WHEN: WEDNESDAY, JULY 16TH
WHERE: CNBC'S "Squawk on the Street"
Following is the unofficial transcript of a CNBC EXCLUSIVE interview with Ken Griffin, Citadel Founder & CEO, live from the CNBC Institutional Investor Delivering Alpha conference in New York City on Wednesday, July 16th.
Mandatory credit: CNBC Institutional Investor Delivering Alpha conference.
KATE KELLY: Ken, thank you so much for being with us. This is a first for Delivering Alpha, and I believe this is a first on television for you.
KEN GRIFFIN: Certainly is.
KATE KELLY: We're delighted to help you experience this wonderful medium. Speaking of which, big news out today about Time Warner and 21st Century Fox making sort of, until this morning, a secret bid to buy the company and being rebuffed. That said, the story is probably not over yet. You own both stocks, curious what your take is on the news of this deal today, or the attempt of a deal, and whether it's going to come through.
KEN GRIFFIN: It's a great deal. Time Warner, great outfit. HBO, Warner Studios, content is king. Both of them have great content. The deal makes a lot of sense for Fox. Makes a lot of sense for Time Warner's shareholders.
KATE KELLY: Except for the fact that at least initially they said no.
KEN GRIFFIN: I think they'll get to yes.
KATE KELLY: So how? Rupert Murdoch is a tireless negotiator. He's been known to pay in the past what some people considered to be almost silly premiums for assets that he legally wants. Are we going to see those characteristics at play? What would you do next?
KEN GRIFFIN: I think one of the dynamics that Time Warner faces is there is no controlling shareholder. Therefore, the company really is in play. And unless they have a great option for their shareholders, this deal looks like the highest way to secure value for the shareholders in the here and now.
KATE KELLY: So it's going to get tough to say no over time?
KEN GRIFFIN: Tough to say no, and I think Murdoch, as you said, has a history of really willing to go the extra mile to get deals done that are important to him.
KATE KELLY: I'm curious about the media space in general. This is really a game changer this morning. Do you expect to see more consolidation?
KEN GRIFFIN: So, again, the issue of controlling shareholders is key. And because so many media assets have a controlling shareholder, the decision to merge is really in the hands of those individuals. And what makes the Time Warner asset so attractive is without a shareholder who is in a controlling position, it's going to come down to the shareholders as a whole in their visual M/A process to make decisions about where to take this transaction.
KATE KELLY: So we need to look to the investor community for guidance in terms of what people would like to see and what other deals may take shape?
KEN GRIFFIN: You have to look to the actual controlling shareholders, what are their personal agendas with the assets that they control. Whereas with Time Warner, because there is no controlling shareholder, this will come down to in a sense the vote of every institutional and every individual investor when it's all said and done.
KATE KELLY: So this could be a litmus test for future deals in that respect?
KEN GRIFFIN: No, this is not a litmus test for future deals. I think this deal represents what happens when you don't have a controlling shareholder. When the shareholders in a sense have a chance to vote on what they want the outcome to be.
KATE KELLY: Right, right. I'm just wondering looking forward, though, if there are any lessons we could take at this early stage about whether the deal making landscape is ripe for more.
KEN GRIFFIN: There's obviously synergies to be had in media today. Particularly as media becomes more and more global. One of the great things about Murdoch's assets is they are fantastically well positioned in the global growth story. They've done a great job of really maximizing their global revenue growth.
In a global world, there is a lot of attractions to M&A in this space. But, again, you have to get back to the fundamental question of which assets can be brought, given the nature of so many of these assets being controlled by a small group or individual shareholder.
KATE KELLY: Right, right. Let's talk about what's been probably a bit of a thorn in your side so far this year, which is Michael Lewis, Flash Boys, the whole debate over high-frequency trading. You testified before the Senate Banking Committee last week about this topic and what you guys do now, what you've done historically.
I know from your remarks that day, you feel what's happened in recent years is good for investors, that vast technology has improved order fills for everybody, that the old boy's network of the four brokerage firms and so on has been upended in a constructive way.
That said, there's some interesting details in Lewis's book about sort of payment for order flow, for example. What is the rationale for payment for order flow? Do you guys do it and why?
KEN GRIFFIN: So payment for order flow is where a large brokerage house, primarily online brokers, are able to negotiate de minimis payments from their executing broker at the time an order is executed on behalf of a retail investor. Now we're looking at something like roughly 1/10th of a cent per share is a typical payment for order flow number in the industry. It's a practice that has a long history. It has replaced a variety of reciprocal business relationships that used to exist, and it's also replaced internalization. If you go back just 15 years ago, a huge portion of all retailer...from the United States was internalized by the executing broker.
KATE KELLY: Which is sort of an early version of dark pool?
KEN GRIFFIN: I wouldn't say it's an early version of dark pool. It was just where the markets were 15 years ago. And what's happened is the market has, like in much of our economy, separated into areas of excellence, the large market makers that cater to the online community, us...Knight, UBS, Citigroup are in a position to provide better execution quality as standalone boutiques focused on that activity, than the old internalization deaths that used to exist within the online brokerage community.
KATE KELLY: One issue that came up with Flash Boys, particularly with the vast...exchange of one of your competitors, is this idea that are two fees essentially. Super fast fee, that will be more expensive than the sort of normal fee. Super fast fee, if you're trading and you're connecting with stock market, is going to give you additional information about an offer and perhaps better filled because you have the more granular prices available to you, more granular bids and offers that are in smaller increments than the sort of normal fee that has less information.
Is it fundamentally fair, even though we know this exists and there is a price differential, is it fundamentally fair that some people don't have access to the very best bids and offers are filled for a price?
KEN GRIFFIN: So, first of all, the information that you said is available to everybody at the FTC regulated pricing schemes. So the information has to be available to anybody that wants to pay for it.
I don't know about you, but I'm on CNBC's website all the time. Their stock quotes are free. They are delayed by a quarter of a second, a half a second. Not the 1/1,000 of a second that is the difference in speed between that direct feed and the university's...feed. 1/1,000 of a second is the time difference that is at the center of all this controversy. It takes a human about half a second to respond to information, to put it in perspective.
KATE KELLY: But a computer can move much faster.
KEN GRIFFIN: A computer can move faster. In fact, computers do move faster. Almost all shares are executed based upon the direct feed. And so when...sends an order to Citadel for execution, we have to leverage our technologic capabilities to provide that customer with the best possible execution. And what happens amongst the retail brokerage firms, they keep firms like us in competition day in and day out to win their business.
What that means for the retail investor in America -- and this was totally lost in the Michael Lewis story, and it's a story -- what's lost in the story is that us and Knight and UBS and Citigroup and others are competing every day for the retail orders, and so because of that competition, we share with the retail investor our trading product. The better we are as traders, the more we're in a position to share with the customer that sends us the order.
KATE KELLY: Why has there been a veil of secrecy over high frequency trading as a concept? There is an anecdote, and I agree a story in Michael Lewis's book about a guy that once worked for -- or maybe a woman, I'm not sure which, who worked at the Pentagon who needed two security badges to get to the desk that they work at. But at Citadel, where they apparently work, five badge swipes. Do you guys just have super great security or is there something secretive about high frequency trading at Citadel?
KEN GRIFFIN: I read that passage in the book and thought how many card swipes does it take. One from the garage, the main floor, one to the turnstile, one to the elevator floor, and two to get to the desk, to the trading division. Again, the book is a great story. We obviously pay a lot of attention to protecting our intellectual property.
You know all this is, is idea, thoughts and concepts expressed in computer code. And unfortunately, that intellectual property is readily moved, and it's very important for us to protect it.
Think about how much of an effort Coca-Cola makes to protect the recipe for Coke. We have to do the same thing to protect our intellectual property.
KATE KELLY: What about the broader point on high frequency trading? Why does it feel at least to some members of the public like a sort of closely guarded secret? Why haven't we talked about it more up until now?
KEN GRIFFIN: I think what is shocking for those of us who are in the community is how many of the important ideas can be expressed in two sentences. Therefore, we're all very hesitant to say anything because our key concepts and key ideas really come down to a thought you can express in one or two sentences. These aren't necessarily complex insights. They are powerful insights, but because they're often very simple and straightforward, you have to be very careful about how you express those ideas.
KATE KELLY: Do you think because it can be simply synopsized people assume there's something evil lurking under the -- within the generalities?
KEN GRIFFIN: No, I think what happens is the firms that have those insights work very hard to protect those insights, because they're so readily moved across organizations. So it's very important to all of us in the business to protect our competitive trade secrets.
Because going back to my earlier statements, to win order flow in the marketplace from an Ameritrade, from a Fidelity, from a Scottrade, I have to really share my trading prowess and acumen with the retail investors. The retail investor has been a huge beneficiary of the unleashing of competition that's happened under regulation... And every day we have to compete for their orders. That's why about 80 percent of all the orders that we execute are executed within the spread as posted on the exchanges.
KATE KELLY: Okay. Let's move on to another topic.
You made some ripples last year at the Diobo conference saying that Wall Street has sort of a cartel mentality, and also that the banks perhaps needed to be broken up. There is no legislative regulatory impetus for that right now, although theoretically you were a fan of glass eagle...
We haven't seen any hard evidence of that yet, but so far this year fixed income at the banks is flagging, the results we've seen so far for the second quarter underscore the points. Credit Suisse, considering breaking out one of its fixed income businesses into a separate entity. Is this the beginning of something here?
KEN GRIFFIN: I think we're definitely seeing transformation of the banking landscape, and we're seeing the banks take a step back and say which businesses can they be competitive in. Just as I spoke earlier about the competition that exists for execution of retail orders, we're seeing the same dynamic played out now, for example, in interest rates slides. Where the rise of clearinghouses has leveled the playing field and has allowed new entrance into the market making function for interest trade slide.
KATE KELLY: That's a business you're getting into now?
KEN GRIFFIN: That's a business we are pursuing as we speak here today. In fact, we've given them a first trade as a market maker, just a few weeks ago. So what we're seeing is the banks really having to take a step back and go, which businesses do we have core competency in, where can we build competitive advantage, where should we focus our shareholders equity? This is a really important and healthy dialogue.
KATE KELLY: So it's not as though the trading results are going to force immediate change. But you do think there could be something in the works here. This could be a different landscape in five or ten years?
KEN GRIFFIN: I think trading has been, in a sense, a glamorous part of the universal banking model until 2008. Then you look at the losses that took place in 2008 within this glamorous business, look at the cost structure of this supposedly glamorous business, and take a step back and go what is the actual return to my shareholders in trade?
And outside of the very top, well-run firms, those returns for shareholders have been abysmal. So I think much of what we're seeing is the banks are saying, you know what, my retail business is such a great business, my lending business is a great business, I need to focus on my core strengths, and I don't need to be in a business just because it's glamorous.
KATE KELLY: That's a great segue to some of your recent experiences at Citadel. Couple things I want to ask you about. You guys put together an investment bank, opted out of that. You had a very tough time in 2008, billions lost, and it took you four years, but you did regain your high watermark. Talk to me about the post financial crisis period for Citadel. What kind of soul searching did you and your executive team do in terms of figuring out what you wanted to try, what you wanted to avoid, and how did you come out the other end so well?
KEN GRIFFIN: Well, going back to 2008, that was a couple very dark moment for us. As a firm, we had gone through almost 20 years of never experiencing a loss of even double digits. And as you're well aware in 2008, we lost about half our equity capital in 16 weeks. In fact, Steve had the van parked outside our building trying to get the bankruptcy footage if we failed in 2008. So we are a long ways away from that dark moment at the peak of the financial crisis.
If we look at how we moved out of that very dark position, it really comes down to one core asset, which is the quality of the people. We really as a team did a fantastic job of pulling together and making some very difficult decisions on how to reshape and refocus our business in a post-chattel banking world.
The lending markets were forever changed in 2008. The role of the non-bank banks has changed since 2008, and we had to adapt and evolve to confront the changes that were unfolding before us. We were incredibly fortunate we had great long-term investors that supplied their capital. They were supportive of the transformation.
So the right people and the right investors gave us an opportunity to really rebuild the business and to move forward post the crisis of '08.
KATE KELLY: How did you do that top evaluation of the business? Did you bring in outsiders to give you advice? Did you take a cold, hard look at your financial statements in a more granular fashion? How did you even approach it during that moment of crisis?
KEN GRIFFIN: So the key in the moment of crisis was to understand where the future was going to lie. We really felt the future for us was going to be in transparent liquid assets. We moved the entire business towards the trading of equities and fixed income government securities, foreign exchange, oil, natural gas in very liquid, very transparent markets, very low complexity in our business.
There is an old acronym in the military, KISS, Keep It Simple Stupid. But we embraced those four letters because we thought they described distinctly where we were going to take Citadel in the years to come. By having a clear strategy and focusing on liquid markets, liquid products where we had a very long track record of success. By keeping our core team together and focused on moving forward, we were able to find the room that we needed to get back on our feet and prosper.
KATE KELLY: Tell us a bit about building the culture that you've established at Citadel. You're looking toward your 25th anniversary next year. You've started really from scratch. You have avoided some of the regulatory and legal issues that one of your biggest competitors in the hedge fund has faced, which is to say SAC has faced. I'm sure there are no bad apples at Citadel, to begin with.
KEN GRIFFIN: I hope you're right.
KATE KELLY: I'm also curious, though, is it compliance? Is it culture? Where have you avoided some of those issues? Is it the compensation structure that incentivizes people to follow the rules? What ideas do you have for other hedge funds and managers?
KEN GRIFFIN: Let's just take it head on. There are two really important parts of our culture that are key to our success and key to us in a sense being where we are today in the marketplace as a leader in alternatives.
First is, we have an incredible emphasis on hiring the best and brightest people in the world. We are very focused on being very good competitors and winning on the merits. The culture of the firm is we're going to outwork, outbank, outhustle the competition. But we're going to win on the merits.
And behind that is a very strong culture of compliance, which is we appreciate that we are part of a broader system. The rules of the system are intended to engender confidence in the system, fairness in the system, and that we prosper if those rules are in a sense abided to by all.
My general counsel, who has been a partner of mine for roughly decades, has really done a great job of taking to the frontline the importance of compliance.
And of course you said do we have any rotten apples? I sure hope not. But we have a lot of processes in place to make sure that we identify activity that is questionable. We question it. We're very focused on making sure people win on the merits, they dot their Is, they cross their Ts, they do business the right way.
And in our 20-some years, our regulatory track record stands for all of this, because we really do believe in the importance of abiding by and following the laws, both domestically and abroad, that we're subject to.
KATE KELLY: Let me ask you about the market environment and about Kensington and Wellington, and then I want to move on to politics and public policy, before we run out of time.
What is your outlook on the markets this year? We heard from Chairman Yellen yesterday, kind of keeping with the theme she's had for much of the year. Sounds like it could be a little while before we theorize and raise, and if and when we do it could be gradual. She thinks more efforts are needed to help the economy going, pick up slack in the labor force and so on. What does all that tell you and how are you positioned to benefit from what you see coming?
KEN GRIFFIN: So if I think about Jan's testimony, and she's very thoughtful, it's very difficult to halt a rate hike cycle in a sense mid cycle. You're much better off waiting before you raise rates than raising rates and having to stop or roll back that rate increase prematurely.
So we are now several years post the financial crisis of '08, post the great recession that hit the United States, and the Fed is very apprehensive about moving too soon and throwing a wrench into the recovery that we're now enjoying, which is a better recovery than we've seen in a long time. We really appear to have some positive momentum in the labor market for the first time in several years.
So my view, my personal view, is that the Fed is going to stay low a little longer than people expect. But when they do start to move, they will move much more aggressively than people anticipate.
So we're going to wait, wait, wait and then move aggressively and decisively where it's clear that the economy really is accelerating into a strong growth mode.
KATE KELLY: So how do you prepare for that? And to the extent it might hurt you, how do you hedge for that?
KEN GRIFFIN: Look, we trade industry products every day. It's very simple to trade, whether it's short term government bonds or euro dollars, to express views in the interstate markets. And we do that actively, and we do that in response to evolving economic news and economic data.
KATE KELLY: What about the stock market?
KEN GRIFFIN: So in the stock market, we really try to avoid making the big macroeconomic calls. The heart of our business in stock selection is really understanding the businesses that we invest in cold.
So at Citadel, for example, we will do about 10,000 management meetings this year. We will sit down with management teams about 10,000 times around the world in 2014, trying to understand how the businesses that we invest in are evolving, how they are changing, how the products are doing in the marketplace, how the margins are being impacted by dynamics around the world. It's a very granular research process that drives our business.
KATE KELLY: Let me pivot you to one last area of focus, which is Chicago, Illinois politics. A couple of statistics I was looking at. This was from you last year, I think. $200 billion in unfunded pension liabilities. A Gallup poll recently showing more people want to leave Illinois than any other state in the U.S., many of them because of their job situations.
What's going on here? You recently made a donation to Republican gubernatorial candidate Bruce Rauner that broke state records, $2-1/2 million. What could he do or can an active citizen like yourself do to address these problems?
KEN GRIFFIN: So Illinois has historically been a great state to do business in. Unfortunately over the last 20 years, we've moved from being at the top of the list of places to do business to, frankly, the bottom of the list. We need changes in Springfield. Americans talk about the need for change in Washington. I can tell you the need for change in Springfield is far greater than the need for change in Washington. I know it's hard to believe.
[ Laughter ]
KEN GRIFFIN: But it really is.
KATE KELLY: Is that a comment about the President or --
KEN GRIFFIN: I'll let you draw your own conclusion. I mean, we're in America, we're in the United States. We are a country that competes with every single country in the world. We have a broken school system, broken tax policies. We have a series of regulatory decisions that place incredible burdens on American companies. We need to start to make some hard choices about redeeming competitiveness.
And in Illinois, those choices are avoided time and time again, partly to the detriment of everyone, from the pensioner whose pensions will likely be broken unfairly. They have every expectation of receiving the money, and they go to work every day. What teacher would ever think that at the end of their career they're not going to get what the State promised them?
But at the same time, the taxpayers are being saddled with bills they simply can't afford. So we need change in Springfield, change in leadership. We need somebody like Bruce Rauner, who is willing to grapple the hard issues and let the hard-working families in Illinois have a future in our state.
You know Cook County lost more college-educated citizens than any other county in America in recent years. I don't want to be the choice.
KATE KELLY: You've become more active in politics in recent years. You obviously feel strongly about issues in Chicago and Illinois. Would you ever run for Governor?
KEN GRIFFIN: I can't see that in my future.
KATE KELLY: You wouldn't rule it out?
KEN GRIFFIN: Never say never, but I can't see it in my future.
KATE KELLY: Okay. So final question then. In terms of what you were just speaking of, how do we combat this sense of short-termism in politics? How do you get citizens to elect leaders who will actually come up with tough solutions over the long-term? Is there a way?
KEN GRIFFIN: I think one of the key challenges in the United States is that the process of jerrymandering has created lifetime politicians who really become beholden to extremists within their district on both sides. So the polarization that we've seen in Washington really cuts against what most Americans want.
The difference between Republicans and Democrats on most issues is actually pretty small. We make a big deal about very modest differences as a country, and yet the extremes on both sides have a disproportionate...voice in Washington, and that undermines the ability for us to move our country forward.
KATE KELLY: Ken Griffin, thank you so much. It's been a pleasure.
KEN GRIFFIN: Thank you.
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