Latest / Bloomberg Intelligence / Musk’s Proposal Creates Liquidity, Uncertainty, For Tesla Bonds

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Musk’s Proposal Creates Liquidity, Uncertainty, For Tesla Bonds · Bloomberg Intelligence

0:05
Speaker 1: Welcome to the Bloomberg p m L Podcast. I'm pim Fox.
0:08
Speaker 1: Along with my co host Lisa Abramowitz. Each day we
0:11
Speaker 1: bring you the most important, noteworthy, and useful interviews for
0:15
Speaker 1: you and your money, whether you're at the grocery store
0:17
Speaker 1: or the trading floor. Find the Bloomberg p m L
0:20
Speaker 1: Podcast on Apple Podcasts, SoundCloud, and Bloomberg dot com. Tesla.
0:34
Speaker 1: Tesla is more than a manufacturer of electric vehicles. It
0:38
Speaker 1: is more than a stock which is currently down about
0:40
Speaker 1: eight tens of percent, trading at three hundred and seventy
0:43
Speaker 1: seven dollars. It is more than a company that was
0:46
Speaker 1: founded by Elon Muskoo holds nearly of the shares. Tesla
0:52
Speaker 1: is also a company that has eight point six billion
0:55
Speaker 1: dollars worth of debt. And here to tell us about
0:58
Speaker 1: that debt and the very as bonds that the company
1:01
Speaker 1: has issued is Joe Levington, our senior credit analyst for
1:05
Speaker 1: Bloomberg Intelligence, and he joins me here in our eleven
1:08
Speaker 1: three oh studios. Joel, it is always a pleasure. I
1:11
Speaker 1: was gonna say, the best way for me to do
1:13
Speaker 1: this is just to say tell us everything we need
1:15
Speaker 1: to know about what is going on with Tesla bonds
1:20
Speaker 1: because they run the gamut of maturities. There are some
1:24
Speaker 1: that are maturing this year, and there are a lot
1:26
Speaker 1: of interesting details in the bond covenants which actually were
1:32
Speaker 1: affected by yesterday's tweet. Yes um I would say three things. One,
1:39
Speaker 1: the immediate effect is that three point three billion dollars
1:43
Speaker 1: worth of their convertible debt went into the money yesterday
1:47
Speaker 1: off the news, with the stock rose above the three
1:50
Speaker 1: D fifty eight dollar threshold where where those bonds trade.
1:54
Speaker 1: And that includes nine million dollars that comes due next March.
1:58
Speaker 1: So from the liquidity stamp point, the immediate impact is positive.
2:04
Speaker 1: Just explain that for people, So this nine hundred and
2:06
Speaker 1: twenty million dollars it's no longer debt, doesn't have to
2:10
Speaker 1: be right, it can be converted into equity. And that
2:13
Speaker 1: that's true for all all of it, mainly in twenty
2:17
Speaker 1: two issues as well as the slug next March, and
2:21
Speaker 1: so that would be number one. Number two, to your
2:24
Speaker 1: point about the covenants in the bonds which are in
2:27
Speaker 1: the Bloomberg Barkleys in disease, they have a change of
2:30
Speaker 1: control provision and that provision says that a change of
2:35
Speaker 1: control must include a controlling investor owning fifty which initially
2:43
Speaker 1: I think people thought that that is what was going
2:45
Speaker 1: to happen. When Mr must said that I am going
2:48
Speaker 1: to take Tesla private or I'm considering taking Tesla private,
2:51
Speaker 1: the pronoun I being important there, yes, and then he
2:56
Speaker 1: changed he changed his language slightly to there will be
2:59
Speaker 1: no controlling investors, so that would keep the unsecured bonds
3:03
Speaker 1: that they have outstanding, or theoretically that would keep it
3:07
Speaker 1: outstanding and a privatization. And so then it becomes well,
3:11
Speaker 1: what does that mean for those bond holders? And for
3:15
Speaker 1: that I would go to point three to say, look,
3:17
Speaker 1: the issue here would be structural subordination. If they issue
3:21
Speaker 1: secured debt that will get the unsecured notes will get primed,
3:26
Speaker 1: meaning that the secured debt will be on top on
3:28
Speaker 1: the capital structure. Then these blump bonds in the Bloomberg
3:32
Speaker 1: Barclays indocy and then the equity owners. And when you
3:37
Speaker 1: look at that relative to what rading agencies have done
3:40
Speaker 1: in the past with structural subordination, it could mean one
3:43
Speaker 1: to notch is worth of downgrade. So that would be
3:47
Speaker 1: step one. What does that mean in terms of value
3:50
Speaker 1: for the bonds. The value would be if I look
3:53
Speaker 1: at triple C bonds, which is where that might head,
3:57
Speaker 1: would mean about an eight percent yield for five in
4:00
Speaker 1: the triple C zone. That is about a hundred and
4:03
Speaker 1: thirty basis points wider than where we are today, which
4:06
Speaker 1: is equal to about five or six points. That would
4:08
Speaker 1: be a worst case scenario, or how I would frame
4:11
Speaker 1: a worst case scenario. Now, it's true that nothing can
4:14
Speaker 1: happen because nobody has seen any of the financing or
4:17
Speaker 1: if any, if any debt will be issued at all.
4:19
Speaker 1: It could be all equity for all I know. UM.
4:22
Speaker 1: And of course there's always a case where he might
4:24
Speaker 1: decide to call these bonds back anyway. UM. And the
4:28
Speaker 1: way that my math looks at it would indicate that
4:31
Speaker 1: there's about a fifteen percent chance that he would call
4:33
Speaker 1: the bonds in, about forty five percent that would go
4:36
Speaker 1: to triple C, and about forty uh that nothing will happen.
4:39
Speaker 1: That seems to be where the bond yields are today.
4:43
Speaker 1: Are the covenants that you've just described unusual? They're not unusual,
4:49
Speaker 1: but it is very unusual. Uh. You know, as we
4:52
Speaker 1: come up on the anniversary of these bonds. Uh. For
4:56
Speaker 1: a issuer of such weak credit quality to issue unsecure
5:00
Speaker 1: debt and issue with um you know, almost investment grade
5:04
Speaker 1: type covenants, very very limited covenance. But is it usual
5:09
Speaker 1: to have a actual stock price for the convertible bonds?
5:15
Speaker 1: What did you say, three fifty eight dollars a share,
5:19
Speaker 1: and have the CEO of the company do something that
5:24
Speaker 1: would indicate a price for the stock that is higher
5:28
Speaker 1: in order to actually trigger that potential convert and then
5:35
Speaker 1: remove that as debt from the balance sheet so that
5:38
Speaker 1: you can then go out and issue more bonds. Well,
5:40
Speaker 1: Elon Musk is definitely not usual. I have never seen
5:43
Speaker 1: that before in my twenty years of of doing credit research.
5:48
Speaker 1: But you know, twenty years ago there was no Twitter. No, no,
5:51
Speaker 1: clearly I understand that. But I mean, twenty years ago,
5:53
Speaker 1: there were bonds, and there were bond covenants. This is true.
5:56
Speaker 1: But I've never seen anybody take such a monumental offering
6:01
Speaker 1: or potential action and just throw it out there on
6:04
Speaker 1: Twitter as if it's you know, like, uh, just a
6:07
Speaker 1: general thought in his mind. Based on your experience, what
6:12
Speaker 1: would be the normal pattern of trying to take a
6:16
Speaker 1: company of this size private? Sure, Well, typically what I
6:20
Speaker 1: would expect is that the company would be issuing a
6:23
Speaker 1: press release uh and through an eight K filing with
6:27
Speaker 1: the SEC, and that would outline you know that they
6:31
Speaker 1: are investigating strategic alternatives. I think Mylan said something like
6:34
Speaker 1: that today as a very recent example, ticker m y L.
6:39
Speaker 1: And you take it from there. You explain here's the
6:41
Speaker 1: reasoning or here's the logic, and it will take this
6:44
Speaker 1: amount of time. It usually doesn't come out in you know,
6:47
Speaker 1: a sixty one character tweet. Thanks very much, Joe Levington.
6:51
Speaker 1: We always learned a lot. Senior credit analyst for Bloomberg
6:54
Speaker 1: Intelligence talking about Tesla and Tesla bonds. The topic right
7:12
Speaker 1: now is Tesla and the shares of Tesla are down
7:16
Speaker 1: about three quarters of a per cent is coming after
7:19
Speaker 1: Chief executive Elon Musk tweeted yesterday that he was planning
7:23
Speaker 1: and looking forward to bringing the company private at a
7:27
Speaker 1: price of a share. Here to help us understand this
7:31
Speaker 1: more and get his reaction is Gordon Johnson. He is
7:33
Speaker 1: managing director Alternative Energy, Metals and Mining as well as
7:36
Speaker 1: equipment analysts for Vertical Group and Gordon just to underscore,
7:42
Speaker 1: he has already a cell recommendation on Tesla with a
7:44
Speaker 1: price target of ninety three dollars. Shares of Tesla currently
7:48
Speaker 1: traded three hundred and seventies six dollars. Gordon, always a
7:51
Speaker 1: pleasure to hear what you've got to say. What what
7:54
Speaker 1: was your reaction when you saw or learned about the
7:58
Speaker 1: tweet from elon Us? Well, I gotta tell you, Keim
8:02
Speaker 1: and thanks for having me on. I mean, initially it
8:04
Speaker 1: was sure excitement because it seemed to me like this
8:06
Speaker 1: was Thennell and the coffin. Um. I mean, you gotta
8:09
Speaker 1: think about this, right, let's just take a step back
8:11
Speaker 1: just a few days ago. Emon must promise that they're
8:14
Speaker 1: gonna be profitable forever um starting in three UM. So
8:18
Speaker 1: why would he need to go private to end negative
8:20
Speaker 1: propaganda from the shorts? I mean, if they're gonna be
8:23
Speaker 1: profitable forever and he's saying he's gonna go private at
8:26
Speaker 1: I mean the short covering alone, we drive the stock
8:28
Speaker 1: to five dollars. I mean, you gotta think about all
8:31
Speaker 1: the dynamics regarding an LBL. First and foremost, average biout.
8:35
Speaker 1: If you're a leverage biout investors, what you're looking for
8:38
Speaker 1: most is keep it or money generation for the cup
8:41
Speaker 1: from the company to pay the interest on your debt
8:43
Speaker 1: and ultimately the debt. And we know that's not what
8:45
Speaker 1: this company does. And we know that these um you know,
8:48
Speaker 1: they they rebuffed an investment offer from Saudi Eurabia. So
8:52
Speaker 1: if you're passing the hat uh for the largest lb
8:55
Speaker 1: OH syndicate in history, why would you say no to
8:57
Speaker 1: a big check? I mean, it just doesn't make sense.
9:00
Speaker 1: And when you think about the fact this would be
9:02
Speaker 1: a seventy or eighty plus billion dollars deal, um uh,
9:06
Speaker 1: you know, and and then it's my newly choreograph. I mean,
9:09
Speaker 1: the local legal risk for any party involved would be significant.
9:13
Speaker 1: So you know you're talking about you know, uh multiple
9:17
Speaker 1: and uh lawyers that would need to be involved, multiple
9:20
Speaker 1: investments would need to be involved. And we've heard nothing
9:23
Speaker 1: from any of these Tesla financiers or lawyers regarding a
9:27
Speaker 1: potential LBO. And just today we learned that you know, uh,
9:31
Speaker 1: the board members are saying they just started talking about
9:33
Speaker 1: this last week. Listen, here's the thing. The question is
9:37
Speaker 1: if the STC does their investigation, or if they investigate
9:40
Speaker 1: and they decide there's wrong doing here, well, Tesla investors care,
9:43
Speaker 1: you know, if Elon must broke offs here, well they care,
9:45
Speaker 1: probably not. But I think the bigger problem is if
9:49
Speaker 1: there's no real offer out there. If Elon Musk can't
9:52
Speaker 1: over the next few weeks show that there's a real
9:54
Speaker 1: offer out there, I think he has serious problems with
9:57
Speaker 1: respect to his current investors and credibility. I think that's
10:01
Speaker 1: the real problem. And when you're thinking about you know,
10:03
Speaker 1: even if Elon Musk rolls the shares, and you know
10:06
Speaker 1: the share, you know the the employees roll there shares,
10:08
Speaker 1: you're still talking about sixty plus billion and capital that
10:11
Speaker 1: needs to be raised. You have two current investigations alleging
10:15
Speaker 1: frauds with both with Solar City and with the amount
10:17
Speaker 1: of Model three is produced. You have a number of
10:19
Speaker 1: other potential issues um underpinning this company. With respect to
10:23
Speaker 1: a potential sec Wells noticed that maybe out there. I
10:26
Speaker 1: know that people have said that's not the case. But
10:28
Speaker 1: if you listen to the question on the call, the
10:30
Speaker 1: analysts asked the question and not ask Tesla, do they
10:32
Speaker 1: have a Wells nonese that do you have something that
10:34
Speaker 1: procludes you from raising capital, which is not the definition
10:37
Speaker 1: of a Wells. Notice this just seems, I mean, quite
10:39
Speaker 1: frankly ludicrous and uh, you know that was our reaction yesterday. Okay,
10:45
Speaker 1: is there a way that you can see Elon Musk
10:48
Speaker 1: actually completing a deal like this? Would it be? Is there?
10:52
Speaker 1: I mean, set aside for just a minute your skepticism
10:56
Speaker 1: on a technical basis. Is this a deal that is
10:59
Speaker 1: just too big to get done? Or is it possible?
11:03
Speaker 1: That's a great question, Pim, But I don't even think
11:05
Speaker 1: it's about the size of the deal. Again, think about this.
11:08
Speaker 1: A leverage buyout is based on a company generating cash.
11:13
Speaker 1: So if you're an LBO investors, you effectively take debt
11:16
Speaker 1: in a company to take the company over. What the
11:19
Speaker 1: prospect being they're going to generate cash to pay you
11:22
Speaker 1: back for that debt or pay you back your interests
11:25
Speaker 1: and then pay you back for that debt. When has
11:27
Speaker 1: Tesla generated never? So why as an LBO investor would
11:32
Speaker 1: you be willing to go out on a limb and
11:34
Speaker 1: risk potentially uh, you know, a huge default and wasting
11:38
Speaker 1: your money. I mean, it just doesn't make any logical sense.
11:42
Speaker 1: And I think that investors in the public, and you know,
11:46
Speaker 1: quite frankly, sec needs to see this actual money that
11:50
Speaker 1: he says he has secured. Those two words money secured
11:53
Speaker 1: that he said, I think need to be proven out
11:56
Speaker 1: over the next day's, last weeks, and we're highly skeptical
12:00
Speaker 1: that's going to be able to be the case. You know.
12:03
Speaker 1: It's like a very general question, is there enough money
12:05
Speaker 1: out there to do this? Yes? But doesn't make sense
12:07
Speaker 1: absolutely not. Well, let's let LBO investors scrutinized bills much
12:12
Speaker 1: more than equity short sellers do. And I think that's
12:14
Speaker 1: what's gotten lost in a lot of this, you know, uh,
12:18
Speaker 1: you know story. I want to thank you very much
12:20
Speaker 1: for joining us. Gordon Johnson, Managing director Alternative Energy, Metals
12:25
Speaker 1: and Mining and Equipment Analysts for Vertical Group, talking about
12:29
Speaker 1: Elon Musk's Twitter proposal to take Tesla private at four
12:34
Speaker 1: hundred and twenty dollars a share. Stocks have gained this year.
12:55
Speaker 1: The SMP five hundred is currently up nearly seven percent,
12:59
Speaker 1: NASDAC stopped SIR stocks are up nearly fourteen percent, and
13:02
Speaker 1: the Dow Jones Industrial average up just three and a
13:05
Speaker 1: half percent. Here to tell us what to do with
13:08
Speaker 1: money is Chuck Lieberman. He is the chief investment officer
13:11
Speaker 1: at Adviser's Capital Management. He is also a Bloomberg opinion columnist.
13:16
Speaker 1: He helps to manage more than one point three billion
13:19
Speaker 1: dollars of customer assets based in Ridgewood, New Jersey. Chuck Lieberman,
13:23
Speaker 1: thank you very much for being with me. Maybe, and
13:27
Speaker 1: I promise I'm not gonna ask you about Tesla, so
13:29
Speaker 1: you can put that one to the side, right. I
13:31
Speaker 1: mean that you know there are other things in the world. Uh,
13:35
Speaker 1: tell us what you take away from all of the
13:38
Speaker 1: information regarding jobs and the health of the US economy
13:42
Speaker 1: and how that translates into a strategy for investing money. Sure, well,
13:48
Speaker 1: I think everyone agrees that fest labor market is fairly tight. Uh.
13:53
Speaker 1: Some people think there's uh there are some people on
13:57
Speaker 1: the sidelines who could still be sucked into the job market.
14:01
Speaker 1: But the data, no matter how you look at it,
14:04
Speaker 1: in the case pretty clearly that labor is scarce. We
14:07
Speaker 1: have more job openings than unemployed. The unemployment rate is
14:13
Speaker 1: down at very low levels, historically cyclically low levels. Um.
14:19
Speaker 1: We're seeing uh, fifty year lows in unemployment claims. So
14:24
Speaker 1: by every measure, labor is scarce. That's beginning to drive
14:28
Speaker 1: up labor costs. Uh. Some people make the argument that
14:31
Speaker 1: labor costs are not rising that quickly. But if you
14:35
Speaker 1: look at the last five six years, you can see
14:39
Speaker 1: the labor costs started to rise when the unemployment rate
14:41
Speaker 1: hit about five So with the unemployment rate now below
14:45
Speaker 1: four percent, there's every reason to expect more upward pressure
14:48
Speaker 1: on labor costs, and ultimately that will flow into inflation.
14:52
Speaker 1: So that gets to the things to avoid in the
14:55
Speaker 1: things to play for. With a little bit higher inflation
14:58
Speaker 1: and solid economic growth, you want to be in the
15:01
Speaker 1: cyclicals or companies that will benefit from higher inflation or
15:05
Speaker 1: higher interest rates or accommodation, and you want to avoid
15:08
Speaker 1: the ones that are susceptible to those factors. So the
15:11
Speaker 1: susceptible areas are at the bond market, especially long term bonds,
15:15
Speaker 1: and especially high quality long term bonds that include utilities,
15:19
Speaker 1: real estate, investment, trust, consumer stables. Those are royal areas
15:23
Speaker 1: that we see as relatively vulnerable. And the areas that
15:26
Speaker 1: benefit are financials which benefit from rising interest rates. UH,
15:33
Speaker 1: energy and pipelines in particular because they'll benefit from rising
15:38
Speaker 1: prices for crude oil and more volume passing through pipes um,
15:44
Speaker 1: so those are roll attractive areas. Let's talk a little
15:47
Speaker 1: bit about energy. What kinds of energy companies if you
15:50
Speaker 1: can specifically, we're talking master limited partnerships. Are you talking
15:54
Speaker 1: about pure play energy companies, exploration and production, upstream, downstream?
15:59
Speaker 1: Where would you like to be, Well, it depends on
16:02
Speaker 1: the risk appetite and what the client needs. So if
16:04
Speaker 1: they need income, then midstream and downstream are great places
16:09
Speaker 1: to be because they generate a lot of income. The
16:11
Speaker 1: industry is still transitioned from UH partnerships and incentive distribution
16:18
Speaker 1: rights to corporations, and so that's creating a little bit
16:23
Speaker 1: of turmoil and uncertainty in the market. Uh, just explain
16:26
Speaker 1: if you can. I hate to break in, but just
16:28
Speaker 1: explain what is going on, because this is an important point.
16:31
Speaker 1: It's it's a way in which master limited partnerships have
16:35
Speaker 1: typically operated in the energy sector. And as you say,
16:38
Speaker 1: that's changing, yeah, well that's exactly right. So companies used
16:43
Speaker 1: to have these UH sort of operations, daughter companies, spinoffs,
16:47
Speaker 1: however you want to describe them, and those companies would
16:50
Speaker 1: be structured as partnerships with the ownership either in the
16:55
Speaker 1: hands of the public or the parent, and the parents
16:59
Speaker 1: with quickly UH reap some benefits every time the dividend
17:04
Speaker 1: paid to the limited partners increased, so they were motivated
17:08
Speaker 1: to increased dividends for UH, for the investors, but it
17:13
Speaker 1: also meant that the company had relatively little cash flow
17:17
Speaker 1: to finance investments, so the company would be required, really
17:21
Speaker 1: forced to use the capital markets to raise capital and
17:24
Speaker 1: pay for capital investment. UH. That became untenable when oil
17:29
Speaker 1: prices fell and stock prices fell and the cost of
17:32
Speaker 1: capital went up very dramatically. And so these companies are
17:36
Speaker 1: now being converted into corporations and the entire partnership structures
17:42
Speaker 1: is basically being thrown away or gotten rid of. UH.
17:47
Speaker 1: Some more of these companies who are going to operate
17:49
Speaker 1: like traditional companies, where they're going to retact and retain
17:53
Speaker 1: more cash flow, more profits in order to finance their investments. Okay,
17:58
Speaker 1: great description. Tell us now about financial stocks. Do you
18:02
Speaker 1: want to be in banks? Do you want to be
18:03
Speaker 1: in regional banks? What kind of banking stocks are? Financial
18:07
Speaker 1: entities are important? Well? I think the regionals and the
18:11
Speaker 1: money centers are both attractive. UM. I happen to like
18:16
Speaker 1: some of the money centers because they are so cheap.
18:18
Speaker 1: We're talking what JP Morgan Chase Bank of America. Well,
18:23
Speaker 1: JP Morgan Chase is sort of the criminal a crime
18:25
Speaker 1: of the industry, and so it's the most expensive, but
18:28
Speaker 1: it's also the safest investment. UH. City is the cheapest
18:32
Speaker 1: of the group. Uh, it's the least expensive. It's the
18:36
Speaker 1: most international of all the money centers. UH is the
18:39
Speaker 1: cheapest for a reason. Well, I think it's cheapest because
18:43
Speaker 1: it's not as simple a story. Bank of America has
18:46
Speaker 1: a very large retail business. UM, it's very attractive, very cheap.
18:52
Speaker 1: City is cheaper still partly because of its international exposure.
18:56
Speaker 1: I think there's a very rational case to be made
18:59
Speaker 1: for a mix of investing across all of those companies.
19:03
Speaker 1: Do you believe that higher interest rates will show themselves
19:07
Speaker 1: this year? Yes, I like that. That sucks SYNC. You
19:13
Speaker 1: don't hear that often. Well, I'm trying to be straightforward
19:18
Speaker 1: that Uh yeah, I think we are going to see it.
19:21
Speaker 1: I think at the margin, we're already seeing higher inflation.
19:25
Speaker 1: The Fed is going to continue to slowly methodically ramp
19:30
Speaker 1: up policy rates, meaning another basis points in September and
19:34
Speaker 1: another in December. But we're we're running out of room
19:40
Speaker 1: for us to be surprised by a shocking inflation number.
19:44
Speaker 1: I don't dismiss the possibility. But it's already August, so
19:51
Speaker 1: I think we are going to get a number that
19:53
Speaker 1: is kind of a shock to the market. I think
19:55
Speaker 1: the market is very complacent about inflation pressures, and so
20:00
Speaker 1: I think that that's going to be the big mover
20:04
Speaker 1: for the bond market. Give you about twenty seconds, Chuck Lieberman.
20:07
Speaker 1: You mentioned cychnical stocks. What about consumer discretionary Uh, some
20:12
Speaker 1: of those are fairly well placed. Also, with so many
20:16
Speaker 1: households now employed, unemployment so far down, consumers do have
20:22
Speaker 1: more discretionary income that they can afford to spend, and
20:25
Speaker 1: they're doing it. So the discretionary retail space is extremely competitive, however,
20:33
Speaker 1: so you really have to look at company by company.
20:36
Speaker 1: I think the cruise lines, as an example, are well placed,
20:40
Speaker 1: they will do well. The retail space for clothing is
20:45
Speaker 1: just an absolute minefield, and so some companies are losing
20:49
Speaker 1: out and others like Amazon or picking up share. Thanks
20:53
Speaker 1: very much, Chuck Lieberman. He is the chief investment officer
20:56
Speaker 1: at Advisers Capital Management, is also a Bloomberg Opinion columnists.
21:00
Speaker 1: Helps to manage more than one point three billion dollars
21:17
Speaker 1: the world of cryptocurrencies for example, bitcoin Bitcoin now trades
21:21
Speaker 1: about five and a half percent lower than it did
21:24
Speaker 1: yesterday at eighty dollars for bitcoin, Ripple is down about
21:29
Speaker 1: twelve percent, Atherium down four percent, light Coin down seven
21:33
Speaker 1: and a quarter percent. Here to help us understand a
21:35
Speaker 1: little bit more about the world of cryptocurrencies and their
21:38
Speaker 1: exchanges is Joe Marino. He is a partner in the
21:41
Speaker 1: White Collar Defense and Investigations Group at Cadwalader in Washington,
21:46
Speaker 1: d C. But he joins us here in our eleven
21:48
Speaker 1: three oh studios. Joe, it is a pleasure. Thank you
21:50
Speaker 1: for coming in. Maybe just give people a little bit
21:52
Speaker 1: of your background so they understand where you're coming from
21:55
Speaker 1: in your level of expertise. Sure him, and thank you
21:58
Speaker 1: so much for having me so. My background is as
22:00
Speaker 1: a federal prosecutor and I specialized is specifically in terrorist
22:04
Speaker 1: financing at Main Justice down in Washington, d C. And
22:07
Speaker 1: just to give a little background as to what we
22:10
Speaker 1: used to look at in terms of how individuals would
22:13
Speaker 1: funnel money to terrorist groups. In the old days, it
22:15
Speaker 1: was cash, right, It was cash carried over the border,
22:18
Speaker 1: sometimes mailed in FedEx boxes. Then it was Hawalla's right,
22:21
Speaker 1: which are these informal ways with very little documentation of
22:25
Speaker 1: moving money between parties as a way to avoid taxes.
22:28
Speaker 1: The regulators, the I r S, the Treasury Department and
22:32
Speaker 1: so on, and the FBI, and this would be electronic. Well,
22:35
Speaker 1: Hawailli's typically we're kind of old school, you know, person
22:39
Speaker 1: to person, So maybe two persons in the US would
22:42
Speaker 1: exchange money for the purposes of exchanging the same amount overseas,
22:46
Speaker 1: mostly off the books. Well, now we're in a digital age.
22:49
Speaker 1: So now what we're looking at is largely unregulated, unbanked
22:53
Speaker 1: transactions through digital currency, and that is very much on
22:56
Speaker 1: the radar of federal prosecutors and regulators because they see
23:00
Speaker 1: this as really the wild West, and it's a way
23:02
Speaker 1: for people to avoid taxes, to launder money from criminal
23:05
Speaker 1: enterprises potentially, and you know, even to violate campaign finance
23:10
Speaker 1: and various different things. So it's very much on the
23:13
Speaker 1: radar of prosecutors and regulators when it comes to cryptocurrency.
23:17
Speaker 1: And again, there's so much promise to this technology, so
23:20
Speaker 1: it's a shame that it's gotten a bit of a
23:21
Speaker 1: blemish from some bad actors. But when it comes to regulators,
23:26
Speaker 1: I would characterize their view of cryptocurrency as ranging from
23:29
Speaker 1: highly skeptical to openly hostile because of these reasons. So
23:33
Speaker 1: what do you believe the government's process is in determining
23:39
Speaker 1: how to regulate or manage this market, Because as you
23:42
Speaker 1: just describe, they're not agnostic at all. They're not agnostic.
23:47
Speaker 1: So if you are an individual, you can mind cryptocurrency,
23:51
Speaker 1: you can invest in cryptocurrency, you can buy and sell cryptocurrency,
23:55
Speaker 1: and the government will largely leave you alone except for
23:58
Speaker 1: the fact that you have to pay axes on it.
24:00
Speaker 1: And the i r S does consider bitcoin and other
24:03
Speaker 1: types of cryptocurrency to be property, and they expect you
24:06
Speaker 1: to declare and pay capital gains tax on that. And
24:09
Speaker 1: a taxable event can come out a number of different ways.
24:12
Speaker 1: It's not just when you buy or sell or trade
24:15
Speaker 1: the cryptocurrency. It's when you buy something. So if you
24:18
Speaker 1: bought bitcoin at one hundred, it's now at two hundred,
24:21
Speaker 1: and you buy something at two hundred dollars, the i
24:24
Speaker 1: r S sees that as a taxable event and expects
24:26
Speaker 1: you to pay short or long term capital gains on
24:29
Speaker 1: that differential. So, but in general, if you're not in
24:33
Speaker 1: the business of exchanging cryptocurrency, you're largely off the government's radar. Now,
24:38
Speaker 1: if you want to get into the business of exchanging cryptocurrency,
24:42
Speaker 1: and either you're doing crypto for fiat currency like dollars
24:45
Speaker 1: or euro or crypto to crypto like bitcoin and ether,
24:49
Speaker 1: and you do this on a regular basis as a
24:51
Speaker 1: business to take advantage of the spread. Well, now the
24:54
Speaker 1: Treasury Department has made very clear it considers you a
24:57
Speaker 1: money services business and what that means means is it's
25:00
Speaker 1: a term of art under a statute called the Bank
25:02
Speaker 1: Secrecy Act from the nineteen seventies. And what it means
25:05
Speaker 1: is you are now subject to registration. So if you
25:08
Speaker 1: don't register and you engage as a cryptocurrency exchange, you
25:11
Speaker 1: are operating an unlicensed money service business. If you do register,
25:15
Speaker 1: which you should if you think you fall into this category.
25:18
Speaker 1: Now you have a whole range of record keeping and
25:21
Speaker 1: reporting and audit responsibilities to finn SEND, which is the
25:25
Speaker 1: Financial Crimes Enforcement Network which is a part of the
25:28
Speaker 1: Treasury Department. And this comes to a surprise to a
25:30
Speaker 1: lot of companies, whether they be startups or traditional brick
25:33
Speaker 1: and mortar banks and broker dealers who want to get
25:36
Speaker 1: into the crypto space. Now you said that this is
25:38
Speaker 1: something that the companies have to do. What are the
25:41
Speaker 1: what are the responsibilities of the people who are actually
25:45
Speaker 1: running the companies? Well, so it often these often come
25:48
Speaker 1: to a surprise, a surprise to these people because now
25:51
Speaker 1: they have not just tax, not just Treasury, but also
25:54
Speaker 1: even sanctions obligations. So you have to make sure if
25:57
Speaker 1: you're running a business now, you're not running a foul
26:00
Speaker 1: of the various laws that apply to traditional financial institutions. Again,
26:04
Speaker 1: traditional banks, they're accustomed to being regulated entities. They know
26:08
Speaker 1: for for decades how to respond to Treasury, how to
26:11
Speaker 1: respond to the compliance divisions. With expertise such as yourself,
26:16
Speaker 1: they can call it's an entire industry, right, Not so
26:19
Speaker 1: much in the crypto space with these startup companies that
26:21
Speaker 1: are you know, they're just they're just figuring out the technology,
26:23
Speaker 1: they're getting into it. It's exciting, they're getting investors, they're
26:26
Speaker 1: getting customers. They are often shocked at the compliance and
26:30
Speaker 1: regulatory burden that's imposed on then. And this is not
26:33
Speaker 1: a sleepy industry. Like I started off saying, the government
26:36
Speaker 1: is very much attuned to it. So they're looking to
26:38
Speaker 1: make examples, they're looking to delve into the books and
26:41
Speaker 1: records of these companies and figure out what's going on
26:44
Speaker 1: and are they in compliance. What are mixers and tumblers? Okay,
26:49
Speaker 1: so those are terms of art in the industry. They
26:53
Speaker 1: are specific technologies that provide for further anonymity, and they're
26:58
Speaker 1: red flags to be doubt for. Right. So part of
27:01
Speaker 1: the appeal of cryptocurrency is that it's largely anonymous. Right.
27:05
Speaker 1: The blockchain documents the transaction itself, but tying people's names
27:10
Speaker 1: to those transactions can be difficult because there's no universal directory.
27:14
Speaker 1: So what mixers and tunnelers do is they make it
27:17
Speaker 1: even more anonymous. Possibly that is appealing to bitcoin users
27:23
Speaker 1: for whatever reason that they want to stay you know,
27:25
Speaker 1: off the radar, but to regulators that's a red flag.
27:28
Speaker 1: So if I'm advising a client that's trying to get
27:30
Speaker 1: into the crypto space, I say, okay, if we're looking
27:32
Speaker 1: for red flags such as transactions to be wary of,
27:36
Speaker 1: or customers to avoid any involvement of a mixer or
27:40
Speaker 1: a tumbler or any other technology that further anonymizes the transaction.
27:45
Speaker 1: Is something from the company perspective you want to be
27:47
Speaker 1: wary of. Do you believe that online gaming is an
27:51
Speaker 1: area that is specifically targeted by regulators to watch out
27:56
Speaker 1: for these kinds of red flags. It's definitely something that
28:00
Speaker 1: is going to be on is on their radar. So again,
28:02
Speaker 1: if you are triaging, you want to get into the
28:04
Speaker 1: crypto business, right you want to think about what kind
28:06
Speaker 1: of counterparties, what kind of clients am I taking on?
28:09
Speaker 1: And an online gambling company comes to you, it's one
28:12
Speaker 1: of those red flags. Doesn't necessarily mean they're doing something wrong.
28:15
Speaker 1: They could be in full compliance if they're off shore
28:17
Speaker 1: and they're running their business in compliance with the laws
28:19
Speaker 1: of whatever jurisdiction they're based in. But do you, as
28:22
Speaker 1: a US company, as a bank or money services business,
28:25
Speaker 1: want to be doing business with an online gambling company
28:28
Speaker 1: knowing that they might be under the radar of US
28:31
Speaker 1: regulators who might take a lot of interest in that
28:33
Speaker 1: particular client. Thank you very much for being with us.
28:36
Speaker 1: Joe Marino, excellent partner White Collar Defense and Investigations Group
28:40
Speaker 1: for KED Walader based in Washington, d C. Giving us
28:44
Speaker 1: his take on the world of cryptocurrencies. Much appreciated. Thanks
28:50
Speaker 1: for listening to the Bloomberg P and L podcast. You
28:53
Speaker 1: can subscribe and listen to interviews at Apple Podcasts, SoundCloud,
28:57
Speaker 1: or whatever podcast platform you prefer. I'm pim Box, I'm
29:00
Speaker 1: on Twitter at pim Fox. I'm on Twitter at Lisa Abramo.
29:04
Speaker 1: It's one before the podcast. You can always catch us
29:07
Speaker 1: worldwide on Blueberg Radio