Was the SEC Right to Block the Hertz Offering?

By John Banks

On June 15, Hertz announced plans to raise $500 million in a new share offering.

This was controversial because Hertz is in Chapter 11 bankruptcy, the creditors have dibs on the assets, and the new shares have statistical near-certainty of being worth zero.

We wrote about this fiasco on June 17. That same day, the Securities and Exchange Commission (SEC) put a stop to the $500 million offering by announcing they had comments on the disclosure document.

(If you are a U.S.-listed company preparing a new share offering, and Jay Clayton, the Chairman of the SEC, goes on television to announce “comments” on your disclosure, you stop everything you are doing.)

Hertz shares (symbol: HTZ) were halted for three hours due to the SEC’s action, which effectively blocked the $500 million share offering.

As of this writing the offering is in limbo, and probably dead, and yet HTZ is still up more than 350% from its May 26 lows of 40 cents, because that is how Robinhood investors roll.

The whole situation is bizarre, which is perhaps par for the course in 2020.

But with the SEC stepping in, a new question arises: Should Hertz have been allowed to sell the shares?

Or, to put it another way, was the SEC right to stand in the way?

There are different ways to look at the question. On balance, the SEC probably did the right thing.

The pro-Hertz argument — which would say let the $500 million share sale go forward — is a combination of “free markets for free citizens” and “caveat emptor.”

That is to say, if an action in public markets is legal and fully disclosed, investors should be free to make their own choices. What Hertz wanted to do was, in fact, legal and fully disclosed, so why stop them?

By this rationale, Hertz is being transparent and should not be kept from the marketplace. Sure, the company is bankrupt — but they aren’t trying to hide it. The stock is on the way to being delisted by the NYSE — but they aren’t hiding that, either.

Then, too, no company in Chapter 11 bankruptcy, with a huge debt overhang and the bonds trading at a deep discount, has ever issued $500 million worth of new shares before — but hey, it’s 2020.

In the prospectus, Hertz made very clear the shares were likely to be worthless. The document even used the term “worthless” as a specific term, repeatedly throughout the text.

So, given all that, if day traders and retail gamblers on Robinhood (or wherever) still want to own HTZ and trade it, why stop the share float from expanding? Why not let the bagholders learn a lesson?

There are at least two arguments against the “free markets and caveat emptor” approach.

The first argument against the Hertz offering — and in favor of the SEC stepping in — is that vulnerable people, who don’t have a lot of money, would potentially be hurt.

If Hertz can extract funds from retail investors who aren’t paying attention, or who don’t understand the implications of Chapter 11 bankruptcy, then maybe it becomes open season on such investors.

And the average Hertz investor, at this point, is not a moneybags by any means.

The Associated Press reported on Hertz investors like 22-year-old Bryan Quevedo, a Los Angeles delivery driver who put $1,000 worth of his $1,200 stimulus check into HTZ, and later added $450 more, and Sherrie Hardy, a 33-year-old Michigan worker who invested her and her fiance’s stimulus checks into Hertz “with no plans to sell.”

So small-time retail investors could be hurt by a Hertz collapse. One could say, rightly, that they should have known better, or listened to people shouting in their ears. But the optics would still be horrible for a bankrupt company to have been seen pulling $500 million from such people.

Worse still, the Hertz fiasco threatens to erode trust in public markets. The problem with “caveat emptor” is not so much one of libertarian ethics. It is more about how comfortable the average investor feels putting their savings to work in stocks.

In a world where Hertz and other companies can get away with truly crazy stuff, the SEC might reason, a larger percentage of investors might start fearing booby traps around every corner.

This would be bad for public markets. Investors might start to wonder, “What else can they get away with that is technically ‘legal’ but could badly hurt me?” 

Then, too, the SEC likely wanted to avoid the spectacle of Hertz actually going to zero — with the NYSE delisting the stock — and the media piling onto the story, noting with horror that a last $500 million had been snatched from the pockets of the “little guy” as the creditors left town.

That wouldn’t be helpful.

Shenanigans and tomfoolery within the four corners of the law is one thing. An ugly spectacle that erodes trust in public markets — even more than it has already been eroded — is another.

The SEC was probably wise to ice the deal at the last minute — though it still counts as one for the history books.