The basic story of Mark Walter and TWG Global, his holding company, is that TWG owns some insurance companies, and those insurance companies would raise money by selling annuities to customers, and Walter would control how that money was invested, and he would lend some of the money to himself to buy sports teams. Insurance regulators have pretty strict rules about related-party transactions, for reasons that are obvious if you think for a minute about the phrase “lend some of the money to himself to buy sports teams.” When an insurance company is lending its boss money to buy sports teams, it is taking different and spicier credit risk than it would be if it were just buying normal bonds of unaffiliated companies.

But TWG’s insurance companies would make a lot of those loans through third parties, which would then turn around and lend the money back to TWG’s businesses. And the insurance companies’ financial statements would not count those loans as related-party loans. Eventually federal prosecutors and insurance regulators started asking questions. “After receiving subpoenas, those insurers disclosed more than $20 billion of loans that should have been labeled as affiliated transactions, but weren’t.” Bad.

At the same time, though, owning sports teams has been a lucrative business in recent years, and as far as I can tell it has all worked out great? TWG put out a statement in August saying so:

Affiliated transactions should be properly disclosed, but to state that they “generally” have the potential to “loot” the insurer is untrue.

The reality is that Group 1001 [the TWG insurance group] has invested in real assets that are performing well; the insurance companies have recognized significant income from the investments and no policyholders have lost money because of these transactions.

The statement also said: “There is no victim here. No one has been harmed, and no one has claimed they were harmed.” I have pondered that claim a few times. It can’t quite be true. If the world had known the true level of the insurance companies’ affiliated transactions, then … something. Something. Like:

1. Insurance regulators would have demanded that the insurance companies have more capital to offset the increased risk of all those affiliate transactions.
2. Ratings agencies would have given the assets lower ratings, and the insurance companies would have responded by having higher capital to preserve their own financial-strength ratings.
3. Ratings agencies would have given the insurance companies lower ratings, and they would have had to pay higher interest rates on the annuities they sold.
4. Financial advisers would have read the disclosures, said “hmm this sounds risky,” and recommended that their customers look elsewhere for annuities, again driving up the rates that the TWG insurers had to pay on annuities.

Or some combination of those things. Or something else. There is not a crisp mechanism here; the counterfactual is not obvious. There is just a general sense that, by under-reporting their affiliated transactions, the TWG insurers understated their credit risk, or at least their conflict-of-interest risk, and that if the world had known their real credit risk it would have cost them some money. 

So I get what TWG meant when it said there were “no victims”: No customer lost money, relative to that customer’s contracted cash flows. But I also think it was wrong: The customers did lose money, relative to the cash flows they would have demanded if they had known the truth, or rather the cash flows they would have demanded if the regulators and ratings agencies and market had known the truth. 

In any case, if you go around filing incorrect financial statements and then put out a press release saying “there is no victim here,” you are tempting fate in an obvious literal way: Lots of plaintiffs’ lawyers are going to read that press release, take it as a personal challenge, and go find some victims to sue you. The Wall Street Journal reports:

A suit filed Monday is at least the third to allege Walter and his insurers sold annuities based on misrepresentations and false promises. The suits, brought by class-action lawyers seeking to represent a larger group of policyholders, come after two of Walter’s insurers disclosed in June that they were under federal investigation for failing to report how much of their portfolio was deployed as loans to other companies connected to Walter’s sports-and-financial empire. 

Rick Phillips, a Los Angeles-area retiree, filed suit on Monday asking that policyholders at two Walter insurers, Clear Spring and Gainbridge, be let out of their annuity contracts without penalty or reimbursed for the difference between what they paid and the cheaper price the companies might have had to accept had they been upfront about the extent of their affiliated investments.

Here is the complaint. On the one hand, the insurers sold annuities mostly on the promise “we’ll pay you back your money at the contracted rate,” and that promise seems to have been true. On the other hand, the insurers also sold annuities on various implicit indirect promises along the lines of “the financial statements we file with regulators correctly reflect our level of affiliate transactions,” promises that surely Rick Phillips didn’t pay attention to, but that do sort of feed into price. From the complaint:

In a market where premiums, rates, fees, and guarantees are published, compared, and competitively bid, a purchaser who knew that over forty-five percent of the assets in Clear Spring’s general account and nearly sixteen percent of the assets in Gainbridge’s general account consisted of loans whose repayment depended on ventures related to Walter would have demanded a lower premium, a higher credited rate, a higher participation rate, a lower rider charge, a larger guarantee, or some combination of those terms — or would have bought from a different insurer entirely. By delivering an annuity that was riskier than what had been represented, Clear Spring and Gainbridge breached their contract with Plaintiff and the Class. …

Plaintiff and the proposed Class assert claims and seek damages or rescission of their annuity contracts with Clear Spring and Gainbridge for breach of contract and breach of the implied covenant of good faith and fair dealing. Their damages are measured by the difference between (i) the value of the annuities at the premiums Plaintiff and the Class paid and (ii) the inferior value of those annuities and/or the lower premium that would have been required to purchase the annuities had the related-party nature of Clear Spring’s and Gainbridge’s general accounts been disclosed as required.

The actual monetary harm is a little hard to quantify, but surely the basic theory is right. TWG’s insurance companies were riskier than people thought, so they should have paid extra for their annuities. And now the customers want their extra money.

The basic way to make money as an investment manager is:

• People give you money to invest,
• You invest it and earn a return, 
• You pay them some portion of the return, and
• You keep the rest.

Your earnings are the spread between the returns you get on your investments and the returns you pay to your investors. One way to increase your earnings is by getting a higher return on your investments. But of course the other way is by paying a lower return on your funding.

There are three broad funding models:

1. Pass-through funding: You raise money from investors, promising to invest it in stuff and give them the returns, minus some set fees. Mutual funds do this: They invest their customers’ money in stocks or bonds, and the customers get the returns on those stocks or bonds minus some annual fee. Traditionally hedge funds and private equity funds do this too: They invest in stuff and give their clients the returns, minus (classically) 2% of assets and 20% of returns. 
2. Fixed funding: You raise money from investors, promising to pay them some fixed or formulaic return, 7% per year or 200 basis points over Fed Funds or whatever. You pay them the fixed return, you earn a variable return (on whatever you invest in), and you keep the difference (which might be negative). This is classically how banks work: They borrow money from depositors, invest it in loans or whatever, earn returns on the loans, pay a fixed interest rate to the depositors and keep the rest. But lots of investment firms get some portion of their funding by borrowing it (from banks, bond markets, prime brokers, etc.); they pay a fixed return on that capital and keep what’s left over. [1]
3. Discretionary funding: You raise money from investors, you invest it in stuff, you earn returns on the stuff, you pay the investors whatever you think is fair and you keep the rest. Nobody quite puts it like this — this sounds like a joke — but I have argued that this is sort of how the big multimanager multistrategy “pod shop” hedge funds work these days. They typically charge “pass-through fees” to cover their expenses, including employee compensation. The investors get what they get. If what the investors get is too low for too long, they will demand their money back and the fund won’t be able to raise new money; this model is not really “ehhh keep whatever you want, have fun.” But it is a model that depends on the hedge fund managers having a lot of negotiating leverage with their clients. 

We have talked a few times about private credit’s funding model. One way to think about it is that a private credit fund has straightforward pass-through funding: Investors give the private credit fund money, the fund invests it in loans, the loans pay a return, and the investors get the returns minus fees.

But an important funding source for private credit funds is insurance companies, more specifically annuity companies. Like TWG, many big private credit managers own insurance companies and run large annuity businesses, which they invest in private credit (and private equity). You could collapse the two parts and say that actually private credit is (partially) funded by annuities. 

Often that is a fixed funding model, like bonds. The annuity company borrows money from retail investors, promising to pay them back their money with (say) a 7% return over (say) five years. It invests the money in private credit loans and earns (say) 12%, and it keeps the difference between 12% and 7%.

But not all annuities have fixed rates. Another model is a variable-rate market-linked annuity, along the lines of:

• The annuity company borrows money from retail investors, promising to pay them back their money with (say) a return equal to, say, half the return on the S&P 500 stock index minus 2% per year, floored at zero. Unless that’s too much. If it’s too much, the annuity company can adjust it down to the rate it thinks is fair.
• The annuity company invests the money in private-credit loans, earning (say) a 12% return.
• If the private credit loans do well, the annuity company keeps the difference between the 12% it earns and the half-the-S&P-minus-2% it pays to its annuity customers.
• If the private credit loans do less well, the annuity company says “actually we’re gonna pay you a quarter of the return on the S&P 500 minus 2%, that seems fairer.”

Here’s a Wall Street Journal story about indexed annuities:

When Sabrina Elliott inherited some money, her son-in-law helped her invest $40,000 in a product that dangled the prospect of stock-market gains with no risk of loss.

In exchange for locking up her money for 12 years, it promised returns tied to the market’s performance. One catch: The company behind the product, Aviva, could periodically lower the portion of market gains Elliott received. ...

In the first year of Elliott’s policy, 60% of her money earned returns tied to the S&P 500, minus a 2.9 percentage-point spread. In the policy’s seventh year, Athene lowered that share to 55%, then to 45% in the 11th year. The rest of the money grew at a fixed rate of 1%. ...

The 3.7% annualized rate she earned over the 12-year life of her annuity handily beat the 1.9% she would have gotten from Treasurys. But it paled next to the annualized return of 13% on the S&P 500, the index to which her annuity was linked. …

Indexed annuities were particularly attractive [to asset managers]. Payouts follow a relatively predictable timetable, and the policies typically last about a decade, compared with about three to five years for fixed-rate annuities. That gives asset managers flexibility to put the money into riskier, less-liquid private-credit investments like collateralized loan obligations or asset-backed securities.

If their investments do poorly, the insurer can cushion against loss by lowering the caps on policyholder gains, and if their investments do well they can fatten their profits the same way, said Larry Rybka, chief executive of Valmark Financial Group, which sells life insurance, annuities and investment products. 

If you’re an alternative asset manager, probably (1) your investments have some beta to the public stock market and (2) you think you’re a pretty good investor and will outperform the broad public index. Promising your customers the return on the public stock market — adjusted for the lower risk of your product — gives them an attractive product and also lets you keep all your outperformance. But it’s nice to have a little extra cushion just in case.

Well he’s very annoying, is my basic legal analysis. Like, imagine that the US Federal Trade Commission brought an antitrust case against a pharmaceutical company, “alleging an elaborate anticompetitive scheme to preserve a monopoly for [a] life-saving drug.” Imagine that the FTC won that case emphatically. What would the consequences be? The company might lose its monopoly or get shut down. The company, and/or its chief executive officer, might pay a big fine. The CEO might go to jail, or be banned for life from running a pharmaceutical company. 

But would the CEO be banned from tweeting about pharmaceutical companies? Would he be banned from owning 100 shares of a pharmaceutical company’s stock? Is that a normal thing? I don’t know. Seems a little extreme. But the FTC did bring that antitrust case against Martin Shkreli and his former company, Vyera Pharmaceuticals LLC, and in 2022 — while Shkreli was in prison for a somewhat unrelated securities fraud — a judge banned “him for life from participating in the pharmaceutical industry in any capacity,” specifying that “participating in the pharmaceutical industry” included “acquiring or holding” pharmaceutical company stock and “taking any action to directly or indirectly influence or control the management or business of any Pharmaceutical Company.”

He objected: What about tweeting? He argued that the ban “would infringe his free speech rights by prohibiting him entirely from, among other things, using social media to discuss the pharmaceutical industry.” So the judge specified that:

Shkreli’s public statements about a Pharmaceutical Company will be deemed an action taken to influence or control the management or business of any Pharmaceutical Company if Shkreli intended the statement to have that effect or if a reasonable person would conclude that the statement has that effect.

So Shkreli is not legally allowed to own pharmaceutical stocks, and he is not allowed to tweet about pharmaceutical stocks to “influence” their “management or business,” which is not quite the same as saying that he’s not allowed to tweet about pharmaceutical stocks, but which kind of has that effect. She wrote:

Shkreli has not expressed remorse or any awareness that his actions violated the law. … He has also denied that what happened here was egregious, arguing that the Plaintiffs have not proven that any patient died due to the price he set for Daraprim. He chose to not even attend the trial. [2] ..

This is an egregious case; death is not the only relevant metric. If a court sitting in equity is powerless to impose a lifetime industry ban to protect the public against a repetition of the conduct proven at this trial, then the public could rightfully ask whether its wellbeing has been adequately weighed. ...

There is no reason to believe that a narrowly crafted injunction will succeed in providing adequate protection against a repetition of illegal conduct. Shkreli has demonstrated that he can and will adapt to restrictions. With help at times from a contraband phone, Shkreli managed to control his company even from federal prison.

Shkreli’s anticompetitive conduct at the expense of the public health was flagrant and reckless. He is unrepentant. Barring him from the opportunity to repeat that conduct is nothing if not in the interest of justice. “If not now, when?”

I do think that the legal analysis here is something like “this guy is really annoying and we need to shut him up.” An appeals court agreed.

If I told you that Martin Shkreli has spent 20 hours a day for the last four years trading the stocks of pharmaceutical companies and tweeting about their management and business, would you be the least bit surprised? Bloomberg News reports:

The Federal Trade Commission and seven states started contempt proceedings against Martin Shkreli, the “Pharma Bro” who served almost seven years in prison for defrauding investors.

The FTC said in a statement Tuesday that Shkreli flagrantly and repeatedly violated a 2022 court order that banned him from the pharmaceutical industry. Since his release from prison in May 2022, Shkreli has been violating the ban by publicly trading in pharmaceutical stocks and broadcasting his opinions about companies in the industry, the FTC said.

Here are the FTC’s press release and the motion for contempt. From the press release:

Shkreli has publicized his order violations by livestreaming and posting on numerous social media platforms, including YouTube, X, and Reddit. The motion alleges that, while livestreaming his trades in pharmaceutical industry stocks, Shkreli told his viewers “I’m showing you how to trade and invest in biotech.” The motion further alleges that, in another livestream, Shkreli confessed his “magic trick”: “It doesn’t matter what trades I make because I can always find a couple of biotech stocks to smoke.” As alleged in the motion, Shkreli used his livestreams to wage multiple public campaigns to short certain pharmaceutical company stocks based on his prediction that their key clinical trials would fail. 

Sure. I wrote once, about another guy with a Twitter ban, that “‘contempt of court’ is a term of art, and it’s possible to be held in contempt of court without actually having any particular contempt for the court.” But, as with the other guy, one does get the sense that there is some actual contempt involved here.

I will say, a big part of these accusations is that Shkreli vocally shorted a lot of biotech stocks. “Shkreli has repeatedly described the tens of millions he has made on his infamous biotech shorts,” says the motion. Is that … actually forbidden? He’s not allowed to “acquire or hold” any pharmaceutical stocks, but shorting the stock doesn’t involve acquiring or holding it. (It involves acquiring a negative amount!) Is shorting a pharmaceutical stock and saying that the company “is lying about their data, like they have before” really a way “to influence or control the management or business”? Is the company going to change its strategy because a short seller is trolling it on Twitter?

The thrust of the accusations here is not that Shkreli is violating the court order by getting back into the pharmaceutical industry and doing anticompetitive things at the expense of public health. The thrust is that Shkreli continues to be very annoying about pharmaceutical companies on social media, and the FTC wants him to stop.

We talked yesterday about the legal dispute over Kalshi’s sports bets. Basically Kalshi and the US Commodity Futures Trading Commission argue that sports bets — sorry, sports event contracts — that trade on prediction markets are “swaps” under the US commodities laws, and therefore are subject to the exclusive jurisdiction of the CFTC. Therefore state gambling regulators can’t do anything about them, and Kalshi can offer sports bets to 18-year-olds, in states where sports betting is illegal, etc. Most states disagree and think that prediction-market sports contracts are obviously sports bets subject to state regulation. Several federal appeals courts have considered this question; two have ruled for states and one for Kalshi. The state that lost the last case (New Jersey) is asking the Supreme Court to consider the question, and several parties — other states, the National Football League, Gary Gensler — have filed briefs urging the court to side with New Jersey.

As I mentioned yesterday, one argument against Kalshi’s and the CFTC’s position is that, if sports bets are really “swaps” subject to exclusive CFTC regulation, then that means that all other sportsbooks are illegal. The basic rule is that you can’t offer “swaps” to retail customers except on a federally regulated exchange: You can sell swaps to retail bettors on Kalshi, but not on a state-regulated sportsbook. Therefore, if sports bets are swaps, then all sportsbooks are illegal and have been for 15 years, but nobody has noticed. That seems absurd. As Gensler’s brief says:

Congress and the CFTC (at least until the past year) did not behave as though Congress had made such a fundamental change. No one suggested that casinos had to shut down their off-exchange sports-betting operations. … If Dodd-Frank had preempted the states and tribes on sports betting, it would have been one of the biggest stories about Dodd-Frank at the time. But nobody ever mentioned it.

This point is obviously embarrassing for the CFTC, so embarrassing that last Friday it tried to fix it:

The Commodity Futures Trading Commission [Friday] published an Interim Final Rule that codifies the CFTC’s longstanding position that casino-style gambling products, including wagers placed on sportsbooks and casino games, are excluded from the “swap” definition.

“Casino-style gambling products are not derivatives,” said Chairman Michael S. Selig. “Just as the CFTC has done with respect to other products historically regulated by the states, the Commission today provides clarity regarding the limits of its regulatory remit by codifying the exclusion of casino-style gambling products from the ‘swap’ definition.”

Here is the rule, which is clearly motivated by the fact that Kalshi has lost some court cases:

In recent months, many have expressed concern that a natural, plain-text interpretation of the “swap” definition would necessarily encompass casino-style gambling products and, finding that consequence untenable, have diverged from the plain text of the statute. For example, the Sixth Circuit viewed sports event contracts as legally indistinguishable from casino-style sports wagers, and thus, it expressed concern that, if sports event contracts are swaps, any sports wager — including “every sports wager placed in a casino, on an online sports book, or between two friends at a bar” — would need to “take place on federal markets.” Indeed, the Sixth Circuit explained, a person would commit a felony by engaging in gambling off a designated contract market (“DCM”).

So the CFTC put out a rule saying, no, not that. Sports bets on sportsbooks are sports bets and always have been, but sports bets on Kalshi are event contracts. The rule draws an analogy to insurance: Insurance contracts typically pay out money “dependent on the occurrence, nonoccurrence, or the extent of the occurrence of an event or contingency associated with a potential financial, economic, or commercial consequence,” which is the statutory definition of a swap, but obviously insurance contracts are not commodity futures that have to be traded on an exchange. So the CFTC’s rules exempt insurance contracts from swap regulation, and now they exempt “casino-style” sports bets from swap regulation. Are Kalshi’s sports bets “casino-style”? No no no no no no no, why would you say that, what, look over there.

A reader pointed out that, in August, the CFTC “warned [prediction markets] that displaying pricing information in the ‘American’ odds format used by casino gambling bookmakers” is not allowed. So Kalshi can tell you that the Seattle Seahawks are trading at a 59% chance to beat the Denver Broncos on Thursday, but not that the moneyline is -144. Those things — 59% implied probability, -144 moneyline — mean the same thing. But style, apparently, matters.

Elsewhere in casino-style gambling, the Wall Street Journal reports:

Individual investors aren’t letting anything get them down these days.

Their fervor is showing up in frenzied trading of options, or contracts that allow holders to buy or sell a stock at a set price, by a certain date. Volumes in options tied to individual stocks have recently reached levels seen during the meme-stock mania of 2021, about $700 billion of notional volume a day, according to Carrick Lane, an investment manager specializing in options strategies. The prices of call options, which give the right to buy, have eclipsed levels seen during that time.

I think a lot about Robinhood Markets Inc. Chief Executive Officer Vlad Tenev’s appearance on Bloomberg’s Odd Lots podcast last year, in which he argued that retail investors should be able to buy stock in private companies because there are so many worse things they could buy:

You have access to so many things. You can just spend your money on Amazon and buy all sorts of trinkets that immediately lose value and depreciate. You can buy meme coins. So the idea that those classes of ways to spend your money are okay, but buying OpenAI or SpaceX stock, I think on its face, it’s illogical.

This is, I think, the master key to all of modern US retail financial regulation. “There is a lot of dumb stuff you can buy. Some of it is dumber than this stuff. Therefore you should be able to buy this dumb stuff.” 

“Asian capital is the fuel that feeds the US AI boom.” JPMorgan Posts Surprise Drop in Fixed-Income Trading Revenue. Goldman’s Equity Traders Post Big Haul as Credit, Rates Miss. Citi Fixed-Income Traders Post Higher Revenue as Rivals Miss. Wells Fargo Beats as Resilient Customers Curtail Loan Losses. CFTC Staff Were Told to Retract Analysis of Suspicious Oil Trades. Albertsons Wants $8 Billion From Kroger After Failed Merger. Getty Images to File for Bankruptcy, Go Private Via Koch Deal. Bumble to Delist in $1.3 Billion Deal With Ithaca Holdings. ‘Phantom’ Data Centers Are Demanding More From the Power Grid Than They Need. The Luxury Beverly Hills Condo Project Borrowing Money From Its Future Residents. Screenwriter Beats Wall Street on Inflation Bets From His Garage. The best gilets for finance bros. 

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