| I love my job but I'd take a sabbatical to write this test: A group of lawmakers has proposed legislation that would allow any investor capable of passing an exam to buy private securities—an array of investments like shares in pre-IPO startups or loans to private companies that are considered riskier because they have looser disclosure rules than public securities and can be harder, and sometimes impossible, to sell in a pinch. The idea is that the ability to make these high-risk, high-reward bets should be open to all sophisticated investors, not just those with the biggest bank accounts. It is a pitch that has lots of fans on Wall Street and many smaller advisory firms, where a movement is trying to get a bigger slice of everyday investors' retirement funds and savings in private-equity funds and other nontraditional investments. "Investing your hard-earned money in startup businesses in your community shouldn't be limited to the wealthy," said Sen. Tim Scott (R., S.C.), the ranking member of the Senate Banking Committee and who proposed the bill.
Crudely speaking the rules in the US are: - Ordinary retail investors are only allowed to invest in "public" investments — stocks, mutual funds, exchange-traded funds, etc. — that are subject to strict disclosure requirements, so that the investors know what they're getting into.
- "Accredited" investors — ones who are sophisticated and able to bear risk — are allowed to invest in whatever they want, without any mandatory disclosure; the accredited investors are assumed to be able to negotiate disclosure and governance terms for themselves, to make their own decisions about how much information they need, and to bear the risk of losing money.
- The main way you get accredited is by making more than $200,000 per year ($300,000 for married couples), or having a net worth of more than $1 million.
Every part of this feels antiquated. Start with the public investments. In theory the disclosure requirements protect public investors: They can read a prospectus and financial statements before buying a public stock or ETF, so they can evaluate the investment intelligently. In practice it would be extremely weird for a retail investor ever to read a prospectus. When retail investors kept piling into irrationally priced meme stocks a few years ago, the US Securities and Exchange Commission scolded the meme-stock issuers to put language in prospectuses saying "this makes no sense," and they did, and it didn't matter. We have talked about how Bed Bath & Beyond Inc. raised hundreds of millions of dollars from retail investors, to hand over to its creditors in bankruptcy, while explicitly saying "we're gonna go bankrupt and you'll lose all your money." This did not matter at all! They bought the stock anyway! And lost all their money. This is naive; the point of public disclosure requirements is not really that retail investors are supposed to read the disclosures. The point is that public securities tend to trade in public liquid markets, and somebody reads the disclosures (hedge fund managers, etc.), and they compete to make prices rational, so public shareholders benefit from efficient markets based on public disclosure. But that is not guaranteed by the public disclosure regime, and it's not always true. There are plenty of thinly traded public penny stocks that retail investors can buy whose prices are not set by rigorous competition among multibillion-dollar hedge funds; there are also some heavily traded meme stocks like that. There are plenty of publicly listed exchange-traded funds with weird and risky payout structures that anyone can buy; some people surely do their research before buying triple-levered daily-return ETFs or single-stock zero-day options, but some people surely don't. Then there's the theory that private investors have the sophistication and leverage to negotiate for the disclosure and governance that they want, so they don't need the protections of public securities regimes. Is that true? Well, at the top end of private investors — pensions and endowments who invest in venture capital and private equity, etc. — it makes a certain amount of sense. But even there, the SEC clearly doesn't believe it, because it has proposed rules (which were shot down by a judge) to mandate more disclosure and governance terms in those investments, on the theory that those sophisticated private investors really can't protect themselves. But not every private investor is a giant pension fund with a professional staff. Some private investors are dentists investing in their free time. Can they negotiate for the disclosures they need? Then there's the fact that the accredited investor designation used to "be limited to the wealthy," but over time, with inflation, the bar has gotten lower. As of 2022, about 24.3 million US households, or 18.5% of them, qualified as accredited. Meanwhile only 21% of US households own public stocks directly. (More own stock via mutual funds or retirement plans.) The pool of people who can buy private investments is about as big as the pool of people who do buy stocks. And so if you are a retail financial adviser telling your clients what stocks and ETFs to buy, there's a pretty good chance that your client is accredited, so you can go ahead and tell her to buy shares of private credit funds or non-traded real estate investment trusts or other private stuff too. You could also advise her to buy shares of SpaceX, if you want, but you probably can't get her any SpaceX shares. (You could advise her to put her money into Citadel's hedge fund, or Renaissance Technologies' for that matter, but you probably can't get her into those funds either.) There are private investments that are, as it were, mass marketed to accredited investors, and there are others that are not. There is some reason to think that the hottest startups are not looking to raise every last dollar from dentists, while the least hot startups might be. Anyway everyone understands that this is an unsatisfying situation, so there are frequently proposals to fix it. Often these proposals seize on two problems: - Many of the biggest returns in investing come from private markets (pre-IPO startups, etc.), so it seems unfair that those are off-limits to ordinary investors.
- Limiting private investments to "accredited investors" makes it sound like those investors are smart, so it seems unfair to make it actually an income-based qualification. Shouldn't you be able to take a test to get "accredited"?
I sometimes start from the opposite perspective: - Many of the biggest losses in investing come from private markets, and it's not like anyone is offering you SpaceX stock.
- Private fund managers are not salivating over an audience of retail investors because they think they are ultra-sophisticated, and if you think of the "accredited investor" standard as signaling sophistication you will make mistakes.
I have proposed my own solution, which I call the "Certificate of Dumb Investment." The idea is that anyone can go to the SEC and ask for the certificate, which says: I want to buy a dumb investment. I understand that the person selling it will almost certainly steal all my money, and that I would almost certainly be better off just buying index funds, but I want to do this dumb thing anyway. I agree that I will never, under any circumstances, complain to anyone when this investment inevitably goes wrong. I understand that violating this agreement is a felony.
And then the SEC will slap you in the face and say "really?" and if you say "yes really" then they give you the certificate and you can buy whatever private investment you want. Obviously I am partially joking about this, but only partially. The essential point about the Certificate of Dumb Investment is that it is not aspirational. It's not that you go to the SEC and take a test and get 100% on the test and they're like "congratulations you're so smart" and you are like "I know right" and they give you the Certificate of Being a Smart Investor Who Can Buy the Good Investments Now and a little button saying "SMART INVESTOR" and you walk out of the SEC office wearing that button and you are absolutely mobbed by people selling structured notes. People selling financial products love investors who think they are sophisticated. Though I guess it depends what's on the test: The new Scott-proposed bill would let the SEC or another regulator write an examination that would test "financial sophistication," by quizzing individuals on such topics as the types of securities, disclosure requirements under securities laws, corporate governance, financial statements and the liquidity and leverage risks involved in these transactions. … A Senate aide said it shouldn't be as easy as a driver's learning permit test, but it also can't be "impossible."
Ehh, sure. My impression, though, is that when people talk about "financial sophistication" and "financial literacy," they tend to underweight some topics. One is basic financial trivia, things like "to within a factor of two, what is the current yield on the 10-year?" I once tweeted that "the basic test of financial literacy has one question: If I offer you a 20% risk-free return, am I lying?" To answer that question, you need to know that a 20% annual return is high. If I were writing the test I'd also have a section on fees. Like: "To within an order of magnitude, how much are you paying for your index fund? If your broker tells you to buy a structured note, how much do you think he gets paid for that?" Stuff like that. But the main thing I'd put on the test is a section on adverse selection. It would have questions like: - You are a dentist. Your financial adviser offers you the chance to invest in XYZ AI, a private artificial intelligence startup that he says is very hot. Is Sequoia also an investor in XYZ?
- You see an online ad for a course that will teach you to make millions trading foreign exchange markets. The course costs $250 per month. How much money can the teacher make trading foreign exchange markets?
The essential difference between public markets and private markets is that, in public markets, everyone has the same menu of investing choices. In private markets, you can only invest in the things that people offer to you. The point of the test is to understand why they are offering you the investments. If you want to call your investment fund an ESG (environmental, social and governance) fund, the rule in the US is roughly: - "ESG" can mean whatever you want, but
- You have to say what it means, and
- You then have to do what you say.
So: Can an ESG fund put 100% of its money into fossil fuel producers? Sure why not; here's one. But if you say "as part of our ESG standards, we do not invest in companies that produce any fossil fuels at all," then you can't invest in companies that produce fossil fuels. And if you say that, and invest in a wind power company that quietly operates one oil well, then you will get in trouble. The US Securities and Exchange Commission, like many investors, does not like "greenwashing," which means saying that you are ESG while not being ESG. But the SEC has no ability to make substantive determinations about whether something is or is not ESG. All it can do is look at your definition of ESG, and check to make sure you're following it. Weirdly a lot of people aren't. Yesterday the SEC fined WisdomTree Asset Management Inc. $4 million for not being as ESG as it claimed: According to the SEC's order, from March 2020 until November 2022, WisdomTree represented in prospectuses for three ESG-marketed exchange-traded funds, and to the board of trustees overseeing the funds, that the funds would not invest in companies involved in certain products or activities, including fossil fuels and tobacco. However, the SEC's order finds that the ESG-marketed funds invested in companies that were involved in fossil fuels and tobacco, including in coal mining and transportation, natural gas extraction and distribution, and retail sales of tobacco products. According to the SEC's order, WisdomTree used data from third-party vendors that did not screen out all companies involved in fossil fuel and tobacco-related activities. The SEC's order further finds that WisdomTree did not have any policies and procedures over the screening process to exclude such companies.
The SEC's order quotes the funds' prospectuses saying that "'[s]ecurities of companies involved in certain controversial products or activities,' including 'fossil fuels' and 'tobacco,' 'are excluded regardless of revenue measures.'" But WisdomTree did its screening by buying data from a vendor — "Vendor B" in the SEC order — which divided companies by industry sectors: Vendor B's data used by WisdomTree classified companies by their primary business sector. … Vendor B's delineation of industry sectors meant that multiple sectors had involvement in fossil fuels. Information concerning the Vendor B data (including the limitations of that data) was publicly available on Vendor B's website. WisdomTree only used Vendor B's "Energy Sector" data to exclude the securities of companies from the portfolios of the ESG Funds, even though other Vendor B industry-sector classifications included companies involved in fossil fuels. For example, the "Utilities Sector" included utility companies that distributed natural gas to residential and industrial customers that were not identified in Vendor B's "Energy Sector" data.
And so it got a few non-energy companies that nonetheless did fossil-fuel stuff: The WisdomTree U.S. ESG Fund held the securities of: (i) multiple utility holding companies that owned natural gas distribution utilities from March 2020 until the fund was liquidated on February 5, 2024; (ii) a utility holding company that owns a large natural gas distribution utility and also has an operating division engaged in the extraction of shale gas from June 2022 until March 2023; (iii) a steelmaker that owned a 49% stake in a company that maintained properties with oil and gas reserves from June 2021 until the fund was liquidated on February 5, 2024; and (iv) a freight railroad that hauled coal, fracking sand, petroleum coke, and crude oil from June to September 2020 and again from December 2020 to December 2021.
It had data from another vendor, Vendor A, which did classify companies by whether they had any involvement in fossil fuel activities, but it … didn't have all the data? Vendor A did not offer to subscribers like WisdomTree a single data set that encompassed or otherwise was described as "fossil fuels." Instead, Vendor A offered several data sets that addressed different aspects of fossil fuels activities that were described as: "Arctic Oil and Gas Exploration," "Thermal Coal," "Oil Sands," "Shale Energy," and "Oil and Gas." WisdomTree did not subscribe to the latter two data sets and WisdomTree's agreement with Vendor A did not include them.
Yes right there are probably definitions of ESG that are like "shale energy is ESG but arctic oil exploration, thermal coal and oil sands are not." If you ran a fund with that definition, you can subscribe to only those data sets. But WisdomTree's definition didn't say that. Similarly lots of retailers are "involved in" tobacco, in the sense that they operate big stores that sell some cigarettes among many other products. Vendor A's tobacco data set initially "would not capture a company's tobacco retail sales if those sales comprised less than 10% of such company's revenue," so WisdomTree's funds owned some stocks of companies that sold cigarettes. Again, perhaps a reasonable thing to do in an ESG fund in the abstract, but not what WisdomTree said it was doing. This is not the first greenwashing case like this. We talked about a similar case against BNY Mellon in 2022, and last month there was what I called a "Biblewashing" case, where the SEC charged a biblically responsible investment fund with not doing what it said it was doing. The SEC doesn't know what is mandated by the Bible, or by ESG principles. But it can read what you say is mandated by those principles, and check to see if you did what you said you would. Ordinarily the way you acquire a company is that you go to the owner of the company, offer to buy it, and negotiate a price. If the owner is an individual, you call up that individual to negotiate. If the owner is a private equity firm, you probably call up the managing director in charge of the investment. If the owner is itself a company — if the company you want is a subsidiary of a bigger company — then you probably call up an executive at the parent company. If the company is owned by dispersed shareholders — if, for instance, it is a public company with lots of investors — then you will negotiate the deal with its managers and board of directors. The board represents the shareholders, and is tasked with negotiating the price on their behalf. But then generally the shareholders get the final say: The board approves the sale, but then the shareholders get a vote, and if they are unhappy with the deal that the board got for them, they can vote no. This sometimes happens. If you're buying a public company, you might have to do two rounds of negotiations, one with the board and a second, less organized one with the shareholders. Last month DirecTV agreed to buy Dish Network. Dish's owner, nominally, is EchoStar Corp., a bigger company, so DirecTV sensibly negotiated the deal with EchoStar and agreed on a price. The price was approximately negative $1.568 billion: EchoStar would get $1 for Dish, and DirecTV would take over Dish's assets and liabilities minus $1.568 billion of debt. The way it would get rid of that $1.568 billion of debt was by asking the holders of Dish's $9.75 billion of bonds to accept less than 100 cents on the dollar. Now, on the one hand, that is how you have to do this: You have to go to EchoStar, the nominal owner of Dish, to get it to agree to a deal. On the other hand, if the deal that you agree on is "the bondholders will pay me to take Dish off EchoStar's hands," you have not really negotiated your deal with the owners. The actual owners of Dish, in that scenario — the residual claimants who are economically affected by the price you pay — are the bondholders. Perhaps in some sense EchoStar represented the bondholders in negotiations with DirecTV, though not really, but in any case the bondholders get their own say. So far they've said no. The Financial Times reports: According to documents seen by the Financial Times, Dish creditors have pushed DirecTV to narrow the discount from $1.6bn to about $300mn, but the bidder has refused to change its terms. Letters exchanged between DirecTV and members of the bondholder group, including BlackRock, show that the two sides are at an impasse, threatening the exchange offer less than two weeks before it expires on October 29. Holders of two-thirds of the bonds by value must agree to the exchange for the merger to close. Should the offer fail, DirecTV can terminate the deal contract by November 9. "The [bondholder] group's expectations, as reflected by the proposal, do not represent terms that DirecTV will accept and further DirecTV has no intention of restructuring terms that were negotiated at length between the parties," Ryan Preston Dahl, a Ropes & Gray lawyer representing DirecTV, said in a letter sent on Sunday to Lazard and Milbank, which are advising Dish bondholders. "Time is of the essence," he said.
Yeah I don't know about "no intention of restructuring terms that were negotiated at length between the parties." DirecTV definitely negotiated the terms of this deal at length with somebody (EchoStar), but I'm not sure it was the relevant party. It wants to buy Dish from its bondholders, so it has to make a deal — or not — with them. I wrote last week that "most cannabis companies used to be gold mining companies." That was a joke, sort of. The point is that there are a bunch of public companies in the US whose main asset is being a public company. Their business is tiny or unprofitable or failed — they owned a gold mine that had no gold in it, or a single deli — and they're not generating any value for shareholders. But they are public companies, often listed on a stock exchange, so retail investors can buy and sell their stock. Meanwhile there are other companies out there that have, maybe profitable businesses, but more often promising businesses, interesting businesses, fun business ideas that will require some money to pull off. But those companies are not public, so they have a hard time raising money from public investors, and for whatever reason they also do not raise money from venture capitalists. Nor do they have the money or name recognition to do an initial public offering. If they just were public, that would be great, but the process of going public is too daunting. And so there is a trade. The company with a public listing but no business merges with the company with a business (or business idea) but no public listing; the combined company has both the listing (so it can raise money from public investors) and the business (so it has something to pitch them). In general there is no real need for the two companies to have anything else in common, and there are broad trends in popular business ideas, so it is fairly normal for a gold mining company to become a cannabis company: The gold miner has a listing but no gold, the cannabis company has cannabis but no listing, and nobody is all that squeamish about working together. There's a lot of mild comedy in this stuff. Here is a public company called 180 Life Sciences Corp. It is listed on the Nasdaq and has a market capitalization of about $6 million. From its quarterly report filed in August: The Company is a clinical stage biotechnology company focused on the development of therapeutics for unmet medical needs in chronic pain, inflammation, fibrosis, and other inflammatory diseases. … Due to restrictions in the Company's resources, the Company has slowed down research and development activities significantly in the SCA platform and the anti-TNF platform. The Company has not made progress on the α7nAChR platform and has suspended further research and development activity in this program. The Company is currently evaluating all options to monetize its existing assets, in addition to exploring other strategic alternatives to maximize value for its stockholders.
So it's a drug company with no drugs but a public listing. Can you guess what's next? Here's a press release from last week: We are excited to announce that 180 is planning to strategically enter into the online gaming industry, utilizing its newly acquired "back-end" gaming platform, which incorporates blockchain technology and full cryptocurrency operability (the "Gaming Technology Platform"). The Company plans to use this technology platform to establish a blockchain-based business aimed at the global iGaming market. Initially focusing on B2C (business-to-consumer) online casinos, the Company also plans to expand into a B2B (business-to-business) model, offering a seamless blockchain-enabled technology platform for gaming operators worldwide. In addition, management has identified certain global iGaming industry characteristics and trends that they believe make potential acquisition opportunities attractive. Management believes that the combination of the Gaming Technology Platform and the strength of a Nasdaq listing make the Company an attractive consolidation vehicle for the iGaming industry, and plan to work to identify potential acquisitions (although no targets exist at present).
A rollup of blockchain-based online casinos. Why not. Why is a semi-defunct biotechnology company with a $6 million market capitalization the right platform to roll up that business? Well, "the strength of a Nasdaq listing" helps. I'm sure that, out of the millions of knowledge workers who sit at computers all day, there is at least one person who has blocked off half an hour, cleared her schedule, shut down all distractions, put away her phone, and sat down to watch an internal training video to fulfill her regulatory continuing education requirements. "Ooh, an interactive online course on new trends in data security, I will want to watch that with total focus and take detailed notes," this hypothetical person hypothetically said to herself. The world is large and some people have weird proclivities. Anyway here's this: EY has fired dozens of US staff for what the accounting and consulting firm called cheating on professional training courses, sparking an internal debate about business ethics and the limits of multitasking. The dismissals took place last week after an investigation found that some employees had attended more than one online training class at a time during the "EY Ignite Learning Week" in May. Several of the fired employees told the Financial Times they did not believe they were violating EY policy and were just trying to take advantage of interesting sessions that ranged from "How strong is your digital brand in the marketplace?" to "Conversing with AI, one prompt at a time". The sessions counted towards the 40 continuing professional education credits that EY required employees to complete in a year. The firm determined that watching two at a time amounted to an ethical breach. ... One consultant who was fired last Friday said there was no warning that watching multiple sessions simultaneously was not allowed. "Their emails marketing EY Ignite actually encouraged us to join as many sessions as our schedule allowed," the person told the FT. "We all work with three monitors. I was hoping to hear new ideas that I could bring to the table to separate myself from others."
I think you have to distinguish two things: - Watching two training videos at the same time shows initiative and multitasking skill, getting you twice as many new ideas that you can bring to the table to separate yourself from others.
- Billing for two training videos at the same time — in the loose sense of counting both of them toward your 40 hours of continuing education requirements — seems like an ethical red flag? (One employee told the FT: "I know a partner who will do two [client] calls and switch their camera on and off depending on who he is talking to. If this is unethical, then that is unethical, too." Yes, sure, but that's why EY is cracking down!)
But there is no practical way to separate the two — if you watched two videos at the same time, the system also gave you credit for both of them, until you got fired — and the question is just whether the employees were doing this mostly for the credit hours or mostly for the knowledge. They say, to the FT, that it was for the knowledge. EY assumes otherwise. What does that tell you about EY's opinion of its own training content? US rolls out 'open banking' rules to make sharing financial data easier. Red-Hot Bond Market Powers Wave of Risky Borrowing. HSBC Kicks Off Biggest Restructuring in Decade Under New CEO. Yellen Rebukes Chinese Lending Practices in Call for Debt Relief. "The prototype of the person you are competing with, the people in nearly all of the successful positions, have a stay-at-home partner." Marc Lasry Sues Ex-Employee for Allegedly Trying to Extort $50 Million. Former Abercrombie CEO Mike Jeffries Is Arrested in Sex-Trafficking Case. Bed Bath & Beyond Stores to Return in $25 Million Partnership With Kirkland's. Activist Urges Cheesecake Factory to Consider Breakup. Hugh Hefner's Son Offers to Buy Playboy Brand for $100 Million. Is Elon Musk's $1 Million Giveaway Legal? Ava Cado. Chaos packaging. Party barns. 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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