Everything is securities fraudIt is illegal to sell illegal drugs. (Obviously.) It is illegal to operate an online marketplace for illegal drugs; ask the Silk Road guy. But "online marketplace for illegal drugs" is a vague and general description; really any internet service that allows users to create their own content could be used as an online marketplace for illegal drugs. You could try to offer drugs for sale on eBay or Etsy or Twitter or LinkedIn or WeChat or Discord or Slack or Zoom or Goodreads or Google Hangouts or, and let me be clear that I do not condone this, the comments section of Money Stuff. Type in the box "I've got some kind bud for sale," someone types in the box below it "I want some," you type "okay where are you," they type their address, you go meet them with the drugs, boom, online marketplace for illegal drugs. There are so many places on the internet where you can type in a box. Facebook is a big one. If you're selling something and want to reach the broadest possible audience (not necessarily a great idea for drug dealers!), Facebook is where everyone is, so you might post your ad for illegal drugs there. Or on Instagram, also operated by Facebook Inc., where you can post a nice picture of the drugs. It is, however, mostly not illegal to operate Etsy or Twitter or the Money Stuff comments or Facebook, even if sometimes people post ads for illegal drugs there. The U.S. has a broad and sensible policy of not holding general internet platforms legally responsible for the stuff that users post on them, so if you are not trying to run a drug market, and if you do a reasonable job of taking down any drug content that anyone points out to you, you are probably fine. (Not legal advice!) Not everyone is happy about this. You might say: Yes, it is legal for Facebook to host the occasional illegal drug sale, but I want it to be illegal. What can you do? What recourse is there for you, if something is legal but you think it should be illegal? Well I don't know you could call your congressperson or whatever, but here in America in 2020, or at least here at Money Stuff, we have a more efficient, weirder answer. You could sue for securities fraud. Facebook Inc. is a public company, and as I often say, anything bad that a public company does is also securities fraud. Sometimes this means that if a company does something illegal, that illegal thing is also securities fraud: Regulators fine the company for the illegal thing, and shareholders sue it for getting fined. But often it means that if a company does something that you wish was illegal, you can sue it for securities fraud. Fossil fuel companies contribute to climate change by drilling for oil; climate change is bad; drilling for oil is legal; what can you do? You can sue them for securities fraud. Other bad things are ambiguously legal, or illegal but hard to prove; suing for securities fraud can get around complicated questions of law and fact. The point is that if the company is doing something that seems bad, that exposes it to a theoretical risk of legal liability or bad publicity or future regulation or whatever, shareholders can sue, saying "you're doing the bad thing without properly warning us about the risks of liability." So here you go: A consortium of Facebook insiders and critics filed a confidential whistleblower's complaint to the Securities and Exchange Commission late Tuesday, claiming the social media giant is aware of illegal activity on its platform, such as the sale of opioids, and has failed to properly police it. The complaint, which was obtained by The Washington Post, includes dozens of pages of screenshots of opioids and other drugs for sale on Facebook and its photo-sharing site Instagram, with some having seemingly obvious tags such as "#buydrugsonline." It also notes that Facebook has a pattern of taking down content when it is pointed out by media or activists, only to have it reappear later. The filing is part of a campaign by the National Whistleblower Center to hold Facebook accountable for unchecked criminal activity on its properties. By petitioning the SEC, the consortium is attempting to get around a bedrock law — Section 230 of the Communications Decency Act — that exempts Internet companies from liability for the user-generated content on their platform. Instead, the complaint focuses on federal securities law, arguing that Facebook's failure to tell shareholders about the extent of illegal activity on its platform is a violation of its fiduciary duty. If Facebook alienates advertisers and has to shoulder the true cost of scrubbing criminals from its social networks, it could affect investors in the company, the complaint argues.
I do not, ever, want to participate in a debate about whether drug dealing is a "victimless crime," but I do want to say that the victims of drug dealing are obviously not Facebook shareholders. Like so many "everything is securities fraud" cases, this is not about securities fraud, and the people involved do not care about the Facebook shareholders who are supposedly the victims here. You can tell, in part, from the fact that this is a whistle-blower complaint rather than a lawsuit: Facebook shareholders haven't lost money due to its alleged drug dealing, its stock hit an all-time high last week, Facebook's shareholders are fine. The whistle-blowers here want the SEC to fine Facebook (that is, take money from its shareholders and give some of it to the whistle-blowers), and impose new costs and obligations on it to shut down the drug dealing. The timing of this is fortuitous because, as these people are pestering the SEC to shut down Facebook, Donald Trump is pretending he is going to shut down Twitter Inc. for pointing out that he sometimes lies on Twitter. There is a draft executive order floating around that would limit social media companies' protections under Section 230, making it easier to punish them for the speech or actions of their users—exactly what the "whistle-blowers" here want for drugs on Facebook. You don't need the SEC to regulate Facebook indirectly as securities fraud, if you can make the Federal Communications Commission regulate Facebook's platform directly. The point that I often make, when I say "everything is securities fraud," is that there is a tendency in America to use securities laws as a way around the democratic process, as a way to regulate non-financial conduct without actually going to the trouble of getting laws or rules passed. But I also want to say that, right now, the democratic process is soul-destroyingly terrible, a pure cynical exercise in partisan power without the slightest pretense of working for the public good. If you asked me, in the abstract, "should social media companies' liability for illegal activity be regulated by congressional legislation balancing the legitimate interests of everyone in society, or by the SEC looking out for the companies' shareholders," I would choose legislation. But if you asked, "should social media companies' liability for online activity be regulated by the SEC looking out for the companies' shareholders, or by Donald Trump's sense of grievance at being fact-checked and his desire to boost his own re-election chances"—the actually relevant question!—I would choose the SEC. "Everything is securities fraud" is not a comment on the imperial ambitions of the SEC, and it's only sometimes a comment on the opportunism of private securities lawyers. Really it's a comment on the brokenness of the rest of American government. Everything is securities fraud because at least securities law more or less works. At least the SEC is looking out for someone other than itself. Well, not everything is securities fraudOne bad thing that can happen to a company is bankruptcy. Is bankruptcy therefore securities fraud? Sure, says the theory, why not. If a company goes bankrupt and you owned its stock, it probably didn't tell you "hey we're gonna go bankrupt soon" before you bought it, so that's a failure of disclosure and you can go ahead and sue it for securities fraud. But there is a practical problem: The company is bankrupt, so it doesn't have any money, so suing it for securities fraud is kind of pointless. Sometimes there is a solution to this practical problem. If the company recently issued stock or bonds, if it did a securities offering in the few months before filing for bankruptcy, then the investment banks that underwrote the offering will be on the hook for any misstatements in the offering documents. They still have money; you could sue them. (You won't necessarily win—underwriters are careful, and the offering documents probably do say something like "hey we might go bankrupt"—but you can sue.) But what if, instead of stocks or bonds, you recently bought loans? A famous little puzzle in securities law is that loans are not securities. In the olden days this made sense: A security was something offered to the public and traded in the market; anyone could buy or sell securities, and they relied on the company's public disclosures in making their investing decisions. A loan was a contract bilaterally negotiated with a bank; the bank had a long, deep relationship with the company, held the loan to maturity, and monitored it closely. Banks were just not the sort of investors that securities law was supposed to protect. But now loans, especially syndicated loans to high-yield companies, feel a lot like securities. They are sold to hundreds of investors, hedge funds and institutions rather than just banks, who will not necessarily have any close relationship to the company. They trade freely in the secondary market. The same people who trade high-yield bonds will often trade leveraged loans, and it is weird to think that one is a security and one isn't. Particularly, if you buy a bond from a company that then goes bankrupt, you will sue the underwriter for not telling you about whatever caused the bankruptcy. If you buy a loan from a company that then goes bankrupt, you will also want to sue the underwriter. Can you? Well, you can sue, but it won't go very well. Here's a memo from Cleary Gottlieb Steen & Hamilton LLP (citation omitted): Under the current regulatory regime, loans are not treated as securities. In Kirschner v. J.P. Morgan Chase, et al., the plaintiff challenged these well-settled expectations by trying to bring state securities law claims based on the syndication of a rated term-loan facility. However, on May 22, 2020, the Southern District of New York rejected these claims and reaffirmed the widely held understanding that syndicated loans are not securities. Relying heavily on the Second Circuit's 1992 decision in Banco Español de Crédito v. Security Pacific Nat'l Bank, which held that similar "loan participations" were not securities, the Court held that syndicated loans are just that—loans and not securities. ... The dispute in Kirschner arose out of a $1.775 billion syndicated loan transaction that closed on April 16, 2014. In that transaction, several banks assigned portions of a term loan made to Millennium Laboratories LLC ("Millennium") to about 70 institutional investor groups, including approximately 400 mutual funds, hedge funds and other institutions, evidenced by notes (the "Notes"). After Millennium filed for bankruptcy in November 2015, the investors' claims were contributed to the Millennium Lender Claim Trust ("Plaintiff"), which filed a complaint in August 2017 against the arranging banks asserting claims under several state securities laws and the common law. The complaint alleged that Millennium, a California-based private company that provided laboratory-based diagnostic testing of urine samples for physicians, violated various federal laws prior to the loan transaction. … On this basis, the complaint alleged that the defendant banks ("Defendants") involved in the loan made misstatements and omissions actionable under state securities laws because the offering materials failed to disclose Millennium's underlying wrongdoing.
If this was a bond offering, those arguments might have worked, but it was a loan syndication, so they didn't: The judge dismissed the case, finding that the loans were not securities. The reasoning here is pretty much just that nobody thinks loans are securities, so they aren't securities; the actual distinction between loans and bonds seems pretty thin.[1] But "nobody thinks loans are securities, so they aren't securities" is actually a pretty good way to do market regulation. Everyone here is a big sophisticated investor, and the goal of regulation should really be just to make sure that everyone knows and agrees on the rules. Here everyone knew that loans aren't securities, so there's no reason to change the rules after the fact. When we first talked about this case last year, I wrote: The point here isn't so much that this regime is good … but that it's the regime that everyone agrees on. There is a pretty widespread assumption in financial markets that, if everyone in a particular market is a sophisticated professional, then the rules that they agree on are the rules. Sometimes courts and lawyers come in and disagree, but it's a decent working assumption.
This time the court agreed. Are floor traders good?We are in the middle of a natural experiment that will shed some light on that question. A few months ago, there were some financial exchanges—most famously the New York Stock Exchange, though also some commodities exchanges—that combined electronic trading by algorithms and face-to-face floor trading by humans. Then the coronavirus pandemic made face-to-face floor trading deadly, so it stopped, though it's starting up again. (The NYSE reopened its floor this week.) So the obvious question is: When NYSE shifted from computers-and-humans to just computers, did trading get better or worse? We talked last week about one attempt to answer that question, which concluded "better": Edwin Hu and Dermot Murphy found that NYSE's closing auction became more efficient when it was fully automated and floor traders did not get any advantages. Here's another one, though, which concludes "worse." In "Does Floor Trading Matter," Jonathan Brogaard, Matthew Ringgenberg and Dominik Rösch found that markets got worse without floor traders: On March 23, 2020 the NYSE suspended floor trading because of COVID-19. Using a difference-in-differences analysis, we find that floor traders are important contributors to market quality, even in the age of algorithmic trading. The suspension of floor trading leads to higher effective spreads, volatility, and pricing errors. Moreover, consistent with theoretical predictions about automation, the effects are strongest during and immediately following the opening auction when complexity is highest. Our findings suggest that human floor traders improve market quality.
One awkward thing about the Covid natural experiment in financial markets is that, you know, the effect of Covid on stock markets is not just that it shut down the trading floor. The pandemic caused a general economic and financial crisis, and you'd expect volatility and bid-ask spreads to be higher in a crisis. But the authors' point here is that NYSE stocks had bigger increases in spreads and volatility than Nasdaq stocks (which always traded purely electronically), suggesting that the shutdown of the trading floor, and not just the economic harm of the pandemic, is what made trading worse. Art Stuff"Also, I really wanted to collaborate with my lawyer on art," is an amazing quote from this article. Really if there is one thing that this column is about, it is People Who Collaborate With Their Lawyers On Art. The great theme of Money Stuff is that people often work with their lawyers to do amazing, novel, conceptually revolutionary things, and that the proper reaction to these things is to hang them on a wall in a museum and appreciate them aesthetically. We talked the other day about how Goldman Sachs Group Inc. got in trouble for selling bad mortgages to investors, and as punishment it had to help consumers by giving them mortgage relief, and it collaborated with its lawyers to do that in a way that (1) can be profitable for Goldman and (2) involves foreclosing on thousands of houses. You could reasonably be angry at that but it is also amazing, it is an alteration of the fabric of reality that reveals new aspects to me every time I revisit it, and as a commentary on our times it vastly exceeds in sophistication and daring anything that any more traditional artist has ever come up with.[2] Or what is Elon Musk's Twitter feed if not a collaboration with his lawyer on art? In his case the collaboration involves him making dumb jokes while the lawyer is exasperated and ignored, but the lawyer is nonetheless an essential part of the collaboration. Musk's tweets about Tesla Inc.'s production numbers and stock price are only funny because a court has ordered him to run those tweets by a lawyer, and a lawyer is standing by ready to review those tweets, and he never ever ever sends the tweets to the lawyer. The lawyer is Charlie Brown with the football, Margaret Dumont to Musk's Groucho Marx, Abbott in "Who's on First," the classic archetype of the exasperated straight man. The lawyer's sad silent presence is what makes the joke a joke, what makes it art. In fact that marvellous quote is from Claire Boucher, the singer known professionally as Grimes and personally as "c," who is dating Musk and collaborating with him on the art project of telling people that they've named their newborn child "X Æ A-Xii." The story is about an exhibition of her visual and conceptual art: One such work, also titled Selling Out, is a legal document whereby the purchaser acquires a percentage of Grimes's soul. When she began to conceive of Selling Out, the artwork, "I didn't want anyone to buy it, so I said we should just make it $10 million and then it probably won't sell." After enlisting her lawyer to draft a contract for the sale, "the deeper we got with it, the more philosophically interesting it became," she says. "Also, I really wanted to collaborate with my lawyer on art. The idea of fantastical art in the form of legal documents just seems very intriguing to me."
To me too, c, to me too. And, yeah, that is good financial art! I want to buy her soul securitization and tokenize it on the blockchain. Though in like a week Musk is going to tweet "Grimes soul price is too high imo" and that will be awkward. Things happenRoche Partners With Gilead in Covid Trial of Drug Combination. (Earlier.) Japan Bank's Foray Into Risky U.S. Debt Leaves $3.7 Billion Hole. Financial Hiring Gets Even Tougher in Never-Meet-in-Person Era. Hertz Fleet Losing Value by the Day, Hindering Restructuring Efforts. SoftBank's Vision Fund Is Planning to Cut 10% of Staff. Samsung Partners With Winklevoss Exchange to Expand Crypto Push. GE Exits Lightbulb Business It Pioneered. Payment holidays in the age of Covid: implications for loan valuations, market trust and financial stability. CEOs Call in the Coaches as Covid-19 Tests Their Companies. Insider gambling on sports Covid news. Deutsche Bank's latest perk: An €80 sneaker staff have to pay for. Etsy vendor's misspelled Yiddish 'NYC crotch' mask is selling out, so she's making one for L.A. Research affirms saying the F-word might help take the pain away. 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! [1] There's a four-factor test for deciding if a loan is a security. One factor is "the motivations that would prompt a reasonable seller and buyer to enter into" the deal, which are obviously similar in a bond and a loan (seller wants money, etc.) and did not matter much here. Another is "the plan of distribution"; here the court "found that the assignment restrictions in the loan 'worked to prevent the loan participations from being sold to the general public,' and that the solicitation of investment managers, solely from institutional and corporate entities, constituted a relatively small number compared to the general public," but that is almost equally true of 144A bond offerings. Another is "the existence of another regulatory scheme," and I suppose bank regulation covering the sale of syndicated loans counts. Finally there is "the reasonable expectations of the investing public," which was decisive, and just means that if everyone thinks loans aren't securities—including the well informed institutional investors who bought them—then they aren't. [2] Disclosure, I used to work at Goldman. It sometimes felt like art. | 
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