Class Actions and Tax Cuts
Uber class action.
One reason that big technology companies seem to be staying private longer is that they are afraid of being sued if they go public. If you stay private, your shareholders are basically your employees and venture capital investors, and there are strong norms against VCs suing their portfolio companies.
If you go public, though, you lose the ability to control your shareholder base. Lots of random people will buy your stock, and lots of securities lawyers will keep an eye on it. And if it goes down, they will put together a complaint saying, in essence, "you did bad things and didn't tell us about them, and that's why the stock went down, and that is fraud." (Every bad thing that a company does, I often point out, is securities fraud, and plaintiffs' lawyers take that idea very seriously.) And then they will go out and shop that complaint around until they can find a shareholder willing to put his name on the complaint, and they'll file it as a billion-dollar class action purporting to represent every shareholder.
Again, you do not see that sort of thing much in private companies, because (1) plaintiffs' lawyers can't watch your stock to see if it goes down, and (2) even if they could, and they wrote a complaint and shopped it around to your investors, none of your VCs is going to sign on to be lead plaintiff in a class action. There is also a more technical reason: If you are a public company, every public statement you make might induce someone to buy your stock on the stock exchange, so there are a lot more opportunities for you to mess up and mislead investors. If you are a private company, people are only buying their stock from you, in an offering, and the only real fraud question is whether the offering documents are accurate.
But Uber Technologies Inc. is not like other private tech companies, and here is a class action complaint against Uber brought by the Irving Firemen's Relief & Retirement Fund. The basic claim is that Uber did some bad stuff and its stock went down. But the secondary, implicit claim is that Uber was more or less a public company. "Beginning in 2014 Uber and Kalanick commenced a mass media campaign designed to induce investors to invest billions of dollars in the Company," says the complaint. That is: You can think about this case as a regular public-company stock-drop case, where the company's public statements induced random investors to buy in the public markets without any relationship with the company, opportunity to do due diligence, or specific offering document.
That is not ... quite ... true? Here's how the lead plaintiff's share ownership is described in the lawsuit:
Plaintiff purchased Uber securities through an interest in New Riders LP (“New Riders”), a Delaware limited partnership, in January 2016. The sole purpose of New Riders is to invest in Uber Series G preferred shares. New Riders is managed by Morgan Stanley Investment Management Inc. and its general partner is MS Alternatives Holding D Inc., an entity owned by Morgan Stanley.
We talked about New Riders back when it launched; I described it in very rough terms as "sort of a one-stock mutual fund" that raised money from Morgan Stanley clients and used it to buy Uber shares. New Riders is an Uber shareholder, and if its managers are unhappy with Uber they could always, I suppose, sue. But the Irving Firemen's fund does not actually seem to be an Uber shareholder, so it is an odd choice to represent a class of all Uber shareholders. At some point, big private tech companies usually become public companies and lose the opportunity to choose their investors, but I suspect Uber is not at that point yet.
My model of Uber is that it is a large public company with an unusual governance structure. It happens! There are large public companies with non-voting shares, or no fiduciary duties to shareholders, or weird control structures or whatever. Uber's odd governance feature is that it happens to be a private company -- unusual for a large public company, but, you know, we can work with it. It has many of the attributes, good and bad, of a big public company: limitless fundraising, merger currency, name recognition, (some) secondary-market liquidity, battles between management and activist shareholders, class-action stock-drop suits. It lacks some other traditional attributes: quarterly financial disclosures, real-time stock-price updates. But one lesson of the unicorn boom is that no attributes are essential, that there is not a clean divide between "normal public company" and "normal private company," that many big tech firms exist in shades of gray.
Elsewhere here is Bernard S. Sharfman with "Another Reason Why Companies Avoid IPOs," which is "the reduced ability of corporations to take advantage of private ordering once they become a public company." And: "Dual-Class Shares Are Coming Under Fire—Again."
Yesterday a reporter effectively asked Gary Cohn if the Trump administration's tax plan will raise taxes on the middle class in order to pay for a massive tax cut for Donald Trump himself, and while the answer to that question definitely appears to be "yes," Cohn cleverly deflected by telling reporters that he doesn't know how much cars cost:
“If we allow a family to keep another $1,000 of their income, what does that mean?” Cohn said. “They can renovate their kitchen, they can buy a new car, they can take a family vacation, they can increase their lifestyle.”
That is distracting! Cohn added that the tax plan is "purely aimed at middle-class families," but, you know, you aim a gun. On the other hand, one controversial tax increase in the new proposal -- the elimination of the deduction for state and local taxes -- already seems to be in trouble, so it is perhaps silly to be too concerned at this stage with little technical details like whose taxes would go up or down under this plan.
Elsewhere, here is some speculation on "What Awaits Wall Street in Trump Tax Plan," though perhaps the biggest question for banks -- what will happen to corporate interest deductibility -- has no answer yet:
Another issue is a proposal to partially limit companies’ ability to deduct net interest expense. The administration didn’t define what partially limited meant.
That is important. Bank executives have said that they hope this will mean that financial institutions are exempted. If not, their business model would be under threat.
And here are some claims that the Trump administration is committed to ending the "carried interest" loophole, though that was not in the tax plan, which would actually lower the tax rate on hedge-fund and private-equity earnings by taxing them at a new 25 percent rate for pass-through business income.
Here are a law review article and related blog post that are very much relevant to my interests, which are, roughly, "goofy hypothetical insider-trading tricks." This one is called "Insider Tainting: Strategic Tipping of Material Non-Public Information," it's by Andrew Verstein of Wake Forest and the University of Chicago, and it's arguably not entirely hypothetical:
I analyze the strategic use of insider trading law to disable the trading activity of an information recipient. I call this phenomenon “insider tainting.” While most tips of information open doors, insider tainting closes them. Rather than empowering and enriching the tippee, the tipper conveys information to constrain her. Tainted with inside information, the tippee faces legal risks to her preexisting or potential trading plans.
Verstein cites the example of Mark Cuban: The chief executive officer of Mamma.com told Cuban about an upcoming dilutive equity issuance, Cuban didn't like the news and sold his shares, and the Securities and Exchange Commission pursued Cuban for years for insider trading before he was ultimately vindicated at trial. No one disagreed that Cuban traded on inside information; the issue at trial was whether he had agreed not to trade. Cuban said he hadn't (which would make his trading legal, since he had no duty of confidentiality when he received the information), the SEC said he had, and it took many years to sort out.
Cuban traded, and won, but Verstein's quite plausible hypothesis is that many people in his situation wouldn't have. Insider trading law is sometimes murky, and prosecutors, jurors and the SEC all tend to think that any trading on inside information, whether or not there is a violation of a duty of confidentiality, ought to be illegal. If you get inside information from a corporate CEO, you might not want to risk trading. And so if you are a corporate CEO, and you want to, say, do a big dilutive equity offering without impacting your stock price too much, you might call up some of your big shareholders and say "hey we're doing a big dilutive equity offering, now you know, don't trade, bye!" And it might work.
Obviously there are problems with this approach, for the CEO. For one thing, if the CEO tips the shareholder, and the shareholder trades anyway, then the CEO might risk being accused of insider trading. This seems unlikely, though, if the CEO got no personal gain, was doing the tipping/tainting on behalf of the company, and tells the shareholder not to trade. This is allegedly what happened in the Leon Cooperman insider trading case, where a corporate executive had multiple conversations with Cooperman about an undisclosed material event and then, in one of the later conversations, said something like "don't trade, bye." I found that silly -- "corporate executives don't usually say 'oh hey by the way you're locked up' after talking," I wrote -- but perhaps it was part of a cunning plan. In any case Cooperman was charged with insider trading, and settled; the executive wasn't.
Another problem is Regulation FD, which forbids companies from selectively disclosing information to some investors without locking them up. This is not a huge problem because Regulation FD is rarely enforced, but also, Regulation FD prohibits tipping investors who are likely to trade, and if you just do it to prevent them from trading, you might have a decent defense.
It is an odd little trick. You would not expect companies to use it all that often. But sometimes companies do announce things that annoy and dilute big shareholders, and want those shareholders' support. Calling up those shareholders, tainting them with inside information, and then asking for their support can be a good and cynical strategy: Maybe they'll support you (buy your stock offering, etc.), but even if they don't -- even if the phone call makes them more annoyed -- they won't be able to dump their stock, which is almost as good.
D.R. Horton Inc. is acquiring Forestar Group Inc., and is letting Forestar shareholders choose to be paid in cash or stock. "Approximately 91.23%" of Forestar's shareholders chose cash. "Approximately 10.16%" of them chose stock. Further financial analysis reveals that 91.23 plus 10.16 equals 101.39, which is a higher number than you'd normally like to see in a percentage.
Because the number of shares subject to elections above (42,519,175 shares) exceeds 41,938,936 shares, which was the number of shares of Forestar common stock outstanding as of the close of business of September 27, 2017, it appears there are duplicative elections made pursuant to guaranteed delivery procedures. These duplications will be eliminated in the final results.
Hmm. I don't know what is going on and I'm not sure they do either, but one obvious explanation -- which we have discussed before -- is that most public companies have more shares than they have shares, if you will. If Forestar had 100 shares outstanding, and someone borrowed 2 shares and sold them short, then there would be people with 102 shares who think they are entitled to the merger consideration. This all works out fine, to within a reasonable rounding error, because the person who was short the 2 shares has to deliver the merger consideration to the person she borrowed them from, so the books balance. Most of the time. But I suppose it is a little unnerving for the acquirer to send out election forms asking if shareholders want to be paid in cash or stock, and get back more forms than it sent out. You kind of want to know how many shares you are buying, before you pay for them.
Blockchain blockchain blockchain.
"tZero, a subsidiary of online retailer Overstock.com Inc., is joining with Argon Group and RenGen LLC to form a digital tokens exchange that Overstock Chief Executive Officer Patrick Byrne said will be the first in compliance with Securities Exchange Commission and Financial Industry Regulatory Authority guidelines." If, I don't know, half of all initial coin offerings are for tokens that really are securities and ought to be regulated by the SEC (which seems to me like a conservative estimate), and if a lot of other token exchanges just shrug and list whatever tokens anyone wants to trade, then ... I mean, this is not legal advice, but then I think some people are illegally operating unlicensed securities exchanges? And if you go and open a licensed securities exchange, and regulators actually crack down on the unlicensed ones, you could find yourself in an excellent competitive position.
Still I guess it would be fair to say that, if you run a cryptocurrency exchange, violating the securities laws might be the least of your problems. Here is a story -- "Chaos and hackers stalk investors on cryptocurrency exchanges" -- that describes, among other problems, sanctions violations, money-laundering problems, flash crashes, fake trading volumes, market manipulation and, perhaps most notably, the endless litany of bitcoin exchanges that have been hacked and had their bitcoins stolen. I suppose once you fix all those things you can worry about whether you are illegally listing unregistered securities.
People are worried about unicorns.
Yesterday we talked briefly about a New York Times article about Jason Calacanis, an angel investor who made a lot of money on Uber and who is now on a mission "to inspire 10,000 people to become full-time angel investors," in part by reading his book, "Angel: How to Invest in Technology Startups — Timeless Advice From An Angel Investor Who Turned $100,000 into $100,000,000." That mission, and that title, inspired a certain skepticism, and I briefly imagined a lottery winner ("... Who Turned $1 into $400,000,000") writing a similar book. (That joke was, I realized, inspired by this xkcd cartoon.) Calacanis and his fans criticized me on Twitter for making fun of him without reading the book, and while that wasn't really the point -- I was commenting on his dream of turning a thousand dentists in Peoria into venture capitalists, not the contents of the book -- I went and read the book yesterday anyway. (It's a quick read.) "I buy lottery tickets for a living," writes Calacanis in the actual book, "but unlike the normal schmucks on the street, I get to buy tickets that are in the top 1 percent of the winning pool." I feel like my lottery joke is vindicated.
I ended up being pretty charmed by the book, for a business book. It is a good introduction to how angel investing works, with breezy and idiosyncratic discussions of what makes a good founder, how to network, how to take notes in a pitch meeting, and why you should demand pro rata rights when making seed-round investments. If you are a multimillionaire founder or ex-Google employee looking to dabble in angel investing, you might profitably read this book. Also it uses (coins?) the term "decade-acorn," meaning "the startups that come along once a decade, on average, and become worth over $100 billion," which I enjoyed, especially if you pronounce "acorn" like the nut instead of like the last two syllables of "decacorn."
But if you are a dentist in Peoria, the overall advice in the book is a bit strange. Essentially it is: If you have $10 million or so in net worth, and no angel-investing experience or tech contacts, you should move to Silicon Valley and spend at least 20 hours a week meeting with founders to try to find places to invest $1.5 million of your money. If you do that, and put in years of hard work, and get lucky, you might turn your $1.5 million into more millions. I mean, fine? Sure? I might keep my dental practice, and my house in Peoria, and put my millions in index funds, but, you know, sure.
"Georgetown bank teller stole $185,000 from homeless customer with garbage bag of cash," is the headline here, and bankers stealing money from homeless people does feel like a particularly early-21st-century form of crime. Other excellent aspects of this story:
- The teller's name is Phelon Davis, making his guilty plea to a felony a little on-the-nose;
- The bank is Wells Fargo & Co.; and
- He stole the money by setting up fake accounts in the homeless customer's name.
One thing that I have generally maintained about the Wells Fargo fake accounts scandal is that it didn't directly cost customers all that much money: A few people were put into fake accounts with fees, but for the most part, the point of setting up fake accounts was to meet productivity goals without the customers noticing, and there were plenty of ways to do that by giving the customers free products without telling them about it. But I guess if you give your tellers lots of practice in opening fake accounts, one risk is that they might use those skills to steal their customers' money.
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