Crypto Offerings Slowly Grow Up
(Bloomberg View) -- The crypto.
In the beginning, people assumed that if you called something a "cryptocurrency" and did an "initial coin offering," then it was not a "security" and didn't need to be registered with the Securities and Exchange Commission. That did not last long: Lawyers soon looked at the ICOs that were getting done and realized that most of them were obviously investments of money in business ventures that legally counted as securities offerings. (Eventually the SEC caught up too.)
And so there was a second wave, of ICOs that confessed they were securities offerings, but that were offered only to accredited investors (or only outside of the U.S.) in order to avoid SEC registration. But this is awkward: If you want your cryptocurrency to be freely transferable on its own blockchain, to be usable as a medium of exchange, etc., then you don't want to limit it to accredited investors.
And so you'd expect one day for ICOs to be done as registered securities offerings, where they file registration statements with the SEC and deliver prospectuses and generally behave like public stock offerings. And that day seems to be here: "The Praetorian Group filed what appears to be the first initial coin offering (ICO) registering tokens with the SEC," reports Renaissance Capital. Here is the registration statement, and I am sorry to say that it is full of firsts. For instance, this is the first time I have seen this sort of disclaimer in a prospectus for a securities offering:
To the maximum extent permitted by the applicable laws, regulations and rules the Company and/or the Distributor shall not be liable for any indirect, special, incidental, consequential, or other losses of any kind, in tort, contract, tax or otherwise (including but not limited to loss of revenue, income or profits, and loss of use or data), arising out of or in connection with any acceptance of or reliance on this Prospectus or any part thereof by you.
Nope nope nope nope nope nope nope! That is not how a prospectus works! The way a prospectus works is, you write it, and your lawyers read it and make sure it's right, and then you deliver it to investors so that they can rely on it. That's the whole point. You don't just hand the investors some random scribblings and say "here's some stuff but definitely don't rely on it." Come on.
Meanwhile here is a story about how the U.S. Treasury's Financial Crime Enforcement Network thinks that "a developer that sells convertible virtual currency, including in the form of ICO coins or tokens, in exchange for another type of value that substitutes for currency is a money transmitter and must comply with" anti-money-laundering and anti-terrorism-financing requirements. It is not exactly clear how seriously FinCEN means that -- here is the letter setting out that position -- but if it does mean it it's rather harsh. If a public company sells stock, it doesn't become a money transmitter, but if it sells tokens, then it does.
That actually seems ... kind of wrong? Praetorian or Dentacoin or Kodakcoin or whatever aren't really currencies, and they're not running money-transmitting businesses. They're securities, and they're running, I don't know, real-estate or dentistry or photo-licensing businesses. They are just using the lingo of "coins" and "tokens" because those are popular now. And they are popular now in part because people thought they were a way to avoid SEC regulation.
But they were wrong! The SEC regulated them anyway! And now so will FinCEN. It is a fundamental problem. If you try to raise money by selling blobzooks, you might think "well, there is no agency that regulates blobzooks, so I can sell them with no regulation." But in fact the more likely outcome is that every agency will take a look at your blobzooks and decide that they fall under its purview. ICOs were a way to sell securities without calling them securities. But the SEC quickly saw through that and declared that ICO tokens were securities. But they're also money transmitters. They're probably commodities and insurance and cigarettes and nuclear waste too. They're not less regulated than stocks; they're more regulated than stocks: They didn't fit in any existing regulatory category, so they can be claimed by all of them.
Elsewhere in the crypto:
- "Coinbase Offers Index Fund Tracking Cryptocurrencies on Exchange." It will charge fees of 2 percent a year, because the basic function of cryptocurrency is to recreate every aspect of regular finance but 50 times dumber.
- "'The simplest way to fix them is to drag Wall Street behind the barn and kill it with an ax and re-create it on blockchain,' [Overstock.com Inc. CEO Patrick] Byrne said, as a screen behind him showed a bull disappearing behind a cartoon barn, then a splash of red gore."
- Venezuela's National Assembly repudiated the Petro.
- Here's a statement from the SEC reminding everyone that cryptocurrency exchanges that trade tokens that are securities are probably illegal.
- Here's a story about how "Crypto Exchanges Are Raking in Billions of Dollars."
- Here's a story about a crypto conference that fed everyone marijuana edibles without clearly warning them.
- Here's Elaine Ou on Lightning and "Batching Mental Transaction Costs."
A strange thing that has happened in modern American financial capitalism is that most gun companies are owned mostly by people who do not like guns. That is: The gun companies' biggest shareholders are mostly big index funds and quasi-indexed institutional investors, whose ultimate owners -- the people whose money the funds are managing -- have no special interest in guns, and whose managers -- the financial-industry professionals in New York and Boston and California and Philadelphia -- are probably less fond of guns than the average American. On the other hand the companies' customers are, by definition, more fond of guns than the average American.
And so after the Parkland school shooting there has been a weird dynamic. The professional managers who own most of the gun companies have been pressured by their own investors to put pressure on the gun companies to do something to reduce gun violence, and probably themselves feel that the companies should do something about gun violence. But they are professional money managers with fiduciary duties to their investors, and so they cannot quite bring themselves to say "gun violence is bad and the gun companies must do something about it." Instead they warn that gun violence might be bad for the business of the gun companies, despite a distinct lack of evidence for that proposition.
And to assuage their consciences, and their investors, they promise to sit down with the gun companies and ... you know ... talk about it? There are a lot of listening tours planned. BlackRock Inc. has "reached out to the major publicly traded civilian firearms manufacturers and retailers to engage in a discussion of their business practices." Capital Group is "engaging with gun manufacturers to understand their plans to ensure the safe use of these products." Wells Fargo & Co. -- not a gun-company owner, but the biggest lender to those companies and to the National Rifle Association -- "is reaching out to customers that legally manufacture firearms to discuss what they can do to 'promote better gun safety.'" (Vanguard Group, on the other hand, is an outlier, saying "We believe mutual funds are not optimal agents of social change.")
I kind of wonder what those meetings are like. I assume there's a line of mutual-fund managers at the door, and each one dutifully troops into the gun-company executive's office and asks "so, um, what are you going to do about gun violence?" And the gun executive says "literally nothing," perhaps while stroking a gun. And the index-fund manager shrugs helplessly and slinks out and sends in the next one. I mean, here is the response to BlackRock's inquiries from the manufacturer of the gun used in the Parkland shooting:
“We do not believe that our stockholders associate the criminal use of a firearm with the company that manufactures it,’’ American Outdoor said in its response, posted on its website. “We do believe, however, that there would be far greater reputational and financial risk to our company if we were to manufacture and market products containing features that consumers of our products do not desire, or if we were to take political positions with which consumers of our products do not agree.’’
That first sentence is plainly wrong: The fact that BlackRock and others are asking the questions pretty strongly suggests that they do associate the criminal use of guns with the gun manufacturers. But the drift of the answer is surely right: American Outdoor's commercial interests are probably best served by catering to its customers, who like guns and dislike gun restrictions, rather than to its shareholders, who are more concerned about gun violence. I suspect a lot of the shareholders know this, which is why they are expressing their concerns about gun violence in the form of listening tours rather than proxy proposals or share sales.
Elsewhere: "BlackRock Is Exploring Index Funds That Omit Gun Makers, Retailers."
Another strange thing that has happened in modern American financial capitalism is that most people finance the biggest purchases in their lives by borrowing from the government. I mean, people mostly don't borrow directly from the government to buy houses, but Fannie Mae and Freddie Mac are the giants of guaranteeing mortgage credit risk, and they are both, for most practical purposes, wholly-owned subsidiaries of the federal government. This has a lot of good points: It allows the government to make housing-finance policy directly through Fannie and Freddie, and since Fannie and Freddie are basically lucrative businesses it raises revenue for the government. It also has various bad points, one of which is that mortgage lending just seems like a weird job for the federal government. Credit provision, mortgage underwriting, capital-markets funding: These are all things that you'd expect a private financial sector to be better at, that would benefit from market discipline.
And people do mostly borrow from the federal government to finance their college educations:
The U.S. Education Department makes about 90% of student loans annually, a market that totaled $107 billion in new originations in the most recent academic year, according to the College Board.
It's weird! There are borrower-fairness and taxpayer-risk arguments against this situation, and there are direct-implementation-of-policy-through-government-subsidiary-lenders for it, but the main thing is, it's just weird. You know, there are banks, they are in the business of lending to people; why should the government displace them?
Anyway the banks are now making that argument:
The banking industry’s main lobbying group, the Consumer Bankers Association, is pressing for the government to institute caps on how much individual graduate students and parents of undergraduates can borrow from the government to cover tuition.
That could lead more families to turn to private lenders to cover portions of their bills, meaning lower interest rates for households with good credit histories and constrained funding for households with blemished records.
People will complain that this will make student loans more expensive and difficult to get, which is probably true, and that the banks are grubbily seeking to increase their profits by lobbying, which is certainly true. But it does make conceptual sense. "We are banks," say the banks to the government, "so let us do bank stuff, and stop doing it yourself for cheaper." It is not an unfair argument.
I should never take vacation.
Just ... a lot of stuff happened in the last week, you know? Here I am going to list some of that stuff that happened, though you probably already know about it, since you were here when it happened.
- Gary Cohn announced that he would resign as the head of the National Economic Council after President Trump promised to impose tariffs on steel and aluminum. The obvious problem with drafting a resignation letter when your boss praises Nazis, and sending the resignation letter when your boss praises tariffs, is that you have given people an understanding of your priorities, and also that your priorities are bad. "Gary Cohn Resigns In Protest Of Trump's Bigoted Comments Towards Aluminum" is the Onion's headline. But Cohn's departure from the White House is obviously making a lot of people nervous, since he knows things about markets, and no one else there seems to. If you are a lot braver than I am you can read this article titled "Here Are the Names Circulating to Replace Gary Cohn."
- Spotify Technology SA filed the registration statement for the initial public offering that it is not doing? Ha, no, I kid: Spotify's private shareholders might sell stock, and those sales have to be registered, so they are being registered. And since those sales will be Spotify's first public sales of stock, the registration statement looks a little like an IPO registration statement, though the sales do not otherwise look especially IPO-like. The point is that if you are going to do an IPO that is not an IPO you still have to file for an IPO. It is a little confusing.
- Bill Ackman threw in the towel on his Herbalife short. The stock is up since then, which is I guess a teeny consolation?
- The Fyre Festival guy pleaded guilty to fraud, which, duh, but his plea agreement included "non-binding guidelines that would yield a sentence of eight to 10 years," which seems high. I said that about Martin Shkreli's potentially decade-long sentence too. The right sentence for Shkreli, and for the Fyre Festival guy, and for most sort of normal-sized frauds, is about two years. Two years is fine. More if you're Madoff or whatever. But 10 years for the Fyre Festival guy, or for Shkreli, seems extreme.
- Speaking of Martin Shkreli: We talked a while back about Andrew Verstein's article on "insider tainting," the idea that a public company that doesn't want an investor to sell stock can call up the investor, lob material nonpublic information at him, and then tell him that he's locked up from trading. Verstein emailed me to point out that Shkreli was actually caught doing some insider tainting. Specifically he sent an email to some investors in his public company with the subject line "OVER THE WALL: Retrophin Marketing PIPE." Once you get an email saying -- in the subject line, so you can't miss it! -- that a public company is marketing a PIPE ("private investment in public equity") and that you are "over the wall" on it, you might be a bit hesitant to sell. (I think you'd be within your rights to sell, actually, but you'd get a lot of awkward questions.) And the judge in the case found that the intent of the email was to prevent people from selling the stock: "After Mr. Shkreli became concerned that Mr. Pierotti was selling the Fearnow shares," she wrote last week, "he began to take actions intended to prevent Mr. Pierotti and the other Fearnow shareholders from trading, including sending the Fearnow shareholders the 'over the wall' email to restrict their ability to trade or sell their Fearnow shares." This is not exactly the crime he was convicted of, but it is evidence that he conspired to control shares that he disclaimed control over, so let's just say that he will go to prison in part for insider tainting.
- In other Martin Shkreli news, he will apparently have to forfeit that Wu-Tang Clan album, which I look forward to the U.S. Marshals auctioning off.
- I spent some time four years ago making fun of U.S. banking regulators' efforts to impose a leverage cap (of six times earnings before interest, taxes, depreciation and amortization) on banks' leveraged lending. It was funny because the banks just ... sort of ... kept saying no? It is not how regulation normally works. But last week Federal Reserve Chairman Jerome Powell told Congress about the leverage cap that "we do accept and understand that’s non-binding guidance," and that "we’re in discussions and thinking about other ways we can underscore that." Normally if you put out non-binding guidance it is because you want people to follow it, and you think about ways to underscore your guidance. But now the Fed is thinking about ways to underscore that it is just non-binding guidance. The point is that the banks ignored the regulation -- sorry, guidance -- long enough that it went away.
- Elsewhere, Congress is probably going to roll back some Dodd-Frank rules for medium-sized banks.
- United Airlines launched and then un-launched a program where, instead of paying everyone small bonuses, it would run a lottery and give most employees no bonus and some bigger bonuses. United also cut the overall size of the bonus pool, so people objected, but I guess they would have objected anyway to the randomness. But now I kind of want to see someone give it a shot in the financial industry? Like instead of giving everyone bonuses equal to their base salary, you give most people no bonus and give 10 percent of the people a bonus of 10x their salaries. And then everyone quits: The 10 percent call in rich, and the 90 percent are all disgruntled and leave for more predictable bonuses. I guess it is an obviously terrible idea but it seems like it would be fun to observe from a safe distance.
- Carl Icahn, who previously traded renewable-fuel credits while working to revise the federal policy about those credits, sold stock in a crane manufacturer "just days before Trump announced plans to impose steep tariffs on steel imports." Icahn denies that he had any advance notice of the tariffs. The problem with (1) hanging around the Trump administration a lot and (2) trading in industries affected by Trump administration policies a lot is that people are going to connect the dots even if everything is totally innocent. This is why you usually try to avoid even the appearance of a conflict of interest.
- Peyton Manning "sold his stake in 31 Denver-area Papa John’s locations two days before the NFL and the pizza chain ended their sponsorship agreement late last month," and people tweeted at me like "isn't that insider trading?" First of all, I have no earthly idea why Peyton Manning would be privy to inside information about NFL sponsorship agreements. If he did have advance notice of the changes, though, I still think it would be a bit silly to analyze it as insider trading. This was a negotiated sale of a stake in a business, presumably with a sale agreement, representations and warranties, etc. The question is roughly, did the buyer ask about the sponsorship stuff, and did Manning make any misrepresentations? Most of the time when you sell something -- certainly when you sell a business that you own -- you know more about the thing than the buyer does, and that is expected, and the buyer's protections tend to involve representations and warranties and due diligence, not insider-trading-type notions of a level playing field. Securities law is the outlier in this respect, not the norm.
- Cliff Asness and Aaron Brown released a paper on pulling the goalie in hockey, and its implications for investing. The simplest implication may be that pulling the goalie is always a negative-expectation move in terms of goals (if you pull your goalie then the other team's chances of scoring go up more than yours do), but can be positive in terms of wins (if you pull your goalie when down by a goal you increase your chances both of tying, which is good, and of losing by two, which is no worse than losing by one). Adding variance in the number of goals -- even with negative expectation for goals -- can improve your expectations for wins (or ties). Distressed-debt investors and options traders, of course, already knew that. "The most basic lesson," write Asness and Brown, "is to make sure you are thinking about the right risk."
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Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
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