I drafted this post before, well, the SEC got dragged into the middle of an SDNY meltdown and that’s obviously way more interesting than what I was going to say, but I have this whole post already here so… here goes.
One of the big business news stories of the past week has been Hertz and its failed stock offering. (N.B.: Well, it seemed like a big deal when this post was originally drafted)
During the pandemic, stock markets have gyrated wildly, apparently driven in part by retail traders who, left without the opportunity to bet on sports, have turned to trading as an alternative form of gambling. They’re apparently encouraged by free trading apps and especially Robinhood, which – unlike other platforms which treat trading as srs bzns– gameifies the experience. As one trader put it, “With sports, if I throw $1,000 at something, I lose the whole thing real quick, but here if things go south you can cut your losses.”
That particular theory was sort of tested when it came to Hertz, which is in bankruptcy. Despite that fact, its stock started to climb, in what has been described as the equivalent of a Jackass sketch. Everyone understood there was almost no chance of the company actually generating value for shareholders, but the coordinated attention acted as something of a combination dare, Ponzi scheme, market manipulation, and performance art.
Hertz tried to take advantage of it all by selling new stock, figuring hey, this might be an easy way to pay off its creditors, and that all by itself seems to have burst the bubble; traders weren’t expecting anyone to take them seriously. But the plan was scotched when the SEC raised questions about the sufficiency of Hertz’s prospectus disclosures.
Really, though?
We are in the process of a reorganization under chapter 11 of title 11, or Chapter 11, of the United States Code, or Bankruptcy Code, which has caused and may continue to cause our common stock to decrease in value, or may render our common stock worthless.
And also here:
The price of our common stock has been volatile following the commencement of the Chapter 11 Cases and may decrease in value or become worthless. Accordingly, any trading in our common stock during the pendency of our Chapter 11 Cases is highly speculative and poses substantial risks to purchasers of our common stock. As discussed below, recoveries in the Chapter 11 Cases for holders of common stock, if any, will depend upon our ability to negotiate and confirm a plan, the terms of such plan, the recovery of our business from the COVID-19 pandemic, if any, and the value of our assets. Although we cannot predict how our common stock will be treated under a plan, we expect that common stock holders would not receive a recovery through any plan unless the holders of more senior claims and interests, such as secured and unsecured indebtedness (which is currently trading at a significant discount), are paid in full, which would require a significant and rapid and currently unanticipated improvement in business conditions to pre-COVID-19 or close to pre-COVID-19 levels. We also expect our stockholders’ equity to decrease as we use cash on hand to support our operations in bankruptcy. Consequently, there is a significant risk that the holders of our common stock will receive no recovery under the Chapter 11 Cases and that our common stock will be worthless.
Note how these disclosures were reported in the media:
“Hertz says it expects stockholders to lose all their money in filing for selling more stock”
“Hertz’s filing to sell its shares came with more dire warnings than a bottle of bleach.”
This does not, in short, seem like a disclosure problem at all. And that means there’s a lot to think about.
First, there have been a lot of comparisons to the dot com bubble, and I agree, but in a very specific way. The internet bubble featured anonymous commenters who’d engage in pump-and-dumps – recommend a stock, watch everyone pile in, and sell out – but it wasn’t necessarily the case that anyone was fooled. People used the comments as a coordinating mechanism – which stock they’d all buy now – and play musical chairs to see who could make money and cash out before the crash. That’s how Donald Langevoort viewed the SEC’s case against Jonathan Lebed, anyway, and it definitely is an element of what’s happening here. (See this article about a website devoted to tracking Robinhood trades). So all that raises the question of how much transparency markets can really bear. (Cf. Matt Levine, writing about a different kind of transparency, in Too Much Information Can Be Bad)
Beyond that, the SEC’s interference betrays a rather surprising lack of faith both in market efficiency and investor autonomy, and thereby illustrates the SEC’s Janus-faced (heh) approach to investor protection. Recently, the SEC has been fairly aggressive in its insistence that disclosure is a cure-all, that markets are efficient and no one needs to be told anything twice, and that retail investors should have more access to private capital. At the same time, the SEC has resisted and denigrated the demands of actual investors regarding the types of information they need to make intelligent decisions. And now, apparently, the SEC is willing to step in to save Hertz investors from themselves – even when they act with full disclosure on a widely traded, exchange-listed (for now), stock. It seems the SEC has complete faith in efficient markets and investor wisdom, except when it doesn’t.
Another aspect of this story has to do with market efficiency in – as William Fisher once put it – “a time of madness.” As I said, it wasn’t just Hertz; there have been reports of retail traders playing stocks like a roulette wheel and even manipulating prices for the lulz. There have also been several securities fraud lawsuits filed since the lockdowns, particularly ones pertaining to the coronavirus. These are fraud-on-the-market cases, and they depend at least on market informational efficiency, if not fundamental value efficiency, which implies some amount of rationality. Will the evident irrationality of markets at this time affect the plaintiffs’ ability to certify a class?
It’s not an entirely crazy question; there is some precedent for courts treating market irrationality as evidence of inefficiency. See In re Initial Public Offering Securities Litigation, 260 F.R.D. 81 (S.D.N.Y. 2009) (“there is insufficient evidence of efficiency to permit the use of the Basic presumption with respect to trading during the quiet periods. To the contrary, the evidence indicates that the quiet periods were marked by chaotic pricing, irrational purchases, and market inefficiencies. [Plaintiffs’] own evidence demonstrates that the markets for the focus case shares were inefficient during the first weeks of trading. A purchaser of these securities during the relevant quiet period could not reasonably rely on the market price to reflect the market’s judgment of the security’s value. Therefore, the Basic presumptions cannot apply to these periods.”)
That said, the Supreme Court’s Halliburton v. Erica P. John Fund, 573 US 258 (2014), may have established a more forgiving standard for evaluating market efficiency, so we shall see.
But my final observation is this: All of this is kind of hilarious until you read these kinds of stories, where some 20-year-old Robinhood trader may have killed himself because he – mistakenly – believed he’d lost $700K. Additionally, the Twitterati is ablaze with anecdotal reports of teens and even pre-teens trading stocks in Robinhood, treating it as an alternative to Fortnite – and I can’t wait to see what happens if those kids are trading on margin. Now, Robinhood purports to require that accountholders be at least 18, so we have a bunch of questions: (1) are there really a bunch of children trading, or are those isolated examples no matter what Twitter says?; (2) are parents are intentionally giving their kids access to brokerage accounts, or are children just lying their way in?; and (3) just how robust are Robinhood’s age and suitability checks? Robinhood has now promised to improve its interface regarding options trading, to consider “additional criteria and education for customers seeking level 3 options,” and to, umm, make a “$250,000 donation to the American Foundation for Suicide Prevention.” So, yay?