Money Stuff: Private Markets Are the New Securities Fraud

Two popular themes around here are:

1. Everything is securities fraud, and
2. Private markets are the new public markets.

We talked about this last month. I wrote then that those themes are related. “Everything is securities fraud” means that any time a bad thing happens at a US public company, enterprising plaintiffs’ lawyers will sue the company for securities fraud (or for violations of fiduciary duties), arguing that shareholders were somehow deceived about the bad thing. “Private markets are the new public markets” means that companies are staying private longer, mostly for structural reasons having to do with the increasing availability of private capital, but also a little bit because they do not want to be sued for securities fraud whenever something bad happens.

What prompted me to write about this last month was that the US Securities and Exchange Commission is looking to solve the second problem by solving the first problem: It is encouraging new public companies to prohibit shareholder lawsuits (and require arbitration instead), to make everything not securities fraud and thereby “make IPOs great again,” as SEC Chair Paul Atkins put it. If shareholders couldn’t sue public companies, that would make being public more attractive.

One can, however, turn this analysis around. Why is it that bad news at public companies generally leads to lawsuits, while bad news at private companies generally doesn’t? I think there are two main reasons:

1. Private investors are big and sophisticated, while public investors include normal individual retail investors. Big sophisticated investors can, in principle, do due diligence and ask questions and evaluate risks; public retail investors, stereotypically, rely on what the company says. If the company says “we are an ethical company” and it turns out that it actually had a sexual harassment problem, the retail investors can go to court and look real innocent and say “how were we to know, we just read the disclosures, we were deceived.”
2. Private companies tend to raise money in direct interactions at discrete times. If you are buying shares in a private company, you are probably buying them from the company in an organized process; you get an offering document and meet with the company and sign a contract with the terms of your investment. If the offering document is full of lies, you can sue, but you probably can’t sue for every random interview that the chief executive officer has ever done. Whereas public companies’ shares trade continuously in public markets, so if the company ever says anything misleading in any format, somebody can say “I saw that interview and then bought the stock and was deceived.”

And one thing that is happening these days — a different aspect of “private markets are the new public markets” — is that those differences are collapsing. There is a huge, pervasive, government-backed push to get ordinary retail investors into private assets, which means that (1) the investors in private assets will be increasingly “unsophisticated” and (2) they will probably be investing more continuously: Think a lot of $100 401(k) contributions twice a month rather than a big funding round every few years.

So: Will “everything is securities fraud” come for the private markets? Not so much for big private tech companies (which mostly try to avoid having retail investors), but for the big alternative asset managers that are trying to get their private funds into the hands of retail investors? Here is “Private Equity, Public Capital and Litigation Risk,” by Ludovic Phalippou and William Magnuson:

For nearly a century, securities regulation has drawn a sharp line: firms that seek to raise capital from the public must comply with strict governance and disclosure duties, while firms that remain "private" may organize their internal governance structures as they see fit. But the line between public and private capital is now eroding. Private equity firms, once funded solely by institutions, increasingly raise capital from ordinary investors, while remaining outside the reach of securities regulation through a combination of complex financial structures and well-worn legal exemptions. As a result, asset classes long confined to qualified investors are now being offered to the public, but without the protection traditionally attached to public offerings. This Article argues that this retailization of private equity creates a significant regulatory gap. Practices normalized in institutional settings — misleading performance metrics, manipulable valuations, opaque fees, limited liquidity, and fiduciary duty waivers — become significant litigation risks when ordinary investors enter the picture. Financial regulators are ill-equipped to address these risks, a problem exacerbated by the deregulatory agenda of the last two decades. But while public enforcement is likely to remain ineffective, private equity's retailization opens a new and potentially more powerful avenue for holding firms to account: private enforcement. By broadening their investor base, private equity firms have exposed themselves to litigation under a wide range of domains, from contract to tort, from fraud to consumer protection. These doctrines, long thought peripheral to private equity, are often broader and stricter than traditional securities regulation.

To be fair this is not really about “securities fraud” per se, but rather lawsuits involving contract claims, fiduciary duties, consumer protection, etc. But also securities fraud:

While Rule 10b-5 [the securities fraud rule] has historically been enforced primarily against public companies, it could prove a powerful tool against private equity ones as well. The rule does not apply solely to the sale of share in public companies. It applies to all securities. ...

As retail exposure to private equity has grown, the line between stylized financial storytelling and actionable fraud has narrowed. Displays of internal rates of return that might once have passed as harmless exaggeration, for example, may soon fall on the wrong side of the fraud line.

Indeed, it is precisely these kinds of discrepancies—between public statements and economic reality—that fraud law is designed to address. Deceptive devices and affirmative misrepresentations are impermissible, under Rule 10b-5, under the Investment Company Act of 1940 and under the SEC’s marketing rule applicable to registered investment advisers. Private equity funds have largely avoided these regimes, or at least litigation under them, by virtue of limiting their marketing to qualified purchasers. That firewall has crumbled with the rise of semi-liquid funds, feeder structures, and retail-facing platforms.

To be fair, they also add that private funds could try mandatory arbitration to cut back on some of these potential lawsuits. Still it might be the case that, in the US, the cost of access to retail capital might be not so much “you have to follow public disclosure rules” but rather “you’re going to get sued a lot.”

It seems sort of obvious that predicting the weather has lots of economic uses. If the future weather was knowable, farmers could make better decisions about what crops to plant and when, airlines and hotels could make better decisions about what flights and rooms to offer, power companies could make better decisions about how much power to generate, etc., just a lot of simple straightforward economic impacts of weather. And if you went to a bunch of farmers and hotels and airlines and utilities and said “hey I can tell you next month’s weather if you pay me $100,000,” probably some of them would pay you. And so there are natural economic incentives to get really good at predicting the weather. If you build a fantastic new weather model, you should be able to sell it for good money to real-economy users.

Maybe? In practice, when we talk about the weather around here, we talk about traders at hedge funds and other financial firms — commodities traders, power traders, catastrophe bond traders — who need to know the weather to make the numbers on their screens go up. Financial markets impose a layer of abstraction between the real-economy people who need to know the weather and the meteorologists coming up with good weather models. In practice, if you build a fantastic new weather model, you should sell it to a hedge fund, and then the hedge fund will use that model to make commodities and power markets more efficient so that price signals will trickle back to the farmers and utilities.

Anyway Bloomberg’s Joe Wertz reports:

Google DeepMind has released a new artificial intelligence weather model that it says is faster and more accurate than anything it’s built before, while providing additional tools for energy traders. ...

The new model not only provides more accurate two-week forecasts of temperature, pressure and wind, but can also better predict tropical storm tracks, according to DeepMind researchers. That means its predictions of a hurricane’s path are as accurate three days ahead as the previous method was at two days out, testing shows.

The new weather model has other improvements sought by energy traders, including hourly forecasts instead of 12-hour outlooks. It can also generate predictions roughly eight times faster than DeepMind’s previous AI weather model.

“It gives you a more granular forecast,” said DeepMind AI researcher Akib Uddin. “Many other industries are quite interested in these one-hour steps. It helps them make more precise decisions. Their goal is, how can they make their business more resilient to weather?”

“Many other industries are quite interested in these one-hour steps,” but the energy traders are the ones who ask for them, and presumably the ones who pay.

I wonder, does anyone short these:

Even if the US Supreme Court strikes down Donald Trump’s sweeping tariffs, there still appear to be significant doubts that trades betting on government refunds will ever pay out.

Several Wall Street heavyweights have struck deals with companies that could be eligible for reimbursement if the levies are found to be unlawful — an outcome that betting markets see as more likely after a hearing [Nov. 5].

Yet investors are still finding the trade can be had for relatively cheap. Depending on the kind of tariff, the claims were quoted around 10 to 25 cents on the dollar this week, according to people familiar with the matter, who asked not to be identified discussing trades. That’s only a modest increase from before the Nov. 5 hearing, suggesting there are still plenty of questions over whether the gambit will ever deliver. …

By hedge fund standards, the tariff refund bets aren’t massive. Companies have paid more than $100 billion in tariffs so far, but each trade is idiosyncratic and they’re hard to do in size. The importer remains the legal owner of the claim, but in exchange for the agreed-upon price, agrees to pursue a refund and facilitate its payment to the investor, according to people familiar with the contracts.

The legal complexities are substantial enough to discourage some investors, along with the likelihood that it would take a long time to get repaid, even in the best-case scenario.

If you’re an importer who has paid a lot of tariffs, you have a potential-tariff-refund asset, which you can sell to a hedge fund: The fund will pay you 10 to 25 cents on the dollar now, and then if the Supreme Court strikes down the tariffs and you get a refund, you will have to pass it to the hedge fund. If you think that there’s a much greater than 25% chance of getting a refund, you might not take this trade: You’ll hold on to the asset and try for the refund yourself. [1]  If you think that there’s a much lower than 10% chance of getting a refund, you should sell.

If you’re a hedge fund and you think there’s a much greater than 25% chance that all the tariffs will be refunded, you should buy as much of this stuff as you can. But if you’re a hedge fund and you think there’s a much lower than 10% chance that all the tariffs will be refunded, you should sell as much of it as you can. But: Can you? You don’t import anything; you have no tariff refund claims of your own lying around to sell. You want to sell them short, to speculate. Is there a synthetic tariff refund trade? A naked short tariff refund trade? A swap referencing some unrelated importer’s tariff refund claim?

I assume not. There are, of course, prediction market contracts on the legality of the tariffs and whether they will be refunded, where anyone can take the “no refund” side, but they remain quite small. (The Kalshi “Will the Supreme Court rule in favor of Trump's tariffs?” contract shows just $1.2 million of volume, whereas Bloomberg reports that “Oppenheimer said it had traded $550 million worth of tariff claims as of the end of October.”) I will say, though, that “10 to 25 cents on the dollar” sounds pretty low? (Not investing advice!) This is not a market where prices are inflated by the difficulty of short selling; this is more of a market where prices are deflated by the legal and counterparty complexities of long buying. 

Sure why not:

Stocks, bonds and commodities are the name of the game for most hedge funds. But Luxus has a unique investment: Hermès bags. The venture-backed wealth-tech company focused on luxury investments, which was founded by ex-Blackstone exec Dana Auslander, just unveiled two Hermès-only funds dedicated to Birkin and Kelly bags, treating them as investment-grade assets.

“My passion was always to create financial products and alternative investments, so it was mostly hedge funds, private equity, private credit,” Auslander says. “But I've always loved the fashion girlies and try to inject a little bit of fun into the boring private equity and hedge fund worlds. My thesis is very simple: The investor and the collector are the same person, so you have to cater to them in the same way, and they want to be able to also invest in the assets that they collect, whether it's art, whether it's jewels, whether it's Hermès. Trust me, a lot of people collect Hermès.”

Backed by Christie’s, as the world's first Hermès-dedicated investment fund strategy, the initial fund raised $1 million in May and realized a 34% net ROI, with a 43-day average resale timeline. Sparked by overwhelming demand, they created a second fund that raised $2 million. Until now, the fund has been in stealth mode, gaining investors via word of mouth. The idea is that Hermès bags perform similarly to gold.

“On the secondary market, Hermès Birkin and Kelly bags have demonstrated resilience and appreciation,” says Rachel Koffsky, international head of handbags and accessories at Christie’s. “Over the past decade, prices have increased by an average of approximately 5% annually. During the pandemic, as demand surged, prices climbed rapidly. While there was a market correction post-pandemic, values have remained above pre-pandemic levels. Although certain styles experience fluctuations based on trends or availability, the overall trajectory of the secondary market for Hermès Birkins and Kellys has been steadily upward.”

I don’t know what it means that this fund “realized a 34% net ROI” (since May?) while “prices have increased by an average of approximately 5% annually.” Maybe the last six months were unusually good for Hermès prices. Or I do not know a ton about Hermès market structure, but I gather that there is not a central electronic handbag exchange; perhaps this fund is very good at buying from motivated sellers and selling to motivated buyers in opaque markets, and is in essentially a market-making business. Or maybe it’s, like, a 5% return on assets but they lever the bags 30 times; that would be sort of cool. [2]  I hope some bank somewhere is in the Hermès bag prime brokerage business.

Also. What is an “alternative asset”? We talked last week about the “total portfolio approach” and the notion that all sorts of different asset classes tend to be driven by similar factors. In many obvious senses, luxury goods are very unlike stocks: They have no cash flows, they are relatively nonfungible, their prices are driven by aesthetic and prestige considerations, they are made out of leather, etc. But in another sense, surely the main time you buy a Rolex or a Birkin is when your stocks go up? [3]  I wrote a few months ago:

My assumption is that all sorts of luxury markets — art, wine, watches, classic cars, fancy real estate, etc. — are highly correlated to the stock market, particularly tech and financial stocks, and that they are even more correlated to the crypto market. People buy fancy stuff when they’re rich, especially when they’re suddenly rich, and the main routes to sudden wealth in modern society are tech, finance and especially crypto. If you buy some art and are looking to resell it at a profit, you will hope that there are a lot of crypto billionaires around and that they are feeling good.

To be fair, I then discussed a paper finding that the luxury watch market has only a 0.04 correlation with equities, though one can wonder if that is partly an artifact of lagging and infrequent reporting. Anyway I hope some institutional endowments are buying Birkins for diversification.

Elon Musk’s job, now, is to turn Tesla Inc. into an $8.5 trillion company. How does one get there? Well, it’s Elon Musk, so there are various science fiction-y ideas, but the simplest pattern matching is (1) there are no $8.5 trillion companies, (2) there is however one $4.5 trillion company, (3) it’s Nvidia Corp. and (4) it got that way by making computer chips for the artificial intelligence boom. Thus:

Tesla is considering building its own chip fabrication plant. … Musk had already discussed plans for such a chip fab internally at Tesla months before the shareholder meeting, describing it as a make-or-break project for the company, according to a person with direct knowledge of the comments. If Tesla goes forward with a chip fab, xAI would likely buy chips from it, according to another person familiar with the matter. Musk also hinted earlier this month that SpaceX may one day use Tesla-designed chips to power data centers in space. The possibility of Tesla building a chip fab to supply several of Musk’s companies would make the automaker even more central to his empire.

Starting a semiconductor fab is notoriously hard (“It’s not rocket science—it’s much more difficult”), and it is perhaps not obvious that a car company is well suited to do it, but on the other hand it’s an Elon Musk car company so sure. The point is that, for their $1 trillion, Tesla’s shareholders were presumably expecting some fun surprises, and this is one.

Here’s another, from that same article in the Information:

Musk is also banking on far out ways to make his two most ambitious bets within Tesla—its Cybercab autonomous vehicles and Optimus humanoid robot—work together. He has told teams working on Optimus that he wants the robot to be able to get into and out of the Cybercab to make package deliveries, according to a person with direct knowledge of the Optimus program, similar to Amazon’s goals of one day using humanoid robots for deliveries. That means Tesla would have to update the design of Optimus so it can easily enter and exit the car, the person said.

But can it drive the car? Like in a sense the really naive sci-fi future that you might want is not “autonomous car quietly drives itself” but rather “C-3PO complainingly squeezes himself into the driver’s seat of a normal car, turns the key in the ignition, grabs the steering wheel and merges onto the highway while fretting about traffic.” It will be very pleasing — for me, not necessarily for the car owners — if Tesla’s self-driving ends up being “you buy a humanoid robot and it drives your car while you sit in the back seat avoiding eye contact.”

Last Wednesday, really truly at random, I mentioned Sealed Air Corp. in this column. After the market closed that day, the Wall Street Journal reported that Clayton Dubilier & Rice was in talks to take Sealed Air private; the stock opened up 20% the next day. And today Bloomberg reports:

Clayton Dubilier & Rice agreed to buy Sealed Air Corp. in a deal valuing the packaging company that invented Bubble Wrap at $6.2 billion.

The private equity firm will pay $42.15 a share for Charlotte, North Carolina-based Sealed Air, according to a statement Monday. That’s slightly below Friday’s closing price of $43.28 a share, after reports that CD&R was weighing a takeover.

Pure coincidence! But I wrote on Thursday: “If you made money by (1) reading Money Stuff yesterday afternoon, (2) thinking ‘huh Sealed Air that sounds fun’ and (3) buying short-dated out-of-the-money call options, please let me know.” I got an email from a reader saying: “My brother-in-law works at CD&R, and I relied on your newsletter as parallel construction to justify why I was buying short-dated out-of-the-money call options on Sealed Air yesterday.” I’m pretty sure is a joke, but also, that is a guy who reads Money Stuff carefully. 

In related jokes, someone posted on Bluesky: “The bot I built to buy short-dated out-of-the-money call options on companies mentioned in Money Stuff is going to get me investigated by the SEC, thanks a lot.”

UBS chair talked to Scott Bessent about moving bank to US. Murati’s Thinking Machines in Funding Talks at $50 Billion Value. Now Tech Moguls Want to Build Data Centers in Outer Space. Private Credit’s Rapid Evolution Is Raising Risks, Moody’s Warns. Private credit pushing reinsurers into riskier business, industry warns. Lackluster Returns Dampen Outlook for US Firms Waiting on IPOs. Before Buyout Offer, a Boardroom Feud Festered at Grindr. Hedge Funds Call This Psychologist When Their Traders Start Losing. Ex-Fed Governor Kugler Resigned After Violating Trading Rules. Forgotten 401(k) Plans Are Costing Americans Billions in Lost Investment Gains. Diameter Raises $4.5 Billion Credit Fund Betting on Dislocation. Crypto’s Riskiest Tokens Plummet to Pandemic-Era Levels. “The prop bet is not just a piece of the economy of legal sports betting. It has become the backbone of the most popular, and profitable, wagers—the single most efficient means of turning a sports fan into a profit engine for betting companies.” Taking GLP-1s to Get Ahead at Work. Trump family and Saudi partner unveil tokenised Maldives resort. A current cast member of “Real Houswives of Miami” is supposedly “Spending a Fortune to Live in Extreme Privacy.” “May I meet you?”

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