I like taking cheap shots at the SEC as much as the next guy, maybe more, so when I see a headline like “The SEC is investigating Michael Milken” it’s tempting to say “oh, yeah, he supposedly did some insider trading in the mid ’80s, so it makes sense that the SEC would be getting to it now.”1 But no, turns out they got that one already; this is new (newish) news:
Milken’s settlement with the SEC for his role in the 1980s Wall Street scandals allows him to manage his own money. But he is banned from acting as an investment advisor or broker. The SEC is looking at whether Milken is violating that ban by effectively acting as a manager of Guggenheim [Partners] investments beyond his own, according to sources familiar with the investigation. The question is: Has Milken provided advice in exchange for some form of compensation? The SEC is looking at a number of transactions that Milken has done with Guggenheim. In one instance being investigated, Milken and the firm jointly invested in an energy company called Milagro, which says the infusion helped it buy the Gulf Coast operations of Petrohawk Energy for $825 million in 2007.
From this brief description it sounds like there is a genuinely interesting issue here, which is: what is advice? Also, what is compensation? So two interesting issues I guess.2 One could imagine a scenario where Milken sources the Milagro investment for himself, the company needs more money, and Milken talks about the idea with his guys at Guggenheim, who after all manage some $800 million of his money and with whom he chats frequently. Guggenheim invests alongside Milken, and because Milken came up with the idea and had the contacts, Guggenheim agrees that he gets better terms – say, more of the deal for less cash – than do Guggenheim and its non-Milken clients.3 Is that just Milken making a smart investment and negotiating good terms for himself, while also bringing in Guggenheim because he likes them or needed them to complete the deal or both? Or is it Guggenheim giving him “some form of compensation” in exchange for his “advice” on the deal?
I don’t know, but honestly: who cares? You might be interested in these questions out of idle curiosity, or for your own nefarious purposes,4 but why would the SEC want to make a fuss over them? Banning someone from being an investment advisor or broker is a tricky beast, much harder than banning them from being an airplane pilot or a hairdresser, because at their core “investment advising” and “brokering” consist of saying “hey, this is a good investment,” or “hey, Joe, have you met Sue?,” respectively. And there’s a certain constitutional squickyness about preventing people from saying stuff. Here you can read a man who was banned from the securities industry opining on the goodness of an investment; I submit to you that the SEC is not going to come after him for it. (Nor should they.)5
Given that trickiness it’s hard to see why the SEC should go after Milken just for foot-faulting from “investor with ideas” into “investment advisor.” Unless, I suppose, other Guggenheim investors were harmed. I’m sort of a willing-buyer-willing-seller kind of guy when it comes to private equity investors, for the most part, so I’m not too troubled. I believe that Guggenheim was looking for the best possible investments for its investors, and a 25% IRR on a deal with Milken – even one where he effectively gets a promote – is better than a 15% IRR elsewhere.
But the SEC might worry if Milken was getting that compensation, or pseudo-compensation, or whatever, in a way that was undisclosed to Guggenheim’s other investors. Giving him some arguable form of compensation without telling investors looks shadier than just saying “we have a sub-advisor contract with Mike Milken where we pay him $X,” or disclosing to coinvestors in Milagro that Milken was getting a promote for sourcing the deal. It sounds like that’s what they’re worried about:
[Guggenheim president Todd] Boehly has been subpoenaed by the SEC, and the firm has provided thousands of trading records and e-mails to investigators. The agency has contacted Guggenheim clients about Milken. SEC investigators are in regular communication with Guggenheim, but so far the probe — which has continued for two years — hasn’t resulted in any formal action.
Still, seems a little harsh to come after him over that. In SEC offering documents and merger fairness opinions, banks like to go overboard in disclosing potential conflicts of interest and things that look like compensation, because they don’t want there to be any dispute that any quasi-compensation-looking thing was an undisclosed payment. But Guggenheim and Milken couldn’t do that. A disclosure like “FYI, just to be clear, Mike Milken invested alongside us, and brought us into the deal, and so he’s getting more of the equity,” or whatever, would look a lot like an admission that Milken was acting as a broker or investment advisor. Which is what he wasn’t allowed to do in the first place.
The SEC faced a five-year statute of limitations on bringing a case. The agency alleged the market timing took place between 1999 and 2002, but it didn’t bring a complaint until 2008. The defendants, Marc J. Gabelli and Bruce Alpert, argued the agency’s five-year clock ran from the time of the alleged offense, but the SEC said the clock should have started later, in late 2003, when it says it discovered the conduct.
The high court flatly rejected the SEC’s arguments. “We have never applied the discovery rule in this context,” Chief Justice Roberts wrote in an 11-page opinion.
So as a legal matter I agree with the unanimous Supreme Court (edgy of me I know), but never mind that. Notice the SEC discovered misconduct in 2003 and brought the case in 2008. That’s not great, no?
4. My nefarious purposes include building a Volcker-compliant private equity business within a bank. Exercise for the reader: construct such a business using coinvesting rather than explicit management agreements.
5. I suppose you can prevent them from getting paid for saying stuff – it would probably be a no-no for Milken to get an explicit salary from Guggenheim – but the fact that he’s investing his own money makes that harder to trace. There’s nothing wrong with one investor in Guggenheim’s hedge funds, or in Milagro for that matter, getting a better deal than other investors because of some value that they bring to the table, as long as that value isn’t “investment advice.”
Anyway presumably Blodget is making money on Business Insider, or at least planning to.