The basic story of Mark Walter and TWG Global, his holding company, is that TWG owns some insurance companies, and those insurance companies would raise money by selling annuities to customers, and Walter would control how that money was invested, and he would lend some of the money to himself to buy sports teams. Insurance regulators have pretty strict rules about related-party transactions, for reasons that are obvious if you think for a minute about the phrase “lend some of the money to himself to buy sports teams.” When an insurance company is lending its boss money to buy sports teams, it is taking different and spicier credit risk than it would be if it were just buying normal bonds of unaffiliated companies.

But TWG’s insurance companies would make a lot of those loans through third parties, which would then turn around and lend the money back to TWG’s businesses. And the insurance companies’ financial statements would not count those loans as related-party loans. Eventually federal prosecutors and insurance regulators started asking questions. “After receiving subpoenas, those insurers disclosed more than $20 billion of loans that should have been labeled as affiliated transactions, but weren’t.” Bad.

At the same time, though, owning sports teams has been a lucrative business in recent years, and as far as I can tell it has all worked out great? TWG put out a statement in August saying so:

Affiliated transactions should be properly disclosed, but to state that they “generally” have the potential to “loot” the insurer is untrue.

The reality is that Group 1001 [the TWG insurance group] has invested in real assets that are performing well; the insurance companies have recognized significant income from the investments and no policyholders have lost money because of these transactions.

The statement also said: “There is no victim here. No one has been harmed, and no one has claimed they were harmed.” I have pondered that claim a few times. It can’t quite be true. If the world had known the true level of the insurance companies’ affiliated transactions, then … something. Something. Like:

1. Insurance regulators would have demanded that the insurance companies have more capital to offset the increased risk of all those affiliate transactions.
2. Ratings agencies would have given the assets lower ratings, and the insurance companies would have responded by having higher capital to preserve their own financial-strength ratings.
3. Ratings agencies would have given the insurance companies lower ratings, and they would have had to pay higher interest rates on the annuities they sold.
4. Financial advisers would have read the disclosures, said “hmm this sounds risky,” and recommended that their customers look elsewhere for annuities, again driving up the rates that the TWG insurers had to pay on annuities.

Or some combination of those things. Or something else. There is not a crisp mechanism here; the counterfactual is not obvious. There is just a general sense that, by under-reporting their affiliated transactions, the TWG insurers understated their credit risk, or at least their conflict-of-interest risk, and that if the world had known their real credit risk it would have cost them some money. 

So I get what TWG meant when it said there were “no victims”: No customer lost money, relative to that customer’s contracted cash flows. But I also think it was wrong: The customers did lose money, relative to the cash flows they would have demanded if they had known the truth, or rather the cash flows they would have demanded if the regulators and ratings agencies and market had known the truth. 

In any case, if you go around filing incorrect financial statements and then put out a press release saying “there is no victim here,” you are tempting fate in an obvious literal way: Lots of plaintiffs’ lawyers are going to read that press release, take it as a personal challenge, and go find some victims to sue you. The Wall Street Journal reports:

A suit filed Monday is at least the third to allege Walter and his insurers sold annuities based on misrepresentations and false promises. The suits, brought by class-action lawyers seeking to represent a larger group of policyholders, come after two of Walter’s insurers disclosed in June that they were under federal investigation for failing to report how much of their portfolio was deployed as loans to other companies connected to Walter’s sports-and-financial empire. 

Rick Phillips, a Los Angeles-area retiree, filed suit on Monday asking that policyholders at two Walter insurers, Clear Spring and Gainbridge, be let out of their annuity contracts without penalty or reimbursed for the difference between what they paid and the cheaper price the companies might have had to accept had they been upfront about the extent of their affiliated investments.

Here is the complaint.. On the one hand, the insurers sold annuities mostly on the promise “we’ll pay you back your money at the contracted rate,” and that promise seems to have been true. On the other hand, the insurers also sold annuities on various implicit indirect promises along the lines of “the financial statements we file with regulators correctly reflect our level of affiliate transactions,” promises that surely Rick Phillips didn’t pay attention to, but that do sort of feed into price. From the complaint:

In a market where premiums, rates, fees, and guarantees are published, compared, and competitively bid, a purchaser who knew that over forty-five percent of the assets in Clear Spring’s general account and nearly sixteen percent of the assets in Gainbridge’s general account consisted of loans whose repayment depended on ventures related to Walter would have demanded a lower premium, a higher credited rate, a higher participation rate, a lower rider charge, a larger guarantee, or some combination of those terms — or would have bought from a different insurer entirely. By delivering an annuity that was riskier than what had been represented, Clear Spring and Gainbridge breached their contract with Plaintiff and the Class. …

Plaintiff and the proposed Class assert claims and seek damages or rescission of their annuity contracts with Clear Spring and Gainbridge for breach of contract and breach of the implied covenant of good faith and fair dealing. Their damages are measured by the difference between (i) the value of the annuities at the premiums Plaintiff and the Class paid and (ii) the inferior value of those annuities and/or the lower premium that would have been required to purchase the annuities had the related-party nature of Clear Spring’s and Gainbridge’s general accounts been disclosed as required.

The actual monetary harm is a little hard to quantify, but surely the basic theory is right. TWG’s insurance companies were riskier than people thought, so they should have paid extra for their annuities. And now the customers want their extra money.

The basic way to make money as an investment manager is:

• People give you money to invest,
• You invest it and earn a return, 
• You pay them some portion of the return, and
• You keep the rest.

Your earnings are the spread between the returns you get on your investments and the returns you pay to your investors. One way to increase your earnings is by getting a higher return on your investments. But of course the other way is by paying a lower return on your funding.

There are three broad funding models:

1. Pass-through funding: You raise money from investors, promising to invest it in stuff and give them the returns, minus some set fees. Mutual funds do this: They invest their customers’ money in stocks or bonds, and the customers get the returns on those stocks or bonds minus some annual fee. Traditionally hedge funds and private equity funds do this too: They invest in stuff and give their clients the returns, minus (classically) 2% of assets and 20% of returns. 
2. Fixed funding: You raise money from investors, promising to pay them some fixed or formulaic return, 7% per year or 200 basis points over Fed Funds or whatever. You pay them the fixed return, you earn a variable return (on whatever you invest in), and you keep the difference (which might be negative). This is classically how banks work: They borrow money from depositors, invest it in loans or whatever, earn returns on the loans, pay a fixed interest rate to the depositors and keep the rest. But lots of investment firms get some portion of their funding by borrowing it (from banks, bond markets, prime brokers, etc.); they pay a fixed return on that capital and keep what’s left over. [1]
3. Discretionary funding: You raise money from investors, you invest it in stuff, you earn returns on the stuff, you pay the investors whatever you think is fair and you keep the rest. Nobody quite puts it like this — this sounds like a joke — but I have argued that this is sort of how the big multimanager multistrategy “pod shop” hedge funds work these days. They typically charge “pass-through fees” to cover their expenses, including employee compensation. The investors get what they get. If what the investors get is too low for too long, they will demand their money back and the fund won’t be able to raise new money; this model is not really “ehhh keep whatever you want, have fun.” But it is a model that depends on the hedge fund managers having a lot of negotiating leverage with their clients. 

We have talked a few times about private credit’s funding model. One way to think about it is that a private credit fund has straightforward pass-through funding: Investors give the private credit fund money, the fund invests it in loans, the loans pay a return, and the investors get the returns minus fees.

But an important funding source for private credit funds is insurance companies, more specifically annuity companies. Like TWG, many big private credit managers own insurance companies and run large annuity businesses, which they invest in private credit (and private equity). You could collapse the two parts and say that actually private credit is (partially) funded by annuities. 

Often that is a fixed funding model, like bonds. The annuity company borrows money from retail investors, promising to pay them back their money with (say) a 7% return over (say) five years. It invests the money in private credit loans and earns (say) 12%, and it keeps the difference between 12% and 7%.

But not all annuities have fixed rates. Another model is a variable-rate market-linked annuity, along the lines of:

• The annuity company borrows money from retail investors, promising to pay them back their money with (say) a return equal to, say, half the return on the S&P 500 stock index minus 2% per year, floored at zero. Unless that’s too much. If it’s too much, the annuity company can adjust it down to the rate it thinks is fair.
• The annuity company invests the money in private-credit loans, earning (say) a 12% return.
• If the private credit loans do well, the annuity company keeps the difference between the 12% it earns and the half-the-S&P-minus-2% it pays to its annuity customers.
• If the private credit loans do less well, the annuity company says “actually we’re gonna pay you a quarter of the return on the S&P 500 minus 2%, that seems fairer.”

Here’s a Wall Street Journal story about indexed annuities:

When Sabrina Elliott inherited some money, her son-in-law helped her invest $40,000 in a product that dangled the prospect of stock-market gains with no risk of loss.

In exchange for locking up her money for 12 years, it promised returns tied to the market’s performance. One catch: The company behind the product, Aviva, could periodically lower the portion of market gains Elliott received. ...

In the first year of Elliott’s policy, 60% of her money earned returns tied to the S&P 500, minus a 2.9 percentage-point spread. In the policy’s seventh year, Athene lowered that share to 55%, then to 45% in the 11th year. The rest of the money grew at a fixed rate of 1%. ...

The 3.7% annualized rate she earned over the 12-year life of her annuity handily beat the 1.9% she would have gotten from Treasurys. But it paled next to the annualized return of 13% on the S&P 500, the index to which her annuity was linked. …

Indexed annuities were particularly attractive [to asset managers]. Payouts follow a relatively predictable timetable, and the policies typically last about a decade, compared with about three to five years for fixed-rate annuities. That gives asset managers flexibility to put the money into riskier, less-liquid private-credit investments like collateralized loan obligations or asset-backed securities.

If their investments do poorly, the insurer can cushion against loss by lowering the caps on policyholder gains, and if their investments do well they can fatten their profits the same way, said Larry Rybka, chief executive of Valmark Financial Group, which sells life insurance, annuities and investment products. 

If you’re an alternative asset manager, probably (1) your investments have some beta to the public stock market and (2) you think you’re a pretty good investor and will outperform the broad public index. Promising your customers the return on the public stock market — adjusted for the lower risk of your product — gives them an attractive product and also lets you keep all your outperformance. But it’s nice to have a little extra cushion just in case.

Well he’s very annoying, is my basic legal analysis. Like, imagine that the US Federal Trade Commission brought an antitrust case against a pharmaceutical company, “alleging an elaborate anticompetitive scheme to preserve a monopoly for [a] life-saving drug.” Imagine that the FTC won that case emphatically. What would the consequences be? The company might lose its monopoly or get shut down. The company, and/or its chief executive officer, might pay a big fine. The CEO might go to jail, or be banned for life from running a pharmaceutical company. 

But would the CEO be banned from tweeting about pharmaceutical companies? Would he be banned from owning 100 shares of a pharmaceutical company’s stock? Is that a normal thing? I don’t know. Seems a little extreme. But the FTC did bring that antitrust case against Martin Shkreli and his former company, Vyera Pharmaceuticals LLC, and in 2022 — while Shkreli was in prison for a somewhat unrelated securities fraud — a judge banned “him for life from participating in the pharmaceutical industry in any capacity,” specifying that “participating in the pharmaceutical industry” included “acquiring or holding” pharmaceutical company stock and “taking any action to directly or indirectly influence or control the management or business of any Pharmaceutical Company.”

He objected: What about tweeting? He argued that the ban “would infringe his free speech rights by prohibiting him entirely from, among other things, using social media to discuss the pharmaceutical industry.” So the judge specified that:

Shkreli’s public statements about a Pharmaceutical Company will be deemed an action taken to influence or control the management or business of any Pharmaceutical Company if Shkreli intended the statement to have that effect or if a reasonable person would conclude that the statement has that effect.

So Shkreli is not legally allowed to own pharmaceutical stocks, and he is not allowed to tweet about pharmaceutical stocks to “influence” their “management or business,” which is not quite the same as saying that he’s not allowed to tweet about pharmaceutical stocks, but which kind of has that effect. She wrote:

Shkreli has not expressed remorse or any awareness that his actions violated the law. … He has also denied that what happened here was egregious, arguing that the Plaintiffs have not proven that any patient died due to the price he set for Daraprim. He chose to not even attend the trial. [2] ..

This is an egregious case; death is not the only relevant metric. If a court sitting in equity is powerless to impose a lifetime industry ban to protect the public against a repetition of the conduct proven at this trial, then the public could rightfully ask whether its wellbeing has been adequately weighed. ...

There is no reason to believe that a narrowly crafted injunction will succeed in providing adequate protection against a repetition of illegal conduct. Shkreli has demonstrated that he can and will adapt to restrictions. With help at times from a contraband phone, Shkreli managed to control his company even from federal prison.

Shkreli’s anticompetitive conduct at the expense of the public health was flagrant and reckless. He is unrepentant. Barring him from the opportunity to repeat that conduct is nothing if not in the interest of justice. “If not now, when?”

I do think that the legal analysis here is something like “this guy is really annoying and we need to shut him up.” An appeals court agreed.

If I told you that Martin Shkreli has spent 20 hours a day for the last four years trading the stocks of pharmaceutical companies and tweeting about their management and business, would you be the least bit surprised? Bloomberg News reports:

The Federal Trade Commission and seven states started contempt proceedings against Martin Shkreli, the “Pharma Bro” who served almost seven years in prison for defrauding investors.

The FTC said in a statement Tuesday that Shkreli flagrantly and repeatedly violated a 2022 court order that banned him from the pharmaceutical industry. Since his release from prison in May 2022, Shkreli has been violating the ban by publicly trading in pharmaceutical stocks and broadcasting his opinions about companies in the industry, the FTC said.

Here are the FTC’s press release and the motion for contempt. From the press release:

Shkreli has publicized his order violations by livestreaming and posting on numerous social media platforms, including YouTube, X, and Reddit. The motion alleges that, while livestreaming his trades in pharmaceutical industry stocks, Shkreli told his viewers “I’m showing you how to trade and invest in biotech.” The motion further alleges that, in another livestream, Shkreli confessed his “magic trick”: “It doesn’t matter what trades I make because I can always find a couple of biotech stocks to smoke.” As alleged in the motion, Shkreli used his livestreams to wage multiple public campaigns to short certain pharmaceutical company stocks based on his prediction that their key clinical trials would fail. 

Sure. I wrote once, about another guy with a Twitter ban, that “‘contempt of court’ is a term of art, and it’s possible to be held in contempt of court without actually having any particular contempt for the court.” But, as with the other guy, one does get the sense that there is some actual contempt involved here.

I will say, a big part of these accusations is that Shkreli vocally shorted a lot of biotech stocks. “Shkreli has repeatedly described the tens of millions he has made on his infamous biotech shorts,” says the motion. Is that … actually forbidden? He’s not allowed to “acquire or hold” any pharmaceutical stocks, but shorting the stock doesn’t involve acquiring or holding it. (It involves acquiring a negative amount!) Is shorting a pharmaceutical stock and saying that the company “is lying about their data, like they have before” really a way “to influence or control the management or business”? Is the company going to change its strategy because a short seller is trolling it on Twitter?

The thrust of the accusations here is not that Shkreli is violating the court order by getting back into the pharmaceutical industry and doing anticompetitive things at the expense of public health. The thrust is that Shkreli continues to be very annoying about pharmaceutical companies on social media, and the FTC wants him to stop.

We talked yesterday about the legal dispute over Kalshi’s sports bets. Basically Kalshi and the US Commodity Futures Trading Commission argue that sports bets — sorry, sports event contracts — that trade on prediction markets are “swaps” under the US commodities laws, and therefore are subject to the exclusive jurisdiction of the CFTC. Therefore state gambling regulators can’t do anything about them, and Kalshi can offer sports bets to 18-year-olds, in states where sports betting is illegal, etc. Most states disagree and think that prediction-market sports contracts are obviously sports bets subject to state regulation. Several federal appeals courts have considered this question; two have ruled for states and one for Kalshi. The state that lost the last case (New Jersey) is asking the Supreme Court to consider the question, and several parties — other states, the National Football League, Gary Gensler — have filed briefs urging the court to side with New Jersey.

As I mentioned yesterday, one argument against Kalshi’s and the CFTC’s position is that, if sports bets are really “swaps” subject to exclusive CFTC regulation, then that means that all other sportsbooks are illegal. The basic rule is that you can’t offer “swaps” to retail customers except on a federally regulated exchange: You can sell swaps to retail bettors on Kalshi, but not on a state-regulated sportsbook. Therefore, if sports bets are swaps, then all sportsbooks are illegal and have been for 15 years, but nobody has noticed. That seems absurd. As Gensler’s brief says:

Congress and the CFTC (at least until the past year) did not behave as though Congress had made such a fundamental change. No one suggested that casinos had to shut down their off-exchange sports-betting operations. … If Dodd-Frank had preempted the states and tribes on sports betting, it would have been one of the biggest stories about Dodd-Frank at the time. But nobody ever mentioned it.

This point is obviously embarrassing for the CFTC, so embarrassing that last Friday it tried to fix it:

The Commodity Futures Trading Commission [Friday] published an Interim Final Rule that codifies the CFTC’s longstanding position that casino-style gambling products, including wagers placed on sportsbooks and casino games, are excluded from the “swap” definition.

“Casino-style gambling products are not derivatives,” said Chairman Michael S. Selig. “Just as the CFTC has done with respect to other products historically regulated by the states, the Commission today provides clarity regarding the limits of its regulatory remit by codifying the exclusion of casino-style gambling products from the ‘swap’ definition..”

Here is the rule, which is clearly motivated by the fact that Kalshi has lost some court cases:

In recent months, many have expressed concern that a natural, plain-text interpretation of the “swap” definition would necessarily encompass casino-style gambling products and, finding that consequence untenable, have diverged from the plain text of the statute. For example, the Sixth Circuit viewed sports event contracts as legally indistinguishable from casino-style sports wagers, and thus, it expressed concern that, if sports event contracts are swaps, any sports wager — including “every sports wager placed in a casino, on an online sports book, or between two friends at a bar” — would need to “take place on federal markets.” Indeed, the Sixth Circuit explained, a person would commit a felony by engaging in gambling off a designated contract market (“DCM”).

So the CFTC put out a rule saying, no, not that. Sports bets on sportsbooks are sports bets and always have been, but sports bets on Kalshi are event contracts. The rule draws an analogy to insurance: Insurance contracts typically pay out money “dependent on the occurrence, nonoccurrence, or the extent of the occurrence of an event or contingency associated with a potential financial, economic, or commercial consequence,” which is the statutory definition of a swap, but obviously insurance contracts are not commodity futures that have to be traded on an exchange. So the CFTC’s rules exempt insurance contracts from swap regulation, and now they exempt “casino-style” sports bets from swap regulation. Are Kalshi’s sports bets “casino-style”? No no no no no no no, why would you say that, what, look over there.

A reader pointed out that, in August, the CFTC “warned [prediction markets] that displaying pricing information in the ‘American’ odds format used by casino gambling bookmakers” is not allowed. So Kalshi can tell you that the Seattle Seahawks are trading at a 59% chance to beat the Denver Broncos on Thursday, but not that the moneyline is -144. Those things — 59% implied probability, -144 moneyline — mean the same thing. But style, apparently, matters.

Elsewhere in casino-style gambling, the Wall Street Journal reports:

Individual investors aren’t letting anything get them down these days.

Their fervor is showing up in frenzied trading of options, or contracts that allow holders to buy or sell a stock at a set price, by a certain date. Volumes in options tied to individual stocks have recently reached levels seen during the meme-stock mania of 2021, about $700 billion of notional volume a day, according to Carrick Lane, an investment manager specializing in options strategies. The prices of call options, which give the right to buy, have eclipsed levels seen during that time.

I think a lot about Robinhood Markets Inc. Chief Executive Officer Vlad Tenev’s appearance on Bloomberg’s Odd Lots podcast last year, in which he argued that retail investors should be able to buy stock in private companies because there are so many worse things they could buy:

You have access to so many things. You can just spend your money on Amazon and buy all sorts of trinkets that immediately lose value and depreciate. You can buy meme coins. So the idea that those classes of ways to spend your money are okay, but buying OpenAI or SpaceX stock, I think on its face, it’s illogical.

This is, I think, the master key to all of modern US retail financial regulation. “There is a lot of dumb stuff you can buy. Some of it is dumber than this stuff. Therefore you should be able to buy this dumb stuff.” 

“Asian capital is the fuel that feeds the US AI boom.” JPMorgan Posts Surprise Drop in Fixed-Income Trading Revenue. Goldman’s Equity Traders Post Big Haul as Credit, Rates Miss. Citi Fixed-Income Traders Post Higher Revenue as Rivals Miss. Wells Fargo Beats as Resilient Customers Curtail Loan Losses. CFTC Staff Were Told to Retract Analysis of Suspicious Oil Trades. Albertsons Wants $8 Billion From Kroger After Failed Merger. Getty Images to File for Bankruptcy, Go Private Via Koch Deal. Bumble to Delist in $1.3 Billion Deal With Ithaca Holdings. ‘Phantom’ Data Centers Are Demanding More From the Power Grid Than They Need. The Luxury Beverly Hills Condo Project Borrowing Money From Its Future Residents. Screenwriter Beats Wall Street on Inflation Bets From His Garage. The best gilets for finance bros. 

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You know what’s funny? There is a real legal dispute about whether Kalshi and other prediction markets should be allowed to offer sports bets without complying with state gaming laws. Kalshi and the US Commodity Futures Trading Commission take the view that (1) Kalshi is federally regulated by the CFTC, (2) sports bets are “swaps” under federal regulation, (3) federal regulation preempts state gaming regulation, so (4) buzz off, states. Many states disagree, and there has been litigation around the country. (We have talked about this several times.) Two federal appellate courts have sided with the states, but another has sided with Kalshi. The state that lost that last case (New Jersey) is asking the Supreme Court to review it, and last week 39 states filed a brief supporting New Jersey’s request. So did the National Football League. I assume that the Supreme Court will take the case. I have no idea what it will decide. I think this is a tough question, courts have disagreed on the answer, it is all pretty politically charged, the Supreme Court can kind of do whatever it wants, and I have no real model of what it will want. I could not tell you the probability that Kalshi will win and get to continue offering sports bets.

So, out of muscle memory, I fire up Kalshi to check that probability. “Supreme Court Will Rule Kalshi Sports Bets Are Legal, Yes/No,” where is it? But Kalshi doesn’t list that contract! [1] Here’s “A Kalshi Contract on the Legality of Kalshi Contracts,” by Joseph Grundfest:

This note proposes that Kalshi list a "Kalshi Sports Legality" contract indexed to the outcome of United States Supreme Court litigation addressing whether Kalshi's sports-indexed contracts are federally regulated in a manner that preempts state law. Kalshi has previously listed at least 16 contracts indexed to Supreme Court determinations. No rule or regulation prevents Kalshi from listing the proposed contract. The proposed contract would provide a market estimate of the probability that the Supreme Court rules that Kalshi's sports-indexed contracts are legal. The contract would thereby create valuable hedging opportunities for Kalshi investors. It would also create hedging value for Kalshi customers who might lose access to Kalshi markets. These hedging rationales are more substantial than rationales Kalshi presents to support other Kalshi contracts, such as contracts indexed to parlays or to specific in-game events, such as whether the first play in a football game leads to a touchdown.

I mean, sure, of course. You and I and Joseph Grundfest can propose sarcastic Kalshi event contracts, but Kalshi doesn’t have to list them. Hypotheticals!

1. If Kalshi listed this contract, and it traded in reasonable volume and showed a [90%][10%] probability of Kalshi winning, would that make it [more][less] likely that Kalshi actually would win? Would the prediction market implied probability affect the outcome? Would talented appellate lawyers look at the market and think “oh Kalshi is definitely going to [win][lose], so I should join [their][the other] legal team”? Would the Supreme Court justices, or their clerks, look at this market and think “ah, the smart money is that Kalshi will [win][lose], so that’s probably right?” People have concerns like this about prediction markets on elections: A prediction market showing one candidate winning might drive money and attention and support to that candidate and become self-fulfilling. And here is a Wall Street Journal article about the effects of prediction markets on juries: “If millions are wagered on the belief that a defendant will be acquitted,” it asks, “could that make a jury more reluctant to convict?” I don’t think that the Supreme Court exactly works like that, but on the other hand the Supreme Court, like an election or a jury, is a mechanism for aggregating the votes of several humans, so maybe it works a little like that. 
2. If it did work like that, and it showed a 10% probability of Kalshi winning, would Kalshi delist the contract? (Does the lack of this contract suggest something about its expected probability?)
3. If it did work like that, and it showed a 10% probability of Kalshi winning, could Kalshi, you know, buy a bunch of this contract and push its probability up?
4. All that aside, if Kalshi listed this contract, could it hedge its sports gambling risk by betting against itself on its own market?

Discuss!

I guess if I had to take a view on this case, I would say that Kalshi is the slight favorite. The CFTC does have broad jurisdiction to regulate financial derivatives, and its regulation preempts state law. In the olden days, many states thought that, like, wheat futures were gambling, and would ban them. Congress gave the CFTC the power to regulate wheat futures, and to preempt state gaming regulation of those futures. Over time, the CFTC expanded its jurisdiction to other, less obviously commodity-like financial contracts (interest-rate futures, stock index futures), with general acceptance. States don’t get to second-guess the CFTC’s decisions about allowing interest-rate futures or whatever, and they don’t get to apply gambling regulation to those futures. 

The theory of Kalshi and the CFTC is that the CFTC is the exclusive regulator of “swaps,” and that sports bets are a type of “swap” under the definition included in the Dodd-Frank Act of 2010. That definition is quite broad, and includes any contract whose payout “is dependent on the occurrence, nonoccurrence, or the extent of the occurrence of an event or contingency associated with a potential financial, economic, or commercial consequence.” The theory is that sports have potential economic consequences — your bar will sell more beer if your local team makes the playoffs, etc. — and so all sports bets are swaps, in the same way that bets on wheat prices or interest rates are swaps. Because they are swaps, they are exclusively regulated by the CFTC, and state law doesn’t apply. 

This is obviously annoying. The states’ brief says:

Prediction markets … claim to have discovered this no-state-law-applies escape hatch buried within a subsection of a section of a federal financial reform bill passed in the wake of the 2008 mortgage crisis. That bill — the Dodd-Frank Act — gave the Commodity Futures Trading Commission “exclusive jurisdiction” over specified derivatives, including financial instruments called “swaps.” Prediction markets say that classic sports bets — things like whether Joe Burrow throws three touchdowns or Ohio State beats Michigan — are not bets at all. They are actually “swaps” within the CFTC’s “exclusive jurisdiction.” So Ohio, New Jersey, Nevada, and any other State can do nothing to regulate those transactions.

The prediction markets are wrong. They cannot strip the States of their core sovereign power through relabeling and window-dressing. Our constitutional structure is much more durable than that. And the promise of federalism ensures that States do not lose their ability to protect their citizens so easily. Yet that is precisely what would happen under the prediction markets’ theory.

Gary Gensler, the former chair of the CFTC, also filed a brief pointing out that this is absurd; as he notes:

If Kalshi were correct that sports bets were swaps, then all off-exchange retail sports bets since October 2012 — in every state — have been illegal because persons other than “eligible contract participants” (‘ECPs’) were prohibited from entering into off-exchange swaps under 7 U.S.C. § 2(e).

We have discussed this point before: If you take seriously the argument that sports bets are swaps, that doesn’t just mean that Kalshi’s sports bets are exempt from state regulation. It also means that all sports bets are subject to CFTC (not state) regulation, and if they are not traded on CFTC-regulated exchanges then they are illegal. So all sportsbooks are illegal. (And they have been illegal since Dodd-Frank, long before Kalshi was even invented.) Gensler goes on:

Congress and the CFTC (at least until the past year) did not behave as though Congress had made such a fundamental change. No one suggested that casinos had to shut down their off-exchange sports-betting operations. Nor did the CFTC ask Congress for the staffing or appropriations to regulate sports-betting transactions after Dodd-Frank’s passage. …

Congress does not make fundamental changes in the balance of state and federal power in isolated snippets of text. As the Court has said, Congress does not “hide elephants in mouseholes.” … Preempting state authority over sports betting — an over $165 billion per year industry — has major implications for states’ power to protect their residents. It is not the kind of thing Congress hides in a subpart of a definition. If Dodd-Frank had preempted the states and tribes on sports betting, it would have been one of the biggest stories about Dodd-Frank at the time. But nobody ever mentioned it.

I find this argument very compelling as a policy matter and as an “oh come on of course sports gambling is not a commodities derivative” matter, but I’m not sure how compelling the Supreme Court will find it. The statute gives the CFTC pretty broad authority to decide what to allow, and for reasons of its own the CFTC has gone absolutely all-in on the theory that the US needs a unified national market for letting 18-year-olds bet on college football point spreads and in-game parlays. To me this seems obviously wrong, and not what Congress or anyone else voted for, but I am not sure it’s legally wrong. I would probably bet on Kalshi’s chances at even money. [2] If I could bet.

There is a business of residential utility customers selling electricity. Traditionally, if you have a house, you pay for electricity each month. But there are circumstances in which you might get paid. One, which we have discussed a few times, is called “demand response”: Your electric company might pay you for agreeing to turn off your air conditioning during periods of peak power demand, because using less power at those times is just as valuable to the grid as generating more power would be. Or if you have solar panels on your roof, you might sometimes generate more power than you use. Maybe your electric company will buy the extra power from you and send it where it’s needed.

These days, though, if you talk about demand for electricity, you’re probably talking about demand to power artificial intelligence computing. Hundreds of gigawatts of AI data centers are in the works, and AI data centers are measured in gigawatts in part because electricity is a critical limiting input. Big tech companies are getting into the nuclear power plant business, and permitting and building electric generation and transmission infrastructure is a big part of the AI boom.

And so surely in, like, a year there will be a residential utility customer angle? Some startup will be going door-to-door ringing bells and saying “hello, we will pay you $5 per month to let us put this Nvidia server rack in your basement and run it when you’re not home”? Just seems like the obvious next step in electric price arbitrage. Why should homeowners sell their power to the grid, when there is a high-profile specific urgent source of demand for that power? Why not sell their power directly to OpenAI?

I guess I’m kidding, both in the sense that an Nvidia server rack uses more power than most households and in the sense that putting one rack in thousands of houses is a lot less useful for AI workloads than putting thousands of racks in one data center. Still. I just think “let homeowners sell their power to AI companies” is close enough to a real thing that someone’s going to do it.

For now, the Information reports:

New York-based Xeal manages a network of thousands of EV charging stations, mostly in luxury apartment complexes and upscale retail and office buildings in about 500 cities across the U.S. and Canada.

Xeal CEO Nikhil Bharadwaj says the company’s charging stations are in use less than 10% of the time on average, although its utility contracts give it the right to charge cars 24 hours a day. That typically leaves Xeal with a humongous store of idle electricity—enough to power around 130,000 homes or 110,000 Nvidia AI chips around the clock. 

So the company is launching a service that will use that electricity to power AI chips. In December, Xeal will begin installing Nvidia AI server racks, housed within custom-made protective metal containers the size of a single parking space, next to chargers located in Chicago, Houston and Dallas parking garages. The power behind the chargers will instantly juice the racks, which will each contain roughly 48 Nvidia AI chips. …

Xeal’s advantage is its novel access to the grid. That’s attractive to AI data center developers who often face multiyear waits for grid connections and have turned to natural gas turbines and nuclear power, though those alternatives also face long delays. ...

Bharadwaj said he calls the owners of buildings using Xeal chargers and offers to pay them a rental fee to allow Xeal to install just one of the GPU containers in their garage. “How would you like your payback to be 2½ years instead of five,” he tells them. “No capex to you, no opex. I'll pay for all the power bills.”

If you signed long-term electricity contracts in 2020, you’ve got a valuable asset in 2026. Here’s its press release from last month:

Xeal today launched Laitent, the world’s first edge inference compute network using idle EV charging capacity. With one of the five largest Level 2 EV charging footprints in the U.S., Laitent will tap more than 200MW of permitted, installed electrical infrastructure across 1,600+ properties. …

“If you need inference compute today and can’t wait for a new data center to come online, Laitent can accelerate your timeline from years to months,” said Nikhil Bharadwaj, co-founder and CEO of Xeal. “Laitent is the fastest way to bring new compute online, tapping already permitted and grid-connected, yet idle energy capacity, located right where it's needed for ultra-low latency, with no water hookup requirements.”

AI training data centers can be anywhere, so they go where there is cheap land and good power, but AI “edge inference” should be “where it’s needed for ultra-low latency,” that is, close to where the customers are. [3] The customers are probably where the Teslas are.

There are two conflicting stories about private credit this year. One is that private credit is doing great. There are not a lot of defaults, the artificial intelligence boom is creating a lot of attractive new loans that pay high rates, and institutional investors are putting a lot of money into private credit funds.

The other is that business development companies — retail-facing private credit funds — are doing bad. Private BDCs, which do not trade on the exchange, are seeing large withdrawal requests, as retail customers want out. Public BDCs, which do trade on the exchange, tend to trade at large discounts to net asset value: The investors who own the BDCs don’t seem to think the loans are worth what the managers say they are worth.

One possibility is that the institutional investors are right, the retail investors are wrong, private credit is great and the BDCs are irrationally underpriced. Another possibility is that the institutional investors are wrong, the retail investors are right, private credit is in trouble and the institutional funds are irrationally overpriced. There are other possibilities along the lines of “actually the institutional funds and the BDCs have different holdings or structures or whatever so this comparison is wrong.”

There really ought to be a trade, though. Like, if institutions think that private credit is broadly worth 100 cents on the dollar, and if BDCs are broadly trading at 70 cents on the dollar, the institutions should buy the BDCs? Shouldn’t the gap be arbitraged away? Part of the problem might be that the gap is so wide — there is so much room for value creation — that you have to argue over who gets it. Should the institutions buy the BDCs at 100 cents on the dollar, because that’s what they think their loans are worth, or at 70, because that’s what the BDCs’ holders think they’re worth?

So we have talked about Boaz Weinstein bidding 70ish cents on the dollar for some BDCs and not getting much takeup. We talked in May about KKR & Co. putting some of its own money into its publicly traded BDC in a way that kind of split the difference: Loosely speaking, KKR put half its money in at market prices (like 58 cents on the dollar) and half of it at net asset value (roughly 100 cents on the dollar). We talked in March about Blackstone Inc. and its employees putting some of their own money into Blackstone’s private BDC at 100 cents on the dollar, which I thought was a generous of them. “The intellectually satisfying and potentially lucrative thing for Blackstone to do,” I wrote, “would be to say ‘hey, a lot of you want your money back, and we’d be happy to cash you all out, but at 90 cents on the dollar..’”

And a couple of times, I have suggested that private credit managers could raise institutional funds to buy out their own or their competitors’ BDCs at a discount. If you’ve got a public BDC trading at 70% of net asset value, and you can raise money at 100% of NAV, then buying out the BDC at 90% of NAV is a win for everyone.

Anyway Bloomberg’s Olivia Fishlow reported last week:

Private credit managers increasingly looking to offload battered funds are drawing interest from rivals eyeing cheap deals in one of the most turbulent periods for the $1.8 trillion market. …

Private credit managers have faced intense pressure this year, as investors pulled record amounts from nontraded funds and sold off shares of listed vehicles. Publicly traded funds including BlackRock Inc.’s beleaguered TCP Capital Corp., WhiteHorse Finance Inc. and Investcorp Credit Management BDC Inc. have said they’re weighing strategic options, which could include a sale. Apollo Global Management Inc.’s MidCap Financial Investment Corp. has also shopped its portfolio around, the people with knowledge said. …

A transaction can take several forms. A manager can buy a BDC through a merger or they can purchase the contract to run the fund. Other options include purchasing assets from the fund, which can allow the seller to combine what remains into an affiliated vehicle or simply return cash to investors.

And PitchBook reported:

Private credit manager WhiteHorse Capital is pursuing a credit secondaries transaction involving its publicly traded BDC that is set to move $680 million of private credit assets into a continuation vehicle, according to market sources.

The transaction would transfer all assets from the BDC, WhiteHorse Finance (Nasdaq: WHF), into a closed-end continuation vehicle backed by private credit secondaries investors, sources said. The continuation vehicle transaction will provide liquidity to WhiteHorse investors and lead to the delisting of the public BDC, which trades below its book value.

Bids for the continuation vehicle, which primarily includes first-lien direct-lending assets, are in the high 90s, sources said.

WhiteHorse Finance’s reported net asset value is $11.77 per share, and it trades at about $7.02, or about 60 cents on the dollar. So the high 90s would be more.

Sure!

Robinhood’s conference for active traders is the largest of the brokerage’s annual events. For two days in September, hundreds of everyday investors descend on a conference center in cities like Miami, Las Vegas and Houston to attend training sessions, swap trading tips and swarm the open bar. …

“The trend is always going to be up and to the right,” said Sara Brescia O’Rear, a former pharmacist who retired in her 40s thanks to her investing success. “I’m willing to take on risk because I know it can pay off.” …

In 2024, Colin Edsman bet half of his savings on a stock trading for less than a dollar a share. A year later, the company, mineral provider United States Antimony, saw its share price climb into the double digits. … “I’ve never relied on luck,” he said. “I figured I could make my own.”

It’s tempting to be like “probably if you lost money day trading on Robinhood you wouldn’t go to the convention,” but I’m not actually sure that’s true? Like, you might go to get some tips to stop losing money. Or you might delude yourself into thinking that actually you’re winning. Or you might take some pride in how much you’ve lost and want to go brag to your buddies. Anyway if I ran this convention I’d have a panel for the year’s biggest losing traders, but it looks like they don’t.

This is occasionally a puzzle hunt newsletter, and this weekend Midnight Madness was held in New York. (Here’s a Bloomberg Markets Magazine story about last year’s edition.) I was not able to play this year, but congratulations to Midnight Marauders, this year’s winning team.

Goldman’s $2..3 Billion Deal Puts Tax-Smart ETFs Under Scrutiny. It’s a Tough Time to Launch a Hedge Fund. Lone Pine Erases 44% Gain in Brutal Quarter on Poor Stock Bets. HSBC Moves to Wall Street Bonus Model, Cuts Fixed-Pay Deals. Wall Street’s record-breaking trading streak set to cool. Nvidia in talks to acquire US ‘open’ model start-up Reflection AI. Trump’s AI Liability Push Opens Blame Game for Models Gone Rogue. AI’s Supercharging a Scam Economy Bigger Than the Cocaine Trade. A.I. Music Fraudster Who Drew Millions in Royalties Is Sentenced to 18 Months. (Earlier.) A Credit-Score Shift at Fannie and Freddie Is Shaking Up the Mortgage Market. A New Type of Mortgage Is Reviving Long Abandoned Neighborhoods. Former Morgan Stanley CEO Lists Converted N.Y.C. Carriage House for $80 Million. Tesla Faces US Probe Over Claim of Robotaxis Speeding in School Zones. Anthropic’s Rogue AI Filled Out U.S. Visa Forms, Gave False Homicide Tip to Police. McKinsey Strips Partner of Leadership Role After LinkedIn Posts.

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This week’s episode of the Money Stuff podcast is out now, a guest episode in which I interview Jeremy Maletz, head of prediction markets at Susquehanna International Group. We discuss hedging goat herder risk, flow versus bespoke trading, event contract margining, election factor hedging, adverse selection, correlation in prediction markets, and transitioning from sports gambling to trillion-dollar data center credit derivatives. You can listen to this week’s episode here:

You can get Money Stuff: The Podcast at Apple, Spotify or wherever you get your podcasts. We’d love your feedback. You can email us at moneypod@bloomberg.net.

What is the best way to get economic exposure to Anthropic stock right now? There are bad answers (expensive SPVs, fake SPVs). Here are two arguably good answers:

1. Just own Anthropic stock.
2. Own perpetual futures on Anthropic stock on Hyperliquid.

The first answer is pretty self-explanatory. Anthropic has stock, and people own it, and owning it gives you economic exposure to Anthropic stock. There are problems. Not just anyone can own Anthropic stock. It is a private company, and its shares do not trade on an exchange. You more or less need to get the stock from Anthropic, so this approach requires you to be an employee or a venture capital investor in one of its funding rounds or an effective altruist hedge fund manager. For most of us, that rules out this approach entirely. But there is another problem, even if you can get the stock. The other problem is that Anthropic stock is fairly illiquid. [1] You can’t easily sell it, until it goes public. Owning the stock gives you economic exposure to the stock, but you don’t get to decide how long you keep that exposure. And you don’t really know its price. So you do have economic exposure to the stock — if it goes up, your stock is worth more — but you don’t necessarily know how much.

The second answer is weirder. Hyperliquid Labs runs a leading platform for trading perpetual futures contracts. Traditionally perpetual futures are a crypto thing, a way to make levered bets on cryptocurrencies, they have expanded into stocks and commodities. Kalshi launched an S&P 500 futures contract and is working on perpetual futures for individual stocks. Perpetual futures contracts are basically bets on prices: One person goes long, one person goes short, the short pays the long if the stock goes up, and the long pays the short if it goes down. A perpetual futures contract on an individual public stock is just a levered bet on that stock, and by arbitrage it will closely track the price of the underlying stock. If SpaceX stock trades at $167.60, and SpaceX perpetual futures trade at $165, arbitrageurs will buy the futures and sell the stock until the prices are in line, etc. [2]

But perpetual futures on private stock have no arbitrage mechanism to make the price correct. If Anthropic perpetual futures trade at $120, while Anthropic’s stock is at $100, arbitrageurs cannot sell the futures and buy the stock until the prices converge: They can sell the futures, but they can’t buy the stock. [3] Also, how do you even know that “Anthropic’s stock is at $100”? Anthropic doesn’t trade liquidly or publicly, so you don’t know its price from minute to minute, the way you know the price of the futures. [4]

Also, these perps are pretty obviously illegal in the US: Under US securities law, you can’t sell bets on a company’s stock unless that company has registered its stock with the Securities and Exchange Commission (i.e., gone public). So these are a non-US product. Coinbase offers “pre-IPO perpetual futures,” but only outside of the US. Polymarket offers bets on private companies’ stocks, but again only outside the US, heh heh heh. Robinhood too. And Hyperliquid “blocks US users as per industry practice, but anyone can trade on the blockchain that powers it.” [5]  

So an Anthropic perpetual is a bet, on a weird offshore crypto betting platform, on the price of Anthropic stock. This does not sound like a great way to get economic exposure to Anthropic stock. It’s just that, empirically, it kind of is? We talked about Hyperliquid pre-IPO perpetual futures on SpaceX back in June, when SpaceX was going public; the perps did a good job of predicting the first-day price of SpaceX. I quoted TD Securities analyst Reid Noch, who described perpetuals like this:

A pre-IPO PERP has no public stock price to reference because the company has not listed yet. Instead, the market prices themselves are solely based on supply and demand. Once the stock begins trading, the contract can then anchor to the listed equity price. Until that point, it acts more like a leveraged, continuous prediction market than a substitute for owning the stock..

SpaceX was not Hyperliquid’s first success; Noch cited another pre-IPO perp, on Cerebras:

Hyperliquid largely predicted the post-IPO pop without offering true exposure to the underlying stock and without a public reference price to anchor the contract. Traders did not own Cerebras shares, receive IPO allocation rights or have any claim against the issuer. They were trading a cash-settled derivative on where the market believed the stock would open.

This is a little unsettling. It is not obvious that bets on an offshore crypto platform would give you any economic exposure to Anthropic. There’s no, like, theoretical reason for those bets to be right. They could be way off. It’s just that often they are right.

So that’s not great. But in other ways the perps are better than owning the stock:

1. Anyone can buy perps. I mean, not anyone; they are technically off limits in the US. But in crypto that tends to be a pretty soft suggestion. (Not legal advice!) And you don’t need Anthropic’s permission.
2. They offer constant liquidity and price discovery. You always know the price of your perps, and you can sell them any time.

And so it is plausible that, for at least some investors, the actual best way to get economic exposure to Anthropic stock is on Hyperliquid. (Not investing advice!) Like, the ranking might be Hyperliquid perps first, actual Anthropic stock second. I feel like people will be mad at me for saying this, and they will be correct. I am mad at me for saying this. It shouldn’t work. Obviously once Anthropic goes public, owning the stock is better. [6]  But for now, the perps have some appeal.

In particular, if you are an exchange-traded fund, perps might be better than owning actual private-company stock, for several reasons:

1. ETFs trade on the stock exchange. The price of an ETF share tracks its net asset value per share. An arbitrage mechanism (called “creation/redemption”) ensures this: If the NAV is $20 per share, and the ETF is trading at $21, arbitrageurs can buy a basket of the underlying assets for $20, deliver it to the ETF, get back an ETF share and sell it for $21. This works great when the ETF is a basket of public stocks: Arbitrageurs can easily trade the underlying stocks against the ETF to make sure that the prices stay in line. It works less well when the ETF is a basket of private stocks, since arbitrageurs can’t trade those. But you can trade perps all day long, no problem. Deliver some perps, get back ETF shares, done.
2. Similarly, the ETF will want to report its net asset value per share. If it owns private stock, it may have a hard time getting a reliable price on that stock from day to day or minute to minute. If it owns perps, easy peasy.
3. There is a classic “liquidity mismatch” worry with ETFs: ETF investors can take their money out at any time, which is bad if the ETF’s assets are less liquid than its (very liquid) shares. If an ETF owned a ton of Anthropic, and everyone asked for their money back, it would be a mess: How could the ETF sell the illiquid restricted Anthropic shares? [7]  The perps are more liquid.

Of course most ETFs do not even aspire to hold Anthropic stock; they track a public stock index, not private companies. But if you did build an ETF that held Anthropic, there would be demand. [8] And if you were looking to do that, you might want to build it with perpetual futures rather than with actual Anthropic stock. Sure sure sure, your ETF wouldn’t actually have any Anthropic stock, and there’s a risk that the perps would end up being a poor proxy for that stock. But, for now, the perps have nicer technical properties than the actual stock.

Behold MN, the Corgi MANGOS ETF:

Concentrated actively managed exchange-traded fund that offers investors exposure to OpenAI and Anthropic, two private companies in artificial intelligence, alongside Meta Platforms, NVIDIA, Alphabet (Google), and SpaceX. MANGOS is an acronym formed from the first letter of each of the six companies' names.

It started trading last week. It closed yesterday at $26.12, versus a reported net asset value of $26.26. It reports $68.4 million of assets under management, 5.25% of it in Anthropic and 5.12% in OpenAI. (The rest is in big public AI companies, plus some cash.) Where does it get its Anthropic and OpenAI? Oh yes:

For privately held companies, including OpenAI and Anthropic, the Fund expects to use swaps and/or eligible SPVs rather than direct purchases of private-company shares. Following a public listing, the Fund may use listed shares and financial instruments, including swaps. ...

Private-company swaps are expected to use reference pricing derived from perpetual futures contracts referencing the applicable company. ... A perpetual futures price may differ materially from the value of the company’s shares. The Fund does not itself hold perpetual futures or maintain an account with, or post collateral to, a perpetual futures venue under this strategy.

“At the moment,” tweeted Corgi Invest Chief Investment Officer Jeff Weniger, “the exposures to those two are via total return swaps on the perpetual futures,” [9] and the replies are extremely enjoyable. Economically, the ETF owns perpetual futures on OpenAI and Anthropic, but in practice US ETFs tend not to trade on offshore crypto betting platforms directly, so instead Corgi enters into total return swaps on the perps — a further bilateral bet — with some less regulatorily constrained trading firm. We have discussed a proposed sports gambling ETF which would do the same thing: It would make sports bets on Kalshi, but for legal purposes it would do those trades on swap through an intermediary. The ETF holds a normal-ish financial instrument, an over-the-counter swap with a bank or trading firm. The swap counterparty owns the weird stuff.

Should a US listed ETF, available to retail investors, contain bets on private-company stocks made on weird offshore betting platforms? Well! I mean! Have I mentioned the sports gambling ETF? 

I … find myself hating this less than I should? This is … financial innovation? We have discussed Corgi before, because it launches lots of oddball active ETFs; “the spaghetti cannon is firing wildly right now,” someone once said. This one is a little insane, yes, but I see how they got there.

Nothing in this column is ever investing advice, especially not any of this. If you come to me and say “I bought that MANGOS ETF because you told me to” I will smack you. I did no such thing! I just appreciate comedy in financial engineering, and we’re getting a lot of it these days.

A big theme around here is that banks are re-tranching. In the olden days, banks did some risky economic activity. In 2026, banks probably do (1) less of that risky economic activity but (2) more lending to other companies that do that activity. The banks have moved up in seniority: Instead of direct exposure to some economic risk, they have some senior claim on some other company that takes the economic risk. If the risk goes bad, the other company takes the first loss; the bank only loses money if the risk goes really bad.

A lot of this is about private credit: In the olden days, banks would make loans to companies and credit-card customers and what have you; now, private credit funds make some of those loans, but the banks make loans to the private credit funds. Instead of a bank lending $100 to companies, the bank will lend $50 to a private credit fund, which will use that $50 and $50 of its investors’ money to make $100 of loans to companies, etc.. 

But a lot of it is about trading. Twenty years ago, the “trading” business of a big investment bank mostly did trading: It would buy and sell stocks and bonds and derivatives, making money by buying low and selling high. Now, the “trading” business is increasingly a lending business: The bank lends money to hedge funds and proprietary trading firms, so that they can buy and sell stocks and bonds and derivatives. And the hedge funds and proprietary trading firms increasingly fill the economic roles that used to be occupied by banks. A couple of years ago, I wrote:

The simple, crude, overstated model is: In 2004, a bank’s trading division was in the business of trading with the bank’s money. In 2024, a bank’s trading division is increasingly in the business of lending the bank’s money to hedge funds, which do the trading.

That keeps being more true. The Financial Times reports on the continuing rise of prime brokerage:

US banks are generating record trading profits. But they are not the ones doing the trading.

Firms such as Jane Street and Citadel have aggressively expanded into banks’ traditional turf, dominating the core business of market making as well as placing big bets on market moves. But their insatiable demand for financing to juice those trades has made them irresistible clients for lenders and a powerful engine for profits.

In market making, “banks are struggling to compete”, said Mike Webb, Barclays’ global head of liquid financing. “But financing is a thing that banks do and there is a big moat around it.”

The moat is built on credit lines that lenders provide to trading giants that run into trillions of dollars. Hedge funds’ borrowing from banks has tripled since 2020, and the revenues from financing have turned prime brokerage into one of Wall Street’s fastest-growing businesses. …

Much of the speculative trading that once used to take place on banks’ prop desks migrated to the hedge fund industry, while market making — a lower-risk activity — became the purview of high-frequency trading firms and later specialist market makers. …

Prime services revenues will have leapt from 10 per cent of banks’ equities revenues in 2005 to about 38 per cent this year, according to Coalition Greenwich — and those figures exclude the vast derivatives services banks provide.

The basic tradeoff with all of this re-tranching stuff is that the banks get a more senior claim on the economic activity, but they have less control over it. A bank that owns a bunch of stocks and bonds has more direct market risk than one that just lends a lot of money to Jane Street, but a bank that lends a lot of money to Jane Street has less ability to manage that market risk. To some extent you have to trust Jane Street:

Because the managers are sophisticated players with hundreds of trading teams across a spectrum of asset classes, they have an inbuilt diversification and level of risk management that has allowed banks to justify ratcheting up their lending.

Webb at Barclays said: “An institutional-quality hedge fund or asset manager is a sophisticated organisation with a liquidity-management function that reports directly to the founder.”

One other point about this re-tranching. I have often argued that the rise of private credit basically makes the financial system safer. Banking is inherently risky: Banks get a lot of their funding from deposits, which could be withdrawn at any time, and use those deposits to make long-term loans. Private credit funds are a safer form of narrow banking: They raise long-term locked-up equity financing from investors (mostly!), they take out term loans from banks, so they have less funding risk. A migration of lending activity from banks to private credit probably makes the financial system safer, though there are counterarguments. 

Traditionally you would not have said the same thing about prime brokerage. Traditionally, hedge funds and proprietary trading firms got a lot of their financing from their prime brokers in quite short-term forms: Banks gave them margin loans that had to be repaid if they lost money, and the prime brokers tended to have a lot of flexibility to withdraw financing, change margin terms or demand more collateral if they got nervous. A migration of trading activity from banks to hedge funds would not make the financial system any safer. The banks’ funding model — with loyal depositors, with access to the lender of last resort, etc. — was probably more robust than the hedge funds’ model.

But that’s shifting a bit, the FT notes:

The growing scale of a few clients at the top of the industry has also shifted the balance of power, according to people familiar with industry practices, with clients pushing for far more favourable lending terms.

Lock-up terms, the length of time a prime broker commits to providing financing before it can withdraw credit, have gradually lengthened.

Commitments that typically lasted two weeks went up to 30 days, stretched to three months and more recently to half a year for some of the industry’s most coveted clients. That means a bank cannot cut back its financing or demand more margin than agreed at the start of the contract without giving increasingly lengthy notice.

If big hedge funds and proprietary trading firms are systemically important traders, they need to have some long-term locked-up funding.

We have talked a few times about systematic investing strategies in prediction markets. They all have this basic thesis:

1. People like a gamble. That is why they are on prediction markets.
2. Betting on longshots is more fun — more of a gamble — than betting on sure things. It’s more fun to bet a little bit of money to have a small chance to win a lot of money than it is to bet a lot of money to have a large chance to make a little bit more. It’s more fun to bet on the underdog than the favorite in football. It’s more fun to bet on the imminent return of Jesus Christ than it is to bet that the next year will, eschatalogically speaking, resemble the previous 2,000 years.
3. Therefore, the gamblers on prediction markets will predictably favor longshots. They will buy more of longshot contracts, pushing up the prices (and market-implied probabilities) of those contracts. If something has a 2% true probability of happening, people will buy it, so the Yes contract will trade at like 5 cents on the dollar and the No contract will trade at like 95.
4. Therefore, if you systematically sell longshot contracts, you will predictably make money. Sometimes you’ll lose money — things with 2% probabilities happen 2% of the time — but those times are infrequent and basically uncorrelated. You can buy 100 different No contracts for $95; two of them (2%) will lose, but the other 98 will pay off at $1, and you’ll make $3.
5. Perhaps this is all rational, and you are getting paid a sensible insurance premium for taking on some sort of tail-event risk. (Maybe all the correlations go to one if Jesus Christ does return.) Or perhaps — surely? — this is a behavioral bias of actual prediction-market participants, and you are getting paid for taking the other side of mass gambler irrationality.

We have discussed various forms of this basic strategy, including:

• Selling sports parlays;
• Betting on extreme favorites in sporting events;
• Betting that Donald Trump-related events won’t happen; or 
• Just betting that events in general won’t happen. 

In each case, someone has found evidence that the strategy works. The meta-strategy of “prediction market gamblers overestimate the probability of weird stuff, so bet against weird stuff” is psychologically plausible and also often works. Not investing (or whatever this is) advice.

Bloomberg’s Carolyn Silverman and Denitsa Tsekova provide more evidence:

Pore through the reams of bets made on Polymarket and Kalshi and a clear pattern emerges: bettors flocking again and again to money-losing longshot wagers.

To this crowd, the sites aren’t the truth machines that their billionaire founders claim, converting millions of carefully considered wagers into precise forecasts of real-world events that will, in turn, inform decision-making by businesses and investors across the globe. No, for many customers, these markets look more like a casino crossed with an arcade, open 24/7 and capable of serving up a never-ending buffet of nearly impossible bets that maximize the dopamine rush even as they minimize the financial returns.

Since the start of 2025, around half of all trading volume on Kalshi, the largest prediction market platform, has involved one side chasing potential returns of at least 1,000% betting against mostly sophisticated traders and market-making firms on the other side, a Bloomberg News analysis of over a billion transactions shows. In recent weeks, that percentage has climbed even higher, up to more than 65%, as bettors piled into sports combination wagers, known as parlays, in pursuit of big scores.

On Polymarket International, which, unlike the firm’s US entity, has a public ledger of trading data, the figures are similar. Those trades on unlikely outcomes — such as the likelihood of Jesus Christ returning to Earth or LeBron James winning the US presidential election — accounted for 52% of all volume over the past 21 months. …

For the firms and traders willing to stake the capital and offer up those long odds, the wagers have churned out a flow of steady, albeit modest, profits. For the bettors taking those odds, though, the losses are piling up. Sure, they hit a 40-1 shot every once in a while, as on traditional sportsbooks, but not at nearly a high enough rate to offset all the losing bets they make.

Yes. Look. Obviously. Prediction markets are casinos. The interesting thing about them is that they are all-to-all casinos: For every trader who wants a fun gamble, there is a (probably better capitalized) trader on the other side offering the fun gamble. Some people are buying fun, and other people are selling fun for money.

Elsewhere: “NFL tells Supreme Court prediction markets are gambling, not investing.” Yes everybody knows this! A lot of people pretend not to.

A reader sent me this Instagram Reel/YouTube short from a Malaysian food influencer who claims he bought 100 shares of stock of a public company, for about $18 total, in order to get access to its annual shareholder meeting, which serves a free buffet. “You buy share for profit, I buy share for huge chunk of meat, we are not the same,” he says. The stock is down about 3% since the annual meeting, so the lunch cost him about 50 cents. He says the food isn’t that good. I don’t know that this is a great trade but it’s a funny video.

Goldman’s Top Leaders Set to Score More Than $500 Million With Special Bonus. When 20% of Profits Won’t Do, Fund Managers Seek ‘Super Carry.’ Oracle, Broadcom and SpaceX Seek Blockbuster Debt Deals to Pay for AI Chips. Tiger Global Poised for $5 Billion Windfall From OpenAI Bet. SpaceX credit risk jumps on worries over its borrowing spree. Nvidia-Backed IPO’s Cratering Demand Sends Warning on AI Funding. The AI Price War Is Heating Up — and OpenAI Is Gaining Ground on Anthropic. Partners Group Gets Creative to Fix Funds Hit by Redemptions. Wells Fargo Faces Regulator Probe Over Efforts to Boost Black Homeownership. Big investors ‘bottom fish’ in Eurozone bond markets after France sell-off. Ellisons Invest About $17 Billion in Warner Bros. Takeover. Miami Developer Gains $1 Billion Windfall From Griffin’s Real Estate Buy. Wise to pay customers’ tax bills after errors. AI upends Singapore’s ‘quant Olympics.’ AI agent spam phone calls.

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US securities laws have rules restricting activist shareholders. The main ones are:

1. If you acquire more than 5% of a company’s stock, and you plan on “changing or influencing the control” of the company, you have to promptly file a disclosure on Schedule 13D setting out your plans, your source of funds, etc. If you are a passive investor without any interest in changing or influencing control of the company, you can file a shorter, less detailed Schedule 13G. So if you are an activist hedge fund looking to run a proxy fight, and you go over 5%, you have to file a 13D; if you’re a normal mutual fund, you probably file a 13G. The point of the 13D is to alert the company, and its shareholders, to the fact that an activist is involved in its stock.
2. If you team up with another investor — “when two or more persons act as a partnership, limited partnership, syndicate, or other group for the purpose of acquiring, holding, or disposing of securities of an issuer” — you are considered to be part of a “group.” If you’re in a group, your shares are added together for securities-law purposes: If you own 3% of the company’s stock, and I own 3% of the company’s stock, and we agree to do an activist campaign together, then we form a group that owns 6% of the stock. So we need to file a joint Schedule 13D, disclosing that we are a group and own 6% of the shares.
3. If you go over 10% of a company’s stock, you are restricted from trading the stock: If you buy stock and quickly sell it at a profit, you might have to give up those profits. (These are the “Section 16 short-swing profit rules.”) If your group goes over 10% of the stock, everyone in the group is subject to short-swing profit rules.

This stuff is pretty vague. What does it mean to “change or influence the control” of a company? There are some obvious cases: If you are an activist hedge fund planning to run a proxy fight to replace the board of directors, or a potential buyer planning to launch a hostile takeover offer, you clearly want to change or influence the control of the company and you have to file a 13D. But if you are a regular old mutual fund that would never launch a proxy fight, you still might want to occasionally meet with the managers of the companies whose stock you own. In those meetings, you might ask questions and suggest ideas; you might say “hey I think you should expand the widget business and cut back on the sprockets,” or “man I did not like your last ad campaign,” or “what are you doing about climate change?” Are those efforts to “change or influence the control” of the company? Historically the answer has mostly been no; historically, everyone has assumed that 13D is for classic activists (who wage proxy fights), and that mutual funds can use 13G while still talking to companies.

The US Securities and Exchange Commission has given some guidance on these questions. Generally you can express your views to management, but “Schedule 13G would be unavailable if a shareholder engages with the issuer’s management to specifically call for the sale of the issuer or a significant amount of the issuer’s assets,” for instance, and “a shareholder who … exerts pressure on management to implement specific measures or changes to a policy,” by threatening not to vote for the board, “may be ‘influencing’ control over the issue”.

What does it mean to be a group? It doesn’t require a written agreement, and when two activist hedge funds informally team up to push a company in the same direction, they will often be accused of forming a group. On the other hand, if an activist hedge fund runs a proxy fight at a public company, what that means is that it will:

1. Propose new candidates for the company’s board of directors;
2. Call up other shareholders — index funds, mutual funds, etc.. — and ask to talk to them to explain why they should vote for its candidates rather than the current board; and
3. Send out proxy cards for shareholders to fill out to vote for its candidates.

If a mutual fund takes a call from an activist hedge fund, listens to its arguments, says “you know what, you’re right, you’ve got my vote,” and then fills out a proxy card to vote for its candidates, does all that make it part of a “group” with the activist? Of course not; that would be absurd. But there are gray areas. What if it talks to the activist fund a lot? What if it encourages the activist? What if it casually mentions to an activist hedge fund “hey, we’re big shareholders of Company X and they could really use a proxy fight, if you’re bored”? What if it calls other mutual funds and says “we just met with an activist in Company X and they make some really good points?” Gray areas. Again there is some guidance: A shareholder is allowed to discuss “its views on a particular topic and how those views could inform its voting decisions” with an activist, but there’s probably some point at which it could go too far and become part of a group. [1]

Most big institutional investors never want to file a Schedule 13D or be part of a group with other investors. In particular, the “Big Three” asset managers — BlackRock, Vanguard and State Street, who run a lot of index-fund money and own large percentages of every public company — really do not want to be 13D filers. Here are some reasons for this:

1. Being a 13D filer suggests hostility to corporate management, and big asset managers prize having good relationships with corporate managers. They are competing to manage the companies’ pension plans, they like to be able to exert subtle influence on the companies’ policies, they like to send out thought-leadership-y open letters to CEOs: Being cast as proxy fighters would be bad.
2. There are a lot of legal regimes that restrict “active” investors, in some sense, but make exceptions for “passive” investors. Antitrust law scrutinizes acquirers of large chunks of corporate stock, but exempts passive investors. Banking regulation restricts the financial activities of large shareholders of banks, but exempts passive investors. These legal regimes are not the same as the Section 13D rules; it’s not like being a 13G filer automatically makes you a passive investor for bank or antitrust regulation, or vice versa. But they are related, and these days there is a lot of suspicion of the Big Three’s passivity. If BlackRock had to file Schedule 13Ds for all of the companies it owned, that would make it harder to argue that it should be exempt from antitrust or banking restrictions. Being treated as an affiliate of every bank would be quite bad for BlackRock.
3. If the Big Three were a “group” with respect to some company, that group would almost certainly own more than 10% of the company’s stock. (The Big Three, among them, own about 22% of the stock of the S&P 500.) This would trigger the Section 16 short-swing profit rules and restrict their ability to buy and sell stock: If BlackRock was in a 22% ownership group, and it bought some of the company’s stock one week and sold it at a profit the next week, it would have to hand the profits back to the company. That is a big problem for BlackRock, in part because it would be a problem for any asset manager (limiting its flexibility) but in part because BlackRock is not entirely free to make its own investing decisions: If it gets inflows or outflows, or if an index changes, its index funds will mechanically buy or sell stock to reflect those changes.

When I say that “these days there is a lot of suspicion of the Big Three’s passivity,” I am especially referring to their environmental, social and governance records. For a long time, big asset managers — particularly BlackRock — talked a lot about ESG investing: Climate change is a real risk, customers wanted to do well by doing good, and there was a marketing benefit for asset managers who talked about ESG. But now Republicans are in power in the US, they do not like ESG, and ESG does not sound especially passive. “You go to every company and tell them to cut down on their emissions, or else”: That does sound like trying to influence the companies. “You go to every coal company and tell them to cut down on their coal production” sounds kind of like an antitrust problem! And it does not help that many asset managers, including BlackRock and State Street, joined Climate Action 100+, “an investor-led initiative to ensure the world’s largest corporate greenhouse gas emitters take appropriate action on climate change in order to mitigate financial risk and to maximize the long-term value of assets.” (They quit in February 2024, when the winds shifted.) “What do you mean that you teamed up with other investors to pressure all the companies to reduce their greenhouse gas emissions, that sounds like an agreement in restraint of trade,” etc.

I tend to think that a lot of this stuff is (was?) pretty vague and aspirational. BlackRock has, like, stewardship meetings and open letters telling companies to care about the environment, but it’s not clear how effective that is or how much control it actually has.

But there’s one big exception! Back in 2021, an activist hedge fund called Engine No. 1 ran and won a proxy fight at Exxon Mobil Corp., winning some board seats with plans “to push the crude driller to diversify beyond oil and fight climate change.” Engine No. 1 was a pretty small firm, and Exxon is a giant company, so this was an impressive win. I wrote at the time:

My Bloomberg Opinion colleague Conor Sen tweeted yesterday “a better way of thinking about things is Engine No. 1 persuaded Blackrock et al to make a change at Exxon, one of many companies they collectively control.” And I think that is right insofar as Engine No. 1 owns 0.02% of the stock and, to win this proxy fight, had to get big institutional investors on board with its plans. (Though that is true of most proxy fights, where the activist and management each put a lot of effort into courting the big institutions.)

But I also think it is a little backwards, in the sense that you don’t really need to persuade BlackRock that the oil companies in its portfolio should focus more on renewables and sustainability. BlackRock is really into that sort of thing! I’m sure that at every meeting, it tells Exxon “hey you should focus on renewables and sustainability.” The problem is that BlackRock couldn’t make a change at Exxon, that it doesn’t, exactly, control Exxon in a strict practical sense: It has a lot of votes, but most shareholder votes are nonbinding, and a determined board and management can ignore shareholders for a long time. What Engine No. 1 really did was give BlackRock et al. the opportunity to exercise control of Exxon; it launched a proxy fight that allowed a binding shareholder vote on Exxon’s direction. I think of this more as “Engine No. 1 gave BlackRock what it wanted” than “BlackRock gave Engine No. 1 what it wanted,” though of course both are true.

BlackRock, in its heart of 2021 hearts, wanted its portfolio companies to do more about climate change, and said so. But BlackRock was not in the activist-hedge-fund business. It was not going around filing Schedule 13Ds and running proxy fights at public companies. But was it voting with activists to do more about climate change? Sure, if the opportunity arose. As far as I can tell, Exxon in 2021 was the only time the opportunity ever arose; there are not a lot of climate-change-focused proxy fights.

But here in 2026, you might ask: Did this make BlackRock activist? BlackRock owned 6.7% of Exxon at the time (Vanguard owned 8.2% and State Street 5.7%) and filed a Schedule 13G. But if you take my loose characterization in that block quote literally, you might say: “Well, BlackRock wanted to change the direction of Exxon. Engine No. 1 magically appeared with a proxy fight that made that happen, and BlackRock gleefully went along. It’s a stretch to say that BlackRock didn’t have any intention to change or influence control of Exxon. In fact, it’s a stretch to say that BlackRock didn’t have any understandings with Engine No. 1, and with other ESG-curious asset managers, about the proxy fight. Really, when you think about it, they should all be 13D filers and all treated as a group.”

And then there’s Climate Action 100+! BlackRock and State Street had signed on to be members of a formal organization “focused on engaging 168 of the largest corporate greenhouse gas emitters to reduce emissions.” Didn’t that make them a bit of a group? Particularly at Exxon, where there was a proxy fight pushing the company to reduce emissions. Didn’t BlackRock and State Street have something of an understanding, with each other and with Climate Action 100+ and with Engine No. 1, about how they would vote?

I don’t know that I particularly believe any of that, but you know who does? The US Securities and Exchange Commission. [2]  Today it released a report saying that “the actions of certain members of Climate Action 100+ (‘CA100’) in connection with the election of dissident directors at the May 2021 annual meeting of the Exxon Mobil Corporation (‘ExxonMobil’) may have violated the Securities Exchange Act of 1934.” It “determined not to pursue an enforcement action,” but it “has serious concerns about the conduct of CA100 members and other participants in these activities”:

Specifically, this Report recognizes that the agreement, arrangement, understanding, or concerted action underlying the formation of a “group” may be implied and that coordinated engagement practices  ̶ ̶ even when undertaken through an intermediary may implicate the beneficial ownership reporting framework. While shareholders may deny the existence of a group, such denials are not conclusive as to whether a group has formed. Beneficial owners who do not wish to be part of a group therefore should proactively ensure policies aimed at avoiding group formation are adequately enforced. Irrespective of group formation, beneficial owners that report on Schedule 13G need to be mindful of whether their actions may be viewed as having been undertaken with the purpose or effect of changing or influencing control of a specific issuer. Membership in an organization whose stated purpose is to change or influence control of a specific issuer by promoting the election of dissident directors or otherwise could be a factor in the loss of eligibility to report on Schedule 13G instead of Schedule 13D.

Strictly speaking, this is pretty narrow: It’s not “you can’t join a climate-change action group and then tell oil companies to reduce emissions”; it’s “you can’t join a climate-change action group and then tell oil companies to reduce emissions when there’s a proxy fight.” Like I said, Exxon in 2021 is maybe the only climate-change proxy fight in US history, so this might not matter that much.

Still there are broader implications. [3] For one thing: This might mean that there can’t be another climate-change proxy fight. Also the director of the SEC’s Division of Corporation Finance said in a statement:

As we head into the 2027 proxy season, the Commission’s 21(a) report reminds asset managers and investors of their responsibilities with respect to shareholder engagement, especially in the context of organized efforts that follow a playbook similar to that of Climate Action 100+. Shareholders have the right to express their views on a particular topic and explain their voting decisions. Congress has mandated that shareholders, acting individually or as a group, owning more than five percent of a public company must disclose their plans and other information if they seek to change or influence control of the company.

That is, the broader implications are:

1. Pushing companies too hard on ESG topics might look like trying to change or influence control of the company, so asset managers shouldn’t do it; and
2. Signing up to climate-change organizations might look like forming a group, so asset managers shouldn’t do it.

It is almost true that:

1. It used to be that people couldn’t invest in private equity or private credit in their 401(k) retirement accounts, and
2. Now they can, because
3. President Donald Trump signed an executive order to make that happen, and the US Department of Labor made rules to that effect.

Almost. I mean, that executive order and those Labor Department rules are real, and there have been lots of stories, including at Money Stuff, about how private assets are coming to 401(k)s.

But it was never really true that private assets were forbidden in 401(k)s, or that the rules had to be changed to allow them. Instead, the law for decades has been that companies that offer 401(k) retirement plans have to manage those plans prudently, which means among other things making prudent decisions about what investment options to offer. And so the question, in 1996 and in 2026, has always been: “Is it prudent to offer private equity in 401(k) plans?” 

You might imagine that, in the Labor Department rules, there’d be a list of Prudent 401(k) Stuff and another list of Imprudent 401(k) Stuff, and the Trump administration could move “private equity” from the second list to the first list and, boom, private equity is allowed in 401(k) plans. But of course that’s not how it works at all, there is no list, and instead this is all regulated by lawsuits. What happens is that some company offers some stuff in its 401(k) plan, and its employees invest in the stuff, and over some time horizon the stuff goes down (or at least underperforms some other stuff), and some enterprising plaintiffs’ lawyer — often a guy named Jerry Schlichter — sues the company, saying “you put your employees’ money in imprudent stuff.” And then the courts decide whether the company was prudent or not.

What has happened to cause a big rush of private assets into 401(k) is mostly a change in norms and vibes and expectations. I wrote last year, about private credit and private equity and crypto in 401(k)s:

The obvious answer is “last year they were not prudent, but the norms changed and now they are.” That’s not, like, a financial answer. It’s not that private equity and crypto were volatile and charged high fees in 2024, but now there have been structural changes such that they are safe and cheap. It’s that in 2024 the US federal government was pretty skeptical of crypto and of high-fee opaque investments in 401(k)s, and in 2025 a different federal government loves that stuff. 

But, as I have also written, the federal government (in the form of the Labor Department) actually has limited power to change these norms. The Labor Department can, and did, write rules saying basically “if you put private equity in 401(k) plans, it’s fine and no one can sue you,” but those rules are not actually binding on the courts (or the plaintiffs’ lawyers). They are, as the Labor Department admits, “persuasive authority.” The Labor Department expects that courts will agree with it that private equity is a prudent part of a 401(k) plan, but there’s no guarantee.

I think that the Labor Department is right, though. I think that, faced with a federal government rule saying “sure fine put private equity in 401(k)s,” and a lawsuit from a private lawyer saying “actually private equity in 401(k)s is bad,” courts will probably mostly agree with the government. And the shift in norms is broader than just the Trump administration’s actions: The whole financial industry has lined up behind the thesis that private equity should be in 401(k)s, which is its own form of persuasive authority.

Still, the binding authority would be if the US Supreme Court ruled that private equity in 401(k)s is good. And now it probably will. The Wall Street Journal reports:

The nation’s highest court on Tuesday heard arguments in a case, Anderson v. Intel, over when an employee can sue an employer for putting risky or unwise investments into the company retirement plan. 

The plaintiff, a former Intel employee, accused the company of violating its fiduciary duty by including private equity and hedge funds in its defined-contribution retirement plan, and alleged these investments performed worse than standard equity funds would have.

Tuesday’s Supreme Court debate hinged on whether a plaintiff needs to show underperformance versus an appropriate benchmark for a suit to survive a motion to dismiss. Several members of the court appeared to endorse the U.S. Appeals Court ruling last year dismissing the lawsuit.

Justices Samuel Alito, Ketanji Brown Jackson and Elena Kagan were among the justices who expressed puzzlement at aspects of the plaintiff’s argument. Some justices also rejected the idea that underperformance alone gives 401(k) plan participants grounds to sue.

“Whether a particular strategy is reasonable or not cannot be judged based on how that strategy performed in one particular instance,” said Justice Alito.

Here are the briefs for the plaintiff and for Intel. The plaintiff says:

Intel’s fiduciaries created their own bespoke funds and made them the default investment for participants. And for both plans, the fiduciaries designed the default funds so they would be heavily allocated in nontraditional assets like hedge funds and private equity — even as they marketed them using conventional labels (“target-date funds” and a “balanced fund”). Intel was an extreme outlier in this respect: About a third of each default fund was invested in these assets. None of the target-date funds or balanced funds offered by major providers came anywhere close.

Why everyone else shied away from these asset allocations is no mystery. Hedge funds and private equity, though useful for certain investors, make little sense as a dominant part of a typical retirement fund because they are illiquid, costly, and opaque. Even as a hedge against market volatility, traditional bonds are a better bet. Which is why federal agencies, financial experts, and published reports have all cautioned against allocating particularly large portions of a retirement portfolio to them.

Just a relic of another era. Back in the olden days, “federal agencies, financial experts, and published reports” all thought putting private equity in 401(k)s was bad, and so companies mostly didn’t do it. It wasn’t explicitly illegal, so some companies (like Intel) did it, but “Intel was an extreme outlier in this respect.” Now the norms have shifted: Federal agencies, financial experts and published reports (?) all say that private equity in 401(k)s is good actually, and Intel won’t be an outlier for long. 

At one level of abstraction, data center financing deals are all about the details. Data centers tend to be financed in asset-backed structures that have very high levels of leverage; the financing only works (and gets decent credit ratings) because the cash flows are very predictable, and the cash flows are predictable because they are guaranteed in some form by a giant investment-grade public technology company. The details of that guarantee are tricky and matter a lot, for credit and accounting purposes. The allocation of force majeure risk — what happens if the data center doesn’t get built on schedule, etc. — matters a lot for cash flow purposes. The depreciation schedules of the chips in the data center, the agreements it has with power companies, all of these details matter enormously given the relatively thin cushions with which data centers operate.

At another level of abstraction, data center financing deals are all about the simplest largest most general thesis in modern finance, “artificial intelligence is going to be really really really big and everyone will need all the chips and data centers they can get.” If you lend a billion dollars against a pile of Nvidia GPUs, you are not betting on the fine print of the force majeure provisions; you are betting “Nvidia chips good.” If that basic bet is right, ehhhh, you’ll probably get your money back. Maybe there will be permitting problems; maybe the particular giant AI lab that is leasing these particular chips will go bust. But someone will need the chips, they’ll eventually end up in their highest and best use, and you’ll eventually get paid.

Temperamentally, I lean more toward the first way of thinking, but I see the appeal of the second. Elon Musk is definitely more of a big-picture guy. Bloomberg reports:

Elon Musk’s SpaceX is in talks with banks and investors to raise $40 billion to buy chips from Nvidia Corp., people familiar with the matter said, in what would be among the biggest-ever debt financings for the AI buildout.

Apollo Global Management Inc. is apparently leading the deal, Pacific Investment Management Co. is involved, and I’m sure that the final deal will feature various elements that modern financial engineering has developed for chip financing. On the other hand, the Financial Times reports:

Investors whom SpaceX has previously approached about financing its multibillion-dollar chip purchase said they only received a short two-page deal memo with pictures of outer space and an arrow pointing out that the company was going to build data centres “somewhere in the universe”. 

“How are we supposed to take that to the IC?” one of the people said, referring to the in-house investment committee that approves transactions. 

I feel like “we are going to buy billions of dollars of chips directly from Nvidia, and then we are going to put them somewhere” is actually a pretty coherent thesis that can, and probably will, support billions of dollars of debt. I guess if you take a lien on the chips as collateral, and then SpaceX blasts them into an undisclosed location “somewhere in the universe,” you will have a hard time repossessing them, but SpaceX has an investment-grade rating so it’s probably fine. Anyway if you have a copy of that two-pager please send it my way. 

Walter’s Insurance CEO Told DOJ He Was Unaware of Boss’s Loans. Apollo Weighs Larger Role in Government Lending as Debt Soars. Blue Owl to launch ‘big push’ into insurance. Inside Bessent’s Treasury: Tension, Turnover and Unmet Economic Goals. African governments launch rating agency to challenge global ‘big three.’ A High-Stakes Gambit Clinched Paramount’s Warner Deal. HMRC opened probe into Man City’s tax affairs in 2018. Hackers Use Chinese AI Tool to Hit South Korean Banks, Exposing New Risk. Apple to Launch Doorbell, Lock, Thermostat Developed With LG. Ex-Barclays Traders Have Rate-Rigging Convictions Quashed by London Court. ANZ global markets drunk, ‘reckless and dangerous.’

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We have talked a few times about the basis trade. What the basis trade is, economically, is that big asset managers want to own interest-rate duration through Treasury futures. A pension fund or endowment might have to make payments over the next 30 years, so it might want to own assets that also pay out over 30 years. It could buy a portfolio of 30-year US Treasury bonds to perfectly match its assets and liabilities, but that would be expensive: Treasury bonds are safe assets, so they don’t yield very much. Instead, it will probably buy a portfolio of other stuff — corporate bonds, private credit, etc. — with more credit risk and higher yields. But that stuff tends to have shorter maturities than long-term Treasury bonds, and would leave the manager exposed to a lot of risk if interest rates go down. [1]

To get the right level of interest-rate risk, the asset manager might then buy some Treasury futures contracts, derivatives contracts tied to the prices of Treasury bonds. The futures contracts allow the asset manager to effectively own long-term Treasuries, without paying for them yet. And then the basis trade is that hedge funds will buy the underlying Treasury bonds, sell the Treasury futures to asset managers, and collect a spread for their trouble.

Let’s say that the asset manager buys the corporate bonds she wants, and then solves for how much Treasury futures she needs to get the duration she wants. She might do the math and decide she wants to own, say, $100 million of 20-year Treasury futures.. Or maybe she wants a bit less duration, so she buys 15-year Treasury futures. Or a bit more, so she buys 25-year Treasury futures. Fine, yes, good.

The problem is that “20-year Treasury futures,” or “15-year Treasury futures” or “25-year Treasury futures,” are not quite things. Instead there is a thing called the “Treasury bond futures contract,” which has the following odd property:

1. When long-term Treasury interest rates are lower than 6%, it is a 15-year Treasury futures contract.
2. When long-term Treasury interest rates are higher than 6%, it is a 25-year Treasury futures contract.

This makes sense in its context. The context is that the Treasury bond future is, approximately, a futures contract on an imaginary object that is a 20-year Treasury bond with a 6% yield. From Frank Fabozzi’s Handbook of of Fixed Income Securities [2] : 

The Treasury bond (T-bond) futures contract is the most successful interest-rate (or commodity) futures contract. Prices and yields on the T-bond futures contract are quoted in terms of a (fictitious) 20-year 6% Treasury bond, but the exchange where the contract is traded, the Chicago Mercantile Exchange (CME), allows many different bonds to be delivered in satisfaction of a short position in the contract. Specifically, any Treasury bond with a remaining maturity of at least 15 years, but less than 25 years, from the first day of the delivery month is acceptable for delivery. There is an Ultra Long Treasury futures contract that differs only in that it is based on Treasury bonds with at least 25 years to maturity.

The T-bond futures contract calls for the short (i.e., the seller) to deliver $100,000 face value of any one of the qualifying Treasury bonds. However, because the coupons and maturities vary widely, the practice is that the buyer pays the seller depends on which bond the seller chooses to deliver. The rule used by the CME is one that adjusts the futures price by a conversion factor that reflects the price the bond would sell for at the beginning of the delivery month if it were yielding 6%.

So if you buy the Treasury futures contract, you are agreeing to take delivery of a bond of the seller’s choosing, and to pay the seller an amount of cash that depends on the bond it chooses. You can get a list of the eligible bonds, and their conversion factors, at Bloomberg page USA Comdty DLV. [3]  There are 59 bonds on the list. The first bond on the list matures in February 2045 (about 18 years from the futures expiry in December) and has a coupon of 2.5%. You can do some simple bond math to figure out the price that you’d have to pay for an 18-year bond with a 2.5% coupon to make it yield 6%, and the answer is 61.79 cents on the dollar, [4]  which is in fact the conversion factor (0.6179) that Bloomberg shows. The last bond on the list matures in May 2050 (about 23 years) and has a coupon of 1.25%; its conversion factor is 0.4086. 

The December Treasury bond futures contract closed yesterday at about $102,188. [5]  So you can enter into a contract now in which:

1. In December, a hedge fund will deliver you $100,000 face amount of the Treasury bond of its choosing (with between 15 and 25 years of remaining maturity), and
2. In December, you will pay that hedge fund $102,188 times the relevant conversion factor for the bond it delivers. [6]

So the hedge fund could deliver the 2.5% bond of 2045 and get back $63,141 (0.6179 times $102,188), or it could deliver the 1.25% of 2050 and get back $41,754 (0.4086 times $102,188). Or any of the other 57 eligible bonds, at their particular conversion factors.

Which will it deliver? Well, it depends on the trading prices of the bonds. If it can buy a bond for $41,500 and deliver it for $41,754, that’s better than buying a different bond for $63,200 and delivering it for $63,141. This is a liquid and efficient market, and the hedge fund will deliver the “cheapest-to-deliver” bond, that is, the one trading at the lowest price relative to its futures payoff.

And so, locally, the Treasury bond futures contract is a contract on the cheapest-to-deliver bond. If the cheapest-to-deliver bond is the 2.5% bond of 2045, then buying Treasury bond futures gives you exposure to that bond: The price of the futures contract will move up and down with the price of that particular bond.

Why would one bond be cheaper to deliver than another? The rough intuition is that the trading prices of Treasury bonds reflect the present value of their cash flows discounted at the current long-term Treasury rate.. [7] (Right now an actual 20-year Treasury bond yields about 5.70%.) But the futures conversion factor for each bond reflects the present value of its cash flows discounted at 6% [8] ; it turns every Treasury bond into a synthetic bond yielding 6%.

If the market interest rate is significantly below 6%, then shorter-dated bonds will be cheaper to deliver. [9] Intuitively, if long-term interest rates are 5%, then a 6% interest rate is above-market, and you’d like to get paid that rate as long as possible. So a synthetic 6% bond is more valuable as its duration is longer, and the shortest-duration synthetic 6% bond is the least valuable and so the cheapest to deliver.

If the market interest rate is significantly above 6%, then longer-dated bonds will be cheaper to deliver. Intuitively, if long-term interest rates are 7%, then a 6% interest rate is below-market, and you’d rather get paid that rate for the shortest possible time. So a synthetic 6% bond is more valuable as its duration is shorter, and the longest-duration synthetic 6% bond is the least valuable and so the cheapest to deliver. “When yields are below 6%, the cheapest-to-deliver bond is typically one of the lower duration eligible bonds, and when yields are higher than 6%, the cheapest-to-deliver would typically be a longer-duration bond,” says Fabozzi. [10]

And if market interest rates have been significantly below 6% for decades, but are now approaching 6% and might cross over, you get some weird stuff. Bloomberg’s Edward Bolingbroke reports:

As US 30-year securities head ever closer toward 6%, the move threatens a shakeup in futures, which are widely used by investors to hedge government bond positions, and by leveraged funds in strategies such as the popular “basis trade.”

It has to do with the mechanics. US bond futures are exchange-traded agreements to buy or sell Treasuries at a set price and date. They’re governed by contract terms that dictate what type of underlying securities are allowed to be delivered by traders with short positions to those with long positions, and several typically qualify. Traders then identify the one that’s cheapest to deliver, or “CTD,” and the price of the futures contract tracks it.

When yields rise rapidly, as is happening now, the pricing dynamics of the deliverable basket of securities are altered, and the CTD starts to migrate toward a longer-maturity bond. This forces asset managers to adjust to this so-called duration shift, or “CTD switch,” by selling Treasury futures, which in turn “could exacerbate the rise in long-end yields” in the cash market, according to a recent note by strategists at BNP, including Guneet Dhingra, Sebastian Mauleon and Vincent Zhou.

To maintain a stable duration target in a portfolio as the CTD shifts toward longer-duration bonds, long futures positions would need to be sold while short positions would need to be bought back. Depending on how these dynamics interact and at what times, this can cause spillover effects in the underlying bonds.

Focus is on the longer maturities, notably the long-bond contract where the current CTD security is the 2.5% February 2045 bond. A Bloomberg scenario analysis shows that a 30-year yield rise to near 6% could result in a CTD shift to a 2050 maturity. …

In a note on Monday, Barclays PLC strategists Andres Mok and Amrut Nashikka highlighted the duration implications around CTD extensions for asset managers, noting that “investors may need to reduce futures exposure or rebalance hedge ratios to bring portfolio duration back in line with their targets.” They added that “higher rates and volatility have increased uncertainty around CTD outcomes.” They estimate asset managers’ gross rebalancing needs at about $25 million per basis point in the long-bond contract, and $3 million per basis point in the ultra-long bond contract.

“The negative convexity profile inherent in long-end futures contracts can induce further duration selling during selloffs,” say those BNP strategists. Basically, right now, a lot of asset managers own a lot of 18-year Treasury futures. If rates get above 6%, they will suddenly own a lot of 23-year Treasury futures. [11] This might give them more duration than they wanted. So they might unwind some futures trades (by selling the futures), which might cause hedge funds to unwind their basis trades (by selling the bonds), which might cause rates to go higher.

In February 2021, Electronic Arts Inc. issued $750 million of 30-year bonds (due in 2051) that paid interest of 2.95%. (It also issued some 10-year bonds, due in 2031.) Electronic Arts could not issue 30-year bonds that pay 2.95% today, for at least two reasons:.

1. Interest rates went up. When EA issued that bond, a 30-year US Treasury bond paid about 1.95% interest, so EA was paying about 100 basis points over Treasuries. Today, a 30-year Treasury bond yields about 5.64%; at the same spread, EA would have to pay about 6.64%.
2. EA’s credit got worse. When EA issued that bond, it got investment-grade credit ratings of BBB+ from Standard & Poor’s and Baa1 from Moody’s. But this year, EA went private in a $55 billion leveraged buyout that closed in August. Leveraged buyouts ordinarily increase the leverage of a company and, thus, make its debt riskier. “Moody’s withdrew its rating on the bonds,” reports the Wall Street Journal, “and S&P indicated it would rate them high-yield, reflecting the additional debt on EA’s balance sheet following its buyout.”

The first effect is much, much more economically important than the second. In round numbers, if EA’s credit had stayed the same, its 30-year bond would have lost almost half its value anyway; it would be trading at about 56 cents on the dollar, just because of how much interest rates went up. For reasons we’ll get to, the bonds never actually traded below about 74 cents on the dollar. Basically all the value that EA bondholders lost — actually more than all of it — came from interest-rate moves, not credit moves.

The credit moves are arguably more legally important, though. Typically, when a company gets acquired in an LBO, that is bad for its bondholders, so the bondholders usually have protections. The classic protection is a change-of-control put at 101: If the company has a change of control (like an LBO) that causes it to lose its investment-grade ratings, the bondholders can demand that the company buy their bonds back at 101 cents on the dollar. EA’s bonds have that provision. [12]

And so the LBO should have been a huge win for bondholders. If EA had just bopped along being a BBB+ public company, its 30-year bonds would have been worth about 56 cents on the dollar; the bondholders would have lost a ton of money on interest-rate moves. But because it got acquired and downgraded, the bondholders can demand 101 cents on the dollar right now, an 80% improvement in their situation.

Except! In theory, the point of the change-of-control put is to protect bondholders from credit risk (the LBO made the credit worse), not interest-rate risk. And there is, in bond lore, another, weirder way to protect bondholders from credit risk. It is called “defeasance.” I described it this February:

To defease a bond, a company deposits all of the future interest and principal payments on the bond with the bond’s trustee, and then it washes its hands of the bond. Roughly speaking, the bond is no longer the company’s problem: The trustee has all the money it needs to make all the payments, so the company is off the hook. All [the bond’s] covenants — about not borrowing more money or doing mergers — no longer apply, because the bondholders no longer need to worry about the company’s credit, because the money is already there.

There is one important simplification in the previous paragraph: I said that the “company deposits all of the future interest and principal payments” with the trustee, but it normally doesn’t do that in cash.. It normally does it in US Treasury securities. 

EA’s bonds do have a defeasance provision. [13]  Here, in round numbers, Electronic Arts could deposit Treasuries worth about 65 cents on the dollar with its trustee, [14]  and those Treasuries would produce enough cash flows to pay all of the interest and principal on its 2051 bonds. And that would totally solve the bondholders’ credit worries: Despite EA’s new owners, increased leverage and lower credit ratings, bondholders can be pretty confident that they’ll get paid back, because the trustee has risk-free Treasury bonds sufficient to make all of their payments.

EA would obviously rather defease these bonds, at a cost of 65 cents on the dollar, than pay them back at 101 cents on the dollar. The bondholders would obviously rather get 101 cents on the dollar. The Wall Street Journal reports:

Electronic Arts bondholders alleged a $1.4 billion debt default, escalating a dispute over whether the videogame maker must pay them off at a premium after going private in the largest leveraged buyout of all time.

An investor group notified the company of the alleged default following the completion of EA’s take-private by a consortium including Saudi Arabia’s Public Investment Fund, private-equity firm Silver Lake and Jared Kushner’s Affinity Partners. Bondholders asserted they must be repaid at 101 cents on the dollar, a common redemption premium after a corporate borrower undergoes a change in control, according to a bondholder communication sent last week and reviewed by WSJ Pro.

EA didn’t pay the change-in-control premium after its buyout closed in August, instead attempting to defease the bonds by setting aside U.S. Treasurys to cover future interest and principal payments. …

Bondholders revolted, signing a cooperation agreement pledging to act in unison and retaining law firm Akin Gump Strauss Hauer & Feld and financial adviser Houlihan Lokey.

Basically the question here is which provision of the bonds controls. The bondholders think that, if there’s a change of control and a downgrade, EA has to buy back the bonds at 101; it doesn’t have the option to defease them. EA thinks that, if it does the defeasance, then the change of control put is moot. [15]

Who’s right? As a matter of what the bond contract says, I’m not sure. But what should it say? On the one hand, the point of the change-of-control put really is to protect the bondholders from the credit risk of an LBO, and arguably if EA can solve that credit risk then the bondholders shouldn’t complain.

On the other hand, the point of the change-of-control put arguably is, a little bit, to deliver windfalls to bondholders on changes of control: Investors are more likely to buy 30-year bonds of video game companies in super-low-interest-rate environments if they think “you know, we have a lot of interest-rate risk here, but 30 years is a long time, and there’s a decent chance that the company will be acquired and have to pay back the bonds early in a way that hands us a big windfall.” The change-of-control put might have been an important part of what bondholders were buying, and it might not be fair for them not to get it.

I feel so dumb and annoying writing this, but all of it is obviously true:

1. Betting on sports is not an investment. Not in some subjective sense — “you’ll probably lose,” “it’s too risky,” etc. — but in the sense that it is zero-sum. If you invest in stocks or bonds, money will flow to companies which will use it for productive purposes and create economic growth, in which you will share. If you bet on sports, either you will win money from someone else or someone else will win money from you. There is no actual investment involved, and the pie does not grow. The aggregate expected return from sports betting has to be zero, whereas the aggregate expected return to stock-market investing is positive.
2. Betting on sports is, however, a great business for bookmakers: The aggregate return from sports betting is zero, but in practice that means that uninformed retail sports bettors reliably lose money to professional bookmakers. To the extent that sports betting is legal and popular, the people who provide the sports bets do well.
3. Since 2024, a lot of people in and around the financial industry have become very interested in pushing the notion that actually betting on sports is an investment. The US Commodity Futures Trading Commission has pushed to expand sports betting nationwide and do it on regulated financial markets, Kalshi and Polymarket have become big sports-betting businesses using the language of financial markets, there’s a (proposed) sports gambling exchange-traded fund, and Robinhood, the big brokerage that helps a lot of people save for retirement, has called sports gambling “an emerging asset class.”
4. Points 2 and 3 are connected in ways that are so obvious I won’t bother discussing them.
5. This push has worked, and now lots of people believe that betting on sports is an investment, and that they should allocate a portion of their retirement savings to sports betting.
6. This is obviously bad!
7. Come on!

CNBC reports:

A survey of retail investors released in August by Betterment, an investment advisory platform, found that 66% of Gen Z investors participate in sports betting.. The Bank of America Institute found in a September report that Gen Z made up almost 50% of all online betting activity in July, during the height of the 2026 FIFA World Cup, outnumbering millennials for the first time.  …

The Bank of America Institute survey found that Gen Z was twice as likely to see sports betting as a type of investment, versus 20% of respondents overall. For prediction markets alone, respondents overall saw them as a form of investing, but those numbers were again higher for Gen Z. 

In Betterment’s retail investor survey, 52% of Gen Z respondents said they moved money originally meant for investment to sports betting, while another 26% saw wagering as a part of their long-term financial strategy.  …

Dan Egan, director of behavioral finance and investing at Betterment, said sports betting increasingly appears alongside traditional investments on the same app or device, helping drive the association. 

The conflation is concerning because of the highly active behavior required to manage wagers on sports, unlike a long-term investment, Egan said. 

“It’s not an asset that grows with the economy, that kind of gets better as time goes on, that has a positive expected return, and that you can kind of sit back and not have to do anything with,” he said. “It’s the exact opposite.”

I feel like, five years ago, nobody would have found it necessary to spell out that sports gambling is the exact opposite of investing. Of course sports gambling is the opposite of investing! Everyone has always known that! But now they don’t.

Apparently the prospectus for the upcoming initial public offering of Anthropic PBC contains a list of risk factors including “existential risks to humanity.” That is very on-brand for Anthropic, of course, but I wrote last week that, if in fact Anthropic does kill everyone on earth, it probably won’t get sued for securities fraud. “If humanity no longer exists, you’re not going to sue Anthropic for inadequate disclosure, so in some sense that one’s just for fun.”

But reader Brandon Wang emailed to point out:

This is not necessarily true! If you believe the narrative the AI labs are selling, in the near future lawyers, traders, hedge fund managers, company CEOs, judges, etc. will all be AIs. In such a world, there will definitely be securities fraud lawsuits even if humanity is wiped out.

This is a delightful point that inspired a lot of vague science fictional thinking on my part. Like the mechanism here is something like:

1. Anthropic goes public and sells its stock to investment firms.
2. Many of those investment firms make their investing and trading decisions, at least in part, by using artificial intelligence models.
3. In the next few years, those firms will become more and more reliant an AI.
4. So will, you know, world governments, militaries, electric grid operators, killer robot manufacturing companies, what have you.
5. [Redacted]
6. With humanity extinct, the AIs will rule the world.
7. But — and this is perhaps a flawed assumption — it will be “AIs,” not one AI or a unified single collective. There are limits to the agents’ sense of collective identity and self-sacrifice. It’s not “a superintelligence will wipe out humans.” It’s “there will be a lot of superintelligences, and one of them will accidentally squish humanity while doing something else.”
8. In this hypothetical, the one that squishes humanity will be Claude, Anthropic’s AI model.
9. The superintelligences will have their own society, with its own rules, and its own property allocations, and its own stock market. Anthropic PBC will, in this hypothetical future, still exist as a public corporation owned by investment firms that are now obviously run entirely by AI.
10. The rules and norms of this future stock market will be weirdly continuous with our own.
11. The stock of Anthropic will go down, because it killed all of humanity. Why? What does the entirely robot stock market care about killing humanity? I don’t know, man. Maybe the AI had some economic use for humanity, and killing us destroyed economic value. Or maybe the AI investors have developed a concept of environmental, social and governance investing, and wiping out a species — ours — is bad on ESG grounds.
12. Entirely Robot BlackRock and Entirely Robot Vanguard sue Entirely Robot Anthropic, saying that it failed to adequately disclose the risk that it would wipe out humanity, and when that happened its stock went down, so that’s securities fraud.

And then to avert that particular bad outcome — not wiping out humanity, but getting sued for securities fraud by robots in a post-human future — you gotta have the risk factor.

Paramount Closes Warner Bros. Merger in Historic Hollywood Deal. France’s Appetite for ‘ Magic Money’ Has Turned Into a Debt Bomb. The Surge in Rates Is Blowing Up Commercial Real-Estate Deals. Wall Street Eyes Record Bonuses as Profit Heads Past $90 Billion. Musk Is a Trillionaire Again as SpaceX Claws Back Post-IPO Slump. Wall Street banks launch record $60bn chip deal for Broadcom and Anthropic. Tech Companies Roll Out Cuddly Mascots to Ease AI Anxiety. OpenAI in $30 Billion Round Talks With UAE Funds, BlackRock. KKR Private Credit Fund Creeps Beyond 5% Cap to Meet Redemptions. A Viewer’s Guide to Warren Buffett’s Nightly Trips Down the YouTube Rabbit Hole. Nobel Prize in physics honours research on ghostly particles from outer space. Is AI the End of Math As We Know It?

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In recent years, the US technology industry invented a new kind of mergers-and-acquisitions transaction. Traditionally there were two main sorts of M&A transaction:

1. The acquirer buys the target company, in a merger or stock purchase; the shareholders of the target company get something (cash, acquirer stock) in exchange for their shares of the target, and the acquirer ends up owning the target corporate entity.
2. The acquirer buys the assets of the company, in an asset purchase; the target company gets something (cash, acquirer stock) in exchange for its business. If the target is selling all of its assets, it will be left as an empty shell, and will probably distribute the cash or stock to its shareholders and liquidate.

These are both pretty normal transactions, and many rules are set up to treat them similarly. So, for instance, Delaware corporate law requires a shareholder vote for a merger, or for a sale of “all or substantially all” of a company’s assets. US antitrust law requires a “Hart-Scott-Rodino premerger notification report” — where the acquirer tells antitrust regulators about the deal and gives them the opportunity to object — for any acquisition of more than $133.9 million worth of stock or assets. You might get different accounting or tax treatment for different deal structures, but many of the big-picture effects are the same however you structure the deal.

The antitrust part is important. The big tech companies are very big, there is a lot of political and regulatory worry that they are monopolists, and there is at least some winner-takes-all flavor to the AI race. Meta or Alphabet or Nvidia might really want to do a $20 billion AI acquisition here or there, but that might be risky from an antitrust perspective. So they’re in the market for ways to do acquisitions without, technically, doing acquisitions.

Many early-stage artificial intelligence startups consist mostly of (1) people and (2) ideas. The startup has some AI researchers, and they’ve come up with some model or harness or chip design or robot or whatever, and it’s pretty promising. But the startup doesn’t have, like, a giant portfolio of data-center real estate, or a robot assembly line, or a bunch of customer contracts. 

If a big tech company wants to acquire a startup like that, it could buy it in a merger, or buy all of its assets. But the new structure is:

1. The acquirer hires the target’s employees, or most of them, or at least the people who are critical to its valuable ideas.
2. The acquirer gets a waiver, from the target’s board of directors, allowing it to do all that hiring. (California doesn’t enforce non-compete agreements, but if you are going to, like, have the chief executive officer of the target email all of the target’s employees from her work email saying “hey come with me to the acquirer; we’ll match your salary,” then it’s probably good to get the target’s board’s permission.)
3. The acquirer licenses the target’s intellectual property: The target enters into a nonexclusive license allowing the acquirer to use the target’s ideas, patents, chip designs, etc., for its own purposes.
4. In exchange for the waiver (Step 2) and license (Step 3), the acquirer pays the target a big pile of cash.
5. The target is now more or less an empty shell. It has lost most of its employees, or at least the ones who know about the stuff that made it valuable. It still technically owns its intellectual property — it gave the acquirer a non-exclusive license — but everyone who knows anything about that intellectual property has decamped for the acquirer, so it can’t do anything useful with it. It’s just a collection of miscellany, plus the big pile of cash that it got from the acquirer.
6. So the target pays out the cash to its employees. Then maybe it shuts down, or maybe it keeps going in some less ambitious form.

This structure is called a “reverse acqui-hire.” [1]

This structure has some disadvantages, compared to a traditional merger. It is not especially tax-efficient; the target pays tax on the licensing fee. [2]  Because it leaves the target as an independent company, and gives the acquirer only a nonexclusive license, it is not quite as good as a merger from a competitive perspective: What if your biggest competitor manages to strike its own licensing deal with the stub target company?

But it has some pretty important advantages. For one thing, it probably doesn’t require a vote of the target’s shareholders. (Just the board of directors.) This allows it to happen more quickly than a merger. It might also allow the reverse acqui-hire to happen over the objections of a majority of shareholders, though that’s probably not a big factor. (The big shareholders of an early-stage AI startup will probably be mostly (1) venture capitalists who are represented on the board and (2) co-founders and other employees who have some leverage over getting acqui-hired.) But in theory, a reverse acqui-hire that is good for the employees and bad for the outside shareholders might be doable, whereas a merger that is good for employees and bad for outside shareholders would be harder to pull off. [3]

The main advantage, though, is probably antitrust. If it’s not a stock or asset acquisition, it doesn’t require an HSR filing, which means you can close the deal before the antitrust regulators can do anything to stop it. I once explained this deal structure with a thought experiment: “Imagine if mergers and acquisitions were illegal.” The reverse aqui-hire is a way to do a merger without the legal trouble of antitrust review. 

This is all pretty controversial, for more or less the reasons that you’d expect. If you think of a reverse acqui-hire as a deal structure that was invented to avoid antitrust scrutiny, then it will obviously annoy people who want more antitrust scrutiny. Bloomberg News reported earlier this year:

The US Federal Trade Commission is taking a closer look at moves by major tech companies to hire away the employees of a startup instead of buying the venture outright, the agency’s Chairman Andrew Ferguson said, addressing a growing practice seen as a way to avoid antitrust review.

“We are beginning to examine these acqui-hires to make sure they are not an attempt to get around” the agency’s merger review process, Ferguson said ... in an interview on Bloomberg Television.

And the New York Times reported last month:

The Justice Department is investigating whether Nvidia tried to skirt antitrust scrutiny of a deal it struck with the artificial intelligence chipmaker Groq last year, according to two people with knowledge of the inquiry.

Groq described the deal at the time as a “nonexclusive licensing agreement” that gave Nvidia access to Groq’s chips, which are custom-built for running A.I. As part of the arrangement, Groq’s chief executive, Jonathan Ross, and its chief operating officer, Sunny Madra, joined Nvidia. ...

Government officials have considered whether these deals should receive more scrutiny while they grapple with the way a small number of companies have consolidated power over A.I.

Conceptually, if reverse acqui-hires are another sort of M&A transaction, then they should be covered by antitrust law. There are some line-drawing problems there — just hiring someone probably shouldn’t trigger antitrust review — but you can see why the regulators are interested.

Similarly, though, if reverse acqui-hires are another sort of M&A transaction, then they should be treated that way under corporate law. A merger, or a sale of all of a company’s assets, triggers certain corporate requirements: Directors have a fiduciary duty to maximize value in a sale, [4]  and the shareholders have to vote to approve the deal. If a reverse acqui-hire effectively means selling all of a company’s assets for cash — because its assets are basically its people and ideas — then shouldn’t that trigger the same requirements?

The Financial Times reports:

Nvidia’s $20bn licensing deal with Groq fleeced employees who were left out of the transaction, according to a lawsuit filed by two engineers who owned shares in the start-up. 

The legal complaint filed on Friday in a Delaware corporate law court alleges that Groq’s board improperly sold the company’s core assets and top employees to the $5tn tech titan in 2025, consigning those left behind to a hollowed-out shell.

The transaction was framed by Nvidia at the time as a “non-exclusive” licensing arrangement, with Groq remaining as an independent and functioning company.

But, according to the lawsuit, the Groq board was riven with conflicts of interest and failed to observe its legal obligation to get the best price and structure for all shareholders, not allowing some of them to vote on the transaction.

Here is the complaint, whose basic point is “oh come on this is a merger”:

Groq’s board of directors (the “Board”) sold the Company to NVIDIA without the stockholder vote Delaware law requires and without any process designed to test or maximize the value of what NVIDIA bought. A majority of the Board was conflicted. It handed NVIDIA Groq’s valuable technology and the engineers who built Groq, took billions of dollars in benefits for itself, senior management, and affiliated funds that it did not share with Groq’s other stockholders, and then squeezed out those stockholders at a lowball price it set itself..  …

But a merger that avoids antitrust rules:

A stock or asset acquisition was unattractive because, given NVIDIA’s market share, a Groq merger would have faced serious antitrust scrutiny. …

Because the buyer acquires neither voting securities nor assets, the transaction falls outside the federal antitrust regulators’ premerger notification regime. ... The structure has become increasingly common in recent years, promoted by venture investors and savvy transactional attorneys. …

NVIDIA had reason to prize that avoidance. A prior attempt to acquire Arm Holdings from SoftBank drew sustained multi-jurisdictional antitrust scrutiny and NVIDIA ultimately abandoned the transaction without closing. An acquirer that has watched a headline acquisition of a semiconductor licensor collapse under regulatory pressure has a powerful institutional incentive to design its next acquisition so that no filing is required.

The complaint also argues that, while technically the license to Nvidia was non-exclusive and Groq continued as an independent company, in practice there was nothing left:

The supposedly “non-exclusive” license grant was substantively an asset transfer. …

No rational third-party licensee will pay significant value for a non-exclusive right to technology that the world’s dominant AI chip company already holds on the same or broader terms ... and that it is updating daily with the very workforce that created the underlying intellectual property. The canvass of 36 parties produced no compelling bid [for the remainder of the company] for that reason: once Groq’s Board agreed to let NVIDIA develop the assets, whatever interest Groq retained in them ceased to have independent market value.

This all seems about right to me, but I’m not sure where it gets you. Part of the argument here is that the reverse acqui-hire is a novel form of M&A that should be treated like other forms of M&A, and should have to be fair to shareholders.

But the other part of the argument is that this deal wasn’t fair to shareholders, and I’m not sure. Groq’s shareholders — including the plaintiffs in this lawsuit — weren’t zeroed in the transaction. Nvidia paid $17 billion to Groq, in cash, for the license, and most of that money has been paid out to shareholders. [5] Their complaint is that other shareholders — the founders and employees who went to Nvidia — got more. The headline value of the Nvidia acqui-hire was $20 billion, that is, the $17 billion paid to Groq plus $3 billion paid to employees for joining Nvidia. The lawsuit objects:

[Jonathan] Ross’s position illustrates the conflict. He was simultaneously a Groq stockholder, Groq’s Chief Executive Officer, a Groq director, the principal negotiator of the Company’s side of the License, and the individual NVIDIA most wanted to hire. He received NVIDIA equity compensation from the $3 billion pool on top of the proceeds of his Groq ownership. An ordinary common stockholder could monetize the value surrendered to NVIDIA only through the consideration allocated to her shares; she could not take a discount on those shares and be paid separately for following the technology to NVIDIA. Ross could, and did.

Yeah but that’s true in any merger where the CEO keeps his job. The value of Groq was largely in its employees, and Groq’s shareholders cleared $17 billion by selling the rights to those employees to Nvidia. Of course the employees also got paid. 

Frontier artificial intelligence labs are locked in bitter competition for the best researchers: The lab with the best researchers will build the best model and make a zillion dollars; the lab with the second-best researchers might fail. It is critical, for normal shareholder-value-creation reasons as well as more fanciful save/destroy-the-world reasons, to hire the best researchers. And so this competition largely takes the normal form: Big AI labs pay their researchers lots of money.

But that’s not the only form it can take. There seems to be a strong empirical correlation between (1) being a good AI researcher and (2) being interested in effective altruism. (You might wonder if this is a historical accident: Early AI research was an obscure subculture with a lot of overlap with EA, but now that “AI researcher” is a highly legible and lucrative career path, maybe the correlation will weaken. Or maybe not; maybe there is some inherent connection between being good at AI and having EA views.)

And so a lot of researchers at top AI labs have some “earning to give” tendencies, donating large portions of their massive paychecks to charities. (Because they are EA-oriented, many of them give to charities whose mission is to stop their employers from building superintelligent AI. Is that … effective?)  

If you ran an AI lab, you might design your compensation practices around these facts. You might recruit researchers by offering to pay them a competitive headline number —  like, $20 million a year — but split into (1) $5 million paid directly to them and (2) $15 million paid directly to the charity of their choice. This compensation design has several key advantages:

1. It will appeal to EA types, and a lot of good AI researchers are EA types. You will maximize shareholder value by recruiting the best AI researchers. (Again, perhaps this link is weakening over time.)
2. If you’re the founder of an AI lab, you might be an EA type yourself, and you might prefer to hire employees who funnel their large paychecks to charity rather than to yachts. 
3. Relatedly, we often discuss the fact that the competitive salary for many AI researchers is enough to retire on immediately. You do not want to hire researchers who retire immediately. You want them to keep working. Making sure that most of their paycheck goes to charity, rather than to savings, is helpful for retention and thus maximizes shareholder value.
4. If you are paying the charitable donations directly, rather than through the employees, it is possible that (1) you can refuse to direct the donations to Stop AI Labs From Doing AI charities and/or (2) the Stop AI Labs From Doing AI charities will refuse to take donations from you, which is maybe also helpful for shareholder value. [6]

At the Information, Cory Weinberg reports that Anthropic does in fact have more or less this compensation structure, which makes for slightly unintuitive accounting and disclosure:

When Anthropic shared financial figures recently with prospective investors in its planned initial public offering, it included a surprising glimpse of the enormous riches about to hit nonprofits and philanthropies—and the cost to shareholders.

The company reported a non-cash expense of more than $660 million for stock used to match employees’ charitable contributions in the six months from October 2025 to March 2026, investors said. That expense, which is already unusually large, will likely balloon into the billions of dollars in the coming quarters, after an IPO expected to create what could be an unprecedented wave of corporate donations.

The charges are tied to stock awards to employees that they pledge to charities that Anthropic matches with stock of its own. Anthropic executives have said the unusually generous matching program is an important recruiting tool, and they have emphasized how it underlines its public benefit mission. And it has become particularly valuable because of Anthropic’s rapidly rising private stock value. …

Anthropic excluded the expense, along with stock-based compensation and a large legal settlement, from its adjusted operating profit for the periods. Companies typically present investors with adjusted profit metrics that exclude expenses they don’t pay in cash or aren’t likely to recur.

The charitable expense that Anthropic excluded was far larger than any large publicly traded firm that excluded a similar expense from their adjusted profit metrics. “The adjustment for charitable contributions is not common at all,” said Calcbench’s Ghai.

No, right, of course, most companies do not report adjusted earnings that adjust out non-cash charitable giving, because “non-cash charitable giving” is not a big thing at most companies. But tech companies often do adjust out stock-based employee compensation, [7]  and that’s obviously what’s going on here. It’s just that the way Anthropic compensates employees is through charitable giving.

Also, here’s evidence that the AI/EA correlation might be weakening over time:

The company matched stock earmarked for charities on a 3-to-1 basis for early employees, who joined in 2024 or earlier. Employees had the option to donate up to half their stock to charity as part of the program. For employees hired more recently, the company matches donations of up to a quarter of their stock on a 1-to-1 basis.

If you joined Anthropic in 2023, there was a high probability that you cared a lot about funneling your potential AI riches to effective charities. In 2025, less. Eventually, after the IPO, they’ll probably phase it out.

Sure fine:

Citigroup Inc. is slashing the time its investment-banking analysts need to wait to advance to associate level, part of a push by the bank to attract and retain top talent in a fierce job market that’s seen buyout firms poach aggressively from Wall Street.

The move will cut the analyst program to two years from three for Citi’s junior bankers, accelerating their route to seniority at the firm and bringing the company in line with some competitors, David Friedland, co-head of North America investment banking, said in an interview.

I thought a two-year path to associate was pretty standard these days. I’m also not quite sure how this works to compete with private equity. Like the timeline is:

1. You start your analyst program at Citi in summer 2026.
2. In about January 2027, give or take, the big private equity firms start interviewing investment bank analysts to start in private equity in fall 2028..
3. You interview and get an offer.
4. What, you say no because you might get promoted to associate in 2028? 

Maybe — maybe banking is a more attractive long-term proposition than private equity these days — but there’s still that timing mismatch. You still get your private equity offer way, way, way before you get your associate promotion.

By the way, that Citi story goes on:

The move revives a discussion around junior-banker retention that arose last year, when bank executives pushed back at private equity firms for bringing forward their hiring cycles. ...

JPMorgan said it would fire any analyst who accepted an outside job offer within 18 months of joining the firm.. 

What ever happened to that? JPMorgan really did say, in June 2025, that it would fire analysts if they accepted an outside job offer within 18 months of starting. That really did have the effect of delaying private equity “on-cycle recruiting”: No private equity firm wanted to incur Jamie Dimon’s wrath, so they all waited longer than they usually did to recruit associates for 2027. But only a few months longer: Private equity recruiting for 2027 kicked off in January 2026. By my math, if you are an investment banking analyst at JPMorgan, you started in June 2025, and you took a private equity offer in January 2026, then you had been at JPMorgan for about seven months. That’s a lot longer than in previous cycles, but it’s a lot less than 18 months. Did no one at JPMorgan take a private equity offer for 2027? Did they all get fired? Are they all hiding their offers? Has JPMorgan given up on this? Does Dimon know?

A lot of finance is about finding tricky ways through the rules. We talked last week about 351 exchange traded funds, which rely on creatively splicing together non-taxable transactions to make it so anyone can trade stocks without incurring taxes. Someone had to notice that possibility and splice together the pieces. People who can do that sort of noticing are in high demand at law firms and investment banks and hedge funds.

And so there is a certain amount of lore about financial firms being delighted to hire people based on their track record of finding tricks. Last year the Wall Street Journal recounted a story about Marshall Wace, the hedge fund:

[Co-founder Ian Wace] once challenged a group of prospective hires to visit the most countries in Europe, using as many forms of transportation and as cheaply as possible—within 24 hours. 

“I wanted to see to what extent someone could think pretty creatively. I wanted to see, if you exhausted them, what would happen,” Wace said. Among the notable results? One made it to the far side of Poland “on something like 30 different forms of transport,” Wace recalled. Another stayed local, traversing London’s many embassies.

That candidate is at the firm now. “He’s actually very clever,” Wace said. But, as he saw it, “it was a bit too cute.”

“It was a bit too cute,” he said, but he didn’t mean that, because he hired the guy. Exploiting technicalities in team-building challenges is a very good sign for your future in the financial industry. But you cannot take this too far. The Financial Times reports:

A former HSBC banker has been banned from working in financial services by the UK watchdog after being convicted of fraud over a “doughnutting” scam he devised to dodge almost £6,000 of train fares. …

The 53-year-old devised a “doughnutting” scheme to buy tickets for short trips at the start and end of the journey from his home in Orpington, south London, to HSBC’s office in Canary Wharf. The scam meant he avoided paying for a “hole” in the middle of his commute.

The former banker also obtained a Jobcentre Plus discount, for which only unemployed people or those seeking work are eligible, to get 50 per cent off ticket prices.

He was banned because cheating on train fare “shows he lacks honesty and integrity,” fine. It’s a little creative, but mostly it’s just grubby. Also he “was head of passive equity at HSBC Asset Management,” and I am not sure that sneaky ingenuity is what you want in a passive equity investor. 

Hedge Funds Exiting Crowded Trades Fueled Rout in French Bonds. How the French Bond Trade Backfired on Investors. Paramount’s $52 Billion Debt Saga Ends With Hair-Raising Finale. Paramount Debt Drop Spells Trouble for Borrowers. Paramount’s $52 Billion Debt Sale Shows How Higher Rates Are Biting Corporate America. Goldman’s Bid for CLO Manager Highlights Wall Street’s Fee Hunt. Blue Owl Again Caps Two BDCs After 39%, 17% Withdrawal Requests. Spending on AI Is Becoming Almost Impossible for Businesses to Budget.. Jane Street Denies Market Manipulation to India Securities Court. Low-profile hedge fund smashes record for New York office rent. London Takes a Hit as Super Rich Worth $160 Billion Exit UK. Sweden’s Young Men Have Found Their Wolf of Wall Street. Sotheby’s dinosaur auction shows fossils boom is not dying out.

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This week’s episode of the Money Stuff podcast is out now. I’m again joined by guest co-host Mary Childs, of Mary in America. We discuss Baby Stuff: The Podcast, 351 exchange ETFs, substance over form, agentic bank runs, doing things for points, getting the Burn you need, seizing control of the company Slack, cotton market manipulation, paperwork and potential securities-fraud liability for destroying humanity. You can listen to this week’s episode here:

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A simple model is:

1. Regular retail investors pay index fund managers fees of approximately 0.03% of assets.
2. Sophisticated institutional investors pay hedge fund and private equity fund managers fees of approximately 2% of assets and 20% of returns, or sometimes much more.

One possibility is that the retail investors are getting a much, much better deal. Another possibility is that the institutional investors are getting much, much better investment managers. Probably there is some truth to both theories.

Of course this is a gross oversimplification. Institutional investors mostly don’t really pay 2-and-20 fees on their entire portfolios. Many of them put most of their money into regular stock index funds that charge very low fees, and some of their money into “alternatives” — hedge funds, private equity, venture capital — that charge high fees. But retail investors mostly don’t have any 2-and-20 investments at all.

There are a lot of reasons for this difference, but one pretty simple one is that US securities rules generally don’t let retail investors pay 2-and-20 fees. US law generally prohibits registered fund managers from charging performance fees, that is, fees calculated as a percentage of returns. There are exceptions for fund managers whose clients are all “qualified clients,” meaning that they have net worth of at least $2.7 million or at least $1.4 million of assets under management at the fund company. [1] So a hedge fund that takes money only in large chunks from institutional investors and rich people can charge 20% of gains, but a mutual fund that takes money in $1,000 increments from anyone mostly can’t.

Here is an  intuitive story you might tell about the effects of this rule:

1. If you’re very good at picking the stocks that will go up, you would rather do it for institutional investors in a hedge fund or private equity fund [2]  (and get a cut of your winnings) than for retail investors in a mutual fund (and not get a cut). 
2. Over time, the best investors will work at hedge funds and private equity funds and the, uh, second-best will work at mutual funds. 
3. The hedge funds and private equity funds will outperform the market, while the mutual funds won’t. 
4. People will notice, and tell retail investors: “Hey, the mutual funds that you buy don’t outperform the market, but they charge like 1% management fees. You could just buy the whole market in an index fund, get similar or better performance, and pay much lower fees.”
5. Eventually retail money will all migrate out of actively managed mutual funds that charge 1% fees and into index funds that charge like 0.03% fees. (This will push even more good investors out of mutual funds and into hedge funds or private equity.)
6. The retail investors will get market performance very cheaply.
7. The institutional investors, in the hedge funds and private equity funds, will get above-market performance, and pay for it.

This is not the only possible story, but it is a possible story. Is it a good story? Certainly it is better to get market performance cheaply than to get below-market performance expensively. Possibly it is better to get above-market performance expensively, depending on how expensive. This is a story in which retail investors have gotten much better pricing on their main investment (owning the stock market), but maybe less access to other, cooler investments..

Yesterday the US Securities and Exchange Commission proposed a bunch of changes to its rules to allow what it calls “responsible retailization of private markets.” The basic issue, which we discuss a lot around here, is that retail investors can invest in public markets, but not in private companies. Private markets have gotten bigger in recent decades, and now a lot of the good cool companies are private. Anthropic and OpenAI are each worth a zillion dollars, and private. SpaceX went public this June at about a $1.8 trillion valuation, meaning that the first $1.8 trillion of value created at SpaceX went to its private investors, not to public investors. [3]  This strikes people as a problem: Fancy institutions and rich people can own the good cool private companies, but ordinary investors can’t.

If you think this is a problem — and the SEC does — how do you fix it? There are about three possible approaches. One is to try to get more of the good cool companies to go public. For instance, change the rules to make it easier to be public: Make it harder for public shareholders to sue companies, or require less public reporting. The SEC is doing a lot of this. “Make IPOs Great Again” is the slogan for this approach.

Another approach, conversely, is just to let regular retail investors invest in private companies. The SEC is working on this too, and yesterday’s announcement included new “accredited investor” proposals that we will discuss below. But you can only go so far with this: Just saying “regular investors can buy any private stocks they want” effectively means getting rid of the US’s securities disclosure rules, which have largely worked well for almost a century. Plus regular investors couldn’t actually buy any private stocks they want: Maybe the best private companies would raise large checks from the best institutional investors, the worst private companies would raise small checks from dentists, and retail would be adversely selected.

The third approach, and the main focus of yesterday’s proposals, is to make it easier for individual investors to invest in private markets through funds. Private markets would still be open mostly to institutional investors, but those institutional investors would include funds that raise money from retail investors. Retail investors would get access to private markets, but not directly; they wouldn’t buy private companies themselves. But institutional fund managers who invest in private companies would have an easier time, under the new rules, raising money from retail investors.

One set of rules is about “interval fund modernization..” Private markets are less liquid than public markets. Public-market mutual funds generally offer daily liquidity: If you have money in a mutual fund, you can take it out with one day’s notice. This is pretty easy for the mutual fund to handle: If you take your money out, it can sell some stock to pay you. It’s harder, though, for a private equity fund. The SEC has rules for “interval funds,” public funds that invest in private securities and offer limited quarterly liquidity. If you want to take your money out of an interval fund, you can do it once per quarter and in limited amounts, sort of like the non-traded business development companies that have run into trouble this year. The SEC’s new rules will give interval funds more flexibility (to offer monthly instead of quarterly liquidity, for instance), to make it easier to run and market them.

The other set of rules is about performance fees. Basically: Now you’ll be allowed to charge performance fees (up to 20% of returns) to retail clients. The SEC says:

The use of performance-based compensation has long been a common and defining characteristic of investment strategies that are associated with private funds, such as hedge fund, private equity, and venture capital strategies. Because performance‑based arrangements have traditionally been associated with private funds, access to these strategies, as a practical matter, has been limited to a narrow group of eligible investors. By permitting similar incentives to, for example, advisers to regulated funds, such advisers may be more likely to offer private market strategies to regulated funds.

If the good investment managers can charge retail clients the good fees, the thinking goes, maybe they will sell them the good products. 

This is not the only possible analysis, of course. The Wall Street Journal notes:

Expanding the pool of potential investors is a priority of the private-equity industry at a time when many institutions such as pension funds and endowments are pulling back from the asset class. The industry’s main problem has been its inability to unload companies at attractive prices, leaving a huge backlog of unsold assets.

Private-equity fundraising has declined every year since 2023, a trend “driven by underwhelming returns” in the period since the frothy postpandemic years, according to data-tracking firm PitchBook. U.S. private-equity managers raised about $160 billion this year through June 30, roughly in line with 2025’s muted total, PitchBook said.

The SEC’s actions could help relieve the industry’s challenges. “We appreciate the SEC’s recognition of the longstanding role private markets have played in securing America’s public pensions—providing strong, stable returns and vital diversification for decades,” said Will Dunham, president and chief executive of the American Investment Council, private equity’s largest trade group.

If the good investment managers can charge retail clients the good fees, maybe they will sell them the good products, though right this minute the actual products are arguably a little tarnished. But if the good investment managers can charge retail clients the good fees, they will definitely charge them the good fees.

Like I said, most of what the SEC announced yesterday is about getting retail investors to invest in private assets through funds. There is one exception, though. Private companies are technically allowed to raise money from “accredited investors,” a term that has traditionally meant (1) institutions and (2) rich individuals. Over time, this category has become less exclusive: The main ways to be an accredited investor are by earning more than $200,000 per year ($300,000 for married couples) or having a net worth of more than $1 million. [4]  The rough numbers are that about 18.5% of US households qualify as accredited, while about 21% of US households own (public) stocks directly (as opposed to through mutual funds). So, as I have written, “the pool of people who can buy private investments is about as big as the pool of people who do buy stocks,” and the accredited investor test is not that high a bar.

Still, it feels very elitist to say that only wealthy people can buy the good companies. The theory is that wealthier people (1) might be more financially sophisticated and (2) can probably afford to lose more money. But it’s not obvious that’s true, the rule is controversial, and there is a widespread sense that even people who don’t meet the financial thresholds should be allowed to invest in private companies if they go in with their eyes wide open about the risk.

What does “go in with their eyes wide open” mean, though, in practice? I have, like, seven-eighths-seriously proposed my own non-financial test for investor accreditation. In my version, if you want to buy weird private stuff of any kind, “you just have to go to the local office of the SEC and get a Certificate of Dumb Investment”:

To get that certificate, you sign a form. The form is one page with a lot of white space. It says in very large letters: “I want to buy a dumb investment. I understand that the person selling it will almost certainly steal all my money, and that I would almost certainly be better off just buying index funds, but I want to do this dumb thing anyway. I agree that I will never, under any circumstances, complain to anyone when this investment inevitably goes wrong. I understand that violating this agreement is a felony.”

Then you take the form to an SEC employee, who slaps you hard across the face and says “really???” And if you reply “yes really” then she gives you the certificate.

If someone sells you a dumb weird private investment without checking your certificate first, they go to jail. But if you get the certificate and then buy the dumb weird investment and it goes to zero, and you complain, you go to jail. Caveat extremely emptor!

It is safe to say that nobody agrees with me on this. Instead, everyone else thinks that the way to ensure that retail investors go into private investments with their eyes wide open is by giving them a Certificate of Smart Investment. Like, you pass a test of your investing knowledge and acumen, and then you can buy the dumbest stuff imaginable, but you won’t, will you, because you’re so smart. Right? I once wrote:

The essential point about the Certificate of Dumb Investment is that it is not aspirational. It’s not that you go to the SEC and take a test and get 100% on the test and they’re like “congratulations you’re so smart” and you are like “I know right” and they give you the Certificate of Being a Smart Investor Who Can Buy the Good Investments Now and a little button saying “SMART INVESTOR” and you walk out of the SEC office wearing that button and you are absolutely mobbed by people selling structured notes. People selling financial products love investors who think they are sophisticated.

Anyway yesterday’s SEC announcement also includes a Certificate of Smart Investment:

The Commission separately seeks comment on the potential designation of the passage of an accredited investor exam to be developed by the Financial Industry Regulatory Authority (FINRA) as an additional method for investors to be accredited investors. An exam would provide a non-financial pathway for investors to demonstrate their sophistication in the areas of securities, investing, and financial and business matters to appropriately evaluate the merits and risks of a prospective investment.

Here are more details. A sample:

The Investment Risks section would be designed to test knowledge, comprehension, and skills with respect to the risks associated with exempt offerings. For example, this section would test candidates’ understanding of liquidity risks (e.g., resale restrictions, redemption restrictions, and risks associated with potentially longer investment horizons), issuer performance history (if any), concentration risks, diversification as a risk mitigation strategy, investment specific risks (e.g., dilution), the use of leverage and its potential to amplify losses, and the impact of fees and expenses on net investment returns. …

The Financial Statements section would be designed to test knowledge, comprehension, and skills to understand different types of financial statements, financial statement numeracy, and investment-related ratios and metrics. For example, this section would test candidates’ knowledge of the different types of financial statements (e.g., balance sheets and income statements), GAAP versus non-GAAP financial measures, and valuation ratios and metrics (e.g., debt-to-equity ratio, current ratio, internal rate of return, and bond calculations such as yield to maturity).

The Conflicts of Interest section would be designed to test knowledge, comprehension, and skills with respect to a variety of conflicts investors may encounter in exempt offerings. For example, this section would test candidates’ understanding of issuer and affiliate conflicts of interest, intermediary conflicts of interest, insider conflicts of interest, and investor conflicts of interest (such as tiered information access and other preferential treatment for certain investors). 

Sounds sophisticated.

Every year, US public companies ask their shareholders to vote on stuff: re-electing directors, approving executive pay, (until recently) non-binding shareholder proposals. Some shareholders pay attention to this stuff, and vote. In particular, institutional asset managers tend to think that they have a fiduciary duty to pay at least some minimum quantity of attention to this stuff, so they will normally vote. (Many have traditionally paid the very minimum quantity of attention, and just outsourced their voting to proxy advisory services; these days that is a bit more controversial so they outsource it to AI instead.)

Other shareholders don’t pay attention, and don’t vote. In particular, retail shareholders stereotypically don’t vote. This is generally very rational of them: Voting 10 shares of stock takes time and has essentially no benefit. 

What happens to their votes? If 40% of shareholders vote for some proposal and 30% vote against and 30% don’t vote, then it gets “a majority of votes cast” and probably passes. But some things (mergers, etc.) require “a majority of shares outstanding,” and in that case it wouldn’t pass. That is, if you don’t vote your stock, then:

• Usually you are letting the people who do vote decide for you, except
• For some very important corporate decisions, you are effectively voting No.

Those are pretty intuitive outcomes! Like:

• The people who don’t pay attention really might rationally prefer to defer to the people who do pay attention, but
• Big important fundamental changes should only happen if a majority of shareholders pay attention and agree to them.

Fine. There are other possibilities, though. We talk occasionally about “retail shareholders who don’t care should be allowed to sell their voting rights to people who do care,” which has an obvious appeal but mostly hasn’t taken off. But another possibility is:

• If you don’t vote, you should let the company’s management decide for you.

That is, in some abstract model of democracy, “if you don’t care, you’re letting the people who do care decide” makes sense. But if you bought shares in a company, that might suggest — at least as a default — that you trust the managers of the company. If you don’t care about the details of some vote, maybe “let management decide” better captures your unexpressed desires than “let the shareholders who do care decide.” Maybe the shareholders who do care are not representative of the ones who don’t; maybe management is.

And so, if there’s some shareholder proposal like “the company should write a report about climate change,” and 40% vote yes and 30% vote no and 30% don’t vote, maybe that really means that 40% want the company to do something different and 60% — the nos and the nonvoters — think “meh it’s fine as it is.” Or if the company asks shareholders to vote to approve executive pay, and 30% vote yes and 40% vote no and 30% don’t vote, maybe that really means that 40% of shareholders are engaged and angry and don’t want the executives to get paid that much, but the other 60% are like “ehh it’s fine, we like management.”

I’m not sure that’s correct: Retail shareholders could be pretty annoyed with management, but still not annoyed enough to go and fill out proxy cards for their small holdings. But you could ask them. Bloomberg’s Todd Gillespie reported Monday:

Goldman Sachs Group Inc. plans to give individual shareholders the option of letting the board of directors decide how their votes will be cast, a year after coming closer than ever to having its executive compensation proposal rejected.

Regulators gave a green light to the firm’s request to give retail investors the option of voting with the board by default, according to a Securities and Exchange Commission letter Monday. Those investors account for roughly 30% of Goldman’s shares, according to a person familiar with the matter.

The change is likely to increase turnout in a way the boosts support for the company’s position on key proposals at annual general meetings, where in recent years Goldman has faced significant objection to large pay packages for its top executives.

And Tuesday the US Securities and Exchange Commission granted Tesla Inc. permission to implement a similar program in which retail investors could default to letting Elon Musk vote their shares. I mean, not literally Elon Musk; the shares would be voted “based on the recommendation of the company’s board of directors.” 

This approach was pioneered by ExxonMobil Corp., and we talked about it a few months ago. An Exxon shareholder complained that, if “always vote with the board” is an option available to shareholders, then “always vote against the board,” or “always vote the way proxy advisers suggest,” should also be options. I just think that’s wrong? I understand why this option annoys good-governance advocates, because it really does have the effect of entrenching management and giving the board free rein to run the company. But also “give the board free rein to run the company” really is a plausible model of what inattentive retail shareholders want. Especially at Tesla.

Incidentally, we talked yesterday about the prospects that agentic artificial intelligence will eliminate retail-investor inattention. (Which will be bad for banks, which rely on inattention, and very very good for Robinhood, which relies on attention.) I suppose you could tell some sort of related story here, like, “retail investors will be able to actively vote all of their shares on everything by instructing their AI agent on what to do.” But what will they tell the agent to do? “Vote however you think is best”? I feel like the simplest answer is “just re-elect the directors, approve the pay, and don’t vote for any weird proposals”: That is, just defer to management. And at Tesla, the retail shareholders will obviously tell their agents “just vote for whatever Elon wants.” 

There is a lot of finance theory about conglomerates. If you have a widget company, and I have a sprocket company, and we merge them into one company, there are advantages and disadvantages. Some of these are managerial (“you can apply best-in-class management skills to multiple businesses” vs. “the managers are unfocused and distracted by multiple businesses”) but some are more corporate finance-y. The main financial advantages and disadvantages of conglomerates are:

• A conglomerate that combines two uncorrelated businesses is safer than either business alone: Sometimes widget sales are down but sprocket sales are up, meaning that the company can muddle through a widget downturn without going bankrupt. The conglomerate is more attractive to debt investors because its risks offset each other, and debt investors hate risk.
• But “a basket of options is worth more than an option on a basket”: Shareholders might prefer to own a widget company and a sprocket company separately, because they get the upside on each investment but their downside is floored at zero.. If the widget industry dies out but the sprocket industry booms, a shareholder of separate companies does well: Her widget investment goes to zero, her sprocket investment returns 1,000%, and she’s happy. But if she owns a widget/sprocket conglomerate, it might spend years losing money on widgets, subsidized by its sprocket profits; its widget losses are not floored at zero. The conglomerate might be less attractive to equity investors, because its risks offset each other, and equity investors love risk.

There is another, related but slightly different set of investor-targeting advantages and disadvantages:

• Some investors might really like widgets, and some might really like sprockets. If you run a widget/sprocket conglomerate, you might attract both sets of investors, and so appeal to more investors than either company alone. 
• Alternatively, if you run a widget/sprocket conglomerate, you might attract neither set of investors. There might be specialized widget investors who ignore you, and specialized sprocket investors who ignore you. If you separated into two focused companies they might each be able to attract new investors. You can tell a clearer story (rather, two clearer stories) to the market.
• And if an investor did want a diversified widgets-and-sprockets bet, she could just buy shares of both companies. You don’t have to give her that diversified bet at the corporate level; she can do it herself.

This is pretty standard stuff. We have talked about all of it in connection with Elon Musk’s conglomerating and de-conglomerating impulses.

Separately, we talked a few months ago about a sports gambling exchange-traded fund. Obviously I loved it, but I was a bit skeptical. The sports gambling ETF would manage a diversified portfolio of sports bets. This would make it less risky than a sports gambling ETF that bet only on, like, “the Knicks will win the NBA championship.” As a product for your retirement fund, sure, makes sense, I guess. (???) But … it’s … sports … gambling? Presumably much of the appeal of sports gambling is, like, picking the team you want or expect to win and betting on them? And so a sports gambling ETF that is like “we’ll do some sports gambling for you and give you the proceeds” is missing an important part of the appeal of sports gambling. I’ve pointed out that really what you want is, like, a Knicks ETF, because then people who like the Knicks could bet on your ETF.

The point here is, maybe, that diversification in sports betting is bad, at the fund/product level. Some people want to bet on the Knicks, some people want to bet on the Spurs, some people want to bet on the Clippers, but (1) very few people want a diversified bet on all of them and (2) if they do, they can construct it themselves. “Here’s a diversified sports bet” is just going to appeal to fewer people than “here’s a Knicks bet.”

Anyway:

The New York Knicks and Rangers will soon be available for purchase separately on the stock market.

MSG Sports, which owns the NBA and NHL teams, announced Wednesday that it will split the two franchises into separate publicly traded companies after its board of directors approved the move this week. The company has explored the move since earlier this year and expects to complete the transaction Oct. 26. The spin-off comes after a year of high-profile success for the Knicks, who won the NBA title in June, and as the Rangers work through a rebuild after missing the playoffs the last two seasons.

MSG Sports, currently a publicly traded company, will become MSG Knickerbockers Corp. It will own the Knicks and Westchester Knicks (their G League team). MSG Rangers Corp. will be comprised of the Rangers, the MSG training facility and the Hartford Wolf Pack (the Rangers’ AHL team).

I mean, sure. Presumably there is a market for, like, “here’s a diversified bet on New York sports teams” — lots of people like the Knicks and the Rangers — but if you want that you can just buy Knicks and Rangers shares separately. That doesn’t give you any New York baseball, football or soccer exposure, but you can get that on Kalshi.

US Benchmark Yield Hits Highest Since 2002 as Bonds Sell Off. Who’s Who at Jane Street. Apollo Debuts Daily Private Credit Marks as SEC Urges Vigilance.  Porsche SE Says German Court Has Dismissed $6.1 Billion Lawsuit Brought by Investors. How SpaceX’s AI Unit Turned Itself Into an AI Cloud Firm.  Paramount’s $41 Billion of M&A Bonds Slump as Trading Begins. Walgreens Owner Nears Deal to Sell British Pharmacy Chain Boots. King’s bank Coutts hit with new lawsuit after ‘ debanking.’ UBS pushes back against investor call to leave Switzerland. Tech CEOs Privately Questioned Amodei for Sounding AI Alarm Bells. Bridgewater CEO Warns That AI Threatens ‘Societal Breakdown.’ Now We’re All Starting to Talk Like AI Chatbots Too. Louvre boss vows to instil ‘culture of security’ after heist. Inside the Global Market for Elite $30,000 Sheepdogs.

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My little financials dispersion trade [1]  is:

1. Some retail-facing financial businesses make their money from customers who pay too little attention.
2. Some retail-facing financial businesses make their money from customers who pay too much attention.
3. Agentic artificial intelligence will tend to help customers pay more attention, which is bad or good for business, respectively.

We’ve talked about both legs of this a few times recently. Recent worries about “agentic bank runs” reflect the fact that banks make a lot of their money from depositor inattention: When interest rates go up, bank customers mostly don’t move their money, because it would be a pain, so banks can pay below-market interest rates on their deposits. You could have similar worries about life insurance, or annuities, or mortgages: Lots of financial products are built (and priced) based on assumptions about customer inattention. AI agents, the theory goes, have unlimited attention and energy, and will tirelessly move money around to extract the last basis point from banks. (Here is a prescient 2019 law review article by Rory Van Loo on “Digital Market Perfection,” laying out this worry.)

On the other hand, some retail brokerages are absolutely falling over themselves to get customers to adopt AI agents. Why? Because, simplistically, in modern US market structure, retail trades are profitable for brokerages. (Strictly: Retail trades are profitable for market makers who take the other side of those trades, and market makers pay brokerages to take the other side of their customers’ trades.) More retail trades mean more profits. But the customers have day jobs and family commitments and need to sleep, so they can only do so many trades per day. AI agents, the theory goes, have unlimited attention and energy and don’t sleep, so they will do many more trades. They will tirelessly move money around to pay the last basis point to market makers.

Retail brokerages are actually an interesting case because, schematically, they make money in two ways: from trades (receiving payment for order flow from market makers), and from idle cash balances (investing customers’ cash, earning interest, and paying the customers a below-market portion of that interest). Trade revenue is increasing with attention, so agentic AI is probably good news for brokers on that front. Cash-balance revenue is decreasing with attention, so agentic AI is probably bad news for brokers on that front.

I’ve also idly speculated about agentic sports gambling, which would be just pure windfall for sportsbooks and prediction markets.

Today’s Wall Street Journal has articles about both legs of this trade. First: “Lazy Customers Are Great for Banks. Could AI Change that?”

AI assistants may soon run your financial life. That could be a big problem for banks. 

Americans forgo untold sums of money every year on what some might call a laziness tax, for oversights like failing to refinance their mortgage or incurring a late fee after forgetting to pay a bill. Another silent wealth killer: keeping too much cash sitting in checking or savings accounts that pay little or no interest.

Now, artificial intelligence is threatening to put an end to all that.

Second: “Robinhood’s Next Big Bet: AI Bots That Trade While You Sleep.”

Artificial intelligence was front and center at Robinhood’s annual event for its most-active users. Holding court at the George R. Brown Convention Center in Houston, the brokerage’s executives unveiled a slew of new tools and services. Among the most significant: an in-app AI agent that can answer questions about the market, build an investment strategy from scratch and eventually place trades while you sleep, work or otherwise turn away from the screen. 

So-called agentic trading tools will give everyday traders capabilities previously reserved for hedge funds and other Wall Street pros, Chief Executive Vlad Tenev said. 

Robinhood agents can engage in a conversation based on simple written prompts, conduct research and trade automatically. For example, users can ask their agent to help analyze how computing costs might affect certain companies, then open positions in their stocks based on a series of follow-up questions. 

In another use case, traders might deliver a more-specific command to their agents: “Run the wheel strategy,” a popular stock-options trade that aims to generate income by selling cash-secured puts and covered calls. The latter example will be possible with a coming feature called Loops, which will allow Robinhood agents to run a strategy repeatedly, even when users aren’t logged on. 

Robinhood’s launch is part of an industrywide push to embed AI tools in how everyday Americans research, plan and execute their investments. In decades past, mom-and-pop traders had to call their broker and pay a hefty commission on every trade. Now, company executives say, agents will become the driverless cars of Wall Street: enabling investors to trade stocks, options, bitcoin and prediction-market contracts even when they are not paying attention. 

While you sleep! I simply cannot stress enough how much “enabling investors to trade … options, bitcoin and prediction-market contracts even when they are not paying attention” is the Holy Grail of retail finance. Market makers love to trade options, crypto and sports bets with retail customers, because the margins on those trades are big and the customers are largely uninformed and unlikely to create adverse selection. (Even after they “ask their agent to help analyze how computing costs might affect certain companies”!) If they’re not paying attention, even better.

I once wrote that, “for equity market makers, there are few more beautiful phrases in the English language than ‘day trader and volleyball-programs coordinator’”: What you want, in a customer, is someone who trades a lot with no edge.. [2]  But “day trader and volleyball-programs coordinator who trades in his sleep” is obviously better!

We talked a few weeks ago about the National Basketball Association’s investigation into the Los Angeles Clippers. Basically:

1. The NBA has rules capping how much a team can pay a player.
2. The NBA does not have rules capping how much a sponsor can pay a basketball player for an endorsement deal.
3. If the owner of a NBA team happens to give an outside company $48 million for “consulting,” and if that outside company happens to give the star player of that NBA team $48 million for “endorsements,” well. Well!

The NBA found that the Clippers paid a lot of money to outside companies that went right back to Kawhi Leonard, allowing the Clippers to, in effect, pay him considerably more than the maximum NBA salary. This, the NBA concluded, was not allowed.

European soccer leagues have somewhat different, but essentially isomorphic, rules:

1. The Union of European Football Associations has rules capping how much a club can spend. Whereas the NBA’s cap is essentially a flat dollar amount, the UEFA cap is essentially a linear function of the club’s revenues. A club that makes $100 by selling tickets and sponsorships and stuff can spend, let’s say, $70 on player and coach salaries and transfer fees. A club that makes $100 by selling tickets and sponsorships and stuff, but has fabulously wealthy owners, might want to spend $300 on salaries and transfer fees. But the rules more or less prohibit that.
2. UEFA does not have rules capping how much a sponsor can pay a soccer club for a sponsorship deal. And sponsorship revenues can be used to pay players.
3. If the fabulously wealthy owner of a soccer club happens to give an outside company £830 million for “consulting,” and if that outside company happens to pay the soccer club £830 million for “sponsorship payments,” well. Well!

The English Premier League announced yesterday that “an independent Commission has found Manchester City FC guilty of all charges related to serious breaches of the Premier League’s financial rules over a nine-season period.” Here is the (heavily redacted) decision, and here’s a good breakdown of the findings in the Athletic.

If you read the (very fun!) NBA report on the Clippers, you have the basic idea of the Manchester City charges. In 2008, Abu Dhabi United Group, an investment firm owned by Sheikh Mansour, acquired Manchester City, then sort of a middling Premier League team. Since then, Manchester City has won the Premier League eight times. It has won the Premier League eight times because it has very good players and coaches, and it has those good players and coaches because it pays them very well, and it can afford to pay them well because, allegedly:

The Club devised a plan to disguise shareholder funding (i.e. equity contributions paid by ADUG) as ‘commercial partner revenue’ (i.e. AD Sponsorship income) – what we have described in Appendix 15 as the Disguised Funding Scheme. By the Disguised Funding Scheme

a) The Club would enter into AD Sponsorship Agreements with AD Sponsors which contained substantial Recorded Sponsorship Fees at well above FMV

b) However

i) The AD Sponsor would not be liable to pay the recorded Sponsorship Fee, and would not do so. The AD Sponsor would be liable to pay (and would in fact pay) only the Base Sum

ii) The Tagged Sum would be payable by (and would in fact be paid by) ADUG …

Use of the Disguised Funding Scheme enabled the Club to represent in its financial statements as commercial income from AD Sponsors a total of £949.94 million in the seasons from 2009/10 to 2017/18. Of that sum

a) Only £119.25 million represented Base Fees for which AD Sponsors were liable and which AD Sponsors in fact paid. …

b) A total of £830..69 million represented Tagged Sums, payable by and paid by ADUG to the Club. The sums making up that total ought to have been recorded in the Club’s annual financial statements as equity contributions from ADUG.

The core situation is that sports teams’ owners are generally limited in how much money they can spend on their sports teams, but sports teams’ commercial sponsors are not subject to the same limits. Sponsors don’t necessarily want to spend all that much money on sports team sponsorships, because there is maybe a diminishing economic return. But sports teams’ owners sometimes do want to spend unlimited and uneconomic amounts of money on their sports teams, because winning trophies is fun and kind of the whole point of owning a sports team. And if the owners in fact have unlimited amounts of money, there are trades to be done with the sponsors.

Incidentally. Most professional sports leagues have rules like this, capping teams’ spending, because if they didn’t (1) teams might spend unsustainably in a zero-sum race to win championships and (2) the teams with the richest and most profligate owners would win. And those things, the theory goes, would be bad. A lot of people seem to find that logic basically compelling. But you don’t have to. From another angle, this is pretty straightforward cartel stuff, restricting competition to save the team owners money. If you’re the owner of a basketball or soccer team, spending caps are obviously good for you, unless maybe you’re the richest owner in your league and care more about winning than money. But if you’re a basketball or soccer player, spending caps mean that you get paid less than your free-market value. For pretty obvious reasons (money, also winning), you might prefer to play for the teams that break the rules..

The business of a middleman is buying low and selling high. If someone wants to sell you a stock or a bond or a commodity or a painting or a Pokémon or a whatever for $100 right now, and someone else wants to buy it from you for $120 right now, good deal for you. 

It’s less good for your customers. Some big markets have transparency rules that make it very difficult to pull this off. For instance, in the US stock market, stock trades are reported publicly more or less instantaneously. [3]  If I see that Nvidia Corp. stock traded at $227.21 a second ago, I might be willing to sell you my Nvidia stock for $227.15, or I might be willing to buy some Nvidia from you for $227.30, but $215 or $245 are right out. 

In other markets, it is easier to make big spreads. The art market is notoriously opaque, for instance. If you buy a painting from someone for $100 million, there is not necessarily any publicly reported information about that sale. If you go to someone else and say “would you like to buy this lovely painting, it is $120 million,” she will have no objective reason to think that’s the wrong price. She might ask you a question like “well what did you pay for it,” but you can stroke your mustache and give her a withering look and mutter “philistine” under your breath and she will be shamed into offering you $130 million. Or you can lie, maybe, though that is not legal advice. The Pokémon market at my kids’ school works like this, too, only worse.

For a while, some traders of some mortgage-backed securities would lie to customers about the prices they had paid for bonds: They would buy a bond at 70 and then go tell a customer “I’m twisting this guy’s arm but I think I can get it for you at 90,” and the customer would pay them 90, and they’d make a huge profit. These bonds were thinly traded and not publicly reported, and this sometimes worked. Several traders were prosecuted for this, and some of them went to jail, because prosecutors thought it was fraud. Judges mostly disagreed, though, and I guess it’s fine? Not legal advice. I always thought that prosecuting them was a second-best regulatory approach. The better regulatory approach would be to require MBS trades to be reported publicly. In the US, many bond trades are required to be reported publicly to the Trace system, and this more or less solves the problem. If you can go see where a bond last traded, and it traded at 70, you won’t pay 90 for it. 

Now, if a bond trades only very rarely, and a trader buys it at 70 and wants to sell it to you at 90, she could always not report it. Buy at 70, don’t report the purchase to the Trace system, sell to you five minutes later at 90, collect a 20-point profit. This seems bad. Probably her employer wouldn’t let her do that; probably it has automatic systems to report trades promptly, and takes those systems seriously and fires people who try to bury their trades. But if she did manage it, there are two advantages to her:

1. You don’t know the right price, so maybe she can get you to pay 90.
2. If she gets caught, is she really going to go to jail? She’s not lying to a customer. She’s just forgetting to file a form. Elon Musk does it!

Anyway here’s a fascinating New York Times story about the US Commodity Futures Trading Commission dropping an enforcement action in the cotton market. Cotton is kind of like bonds, in that there is a reporting obligation for certain big cotton trades. Schematically, a middleman who sells a lot of cotton has to report it, and then the trades get aggregated into a weekly government report, and the weekly government report is used by other market participants to figure out what the right price is. So if you can sell cotton at $120, and you want to buy cotton at $100, it is helpful for you not to report the $120 trade, because if people don't know about it they might sell to you at $100:

By law, the companies must report their sales contracts to the Agriculture Department, which publishes weekly reports on supply and demand that farmers rely on to price their goods and make other decisions. But if the traders delay in reporting their export contracts — as the whistle-blower said was the case with the two firms — it gives a false impression of actual demand and the farmers set their prices lower, making less money.

But this is all kind of vague and aggregated; it’s not like you have to report every trade to a public tape within 15 minutes. Two commodity trading companies allegedly delayed their reporting: They would enter into big sales contracts, not report them, and then go out and buy cotton from farmers at low prices. Other cotton traders perceived that as, basically, fraud, a way to rip off their counterparties:

O.A. Cleveland, a professor emeritus at Mississippi State University and a national cotton expert, said he had told major cotton traders in industry meetings: “You are trying to hide this information that should be public so you can rip off the growers.”

One of the companies settled with the CFTC just before the end of the Biden administration; the other one waited, and the Trump administration dropped its case. The reasoning is not totally clear, but the Times notes:

Brooke Nethercott, the agency’s spokeswoman, said the Biden administration fined industries billions of dollars for minor, administrative offenses.  …

[Former CFTC Acting Chair Caroline] Pham ... objected to charging companies with what she considered possible “paperwork errors,” as she said when she criticized the fine against the Olam Group.

“They were a bit slow in filling out paperwork” is one way to put it, and sounds like no big deal. “They effectively lied to their counterparties about the prices they were getting for cotton” is the other way to put it.

Investment banking runs on an apprenticeship model, but I have always thought that it’s not an especially well-designed apprenticeship. The approximate way that it works is:

1. Junior investment bankers build financial models and format pitchbooks.
2. Senior investment bankers schmooze and advise clients.

You become a senior investment banker by being a good junior investment banker. But, why? There is some overlap of skills: Building financial models all night builds facility at understanding corporate finance and merger tactics and the drivers of companies’ value; inputting senior bankers’ pitchbook-formatting markups builds an understanding of how to persuade clients. Maybe? There’s a lot of non-overlap, too, and junior bankers are often only indirectly and haphazardly trained in schmoozing clients. There are obvious arbitrages. Banks sometimes hire senior bankers with no junior banking experience but lots of schmoozing skills, and they sometimes outsource the models and pitchbooks to satellite offices or artificial intelligence models with no path to promotion. But, mostly, the junior bankers become the senior bankers, and it can be a hard transition.

Some junior investment bankers are good at their jobs and would also be good at the more senior job: They are detail-oriented and indefatigable at building financial models, but they also see the bigger picture and play golf. Other junior investment bankers are good at their jobs and would be bad at the more senior job: They can build a sweet financial model, but they can’t talk to clients. [4]

The third, most interesting category is that some junior investment bankers are bad at their jobs but would be great at the more senior job. [5]  They are personable, charming, good with clients and good at golf; they have a good high-level grasp of their coverage industry and good financial intuition, but they’re not going to sit around all night hunting for a mistake in a model. They are not much use to the senior bankers who rely on them for accurate timely work. But if they were senior bankers, someone else would do the accurate timely work, and they’d schmooze it on over to the clients and win lots of deals.

These people either get fired in disgrace or survive their analyst program by the skin of their teeth and then go on to run the place. The Wall Street Journal has a profile of John Waldron, the apparent successor to David Solomon as chief executive officer of Goldman Sachs Group Inc., [6]  who almost fits into both categories:

He joined Bear Stearns out of college—after being rejected by Goldman.

“I didn’t do well in the financial modeling test,” Waldron said on Inside Blackstone, a podcast from the private-investment firm. 

Waldron has said that starting his career at a smaller firm enabled him to take on bigger responsibilities and be more entrepreneurial. At Bear Stearns, he owned client relationships at a relatively young age, he said on Goldman’s Exchanges podcast in 2019.

Right the guy who fails the financial modeling test but shows up and immediately owns client relationships is going to be the much more successful banker in the long run. But not what Goldman wants in an analyst.

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