← Money Stuff: The Podcast
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- [00:00]
GiveWell
GiveWell, a non profit that researches and recommends giving opportunities, takes the impact of donations seriously to ensure their recommendations withstand tough scrutiny. GiveWell had their own researchers spend months trying to identify flaws in their past work. They then publish their findings, mistakes and all for any donors to use for their giving. It's this kind of rigor that can help your donation make a big impact on the world. GiveWell has now spent over 17 years researching charitable organizations and only directs funding to a few of the highest impact opportunities they've found. Over 125,000 donors have used GiveWell to donate more than $2 billion. Rigorous evidence suggests that these donations will save over 200,000 lives. If you've never used GiveWell to donate, you can have your donations matched up to $100 before the end of the year or as long as matching funds last. To claim your match, go to givewell.org and pick podcast and specify where you heard this ad. Make sure they know that you heard about GiveWell from this podcast.
- [01:01]
Matt Levine
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- [01:30]
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- [02:03]
Katie Greifeld
Bloomberg Audio Studios, Podcasts, Radio News. Should I get closer? Yeah. Even though people like my audio at least relative to Matt's.
- [02:14]
Matt Levine
Yeah, I'm the audio of death. Sorry I'm so low and quiet. Should I do this? Should I do like an Eeyore voice the whole time?
- [02:23]
Katie Greifeld
Maybe they'd like it a little bit more.
- [02:24]
Matt Levine
Hello and welcome to the Money Stuff Podcast.
- [02:28]
Katie Greifeld
And then maybe they would like your normal voice more.
- [02:32]
Matt Levine
Hello and welcome to the Money Stuff podcast, your weekly podcast where we talk about stuff related to money. I'm Matt Levine and I write the Money Stuff column for Bloomberg Opinion.
- [02:43]
Katie Greifeld
And I'm Katie Greifeld, a reporter for Bloomberg News and an anchor for Bloomberg Television.
- [02:48]
Matt Levine
What are we talking about today, Katie?
- [02:50]
Katie Greifeld
Well, Eeyore, we're talking about Vanguard getting put on the SEC's naughty list. We're going to talk about buffered Bitcoin ETFs, and then we're going to talk about two sigma.
- [03:06]
Matt Levine
I wrote this. It might be the last SEC naughty list.
- [03:10]
Katie Greifeld
Yeah, that's true.
- [03:11]
Matt Levine
I'm really interested what's going to happen in the next few years in terms of like, I've made fun of the SEC over the past few years about some of its enforcement things like the cell phone stuff where if you text about work, you get in trouble with the sec. I don't know how much. The SEC is like a sort of self operating mechanism that has inertia and will keep bringing cases and we'll keep going after securities fraud. And how much of it is going to be like the tone from the top is securities fraud is great, and then we just never see an SEC case again. Or you see SEC cases, but they have a very different political posture, anti ESG cases.
- [03:44]
Katie Greifeld
It seems like that sentiment is shared because it was a real rush to the finish for the sec. You had a very long column about everything that the SEC was busy with.
- [03:54]
Matt Levine
No, like one quarter of the thing that the SEC did last week, there's.
- [03:58]
Katie Greifeld
So many things nestled at the bottom was something on Vanguard, of course, Vanguard to pay $106 million to resolve violations related to capital gains distributions in their target date funds. This is a rare moment where Matt and I both wrote about something. Him in Money Stuff, me in the ETF IQ newsletter, dueling newsletters. Yeah. Matt, you find this aggressively boring, but I think it's kind of interesting.
- [04:26]
Matt Levine
Say what?
- [04:27]
Katie Greifeld
Okay, well, this came down and to me it sort of read like the inverse of what we were talking about with Capital One. And let me tell you, sort of, yeah. Okay. All right. So you're buying in. So Vanguard basically lowered the minimum initial investment on its Vanguard Institutional target retirement funds in December 2020. But they also had a retail version of this, and the institutional version had a lower fee than the retail. And my crude explanation in my newsletter was that, okay, they told the investors in the retail product that they were lowering the minimum. And you had a bunch of these retirement investors switch to the now lower fee institutional TRFs that they could get access to. But the bad news came in when the retail funds, to meet those redemptions, then had to sell a bunch of assets and the remaining holders were caught with big capital gains.
- [05:23]
Matt Levine
Yeah. So the two classes are the investor fund and the institutional fund. The investor Fund is not exactly retail. It was like sub $100 million. And so a lot of retirement funds had their money in the investor fund and then they cut the minimum for the institutional fund to 5 million from 100 million. So all these small and mid sized retirement plans were like, okay, we'll get the lower fees by taking our money out of investor and putting it in institutional. But to get the lower fees, that's technically a taxable transaction. Like technically, the retail fund sells all those stocks and the institutional fund buys it. And that means that the retail fund has capital gains and those capital gains are shared by the redeeming holders, but also the continuing holders. So if you had money in that fund, you had a big capital gains tax bill and you were surprised by it because it's not in any sort of proportion to your actual gains. It's like all these people cashed out. So there was a big bill.
- [06:18]
Katie Greifeld
Yeah. So mutual funds.
- [06:20]
Matt Levine
Mutual funds. You were like, I wrote about this and I was like, let me guess, they should have done an ETF.
- [06:25]
Katie Greifeld
Well, I mean, ETFs. With ETFs, this wouldn't have happened. You think about the creation redemption mechanism of ETF shares. People love ETFs because you don't get capital gains bills in the same way that you would with a mutual fund when other holders redeem.
- [06:42]
Matt Levine
Right. It's like you have to sort of think about like, what is the right treatment. So I wrote a few years ago, like Bloomberg, Zach Mitre had a series of stories about the ETF heartbeat trade where basically, like, if you run an etf, broadly speaking, you can avoid realizing any taxable gains because you're doing in kind creations and redemptions. But every so often you need to like adjust the holdings of your fund. And if you traded for cash, you would have taxable gains. If you run an etf, the number one goal is never have taxable gains. And so people have developed all of these complicated mechanisms to take advantage of what a lot of people call the ETF tax loophole. Right. It's a loophole that you can have this fund that never buys or sells stocks and never has taxable gains.
- [07:24]
Katie Greifeld
Yeah. At their heart, it's kind of a tax dodge.
- [07:27]
Matt Levine
Yeah, it's kind of a tax dodge. It is so intuitively appealing to say, I've put my money in a fund, in a year or 10 years or 35 years, I'll take my money out of the fund. If I have gains over those 35 years, I'll pay taxes on the gains. But in between, I shouldn't pay any taxes because I haven't sold anything. Like, what's the taxable event where I just hold the mutual fund and every year I get a tax bill and the tax bill is not really related to my actual gains in the fund. It's just weird.
- [07:53]
Katie Greifeld
Yeah.
- [07:53]
Matt Levine
And, like, that's how the tax law works for mutual funds. It's not how the tax law works for ETFs. In part because there is this ETF loophole and in part because people have built the industry around exploiting the loophole. But, like, the ETF treatment is just more intuitive than the mutual fund treatment. And, like, a lot of people are genuinely surprised that they get a tax bill for their mutual fund trading activity. And the SEC is like, they should have been surprised. Like, it's not fair. They shouldn't get the tax bill, you know, because that is the tax law. But. But, like, no one. No one finds it intuitive or appealing.
- [08:22]
Katie Greifeld
I mean, so mutual funds, when they're in 401ks, what we're talking about, like, sort of goes away. Like 401ks, you don't have that capital gains thing in this specific instance with these Vanguard target date funds. So it was the investors that held these funds in their taxable accounts that we're talking about.
- [08:41]
Matt Levine
So Vanguard sort of assumed that most of These people were 401k investors, theoretically, and in part because a lot of people hold these funds through Vanguard's own platform, like their website and their brokerage. And so Vanguard could look at those people and say, almost all these are 401k plans, so they won't have to pay the taxes, so it's not a big deal. But also, like, people hold billions of dollars of these funds away, like, in other brokerage accounts, and Vanguard didn't have transparency on them and sort of assumed, yeah, it's all 401k plans, that's fine. But in fact, a lot of retail taxable investors had money in these funds and then got a big tax bill.
- [09:15]
Katie Greifeld
Yeah.
- [09:16]
Matt Levine
Because they were outside of the 401k.
- [09:17]
Katie Greifeld
So we've talked a lot about products and wrappers so far. I want to talk, though, about why this is like the spiritual inverse of the Capital One example, because you had a lot of sympathy for Capital One last week, and if that's the case, you must have a ton of sympathy for Vanguard here kind of trying to do this out of the goodness of their hearts for these investors.
- [09:37]
Matt Levine
I do.
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Katie Greifeld
Yeah. Talk about that.
- [09:39]
Matt Levine
The thing they did here was they wanted to lower Fees.
- [09:42]
Katie Greifeld
Yeah.
- [09:43]
Matt Levine
Vanguard is an interesting company because it's sort of not a company. Right. It's like owned by the funds. So it's a mutual in the sort of classic sense. Like the funds ultimately own Vanguard. So it doesn't like charge as much as it can can to like provide returns to the shareholders. It like has a mandate to kind of keep fees low. And so it offered these funds, it set some expense ratios. And the funds gathered a lot of assets, including from like mid sized 401k plans. And they're like, we're making so much money off these plans that we don't need.
- [10:11]
Katie Greifeld
Yeah.
- [10:12]
Matt Levine
Like, let's give it back. And they thought of different ways to give it back. And the way they came up with was lower the minimums on the institutional fund, which there are a lot of other options. And they chose this one for reasons that are not entirely clear to me. But basically the SEC sort of implies that they didn't fully appreciate the tax problem, in part because they thought everyone was in 401 plans and in part because when they were considering this, it was like March of 2020. And so stocks were all the way down. And so they're like, yeah, nobody has capital gains. It's fine, it's not a big deal. But then by the time they actually did it, people had capital gains.
- [10:46]
Katie Greifeld
Yeah.
- [10:46]
Matt Levine
So I sympathize with all of that. The one thing I'll say, I have a soft spot for Vanguard. A lot of my money is in Vanguard funds. But Vanguard feels like a historic innovator in index funds. That is like a little timey.
- [11:00]
Katie Greifeld
Okay. Old fashioned, like, you know, out in the woods of Pennsylvania.
- [11:05]
Matt Levine
Yeah. And like, you know, they sort of resisted ETF ization a little bit more than the other places.
- [11:10]
Katie Greifeld
Jack Bogle had a lot to say.
- [11:11]
Matt Levine
About ETFs, some of that about. But we'll get to weird product ETFs. But like they just didn't like the ETF structure because it felt trader y and they want like a sort of long term buy and hold investors. And the way they've structured this, you could have done this in a lot of other ways. You could have started from the beginning with we have one fund and we can have two classes of shares of the fund and we can lower the fees on one class without lowering, you know, like the problem here is that they had two separate funds. And so when they lowered the fees on some of the investors, those investors had to sell one fund and buy another one, which is like kind of crazy. It shouldn't work that way. So, like, I have a lot of sympathy here for Vanguard because really all they were trying to do was lower fees out of the goodness of their heart. But I also, like, yeah, this is kind of sloppy, you know.
- [11:58]
Katie Greifeld
Yeah, a couple things. Vanguard turns 50 years old on May 1st. May 1st, 1975 was when Vanguard was born. Vanguard does this all the time in terms of lowering fees. Like you talked about their ownership structure a little bit. Like any time that they have extra cash or assets generated by their products, that is just funneled into lowering fees, which has put a crunch on the entire industry because of the way that they're owned. Other people, like BlackRock doesn't operate like Vanguard does, but BlackRock still has to compete with Vanguard and just lower fees to dirt cheap levels, which is interesting. And in the ETF IQ newsletter, after you've read money stuff, if you read the ETF IQ newsletter, the $106 million, I saw some reaction that was like, oh, that's nothing. For Vanguard, they how many? Like $10 trillion in assets. But because their fees are so low, assuming that they charge an average of 10 basis points, $106 million for Vanguard is like napkin math, 1% of their total revenue. So this is actually pretty painful for Vanguard. Maybe it was sloppy, you know, but it was painful.
- [13:12]
Matt Levine
A thing that I write about a lot. I read about cases where either the SEC or like a shareholder class action sues a company for doing a bad thing and the company agrees to pay a big fine or pay a big recovery to shareholders. And people always ask, like, isn't that circular? Like, where does the money come from? And part of the answer is, like, the money sometimes comes from D and O insurance. But like, sometimes, yeah, like the company writes a check to compensate shareholders who lost money on something. And you're like, well, like, how did that help the shareholders? Like, the lawyers got a fee, but like the shareholders are writing a check to the shareholders. Similarly with Vanguard, it's owned by its funds. Right. So if you find Vanguard $100 million in some sense, are you taking that money from the Vanguard investors who, like, lost money because of this tax problem?
- [13:56]
Katie Greifeld
Wow.
- [13:57]
Matt Levine
They're the shareholders, they're the owners.
- [13:59]
Katie Greifeld
That's true.
- [13:59]
Matt Levine
They're the ones paying the fine.
- [14:01]
Katie Greifeld
Those are good points.
- [14:01]
Matt Levine
And when I say they, I mean me.
- [14:03]
Katie Greifeld
Yeah. So it's technically not a fine. And I learned that the hard way because I had to.
- [14:11]
Matt Levine
Because you said it was a fine.
- [14:12]
Katie Greifeld
I said it was a fine. And I had to correct my newsletter. It's technically not a fine because the $106 million will be distributed to those impacted. Yeah, but you should still subscribe to ETF IQ. 90% of the time is correct.
- [14:30]
Matt Levine
Can't really ask for more than that.
- [14:31]
Katie Greifeld
Oh, come on. I'm doing my best.
- [14:35]
GiveWell
GiveWell, a non profit that researches and recommends giving opportunities, takes the impact of donations seriously. To ensure their recommendations withstand tough scrutiny, GiveWell had their own researchers spend months trying to identify flaws in their past work. They then published their findings, mistakes and all for any donors to use for their giving. It's this kind of rigor that can help your donation make a big impact on the world. GiveWell has now spent over 17 years researching charitable organizations and only directs funding to a few of the highest impact opportunities they've found. Over 125,000 donors have used GiveWell to donate more than $2 billion. Rigorous evidence suggests that these donations will save over 200,000 lives. If you've never used GiveWell to donate, you can have your donations matched up to $100 before the end of or as long as matching funds last. To claim your match, go to givewell.org and pick podcast and specify where you heard this ad. Make sure they know that you heard about GiveWell from this podcast. This show is sponsored by BetterHelp.
- [15:37]
Matt Levine
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- [15:41]
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- [16:01]
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- [17:18]
Katie Greifeld
Let's talk about something that Jack Bogle would absolutely hate. They're called buffered Bitcoin ETFs. Buffered ETFs. They're really popular. They've just ballooned over the past several years.
- [17:29]
Matt Levine
Can you tell me why?
- [17:29]
Katie Greifeld
Oh, I don't know. I actually. So, I mean, it's a great pitch.
- [17:34]
Matt Levine
I've written this like it is so close to my heart because it's like a pitch that I learned as a young derivative structure at an investment. Because you'd be like, there's no downside.
- [17:42]
Katie Greifeld
Exactly.
- [17:43]
Matt Levine
Get all your money back. It's great. What a great pitch.
- [17:45]
Katie Greifeld
Yeah. And it sort of evolved to be no downside at all. Of course, 100% protected downside. Buffered ETFs have launched in the past year or so, but buffered ETFs came into existence. I'm sure they existed in other iterations, but they came into existence in 2020, I believe. I was pretty new to the ETF beat. And in that time they've ballooned to this like $60 billion asset class. And it's because the pitch is really good. We're going to shield you against these losses.
- [18:14]
Matt Levine
Yeah. We're going to give you the upside in something. The S and P, whatever, microstrategy, whatever. And if it goes down, it doesn't go down, you get all your money back. It's amazing. What a great pitch.
- [18:24]
Katie Greifeld
It makes sense in stocks. The 100% downside, to me, I can kind of see it in Bitcoin. I don't super understand it because volatility is the selling point of Bitcoin for a lot of people. People have fun trading extremely volatile cryptocurrencies. If you are buying 100% Bitcoin buffer ETF with like an upside cap of 12% or 11%, what is the GD point? What is the GDP?
- [18:55]
Matt Levine
Are you asking me?
- [18:56]
Katie Greifeld
Yes.
- [18:57]
Matt Levine
Right. So CALOS is launching These buffered Bitcoin ETFs, right? Where like these things are all like defined periods. Right. So you get like a one year, like you buy it at the beginning and at the end you get some amount of the return on Bitcoin, but like floor it at some level. Right. So like they have a 100 by like 1:11, something like that. Not exactly sure on what the cap levels are, but so basically you buy it and if bitcoin goes down, you get your money back in a year. And if bitcoin goes up, you get the return on bitcoin, unless it goes up by more than 11%, in which case you only get 11%. Right? So if you're sure that bitcoin will go up, this is like a way to get an 11% return on your money. But if you're sure that bitcoin will go up, you just buy Bitcoin and it'll go up like, you know, a thousand percent. So why would you buy that? I continue to ask you, why do people buy buffered ETFs, right? I mean, like, it's such a good pitch. When I was doing this, they didn't exist in ETF form. They existed in structured notes at banks, right? And like, this is a, this is like a classic structured note product, right? This is like your wealth manager goes to a rich conservative person who's like, oh, I like this stock. And you're like, well, I can give you that stock, but no downside, right? To be clear, like, you're always trading up upside, right? Like the trade is that the advisor goes and buys Treasuries for 96% of the investment, and that provides the downside protection because a $96 treasury bill matures at 100 in a year and then he takes the other $4 and buys a call spread that gives you some of the upside on the asset. Right? So this is a medium to high interest rates product because if interest rates are really low, you have to spend $99 on the treasuries to mature at 100. And so you have only a dollar to spend on a call spread. But if interest rates are really high, you can spend $10 on a call sp and then you're in business.
- [20:39]
Katie Greifeld
Yeah. So a story I actually started reporting like in autumn of last year, right before the Fed started cutting rates, was what happens to these 100% downside ETFs once rates start going lower and it.
- [20:51]
Matt Levine
Seems like have lower caps.
- [20:53]
Katie Greifeld
Yeah, well, that's the thing. Well, no, some issuers, there's a choice you have to make. Yeah. Do you keep the 100% downside protection or do you lower the cap? And some issuers were thinking about, you know, maybe it's not 100% protection, it's 85%. So there's a choice that has to be made. But then interest rates went up like 100 basis points. So it's less relevant right now, but it will become relevant at some point.
- [21:16]
Matt Levine
My crude assumption is that you can get a buffer ETF that has a hundred floor, so you always get your money back. And it has a cap of like crudely twice the treasury bill rate. Right. Because, like, you know, like, your option is like, put $100 in today and get back the treasury rate, or put $100 in today and get back with equal probability between 0 and twice the treasury rate. So it's like that's sort of like the right expected value. It's not exactly right, but it's kind of close. And so you see caps that are around to 110 with a forward and change treasury bill rate. The other thing I'll say is The Bitcoin Buffer ETF that we're talking about from Calamos, they actually have three options. One is like 100 by 111 or whatever, and then the others are like a 90 by 130 and a 80 by 150.
- [22:03]
Katie Greifeld
So, like, those haven't launched yet though, right?
- [22:05]
Matt Levine
Yeah, but they're like, they're talking about them, like by 80 by 150. I mean, like, if Bitcoin goes down by more than 20%, you only go down by 20%. Right. So, like, if Bitcoin loses half its value, you only lose 20% of your investment. But then if Bitcoin goes up, you get up to 50% returns on your investment. So it's like a much wider collar, which is maybe more appealing still. It's like a weird trade. I don't know.
- [22:29]
Katie Greifeld
It is. Before we talk about Trump Coin, which is coming, one more point that I just remembered on Buffer ETFs, broadly, I remember talking to Allianz about this and basically asking the same question that we are, who and why would you buy this? And the point that they made, which I found somewhat compelling, was this is a better version of bonds. If you're putting together a portfolio, don't take from your equity bucket to put into these buffered products. Take from your fixed income allocation. This is a better version of bonds because bonds have been an unreliable hedge since the pandemic. Anyway, this makes more sense as a fixed income alternative. That was their pitch, which, you know, if you're getting 100% downside protection, but, you know, twice what treasury builds are yielding, that makes a little bit more sense.
- [23:20]
Matt Levine
Yeah. And just in general, you have some exciting sounding thing stamped on some bond, like, product. Right. Like you have like, ooh, it's bitcoin, but in bond form. Right. It's appealing.
- [23:29]
Katie Greifeld
Right.
- [23:30]
Matt Levine
I've written a lot about microstrategies, convertibles. Right. Which are bitcoin in bond form. Right. And the appeal of that is a lot of that is to convertible arbitrageurs, but a lot of it is actually to just boring, fundamental institutional investors who are like, I'll take some bitcoin upside and some 100% downside protection.
- [23:48]
Katie Greifeld
Yeah. I feel like there's still work to be done, though, when it comes to the pitch for a buffered Trump Coin etf.
- [23:55]
Matt Levine
Yeah. God, that's going to happen, isn't it?
- [23:58]
Katie Greifeld
Yeah.
- [23:59]
Matt Levine
Someone announced the filing for a Trump Coin etf, not a buffered one. Just like, put your Trump Coin in a stock wrapper.
- [24:06]
Katie Greifeld
Yeah.
- [24:06]
Matt Levine
Because. Yeah. No, it's interesting because you think about what's the Trump Coin audience. Right. A lot of it is like, Trump has a huge crypto native following who are, like, going on Solana and buying Trump Coin, but he also has, like a, you know, less tech native following who would love to buy Trump Coin, but aren't going to, like, mess around with the blockchain. And so selling them Trump Coin in ETF form is like, you know, has an obvious appeal.
- [24:28]
Katie Greifeld
We had Cathie Wood of Ark Investment on ETF iq, the television show this week, and of course, we asked her about Trump Coin, and she stays away from meme coins. She likes the big three, as she called it. And she said something to the effect of, I'm not sure what the utility of Trump Coin, what it is. And it seems like the utility is just funneling money to the Trump family, hopefully.
- [24:52]
Matt Levine
Long aside on utility. I don't know if this is relevant.
- [24:55]
Katie Greifeld
But let's find out.
- [24:57]
Matt Levine
So this gets back to the SEC five years ago. If you talk to crypto people, there's a lot of talk about, like, we're building the future of the Internet. We're building, like, these useful tools that will affect people's lives. We're building new ways of gaming and new ways to store files and decentralize everything. Right. And you don't hear that anymore. And now you hear Fart Coin and Dogecoin and Trump Coin. Right. Why? Well, one very obvious possibility is that all of those promises of utility, many of them were kind of vaporware and they didn't work out. And people are like, yeah, it's fun gambling. Right. Another possibility is that the people who were either building or hyping new technologies in crypto saw a new shiny object in AI. And now we're all building and hyping large language models. But I think a really important explanation for all of this is that the SEC had a huge crackdown on crypto, and it was specifically addressed to, like, people who were building stuff. If you were offering an investment in some project that you thought would, like, build utility for the world, the SEC said, well, that was a securities offering, and you couldn't do it. And if you got it listed on an exchange, the exchange would get in trouble, the crypto exchange would get in trouble. And so there was a SEC crackdown on crypto generally, but specifically on, like, useful crypto. Whereas meme coins, everyone agrees, basically, are not securities because they don't promise anything. They're just like, yeah, it's a meme. It has no utility. As long as you don't have utility, you can sell it to your heart's content. It's like a collectible. It's not an investment. And so the SEC can't regulate it. I feel like if the SEC went back, it would find that to be, like, a bad strategic decision because it didn't stop crypto. It just made crypto more useless. And so one question is, with a much more accommodating sec, will crypto become more useful, or is the meme coin gambling stuff too good? And that's all anyone wants anymore, and it'll just be a lot of no utility meme coins. Yeah, and we'll find out what we want.
- [27:02]
GiveWell
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- [30:11]
Katie Greifeld
2Sigma this was also, you know, in the rush to the finish for the SEC under the Biden administration.
- [30:19]
Matt Levine
Yes, they brought a case against Two Sigma.
- [30:23]
Katie Greifeld
Tell me about it.
- [30:23]
Matt Levine
So Two Sigma announced in like 2023 that it had found someone messing with its models. One of its employees was messing with its models in a way that caused some funds to make an extra $450 million and other funds to lose $170 million. And when the stories came out, it was like he was messing with the models to try to improve his bonus, which is the only reason anyone does anything right. And it's a little bit of a funny story because he succeeded in the aggregate in improving the performance of two Sigma's funds. He made more money on the good funds than he lost on the bad funds. And you could imagine ex ante if you knew that was going to happen, you'd be like, okay, we'll just take $170 million from the funds that win, give it to the funds that lose, then they haven't lost, they're fine. And the funds that win have an extra like, you know, $280 million. Like great work. Here's your big bonus.
- [31:17]
Katie Greifeld
This seems like a happy story, right?
- [31:19]
Matt Levine
But neither Two Sigma nor the SEC saw it that way. The guy was fired and Two Sigma ended up paying like $90 million in penalties to the SEC. And so like, yeah, so he improved the overall performance of the funds and instead of a round of applause, he got fired and Tsigma got fined. And it's a little unclear why. Yeah, I mean part of it is he did it without authorization. Right. And you're supposed to run your hedge fund in a properly supervised way. So one reason they got in trouble was for like failure to supervise because basically there is a long list of parameters that you're not supposed to change without running it through a review process. And he would just change them without running it through that process. Like he just went into the computer and changed the parameters. He was not supposed to do that, but he did it anyway. And so that's like a failure to supervise thing. But the other thing that probably happened is that probably like, you know, a quantitative hedge fund is basically aiming for high risk adjusted returns. It's aiming for some level of risk and the highest possible returns within that level of risk. And it seems like what happened is that he changed these parameters to dial up the risk that the fund was taking on his strategies. Like he built a bunch of strategies for the fundamentals for the funds for two Sigma. And two Sigma's overall model was like, we're going to put this much risk into these strategies in order to achieve good risk adjusted returns. And he kind of turned the dial to put more risk into those strategies which did in fact over the time period mostly lead to higher returns, which was good for his bonus, but which was not what Two Sigma was looking for. And if you ran the simulation 100 times, it might not have made as much money. And they're, they're aiming for sort of long term risk management framework, but like it happened to make more money in the time than he did.
- [33:03]
Katie Greifeld
Yeah. So that one fund overperformed, but one of the funds underperformed. Correct. So investors did lose Money. Some investors.
- [33:12]
Matt Levine
Right. But like, again, like, the overperforming fund overperformed by more than the underperforming fund underperformed. So, like, you know, you could. You could reallocate that to make everyone happy. In theory. You can't really, because, like, there's. They have specific mandates. Right. And if they're not following their mandates, then that's bad.
- [33:28]
Katie Greifeld
Does the fact that one fund overperformed lessen the blow to two sigma at all? Like, this $90 million penalty, would it have been $180 if everyone lost money?
- [33:39]
Matt Levine
I think. I mean, who knows? But I think that there's always a range of rogue trader behavior. Right. Like, this guy's not quite a rogue trader.
- [33:48]
Katie Greifeld
Aren't you supposed to ask for forgiveness later?
- [33:51]
Matt Levine
Right. Like, you know, it's an interesting question of, like, what would happen if he had just made money? Yeah, everything had gone better. I think that a lot of these Kwan funds are, like, really quite rigorous about risk management. And, like, if they caught him just making $900 million for clients, they might have fired him. They might have been like, nope, you messed with our risk management. Like, that is really important and you're fired. Even though you only made $900 million for clients they might not have. I don't know. And like, I think, like, Two Sigma is interesting because it's truly a quant fund. I think a lot of less rigorous banks kind of famously don't fire rogue traders who make money. This is changing a little bit, but that's the stereotype. But, yeah, I think if he had only lost money, then it looks like malice or incompetence or just like, it looks really bad. If he makes money, then it's like he was genuinely trying to make money for the firm and thus for his bonus. That's a little bit less. A little bit less bad conduct.
- [34:47]
Katie Greifeld
Well, maybe he got hired by a bank. You know, maybe he has an illustrious new chapter.
- [34:53]
Matt Levine
Yeah, I mean, like, you know, like, he could start his own fund. Being like, we're like Two Sigma, we take more risk.
- [35:01]
Katie Greifeld
Yeah. Two Sigma, full octane. We do have a listener question on this.
- [35:07]
Matt Levine
Oh, yeah, Listener asked, like, why is this an SEC case? Yeah, you know, it's a good question. Like, the answer is, like, if you read it, it's like they violated anti fraud provisions of the Investment Advisors Act. I didn't say why. It's not like Two Sigma was doing a fraud on its investors in any obvious way. Right. They weren't lying to them. But I don't actually know what their market material said, but they probably didn't describe in detail the information security around the parameters for the. They probably didn't lie to investors at all. But the SEC is like, ah, you did this thing that just seems kind of bad. And so it's probably operated as a fraud on your investors. And in this environment, you settle that case. Is that a case that the next SEC brings? I don't know. I will say there is one other reason that the two sigma got in trouble with the SEC, which is that they have NDAs. And I've written this. It is sort of illegal for financial firms to have NDAs. If you have an NDA that says you won't tell anyone about the secret stuff you learned at this firm, the SEC says, well, but what about whistleblowers? What if a whistleblower wanted to come to the SEC and tell us that you were doing securities law violations?
- [36:17]
Katie Greifeld
Fair question.
- [36:18]
Matt Levine
The NDA would prevent them from doing that. That's a violation of our whistleblower protection rule. And so the SEC goes after all these firms for having NDAs that don't specifically say, but you can tell the SEC. And in fact, Two Sigma had NDAs that did say, you can go tell the SEC. But the SEC said, well, but they didn't say that you were. They said, you know, you had to represent that you hadn't already disclosed any confidential information. And that part didn't say, you can have already told the sec. And so the SEC fined Two Sigma for having this NDA that it sort of said you could tell the SEC but didn't say it in the right way. That was the last one. Never see that case again.
- [36:52]
Katie Greifeld
That's it. Enjoy it.
- [36:53]
Matt Levine
That's not legal advice, but you'll never see that one again, man.
- [36:56]
Katie Greifeld
Paul Atkins over to you. Is he confirmed yet?
- [37:00]
Matt Levine
No, no.
- [37:01]
Katie Greifeld
Paul Atkins potentially over to you soon.
- [37:07]
Matt Levine
And that was the Money Stuff podcast. I'm Matt Levine.
- [37:10]
Katie Greifeld
And I'm Katie Greifeld.
- [37:11]
Matt Levine
You can find my work by subscribing to the Money stuff newsletter on Bloomberg.com.
- [37:15]
Katie Greifeld
And you can find me on Bloomberg TV every day on Open Interest between 9 to 11am Eastern.
- [37:21]
Matt Levine
We'd love to hear from you. You can send an email to moneypodlumberg.net Ask us a question and we might answer it on air.
- [37:28]
Katie Greifeld
You can also subscribe to our show wherever you're listening right now and leave us a review. It helps more people find the show.
- [37:33]
Matt Levine
The Money Stuff podcast is produced by Anna Mazarakis and Moses Andam.
- [37:37]
Katie Greifeld
Our theme music was composed by Blake.
- [37:39]
Matt Levine
Maples, Brendan Francis Newnham is our executive.
- [37:42]
Katie Greifeld
Producer and Sage Bauman is Bloomberg's head of podcasts.
- [37:45]
Matt Levine
Thanks for listening to the Money Stuff podcast. We'll be back next week with more stuff.