Loans or Securities? It’s a SCOTUS Question.

Investor protection in a $3 trillion market. The Supreme Court needs to step up. 

Syndicated loans are a financial construct from the 1980s in which a bank or group of banks extend a loan to a company in exchange for hefty fees. The loans were often times for private equity companies raising money to take over a company, often referred to as leveraged buyouts. More recently, however, banks have immediately sold the loans to others who were not involved in making them by dicing the loan into securitizations. In other words, these loans sure look like securities.

This distinction between loans and securities matters greatly. Investors in securities enjoy SEC protections that owners of loans do not. And securities, because they are widely traded, make their way into portfolios of investors large and small, including retirement accounts. This distinction between loans and securities will be the key issue the Supreme Court decides – if it takes up Kirschner v. JPMorgan.

This case stems from a 2014 transaction. JPMorgan Chase, Citigroup, the Bank of Montreal and SunTrust sold $1.8 billion worth of debt on behalf of a company, Millennium Healthcare, that fraudulently billed Medicaid and Medicare recipients – even if they were already dead. The company later settled the fraud case for over $250 million before filing for bankruptcy in 2015. 

A lawsuit by a trustee for investors accused JPMorgan of concealing critical information – information an investor in securities would normally be due – from creditors and would ultimately culminate in Kirschner v. JPMorgan being heard by the Second Circuit Court of Appeals. In its ruling, the court decided to treat syndicated loans as traditional loans rather than the securities they have become. 

Now, AFR has called on the Supreme Court to take up the case, which could change the way regulators distinguish between loans and securities. 

Says AFR’s Andrew Park:

“It is unacceptable that in this day and age, a $3 trillion market is not subject to basic investor protection under securities laws, allowing banks to withhold critical information to investors without consequences. Also, the lack of securities law protection means there are also no rules around self-dealing and insider trading, even though small investors – who are normally entitled to more robust disclosure – participate in this market through retail brokerages.”

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FINANCIAL STABILITY: Capital Requirements – Pre-Positioning – Fed Ethics – Artificial Intelligence – Wells Fargo Unionization – Munis – Big Bank Background Check – Further to the Banking Crisis
CONSUMER: Banking Junk Fees – Medical Debt – Enforcement Actions
CAPITAL MARKETS: Treasuries Trading Transformed – SPAC and Span – Enforcement Actions
PRIVATE MARKETS: Private Credit – Expanding Into Everything – Private Equity and Healthcare – Private Equity and Homes – Private Equity and Military Quadcopters – Private Equity and the News – Private Equity and Student Loans – Other Private Markets News
CRYPTO: The Exchanges vs. The SEC – Bitcoin ETF – Meta – Bad Crypto Marketing – StableCrimes
CLIMATE AND FINANCE: ESG – State Pensions – Who Benefits from the Climate Crisis?
POLITICS AND MONEY: Nikki Haley – Donald Trump

Feedback? Reach us at afrnews@ourfinancialsecurity.org

FINANCIAL STABILITY

Capital Requirements.

In response to big-bank criticism of incoming Basel III “endgame” capital rules, meant to shore up financial system resilience, the OCC’s Hsu urged them to produce proof of their claims: 

I have encouraged them — provide analysis on what your share buybacks and dividend policies are going to be under these different scenarios. Because there’s a choice to be made with capital…I’m hopeful that folks have included that analysis because if banks are saying it’s really hurting the real economy, but they’re providing increases in their share buybacks, I would suggest that there’s some questions for the bank about what the priorities are with regards to that comment.

Usually, they can’t. The WSJ’s Andrew Ackerman has a Twitter thread with some early criticism of the rules from big banks that turned out “over-the-top and wrong.” Don’t forget AFR’s helpful guide to debunk some of the more popular myths.

Of course, the bank lobby will continue to suggest they’re safe enough already. But, NYT’s Peter Coy writes: “Scholars argue that far from crimping lending, the new rules will give big banks the financial strength to keep making loans even when times are tough. Unfortunately, banks tend to amplify the ups and downs of the business cycle: They lend heavily and sometimes unwisely when times are good and then cut back when there’s a downturn — which, of course, is right when consumers and businesses really need their money.” 

Plus: An American Banker op-ed suggests that “if bank capital has to be higher, let’s regulate nonbanks.” Nonbanks, or shadow banks, need to be regulated either way, higher bank capital or not. 

And: If Republican lawmakers’ arguments against capital requirements sound awfully familiar, it might be because they’ve all but lifted it straight from the Consumer Bankers Association, directly echoing a Wall Street lobby group.

Pre-Positioning.

Expect more talk on this subject, which Comptroller Hsu addressed last week. Politico explains a new concept in financial regulation known as “pre-positioning,” which would compel banks to stash collateral at the Fed to cover short-term outflows, like the ones that rocked the sector during last year’s banking crisis. Banks tend to be reluctant to use the Fed’s discount window, its emergency funding facility, because it suggests they are in trouble. To get them used to it, regulators propose regular “fire drills” in which they’d be required to draw from the discount window.

Fed Ethics.

In 2021, Fed Presidents Rosengren and Kaplan resigned after news surfaced that they made potentially unethical trades in stocks and other investments while they worked to set monetary policy. This week, the Fed’s inspector general cleared both of legal wrongdoing, but criticized their activity for creating the appearance of a conflict of interest – in Kaplan’s case, not disclosing information about selling certain stocks. 

Artificial Intelligence.

Last Friday, the heads of the CFPB, FDIC, Fed and OCC spoke on a panel about the risks of artificial intelligence in the financial sector. The main ideas: regulators already have the power they need to regulate AI use, and financial institutions that opt to use AI need to wary about its impact – just because it’s flashy and techy doesn’t mean they get a pass if its effects run afoul of existing protections, like the Equal Credit Opportunity Act. 

Wells Fargo Unionization.

The union push at Wells Fargo is the first of its kind at a megabank, as branches across the country decide whether to join the Communication Workers of America. Employees at locations in Alaska, New Mexico, Florida and Iowa said they’d hold votes. Daytona, Florida, and Albuquerque, New Mexico, voted to join. Bethel, Alaska, withdrew their attempt. Most recently, a branch in Atwater, California, voted against joining the CWA.

Related: A federal judge approved a $6.5mn settlement in a class action lawsuit filed by California employees of Wells related to wage and time. 

Munis.

“Munis,” or municipal bonds, represent debt issued by states, cities and counties to help them fund their public services or drum up capital for new projects. It’s a $4trn market that has historically relied largely on Citigroup to conduct sales. Now, the “muni giant” has pulled back from the market. Amid pressure from high rates and low borrowing, those local governments will have to look elsewhere to find banks to issue their debt.

And: “Citi’s departure is unwelcome news for investors, too. Muni prices can plummet in times of market turmoil, when scared retail bondholders yank billions from muni mutual and exchange-traded funds. That price drop, in turn, can drive down funds’ share values and payouts. What stops the bleeding is when firms with buying power step in to take advantage of deals.” 

Big Bank Background Check.

New York’s financial regulator advised banks to routinely check whether their top execs and board members had any conflicts of interest or were responsible for regulatory violations in their previous positions. Institutions would also have to report whenever it dismisses an executive or board member on these grounds. 

Further to the Banking Crisis.

NYC v. FDIC. New York City sued the FDIC, as receiver of Silicon Valley Bank, for $2.1mn in back taxes that they say the bank owed before its failure last year. 

CONSUMER 

Banking Junk Fees.

This week, the CFPB proposed a rule that would ban non-sufficient funds (NSF) fees charged when a debit card transaction, ATM withdrawal or certain peer-to-peer payment fails to go through. Generally, when someone tries to make a purchase for more than they have, a bank will either charge an overdraft fee to cover the difference and let the transaction proceed or charge an NSF fee to block it altogether. 

Americans for Financial Reform supports the rule. Say’s AFR’s Amanda Jackson: 

“Banks disproportionately harm Black, brown, and low-income consumers when they seek basic banking services. The proposed effort to ban these fees starts to address the racialized costs and inaccessibility of banking, as consumers often lose access to checking accounts due to predatory practices.”

But, on the topic of overdraft: The CFPB’s recent proposed rule – which would cap the fees at as low as $3 – targets banks with more than $10bn in assets. Some commentators question why it wouldn’t apply to smaller banks, too. Brookings research has suggested that a number of small institutions rely heavily on overdraft, with a much higher proportion of overdraft fees making up their profit. 

And, bizarrely: This WashPost op-ed claiming “capping overdraft fees could actually hurt poor families,” relying on the fallacy that banks will simply make up the profit elsewhere. In fact, poor families are already hit hardest by overdraft fees.

Medical Debt.

The CFPB has been considering proposals to erase medical debt from credit reports. In response to an American Banker op-ed which called it a “terrible idea,” the National Consumer Law Center’s Chi Chi Wu pushed back: “Banks and lenders are not the ones to lose from a ban on medical debts on credit reports. In fact, the financial services industry could benefit from a ban as more consumers become eligible for mainstream credit. Removing medical debts from credit reports benefits consumers tremendously.”

Enforcement Actions.

FloatMe. The FTC will stop the cash advance service’s deceptive “free money” promises, discriminatory practices, dark patterns used to stop consumers from canceling and “baseless claims'' about algorithm-based limits. 

Strategic Financial Solutions. The CFPB and seven states’ attorneys general sued the “illegal debt-relief enterprise” for using a “web of shell companies” to extract “hundreds of millions of dollars in exorbitant, illegal fees from vulnerable customers” and offered little relief to consumers struggling with debt burdens. 

CAPITAL MARKETS

Treasuries Trading Transformed. 

The SEC will require almost all Treasuries trades to occur by way of a central counterparty clearinghouse, a market middleman between the buyer and seller that assumes responsibility for the transaction, in a move that Bloomberg writes will “transform trading.” Since the clearinghouse is on the hook, the arrangement would minimize both the risk of a deal failing to go through and “the danger of contagion from a shock collapse of any one financial institution.” Currently, there’s only one clearinghouse for Treasuries – meaning the risk falls upon just one entity right now – with the opportunity for others to enter the market. 

SPAC and Span.

“Treat like cases alike,” the SEC’s Gensler said, quoting Aristotle, when discussing his agency’s crackdown on special purpose acquisition companies (SPACs), an alternative vehicle for private companies to go public. A host of new rules would treat SPACs like their more strongly regulated cousin, the IPO. AFR has previously supported proposals to tamp down on SPACs, also called blank check companies, in order to provide investors with greater transparency. 

Enforcement Actions.

Robinhood. The online brokerage will pay a $7.5mn penalty after Massachusetts securities regulators alleged it used “gamification” strategies – like confetti raining down on-screen after a user makes a trade – to lure inexperienced investors into making risky trades, Reuters reports.

PRIVATE MARKETS

Private Credit.

Private lending is risky and nearly invisible to regulators, but the landscape is beginning to look a lot like traditional finance. Reuters reports on the use of collateralized loan obligations (CLOs), which chop up corporate bonds into purchasable buckets of varying risk. And their issuance by private creditors is expected to pick up over the next year, up to an estimated $30bn in 2024 – that’s almost a third of the total CLO market altogether.

“Using CLOs can expand their firepower and boost returns, because they can borrow much more than banks were historically prepared to lend…The fusion of private credit and traditional loan alchemy also brings risks if borrowers turn out to have overstretched.” Since private loans don’t get publicly disclosed ratings from credit agencies, they can be harder to sell if things go wrong.

Related: Investment banks want to reclaim ground in the private lending sector. Banks are looking to refinance private loans that seeded leveraged buyouts. Private equity stands to benefit, as it just provides them more lending options to make new buyouts. 

Expanding Into Everything.

Pitchbook explains private equity’s infrastructure playbook, some weeks after Blackstone’s $12.5bn acquisition of Global Infrastructure Partners: “Asset managers’ infrastructure theses hinge on two major changes to the economy over the next 20 years: the carbon transition and digital transformation, which will both require the build-out of new infrastructure, according to investors and analysts.” It’ll put airports, roads, bridges, pipelines and more in private equity’s reach. 

Private Equity and Healthcare.

The Lown Institute details the “rising danger of private equity in healthcare.” The private equity machine multiplied its ownership of physician practices sixfold from 2012-2021, and at least 386 hospitals — over 30% of the for-profit stock — are owned by PE firms. Patients’ 30-day mortality increased among PE-owned hospitals, as did incidence of hospital-related accidents/adverse incidents. And private equity-owned facilities are among the worst in measures of social responsibility.

Private Equity and Homes.

The private equity megafirm Blackstone will buy Tricon Residential, a large corporate landlord that owns 38,000 single-family rentals across the United States. After the 2008 financial crisis, Blackstone “led the charge” of big Wall Street firms scooping up tens of thousands of homes across the country and converting them into rentals. 

Private Equity and Military Quadcopters.

The Kaman Corporation manufactures all manner of “mission-critical” aviation and aerospace components and products, including an unmanned quadcopter used to airlift supplies to Marines and helicopters that were deployed in Afghanistan. Now, the Kaman Corporation will come under ownership by private equity firm Arcline Investment Management, in a $1.8bn all-cash deal. 

Private Equity and the News.

Margot Susca, author of the new book Hedged: How Private Investment Funds Helped Destroy American Newspapers and Undermine Democracy, describes newspapers’ “private investment era,” as private equity firms and hedge funds descend upon the industry: “With that pressure from private equity investors, there was very little digital innovation. Rather than compete digitally, they merged and they acquired, and that put them billions of dollars in debt…What we've had from 2003 onward is a crop of investors and owners that care very little about how a newspaper functions in the community.”

One example Susca uses is the case of Fortress Investment Group. The New York-based private equity firm invested heavily in both railways and in Florida newspapers, by way of its subsidiary GateHouse Newspaper. When two counties in the state filed lawsuits against rail expansion efforts on public safety and environmental grounds, the papers failed to report on the negative implications of the deal. The lawsuits were ultimately dropped. 

Private Equity and Student Loans.

The private equity firm Carlyle will purchase a $415mn student loan portfolio from Truist, and plans to invest separately in private student lender Monogram, marking private equity entrance into a sector from which banks are pulling back. 

Other Private Markets News.

More M&A Going Bust. S&P Global reports the proportion of terminated PE-backed deals to overall totals rose in Q42023. Over 17% of deals had been terminated in the period. 

Selling Rush. Private equity firms are “putting portfolio company sales high on the agenda for early 2024, as the industry seeks to return money to investors after a challenging period for exiting holdings.”

Macy’s. Private equity firms Arkhouse and Brigade Capital made an unsolicited offer to buy out the department store franchise for $5.8bn. When Macy’s declined, their stock value crawled up on Monday. Now, Arkhouse is threatening to go hostile, bypass the board, and take its case to shareholders. 

Philippou. A great profile of “How Ludovic Phalippou Became the Bête Noire of Private Equity” in Institutional Investor. He coined the phrase “billionaire factory” to describe private equity and has long exposed how PE manipulates or misstates returns.

CRYPTO

The Exchanges vs. The SEC.

Coinbase and Binance both came under fire by the SEC in the past year, in cases that rely on the fundamental definition of crypto tokens. Are they securities? (They probably should be seen as such.) 

Within the past week, both groups have asked federal judges to throw out their respective SEC cases, on the grounds that cryptocurrency should be treated as commodities and thus not subject to the SEC’s rules. 

Bitcoin ETF.

Grayscale led the charge for the approval of Bitcoin ETFs, a handful of which the SEC approved earlier this month. Now, WSJ reports, it’s “lost billions from their launch.” Investors pulled $2.8bn from the Grayscale Bitcoin Trust after it was converted to an ETF. Nine non-Grayscale ETFs, meanwhile, attracted $4bn. 

Meta.

House Financial’s Ranking Member Waters wants to know what Meta, a.k.a. Facebook and Instagram, has planned for digital assets and the blockchain, after the Big Tech company filed five trademark applications that hinted at its entry into the crypto sector. This week’s applications relate to, among other things: the design of hardware and software related to the blockchain and digital assets, software to manage and validate digital currency, services related to trading of virtual currency, and a social network/dating service for digital currency investors.

Meta previously tried to create a crypto token called Libra (later, Diem), to be stored in its own digital wallet called Calibra. After pressure from regulators and lawmakers, the project shut down and sold its assets to Silvergate Bank (yes, that one). 

Bad Crypto Marketing.

Among over 500 crypto-related retail communications reviewed by the Financial Industry Regulatory Authority (FINRA), over 70% violated rules governing responsible marketing of crypto assets. That includes false or misleading statements, implications that assets worked like cash, unclear explanations about their risks and misrepresentations of how crypto assets are and aren’t protected by law, among other themes. It’s a bad look, and one that the crypto industry’s given itself. 

StableCrimes.

A report from blockchain analysis firm Chainalysis reveals that stablecoins, crypto tokens tied to the value of the U.S. dollar, enabled $40bn worth of crypto crime since 2022. In 2023, stablecoins were used in 70% of crypto scam deals. The most popular stablecoin-related crime: sanctions evasion. Stablecoins were used in over 80% of transactions to both sanctioned countries and individual sanctioned entities. 

The United Nations identified Tether, one of the most popular stablecoins in circulation, as being the “preferred choice for regional cyberfraud operations and money launderers alike due to its stability and the ease, anonymity, and low fees of its transactions” in East and Southeast Asia. That includes their use in so-called “pig butchering” scams that swindle consumers into making fraudulent investments, as well as in money laundering schemes and illegal gambling rings. 

Related to stablecoins: Figure Technologies wants SEC approval to issue a stablecoin that would accrue interest daily and pay out monthly. It’d be the first interest-bearing stablecoin in the U.S., and the first to be regulated as a security. Sounds like a bank deposit, Willamette Law’s Rohan Grey argues, which securities law couldn’t adequately cover. 

CLIMATE and FINANCE

ESG. 

The oil company Exxon Mobil sued activist investors Arjuna Capital and Follow This to bar them from submitting climate-related proposals during the company’s upcoming annual meeting. In line with their shareholder rights and SEC regulations, they wanted to pressure oil giants to create targets for Scope 3 emissions to reduce greenhouse gas output when burning their products. Should Exxon Mobil win in court, it could deal a serious blow to future shareholder petitions. 

Said Mark van Baal of Follow This: “With this remarkable step, ExxonMobil clearly wants to prevent shareholders using their rights… Apparently, the board fears shareholders will vote in favour of emissions reductions targets.”

State Pensions.

STAND.earth released a first-of-its-kind report delving into the voting records and guidelines among the nineteen public pensions whose officers have claimed to prioritize sustainable and just markets, and to protect against climate risks. All of the pensions, they write, could do more to “protect beneficiaries from growing climate- and environmental-related financial risks.” Among other common missteps, pensions often fail to account for systemic risk, fail to hold their directors accountable, and have inconsistent proxy voting guidelines in regard to climate accountability. 

Who Benefits from the Climate Crisis?

Hedge funds, They’re making bets on insurance-linked securities to generate record returns, as people continue to lose their homes and livelihoods to climate-intensified natural disasters. Insurance companies use catastrophe bonds as a buffer when monetary losses become too large to cover. So, when Hurricane Ian caused $100bn in losses in 2022, it set the stage for an influx of debt. In 2023, catastrophe bond issuance hit $16.4bn. 

POLITICS and MONEY

Nikki Haley.

A cadre of Wall Street billionaires, including Stanley Druckenmiller (a hedge fund magnate) and Henry Kravis (co-founder of private equity firm KKR), planned a fundraiser for Nikki Haley’s presidential campaign next week, Bloomberg reports. (Note: that was before Trump thumped her in the New Hampshire primary.) 

Donald Trump.

According to CNBC, many Wall Street execs have refrained from speaking out against Donald Trump, in case he wins the primary nomination. Some, like megabank CEO Jaime Dimon, have even expressed support.