Homeland Affairs

In 2014, Monash University’s Ben Eltham and I argued in a Contemporary Security Policy article that there were organisational silos in Australian defence and national security policymaking. These organisational silos were a combination of conceptual, institutional, and policymaking gaps.

 

Australia’s Turnbull Government yesterday announced a new Homeland Affairs portfolio:

 

The Government will establish an Office of National Intelligence, headed by a Director-General of National Intelligence, and transform the Australian Signals Directorate into a statutory agency within the Defence portfolio.

The Government will also establish a Home Affairs portfolio of immigration, border protection and domestic security and law enforcement agencies.

The new Home Affairs portfolio will be similar to the Home Office of the United Kingdom: a central department providing strategic planning, coordination and other support to a ‘federation’ of independent security and law enforcement agencies including the Australian Security Intelligence Organisation, the Australian Federal Police, the Australian Border Force and the Australian Criminal Intelligence Commission.

These arrangements will preserve the operational focus and strengths of frontline agencies engaged in the fight against terrorism, organised crime and other domestic threats.

In view of these significant reforms, the Government will also strengthen the Attorney-General’s oversight of Australia’s intelligence community and the agencies in the Home Affairs portfolio.

 

Yesterday’s press conference, media coverage, and media interviews largely focused on the new US-style Homeland Affairs ministry under Peter Dutton’s control, and the Attorney-General’s counter-balancing oversight role. It did not discuss the planning and coordination changes to the Australian Intelligence Community or the likely effects on ‘street level bureaucrats’. It would be interesting to do so. Ben Eltham’s initial response is here.

PhD Mid-Candidature Review Talk on Islamic State

As part of my PhD mid-candidature review I’m giving the following talk at Monash University in October (date TBC):

 

Islamic State: Insights from Strategic Subcultures Theory and Combatting Terrorist Propaganda

Strategic subcultures theory examines why and how certain terrorist groups persist over time and grow despite counterterrorism measures. Abu Bakr al-Baghdadi’s Islamic State has gained control of parts of northern Iraq and Syria. Islamic State also poses a current national security threat to Australia in terms of terrorist propaganda (including social media campaigns) and the possible radicalisation of Australian recruits. This presentation evaluates Islamic State as a potential strategic subculture and considers Yale University philosopher Jason Stanley’s guidance in How Propaganda Works (New Haven, CT: Yale University Press, 2015) about how to strengthen democratic nation-states like Australia – and countering violent extremism – through combatting terrorist propaganda.

Special Order 937

Special Order 937 from Alien (1979)
Special Order 937 from Alien (1979)

 

In organisational strategic subcultures the decision elite / leadership may have different ranked grand preferences to its followers. Ridley Scott’s film Alien (1979) dramatises this two-level game of principal-agent and moral hazard risks in the revelation that the Weyland-Yutani Corporation’s priority is to retrieve the alien xenomorph for its weapons division, and the USCSS Nostromo crew are considered expendable.

 

The Nostromo crew evoke the MacLeod-Gervais-Rao-Church model of role power dynamics in organisations. Parker (Yaphet Kotto) and Brett (Harry Dean Stanton) are Losers: low-level employees who argue with other crew members about bonuses. The rest of the crew are largely Clueless: Kane (John Hurt) puts the crew at risk when he ventures into a derelict alien spacecraft; navigator Lambert (Veronica Cartwright) is a dedicated worker who becomes emotionally unstable; and captain Dallas (Tom Skerritt) makes bad risk management decisions. Science officer Ash (Ian Holm) is a Sociopath who is aware of Special Order 937 and hides this agenda until Ripley (Sigourney Weaver) discovers it. Ripley transforms from Clueless to possible Sociopath near Alien‘s end and becomes a Sociopath in James Cameron’s sequel Aliens (1986).

 

Special Order 937 is a powerful narrative-like metaphor that has wider applicability. It depicts the potential breakdown or fraying of employer-employee relations in circumstances of disruptive industry change, distressed debt, and organisational restructures. The MacLeod-Gervais-Rao-Church model predicts that Sociopaths will externally transfer the negative risks to Clueless and Loser employees – whilst simultaneously covering this up through selective framing / interpretation of facts, policies, and procedures.

 

Awareness of Special Order 937 gives Clueless employees the opportunity to see the underlying Reality of the organisational strategic culture from the decision elite / leadership’s perspective (and perhaps from a whole-systems viewpoint). This provides some optionality and the potential to become more than Sociopath: a fully sovereign actor who is anti-fragile (Nassim Nicholas Taleb).

Dissecting Steve A. Cohen’s Edge

One of my discarded PhD chapter outlines was on the hedge fund SAC Capital and the insider trading case involving former SAC trader Matthew J. Martoma and the firms Elan and Wyeth. I had hypothesised that SAC founder Steve A. Cohen had developed a specific organisational strategic subculture. Recently, I read and analysed Cohen’s legal defence. Now, The New Yorker‘s Patrick Radden Keefe has written a lengthy article on SAC, Cohen, Martoma, and the insider case’s legal outcomes. I reflected on how Cohen developed his edge:

 

1. Cohen had ignition experiences early on in his career. Keefe and the PBS Frontline ‘To Catch A Trader‘ point to Cohen’s formative trading experiences with the investment bank Gruntal & Company as a likely first encounter with insider trading. Possibly more important to Cohen’s creative psychobiography are his early experiences in learning to perceive fluctuations in stockmarket prices, as told to Jack Schwager. This tape-reading ability has been part of trading education since Jesse Livermore and is echoed in the Market Wizards series interviews that Jack Schwager did with Michael Marcus and Paul Tudor Jones II. Cohen’s early experiences also parallel the role of ignition experiences in the literature on genius and creativity. They also meant that Cohen did not adopt the dominant approaches of fundamental and technical analysis. Instead, he anticipated behavioural finance in looking for catalysts that moved stocks and that led to rational herding and overconfidence behaviours he could trade against.

 

2. Cohen hired a performance psychologist. Keefe mentions but does not name the late Ari Kiev as the performance psychologist who Cohen hired to mentor his traders. Kiev’s books notably The Mental Strategies of Top Traders (Hoboken, NJ: John Wiley & Sons, 2009) draw on his SAC experiences and detail his personal synthesis of elite sports training, game theory, portfolio management, and leadership frameworks. Kiev foreshadowed other performance psychologists such as Brett N. Steenbarger who have worked with hedge funds. In doing so, Kiev and Steenbarger became de facto strategic foresight practitioners, albeit with a different knowledge base to futures studies.

 

3. Cohen created a specific organisational strategic culture. Keefe and PBS Frontline‘s narratives focus on SAC’s competitive culture between rival portfolio managers; the inside discussion of “black edge” as material non-public information; how Cohen ran his trading floor; and how Cohen got the best trading ideas from portfolio managers whilst also insulating himself from their information sources. There are observations here worthy of the third generation literature on strategic culture, and how specific organisations have developed ways to hedge risk and volatility. If Keefe had been familiar with the sociology of finance literature then he might have focused on this more. Now that SAC has transformed into Point 72 Asset Management – to manage Cohen’s estimated $9 billion wealth – we may never really know what went on inside SAC, unless there is further operational disclosure in civil cases, or in trader memoirs.

 

4. Cohen was pro anti-fragile. Keefe tells an anecdote about how Cohen would ask job applicants: “Tell me some of the riskiest things you’ve ever done in your life.” Keefe segues from this into an anecdote about insider trader Richard Lee. But there are several other possible ways to interpret Cohen’s question and why he would pose it to SAC job applicants. Cohen may have wanted to assess how the job applicant conceptualised risk; how they made decisions; and what specific decisions they made when faced by risk. As Kiev identified these are crucial aspects to successful trading. The anecdote also suggests to me that Cohen was pro anti-fragile: options trader and philosopher Nassim Nicholas Taleb’s term for phenomena that become stronger due to volatility exposure. Being pro anti-fragile – and taking considered risks – was in part how Cohen turned an initial $US25 million in the early 1990s into his fortune – as a possible successful example also of the Kelly Criterion risk management strategy.

 

5. Cohen factored in transaction and execution costs. Keefe alludes in passing to how SAC used dark pools – private exchanges that hedge funds use to trade their positions – in order to exit Martoma’s Elan and Wyeth trades. Kiev’s game theoretic reasoning about catalysts and other market participants provided one rationale that was influential in SAC’s organisational strategic subculture. Awareness of transaction and execution costs – and their impact on a trade’s profitability – provide another rationale. In one of the few public statements by SAC staff, Neil Chriss emphasised the importance of considering transaction and execution costs in his introduction to Robert Kissell and Morton Glantz’s book Optimal Trading Strategies (New York: AMACOM, 2003), pp. viii – x. Chriss suggested there was “an efficient frontier of trading strategies . . . Each strategy has a certain transaction cost and a certain risk” (emphasis original) (p. x). He then stated: “no institutional manager can afford not to understand transaction costs” (emphasis original) (p. x). In doing so Cohen anticipated the impact that dark pools, and algorithmic / high frequency trading have had on contemporary market microstructure.

 

There is thus far more to Cohen’s hedge fund success with SAC Capital – his sustained edge over two decades – than what the Martoma insider trading case has revealed to-date. Keefe’s New Yorker profile reveals aspects – but more trading knowledge is needed to piece together Cohen’s secrets from public information sources.

Reading Steve A. Cohen’s White Paper in the SAC Insider Trading Case

I’ve followed hedge funds – pooled fund structures that engage in active management often uncorrelated with financial markets – for about a decade.

 

Almost 12 years ago I wrote a Masters paper on Long-Term Capital Management (PDF) in Swinburne University’s Strategic Foresight program. I read Sebastian Mallaby’s history More Money Than God (PDF) and MIT’s Andrew Lo. Hedge funds appeared to be exemplars of Richard Slaughter‘s Institutes of Foresight thesis. More recently, I have thought of hedge funds as possible examples of meso-level, organisational strategic subcultures.

 

Today, I re-watched the PBS Frontline documentary ‘To Catch A Trader‘ (2014) and read the white paper (PDF) from SAC founder Steve A. Cohen’s lawyers in the now-notorious Elan and Wyeth insider trading case. Cohen’s portfolio manager Matthew Martoma was convicted of insider trading and sentenced to jail. Cohen’s SAC was fined millions and is now basically a family office.

 

I’ve had the white paper for over a year but only today got a chance to have a close read of it with an eye on how Cohen’s lawyers describe his trading strategies. I learned to do this when studying strategic foresight methodologies.

 

Some of my summary notes from the white paper:

  • Back of envelope estimate of Steve Cohen’s trading portfolio size in July 2013: $US1,253,000,000.
  • Cohen trades over 80 individual securities a day.
  • Algorithms, direct market access, and dark pools are routinely used for trade execution.
  • The PBS Frontline documentary describes Edge as an informational advantage about market activity.
  • The white paper describes the following as Events: (1) corporate access (competitor announcements; adverse developments); (2) market moving (catalysts, technical analysis); (3) analyst convergence (broker-deal reports; ratings such as downgrades); and (4) market rumours (false market).
  • SAC portfolio managers develop a Company Investment Thesis. This may involve: (1) trimming positions whilst going into earnings announcements; (2) using option hedges to offset long/short positions using a market neutral strategy; (3) anticipating slippage: incremental shifts in share prices due to the timing of executed trades; and (4) responding to risk reviews of large positions.
  • Market price-psychology patterns that Cohen has identified: (1) increases in individual share prices versus S&P 500 declines (deteriorating market) over specific time periods; (2) tests of if positive market reaction is sustainable (possible mean reversion); (3) company news that is ambiguous or less-than-spectacular information that will trigger a decline; and (4) rapid stock appreciation that creates high expectations and the probability of a price decline.

 

The Steve A. Cohen white paper illustrates how to potentially reverse engineer a hedge fund’s trading strategy – as a strategic foresight example – and to not be a Muppet-like naive retail trader.

Ray Dalio’s How The Economic Machine Works

 

Ray Dalio is the legendary founder of the Bridgewater hedge fund which manages $US150 billion for the World Bank and pension fund clients. Dalio is influential for sharing his management principles that inform Bridgewater’s strategic subculture (PDF). He has now shared a 30-minute video on his personal model of global macro dynamics.

 

Maneet Ahuja has a chapter-length interview with Dalio in her book The Alpha Masters (Hoboken, NJ: John Wiley & Sons, 2012) in which he talks about how to learn; how he founded and built Bridgewater; dealing with the World Bank; and how to deal with crises:

 

If you’re limiting yourself to what you experienced, you are going to be in trouble. . . . I studied the Great Depression. I studied the Weimar Republic. I studied important events that didn’t happen to me. (p. 12).

 

Dalio says if you have 15 or more good, uncorrelated bets, you will improve your return to risk ratio by a factor of five. He calls this the holy grail of investing. “If you can do this thing successfully, you will make a fortune,” he says. “You’ll get the pot of gold at the end of the rainbow.” (p. 17).

Gray Matter

 

For several months I’ve been thinking about writing a PhD chapter on AMC’s Breaking Bad. The influential television series features Drug Enforcement Agency and Mexican drug cartel strategic subcultures centered on Albuqurque, New Mexico. One overlooked aspect is Walter White’s (Bryan Cranston) past as a talented graduate research chemist in the now multi-billion dollar firm Gray Matter. One of White’s major character motivations is that he sold his founding stake to Elliott and Gretchen Schwartz for $5000. Its return in the penultimate episode ‘Granite State’ makes the subplot a powerful one for researchers who make decisions on research commercialisation and spinout ventures