The Boston Fed Discusses the Economy

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Susan Collins, CEO of the Boston Federal Reserve Bank, spoke yesterday about the prospects for the US economy, at a program sponsored by National Association of Corporate Directors – New England.  After an erudite and informative presentation, the audience learned much about how the Fed operates, and little new about where the economy was going nor how fast it was going there.

I hasten to add that this is no criticism; the Fed’s public announcements are pretty specific about what their public stance will  be, and it is foolish to expect the head of one of the constituent Fed banks to say, in effect, “well, no, let me give you the real scoop.”  Below for the record, is an anecdotal summary of certain of her remarks:

The Fed’s mandate here is to achieve price stability and robust employment.  Recent inflation was very rapid, unusually so.  It is unclear when it will show sufficient drop to trigger the anticipated but now seemingly delayed decline in interest rates.

The US economy was remarkably strong during the rate hikes.  The reasons were: supply chain was fixed; employment surged, in part due to immigration; employee productivity surged; consumers had a nest-egg from the pandemic to fund domestic spending, which is two-thirds of GDP; salary increases were just catch-up to prices and were confined mostly to lower wage-earners,.

Are we assured of a so-called “soft landing”?  Unclear.  Just now, core inflation ticked up slightly.  “There is so much we don’t know.”  (If the Fed doesn’t know, what are we to conclude?)  The economy will slow down–unclear what that means in detail. “We have been surprised so often.”

As to their mission to support labor: problems abound in affordable housing, child care costs, transportation.  Not a surprise that these issues are significant in New England.  Nationally, housing costs actually declined in 2023, but not the future near-term trend and was not even true in New England.  Low mortgage rates now in effect, vs high rates now offered, means that owners do not move or downsize (they are in “houselock”) and this reduces housing stock for sale which further drives up housing prices for both purchase and rental.

The pandemic clearly altered current patterns of work, which has impact on housing also.  What does the Fed think about whether work patterns we are seeing now reflects the future of work?  “Not settled.”

Questioners probed for clues about rate cuts and soft landings, without eliciting new insight, just recitation of factors.  It was also noted that inflation creates higher income for retirees, who are spenders in the economy and a growing population segment.

My conclusions:  the Fed is weighing many factors relative to rate cut timing and amounts, given the numerous above-cited unknowns and lack of certainty of a soft landing;  Ms. Collins never once said in substance that a “soft landing” was the Fed’s main goal, and I was afraid to ask “so the primary goal is to kill inflation and not to assure a soft landing, is that right?”; thus it is  unclear to me whether or not the audience just assumed that a soft landing was primary; this assumption of mine, with lack of audience probing, was the most fascinating part of the entire program for me.

I leave to my readers the impact of all this on your spending, investment and life planning.  We are promised, from high authority, lack of clarity, lack of settlement, and a history of surprises.

Massachusetts Sustainability Industry

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Today the National Association of Corporate Directors/New England and the Massachusetts Business Roundtable presented a panel program about making Massachusetts the leader in hosting businesses that support climate sustainability.  Globe business reporter Jon Chesto chaired the meeting. The accepted assumption was that climate change must be addressed by society.

Yvonne Hao, Secretary of the Commonwealth’s Office of Economic Development, maintained that Massachusetts is ideal for technological leadership, as our universities and business community can invent requisite technology.  Further, the Governor has proposed a billion dollar budget (part of a legally required  Four Year Economic Plan) to foster “climate tech” businesses with headquarters and production facilities all across Massachusetts.  She expects legislative action before the end of the July 31 term.  Her “pitch” also focused on the availability of investment capital in Massachusetts and the desire to echo Massachusetts’ eminence in med-tech (while also retaining production facilities here in the Commonwealth, which med-tech has not been able fully to achieve).

Lisa Wieland, President of National Grid New England and one of the two major utilities in attendance (Eversource also was represented), stated that Grid was exploring non-carbon energy solutions through hydro, wind and electrification, use of batteries, reducing carbon from sources which can be managed (lowering carbon from cattle, use of faux-leather), and applying A-I to analyze areas prone to negative effects of climate such as flooding.  Grid also is now working with 32 companies to explore cost and mechanics of alternative energy businesses and uses.  Also anticipated is a $2B new clean energy plant.

Kathleen Connors, President of Voltrek, explained the work of her company in installing devices to charge electric vehicles, with focus on companies electrifying fleets and parking facilities for employees.  She discussed the economic impossibility of wiring all parking spaces at scale due to cost and disruption, predicting something akin to “gas station” settings for bulk charging for non-industrial users.

In order to achieve a Massachusetts industrial base in climate-tech, including retaining a workforce of numerous skills, several problems must be addressed: legislative approval of $1B of tax credits (stated to have great ROI, so the audience was asked to call your State senators or reps) and addressing housing cost, child care and transportation issues. The Commonwealth’s Four Year Economic Plan contains task forces to address all of these.

Take-aways offered for corporate board members in the audience were straightforward: be imaginative, be flexible to embrace solutions, recognize that Massachusetts has great advantages for siting companies and facilities (including the best intellectual and political climates) to establish a new climate tech industrial center; and, that the business analysis in the long run should not turn on present tax rates but on overall opportunity.

Investment Advice On the Internet

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Some investment advisers provide service only over the internet.  Until now they filed ADVs (disclosure of their practice) with the SEC but did not need to register with the SEC.  Until now they could advise only over the internet except they could talk directly with up to 15 advisees.  Until now their communications and advertising were not well regulated, and they could not register with the SEC (I do not address state law; note that the general SEC regulatory scheme requires advisers with small numbers of advisees to register only with states).

The SEC has just changed the law, effective after an 18-month transition period:

  1. Regardless of number of advisees, internet advisers may register federally.
  2. No internet adviser can now talk to advisees.
  3. Advertising, eg any communication offering services to new or present advisees, is limited.  Performance of portfolios must report net performance, and must include all portfolios and the entire portfolio and must specify the dates covered.
  4. Endorsers and ratings are allowed but must be identified as to whether the endorsers are clients and whether either is comped.
  5. Any internet adviser that does not register now must maintain digital investment services on an ongoing basis to at least one client.
  6. ADV forms must be amended to comply.

Of course, the SEC publicity announcing these new regulations had to mention that an ancillary benefit is to permit the SEC better to regulate performance of advisers of this type.  As a big fan of robust regulation of financial markets, by reason of the historical ease and magnitude of fraud, I nonetheless continue to be amazed at the granularity with which the present SEC is tightening the regulatory framework– if only to see it rolled back if there is a Republican administration elected in November….

Corporate Luxury=No Stockholders

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Bose Corporation, a Boston area iconic company that has for decades manufactured top-of-the-line audio delivery systems, is a private entity whose stockholders do not seem to care about the value of their stock.  That is because there is no market for it and the controlling stockholder, MIT, seemingly is neither allowed to vote nor participate in management; and, it cannot sell its shares.

Thus sayeth the (fairly new) CEO, Lila Snyder, in remarks last Friday at Neptune Advisors’ ongoing and engaging  lecture series entitled C-Level Community. (I have no specific knowledge as to the corporate structure at Bose and the foregoing is my take-away from Ms. Snyder’s remarks.)

Is there a link between lack of shareholder pressure and the luxury to carefully and slowly engineer the absolutely best possible products?  It was asserted that lack of shareholder pressure on stock price or earnings does allow Bose products, wherever installed and whatever the form of the device, to cater to the highest standards of lovers of music.  Sound quality at Bose is evaluated in musical terms, far more demanding than clear transmission of human voices. This standard and the lack of stockholder pressure allowed Bose scientists to pursue “beautiful ideas.”

That said, over the last few years Bose had a series of layoffs of its inventive scientists.  Why did that happen?  The explanation, if I infer correctly, was that the company had previously aimed at perfect product performance, without regard for whether there was robust public demand for a given product.  Today, the product approach is to expose the scientists to the folks who evaluate what the broader public wants–all the time keeping the standard that products must produce music-quality sound.

While not clear to me that the story line is fully consistent– if you really were after perfect sound as your goal then why do you care that you only sell $5,000,000 of a gizmo and not $25,000,000– the result is pretty clear.  Smart people who are running companies want to make money whether public shareholders demand it or not.  And the new CEO, articulate and frankly quite impressive, came to Bose via McKinsey and a series of high-level positions which trained her to care about making money. And indeed, you cannot run an enterprise perpetually and lose money, as you simply go out of existence.

I apologize to Bose if I am too cynical to be completely in tune with the music that was played.  I have Bose equipment and it is indeed superb.  I will no doubt buy more of it in my lifetime.  I just don’t quite know how to process the offered take-away near the end of the session: as my notes have it, “values endure but culture is a living organism, it must evolve with strategy that addresses the market.”

Bottom line: I suggest that Bose today is operated substantially like any company that cares about the value of its shares of stock; what was in the past is in the past.

SEC Climate Control: Political Battleground

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Today the SEC adopted sweeping disclosure requirements by which public companies over the next few years will compel detailed recitation of two kinds of climate information: what the company emits directly and indirectly, and what risk it fears from climate change.  The details are, well, very detailed and will be parsed minutely in numerous publications;  even this afternoon I see separate statements from the five SEC Commissioners putting different spins on this new rulemaking, and third party commentary reflecting different evaluations.

If you are not part of a public company, and not yet in receipt of disclosures as an investor as that stage is a year and more away, what are the present key take-aways aside from the fact that you will be deluged with both boilerplate (“we strive to reduce emissions” and ” hurricanes ruin our facilities in Florida and reduce the need for some of our products but then again we will sell more sandbags”) and inscrutable technical detail?

As starters, what kinds of emissions are to be analyzed?  You will hear about Scope 1 emissions (what is emitted from fuels and materials consumed within the company premises), and Scope 2 emissions (what is emitted by utilities supplying the company with electricity, heat, cooling, steam, etc.  You may miss the fact that removed from the new Rule is a requirement to disclose Scope 3 emissions, a requirement in the 2022 original proposal that  included reflection of some of the emissions created by a company’s suppliers.  No doubt that task would be very expensive and time-consuming and inaccurate, but the new Rule will favor offloading by manufacturers of emissions  to producers of components they acquire for assembly, thus hiding the real ultimate climatic impact of a given machine, automobile, detergent or any other product.

What is apparent also is the manner in which the political battlefield upon which SEC rulemaking, ostensibly designed to educate investors who are either concerned with the environment or concerned with an accurate financial evaluation of a security, reflects the growing philosophical divide between the Left and Right in this country.  No surprise that the new Rule was adopted by vote of all three Democratic SEC Commissioners over dissent from the two Republicans. Aside from favoring less regulation of business, the Republican position is also premised in the contention that the SEC does not have the legal right to in effect legislate climate policy and social policy.  Although the Rule is framed as disclosure useful to investors, and it will no doubt fulfill that function, the pressure of the marketplace will also no doubt alter the behavior of public companies which will fall under general social scrutiny.

This is part and parcel of the Right’s fight against the administrative state, which many Republicans vow to disembowel.  This is the argument against much of what the SEC decrees in the name of disclosure, and is also an argument advanced against many regulatory initiatives undertaken by other Federal agencies, particularly under Democratic administrations which tend to be more activist in promulgating affirmative regulation.  Among numerous examples, take a look at the recent case brought against the government’s sweeping reporting requirement contained in the Corporate Transparency Act which, in the name of uncovering illegal activity, requires most American businesses to disclose to the government their ultimate owners; one Federal court case just did declare the CTA legislation unconstitutional, setting off a firestorm of reaction in policy forums, courts and within the Federal government itself.

SEC Chair Gensler, a most activist sort of regulator,  has pushed through very many programs favored by the Left; same can be said for other agencies, particularly the FTC and DOJ in antitrust regulation (for which see several prior posts to this site).

I offer no opinion here as to who is more correct, the Left or the Right; I keep my opinions to myself in this regard. However, I recommend viewing current politics partly in light of this tension, and suggest that the results of the Presidential election, already fraught with numerous concerns on all sides, will have significant impact also in the manner in which our Federal government interacts with its citizens and its business organizations.

The Business Economy–Hints

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I was struck today by the flow of news that continually pours over my desk from myriad sources, including  from the NYTimes, the legal press, several data services, the SEC, as well as thinking from my clients who are investors or advisers.  Those who know me understand that I do not give  legal advice in this blog site, and surely not investment advice in any setting, but I confess I am having trouble understanding where the corporate/investment landscape is going.

Anecdotal input just today (I vouch for none of this data but set forth what I was told in person or by incoming information):

after a heady 2023 the stock markets are taking a pause (NYT) and are not a source of 2024 optimism (very sophisticated equity investor);

the stock markets are ahead of the Fed (NYT column);

DOJ increased enforcement cutting down on M&A activity (several sources today including but not limited to the super-market merger) [and see posts December 13 and 20]

M&A activity for 2023 was extremely low in volume at 19% below 2022 and 46% below 2021 (recognized data service to the legal community);

tightening standards for private investors to obtain accredited investor status (and thus be able to invest in typically better equity offerings) is being considered by the SEC [see post of December 15], which  will harm private investment markets in parts of the US and prevent investors from exercising their own investment judgment with their own money (SEC Commissioner addressing the Commission’s Small Business Capital Formation Advisory Committee) ;

public company ownership and filing of IPOs is severely down, as from 2016 to mid-2022 the number of public US companies almost halved and rate of IPOs in last ten years is in substantial decline (same SEC Commissioner address).

The only news (at least that I found interesting enough to comment upon) which suggests uptick in deal pace was contained in my recent post on market pressure leading to a robust 2024 of sales of positions by PE firms [February 13].

Obviously there is a connection between corporate deal cycles and the stock market, and obviously I am not the right person to speculate on those mechanics;  I just was struck by today’s input.  As Sergeant Joe Friday used to say, “just the facts.”

AI and the SEC

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The SEC has pending a proposed regulation, anticipated for adoption before the end of this year, requiring brokers and advisers to remove data analytics which would put the firm’s interests before the interests of investors.  Separately, while speaking this week at Yale Law School, SEC Chair Gensler also admonished these firms to beware AI programs that might lead to spoofing or front-running.

Front-running effects a trade for the firm account (based in this case presumably on AI analytics) prior to affording that trade to clients, while spoofing may distort the market by placing buy or sell orders for future contracts and then withdrawing them prior to execution.

The SEC message is that firms need fully to test AI trading programs to ensure that what is generated is not only factual (not an hallucination) but also must work in the first instance to benefit customers and not the firm’s proprietary trading and to preserve a market driven by fair practices.  However, the requirements here have to do with discharging fiduciary obligations, do not address the purposeful release of false data (clearly a fraud), and relate more closely to avoiding negligence or recklessness on the part of the broker or advisor.  It is not certain, however,  that committing either of these SEC sins will in fact create harm to clients or other marketplace investors, an issue that Gensler himself  believes will be resolved by the courts in a manner he described as “unpredictable.”

And this doesn’t get to court without the SEC bringing suit so … you be the judge as to where this is heading.

When Private Equity Cashes Out a Fund….

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The US economy in 2023 was not really soft, but it was perceived as such and market valuations of enterprises held by PE funds were depressed.  PE Fund refrained from cashing out their investments, hoping that values would rise in the future, that  buyers next year would be more willing to spend,  and that disposition of fund investments at 2024 higher prices would create better returns for fund investors.

According to Dealogic, PE exits in 2023 totaled c $333B; exits in the prior two years were c$6B and over c$893B.  2023 exits were the lowest since 2013.

Now comes 2024 and there will be greater pressure to exit as time will be running out on some funds and since hopefully valuations of positions to be sold will have increased.  Further, companies seeking acquisitions likely have enjoyed profitable 2023s and have not expended acquisition dollars last year, so it seems that fund managers may find willing and solvent buyers for the investments that the funds need to sell.

Strategic buyers looking to purchase PE fund assets may try to balance possibly higher market valuations by careful shopping, in light of the fact that there may be something of a glut of companies for sale given lack of company sales last year.

Interest rates have stabilized and may tick downward during the course of the year, also a factor which may lead to acquisition activity.

Finally, noting the overlay of greater anti-trust enforcement particularly against roll-ups, anti-trust clearance may take a long time to achieve, particularly in markets where there is product/customer overlap and/or in regulator-targeted industry sectors such as med-tech. (See prior anti-trust post to this blog site, dated December 20)

Overall, commentators expect a pretty interesting 2024 acquisition year.

Whistleblowing for the Feds

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The Sarbanes Oxley Act provides that the Federal Government can grant payment to individuals who report illegal actions in connection with securities offerings, and where the government finds that in fact illegal actions occurred.  The statute is often invoked to reward employees who advise the government of employer improprieties and awards can reach into the millions of dollars. .In 2017 a Manhattan jury found that a certain Mr.. Murray had been fired for refusing to alter his research relating to a mortgage-backed security.

The employer claimed that although they did in fact fire Mr. Murray, it was not because of his advising the government of any misdeeds, but rather for other reasons, and that Mr. Murray needed to prove that the firing was in fact retaliatory.  The Federal Government appeared in support of Mr. Murray and confirmed that the bare sequence of events, the reporting of the wrong and the firing, entitled Mr. Murray to his recovery.

While there is surface logic to the decision of the  Department of Labor to make the payment, thus not requiring an employee to in fact prove the state of mind of the employer, the ramifications of this decision are a bit scary.  If an employee turns in their guilty employer, can they then never be fired?  That clearly is not what this case stands for, but it does create a substantial burden on employers in connection with what is normally the prerogative of a business: except for clearly protected groups of employees who have special and express statutory protections relating to firings (labor organizing activity, age, race, military service leap to mind), employers have always assumed they were free to deal with employment without apology.

Add Federal whistleblowers to the list of protected employee groups!.

 

 

 

SEC Regulation of Dealers and Advisers– New Frontiers

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Last week the SEC promulgated two new rules which are of great impact on large-scale securities investors and the firms that advise them.  The below merely touches certain highlights and, I must emphasize, as with all things posted here, does not constitute legal advice.  The regulations and releases are vast (the adopting release for the regulation redefining securities dealers is 247 pages long, has 805 footnotes and is subject to well-reasoned dissents by the two outvoted Republican SEC Commissioners).  Thus forewarned (and if you a registered RIA or a large investment vehicle please call your attorney), here is the broadest of outlines:

DEALERS: A dealer under federal law is defined as an entity or person in the business of buying and selling securities for its own account through a broker or otherwise. BUT it excludes those for which such activity is NOT part of a “regular business.”   We  used to refer to such excluded entities as “investors” or “customers,” who had certain protections under law.  The new Rule requires certain customers, those which regularly invest and trade in securities for its own account with frequency at large scale, to register as a dealer.  The reason is that, according to the SEC, such a trader fulfills the same function as a traditional dealer, funding in the marketplace by creating liquidity for others in the trading markets.

The result of being a dealer is that you must register with the SEC and FINRA (the self-regulatory dealer organization) and file reports with the SEC and comply with regulations that are largely  irrelevant.  While registered investment companies are exempt (they would otherwise have to register with the SEC twice), the new Rule covers private funds and pension funds.  In ways not yet clear at least to me, coverage also does not exclude investment advisers.

In an interesting aside, the SEC Release makes clear that a crypto automated market maker might have to register, which as Commissioner Peirce points out seems tantamount to registering a software protocol.

RIAs: Starting in about a year, registered investment advisers which advise PRIVATE unregistered fund vehicles must  include, in their SEC filings on Form PF, private information about the strategies that such advisers and funds utilize in their securities transactions.  The purpose is better to understand and thus regulate the trading markets, the same rationale for the above dealer regulatory rule.