Money Stuff: Index Funds Are a Bit More Illegal

Ten years ago last month, I first wrote about a then-novel theory that index funds are illegal. The theory is:

• A handful of big asset managers run diversified funds that own large stakes in every public company. In particular, the “Big Three” managers — BlackRock Inc., State Street Corp. and the Vanguard Group — run enormous index funds that are often among the biggest shareholders of companies, and that combine to own 20% or so of most US public companies.
• If two companies in the same industry have the same owners — or even a lot of the same owners — they have less reason to compete with each other. If Company X can reduce prices on its widgets to win some business from Company Y, and doing so would add $0.90 to Company X’s profits by taking away $1 of Company Y’s profit, in a competitive market Company X would do it. But Company X and Company Y have the same owners, that would be bad for them: They would get $0.90 of profit rather than $1, and they don’t care who the profit comes from. So no one will lower prices.
• But that’s bad for consumers: Instead of Company X and Company Y competing to sell as many widgets as possible by lowering prices, consumers get fewer widgets at higher prices.
• The point of antitrust law is to prevent this: The old “trusts” that were the subject of antitrust law were entities that owned shares in multiple companies in the same industry, and that influenced those companies to reduce competition and keep prices high.

When we first discussed this theory, I called it “wonderful” but also “mad.” It is clever, in that it draws logical conclusions from standard theories of (1) investment diversification and (2) corporate fiduciary duties to shareholders. But it had sort of a jokey flavor. In 2015, few people believed this theory that index-fund managers were telling companies to keep prices high. For one thing, they weren’t. The big index-fund managers don’t go have meetings with their portfolio companies to say “hey you should stop competing and raise prices so we make more money.” They don’t do that because it would be illegal, and because each of them only owns a minority stake in each company and can’t tell managers what to do, and because they tend not to get too involved in the operational details of their portfolio companies. They own every company in the index, without making any specific investment decisions, so there is no reason for them to think about any company’s pricing strategy. 

And so if you believed this theory, you had to have a more complicated and implicit mechanism. You had to think something like “corporate managers independently decide to act in the best interests of their common owners by reducing competition,” or “unlike other investors, index fund managers don’t push managers to compete, and so the managers naturally don’t,” or something like that. Not, like, “BlackRock buys up all the companies and tells them to raise prices.” 

Over time, though, this theory became more mainstream and respectable. Back in 2018, I went to a Federal Trade Commission hearing about the theory. As I wrote at the time, people kept coming up to me to ask “so are index funds illegal yet or what,” so it still felt a little jokey, but we were at an FTC hearing about it. So not entirely a joke.

And people noticed one place where big investment managers do explicitly try to tell companies what to do: environmental, social and governance (ESG) investing. In particular, it seems broadly true that, for a while, several big asset managers had a general view that their portfolio companies should reduce their carbon emissions. “Climate risk is investment risk,” BlackRock Chief Executive Officer Larry Fink wrote to his portfolio company CEOs in 2020, and — back when he believed that — it was a systemic risk across all companies. Big index investors had no incentive to pay close attention to each company’s pricing strategy, but they did have a reason to care about the effects of climate change on all of their companies, and they had some reason to think that if all of their companies reduced their emissions that would be good for their whole portfolio.

And then you might just notice that “reduce your emissions” can sometimes mean “reduce your output,” which sort of looks like “sell fewer widgets at higher prices,” which is exactly what the index-fund worriers were worrying about. This is particularly true when the companies involved are, for instance, coal companies: A coal company’s output is carbon, so telling it to reduce its carbon emissions really directly means “sell less coal.” Presumably for more money. 

And there was a political backlash to ESG anyway. And the antitrust argument became useful in that backlash: If you don’t like ESG, you can argue that it is illegal, because it is an antitrust violation. 

And so last year we talked about a lawsuit that the state of Texas brought against the Big Three, alleging that they had an antitrust conspiracy to reduce coal output and keep prices high. As the lawsuit put it:

Defendants have leveraged their holdings and voting of shares to facilitate an output reduction scheme, which has artificially constrained the supply of coal, significantly diminished competition in the markets for coal, increased energy prices for American consumers, and produced cartel-level profits for Defendants.

Nobody quite says that the Big Three were motivated by a desire to keep prices high: They were motivated, presumably, by sincere climate goals, and in fact in other circumstances the state of Texas will tell you that ESG investing reduces shareholder profits. But the theory all hangs together: Big index funds wanted lower carbon emissions, coal emits carbon, index funds own lots of shares of coal companies, so the big shareholders of the coal companies wanted them to lower their coal production. 

To be clear there are still flaws in the theory. As the Big Three pointed out in their filings in the case, coal production went up during the alleged conspiracy. Also, while the Big Three put out some statements about emissions being bad, they don’t seem to have done anything to pressure the coal companies to reduce output. In fact two of the Big Three apparently never even met with the coal companies:

The Complaint offers not one example of a Defendant ever telling a coal company to reduce output or do anything else. … It does not identify any time Defendants communicated with each other on any topic, much less a time they agreed to suppress coal output. … The Complaint alleges that Vanguard, though not State Street or BlackRock, had routine meetings with four of the coal companies in the relevant markets. … It alleges that State Street and BlackRock, though not Vanguard, either withheld votes from or voted against reelecting some directors. … Although Plaintiffs identify thirteen votes against directors at thermal coal or SPRB producers, in ten of those cases, only one Defendant voted against (or withheld) a vote, and in the other three cases, the votes differed as to the directors covered. 

So we are to some extent back where we were 10 years ago: This is a fun theory with a certain logical consistency, but the main objection to it is still “no but big index funds just don’t meet with companies to tell them to cut production and raise prices.”

In some ways, though, we are a long way from 2015. And today the federal government’s antitrust enforcers endorsed the theory. The Wall Street Journal reports:

U.S. antitrust enforcers for the first time are arguing that large institutional investors who own shares in rival companies may violate antitrust laws if they use their influence to affect how those firms compete.

The Justice Department and Federal Trade Commission made those views public Thursday by submitting a brief in a case filed last year by Texas Attorney General Ken Paxton and other Republicans against BlackRock, State Street, and Vanguard Group. The federal government’s filing, known as a statement of interest, says the asset managers’ holdings of multiple companies in the coal industry—known as common ownership—could violate competition laws. 

“This case is about precisely the sort of conduct, including concerted efforts to reduce output, which have long been condemned under the antitrust laws,” the agencies say in their court filing. …

The Justice Department and FTC say they aren’t calling into question all index investing or cases of common ownership. But investors may cross the line when they use their influence over several companies to undermine competition, as Texas and the other plaintiffs allege, they say.

“Carbon reduction is no more a defense to the conduct alleged here than it would be to price fixing among airlines that reduced the number of carbon-emitting flights,” the agencies’ filing says.

It is not a full endorsement of the theory that index funds are illegal, but we have come a long way. Now it appears to be the official policy of the US government that index funds, at least sometimes, cause the public companies they invest in to reduce competition.

Ten years ago, when we first discussed this topic, it was fun to imagine potential solutions. “Index funds shouldn’t be allowed to vote their shares,” or “you should be allowed to diversify by owning exactly one company in each industry,” or “index funds should be smaller.” I am not sure any of them directly address the perceived problem, and they all seem pretty disruptive to the people who put a lot of money into index funds. But I suppose the answer now is simpler and arguably less disruptive, something like “big fund managers shouldn’t talk about ESG.”

The normal traditional kind of securities fraud is when a public company misleads investors about its expected financial results. Here is a New York Times article suggesting some companies might be doing that a little bit:

As companies start to feel the impact of President Trump’s tariffs, especially the 30 percent tax on Chinese goods, they have a responsibility to tell their investors how they will deal with the higher costs. For many companies, that means raising prices.

But Mr. Trump, who insists that other countries are paying the tariffs, doesn’t want to hear that. So executives are speaking even more delicately than usual, including on the perfunctory quarterly earnings calls that are normally of interest only to Wall Street….

Chief executives have a responsibility to investors to speak directly about the impact that tariffs are having on their business, said Stephan Meier, the chair of the management division at Columbia Business School. Retailers are especially vulnerable to tariffs because they import a significant amount of goods from China. ...

He said tailoring talk of tariffs in a way that avoided upsetting the Trump administration would not be “honest, authentic and transparent.”

But we often talk around here about a different kind of securities fraud, which I call “everything is securities fraud”: Every bad thing that happens to a public company can also be characterized as securities fraud, because investors can pretty much always claim “you didn’t warn us sufficiently about the bad thing so we were tricked into buying your stock.” And if companies are honest, authentic and transparent about tariffs, that can be bad for them:

Executives are finding that speaking too plainly has consequences. When Mattel released its earnings in early May, the maker of Barbie said it would raise prices on U.S. toys because of tariffs on imports from China, then totaling 145 percent. It also scrapped its financial forecast for the year, citing uncertainty over trade and tariff policies.

Mattel’s chief executive, Ynon Kreiz, went on CNBC and was asked whether it would be cheaper for the company to manufacture toys in the United States. “We don’t see that happening,” he said.

A few days later, in the Oval Office, Mr. Trump didn’t hide his disdain for the Mattel boss. He threatened to impose a 100 percent tariff on Mattel’s products, saying the company “won’t sell one toy in the United States.” 

The point here is that the risks are symmetrical. If a retailer says in its public statements “tariffs won’t be a big deal for us,” and then its earnings are disappointing and the stock goes down, someone could sue for securities fraud, saying that the company misled investors.

If instead it says “tariffs will be a big deal for us,” and then Donald Trump tweets mean things about it, and then its earnings are disappointing and the stock goes down, someone could also sue for securities fraud. This one is less obvious — who is being deceived?— but these days “making people mad about politics” is pretty clearly the sort of bad thing that can get you sued for securities fraud. We have discussed a lawsuit in federal court in Texas against Target Corp. for doing a Pride Month marketing event and upsetting conservatives. There was pretty clearly no deception involved there — it was a marketing event, and Target quite explicitly warned shareholders about the risk that its position on diversity might lead to boycotts — but a judge let it go forward anyway because, you know, everything is securities fraud. And we talked last month about the New York City Comptroller’s threat to sue Tesla Inc. because Elon Musk, its CEO, is doing a lot of political stuff that upsets liberals. There is possibly no fact in the world that is less concealed than “Elon Musk is doing annoying political stuff,” but, again, everything is securities fraud.

So doing stuff that annoys Donald Trump can also get you sued for securities fraud. It won’t be phrased like that, exactly, but you can sort of imagine how the complaint will go. “The company said that it would have to raise prices because of tariffs, but in fact China pays the tariffs so the company was lying, and its lies led to a customer backlash and reduced sales, [1]  and the company’s risk factors failed to disclose the risk of that happening.” This really is pretty much the Target lawsuit logic; it seems wrong, but that doesn’t mean it can’t work.

A lot of things these days have this essential form: Many choices that companies make are politically polarized and have high stakes, and whichever choice a company makes can get it shareholder lawsuit from the other side. “Everything is securities fraud” is kind of my schtick, so I get emails asking me questions with one or both of the following forms:

• Is it securities fraud for a company to do some thing that Donald Trump wants?
• Is it securities fraud for a company not to do some thing that Donald Trump wants?

And the answer — not legal advice! — is “sure, yes, everything is securities fraud.” Consider the Paramount Global situation: Paramount wants to do a merger with Skydance; Donald Trump has brought a pretty frivolous-looking lawsuit against CBS News, which Paramount owns; the Paramount/Skydance merger “requires approval from the Federal Communications Commission, which is led by Trump-appointed Chairman Brendan Carr”; Paramount is apparently considering settling the lawsuit with some large payment to Trump. If it doesn’t pay Trump and the deal is not approved by the FCC, that is bad for shareholders. [2]  If it does pay Trump there is at least a theoretical risk that it will get in trouble for violating bribery laws, as some US senators have threatened, and of course that would be bad for shareholders. [3] Doing the thing that Trump wants will get you accused of corruption (you allegedly bribed him); not doing the thing that Trump wants can get you accused of corruption (“election interference” is apparently the problem with CBS News); either thing can be bad for shareholders and can get you in trouble. [4]

Here’s one reader email from last week:

The “everything is securities fraud” thesis along with current political trends got me thinking: Suppose political corruption becomes de facto legal and widely practiced. Would it then be securities fraud to not engage in bribery, if doing so could get you, e.g., a key tariff exemption? Would more ethical companies need to file a disclosure saying something along the lines of “we refuse to bribe political officials to give us exemptions to extortionate tariffs on key inputs to our widgets, presenting a material risk to our business”? 

And, sure? Again it is symmetrical. At least in the current US context, people don’t pay explicit bribes; they make donations to settle pretty thin lawsuits. If you pay those quasi-bribes and your stock goes down, someone will sue you for paying bribes (and not adequately disclosing the risks). If you don’t pay the quasi-bribes and your stock goes down, someone will sue you for whatever pretextual thing they were supposed to pay for. [5]

All of this seems bad, but I suppose my particular point is that “everything is securities fraud” as a way of regulating business behavior is bad.

Elsewhere, Bloomberg’s Max Abelson and Annie Massa report on “The Trump Family’s Money-Making Machine,” and the Wall Street Journal reports that “Donald Trump’s private clubs have emerged as a moneymaking venture for the president’s second term, and a hub for donors and favor-seekers alike.” If you are a public-company CEO and you’re not paying $1 million to join Mar-a-Lago, are you really fulfilling your obligations to shareholders?

Sorry but in possibly somewhat related news here’s a Wall Street Journal story about Trumpcoin treasury companies:

Some small Chinese companies are betting President Trump’s memecoin will help them save their shares from losing a place on U.S. exchanges.

A technology company called GD Culture Group said on May 12 that it had struck a $300 million funding deal to help it amass a stockpile of cryptocurrencies, including bitcoin and the president’s memecoin, $TRUMP. The announcement sent shares of GD Culture, which is based in New York but operates in China, up by 14%.

Three days later, Chinese garment maker Addentax Group said it was in discussions with unnamed crypto holders to buy up to $800 million of $TRUMP tokens and bitcoin. Addentax’s stock didn’t quite get the same boost, falling about 7% that Thursday after an intraday surge of more than 150%.

GD Culture and Addentax share more than just ties to China and a mutual affinity for the president’s memecoin: They are both in danger of being delisted from Nasdaq, a major U.S. exchange. And by promoting investments in crypto (and Trump), these companies might simply be grasping for ways to raise their stock prices and hold on to their U.S. listings, securities-industry executives said.

There’s no particular reason that just buying Trumpcoin should increase a company’s stock price, but reasons are not what matter here.

In our meme-y age, a problem that I think about sometimes is: If you are the CEO of a public company, and you can do some dumb thing that won’t help your business but that will mechanically increase your stock price, do you have a fiduciary obligation to do it? On the one hand, increasing the stock price is good for shareholders — is arguably your fundamental job — so  you should do it. On the other hand, too much focus on the stock price is probably bad for the stock price, in the long run; companies that build enduring value do not spend all their time maximizing the stock price. 

But, sure, if you’re a small-cap garment company that is going to get delisted, and you can mechanically increase your stock price by putting out a press release saying “Trumpcoin,” and if that price increase keeps you listed and allows you to attract financing, maybe you should do it? Your job is not just to make garments.

Elsewhere in Trumpcoin: “A Crypto Billionaire Who Feared Arrest in the U.S. Returns for Dinner With Trump.”

One way to think about a tech startup is that it is a resume line. Founding a startup can be an important step in your career, a good thing to have on your resume. You might be more attractive as an employee to a big tech company or a venture capital firm if you have experience as a founder; you might have an easier time raising money for a subsequent startup if you are a seasoned founder. I don’t want to overstate this; the good reason to start a startup is because you want to change the world and build an enduring company, not because you want to put “startup founder” on your LinkedIn. But, you know, at the margin, a little. Most startups do not become enduring institutions, but it’s still cool to found one.

Like any other resume line, you want to make it look good; you want to include the proper action words and descriptions of your impact. In particular, if you have “startup founder” on your resume and you are looking for a job, the first question people will ask is probably “well what happened to the startup,” and some answers are better than others. “It is currently a trillion-dollar public company” is the best answer, but of course then you are probably not looking for a job. [6]  “It was a fraud and I am currently in prison” is the worst answer. “It didn’t work and I shut it down” is much better, and you can probably spin that into a good story about resilience and learning from failure. But “I sold it to Google” is an even better answer. Silicon Valley looks kindly on failure, but it does prefer success.

And so if you are a startup founder, selling your company has some value to you beyond the actual money you get for the company. If you sell your startup for $1 million, that might give you $3 million of utility: $1 million of the purchase price, and $2 million of increased future earnings from having “acquired” under the name of your startup on your LinkedIn. 

You can see how there might be a trade here. What if your startup is worth $0? You had an idea, it didn’t work, you are going to shut it down. [7] If Alphabet Inc. came to you and said “if you write us a check for $1 million, we will acquire your startup for $1, and then you can say on LinkedIn that your startup was acquired by Google, [8] ” that could be a good trade for you. The resume line might be worth more to you than the price you pay.

Google isn’t going to get into that business, for a number of reasons, [9]  though arguably the “ acqui-hire” is a related concept. But someone could. There are a lot of companies in the world, and selling to an acquirer that no one has ever heard of is still arguably better than shutting down with nothing. Here is Exit++, a … startup? private equity firm? joke? … that advertises “Failed Startup? Get Your Exit Anyway. We’ll Buy It For $1. Flex your exit and officially say your startup was ‘acquired’ on LinkedIn, X, and your resume.” There’s a form to fill out to get your $1 and your “aesthetic acquisition agreement.”

It’s mostly a joke; they’re not actually going to buy your startup, in part because $0 is not really a floor on the value of a startup and they don’t want to do due diligence to see what liabilities (or outside investors) you have lurking. [10] “Reputation only deal,” they say: “No asset transfers, just immaculate vibes.” (And in fact if, later, your startup works out, you get to keep it and they have no claim on it.) 

Still you could imagine doing this for … I don’t want to say “for real,” but for slightly more real than this, and charging for it. 

Long-Term Bond Yields Soar Globally on Fiscal Policy Fears. OpenAI mystery device. Deutsche Bank Cut Exposure to Clients at Risk From Tariffs. Elliott Set to Win Two Phillips 66 Board Seats in Proxy Fight. Ex-JPMorgan Analyst Builds a 51%-a-Year Quant Powerhouse in Taiwan. Ex-BofA Senior Banker Faces DOJ Insider-Trading Probe Over Deal. Startup Builder.ai Overestimated Sales by 300% to Key Creditors. Apple, Tesla and Nvidia Shares to Trade as Digital Tokens on Crypto Exchange Kraken. BOE Wants Banks to Hold More Capital Against Weak Foreign Debt. Treasury Sounds Death Knell for Penny Production. America’s Leading Alien Hunters Depend on AI to Speed Their Search. “Your work calendar should not include ‘Vasectomy at 4 p.m.’” Kim Jong Un’s New Warship Capsizes at Launch Due to ‘Absolute Carelessness.’

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