Should index funds be illegal?You know the theory. Common ownership of multiple companies in the same industry by big diversified institutional investors should cause the companies to compete less: If all their profits are going to the same place (the investors who own all of them), then no one should care about which particular company earns the profits; all they should care about is that the total profits are as high as possible. So nobody should compete on price; they should raise prices, not care about market share, and make total profits as high as possible to please their common owners. It's not really a theory about index funds, but I sometimes jokingly call it "should index funds be illegal" because the rise of institutional common owners is connected with the rise of big index funds. The archetypal common owners are BlackRock and Vanguard and State Street, the "Big Three" index-fund providers, who by necessity own lots of competitors in lots of industries. Here is one testable implication of this theory. Imagine an industry with three big companies, Company A, Company B and Company C. Company A and Company B are in the S&P 500 index; Company C is just barely not. It's the 501st company on the list, say. Company A and Company B will be jointly owned by a lot of index funds—enormous amounts of money are indexed to the S&P 500—and also by other large-cap funds that compare themselves to the S&P 500. Company C will have much less overlap, though; all of the S&P 500-focused investors will ignore it. Company C will (taking the theory quite literally) want to compete with Company A and Company B by lowering prices, etc., giving up profits to gain market share. And so Company A and Company B will have to compete with Company C, lowering their prices to defend their market share. But then Company C gets bumped up the list, say to number 499, and is added to the S&P 500. The big index funds—which already own lots of Company A and Company B—will go buy Company C stock. Company C will now share much more of its ownership with Company A and Company B. Again taking the theory very literally, Company C will no longer want to compete as vigorously: It now has the same owners as Company A and Company B, so why should it fight with them over market share? So the implication is that, when Company C is added to the S&P 500, the stocks of Company A and Company B should go up, since they now face less competition. One way to think of it is that being added to the S&P 500 is a little bit like a merger with the rest of the S&P 500. Once you are in the S&P 500 club, you are kind of under common ownership with every other company in the S&P 500. Not exactly, of course: There is no formal corporate structure combining all of the S&P 500, every S&P 500 company is owned by tons of non-indexed and non-overlapping investors, lots of non-S&P-500 companies also have lots of indexed and overlapping investors, etc., this is all a matter of degree and I have exaggerated it a lot here. Nevertheless! We test if an increase in common ownership changes future expected profits with an event study method. We collect instances of a stock entering the S&P 500 index and identify its product market competitors. We measure the change in institutional and common ownership (with product market rivals) and find that entering stocks experience a significant increase in both. We measure the stock returns of the entrant's product market rivals upon the entry news. We find that increases in common ownership (driven by the whole vector of ownership similarity) cause increases in stock returns, consistent with a hypothesis that common ownership raises profits.
That is the abstract of "Testing the Theory of Common Stock Ownership," by Lysle Boller of Duke and Fiona Scott Morton of Yale. From the paper: Consistent with previous literature, we find that the stock prices of index entrants increase at the time of entry likely due to both demand and common ownership effects, and we provide evidence that the size of this increase is linked to the size of the change in institutional ownership that results from index entry. Most strikingly, we find that competitors who are themselves index incumbents incur higher abnormal returns upon the entry of their rivals when compared with non-incumbent competitors. This finding is supported by a null result for two control groups. Entrants that do not experience an increase in institutional ownership do not generate similar spillover effects to their rivals and competitors that are not index incumbents do not incur higher abnormal returns.
Being added to the S&P 500 is good for a company's stock, but it's also good for its competitors' stock, as long as they are also in the S&P 500. Because they are all friends, there in the S&P 500; they all have the same owners and are working toward the same goals. Everything is securities fraudIs it securities fraud for a public company to have only one Black member of its board of directors? We talked last week about a shareholder lawsuit against Oracle Corp., arguing that its diversity policies and public statements about valuing diversity are fraudulent: Oracle tells shareholders that it cares about diversity, the theory goes, and the shareholders buy the stock because they believe it and think diversity is good, but Oracle does not in fact care about diversity, and in fact has no Black directors. So the shareholders, the true victims of all systemic injustice, are misled. Is the theory. This theory is infinitely generalizable; Facebook Inc., for instance, has only one Black director on its seven-member board, so, lawsuit: Facebook's Board, which currently has only one Black individual, has consciously failed to carry out the Company's written proclamations about increasing diversity in its ranks. Black people and other minorities remain conspicuously underrepresented on the Board as well as among the Company's executive officers. In short, Facebook remains one of the oldest and most egregious "Old Boy's Club" in Silicon Valley. A sign advising applicants "Blacks Need Not Apply" might as well hang at the entrance to the Company's headquarters at 1 Hacker Way, Menlo Park, California. ... Zuckerberg and the Company's Directors have deceived stockholders and the market by repeatedly making false assertions about the Company's commitment to diversity. In doing so, the Directors have breached their duty of candor and have also violated the federal proxy laws. Their conduct has also irreparably harmed Facebook. For those who care about diversity, inclusion, and honesty, those who do not adhere to these principles should be boycotted, especially if the perpetrator is one of the largest and most influential corporations in Silicon Valley.
That is from a complaint filed a couple of weeks ago in federal court in California. Kevin LaCroix writes about it here, and notes that the lawyer involved "plans to bring more shareholder derivative lawsuits against Silicon Valley companies who allegedly do not follow through on their diversity initiative." Why not? Everything is a securities fraud, this is a thing, therefore this is securities fraud. (Technically these lawsuits are mostly shareholder derivative lawsuits about violations of fiduciary duty, which is not exactly a matter of "securities fraud" though close enough for me, but they also include allegations that the companies have violated proxy laws, which is securities fraud.) One thing to note about Facebook is that its shareholders have very little direct say over how it is run. It has a board of directors who are elected by shareholders, but founder and Chief Executive Officer Mark Zuckerberg controls a majority of the voting shares and can elect anyone he wants to the board. If all of the outside shareholders of Facebook are dissatisfied with Zuckerberg's regime and want to replace him as CEO, or appoint different directors to supervise him, or even get him to adopt slightly different policies, they can't do it; the deal, when you buy Facebook stock, is that you are putting your fate in Zuckerberg's hands, and if you don't like what he does you can't really vote to change it. But you can sue! You can always sue. Benefit corporationsMeanwhile here is a blog post from Ann Lipton about "public benefit corporations," a category under some state laws that explicitly allows a company to prioritize benefitting someone other than shareholders, to be nice to stakeholders and the community even at the expense of shareholder profits. The idea is that if you are a public benefit corporation and shareholders come to you and say "be less public-spirited and make more money for shareholders," you have some legal tools to say "no, our charter says we are a public benefit corporation, we cannot do that." Lipton is skeptical. Two public benefit corporations have recently filed for initial public offerings, Lemonade Inc., which started trading earlier this month, and Vital Farms Inc., which has not yet gone public. Lipton notes that these companies aren't really relying on public-benefit status to insulate themselves from shareholder pressure; instead, they both have insiders who own a majority of the voting stock and so, like Zuckerberg, can just say no to anything shareholders demand. She writes: My point here is that benefit-corporation status is not, in fact, serving as a commitment device for any of these companies; instead, to remain true to their mission, these companies are relying on more mundane types of insulation from the market for corporate control. But that kind of insulation carries the same risk as any other entrenchment device; the companies will pursue stakeholder interests only so long as their managers feel it in their interests to do so. The benefit-corporation form is not doing much work.
That's true, and it's hard to point to anything in the state laws about public benefit corporations that actually make them less answerable to shareholders, or more likely to benefit anyone else, than regular corporations. What is really going on here is that the companies' managers are less answerable to shareholders due to their voting stakes, which might make them more answerable to other stakeholders, but might just make them answerable to nobody. On the other hand: Everything is securities fraud. If you say in your prospectus "we will try to benefit the public instead of just making money for shareholders," and then you do something bad, it gives people—shareholders!—another hook to sue you. Vital Farms's IPO prospectus says that its public benefits include "bringing ethically produced food to the table" and "being stewards of our animals." Presumably if it mistreats its animals, shareholders can sue it for securities fraud, and they'll have an easier time making their case than they would against Tyson Foods Inc. or some other company that makes no promises of public benefit. The public benefit corporation status serves as a commitment device insofar as a major way to regulate corporate behavior is through securities fraud lawsuits. And so Lipton notes: Lemonade notes the dual risks that its pursuit of stakeholder-oriented goals may diminish profits, and the fact that it may fail to achieve those goals may result in reputational harms that diminish profits. As Lemonade puts it, "There is no assurance that we will achieve our public benefit purpose or that the expected positive impact from being a public benefit corporation will be realized, which could have a material adverse effect on our reputation, which in turn may have a material adverse effect on our business, results of operations and financial condition." Benefit-corp status is thus treated at least in part as a mechanism for pursuing shareholder wealth maximization on the "do well by doing good" theory.
Yeah if (1) they say that they will do good, (2) they do not do good, and (3) that has "a material adverse effect on our reputation, which in turn may have a material adverse effect on our business," they are totally gonna get sued. I should say, about this and the previous section, that the theory of "everything is securities fraud" cannot really, or only, be that any sort of misbehavior can be bad for a company's share price and thus cause shareholders to sue. That is a big part of it—often shareholders sue when the stock goes down—but not all of it. Facebook's stock price is near a record high, despite its allegedly poor diversity performance, and my point here is that if Lemonade or Vital Farms prioritize shareholder interests over the interests of society, then the shareholders will have a right to sue. You can tell a story in which the shareholders would want to sue in that case, out of pure rational economic self-interest—"if the company makes too much money for me, then it will lose the marketing advantage of being a public benefit company, and then it will make less money for me"—but it is a silly story. Instead the real theory is that anyone can be a shareholder, and shareholders can have goals other than profit, and any goal can be vindicated through securities law. If you don't like Facebook's diversity performance, or Vital Farms' treatment of animals, or Lemonade's, uh, insurance, you can buy a few shares and sue them for securities fraud. (Or if you are a state attorney general or the Securities and Exchange Commission, you can investigate and sue them for securities fraud, theoretically on behalf of shareholders, even if your lawsuit will obviously be bad for shareholders.) You don't buy the shares because you want them to go up; you buy the shares because you want Facebook to be more diverse or the animals to be treated better or whatever, and buying shares gives you the right to sue. The shareholders are the universal victims of corporate badness, and the ones with the best chance of getting somewhere if they sue, and it's really easy to become a shareholder. If you are an activist looking to change corporate behavior, buying some shares and suing for securities fraud might be the most straightforward way to do it. Twitter hackInitial reports of last week's big Twitter hack suggested that the first account to be compromised was Elon Musk's, which makes sense. The upshot of the hack seemed to be that famous accounts—Musk, Warren Buffett, Barack Obama, etc.—tweeted a dumb message asking people to send Bitcoin to the hacker's address, and if you want a huge audience of credulous people to send you cryptocurrency it is hard to pick a better person to impersonate than Musk. But in fact Musk's was not the first account to be hacked. At the New York Times on Friday, Nathaniel Popper and Kate Conger reported that, when a hacker first gained access to Twitter and was able to hijack any account he wanted, he started with "y": For online gamers, Twitter users and hackers, so-called O.G. user names — usually a short word or even a number — are hotly desired. These eye-catching handles are often snapped up by early adopters of a new online platform, the "original gangsters" of a fresh app. Users who arrive on the platform later often crave the credibility of an O.G. user name, and will pay thousands of dollars to hackers who steal them from their original owners. Kirk connected with "lol" late Tuesday and then "ever so anxious" on Discord early on Wednesday, and asked if they wanted to be his middlemen, selling Twitter accounts to the online underworld where they were known. They would take a cut from each transaction. In one of the first transactions, "lol" brokered a deal for someone who was willing to pay $1,500, in Bitcoin, for the Twitter user name @y. The money went to the same Bitcoin wallet that Kirk used later in the day when he got payments from hacking the Twitter accounts of celebrities, the public ledger of Bitcoin transactions shows.
You can't run a profitable Bitcoin scam with "y"; nobody is going to send "y" money. But it is a one-letter Twitter username, which is prestigious, in certain circles, so people will pay you for it. After a few hours of stealing and selling Twitter accounts like "dark," "w," "l," "50," "vague" and "anxious," eventually the main hacker ("Kirk") apparently figured out that you could do even better with "elonmusk," and the dumb Bitcoin-stealing game was afoot. When I first heard about the hack last week I tweeted, as did many other people, that if you are going to steal Elon Musk's Twitter account you should do so during market hours. Elon Musk can cause financial asset prices to move by billions of dollars; you could make bets on those moves (buy Tesla Inc. puts, or calls, etc.) and then make them come true (tweet from Musk's account "Tesla is terrible and I quit" or "I'm taking Tesla private but for real this time," etc.). If you are hacking Musk's account and you want money, it just seems like there should be better ways to get money than by running a transparent Bitcoin scam. A lot of smart people pushed back on this idea, fairly I think, noting that making a lot of money here by manipulating traditional financial markets would require (1) capital and (2) a good strategy for getting the money, and yourself, out of reach of the authorities. Bitcoin's irreversibility and anonymity make it a lot safer for this sort of high-profile hack. If you want to maximize the dollar value of your score, in a frictionless no-transaction-costs perfect-market sort of environment, you'd probably trade Tesla options, but in the real world the way to maximize your utility might be to leave a lot of hypothetical money on the table. But even that oversimplifies; who's to say that the hacker's utility is measured primarily in money, or Bitcoin? Maybe the highest goal is prestige, or some particular set of symbolic benefits that you get from, like, the username "dark." The way you get in a position to execute a hack that takes down Twitter is that you are trained in a particular subculture with its own norms and its own sorts of social capital, and if you come from that subculture maybe the reward that you seek is not money but one-letter usernames. Perhaps hackers are just culturally less motivated by money than, uh, Tesla options traders are. Spy StuffHere's some spy stuff about Wirecard AG. Bellingcat's Christo Grozev reports that Jan Marsalek, the former chief operating officer of Wirecard, who ran its Asia businesses that faked their revenue and who vanished when police came looking for him, was in some sort of contact with Russian intelligence services. (We talked about him previously, when it was reported that he "touted secret documents about the use of a Russian chemical weapon in the UK, as he bragged of ties to intelligence services to ingratiate himself with London traders," so, self-confessed Russian intelligence asset?) I tell you what, if I were an intelligence officer for a hostile government and I wanted to undermine Western capitalist democracies, I'd spend a lot of time trying to build big financial scams. Not only because it seems effective and has some vague ideological fit for ex-Communist states (demonstrate the decadence and corruption of Western capitalism etc.), but also because it matches my skill set and seems like fun. Things happenThe Origin Story of Tekmerion, the Hedge Fund That Ray Dalio's Bridgewater Says Stole Its Trade Secrets. Goldman Warns SEC Proposal Could Shroud Hedge-Fund Crowding. A Great Quarter for Wall Street Comes at a Very Awkward Time. Argentine president tells creditors: 'we can't do any more.' Jack Ma's Ant Group Plans Dual IPOs in Shanghai, Hong Kong, Bypassing New York. IAC/Interactive CFO Says Quarterly Guidance Is Bad for Business. Robinhood Effect Is Starting to Shake Up a Stuffy ETF Market. Morgan Stanley commits to tallying its climate impact. U.S. Airlines Face the End of Business Travel as They Knew It. Covid-19 Remakes Elevator Etiquette. Time to Tell America's Dogs This Arrangement Won't Last Forever. East River floaters swept away in giant inflatable swan, prompting rescue. Virtual bris. 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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