Money Stuff

Indexes, Insiders and ICOs

Also proxy voting, volatility products and lost dogs.
Updated on

Index funds.

It is very cheap to run an index exchange-traded fund -- you don't need research or fancy analysts; trading costs are low -- but you do need to pay for an index. If you want to run an S&P 500 ETF, for instance, you've got to pay S&P Dow Jones Indices a fee to license their index. This fee can be a bit galling. Making an index is not that expensive a proposition: If you just want a list of stocks, I will sell you one for a thousand bucks. I cannot promise that it will be a good list, but goodness is not precisely the selling point of the real indexes either.

So it is only natural that, as index-fund providers keep trying to cut costs, they are economizing on name-brand indexes and switching to store brands:

State Street Global Advisors slashed fees on 15 of their exchange-traded funds to as low as 3 basis points, according to a company statement on Monday. The ETFs are now the least expensive U.S. equity funds, along with one product from BlackRock Inc. and two from Charles Schwab Corp. that capture similar segments of the U.S. stock market.

Seeking out less costly ways to build the indexes that ETFs track has become increasingly important in the race to cut fees. For the three cheapest funds State Street announced Monday, the firm developed proprietary mid-cap, large-cap and broad-market U.S. equity indexes to replace FTSE Russell benchmarks.

One problem with the proprietary indexes is, how do you compare your fund's performance to "the market"? If I launch the Matt Mid-Cap Index ETF, and its performance closely tracks the performance of the Matt Mid-Cap Index, should you be satisfied with that, or will you compare my performance to a more popular mid-cap index? If my performance differs, is that "tracking error," or "active management," or just two incommensurable indexes?

Another problem, or opportunity, with proprietary indexes is: Now you are picking stocks. You are not precisely trying to pick the good stocks: You are self-consciously an index fund, so your goal is more "buy all the stocks" than "buy the best stocks." But still there are choices to be made. Will you exclude companies with dual-class shares, as S&P Dow Jones and FTSE Russell partially do? Will you exclude companies that don't turn a profit, as the S&P does? Will you make other financial or governance decisions about which companies you will invest in? Will you justify those decisions as being better for performance ("companies with good governance perform better"), or as reducing tracking error ("the other indexes do this so will we too"), or as completely capturing the investable universe, or what?

If you are licensing an index, you get to outsource these decisions: If you, or your investors, don't like the companies you invest in, you can just shrug and say "well we have to do what the index tells us to do." Or, if you are annoyed enough by the decisions the index providers make, you can complain and hope that they change their rules -- as they did after the Snap Inc. initial public offering brought a backlash against dual-class shares. But if you're making the index yourself, you have to decide. You have to make the philosophical meta-decision about what sorts of rules an index can have, and then you have to make the substantive financial and governance decisions about which rules your index should have.

Oh also you have to do this super cheaply, without research or fancy analysts. Someone has to decide whether, say, U.S. companies should be allowed to go public with nonvoting stock. It remains strange that that someone might be index funds. 

Insider trading.

It is time to formulate a Ninth, and dumbest, Law of Insider Trading, which is: If you are going to insider trade, do it in a company that is far away from a Securities and Exchange Commission office. Like, physically. Don't insider trade in a company whose headquarters is across the street from an SEC regional office. Do it in one further away. You are less likely to get caught. Why would this work? I don't know. The world is strange. Here is "It is Easy to Be Brave from a Safe Distance: Proximity to the SEC and Insider Trading" by Trung T.H. Nguyen of Stanford and Quoc H. Nguyen of the University of Illinois at Chicago:

We use hand-collected data from SEC's litigation releases for insider trading violations to examine the effect of geographic distance on its enforcement activities and insider trading activities. First, we find that the SEC is more likely to investigate companies that are closer to its offices. Second, we find that illegal insider trading increases with a company's distance from an SEC office. Lastly, we utilize the closure of SEC offices as exogenous shocks to geographic proximity and find that insider trading at nearby companies increase significantly compared with trading at otherwise similar companies not affected by the closures. 

"A 100 km increase in distance from the nearest SEC office increases opportunistic trades" -- reported trades by corporate insiders that seem to be predictive of future results -- "by 16.5%." Is securities regulation supposed to make sense? Does this make any sense? Anyway, there you go, Ninth Law.


Here is a sensible memo from Wilson Sonsini Goodrich & Rosati about the legal status of initial coin offerings. Like me, they are very skeptical that you can get around U.S. securities laws just by calling something a "utility token": If you sell people a token that they can't currently use to do stuff, and they use the token mainly to speculate on the future value of your platform, then that is a security even if one day they may end up using it to buy cloud storage. That raises further questions:

When do tokens that are securities stop being securities? This is a central question in the token community right now. Our current view is that once the value of the tokens is primarily driven by their commercial usage, rather than by the efforts of the token sponsor or other developers, the tokens should no longer be deemed to be securities. The SEC has not yet addressed this question.

I agree with them that that is the only really sensible dividing line: If people mostly use your token to buy cloud storage, then it is prepaid cloud storage; if they mostly use it to speculate, then it is a security. But I also agree with them that the SEC hasn't said that, and it's not entirely obvious as a legal answer. 


How does a token platform operate when the tokens are still securities? As long as a token is a security, and unless it has been registered (or qualified under Regulation A+), holders of a token are subject to significant limitations on their ability to resell the tokens. We currently believe that a holder of an unregistered token generally can freely use the token to engage in commercial transactions on the related platform. However, the federal securities laws may restrict that recipient's ability to resell the tokens, which obviously would limit the number of people who would be willing to accept tokens for goods and services on the platform.

Also fun: "Most direct sales of tokens generate taxable income to the token issuer." That's not true of stock sales. If you raise money by selling stock in your company, you don't pay taxes on it. But if you raise money by pre-selling your company's product, then you do, or you should, anyway. 

Elsewhere, here is Adam Ludwin of Chain on the purpose of cryptoassets:

Thus, bitcoin, for example, isn’t best described as “Decentralized PayPal.” It’s more honest to say it’s an extremely inefficient electronic payments network, but in exchange we get decentralization.

Ludwin argues that the main advantage of decentralized systems is "censorship resistance": "No one can stop me from using Bitcoin to pay for something." (Except, you know, by not accepting bitcoin as payment.) I tend to think that crypto-libertarian and Silicon-Valley types overestimate this advantage: Most people seem to care more about convenience than about decentralization, which is why a lot more people use Facebook than bitcoin.

Still elsewhere, "J.P. Morgan’s Jamie Dimon May Hate Bitcoin, but He Loves Blockchain." And the Dilbert guy found out about ICOs.

And finally here is TetzelCoin:

TetzelCoin is a blockchain-based app that forgives users of their sins. Users confess their sins and pay an amount of Ether they believe their sin is worth. In return, they receive forgiveness in the form of SIN tokens. 85% of the proceeds go to medical debt forgiveness.

From the white paper

Since we do not know if a user has already confessed their sin, TetzelCoin requires a user to confess their sin to a priest-like smart contract in addition to simply paying it money for absolution. In return, users are given a token of their forgiveness in the form of SIN tokens, an ERC20-compatible cryptocurrency hosted on the Ethereum blockchain. The amount of SIN tokens each user receives is directly proportional to how much money is given, requiring users to balance speculation-driven profit motives with the guilt they feel for their sin. The confession and the amount of SIN tokens that resulted from the transaction are recorded in the blockchain and displayed in a table of sins that anyone can view.

[Update: The TetzelCoin white paper has deleted the reference to "speculation-driven profit motives," because the SIN tokens are not valuable and buyers should not expect to profit.]

What ... is it? A genuine attempt to apply cryptocurrency principles to solve a real economic/religious problem? An art project? (The project leader is "an artist, engineer and investor," whose "art explores the existential absurdity of human systems that provide us with symbolic value in our daily lives.") A moneymaking scheme? (Where do the other 15 percent of proceeds go?) A joke? What I like about this future for finance is that you don't have to choose; every dumb joke is simultaneously a real cryptocurrency project, and every real cryptocurrency project is, at least a little bit, also a dumb joke.

Also an immutable public blockchain-based ledger of sins is just a good idea, exactly the sort of thing that a good system of finance should develop.

Proxy voting.

Look I mean this is ridiculous:

A significant chunk of the shares were also owned in the actual name of the investors, instead of just brokerage names, which is far more typical. The votes from those shares are only sent to the side who they are voting for, meaning both P&G and Trian had blind spots as they tried to determine the outcome. The P&G disclosure Monday still didn’t include such votes that went to Trian, though it estimated what it believed Trian won.

All of the votes are now in the hands of an independent firm, which will issue its own preliminary tally in coming weeks. After that, begins a certification process that will check if shareholders had the authority to vote, signed and marked ballots correctly and to verify that no one voted more than once.

Procter & Gamble Co. announced that it beat Nelson Peltz's Trian Fund Management in a proxy fight by 6.15 million votes, or 0.2 percent of its shares, but really it is just estimating that; the real answer will come weeks later, after the counting and the authority-checking and the double-counting-elimination and so forth. Imagine if you voted in presidential elections by mailing a paper ballot to your preferred candidate.

"Blockchain blockchain blockchain" is one possible answer here -- I, and Delaware Vice Chancellor J. Travis Laster, have both suggested it -- but as is so often the case it is not a necessary answer. There is no particular value to decentralization in tracking investor votes. Just keeping a regular old centralized ledger of shareholders and their votes -- as Depository Trust Co. almost does -- would be fine. But the actual system we have is a kludgy accumulation of databases and intermediaries and mailed scraps of paper. Replacing it with a sensible centralized electronic system would be a big improvement. But modernizing financial infrastructure by building a sensible centralized electronic system is no longer cool. These days, it is blockchain or nothing.

Elsewhere: "Social Security Numbers: Hacked, Hated—and Irreplaceable."

People are worried that people aren't worried enough.

I guess you would say that these guys are happy that people aren't worried enough, but want them to start worrying more soon:

Brevan Howard Asset Management, 36 South Capital Advisors, One River Asset Management and at least three other firms are rolling out new funds designed to protect investors from rising market turbulence. While so-called long volatility strategies have been some of this year’s worst performers, everyone from Nobel laureate Richard Thaler to BlackRock Inc. Chief Executive Officer Larry Fink has warned that the unusual state of calm in markets may not last.

“This is a multi-decade opportunity to buy volatility,” said Richard “Jerry” Haworth, who co-founded 36 South in 2001 ....

Elsewhere in volatility products, the Financial Industry Regulatory Authority fined Wells Fargo $3.4 million for recommending volatility-linked exchange-traded products to customers without fully understanding those products. "Certain representatives mistakenly believed that Volatility ETPs could be used as a long-term hedge on their customers' equity positions in the event of a market downturn," says Finra. "In fact, Volatility ETPs are generally short-term trading products that degrade significantly over time and should not be used as part of a long-term buy-and-hold investment strategy." One wonders sometimes about the level of financial sophistication among professional financial advisers.

And elsewhere in worry: "How big is the risk of another Black Monday equities crash?"

People are worried about unicorns.

"Every time a pet dies or goes missing, however, Wag and Rover take a public-relations hit," as well they ought to. Wag Labs Inc. and are competing to be the Uber of dog walking, and you just can't scale up to be a global on-demand dog-walking powerhouse without misplacing a dog or two. You probably can do it without getting in fights with the customers whose dogs you've misplaced, as Wag did:

Wag Labs Inc., the app’s parent company, did something unusual for a tech company: fired off a cease and desist letter to one of its own customers. “If your retraction and apology to Wag! are not publicly posted to each and every social media platform that you have used to libel Wag! within 24 hours of the time of this email, this office has been authorized to use all available means to bring as swift as possible an end to your lies,” company attorney Mark Warren Moody wrote.

"All available means to bring as swift as possible an end to your lies" is not exactly normal lawyer language. It carries at least a menacing hint of, you know, all available means. What were they going to do? Kidnap her dog?

Things happen.

Gorman's Brokerage Play Lifts Morgan Stanley to Higher Profits. (Earnings release, supplement.) Goldman Sachs's Equity Investments Lift Profit as Trading Slumps. (Earnings release.) Credit Suisse targeted for break-up by activist hedge fund. Credit Suisse's Biggest Shareholder Dismisses Activist's Plan. As Edward Jones Tops $1 Trillion in Assets, It Seeks Street Cred. Nordstrom Family Suspends Effort to Take Retailer Private. Nordstrom Lenders Demanded Interest Rate the Family Couldn’t Pay. Taylor Impresses Trump for Fed Chairman, Warsh Slips. China’s Xi Approaches a New Term With a Souring Taste for Markets. Airbus Snaps Up Bombardier Jet in New Challenge to Boeing. The World's Largest Oil Hedge Is Complete. Small Endowments May Get to Invest in Bridgewater Associates. Major Clearinghouses Can Avoid Liquidity Crunch in Crisis, CFTC Says. McKinsey admits to errors in South Africa scandal. "Sumner Redstone’s former companion has sued his daughter and grandson for more than $100 million, alleging they effectively ran a criminal enterprise to illegally spy on her and oust her from the media mogul’s life." What's Elon Musk's brother up to? In Flesh-Cutting Task, Autonomous Robot Surgeon Beats Human Surgeons. 

If you'd like to get Money Stuff in handy email form, right in your inbox, please subscribe at this link. Thanks! 

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

    To contact the author of this story:
    Matt Levine at

    To contact the editor responsible for this story:
    James Greiff at

    Before it's here, it's on the Bloomberg Terminal.