| The basic rule is that the chief executive officer of a company works for the board of directors, and the directors work for the shareholders. Sometimes, though, the CEO is also the controlling shareholder, and this becomes circular: She works for the directors, who work for her. If they disagree, things get weird. If they're unhappy with her, they can fire her, but then she can fire them. This doesn't come up all that often in basic job-performance situations: Presumably if you are a director at a company controlled by its founder, CEO and main shareholder, you're there because you believe in her vision for the company, and you don't spend a ton of time thinking about firing her and replacing her with someone else. It does happen, though: We talked last year about World Wrestling Entertainment Inc., whose board of directors pushed out founder-CEO Vince McMahon after sexual misconduct allegations, and then, as controlling shareholder, he pushed them out. It comes up more often in mergers and acquisitions, and particularly in going-private transactions. The basic problem is: - The founder, CEO and controlling shareholder wants to take the company private: She owns much of the stock, but public shareholders own the rest, and she would like to buy their stock for herself.
- She proposes a merger to the board of directors and names a price.
- The board thinks the price is too low and asks for a higher price.
- She says "nope, I'd prefer to pay the lower price."
- They say "as fiduciaries for the public shareholders, we cannot approve a merger at this price, so we are saying no."
- She says "as the controlling shareholder, you're fired," and then tries to find other directors who would be more amenable to the deal.
The directors work for all the shareholders, and they can't just do what the controlling shareholder wants if it's bad for the other shareholders. But the controlling shareholder gets to pick the board, and if they are too independent she can pick a new board. They can get fired for doing their job too well. That is a pretty schematic description, and most actual going-private negotiations don't quite look like that, but they are conducted in the shadow of that possibility. For instance: - Sometimes the CEO and controlling shareholder will come to the board and say "I'd like to take the company private at $10 per share, are you down for that?" And the board will say "well we'd like to run an auction and see if there are any other bidders at a higher price." And the CEO will say "hahaha you do what you want, but if you find a higher bidder, I won't vote for the merger or sell them my shares, so they won't actually be able to complete the deal. The only deal you're going to get is a deal with me." And then the board will be like "okay fine we'll negotiate with you, can you pay $11 per share?" But the board doesn't have much leverage, because the board knows, and the CEO knows, that there will not be another bidder.
- On the other hand, sometimes the board will say "we'd like to run an auction" and the CEO will say "sure, you run an auction, and if you find a bidder who will pay more than I will, I will support their deal." The CEO might do that to avoid getting sued — to create a record showing that her offer was in fact the best available deal for shareholders — or because she really thinks the company is worth $12 per share, so she's a buyer at $10 but a seller at $14. (This is, roughly, Paramount.)
Also generally there is no need for the CEO to fire the board; they can see the writing on the wall and quit first. There is a whole branch of this subject where the CEO is Elon Musk, but I will skip over that for now. Anyway: All seven independent directors of DNA-testing company 23andMe resigned Tuesday, following a protracted negotiation with founder and Chief Executive Anne Wojcicki over her plan to take the company private. It is the latest challenge for 23andMe, which has struggled to find a profitable business model. The stock price rose a penny on Tuesday to $0.35 per share. At that price, 23andMe's valuation is just $7 million more than the cash on its balance sheet. That represents a 99.9% decline from its $6 billion peak valuation just after going public in 2021. In a letter addressed to Wojcicki, the directors wrote that "after months of work, we have yet to receive from you a fully financed, fully diligenced, actionable proposal that is in the best interests of the non-affiliated shareholders." It is very rare for a publicly traded company to see so many directors resign simultaneously. The board members wrote that they differ with Wojcicki on the "strategic direction for the company" and because of her voting power, it was best that they resign. Wojcicki controls 49% of 23andMe votes, giving her a level of control that blocked board members from shopping the company to other potential bidders. She is the only remaining board member after the resignations. … "I am surprised and disappointed by the decision of the directors to resign," Wojcicki wrote in a late Tuesday memo to her employees. She wrote that taking 23andMe private, "outside of the short term pressures of the public markets," is still the best plan for the company and said she would find new independent directors.
Here are the company's securities filing and press release; here's Wojcicki's filing with her response. One possibility is that there is a genuine difference of reasonable opinions here, the old board was intransigently opposed to a deal with Wojcicki, and she'll go and find a new board who negotiates with her more reasonably and ends up with a deal that is good, or at least good enough, for public shareholders. Another possibility is that Wojcicki has unreasonable plans to take the company private at a bargain-basement price, any board of independent directors would have said no, and now she'll go find a new board that will also resign in a month when they realize that they can't work with her. In theory this could go on forever! E.F. Hutton & Co. was a brokerage firm founded in 1904 that grew to be one of the biggest brokers in the US. "When EF Hutton talks, people listen," its old commercials said. Then it went through rough times and was acquired by Shearson Lehman in 1988. As far as I can tell from Wikipedia, the corporate entity ended up as part of Citigroup Inc., which sold the E.F. Hutton brand to some alumni who planned to launch a new firm. That didn't work out, but the brand kept kicking around, and eventually a firm called Kingswood Capital Markets got hold of it and rebranded itself as EF Hutton. And then it became a leading adviser to special purpose acquisition companies, the blank-check companies that were in vogue for a while as a way to take companies public. It worked on the Trump Media & Technology Group deal, for instance. Okay so. When I read, or write, a paragraph like that, I draw some inferences. Here you have a company that rebranded itself as "EF Hutton" to take advantage of a trusted old name that has no actual connection to the current firm. It works on SPACs, which have had a somewhat checkered past. It worked on the Trump SPAC specifically, which, you know. If you were to come to me with some scurrilous gossip about the current incarnation of EF Hutton, I might be inclined to believe you. Here, though, is a really quite extraordinarily nasty lawsuit against Joseph Rallo, the chief executive officer of EF Hutton, saying that he "falsified and personally approved falsified expenses to fraudulently obtain millions of dollars of reimbursements from" the company, including for things like "tickets for premium seats at sporting events that he attended with his gambling bookie" and "intravenous drips, which upon information and belief, were used to treat hangovers from excessive alcohol and drug usage." And: Upon information and belief, Rallo has a severe gambling problem. Rallo bets often, he bets vast amounts (six to seven figures per bet), and he typically loses. Rallo would often share openly with EFH employees his ongoing and recent gambling history. Upon information and belief, from 2021 until now, Rallo has incurred several millions of dollars in gambling losses, particularly, from sports wagers made through an illegal sports book run by a gambling bookie who he considers to be a close friend (the "Bookie"). Upon information and belief, the Bookie also operates a gambling den out of a residential apartment in New York City that hosts card games throughout the day and evening; Rallo would frequent the gambling den during the middle of the workday to gamble and carouse, and afterwards come back to the office in a state that was not conducive or becoming of a CEO of an investment bank.
And also some allegations of securities fraud, why not: On the morning of May 6, 2024, Federal Agents from the Department of Homeland Security and the United States Postal Inspection Service arrived at Rallo's home and served him with a search and seizure warrant issued from the United States District Court for the Eastern District of New York for the seizure of Rallo's cellular phone (the "Warrant"). The Warrant was issued in connection with an investigation by the United States Attorney's Office for the Eastern District of New York, and sought records relating to securities fraud, wire fraud and conspiracies to commit securities and wire fraud involving Rallo (the "EDNY Investigation").
Strong stuff! Anyway that lawsuit was filed by EF Hutton. "Our CEO is under investigation for securities fraud and also leaves the office in the middle of the day to gamble and carouse," says the company. I feel like, for a lot of investment banking clients, that would be kind of a negative? For some SPAC clients, though, maybe it's good. The simple description of credit default swaps is that they are insurance against corporate default. You can buy some bonds of a company, and then you can buy CDS to hedge against the credit risk of the bonds. You pay a premium — like an insurance premium — for the CDS. If the company doesn't pay back the bonds — say, if it goes bankrupt — then you lose money on the bonds. But if that happens, the CDS pays out, and you get a payment on the CDS that is supposed to compensate you for your losses on the bonds. Most of the time when we talk about CDS around here it's because that simple description is not quite right. Actually credit default swaps are a bit more complicated than that, in sometimes counterintuitive ways. Here are some of the ways. First: You could buy CDS to hedge against risk that some bonds you own might default, but that's not the only reason to buy CDS. You might buy CDS to hedge against some other risk: Perhaps you are a supplier of the company, you worry that if it goes bankrupt you'll lose business, so you buy CDS to hedge. Or you might buy CDS, not as a hedge, but just as a bet on default: You did a lot of research on the company, you think it will go bankrupt, and you'd like to make some money if it does. (This is sometimes called "naked CDS" and people get mad about it, but efficient markets tend to allow shorting.) Or you might buy index CDS, not insurance against one company defaulting but a bundle of insurance against a bunch of companies defaulting, as a sort of bet against corporate credit generally, or as a hedge to your general corporate credit risk. Index CDS trades — including the popular CDX series of indexes — consist of a bundle of credit default swaps on individual companies. So you might buy the CDX high-yield index, referencing a list of 100 junk-rated companies; if none of them default, then you lose your premium, but if a lot of them default you get paid. We talked once about Bill Ackman's very lucrative bet on index CDS at the start of the Covid-19 pandemic: That was not insurance against some particular company defaulting, but rather a bet that credit conditions generally would get worse. Anyway what this all means is that a lot of people will own CDS on some company without also owning any bonds or loans of that company. Second: The shorthand way to think about CDS is that it is insurance against default, and so it pays out the amount you lose on default. So if you lend the company $100, and you buy $100 of CDS, and the company goes bankrupt, and in the bankruptcy it divides up its assets and pays every creditor 40 cents on the dollar, then you will get $40 back on your loan, and your CDS contract will pay you $60, so that you get back a total of the $100 you loaned the company. The CDS perfectly hedged your risk on default; it made you indifferent between the company paying you back (and getting $100 on your loan) and going bankrupt (and getting $40 on your loan and $60 from the CDS). But it can be complicated to measure how much you got back on default. If the company goes bankrupt and takes three years to emerge from bankruptcy, and when it does unsecured creditors get not 40 cents in cash but rather equity in the new company and new longer-dated bonds, how much should the CDS pay you? One way to deal with this would be "physical settlement": If the company defaults, and you own $100 of CDS, you can deliver $100 face amount of bonds or loans to the person who sold you the CDS (who "wrote" the CDS), and they have to pay you $100. You are now indifferent — you got back your $100 — and it's the CDS writer's problem to figure out how much the bonds are worth and to turn them into money. This would be a pretty good solution, except that not all CDS can be physically settled, because not everyone who buys CDS also owns the underlying bonds. Again, some CDS buyers are buying index CDS, or making naked bets, etc. If you own $100 of CDS, but you don't own $100 face amount of bonds or loans, you can't deliver the bonds for physical settlement. So instead the way it mostly works is that, when a company defaults, there is an auction for the bonds and loans of the company. People who want them put in bids to buy them, people who want to get rid of them put in offers to sell them, and eventually there is some clearing price. (Also this facilitates physical settlement: If you bought CDS to hedge bonds that you own, you can sell them in the auction and get back cash for them; if you wrote CDS, you can bid for the bonds in the auction.) If the price is, say, 43 cents on the dollar, then the CDS pays out 57 cents on the dollar. This elides a lot of complexity, because the auction will generally cover multiple different bonds and loans — "deliverable obligations" — of the company, and sometimes those obligations can be worth very different amounts of money, so sometimes the auction will produce a result that doesn't entirely reflect the value of the company's debt. Here is a third complication. Sometimes a company will have a lot of CDS, and not a lot of bonds. One way for this to happen is: - The company has a lot of bonds, and a lot of people want to buy CDS on it, so it has a deep, liquid CDS market.
- Its CDS is so deep and liquid that it gets included in a CDS index, so people buy the index — and, thus, the company's CDS — as a bet on general credit conditions.
- Then the company gets rid of all its bonds, but the index CDS is still around.
You could imagine this not mattering. For instance, maybe the company gets rid of all its bonds because it made so much money that it can pay off all its debt and now it's debt-free. Therefore it can't default, so it has no credit risk, so its CDS never should pay off, and the index CDS properly reflects the extreme safety of one of its components. But more realistically what happens is that the company pays off all of its bonds by issuing new bonds out of a new subsidiary that is not covered by the old CDS. The company could still go bust, but if it does, the old CDS won't pay out. (This is called "orphan CDS.") Or, worse: The company pays off most of its bonds that way, but there's still a little stub of old bonds outstanding. There's, like, $1 billion of CDS outstanding on the company, but like $20 million of bonds. And then if the company does default, the CDS will be triggered, and there will be an auction for those bonds. How much are they worth? Well, I don't know, there will be a bankruptcy process, and eventually they will be paid back 0 or 40 or 80 or perhaps even 100 cents on the dollar. Let's say that we know it will be 40 cents on the dollar. If you have written, say, $200 million of CDS on that company, you could just go to that auction and offer to buy all the bonds — all $20 million worth. How much should you pay? Well, the bonds are worth 40 cents on the dollar, or $8 million. But if the auction clears at 40, then you will have to pay out 60 cents on the dollar on the CDS you wrote, or $120 million. You could bid to buy all the bonds at 100 cents on the dollar. You'll lose money on the bonds — you pay $20 million for bonds worth $8 million — but now the CDS won't pay out at all, so you'll save $120 million on your CDS. The actual numbers are rarely this stark, but this is a thing. It irritates people, because it seems to generate a CDS payout that is unconnected to economic reality. If you bought CDS on the company — say as part of a CDS index trade — and the company falls into a messy bankruptcy, and the CDS doesn't pay out because of weird auction dynamics, you will be annoyed. In fact this is such a thing, and such an annoying thing, that there is some history of companies finding some extra bonds to make the auction clear at more normal prices. "We thought we had only $20 million of bonds outstanding, but actually we have $400 million, so there are more bonds available in the auction." And then the clearing price will be lower and the CDS payout will be more sensible. It is kind of weird for a company to find bonds lying around, but it's possible. They could be intercompany notes, where one part of the company loaned money to another subsidiary, where the borrower subsidiary is covered by CDS. We talked about this when Sears Holdings Corp. randomly found some extra bonds for its CDS auction in 2018. Isn't this fun? Anyway Avon Products Inc. is going through it now: - Avon was a public company with a lot of debt outstanding, and it got into various high-yield CDS indexes.
- Then it was acquired by a Brazilian cosmetics firm called Natura &Co, and bought back most of its bonds.
- Not all, though: Bloomberg tells me that there are about $21.9 million of Avon's bonds due 2043 still outstanding, out of an original $250 million.
- It still has lots of credit default swaps outstanding.
- It filed for bankruptcy last month because of "legacy talc liabilities."
- This triggered Avon's CDS.
- So there will be an auction for its teeny little stub of bonds.
Prices of Avon CDS have whipsawed around: The annual premium for five-year Avon CDS was under 1% earlier this year (when it was orphaned CDS), but then it filed for bankruptcy and it began to trade at around a 50% upfront premium (implying that the bonds would pay back about 50 cents on the dollar). And then the price fell, when people realized that there were so few bonds and so much CDS: If you wrote a lot of CDS on Avon, you could just buy all $21.9 million of bonds in the auction at par, and not have to pay anything out on your CDS. And then the CDS price rose again, to something like 60% up-front, when people discovered new bonds. Again, what they actually discovered was an intercompany loan: In 2022, Avon apparently borrowed $405 million from its parent company, Natura. If that $405 million loan was included in the auction along with the $21.9 million of public bonds, the auction would presumably clear at a price that reflects something like the actual expected recovery on Avon's debt. And then the credit derivatives determinations committee, the group of big banks and CDS traders who makes decisions on things like this, met and decided that in fact that loan doesn't count as a deliverable obligation. To be deliverable, a debt instrument has to be a "bond or loan," and the committee decided that the promissory note wasn't a loan because it wasn't "documented by a term loan agreement, revolving loan agreement or other similar credit agreement": It's not signed by Natura (just by Avon), it doesn't have many covenants, it's just not a credit agreement. Nor is it a "bond," because it's not a security. So, even though it is unsecured debt of Avon, it is not the right kind of unsecured debt. And the CDS price fell again, because it looks like it won't pay off much. CDS holders objected; here is a memo from a law firm arguing that in fact the promissory note is a "bond or loan," or at least, somewhere in between: We believe that it would be inconsistent with the Sears ER Decision to apply the "Bond or Loan" requirement in such a way that an instrument would fail to meet this Deliverable Obligation Category merely because the DC cannot determine whether it is one or the other. It is true that the "Bond or Loan" Deliverable Obligation Category is defined as "either a Bond or Loan", but we believe this should be interpreted to encompass any instrument that is a "Bond" or "Loan" or anything in between. Therefore, in seeking to apply the facts of the Promissory Note here, any argument that the instrument is a "Bond" should not be burdened by the possibility that it might be a "Loan" and vice versa.
There is an argument about legal technicalities, but there is also the broader argument about: What is the CDS for? If it is to insure holders against losses on their $21.9 million of outstanding Avon bonds, then I guess it is basically working: If you own those bonds and also CDS, you'll probably get your money back. If it is to sensibly reflect the actual credit risk of a company that is, after all, in bankruptcy, this is all a pretty weird result. One thing that sometimes happens is that people meet potential romantic partners on Instagram or LinkedIn. (Yes.) They chat, flirt, get to know each other, perhaps send each other explicit pictures. (Generally not on LinkedIn: Eventually they move to WhatsApp.) They talk about meeting up in person, but it never quite works out. And then one day the attractive woman messages the homelier man: "You know what would be really romantic is if you were to invest $10,000 in my favorite crypto platform, here is the link, you can make 2% in risk-free returns each day, I can walk you through setting up the account." And the man is like "for you, baby, anything," and puts all his money into the crypto platform, which is of course a scam, and the platform steals it and the woman is fake and ghosts him. This is a common scam sometimes called "pig butchering," and there are variations, but the basic point is that it is a long con in which the mark is attracted not just by the prospect of making a lot of money but also by some fake romantic relationship. Is this securities fraud? Ahahahaha everything is securities fraud: The Securities and Exchange Commission [Tuesday] charged five entities and three individuals in connection with two relationship investment scams involving fake crypto asset trading platforms NanoBit and CoinW6, respectively. The SEC's two complaints allege that the defendants solicited investors via social media apps, lied to them to gain their trust and confidence, and then stole their money. These charges are the SEC's first enforcement actions alleging these types of scams. … The SEC's complaint in SEC v. CoinW6 alleges that, from approximately July 2022 to at least December 2023, scheme participants who purported to be young, wealthy professionals contacted prospective investors via LinkedIn and Instagram and pursued romantic relationships over WhatsApp. Scheme participants gained investors' trust and then convinced them to open accounts on CoinW6's supposed crypto asset trading platform. As alleged, the schemers claimed that investors could earn up to a three percent return per day from CoinW6's crypto asset staking, mining, and yield farming products. In reality, investors' funds were misappropriated, and their ostensible investments, profits, and account balances were fictitious. When investors tried to withdraw their purported profits, the schemers allegedly demanded additional payments for taxes or fees, told investors that the crypto assets were frozen as part of a law enforcement inquiry, or tried to blackmail them using compromising.
I must say that the SEC complaint is one of the least romantic things I have ever read: After establishing initial faux rapport with investors over social media, Scheme Participants sought to develop online romantic relationships with prospective investors using WhatsApp. The Scheme Participants would discuss travel, hobbies, prior relationships, and share photographs. Often after a month of conversations, with very little mention of "cryptocurrency," a romantic relationship developed in which the investor had formed trust in the Scheme Participant, believing their story to be true and their romantic interest in them to be genuine. After Scheme Participants had fostered romantic relationships with prospective investors, they introduced investors to so-called "cryptocurrency," and recommended investment into crypto staking, mining, and yield farming products that the Defendant offered on the CoinW6 Platform. These products, as further described below, offered different daily returns on invested funds for different periods of time, such as 3, 7, 15, or 30 days. To invest in CoinW6's products, the Scheme Participants directed investors to use U.S. dollars to purchase crypto assets such as Tether (USDT), which is a crypto asset purportedly pegged to the U.S. dollar, or Ethereum (ETH), on U.S.-based crypto platforms. From there, they showed investors, using screenshots over WhatsApp, how to open self-custodial crypto wallets, and then move their USDT or ETH crypto assets to those self-custodial wallets. The Scheme Participants then showed the investors how to open an account on the purported CoinW6 Platform and how to deposit their USDT or ETH crypto assets into those accounts. After the investors' accounts on the CoinW6 Platform were purportedly credited with crypto assets, the Scheme Participants walked the investors through investing in CoinW6's purported crypto asset staking, mining, and yield farming products. The investors selected the product almost always based on the Scheme Participants' recommendation.
The complaint quotes a few chats, though it never quite captures the moment where the alleged con artist first switches from pillow talk to "here's how you transfer USDT from your walled to the yield farming platform." (The opposite, yes: "I transferred 2059 to your account for you," says one of them, adding "I don't need your check, honey, I just hope that when we meet, you treat me to a delicious dinner and send me a bouquet of roses, I will be very happy.") I do feel like that transition is the hard part? But they made it work. But: Is it securities fraud? There's a reason that this is the SEC's first romance-scam case: The SEC regulates securities offerings, and it's not at all clear that a typical pig butchering scam is a securities offering. A security is "an investment of money in a common enterprise with profits to come solely from the efforts of others," and this sort of one-to-one romance fraud is not a classic securities offering. On the other hand, they were pitching crypto investment opportunities, and the SEC is pretty adamant that those are securities offerings, and they were fake, so, sure, securities fraud, I guess. The legal analysis is sometimes funny: Investors' potential for profits depended entirely on CoinW6's ability to operate and maintain the CoinW6 Platform as well manage its purported crypto asset products. … The Defendant – not the investor – chose which crypto assets to stake, into which crypto mining pool to invest, or into which liquidity pool to invest (yield farming), and transferred the purported income to the investor from these products. The investor's sole decision was for how long they wanted their crypto assets invested in CoinW6's products. As a result, investors potential for returns were dependent CoinW6's ability to make their crypto asset products profitable.
I mean … no? They were just stealing the money? As the SEC also points out: Reasonable investors would have considered it material to their decision to invest in the Defendant's crypto asset staking, mining, and yield farming products that the products did not exist and hence were not generating any income for investors.
Also: No registration statement had been filed or was in effect for any of the securities offered and sold by the Defendant and no exemption applied.
Imagine if they had registered these sales! I would love to write that prospectus. "Our business model consists of taking your money, pretending to invest it in crypto, but actually stealing it. We obtain this opportunity by seducing you with fake names and profile pictures." It would probably still work. Get Ready to See Stock Prices in Half-Pennies. Fed Opts for Outsize Cut as Powell Seeks to Ensure Soft Landing. Big Rate Cut Forces Fed to Contend With New Obstacles. Dutch bank ING to ditch climate laggards as clients. Berlin 'very sceptical' about UniCredit move on Commerzbank. Xi Unleashes a Crisis for Millions of China's Best-Paid Workers. Tyson Foods Sued for Greenwashing. JPMorgan appoints banker to oversee juniors' 'wellbeing.' Elon Musk's X Bypasses Brazil Ban Through a Software Update. "After making his bitcoin payment Wednesday, Trump said it went quick and 'beautifully.'" If you'd like to get Money Stuff in handy email form, right in your inbox, please subscribe at this link. Or you can subscribe to Money Stuff and other great Bloomberg newsletters here. Thanks! |
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