Complexity Strikes T. Rowe Price

T. Rowe Price: Invest with Confidence… but vote with skepticism?

When we think about complexity, we naturally think about systems that seem risky, like nuclear power, aviation, space flight, the power grid, or high frequency trading.  But a recent, and costly, proxy voting mistake shows that even systems that seem really boring can have big consequences when they fail.

T. Rowe Price, the asset manager, announced this week that it was paying almost two hundred million dollars to clients for mishandling of a proxy vote related to the 2013 leveraged buyout of Dell Inc. At the time of the buyout, T. Rowe Price held the computer maker’s shares in a variety of its mutual funds and client accounts.

Even as T. Rowe Price actively opposed the buyout and advocated for a higher price for Dell shares, their proxy voting system mistakenly voted “for” the merger. Like almost all complexity-driven errors, this was a combination of human error (T. Rowe Price employees failed to check that the voting record matched what they expected), external factors (the shareholder vote was postponed several times, which overwrote the “Against” vote that T. Rowe Price recorded), and seemingly benign design decisions that have unintended consequences: in this case, that the T. Rowe Price’s default vote for a management-supported merger was “For” the proposal.

On May 31, 2016, the court ruled that Dell’s fair value per share was $17.62 and not $13.75. Because of their mistaken vote for the merger, T. Rowe Price’s shareholders were denied the additional $3.87 per share.

In a press release, T. Rowe Price pointed out that the $3.87 difference in share value “[validated] the firm’s original investment thesis.” A validation that’s now resulting in a $200 million loss for the firm. Seems like a Pyrrhic victory.

The challenge for any firm with complex technology like this is that it’s hard to tell where such errors might be lurking. The vast majority of the time, T. Rowe Price’s system recorded the intended vote. The problem is that this mistake came with a large price tag. And more likely than not, the next costly and unexpected error (at T. Rowe Price or another firm) won’t have anything to do with proxy voting. Instead, it will be a mishandled options conversion, dividend election, or something outside of the corporate actions space entirely.

So how can firms manage to protect themselves against the spectrum of possible errors? First, they should think of complexity itself as a risk factor. One way that this could have been explicitly considered is by noting near misses, instances where a vote or other corporate action was almost recorded incorrectly, but was caught. Sensitivity to near misses allows firms to correct deep and systematic errors before they become costly.

Second, recognize that organizational (and technical) boundaries can obscure what’s going on. In this case, interactions between T. Rowe Price’s fund managers and corporate actions group diffused responsibility. And their technology platform, integrated with an external processing agent, didn’t always tell the full picture. Boundaries like this create risk.

Finally, design systems defensively with the assumption that individuals are fallible. T. Rowe Price’s corporate action voting system had sensible defaults recorded for the majority of votes. And though there was a process to change the vote, the Dell leverage buy-out was a clear special case, especially as its multiple postponements required multiple votes. Just as happened at Knight Capital (where a technologist failed to roll out new code on all eight of Knight’s servers), humans struggle to accomplish tasks that require exceptional precision with little differentiation. Designing and using checklists can help, but only when supported by an organizational culture of dissent and healthy checks and balances.

Hat tip to Steve Lofchie at The Cadwalader Cabinet for the story.

The Bracken Bower Prize

To say that we entered the Bracken Bower prize on a whim wouldn’t be quite fair. The original details about the contest came from Ken McGuffin, the Media Relations Manager for the Rotman School of Management, who helped us through the process of writing an Op Ed for the Guardian on the continued risks of deepwater drilling. Ken recommended that we look into the prize. We agreed that it seemed interesting, but we started out by putting it on the back burner, where it sat for several months. Continue reading “The Bracken Bower Prize”

Rethinking the Unthinkable

Managing the Risk of Catastrophic Failure in the Twenty-First Century

“This was not our drilling rig, it was not our equipment, it was not our people, our systems or our processes.”
– BP CEO Tony Hayward, 13 days after the explosion aboard Deepwater Horizon

Despite Mr. Hayward’s assertion, it was ultimately BP’s failure to manage the myriadrisks of deepwater drilling that caused a image_0tragic loss of life, widespread environmental damage, and a bill of upwards of fifty billion dollars. The failure of Deepwater Horizon, and BP’s inability to contain the subsequent oil leak, was not simply a failure—it was a system meltdown. Continue reading “Rethinking the Unthinkable”

Chaos via Control

Regulations, Enforcement Create Risk in the Complex and Rigid Markets

The Flash Crash should have been the impetus for serious reconsideration image_0of the structure of our national markets. But in the five years since its occurrence, assumptions have not been re-examined. The market’s complex and interconnected structure, which regulations mandate, increases the likelihood of destabilizing failures. Despite extensive study, and a recent indictment, regulators have not fully grasped the lessons of the Crash: a simpler set of rules would result in a market more resistant to explosions of volatility.

Continue reading “Chaos via Control”

Courting Catastrophic Failure

Will Managers Ever Learn?

From BP’s Deepwater Horizon disaster, to deadly component failures at image alt textToyota and GM, to technological meltdowns at major stock market participants likeKnight Capital (now KCG Holdings), Goldman Sachs, and NASDAQ, catastrophic failures have devastating effects on the environment, businesses, and customers. And the potential for failures of this kind is growing as both the complexity of our systems and the probability of extreme “trigger” events increase.

Continue reading “Courting Catastrophic Failure”

Preventing Crashes

Lessons for the SEC from the Airline Industry

by Chris Clearfield, András Tilcsik, and Benjamin Berman
A small error on August 1, 2012 nearly bankrupted the Knight Capital Group. Code from a discontinued software component was accidentally reused after nine years, and in just 45 minutes Knight’s automated order router had flooded the market with millions of unintended orders. Knight lost $460 million when it sold back the inadvertently traded stocks—a staggering $10 million dollars per minute.