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New York Times columnist Paul Krugman wrote about crypto currency markets and investing in his column, How Crypto Became the New Subprime. Whether you are a crypto skeptic or advocate, the column draws an interesting comparison between the crypto craze today and the subprime mortgage crisis from a few years ago. Mr. Krugman points out, as data on Tradingview.com (Crypto Market Cap and DeFi Market Cap Charts — TradingView) shows, the market cap of cryptocurrencies reached $3 trillion in November 2021. He cites a survey that 55% of crypto investors do not have a college degree. This data point alone does not mean that the majority of crypto investors are unsophisticated, but an investor’s background can be an important factor when evaluating suitability. 

According to Mr. Krugman, the promotion of crypto today looks at least somewhat like subprime lending a few years ago. Much like crypto is marketed as a way to expand the pool of people who invest, subprime lending was promoted as expanding the pool of potential homebuyers. The subprime mortgage bubble burst, leading to foreclosures, credit problems, and worse. In the bubble’s aftermath, it was clear that predatory lending was behind some of the subprime loans. Similarly, Mr. Krugman is skeptical that most crypto investors understand what they are buying and have the means to suffer losses.

Crypto markets are lightly regulated, if at all. And investors can be defrauded or taken advantage of in even regulated markets. We have seen investors, both large and small, who have suffered material losses after they were convinced to buy cryptocurrencies or trade even more complex financial products that relate to cryptocurrencies. Whether you agree with Mr. Krugman or not, his point that investors should understand what they are investing in is an important one.  

A recent Wall Street Journal article, A Couple Stored IRA Gold at Home.  They Owe the IRS More than $300,000, is a reminder about what can be complex rules for using an IRA to invest in esoteric assets, such as gold, silver, platinum, and other precious metals. Precious metals tax avoidance strategies and investment scams proliferate on the internet and social media. These scams are so common that the Commodity Future Trading Commission published a fraud advisory. According to the California Department of Financial Protection & Innovation, Department of Business Oversight Sues to Stop $185 Million Coins Scam that Targeted Senior Citizens | The Department of Financial Protection and Innovation, for example, the business behind metals.com targeted senior citizens through advertisements on conservative media and websites. Metals.com, according to the state, used fear tactics to pressure seniors to purchase overpriced coins through self-directed IRAs. The promotion of self-directed IRAs to hold esoteric or alternative investments is common in precious metals investing scams. These scams often combine bad tax advice with bad investment advice. They also often charge high fees, which in some cases are not disclosed. In some instances, the people and entities behind the investments are unlicensed. The Wall Street Journal article makes it clear that an investor considering using an IRA to invest in precious metals would be wise to obtain professional advice.

graphic cartoon of a blank contractThe United States House Financial Services Committee recently passed the Investor Choice Act, H.R. 2620. The Investor Choice Act, introduced by Representative Bill Foster, would prohibit broker-dealers, investment advisers, and others from including mandatory arbitration clauses in their customer agreements. H.R. 2620 would also prohibit bans on class action suits in these customer agreements. The bill includes language making it retroactive, meaning if the bill becomes law, any customer agreement in effect before then that violates these prohibitions would be void. The full text of the bill is available here:  Text – H.R.2620 – 117th Congress (2021-2022): Investor Choice Act of 2021 | Congress.gov | Library of Congress. 

Findings in Section 2 of H.R. 2620 include, “Issuers, brokers, dealers, and investment advisers hold powerful advantages over investors, and mandatory arbitration clauses, including contracts that force investors to submit claims to arbitration or to waive the right of investors to participate in a class action lawsuit, leverage those advantages to severely restrict the ability of defrauded investors to seek redress,” and “Investors should be free too—(A) choose arbitration to resolve disputes if they judge that arbitration truly offers them the best opportunity to efficiently and fairly settle disputes; and (B) pursue remedies in court should they view that option as superior to arbitration.”  No Republicans joined the seven Democrats who cosponsored the bill. 

In an article about insider stock sales at publicly traded companies, the Wall Street Journal reported that the father of the CEO of Carvana, an online car dealer, sold $3.6 billion in company stock since October. Much of the sales took place while Carvana was losing money. The WSJ reported that Carvana had net losses of around half a billion dollars over the past six quarters and only reported its first quarterly profit in spring 2021. The WSJ’s article is available here. 

According to the WSJ, Carvana’s ownership structure allows the family that founded the company to sell billions of dollar worth of stock but at the same time keep control. Like many other publicly traded companies, Carvana has different share classes—one available to certain insiders and another available to the public. The WSJ explained that each share held by Carvana’s CEO’s family counts for 10 votes, while each share held by members of the public is worth only one vote. Even after $3.6 billion in sales, the WSJ explained, Carvana’s CEO and his father still control more than 85% of all the voting shares.    

The WSJ also reported that the CEO’s father sold the shares under what is known as a 10b5-1 plan. Often used by insiders, these plans are designed to purportedly prevent insiders from making trading decisions based on nonpublic information by automating the insider’s sale of company stock. Rule 10b5-1 creates an affirmative defense to insider trading, so long as the automated trading plan is adopted in good faith and at a time the insider does not possess material nonpublic information. Perhaps contrary to the intent of these plans, the WSJ reported that Carvana’s CEO’s father modified the plan twice over six months, while selling hundreds of millions of dollars worth of stock.

In a June 7, 2021 speech, SEC Chair Gary Gensler expressed concern about potential abuses of 10b5-1 plans.  The speech can be found here. Chair Gensler said he asked SEC staff to consider “how we might freshen up Rule 10b5-1.” He raised the issue again on September 14, 2021, in testimony before the United States Senate Committee on Banking, Housing, and Urban Affairs. Chair Gensler told the committee that he asked SEC staff to recommend ways to tighten and modernize the rule “and fill perceived gaps in our insider trading regime.”