Felix Salmon

Durbin, Dimon, and interchange

Felix Salmon
Apr 14, 2011 19:32 UTC

Dick Durbin’s bodyslam of Jamie Dimon on the subject of debit interchange is, simply, a must-read. If Durbin ever had any dreams of a cushy sinecure on JP Morgan’s board, those have surely now been quashed forever — but being able to write a letter like this on official US Senate letterhead makes it oh so very worth it:


He’s also not afraid to get personal:


It’s always difficult for a sitting US senator to pick a fight with a US citizen, because it’s so hard to fight back: it can look like very much like bullying. But Jamie Dimon is no ordinary US citizen, and in fact has more power than Dick Durbin or any other senator. When it comes to bullying, the financial industry clearly has much more control of Congress than Congress has over the financial industry. Durbin, here, is just standing his ground in the face of an astonishing onslaught of mendacious lobbying from Dimon and his minions. Good for him!

If and when Durbin finally wins the debit-interchange fight, he might think about next turning his attentions to credit interchange. This chart comes from Nerdwallet’s Tim Chen:


Credit-interchange fees in the US are not only the highest in the world, they also make life particularly difficult for smaller merchants:

According to NerdWallet’s calculations, a small supermarket pays $1.15 to process a $50 credit-card transaction from a Visa Signature” customer, while a large supermarket pays $0.63 to process the same transaction from a basic or simple rewards customer…

In the United States, the level of “swipe” or interchange fees appears to be based on merchants’ ability to negotiate (Walmart pays substantially lower processing fees than smaller stores and restaurants). The regulated interchange fees in Europe seem to be based more on the costs of processing.

It’s worth noting that even the super-low fees begrudgingly allowed Walmart are significantly higher than the regulated fees just about anywhere else in the world.

There’s a case to be made for credit interchange fees being significantly higher than debit interchange fees. But there comes a point at which they’re simply ridiculously high by any standard — and the US has now reached that point. If Jamie Dimon continues to anger Durbin on the subject of debit interchange, I do hope he gets his comeuppance on the credit-interchange front.


I hope Durbin doesn’t have any secret vices. If Elliot Spitzer taught anyone anything, its that Wall St. has no problem getting dirty when a politician goes after them.

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Andy Warhol datapoints of the day

Felix Salmon
Apr 14, 2011 16:28 UTC

Anders Petterson of ArtTactic put together a presentation on the Warhol market for his talk at Artelligence yesterday. There are some astonishing numbers in it, none more so than the fact that Warhol paintings accounted for 17% of all contemporary-art auction sales in 2010. But there’s much more where that came from.

Between Warhol’s death in 1987 and today, the value of his paintings has gone up by more than 30 times; his estate, which was valued at some $220 million when he died, would be worth some $7 billion today. The public market in Warhols dwarfs that of anybody else: Jeff Koons and Damien Hirst between them, for instance, were just 3.1% of contemporary-art auction sales last year. And the money is all at the top end of the market: paintings which sold for more than $5 million accounted for 8% of all the lots, but 69% of the value. Privately the numbers can be even bigger than the $72 million auction record set by the Green Car Crash: a huge Mao has been shopped around in Hong Kong with a price tag of $120 million.

In public, the early work dominates the market: fully 90% of Warhols sold at auction, by value, were painted in the 1960s, with just 5% each from the 70s and 80s. And that includes big sales like the 1986 purple self-portrait which was sold by Tom Ford for $33 million last year.

So what’s going on here? How has Warhol come to dominate the contemporary-art market like this? There are three main reasons.

First is the sheer quantity of Warhol works: some 10,000 over his lifetime, many of which are still in private hands. That results in a steady flow of about 200 paintings a year coming up for auction, which does wonders for the liquidity of the market and the confidence that collectors have in the valuation of their works.

At this level, collectors are hyper-conscious of dollar value: Adam Lindemann told me at the conference that he would never buy a work if he knew its value was going to go to zero while he still owned it. But art is generally so unique that you never really know how much a piece might be worth until it’s sold. Lindemann, during his presentation, discussed a Barnett Newman work sold by Robert Scull in 1973 — a large zip painting, titled L’Errance, from 1953. Lindemann, like Judd Tully, put an estimate of $20 million on its value today — but no one really has a clue how much it might fetch, since Newmans come up for sale so very rarely.

Warhols, by contrast, are pretty much the easiest unique artworks in the world to value. You can never be entirely certain, of course, and sometimes they sell for well above the auction house’s estimate: the $72 million Green Car Crash was hammered down at $64 million, against an estimate of $25 million to $35 million. But with the proviso that error bars in the art world are always very large, it’s fair to say that they’re smaller for Warhol than for any other artist.

What’s more, there’s a lot more uncertainty to the upside than there is to the downside — because there’s a large constituency of collectors with a vested interest in supporting the Warhol market whenever it looks like it might be softening. Foremost among them is the Mugrabi family, which owns more than 800 Warhols: according to ArtTactic, they either bought or were the underbidders on a whopping 31% of all Warhols which came to market during the difficult years of 2008 and 2009. And in 2010 they kept on buying at auction, to the tune of $36.8 million. Essentially, there’s a “Mugrabi put” in the Warhol market, which has a lot of value to collectors.

And it’s not just the Mugrabis, either. Dealer Larry Gagosian also provides important support for the Warhol market, as do Philippe Segalot and Christophe van de Weghe. There are also major collectors who are usually willing to step in and buy at the high end of the market, including Peter Brant, Aby Rosen, Laurence Graff, and Stevie Cohen. All of them know that buying high only serves to increase the value of the rest of their collection.

Finally, Warhol has more institutional support than any other contemporary artist. There are lots of artists who get caught in an upward price spiral, as collectors compete with each other to own a limited number of works. But such spirals are prone to sudden collapse. If an artist is in many major museums, by contrast, that helps to reassure collectors that the work really does have long-term art-historical importance. ArtTactic reports:

The number of [Warhol] museum exhibitions has increased more than ten times since 1996, and in 2007, at the peak of the Warhol market, 127 museum exhibitions were showing Warhol. 26 of these were solo shows…

Another important back-up and support mechanism for the market is the Warhol Foundation… Through cooperative exhibitions, loans and permanent placement of works in museums nationwide, the Foundation has ensured that the many facets of Warhol’s complex oeuvre are widely accessible and properly cared for.

The big artists who are following the Warhol model these days are Damien Hirst, Jeff Koons, and Takashi Murakami. If they really want to learn from his success, the next step will be to assiduously cultivate museum shows around the world. It’s not easy to do that, since museums like to be independent when it comes to such decisions. But that’s what’s going to ultimately make the difference between a flash-in-the-pan, on the one hand, and the next Warhol, on the other.


No, if they really want to learn from his success, they should die. Like Elvis, death was a good career move for Warhol.

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How Levin’s crisis report recasts the Volcker Rule

Felix Salmon
Apr 14, 2011 14:03 UTC

After the Financial Crisis Inquiry Commission fractured into bipartisan incommensurability, I had little hope for the Senate’s report into the financial collapse. But my initial impression is that it’s a great piece of work — almost incredibly so, given that it’s got bipartisan support.

The whole 5.9 MB, 650-page report can be found here, and there are another 5,800 pages of appended documents which can be found from the links at the bottom of this PDF press release. Given the enormous amount of work which went into collating and writing this report, I have to say I’m disappointed in the way in which it doesn’t even have its own web page — this material should all be online, easily indexable and searchable.

I’m going to take my time with this report. But to get a flavor of its tone, take a look at the list of recommendations which are summarized on pages 12-14 (or pages 20-22 of the PDF). They basically take the armature of Dodd-Frank and toughen it up substantially: Carl Levin and his colleagues clearly reckon that Dodd-Frank is a good start, rather than a response which is sufficient in and of itself.

I’m particularly taken with the way in which the report sees the Volcker Rule as an ethical issue, rather than as a moral-hazard issue. As I recall, the stated justification for the Volcker Rule was that it’s ridiculous for the Federal Reserve to give valuable access to its discount window to banks who can just take that money and gamble it on proprietary trades. If people want to gamble, that’s fine, but they shouldn’t do so with taxpayer dollars.

But Levin’s report puts the Volcker Rule in a different light. It quotes Jeremy Grantham:

Proprietary trading by banks has become by degrees over recent years an egregious conflict of interest with their clients. Most if not all banks that prop trade now gather information from their institutional clients and exploit it. In complete contrast, 30 years ago, Goldman Sachs, for example, would never, ever have traded against its clients. How quaint that scrupulousness now seems. Indeed, from, say, 1935 to 1980, any banker who suggested such behavior would have been fired as both unprincipled and a threat to the partners’ money.

It then goes on to say that “the Dodd-Frank Act contains two conflict of interest prohibitions to restore the ethical bar against investment banks and other financial institutions profiting at the expense of their clients”.

The Volcker Rule has yet to be nailed down, of course — and there are serious questions over whether it will ever be enforceable. But if it’s written in a principle-based way, then I think this is a very useful principle to include. Is an investment bank profiting at the expense of its clients? If so, it’s probably violating the Volcker Rule.

In the case of something like the Abacus transaction, of course, the answer is clearly yes. Goldman Sachs said over and over again that IKB, one of its clients in that transaction, was “sophisticated”, as though that in and of itself absolved Goldman of any responsibility to the German bank. But a conflict-centered Volcker Rule would not include carve-outs for sophisticated clients, and might well prevent such transactions in future.

Levin’s report says hopefully that just such a rule can be “well implemented”, and would “protect market participants from the self-dealing that contributed to the financial crisis”. I’m not convinced. But it’s certainly worth a try.


Actually, the FCIC does have a website with report (http://fcic.law.stanford.edu/report). Since the commission does not exist anymore (and neither does their funding), the website has been archived by Stanford –http://tinyurl.com/3ro7867

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Felix Salmon
Apr 14, 2011 06:14 UTC

Durbin’s letter to Dimon, on debit interchange — WSJ

Comment du jour: Summers “still contends that there are certain people who just can’t do math. Formerly they were known as women” — Reuters

Hugh Grant (yes, that one) turns investigative journalist & moves the Murdoch phone-tapping story forwards — New Statesman

White House can’t find anybody willing to replace Warren at CFPB, they might be forced to go with her — WSJ


Durbin’s letter is pure gold. A must read on the debit war and supprisingly accurate for a pol!

The law change will cause profits at my community bank to drop very slightly in the short term… but will push customers away from large banks and into our open arms overtime… on balance small banks win large banks lose.

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US taxation datapoints of the day

Felix Salmon
Apr 13, 2011 20:01 UTC

The dean of tax reporters, David Cay Johnston, has a fantastic cover story in the Willamette Week (of all places and 40 other alt-weeklies), shining a bright light on just how unfair and unequal the US tax system is. The whole 3,000-word article is well worth reading in full, but here are some highlights:

  • In Alabama, the tax burden on the poor is more than twice that of the top 1 percent. The one-fifth of Alabama families making less than $13,000 pay almost 11 percent of their income in state and local taxes, compared with less than 4 percent for those who make $229,000 or more.
  • Between 2000 and 2009, the US population increased by 25,584,644. Meanwhile, the number of people with jobs increased by just 2,803,967.
  • John Paulson has paid no taxes at all on the $9 billion of income that he made in 2008 and 2009.
  • Frank and Jamie McCourt, the owners of the Los Angeles Dodgers, have not paid any income taxes since at least 2004.
  • Between 2000 and 2008, corporate profits rose by 12% while corporate income taxes fell by 8%. Without any change in the corporate income-tax rate.
  • George W Bush did sign one — just one — tax increase. It was on children under the age of 17.

None of this is likely to come as any surprise to tax wonks, but it’s well worth publicizing as Barack Obama now wades into the turbulent waters of long-term fiscal policy. The simple fact is that corporations and the rich aren’t paying as much tax as they have to if we’re going to make a serious dent in the deficit. And although anybody pointing that out is always going to risk being tarred as a class warrior, the country is not going to make any serious progress, fiscally speaking, unless and until it grows up and addresses that fact face-on.


In the U.S. the rich pay much more taxes than the poor or middle class. The top ten percent, for example, pay almost 70% of federal income tax and the top one percent pay more than a third.

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Larry Summers has had enough financial regulation

Felix Salmon
Apr 13, 2011 14:14 UTC

The financial crisis? Regrettable, obviously. But let’s not rush to judgment here. Our financial system, pre-crisis, worked pretty well. Let’s not break it just because there was a crisis.

That’s the message being peddled by Alan Greenspan, predictably, sadly, and hilariously. And now he has a high-profile bedfellow from the other side of the aisle: Larry Summers, who was hanging out in Bretton Woods this weekend. Stephen Gandel Rana Foroohar summarizes:

One of the other big questions was what, if anything, Summers would have done differently in terms of regulating the banking system. The answer – not much. “I’ve been more cautious than many about constraining financial innovation,” he said, adding that he didn’t believe the financial crisis had its roots in “new-fangled financial instruments” but rather in a simple real estate bubble. Hmmm—tell that to Iceland. One thing Summers said that most of the crowd could agree with is that “anger and dissatisfaction with the financial system doesn’t constitute a [coherent regulatory] policy.”

There’s much more where that came from. This, for instance, is classic Larry:

It’s common in a moment like this to go into a general bash on economics. And everyone who hates economics because they don’t like markets in any context, or because they don’t do math, and so if you do a subject with math you have a bias towards believing that math is useless — everyone who doesn’t like economics has piled on at this moment to regard this crisis as a repudiation of economics. And I don’t think that’s right…

How we think about the design of regulatory institutions… the public choice school has taken that very seriously, but they have driven it relentlessly towards nihilism.

Larry’s keen on saying that “we’d make a serious mistake if we threw the baby out with the bathwater here.” But it seems to me that most people talking about babies and bathwater — and Summers is a prime example here — tend to be much more keen to protect their precious babies than they are constructive when it comes to the big questions of how to drain away the poisonous bathwater. In this case, Summers has gone so far as to launch ad hominem attacks on reformers, calling them angry people who hate economics and don’t do math. At one point in his talk, Summers explains that people who want to regulate the financial system are very much like the smart people who became communists and who went on to create the Soviet Union.

Today, of course, the angry people who hate economics and don’t do math are mostly on the other side of the debate, hanging out at Tea Party rallies and trying to dismantle just about any kind of government financial regulation. Meanwhile, it’s generally unhelpful to characterize the people asking important questions about regulatory capture as nihilists or communists.

Summers, of course, has made very good money for himself from financial innovation — over $5 million for one day’s work per week from hedge fund DE Shaw in 2008 alone. And he has lost vast amounts of other people’s money using financial innovation: $1 billion of Harvard’s cash, to be precise, lost in misadventures with things called forward-start interest rate swaps. (A trade which TED called “either rank hubris or free money for Wall Street swap desks.”)

So it seems to me that Summers should be demonstrating substantially more humility here on the subject of encouraging financial innovation, when countries which constrained it did pretty well during the crisis compared to those with a deregulatory philosophy — and when very wise minds like Paul Volcker are credibly arguing that financial innovation almost never adds real economic value. Instead, he seems to have decided that insofar as any reform is warranted, Dodd-Frank did everything that was necessary, and the basic philosophy from here on in should be much the same as it was pre-crisis: that at the margin, having too much regulatory activity is worse than having too little.

This is astonishing, given that Summers actually conceded, during his talk, that the biggest economic successes in the world over the past couple of decades, China foremost among them, owe essentially nothing of their success to financial innovation or deregulation.

In the Ireland vs Iceland debate, Summers is decidedly Irish: “I don’t think any country is likely to allow the complete implosion of its financial system,” he said, effectively saying that Iceland isn’t even a country, or perhaps simply forgetting that it exists.

This seems to me to be a recipe for boom and bust — where the fruits of the boom accrue to a tiny handful of financial engineers and executives, while the costs of the bust are borne by citizens who never really participated in the boom in the first place. if you’re a multimillionaire technocrat with tenure at Harvard, you don’t feel recessions in the way that people do who are losing their homes and jobs, and who are running out of unemployment insurance. It’s worth remembering that, when you dismiss such people as ignorant and uneducated folks who hate economics and math. Because if there’s one thing we’ve learned from this crisis, it’s that what’s good for Larry Summers is not necessarily good for the rest of us.

Update: Brad DeLong puts Summers’s quotes into broader context, and points out that it was actually Rana Foroohar writing for Time, not Stephen Gandel (whose name is on the RSS entry). There’s no doubt that Summers endorsed Dodd-Frank — but at the same time he does seem worried about some of the regulation which comes with it, and he evinces no particular appetite for further regulation on top of Dodd-Frank. I don’t think he’s calling for deregulation, necessarily. But he does seem opposed to having more regulation.


The markets have proved Summers doesn’t know how they really work.

Summers’ ego obviously is so big that it prevents him from realizing he’s not infallible.

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Felix Salmon
Apr 13, 2011 04:43 UTC

“The rule of law is not even worth 20 basis points”: Levitin utterly dismantles Calomiris et al — Credit Slips

More and more Americans are dabbling in currency trading and losing in spectacular fashion — LAT

Evan Osnos joins a Chinese tour bus in Europe — TNY

Jed Rakoff’s lecture from last night — Reuters

Number of ads in the latest issue of Newsweek: 6 — TBI

On stock-market metaphors — Brooks

Surreal: Tech Giants Opposing Debit interchange reform — WSJ


Any insight on the improper-foreclosure settlement? Without details, I’m skeptical that anything real was accomplished.

http://www.ft.com/cms/s/0/636dd2a6-6609- 11e0-9d40-00144feab49a,s01=1.html?ftcamp =rss#axzz1JSCWAWqh

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Homeowners in denial

Felix Salmon
Apr 13, 2011 04:38 UTC

According to the latest Pew survey, only a minority of Americans think that their home has fallen in value since the recession began in December 2007. And the poorer and less educated you are, the less likely you are to think your home has fallen in value:


I don’t have hard statistics on this — I don’t know whether they exist or how they would be put together — but I think it’s fair to say that the overwhelming majority of US homes have fallen in value since the start of the recession. Which means, essentially, that most Americans are wrong.

What does this mean? During the boom, Americans were hyper-conscious of how much their homes were worth. During the bust, they’re in denial. This is probably good for national happiness, but it’s also bad for the future of the housing market — and partially helps to explain why houses sit on the market for so long at a price no one is willing to pay.

This syndrome also contributes, I think, to the relatively low rate of jingle-mail, or underwater homeowners simply walking away from their homes and leaving the bank with the house. It’s the economically rational thing to do — but only if you know that you’re underwater. And given that it’s non-trivial to work out how much your house is worth, I can easily imagine that a large percentage of underwater homeowners don’t know that they’re underwater.

While ignorance of depreciated property values seems to be prevalent everywhere, it’s particularly common among those who didn’t go to college and those who earn less than $30,000 per year. (I don’t believe Pew’s statement that “the recession-era decline in home values has hit those with higher annual household incomes harder than those with lower annual incomes” — not without further evidence, anyway.) It’s probably no coincidence that these are exactly the people who were most likely to be sold unsuitable subprime mortgages: if you’re looking to rip someone off, it’s a good idea to look for a mark who doesn’t have the education or sophistication to understand what you’re doing.

Now here’s the kicker: if you asked me the question in the poll (“Thinking about the recession, which began in December 2007, is your home worth more or less NOW than it was BEFORE the recession began, or is it worth about the same?”) about my own place in New York, I’d probably say it was worth more. I don’t honestly know: I wasn’t particularly following the East Village property market in December 2007, and I’m not doing so now, either. But hey, that tide of money sloshing out from the New York Fed has surely had some effect, no? And it feels nice to think that I — just like everybody in Lake Wobegon — am bucking the national trend. Evidently a lot of other Americans feel much the same way.


I find it difficult to speak to the question because I see the 5% down as a vulnerability and when you show a weak underbelly, it can be easily torn apart. In good times or bad, 5% makes everyone else’s homes vulnerable as well and I agree can push prices up artificially.

Affordability can’t be determined until you see stability and you won’t see it for a couple more years at least. (And don’t bring any sharp objects into our housing market for those 2 years, please)

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How SecondMarket works

Felix Salmon
Apr 12, 2011 20:23 UTC

I spent most of this morning at SecondMarket, having a long conversation with Adam Oliveri, the person in charge of their private company market. That’s the part of the company which gets the most attention: it’s where stock in companies like Twitter and Facebook change hands, for instance. I learned a huge amount while I was there, and have now changed my mind on whether Facebook is going to go public: I finally understand exactly why companies need to do an IPO once they have more than 500 shareholders.

Once the 500-shareholder limit is breached, companies have to start reporting detailed financial information to the SEC. Which isn’t in and of itself a compelling reason to go public — lots of private companies with public debt file that information, after all. But there’s something else which gets triggered when you have more than 500 shareholders: you have to register your equity securities with the SEC. And at that point, your shares can be traded by anybody at all in the public over-the-counter markets, even if you haven’t had an IPO.

It’s conceivable that companies could continue to encrust their shares with various contractual restrictions which prevented shareholders from trading their shares in the OTC markets, even after those shares were formally registered with the SEC. But in practice, it’s almost impossible for companies to prevent OTC trading in their publicly-registered securities. And when a stock trades in the OTC markets, that trade is registered and printed in public. At that point, with a company’s stock being traded by anyone at all, at any time, at a public price, on the basis of public information filed with the SEC, the company is to all intents and purposes public already. So it might as well just make it official by having an IPO.

Now that Facebook has said that it passed the 500-shareholder limit this year, then, it’s pretty certain to go public in 2012. (Kara Swisher thinks it might be even earlier than that: I have a bet with her that it won’t happen before September 21 of this year. If it does, I need to go to San Francsico and buy her dinner, but if it’s still private at this point she needs to come to New York and take me out.)

SecondMarket actually has two platforms for trading private-company stock. The main one is Adam’s private company market, which is about two years old at this point, and has seen equity in 50 different growth stocks change hands. It’s pretty much restricted to growth stocks: none of those 50 companies has ever paid a dividend, and they’re overwhelmingly in the technology space.

For other companies, SecondMarket has set up a much more nascent market, which kicked off in January with those trades in Pimco stock. It’s also designed to help trade stock in partnerships (like McKinsey, say), or maybe even large, established private companies like Mars or Cargill. But mostly it seems that SecondMarket has its eyes on companies like Pimco which are subsidiaries of larger companies but which still use their own equity as a recruitment and compensation tool. Reddit is one company which might try to price stock on SecondMarket, as a way of helping it attract talent and grow while still remaining a part of Conde Nast.

Adam also helped answer my question of why SecondMarket is taking off now. Look at the three companies which really got this market started: Facebook, LinkedIn, and eHarmony. They’re all highly visible companies, with metrics that can be measured externally with quite a lot of specificity by companies like ITG Investment Research. It’s also much easier these days to find such companies’ articles of incorporation and the like online — and of course huge amounts of information about these firms is published by the fast-growing blogosphere. So while the amount of information that would-be investors have is surely lower than if there was a formal SEC-registered prospectus, the rise of the internet has made it much easier to do reasonably good diligence on how much a company might be worth. And that’s especially true when the company is young enough that its revenues don’t matter very much.

On top of that, webby companies like these are generally pretty capital-efficient: there’s very little risk that existing shareholders will be unpleasantly diluted by some big upcoming capital-raising round. It’s no coincidence that SecondMarket hasn’t seen trading in green-tech or biotech startups, which are much more capital-intensive.

And then there’s the big picture, which is simply that we’re seeing fewer IPOs of small companies, and that most companies when they do IPO are more like 8-10 years old rather than 3-4 years old. At that point, you’re likely to have had a reasonable amount of turnover in terms of employees, and early employees who have long since left the company are reasonably going to want a way to cash in their equity stakes. That demand for liquidity — along with long-term employees who have a lot of paper wealth but still live relatively frugally and who would like to monetize some of their stake — is what helped get SecondMarket’s equity business started.

Letting employees sell some of their vested stock doesn’t disalign incentives — quite the opposite, in many cases. After all, venture-capital owners of fast-growing tech startups are looking for high-risk home-runs and have diversified portfolios. Employees, by contrast, are always going to be more risk-averse, and letting them cash out in the growth phase can give them enough money to be willing to take the kind of risks their VC paymasters want to see.

It’s also worth clearing up some of the misconceptions in Dennis Berman’s column today on SecondMarket and SharesPost. For instance:

Many in Silicon Valley and Washington regard SharesPost and rival SecondMarket as small saviors of American capitalism. These markets give young companies and their employees new ways to raise capital or sell private stock without the arduous financial and legal disclosure of fully public companies.

This is partly true, but I’m pretty sure that neither SharesPost nor SecondMarket has ever let a company raise capital using their platform. I asked SecondMarket about this today, and in principle they’re open to exploring the idea in future, but for the time being they’re concentrating on simple transfers of shares, rather than the capital-raising issuance of new equity.

Berman continues:

SEC boss Mary Schapiro seems conflicted about these new markets’ purpose. The agency is investigating potential abuses in these secondary markets, including conflicts of interest and insider trading.

There’s no hyperlink here, so I have no idea what Berman thinks he’s talking about. It’s conceivable, I suppose, that he has an SEC source feeding him secret information about an internal SEC investigation that nobody else knows about. But if he did, one imagines he’d write a news story about that, rather than mentioning it in passing in a column which leads with the death of his grandmother 20 years ago. Certainly I’ve seen nothing to indicate that the SEC is investigating SharesPost or SecondMarket for potential abuses including insider trading; this seems to me to be both inflammatory and false.

After quoting Ben Horowitz as someone who is skeptical about such markets (but not mentioning that Horowitz spent $80 million buying shares of Twitter on SecondMarket in the secondary market), Berman comes out with this:

For a market to work best, investors need to be comfortable that they can trade at will.

This manages to completely miss the point of SecondMarket and SharesPost. They’re emphatically not trading vehicles: they’re designed to facilitate one-off transactions. In the two-year history of SecondMarket’s private-companies market, the company has seen maybe half a dozen instances of what you might call tertiary trades: someone who bought at one point and then sold later, once the price had gone up. SecondMarket gives an opportunity to invest in private equity, and private equity by its nature is illiquid. In fact, that’s why many investors like it: they want to capture the illiquidity premium, happy holding on to their stake for many years and knowing that they have an asset which isn’t highly correlated with public markets.

Going forwards, of course, SecondMarket would love it if the 500-shareholder restriction was relaxed. When the rule was introduced in 1964 it was pretty arbitrary, but it was set at a level which wasn’t particularly onerous: the 500-shareholder limit was very rarely triggered before a company went public. After all, in those days you could go public when you were still small; today, that’s much harder. Today, the 500-shareholder limit is a real constraint on how companies do business, how they compensate their employees, and how they structure themselves internally. Is there any good fundamental reason to change the way you incentivize and compensate employees just because you’re hiring lots of people? Of course not — but that’s the effect the rule has.

So while I worry about the public-policy effects of having fewer public companies, I also see no reason for the SEC to keep this rule at its anachronistic 1964 level. On the other hand, I think it might make sense for the SEC to regulate SharesPost and SecondMarket more explicitly than it does at present, rather than having them operate in the shadow of exemptions which were written long before they were founded. If the SEC set clear rules for how private exchanges like this could operate, then that might open the way to bring the rules for companies listing on public exchanges into the 21st Century.

Update: SecondMarket’s Mark Murphy emails to say that Horowitz’s secondary-market acquisition of Twitter shares did not take place through SecondMarket.


Maybe inflammatory, but no longer false. http://www.sec.gov/news/press/2012/2012- 43.htm

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