given what we know about the scale of exaggeration of most of these SPACs, this has to sting.

Which, of course, brings us to Elon — I must admit I was shocked at how quickly the jury cleared him. In a sense, I think the class action was pretty dubious to begin with — some of the members had calls, when I think the only parties with actionable cases were short sellers. And if you are trading TSLA in the first place, you know what you’re in for — there’s a reason I have hardly touched the stock in its existence even though it realizes great vol. But while gap risk is obviously heightened on individual tickers due to the lower amount of average daily flow, liquidity, and the potential impact of material information (true or not), this one really did feel unfair. Stocks move on incorrect rumors of acquisitions all the time (as a former trader of small cap bio stocks — shout-out to RLYP — believe me, the merger copium is real), but a number coming from the person with the most powerful company key man effect who has a serious problem with short sellers simply shouldn’t be communicating an implied offer — not even a direct one — so carelessly. Of course, there is a strong plausible argument that funding was committed to in a sense — but Elon’s track record is such that he could raise $100mm for a genuinely moronic idea within a couple hours. For people like him, I think you could legitimately argue that funding is secured if he even picked up the phone and connected to a call.

But common rationale does not hold up in a court of law:

“The defense had a better case,” said Robin Cadogan, 47. The nine-member panel took just two hours of deliberations to reject claims that Musk’s August 2018 Twitter posts misled shareholders and caused them to suffer big losses over a 10-day period of Tesla stock price swings before the take-private plan was abandoned.

Speaking to lawyers representing the shareholders after Friday’s verdict in San Francisco federal court, Cadogan said, “I wasn’t really sure what you were driving at.” He expressed concern that the lawsuit seemed to be “relying on just the tweets.”

Yeah, this is a death sentence. If the class was limited directly to short sellers (and put holders) and reduced the time frame to the trading activity directly after the tweet, that’s probably the best argument you have. Also, it’s pretty hilarious that the foreperson (Cadogan) randomly decides to shit on the trading abilities of the named plaintiff:

The juror also said he’s familiar with option trading and thought the testimony and trading record of Glen Littleton, the named plaintiff in the class-action suit, showed “he doesn’t seem like an effective trader.” He was also critical of the market analysis methodology the plaintiffs relied on to prove investors were harmed. 

It’s hard to think that the jurors would have cared that much anyway. A three week trial over whether or not a tweet was intended to and did cause investor losses cannot be interesting at all. I would probably lose my mind on the jury as lawyers and expert witnesses put forth “explanations” that I couldn’t directly argue against as to why certain trades happened the way they did.

Some people may take this result as an explicit sign that Elon is above regulation. To a certain extent, I think he is — the SCTY acquisition was suspect and the way FSD is marketed and how it’s being live-tested on the roads doesn’t exactly seem correct to me. But overall I think it’s a net good thing that it’s hard to hold company insiders accountable for unintentional statements of questionable veracity — it’s already hard enough to be a public company from a compliance standpoint, and adding even more litigation risk to what already exists would further disincentivize IPOs. Furthermore, do we really want to chill the speech of execs who can give clear insight as to how the company is faring? The more transparent a company is, the better (up to a point of course.)