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Utopia Talk / Politics / Why capitalism rulz the world: Hertz
Sat Jun 27 01:13:54



On May 22, Hertz Global Holdings Inc. filed for bankruptcy. Then its stock started to go up. At its post-filing peak, it closed at $5.53 per share on June 8, for a market capitalization of almost $800 million. About 533 million shares—worth almost $3 billion—traded that day. That’s weird. Usually the effect of bankruptcy is to wipe out all the shareholders. Hertz’s senior unsecured bonds were trading at about 40 cents on the dollar at the time, suggesting that its creditors were not expecting to be repaid in full, which they’d need to be if the stock was going to be worth anything at the end of bankruptcy. So the stock rally did not make a whole lot of sense.[1]

As Hertz and its advisers watched the stock trading, they thought: Wait, we should get in on that. The thing about all those people inexplicably buying Hertz stock is, they were not buying the stock from Hertz. They were buying it from each other, on the stock exchange. Hertz really needs money, though. It figured, if people want to buy billions of dollars’ of Hertz stock, they should buy that stock from Hertz, and then Hertz would use the money to be less bankrupt.

So Hertz went to the bankruptcy judge to ask for permission to sell stock.[2] The bankruptcy judge, whose basic job is to maximize the value of Hertz for its creditors, said, well, look, if people want to give you money for nothing, that is good for the creditors, so who am I to object. So she approved. Hertz’s lawyer memorably told her:

“New platforms for day traders may be facilitating this,” Mr Lauria said, referring to Robinhood, the stock trading app popular with young retail investors. “There are forces at work that us non-financial people, that we can only observe.”

So off Hertz went to sell stock. Last Monday, it filed a prospectus for its at-the-market offering of up to $500 million of stock. It is a magnificent document. Like other big mature public companies, Hertz can sell stock using a minimal “shelf” registration statement. The prospectus says almost nothing; the conceit, with big normal public companies, is that everything you need to know about them is already in their other SEC filings, so they don’t need to say much in the prospectus beyond “hey we’re selling stock and here’s why.” If there’s any news since the last quarterly filing, it goes in a brief “Recent Developments” section.

Hertz’s “Recent Developments” is brief, as is customary. It is four paragraphs that say, basically, “lol we’re bankrupt.” That’s a recent development! Hertz’s most recent financial statements are as of March 31, from a Form 10-Q filed on May 11. If you just look at the March balance sheet, you will see book equity of almost $1.5 billion. If Hertz sold its assets and paid off its liabilities, there’d be $1.5 billion left over for shareholders, those financial statements say, as of March 31. Now … well, there’s no updated balance sheet, but here’s what the prospectus says about what’s left over for shareholders:

As previously disclosed, on May 22, 2020, we filed voluntary petitions under Chapter 11 of the Bankruptcy Code in the Bankruptcy Court, thereby commencing the Chapter 11 Cases for certain debtors, including Hertz Global Holdings, Inc. The price of our common stock has been volatile following the commencement of the Chapter 11 Cases and may decrease in value or become worthless. Accordingly, any trading in our common stock during the pendency of our Chapter 11 Cases is highly speculative and poses substantial risks to purchasers of our common stock. As discussed below, recoveries in the Chapter 11 Cases for holders of common stock, if any, will depend upon our ability to negotiate and confirm a plan, the terms of such plan, the recovery of our business from the COVID-19 pandemic, if any, and the value of our assets. Although we cannot predict how our common stock will be treated under a plan, we expect that common stock holders would not receive a recovery through any plan unless the holders of more senior claims and interests, such as secured and unsecured indebtedness (which is currently trading at a significant discount), are paid in full, which would require a significant and rapid and currently unanticipated improvement in business conditions to pre-COVID-19 or close to pre-COVID-19 levels. We also expect our stockholders’ equity to decrease as we use cash on hand to support our operations in bankruptcy. Consequently, there is a significant risk that the holders of our common stock, including purchasers in this offering, will receive no recovery under the Chapter 11 Cases and that our common stock will be worthless.

I have bolded the important bits there, which are that the people who buy stock in the offering will get nothing unless there is “a significant and rapid and currently unanticipated” improvement in the business. “Unanticipated” by whom, you might ask. Certainly by Hertz’s creditors. Presumably also by the bankers and lawyers who wrote that amazing paragraph, and by the bankruptcy judge who gave Hertz permission to go ahead and do this nutty thing. But not by the people buying the stock! You don’t buy stock if you do not anticipate it being worth anything. I think? We are not in normal territory here.

When we last talked about Hertz, before the prospectus came out, I explained the position of the bankers and lawyers writing it. “You don’t have to give investors lavish scary warnings that Hertz might go bankrupt,” I wrote, “because Hertz is bankrupt. ‘We’re in bankruptcy, you dopes, and your stock will probably be worthless’; what more is there to say?” The block quote above is that, in legalese. Hertz went out to investors saying “hey our stock is probably worthless, do you want some,” hoping that the investors would say “no no no you are being too hard on yourself, your stock is great, we will take some.”

In the event, the U.S. Securities and Exchange Commission told them to knock it off. On Monday afternoon, hours after filing the prospectus, Hertz got a call from the SEC staff, who said that they “intended to review the Prospectus Supplement.” By Thursday, “the Finance Committee of the Board of Directors determined that it was in the best interests of the Company to terminate the ATM Program and directed that the ATM Program be terminated,” and this wild experiment was over.[3]

What did the SEC say, I wonder? Here’s Jay Clayton:

“We have let the company know that we have comments on their disclosure,” SEC Chairman Jay Clayton said in a CNBC interview Wednesday. “In most cases when you let a company know that the SEC has comments on their disclosure, they do not go forward until those comments are resolved.”

Now, Hertz’s disclosure was obviously terrible. Imagine how you would actually try to pitch an intelligent investor on the idea of buying Hertz stock now. You’d probably include some up-to-date financial data, like, “here’s how bad April was and here’s the improvement we’re seeing in June.” You might want to extend that into projections of what the next few quarters might look like. Hertz’s fleet of cars, which is the collateral that underpins its asset-backed debt, has a volatile and somewhat knowable value; you might want to include some appraisal data or comparable transactions or something to make the case that the fleet is worth more than the debt. And of course you’d have to check all of this off against the debt; you’d need a sources-and-uses table saying “here’s how much money we have, here’s how much we have to pay to our creditors and our bankruptcy advisers, and here’s how much will be left over for shareholders.” If you did all that and got a positive number, it would just be a guess, an estimate, subject to lots of risks. But you’d have a positive number. That’s something.

Hertz, of course, did none of that. The prospectus doesn’t lay out any proposed plan to pay off the creditors and exit bankruptcy with the stock intact; instead, it says that that probably won’t happen. The last public financial statements, the ones incorporated into the prospectus, are from March, when Hertz wasn’t bankrupt, and they’re wildly misleading now. The “Use of Proceeds” section in the prospectus says: “We intend to use the net proceeds from this offering payable to us for general corporate purposes. We do not currently have specific plans or commitments with respect to the net proceeds from this offering.” Companies say that all the time—that’s what you say, generically, when you’re raising money that you have no immediate use for—but usually they are not bankrupt. If you are currently in bankruptcy, and you go out to investors asking them for money to get out of bankruptcy, it is really only polite to explain to them how their money might achieve that purpose. “If you give us $500 million, here’s how we’ll pay off our debts and right the ship,” that sort of thing. There’s none of that here, the opposite of that really. “If you give us $500 million, that’s your problem,” is the message here.

Part of the reason for that is just timing: Hertz didn’t have a plan to exit bankruptcy yet; it didn’t know if raising $500 million from shareholders would actually help. It just figured it couldn’t hurt, and people were clamoring to buy Hertz stock so there was some urgency. Another part of the reason is just pure cynicism; Hertz didn’t expect the money to be enough, but figured if people wanted to buy it might as well sell.

But another reason is that is just not how prospectuses work: You don’t put estimates of the current quarter, or projections for the next quarter, in a prospectus, because a prospectus is not really a marketing document; it’s not really about making the (uncertain, risky, future-oriented) case for the stock. The prospectus is really a warning document; it’s about making sure you’ve disclosed all the bad things about the stock, so you don’t get in trouble later.[4] If Hertz had actually laid out the best case for its stock in the prospectus, it would have been unusual, and I suspect the SEC would have objected.

Meanwhile Hertz’s actual prospectus seems just fine as a warning document. It seems fine in this specific way: No one who read this prospectus would buy the stock. It makes no case that the stock will have value, and instead explicitly says it will be worthless! But that’s okay, because Hertz was not trying to sell the stock to people who read the prospectus. This was not a normal marketed equity offering in which Hertz’s bankers send out a prospectus to big fund managers and then meet with them to answer questions. This was an “at-the-market offering,” in which Jefferies, Hertz’s broker, was going to go out and sell stock on the stock exchange. People on the stock exchange were already buying Hertz stock, pretty clearly without reading anything or thinking too hard about it, so Jefferies was going to sell stock to them. As a formality, there was a prospectus on the SEC website saying “haha you fools do not buy this,” but that had nothing really to do with the stock sale.[5]

Except that it gave the SEC an excuse to shut down the sale: The SEC found some unspecified problems with the prospectus, so it held up the stock sale until those were fixed. The way to think about this is not that the SEC said “please provide your current financial position and explain how this money will get you out of bankruptcy,” because that is not how prospectuses work or even what the SEC wants, and it's not that the SEC said “please put more warnings in bigger fonts,” because the warnings are adequate and no one will read them anyway. The way to think about it is that the SEC said “please answer these riddles,” and when Hertz answered the riddles the SEC would say “you missed a comma in the fifth riddle, please answer these new riddles,” and it would keep going on like that until the bankruptcy court confirmed a plan that did not involve incinerating $500 million from retail investors. The SEC has a certain amount of discretion to delay stock offerings, is the basic legal-realist point here, and they decided to use that discretion to stop an obviously terrible offering. Hertz saw where this was heading and gave up.

So everything kind of worked out,[6] but in an unsatisfying way. The SEC disclosure regime is so focused on warnings that it just did not occur to Hertz to use its prospectus to actually make the case that its stock is a good investment, and if it had tried the SEC probably would have stopped it. But also, the SEC disclosure regime is entirely focused on warnings even if no one will read them: The warnings in Hertz’s prospectus clearly conveyed the basic message of “this stock is worthless, good luck,” but the SEC quite reasonably decided that those warnings would not be enough to scare off retail investors because they just wouldn’t read them.

Here’s a lawyer:

“There is a reason this hasn’t been done before,” said attorney Thomas J. Salerno, who represented owners of the Phoenix Coyotes hockey team when the NHL property was sold in bankruptcy. “How can you sell stock and then take the position later that you can’t pay all your creditors? It’s either fraud in plain sight, or an admission that the company isn’t really insolvent.”

I love “fraud in plain sight.” The SEC is essentially a disclosure regulator; its job is to make sure that companies offering stock fully disclose the risks of that stock. Here the risk is “the stock is already worthless, don’t buy it,” and Hertz quite candidly said that every chance it got. You can quibble with the details of that disclosure, and the SEC did, but in spirit it was basically fine.

It’s just that disclosure is not actually enough. Saying that a stock is worthless will not prevent people from buying it, if they don’t read the disclosure, or if they assume that you wouldn’t be allowed to offer stock if it was actually worthless, or if they just figure they’ll find a greater fool to dump it on. A popular application of Ethereum, for a long while, was building pyramid schemes with names like “Ethereum Pyramid Scheme.” Is it a fraud, if you tell everyone up front that it’s a fraud?

Similarly, here, Hertz was trying to trick retail shareholders into buying worthless stock by the simple expedient of offering the stock and saying, loudly and publicly and in official SEC disclosure documents, that it was worthless and no one should buy it. It’s a weird strategy! It almost worked.
Everything is securities fraud

One long-running thesis of this column is that everything bad that a public company does, and everything bad that happens to a public company, can be securities fraud: The company did not appropriately warn investors about the bad thing, when the bad thing became public the stock dropped, the investors are aggrieved, etc. “Securities fraud" is not just cooking the books to sell more stock; pollution and sexual harassment and lax cybersecurity and a pandemic are all also securities fraud.

I mostly write about this as a sort of oddity of American legal culture—securities law works, so it’s used to punish all sorts of unrelated bad things—but it is worth also considering it as an economic matter. On a first approximation, securities lawsuits are all very weird because the basic situation is:

The stock goes down.
Shareholders sue.
The company gives them money.

The money that the company gives to the shareholders is, in a sense, the shareholders’ money, since they own the company. After the lawsuit, they have more money (because the company gave them money), but their shares are also less valuable (because the company has less money), so it’s really a wash. A shareholder lawsuit is just a complicated form of dividend, and dividends should not make shareholders richer.

But that is only approximately true. For one thing, shareholders buy and sell shares, so the shareholders who get paid may not be quite the same as the ones who pay. Also, though, the company doesn't always come up with the money. Often its directors-and-officers insurer does: The shareholders sue the company and its directors, and the D&O insurer defends the case and pays the settlement. The lawsuit is not a transfer from shareholders to shareholders, with plaintiffs’ lawyers taking a cut; it's a transfer from D&O insurers to shareholders (with the lawyers taking a cut).

If you imagine that securities lawsuits are mostly about book-cooking and underpriced mergers, then you will think that D&O insurance is a specialized niche product insuring against fairly rare risks. If you imagine that securities lawsuits are a general-purpose way to enforce all laws and norms, then you will think that D&O insurance is a general-purpose product insuring against anything that can go wrong at a public company.

The latter should cost more:

In the U.S., premium rates for directors-and-officers insurance jumped 44% to 104% in the first quarter compared with the year-earlier period, based on different indexes of corporations that are published by brokerage firms at AON PLC and Marsh & McLennan Cos. ...

To hold down the rising costs, some companies are raising their deductibles—the portion they pay before insurance kicks in—while others are reducing maximum payout amounts and setting up self-insurance arrangements.

The decision puts them on the hook for more of the expense of fighting lawsuits. It is an especially difficult decision as many lawyers are anticipating a wave of shareholder litigation tied to alleged shortcomings by managers and boards in regards to their handling of Covid-19 matters.

See? Securities litigation costs are going to go up because of a pandemic. D&O insurers are general-purpose insurers; they insure against pandemics. So premiums go up when there’s a pandemic. But also, D&O insurers are in the process of becoming general-purpose insurers; once they insured companies against the risk of securities fraud, but now they increasingly insure companies against the risk of sexual harassment and pollution and pandemics and any other bad thing. Premiums are going up not only because there are more risks in the world, but because securities-fraud insurance now covers more of those risks.

Meanwhile it is a good time to be on the other side of all the lawsuits:

Meet litigation finance, an esoteric, high-risk investment strategy that lures with the siren song of double-digit returns. It’s an industry with a few publicly traded behemoths, but it remains the preserve of private-equity-style funds that invest in cases, back law firms and act as financial intermediaries when settlements have been reached.

And the pandemic could be its time to emerge from its little-known niche. Some of this will come from coronavirus-related suits, like business interruption claims and lawsuits against landlords who do not fulfill their obligations to safeguard their buildings.
Sat Jun 27 02:00:36
So I read maybe the first half of that post.

Buying stock is alot like voting.once everyone starts doing it you understand why it was once much more limited.
The Children
Sat Jun 27 02:08:01
wall o fuckin text!

give it 2 us in 3 lines, u dumb bitch. aint nobody readin that shit.

so whats the guess. we shuld buy it or what.

i got 2 grand 2 play with and i wanna rich motherfuckers. this isnt my life, this cant be all theres 2 life. fuck this shit.

show me the money.
Sat Jun 27 02:26:11
Tc, Who cares, you can't afford to feed yourself let alone consider purchasing stocks.
Sat Jun 27 02:27:10
Id you really have 2k, move to China.
The Children
Sat Jun 27 03:12:50

i dunt need 2 explain anythin 2 u.

its almost hilarious. u callin me poor? ur playin shitty snes emus on ur crappy pc. thats what u call gamin.

a shitty 25 year old 16 bit games.

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