March 29, 2023

High & Low Finance: Going Dark, and Putting Blindfolds on Investors

That is happening more and more often as companies avail themselves of the right to “go dark” because they do not have very many public shareholders. They no longer have to file financial information with the Securities and Exchange Commission, but the securities are still publicly traded.

These days, such investors seem to have few friends. Congress is much more interested in making it easier for companies — or “job creators” in the current jargon — than it is in protecting unfortunate investors. The so-called JOBS Act, enacted last year with widespread bipartisan support, included a provision making it much easier for small banks to go dark, and hundreds have done so.

Going dark, it should be noted, is not the same thing as going private. When that happens, securities are purchased from the public investors. They may not like being forced out, but they are out.

Not so when a company goes dark. The investors are in, but they may or may not be told what is going on. Companies that go dark sometimes make audited financial statements public, and sometimes they do not.

There is no better example of the perils of going dark — as well as proof that “preferred” can be a misnomer when it comes to stock — than the former Equity Inns, an owner of hotels, whose common shares were acquired by Goldman Sachs in 2007.

Although the common shares went away, preferred shares remained — or actually, new issues of preferreds replaced old ones. What has happened since then “smells like insider trading,” says James J. Angel, a finance professor at Georgetown University and an investor in the preferred stock. Goldman says that is nonsense.

While Goldman acquired the common stock, for $23 a share, or $1.9 billion, it did not acquire the $146 million of preferred shares in public hands. Those shares were in par values of $25 and had been sold primarily to individual investors interested in collecting a reasonably safe income stream. One series paid 8.75 percent a year, and the other 9 percent.

Before the takeover, those shares had been trading above par, and Goldman could have called them at par value. Instead, it took the preferred shares into the dark. The company assured the S.E.C. that there were fewer than 300 shareholders of record for each series of preferred, giving the company the right to go dark. The securities continued to trade over the counter in what Wall Street calls the “gray market.”

Goldman soon halted the dividend payments, and the share prices fell to as little as a penny.

How was the company doing? The financial statements were confidential, but Goldman did agree to let preferred shareholders see them — for a fee — as long as they signed confidentiality agreements that would prevent them from sharing the statements with anyone else, including prospective buyers of the shares.

Someone has, however, violated that confidentiality agreement. After I began calling around for this column, a set of financial statements arrived in an envelope with no return address. Assuming they are accurate, they show that over the three years through 2012, the company had net losses of $315 million on revenue of $1.2 billion. But most of those losses came from $251 million in depreciation. Operating cash flow was a positive $174 million. Told of some of the numbers in the statement, a Goldman spokeswoman did not dispute them.

Those numbers, however, are for the entire company. The preferred shares seem to have an interest in only 1 percent of the assets. If Goldman could find a way to put the 1 percent owner in bankruptcy, while keeping the other 99 percent out, it might be able to largely eliminate the preferred.

Even that might not be necessary. Goldman was also the lender in the deal, and perhaps it could restructure the debt in ways that would essentially give the debt holders — Goldman, that is — the ability to get everything, leaving the preferred shareholders with nothing.

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Knight Capital Announces Sale to Getco

The companies have said the deal will make trading easier and cheaper for investors. But given that one of the firms nearly collapsed in a trading blunder in August, some traders and former regulators were worried about the potential concentration of so much buying and selling in one company.

The Knight Capital Group, which lost $460 million after the Aug. 1 computer misstep, agreed on Tuesday night to be sold to Getco, a privately held Chicago-based firm that has been one of the leaders in the high-frequency trading industry.

The deal values Knight at $1.4 billion, which Getco will pay in a combination of cash and shares.

On its own, Knight has said that it is responsible for from 10 percent to 15 percent of all trading in American stocks.

Getco has kept its size and market share a carefully guarded secret, but industry analysts suggested that it frequently does as much stock trading as Knight across all venues, including public exchanges and opaque private trading platforms. If the new company manages to maintain all of that trading activity, the combined company could be larger than any other participant in the stock market and involved in more trades each day than the nation’s largest stock exchange, Nasdaq, said Larry Tabb, founder of the data firm the Tabb Group.

Knight and Getco are also significant players in trading of futures, options and currencies, among other markets.

“The two 800-pound gorillas are getting together, and they will be a 1,600-pound gorilla,” said James J. Angel, a professor at Georgetown University who specializes in market structure and regulation.

The chief executive of Getco, Daniel Coleman, said in a statement that “the combination of Knight and Getco will create a powerful, dynamic firm with an unmatched ability to deliver results for clients.”

The merger still has to win the approval of shareholders and the Financial Industry Regulatory Authority. Even if the two firms do keep up their current level of trading, lawyers said that the size of the two companies is probably not large enough to create antitrust concerns.

But Annette Nazareth, a former commissioner at the Securities and Exchange Commission, said that given the recent disruptions that have hit the stock markets — including Knight’s breakdown — the size of the company is “something you have to think about in this deal.”

“It is a factor if you have a very large player that could have an impact on the market if it had a problem,” said Ms. Nazareth.

After Knight’s computer problems triggered runaway trading in more than 100 stocks, the firm withdrew from trading for the rest of the day. In corners of the market where Knight was particularly dominant, such as trading of exchange-traded funds, Knight’s disappearance from the market made trading more expensive for other investors, according to data from Index Universe, a firm that tracks E.T.F.’s. Knight nearly went out of business before a rescue effort organized partly by Getco came to its aid.

Joel Hasbrouck, a professor at New York University who has advised exchanges and trading firms, said that the size of the new company worried him because it could give the company too much influence with regulators, as has happened when companies have grown large in other corners of the financial markets.

“Sometimes,” Mr. Hasbrouck said, “just by virtue of sheer size, an organization can have a bit more weight with regulators.” Lawmakers have recently been looking at whether high-speed firms have gained too much of an edge over ordinary investors and if they should face new fees and trading restrictions like those introduced in other countries.

Getco and Knight currently have about 2,000 employees, which is much smaller than the major Wall Street firms. But their dominance in the trading world is evident not just in the total number of shares they buy and sell each day.

On the floor of the New York Stock Exchange, Getco is the so-called designated market maker, agreeing to be a middleman in certain stocks to keep the buying and selling orderly and fair, for 909 of the exchange’s 3,259 stocks. Knight plays the same role for 513 stocks. Together, they would be in charge of 20 percent more stocks on the exchange than their closest competitor, Barclays.

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Lingering Unemployment Poses Long-Term Risk

Nearly five million Americans out of work for more than six months are left to wonder what kind of help might be coming, as the Federal Reserve, the International Monetary Fund and a bipartisan swath of policy experts implore Washington to act — both to alleviate human misery and to ensure the strength of the economy.

The pain of the long-term unemployed has persisted even as the overall jobs picture has brightened a bit and the unemployment rate has fallen to 7.8 percent. The new government report for October was due to be released Friday morning.

“The problem is incredibly urgent,” said Kevin A. Hassett, director of economic policy studies at the American Enterprise Institute and an adviser to Mitt Romney’s campaign. “Spain had a financial crisis in the late 1970s and has never seen its unemployment rate drop back to where it was before that crisis. The unemployed become discouraged, and ultimately the employment to population ratio might take a permanent hit.”

On the agenda for the next Congress and the next president is ensuring that the unusually long spells of unemployment now afflicting jobless workers remain a temporary setback of the recession.

Economists warned that long-term unemployment could be transformed in the next few years into structural unemployment, meaning that the problem is not just too few jobs and too many job seekers, but a large group of workers who no longer match employers’ needs or are no longer considered employable.

“Skills become obsolete, contacts atrophy, information atrophies, and they get stigmatized,” said Harry Holzer of Georgetown University.

That has been the experience of millions of workers like Beatrice Hogg, 55, of Sacramento, a college-educated white-collar worker who has slid from the middle class into poverty.

Her last job — doing administrative work and advising students at a community college — ended in June 2009. Her unemployment benefits ended more than a year ago. She was evicted from her apartment in December and has been staying at friends’ homes and occasionally at train stations. Despite her efforts, she has been turned down for job after job after job, and is surviving on food stamps.

“I don’t enjoy being out of work,” Ms. Hogg said in an interview. “I don’t enjoy having to ask friends to give me rides or get things for me. I want to take care of myself. I’ve been on my own since I was 18 years old. It’s hard for me. It’s demoralizing. It’s hard to ask people for things when you’ve been independent the rest of your life.”

Stronger economic growth may help to whittle the ranks of the long-term unemployed over time, experts said.

“There must have been a lot of workers badly scarred by long bouts of unemployment in the Great Depression,” said Gary Burtless of the Brookings Institution. “Even in 1939 we had unemployment somewhere around 14 percent, as we’d measure it today. A lot of people who were jobless had been jobless for a long, long time. But in the space of a couple of years those disadvantages looked like nothing given that employers had voracious appetites for workers.”

But many economists contended that policies to help the long-term unemployed are needed as well, to ensure that they have the skills necessary to compete for the jobs that the economy is adding — turning construction workers into oil-and-gas extractors and administrative assistants into home health care providers, for example.

In Washington, many politicians support measures for the long-term unemployed; few demand them.

Both Democrats and Republicans have proposed or supported revamping job-training programs, giving states more flexibility in using funds for the unemployed and providing credits to companies that hire workers who have been out of a job for more than six months, for instance.

Annie Lowrey reported from Washington and Catherine Rampell from New York.

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DealBook: Facing Complaints, S.E.C. Opens Whistle-Blower Office

The S.E.C. was hammered by critics for ignoring tips about Bernard L. Madoff's huge Ponzi scheme.Mary Altaffer/Associated PressThe S.E.C. was hammered by critics for ignoring tips about Bernard L. Madoff’s huge Ponzi scheme.

Get your whistles out, corporate employees.

The Securities and Exchange Commission’s whistle-blower office opened its doors on Friday, much to the delight of plaintiffs’ lawyers and the consternation of corporate America.

The new program will issue cash rewards to employees who report fraud to the government, an effort by the S.E.C. to expose corporate crime in the aftermath of the financial crisis. The S.E.C., hammered by critics for ignoring tips about Bernard L. Madoff’s huge Ponzi scheme and other corporate malfeasance before the crisis, is gearing up to spend top dollar for first-class tips.

Under the program, corporate tipsters could reap as much as 30 percent of the money the S.E.C. collects from a company or its executives. To qualify for the reward, an employee must turn over new information that leads to successful enforcement actions yielding more than $1 million in fines. The agency will tap the $450 million Investor Protection Fund to dole out awards.

Still, the S.E.C. says the whistle-blower program will actually save money in the long run, as tipsters offer guidance to the agency’s strapped staff of lawyers and investigators.

The program “will strengthen our ability to carry our mission and it will save us much time and resources in the process,” Sean McKessy, chief of the S.E.C.’s whistle-blower office, said in a speech on Thursday at Georgetown University’s McDonough School of Business.

The agency, Mr. McKessy said, has already received an uptick in quality tips, including lengthy letters laying our elaborate schemes. On Day 1, the office has seven employees to review the claims and a revamped Web site to collect them.

The program is the product of the Dodd-Frank financial regulatory law, which mandated an overhaul of the S.E.C.’s whistle-blower provisions. Until now, the agency limited its whistle-blower program to insider trading cases, and capped awards at 10 percent of the penalties.

Once the S.E.C. adopted the changes in May, Mr. McKessy began a charm campaign to tame some fierce opposition from corporations and their lawyers. He joined some 10 panel discussions and Webinars about the topic and huddled with various lawyers, ultimately reaching more than 1,000 people, he said.

And yet, Mr. McKessy said, “there exists still some misunderstanding about the hotly contested issues.”

Corporate lawyers and lobbyists have compared Mr. McKessy’s office to a bounty program, saying it will generate bogus tips while producing a windfall for plaintiff’s lawyers who represent scorned employees.

When the S.E.C. first announced plans for the office in November, it incited a contentious six-month lobbying campaign by corporate interests. The agency received a flood of more than 200 comments and 1,300 forms letters about the program from a cross section of Wall Street firms and corporate America – including JPMorgan Chase, Citigroup, General Electric and Google. Some of the loudest complaints came from the United States Chamber of Commerce, which alone sent four comment letters and held at least three discussions with S.E.C. officials.

When a divided S.E.C. approved the whistle-blower program in a 3-2 vote in May, the chamber lashed out at the agency.

“In approving this new whistle-blower rule, the S.E.C. has chosen to put trial lawyer profits ahead of effective compliance and corporate governance,” David Hirschmann, president and chief executive of the Chamber’s Center for Capital Markets Competitiveness, said at the time. “This rule will make it harder and slower to detect and stop corporate fraud.”

The chamber’s concerns centered on the most controversial aspect of the program, which allows whistle-blowers to expose fraud without first sounding the alarms at their company. The program, the chamber argues, will undermine internal compliance departments that corporations were forced to bolster under the Sarbanes-Oxley Act.

Mr. McKessy, who previously served as corporate secretary for both AOL and the Altria Group, which owns tobacco giant Phillip Morris, disputed the industry’s alarmist claims. By not mandating internal reporting, he said, the program will enable employees to report fraud, even when their bosses are involved in the scheme.

He also noted that the agency tweaked it original whistle-blower proposal to address some industry concerns. Under the final rules governing the program, the S.E.C is allowed to dish out heftier awards to employees who first report securities violations to corporate compliance departments.

In a December letter to the S.E.C., the Financial Services Roundtable asked the agency to do just that, urging that reporting internally “must be a specific factor in determining the amount of any award.” The language appeared nearly word for word in the S.E.C.’s description of the final regulation, which said working with internal compliance departments was “a factor that can increase the amount of an award.”

The program also allows tipsters to collect their bounty even when they first reported wrongdoing to the company’s compliance department, so long as the employee shares the same information with authorities within 120 days.

“The whistle-blower program will bolster, not hamper, internal compliance departments,” Mr. McKessy said.

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Economix: Why College Brings a Huge Return

My column in the Sunday Review section makes the case for going to college and cites two just-released reports, one by two Georgetown University researchers and the other by two Hamilton Project researchers. Each report has some charts worth reproducing.

The opening chart in the Georgetown paper, by Anthony Carnevale and Stephen Rose, estimates the demand for and the supply of four-year college graduates, both past and future.

Center on Education and the Workforce, Georgetown University

The supply of graduates is easy enough to measure; it is simply the number of graduates. To estimate demand, the two economists look at the wage premium for graduates. When the premium is rising, demand is outstripping supply. When the premium is falling, demand is rising more slowly than supply.

Looking ahead, Mr. Carnevale and Mr. Rose use school enrollment to estimate supply. Future demand is trickier to estimate. Mr. Rose, by e-mail, explains:

Over the last 100 years, the growth in demand for college-educated workers has varied within a narrow range and averaged 2.8% increase per year. Given the current high penetration of computer technologies, this paper takes the conservative position that this growth in demand from 2010 to 2025 will grow by 2 percent per year.

The bottom line is that, unless the country begins producing more graduates, supply is unlikely to catch up to demand — and income inequality is unlikely to fall by much if at all.

The next chart, from Hamilton, estimates the annual return from different investments, including college tuition:

The Hamilton Project

I was surprised that two-year colleges had a higher return than four-year colleges, but Adam Looney, one of the authors, notes that tuition at two-year colleges tends to be very low.

And the fact that two-year colleges have a higher return does not mean it makes sense to stop after two years. The next two years of college still have a huge return. You can see this by comparing the total value of the two degrees, known in economic terms as net present value:

The Hamilton Project

The Hamilton researchers — Michael Greenstone and Mr. Looney — also offer a chart on lifetime earnings, which shows that a big part of college’s value is that it brings much larger raises over someone’s career:

The Hamilton Project

Finally, the Georgetown paper points out that the value of college is not merely that it’s necessary for many good jobs, like doctor, teacher, scientist or corporate executive. A college degree also often lifts people’s earnings in occupations that do not require a degree, like construction worker, day-care worker, plumber and secretary:

Center on Education and the Workforce, Georgetown University

My column and the chart that ran with it have more details on this last point.

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Obama to Set Goal of One-Third Cut in Oil Imports

The president, in a speech to be delivered at Georgetown University, will say that the United States needs, for geopolitical and economic reasons, to reduce its reliance on imported oil, according to White House officials who provided a preview of the speech on the condition that they not be identified. More than half of the oil burned in the United States today comes from overseas and from Mexico and Canada.

Mr. Obama will propose a mix of measures, none of them new, to help the nation cut down on its thirst for oil. He will point out the nation’s tendency, since the first Arab oil embargo in 1973, to panic when gas prices rise and then fall back into old gas-guzzling habits when they recede.

He will call for a consistent long-term fuel-savings strategy of producing more electric cars, converting trucks to run on natural gas, building new refineries to brew billions of gallons of biofuels and setting new fuel-efficiency standards for vehicles. Congress has been debating these measures for years.

The president will also repeat his assertion that despite the frightening situation at the Fukushima Daiichi reactor complex in Japan, nuclear power will remain an important source of electricity in the United States for decades to come, aides said.

He will respond to members of Congress and oil industry executives who have complained that the administration has choked off domestic oil and gas production by imposing costly new regulations and by blocking exploration on millions of acres of potentially oil-rich tracts both on shore and off.

The administration is not prepared to open new public lands and waters to drilling, officials said, but will use a new set of incentives and penalties to prod industry to develop resources on the lands they already have access to.

The Interior Department on Tuesday issued a paper saying that more than two-thirds of offshore leases in the Gulf of Mexico and more than half of onshore leases on federal lands are unused. Oil industry officials called the paper a smokescreen to cover the administration’s stingy approach to drilling permits.

“This is an effort to distract the American people from rising gas prices and the fact that the administration has been delaying, deferring or denying access to our oil and natural gas resources here at home,” said Erik Milito, the director of exploration policy at the American Petroleum Institute. “Lease sales have been delayed or canceled, and this year, for the first time since 1957, we may not have a single offshore lease sale.”

White House officials indicated that Mr. Obama was turning to energy issues after a period of intense focus on turmoil in Libya and elsewhere in North Africa and the Middle East. He will link them by saying the United States cannot be secure as long as it depends on potentially unstable monarchies and dictatorships for a large part of its daily petroleum diet. The reduction in oil imports he has set as a target — roughly three million barrels a day over 10 years — corresponds roughly to current import levels from the Middle East and Africa.

Presidents since Richard M. Nixon have made this point, and American oil imports have continued to rise, except when slowed by recession.

Republicans in Congress have grown increasingly vocal about the administration’s energy and environment policies, saying they discourage domestic oil and gas development and impose heavy costs on industry in a period of economic angst. On Tuesday, House Republicans introduced three bills to reverse the administration’s offshore oil drilling policies, calling for vast new tracts of offshore territory to be opened to deep-water drilling and for speedier approval of drilling permits.

On the Senate floor, Mitch McConnell of Kentucky, the Republican leader, denounced the president for a variety of alleged energy sins, including telling Brazilian officials last week that the United States would be an eager consumer for its offshore oil.

“You can’t make this stuff up,” Mr. McConnell said.

“Here we’ve got the administration looking for just about any excuse it can find to lock up our own energy sources here at home,” he said, “even as it’s applauding another country’s efforts to grow its own economy and create jobs by tapping into its own energy sources.”

The administration imposed a moratorium on most deep-water drilling activities in the aftermath of the Deepwater Horizon explosion, which killed 11 rig workers and sent nearly five million barrels of oil into the Gulf of Mexico. The Interior Department wrote new safety and environmental rules for offshore drilling and officially lifted the moratorium in October.

The department has now issued seven permits for activities that were halted under the suspension, with 12 other deep-water permits pending. An additional 24 permit applications have been returned to applicants for more information.

Mr. Obama is also expected to renew his call from the State of the Union address to increase the percentage of electricity produced from so-called clean sources to 80 percent from the current 40 percent by 2035. The president’s definition of clean energy includes renewable sources like wind, solar, hydro and geothermal, as well as nuclear, natural gas and coal with carbon capture and storage, an as-yet-unproved technology.

On Friday, the president will appear at a United Parcel Service depot in Landover, Md., to talk about ways to make commercial truck and bus fleets more fuel-efficient and to make greater use of domestically produced natural gas in transportation.

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