| The thing about most traditional financial frauds is that they have to end. You get money from investors, you spend it on watches and gambling, you tell the investors their money is safe and earning 10% returns each month, you keep going for a while, eventually the investors ask for all that money back and you don't have it. There are delaying mechanisms — you can do a Ponzi and get new investors to pay off the old ones — but eventually you will run out of time. The problem is that you have promised your investors money, and it is hard to make money, and money is a thing that they actually want and can eventually take delivery of. "The $10,000 you gave me turned into $30,000" is a nice thing for you to say to your investors, and a nice thing for them to hear, but eventually they will want to buy a car and will expect you to actually send them the $30,000. If instead you send them another email saying "now it's $50,000!" that might tide them over for a time, but not forever. A piece of paper saying "you have $50,000 in your account" is not a permanent perfect substitute for $50,000. It would be more soothing to run a fraud where you promise investors something other than money, something that they want (and are willing to pay for) but that they do not ever expect to take delivery of. This thing is called "carbon credits." I mean! The idea is that there are a lot of people who will pay you money for removing a ton of carbon from the atmosphere (or preventing it from going into the atmosphere, etc.). They do not want you to show up with the ton of carbon on a truck. They don't want the carbon. They want it not to be in the atmosphere. In theory, some of them want this because they are concerned about climate change; many others want it because they have stakeholders who are concerned about climate change, and they want to be able to say things like "we are carbon neutral because we remove a ton of carbon for every ton we emit." For these people, a piece of paper saying "I have removed one ton of carbon from the atmosphere for you" is arguably not quite a permanent perfect substitute for actually removing the ton of carbon, but (1) arguably it is though? and (2) how will they check? At no point, ever, will they call you up and ask you to deliver the carbon. You can just keep doing this forever. No, no, I'm sorry, everyone understands this problem, so there is a huge apparatus — of regulation and voluntary carbon credit registries and auditing companies and legal enforcement — set up to address it, to make sure that a piece of paper saying "I have removed one ton of carbon for you" actually represents the removal of one ton of carbon. With reasonably high likelihood. "One ton of carbon removal" is not quite the same sort of thing as "$50,000"; $50,000 is a determinate amount of money that is different from $49,999 or $50,001, while one ton of carbon removal will generally be calculated probabilistically based on some estimate of the efficiency of your process (how much carbon do your trees remove?) and your baseline (how many trees would there be if you didn't do your project?). And if you just go around handing out pieces of paper saying "I removed a ton of carbon," without registering those credits with a registry or going through a rigorous auditing process or otherwise showing your work, nobody will pay much for them. Still there are temptations: Two former executives of carbon-credit project developer CQC Impact Investors have been charged with manipulating data to fraudulently obtain carbon credits for a project CQC ran and for using that data to deceive a backer into investing more than $100 million in the firm. Kenneth Newcombe, the former chief executive of CQC, and Tridip Goswami, the former head of its carbon and sustainability accounting team, used falsified data to get an issuer of voluntary carbon credits to verify reductions in emissions that hadn't been achieved, according to the U.S. attorney for the Southern District of New York, who announced the charges Wednesday. The alleged scheme ran from at least 2021 through 2023, prosecutors said. Former Chief Operating Officer Jason Steele pleaded guilty to his role in the scheme and is now cooperating with the government, according to the Justice Department.
Here is the Justice Department's announcement, and here are parallel civil cases from the US Securities and Exchange Commission (for securities fraud, because CQC raised money from investors by selling shares) and the Commodity Futures Trading Commission (for commodities fraud, because "the absence of carbon" is a commodity). The CFTC points out that this is the first carbon-credit fraud case; it seems vanishingly unlikely that it will be the last. The gist of the case is that CQC is not, primarily, in the business of selling fake carbon credits: It really wanted to reduce carbon. The way it planned to do that "involved installing cookstoves in rural Africa and Southeast Asia," which, "if installed and used properly, were more efficient than the preexisting cooking methods many people in those regions used." And then you have some sort of formula that is, like, number of stoves installed times how much people actually use them times how efficient they are at reducing carbon gives you some number of tons of carbon emissions avoided, and you bring that number to a registry that issues carbon credits, and the registry gives you the credits and you sell them to people who want carbon credits. And if you actually bother to get the stoves and bring them to rural Africa and install them in people's homes, and then it turns out that they're not reducing carbon emissions, then that is a bummer for you. Just like anyone else who took investor money to do a business that didn't quite work, you might be tempted to fudge the data: For example, in or about August 2021, CQC received survey data for two projects in Malawi and two in Zambia. GOSWAMI reported to NEWCOMBE and Steele that the survey data reflected emission reductions that were only approximately half of what CQC had anticipated. NEWCOMBE responded by writing that "[t]his is a disaster for us." NEWCOMBE, GOSWAMI, and Steele exchanged emails about possible solutions, and GOSWAMI ultimately informed them that the "[o]nly option left" was "to 'revise' the survey results." Ultimately, NEWCOMBE, GOSWAMI, and Steele agreed to manipulate the survey data for the Malawi and Zambia projects and enlist a person from outside CQC to fill out fraudulent survey forms to reflect the manipulated numbers. CQC sent the manipulated survey data to Issuer-1 when claiming VCUs for the Malawi and Zambia Projects.
And: Rather than writing off and not claiming credits for stoves that were missing, broken, or not installed in correct locations, NEWCOMBE, GOSWAMI, and Steele conspired to conceal from Issuer-1 the true extent of problems with CQC's Cookstove Projects. One way in which the members of the conspiracy concealed these issues and manipulated survey data about the number of stoves in use was by instituting a practice of having CQC employees rebuild or fix stoves in samples that were missing or broken, then reporting those stoves as operational.
That is: You get some carbon removal value from each stove that is operational. The way you find out which stoves are operational is that you periodically go out and check people's houses to see if their stoves are working. If their stoves are working you check "yes." If their stoves are not working, you fix them, and then you check "yes." Did this remove any carbon? Ehh not during the survey period (the stove was broken). But you are not exactly in the business of removing carbon; you are in the business of telling people that you are removing carbon. No no no no no, you are in the business of accurately telling people (with reasonably high likelihood) that you are removing carbon. How was this fraud discovered? It's not like the buyers of carbon credits have any incentive to investigate and report the fraud: In the first instance they want, not actual carbon removal, but broadly accepted carbon credits, and going around saying "actually the carbon credits we bought are fake" doesn't help them. I suppose the registry has some incentive to investigate, so it can stand behind its credits. But the actual answer seems to be that, while CQC's CEO was allegedly cool with selling fake credits, its other employees and its board of directors were not: In mid-2023, several C-Quest [i.e. CQC] employees raised concerns about data discrepancies in the cookstoves projects and those discrepancies were reported to C-Quest's Board of Directors in December 2023, upon which time C-Quest commenced an internal investigation. As a result of its internal investigation, C-Quest has determined that approximately six million VCUs [verified carbon units] related to its cookstoves projects should be cancelled.
If you run a genuine carbon removal company, you will probably employ a lot of idealists, and if it unluckily turns out you're not actually removing as much carbon as you say you are, they will complain. I suppose if you run a company staffed only with ESG Consultants But Evil you will get a different result. Let's say you're a venture capital firm and you have a thesis on crypto. Your thesis is: (1) Crypto is for real, it is here to stay, and crypto asset prices will go up in the medium term, but (2) crypto is incredibly volatile and there will surely be a 50% drawdown in the next few years. How should you implement this thesis? Let me give you a terrible idea: - You find a crypto exchange whose executives are stealing its customers' money.
- You invest in that exchange — not by buying crypto as a customer (they're stealing the customers' money!), but by buying preferred stock as a venture capital investor.
- Crypto prices fall by 50%, there's a run on the exchange, the money isn't there (due to stealing) and the exchange goes bankrupt.
- The bankruptcy takes a year or two to resolve, but the bankruptcy estate is able to find most of the money that the executives stole.
- During the year or two of bankruptcy, though, crypto prices fully recover.
- When the bankruptcy is over, you get half of the customers' money.
Don't do this trade! There are many reasons you can't do this trade, it won't work, stop. But it is based on two more or less real facts about bankruptcy: - An emerging fairly standard treatment of crypto assets in US bankruptcies — not universal, not free from doubt, but pretty widely accepted — is that crypto claims are reduced to dollars as of the date of bankruptcy. So when your crypto exchange filed for bankruptcy, crypto prices were down 50%, and the customers all got claims denominated in dollars for half of the peak value of their accounts. But then of course crypto prices recovered and the bankruptcy estate actually recovered something closer to 100% of the peak value.
- In bankruptcy, if there's money left over after all the claims of customers and creditors are paid off, it goes to the equity owners, which in this case means you. Also presumably the founders, but you get paid ahead of them because (1) as a venture capitalist, you bought preferred equity that puts you ahead of the founders' common equity and (2) they were stealing the money, nobody is going to let them recover anything, come on. So if the exchange ends up with 100% of the money, but only needs to use 50% to pay customers in full, I guess you get the rest?
Again this is stupid, stupid, stupid, it could never work, there are so many risks that could make it go wrong, but I do have to say: Cryptocurrency firm FTX won court approval to fully repay customers whose digital assets were locked on the platform when it imploded nearly two years ago, an unusual result that could net shareholders in Sam Bankman-Fried's fraud-tainted exchange a slice of $1 billion in seized assets. US Bankruptcy Judge John Dorsey said Monday he'd approve payments to FTX customers harmed by Bankman-Fried under a sweeping proposal formulated by advisers who took charge of the exchange after it collapsed. In November 2022, crypto prices were so low and FTX was in such chaos that advisers initially concluded creditors would recover only a portion of what they were owed. "Certainly we benefitted from the bull crypto markets of the last year," creditor attorney Ken Pasquale told the judge overseeing the insolvency case. The company was able to take advantage of that run up by cutting deals with creditors, government regulators and others, Pasquale said. … The turnaround has been so significant that FTX preferred shareholders could also get some money back. Shareholder payments would come from a portion of the funds seized by the federal government, proceeds that include roughly $626 million generated from the sale of Robinhood Inc. stock previously owned by Bankman-Fried and FTX co-founder Gary Wang. Such payments are rare in Chapter 11, where stockholders are usually wiped-out. … Still, some FTX customers have criticized the plan because unlike other bankrupt platforms repayments are being made in cash instead of crypto, meaning they'll miss out on the full appreciation of digital assets since the firm collapsed.
We talked about FTX's plan in May, when creditors were expected to receive between 118 and 142 cents on the dollar on their claims — but their claims were in dollars, while crypto prices were up something like 200% (for Bitcoin) or 900% (for Solana), so the creditors were actually facing huge losses. I wrote: Where would this money go, if not to [the customers]? The obvious answer is "if there's money left over after paying all the claims in bankruptcy, it goes to the shareholders," but it would be kind of a bad look, after all this, for FTX's shareholders to get any money back. (The biggest shareholder is probably still Bankman-Fried.) Here, though, that is not a problem: In addition to the customer claims, there are billions and billions of dollars of somewhat hazy claims for taxes and fines from the US Internal Revenue Service and Commodity Futures Trading Commission. They are effectively the residual claimants here: If there's money left over after paying back the customers, the US government is going to find a way to get it.
Well, nope! The shareholders might really get paid, though not Bankman-Fried. Probably not that much — probably nowhere close to the $2 billion that FTX actually raised from VCs — but something. The customers won't get all of their money back, but the shareholders will get something. Good for them I guess. I wrote once that the best way to play the crypto bubble was to "take out absolutely bajillions of dollars of non-recourse loans to buy as much crypto as you can, selling enough along the way — and putting the proceeds somewhere your creditors can't get them — to make yourself dynastically wealthy." This trade is not so different from that one. We talked yesterday about two different aspects of exchange-traded funds: - Some bond ETFs are, essentially, in the business of providing a diversified place for institutional investors to stash portfolios of bonds. The idea is that a lot of investors will hold some particular assortment of 100 specific bonds, bonds that can be described in aggregate in some general terms (their average duration, their beta to the broad bond market, their sector exposures, etc.), but that are different — different CUSIPs, different specific issues — from some other portfolio of 100 bonds with similar aggregate characteristics. If you have those 100 bonds and want to sell them, you might not find someone who wants to buy them. In the olden days, you'd call a bank, and the bank would buy them and hold them on its balance sheet for a while, but banks' risk appetites and balance sheets are more constrained now than they used to be. Now, you call Jane Street Group, and it buys the bonds from you, and then it dumps them into an ETF. The ETF — funded in large part by retail investors — has the balance sheet to hold the bonds, and it isn't that picky. It is in the business of offering retail investors broadly diversified, index-ish exposure to the bond market; it wants some set of broad characteristics for its overall portfolio but doesn't care all that much about each individual bond. So if Jane Street comes to an ETF issuer with a portfolio of 100 bonds, the issuer might say "sure give us all of them." I wrote: "Each bond is just a set of factor exposures, you manage your portfolio to some target set of exposures, and the actual bonds involved are interchangeable and unimportant. The bonds are inputs into an equation rather than unique snowflakes."
- Some ETFs, on the other hand, are in the business of selling derivatives trades to retail investors. I wrote: "One way to think about (some) exchange-traded funds is that they are direct-to-consumer structured notes." If you are a private wealth client of a bank, your financial adviser might pitch you on some weird derivatives trade packaged into a structured note issued by the bank — perhaps because you like a gamble, or perhaps because you prefer safety; there's a weird derivatives trade for everyone. But if you're a self-directed retail investor with an online brokerage account, you might have a harder time finding those weird derivatives trades. And it turns out that a lot of self-directed retail investors with online brokerage accounts really do have a taste for derivatives trades, for buy-write strategies and collars and tripled-levered stocks. And so ETF issuers package them for them and sell them to anyone who wants to buy them. "The minute I launch a product, every trader at home can buy it," one of them told Bloomberg. "It's like a sneaker, it's like a potato chip."
You can generalize those two points. The generalization of the first point is something like this: There is some value in an ETF whose investment strategy is something like "we invest in a diversified portfolio with low fees, but we are not that picky about exactly which portfolio." An S&P 500 index fund that contains exactly the stocks in the S&P 500 index, in exactly the same weights as the index, will perfectly track the S&P 500, which is nice. An S&P 500-ish index-ish fund that contains 493 stocks in the S&P 500 index, plus 14 other stocks, in roughly the same weights as the index, will track the index very closely, and be good enough for most people's purposes. And sometimes it might be easier for an ETF to acquire a pile of stocks that are pretty close to the index than it would be to acquire exactly the stocks in the index. The generalization of the second point is something like this: If there is a product that financial advisers sell to high-net-worth retail investors for high fees, it's worth trying to package it into an ETF at, probably, somewhat lower fees. Bloomberg's Justina Lee and Vildana Hajric report on the synthesis of these points: The Cambria Tax Aware ETF (ticker TAX) and the Stance Sustainable Beta ETF (STSB) will each be seeded with the appreciated securities of wealthy investors, who will swap their assets for shares in the funds rather than buy into them with cash. That's a way of disposing of holdings without actually selling, which would realize a taxable gain. … "You'll contribute your portfolio from Schwab, Fidelity, wherever it is," said Meb Faber, co-founder and chief investment officer of Cambria Investment Management, the quant firm advising TAX. "Let's say you've got $1 million in all these stocks, and then the next day you'll have TAX ETF — and it's not a taxable event." The products resemble so-called "swap funds" or "exchange funds," which also combine the holdings of investors in return for shares in a pooled portfolio. Those have traditionally been arranged by banks for the super rich, but have become more common after the now 15-year-long stock rally minted a new class of millionaires, especially in the tech sector. "It's democratizing the idea of the exchange fund for the masses," said Wes Gray, strategic advisor to ETF Architect, which provides the infrastructure for both TAX and STSB. "We're going to do it transparent, low-cost, efficient. Not an opaque, overpriced structured product only for rich people."
"These products resemble ________, which have traditionally been arranged by banks for the super rich," and "it's democratizing the idea of ________ for the masses" are good starting points for brainstorming new ETF ideas. We have talked about swap funds before. The basic idea is that if you have some portfolio of a handful of stocks, you will not feel very diversified, and you might want to diversify. The natural way to diversify is to sell all your stocks and buy an index fund, but if you do that then you'll pay taxes on the sales (if you have gains). The sophisticated way to diversify is to get together with 20 of your friends who each own a portfolio of a handful of stocks, but different stocks, and form a partnership. You contribute your stocks to the partnership in exchange for an ownership share in the partnership, which is not a taxable transaction. And the partnership — which has everyone's stock — is more diversified than anyone's individual portfolio was. One thing that is happening here is democratizing swap funds for the masses. (Well, the masses of people with large appreciated somewhat concentrated stock portfolios: "Gray reckons a typical beneficiary will have at least $500,000 in securities." Also the portfolios can't be too concentrated: This has to be roughly a normal retail stock portfolio, not your huge chunk of shares in your employer.) But another thing that is happening here is sort of good enough diversification. If you get a bunch of people to contribute their stock portfolios to the swap ETF, then the overall portfolio of the ETF will not look exactly like the S&P 500 index or whatever, but it will be a broadly diversified portfolio that will probably give everyone something roughly like the broad market return. The traditional pitch of an index ETF is "we will give you a tradeable share that tracks the broad market return without the expense of active management"; the pitch of this is "we will give you a tradeable share that roughly tracks the broad market return without the expense of active management plus you avoid some taxes." At Sherwood, Tim Fernholz has a cool story about a $7 billion payment that the US Treasury got last year under the line item for estate and gift tax payments. The natural assumption here is that the estate of some recently deceased billionaire paid the tax. But that's weird, because (1) it's by far the biggest estate-tax payment in US history and (2) "these days, paying the estate tax is almost optional": Anyone rich enough to pay a $7 billion estate tax is sophisticated enough to structure their affairs to avoid it. But Fernholz concludes that it was probably an estate-tax payment, it was probably made by the estate of investor Fayez Sarofim, and he probably just didn't care enough to do the tax structuring and trusts to avoid it: [Estate planning attorney Martin] Behn's clients typically want to maximize the money they leave for their children or establish a philanthropic legacy; some seek to do both. But there's a third group. "They say, 'I don't care, we'll pay taxes. Why is the federal government any worse than the charity down the street?'"
It's kind of cool? Like you could imagine a hierarchy, in roughly ascending order of wealth: - Too poor to pay taxes.
- Rich enough to pay taxes.
- Rich enough to not pay taxes.
- Rich enough to not even bother with not paying taxes.
It never occurred to me that the fourth category could even exist. ("'It feels a little un-American,' Behn said. 'Usually European clients have that kind of mentality.'") Though there is another possibility: Some tax attorneys I spoke with theorized that the $7 billion payment was in fact a gift tax paid as part of an estate-planning strategy designed to avoid an even larger payment down the road, a strategy they expect to be common ahead of the Trump tax expiration.
I wrote yesterday about a Costco credit-card-rewards gold-bar-arbitrage trade. Not so much because I had anything interesting to say about it, just because it seemed like the sort of thing about which my readers would have something interesting to say. I wrote: "I'm putting this here only because I fully expect someone to email me to either say 'yes my fund does this' or else 'we looked into this and we found the operational problem was ________.'" The good news is that quite a few of you emailed me to say "we looked into this and we found the operational problem was ________." The bad news is that the answer is boring: Costco limits how much gold you can buy, so you can't do this trade in institutional size. You can do it in retail size and make a few hundred bucks, except that you probably can't really sell gold at the spot price in retail size. So never mind. Roblox Tumbles as Hindenburg Bets Against Gaming Platform. SEC Enforcement Director Who Pushed for Big Fines Steps Down. Former Pfizer chief pitches board on Starboard Value's shake-up plan. ECB's Private Credit Probe Finds Banks Don't See Full Exposures. Ares bolsters real estate business with $5.2bn takeover. Chevron to Sell Oil Sands, Shale Assets for $6.5 Billion to Canadian Natural. AI Startup for Personal Injury Law Valued at Over $1 Billion. Russia Pays Criminals to Sow 'Mayhem' In Europe, Warns U.K. Spy Chief. 'Godfather of AI' Geoffrey Hinton Among Nobel Prize Winners. The Price of a Mega Millions Ticket Will More Than Double to $5. Are these the sellside's best-ever puns? 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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