WEBVTT - The ETF Story 2: The Report

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<v Speaker 1>The market has been going up for a while. Nothing

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<v Speaker 1>goes up forever. If you have been away from your

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<v Speaker 1>television set and haven't heard about the stock market, this

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<v Speaker 1>was it. The market declined to practice. It was probably

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<v Speaker 1>the scariest time of when in my sixteen years to

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<v Speaker 1>the SEC that Monday and into Tuesday. But the idea

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<v Speaker 1>was to create a factual reconstruction of what happened. Meanwhile,

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<v Speaker 1>in downtown New York you had the American Stock Exchange

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<v Speaker 1>and that's where Nate Most and Steve Bloom we're working together.

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<v Speaker 1>These are market nerds. So we were hoping that day

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<v Speaker 1>would take debate, so to speak, and the m X did.

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<v Speaker 1>This is Tralians Presents. I'm Joel Weber. Over the course

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<v Speaker 1>of this podcast, we're going to be sharing the story

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<v Speaker 1>behind the e t F. In our first episode, we

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<v Speaker 1>got into what happened on October nineteenth, or Black Monday,

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<v Speaker 1>when the stock market crash. Every American at this day

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<v Speaker 1>of the game needs to get the house in order

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<v Speaker 1>and also the response of the federal government and regulators.

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<v Speaker 1>I'd say for the next three months through early January,

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<v Speaker 1>a bunch of us had two jobs, which was, you know,

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<v Speaker 1>investigating what happened and writing the report up and doing

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<v Speaker 1>our day job. So the FEDS want to make sure

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<v Speaker 1>this never happens again, and the SEC starts digging to

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<v Speaker 1>find answers and a way to prevent another crash like

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<v Speaker 1>this one, which brings us back to these two guys,

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<v Speaker 1>Nathan Most and Stephen Bloom. Nate Most was in his

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<v Speaker 1>seventies with the background in physics and commodities trading, among

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<v Speaker 1>other things. And then there's Stephen Bloom who at twenty

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<v Speaker 1>seven was fresh out of Harvard with the PhD in economics,

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<v Speaker 1>and the two of them were teamed up at AMS

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<v Speaker 1>to create innovative products for the exchange. They had just

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<v Speaker 1>read the SEC Market break Report, and we're beginning to

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<v Speaker 1>toy with an idea for a new financial tool, one

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<v Speaker 1>modeled after a section that they'd read in the report.

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<v Speaker 1>What the SEC effectively did was to provide the sketch, right,

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<v Speaker 1>It's almost like drawing on paper of what they would

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<v Speaker 1>envision as a market basket instrument. So what Most in

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<v Speaker 1>Bloom did was to take this sketch and fill out

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<v Speaker 1>all the colors, make it into sort of a full

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<v Speaker 1>blown painting, if you will. But instead of a painting.

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<v Speaker 1>It was a legit product that was given back to

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<v Speaker 1>the SEC that was above and beyond what they initially

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<v Speaker 1>put down in their sketch. And here's that initial sketch

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<v Speaker 1>read by one of its artists who you'll remember from

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<v Speaker 1>episode one, the secs, Howard Kramer. We suggest that an

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<v Speaker 1>alternative approach be examined. Presently, program trades must be broken

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<v Speaker 1>up and distributed around the stock floor, with the resulting

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<v Speaker 1>substantial transaction costs and effects discussed above. The creation, however,

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<v Speaker 1>of one or more posts where the actual market baskets

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<v Speaker 1>could be traded, might alter the dynamics of program trading.

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<v Speaker 1>The availability of basket trading on the n y C

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<v Speaker 1>would in effect restore program trades two more traditional block

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<v Speaker 1>trading techniques. The basket specialists would be able to identify

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<v Speaker 1>the nature of each trade. We are hopeful that this

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<v Speaker 1>would encourage block positioners to again become active in providing

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<v Speaker 1>capital to position the program blocks, while arbitrage would continue

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<v Speaker 1>to flow directly to the individual stocks to maintain their

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<v Speaker 1>pricing efficiency. Other institutional trades could be focused on the

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<v Speaker 1>basket posts, where the specialists and trade and crowd could

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<v Speaker 1>provide an additional layer of liquidity to the system and

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<v Speaker 1>cushioned somewhat the individual stocks from the intra day volatility

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<v Speaker 1>caused by program activity. Okay, that was a little dense, Eric,

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<v Speaker 1>Can you help us make sense of what that means.

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<v Speaker 1>What they're basically outlining here is, Look, you're gonna have

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<v Speaker 1>a product that represents a bunch of stocks, it's gonna

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<v Speaker 1>be traded by market makers, and it's gonna be physically

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<v Speaker 1>backed after the SEC publishes this thing. Grammer says he

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<v Speaker 1>remembers getting a slew of phone calls about the report.

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<v Speaker 1>The report came out with some time in early eighty eight,

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<v Speaker 1>so I'm guessing, you know, just just a guess, you know,

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<v Speaker 1>six months later, eight months later or something like that.

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<v Speaker 1>Then he hears from most in Bloom and they're like, hey,

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<v Speaker 1>you know, we we noticed that you have this suggestion

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<v Speaker 1>in the report, and we'd like to hear a little

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<v Speaker 1>bit more about it. And there are some discussions back

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<v Speaker 1>and forth. I highly respected name Moos and Steve Bloom.

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<v Speaker 1>They were rocket scientists at that time and in that

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<v Speaker 1>sense of the word, and they were really good at

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<v Speaker 1>and adapted developing the products. Myself and others in the

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<v Speaker 1>division had some discussions, and at some point, I don't

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<v Speaker 1>remember when, they probably sent in a draft prototype and

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<v Speaker 1>or draft of what they were talking about. Creamer and

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<v Speaker 1>the others at the SEC are not the only ones

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<v Speaker 1>with whom they share this prototype. Most took the idea

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<v Speaker 1>to Jack Bogel, who was running Vanguard at the time.

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<v Speaker 1>Bogel says he gets a cold call from Nate Most.

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<v Speaker 1>And it's important to note here that Jack Bogel may

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<v Speaker 1>be the most influential investor of all time, even more

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<v Speaker 1>so than Warren Buffett. Bogel basically invented indexing and founded

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<v Speaker 1>the behemoth Vanguard, whose low cost mutual funds have helped

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<v Speaker 1>millions of Americans retire. So it's a big deal to

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<v Speaker 1>just cold column. And he has very clear thoughts about

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<v Speaker 1>Wall Street and investing, namely, watch the fees, diversify, focus

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<v Speaker 1>on the long term. But Bogel says Nate was different

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<v Speaker 1>than all the other cold colors he's had through the years.

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<v Speaker 1>But he was not a promoter type. You could warm

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<v Speaker 1>up to Nate Most and maybe he's he more of

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<v Speaker 1>my type of guy than some flashy US star salesman,

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<v Speaker 1>if you will. So, Most gives Bogol an outline of

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<v Speaker 1>his proposal. The proposal was that we would let him

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<v Speaker 1>use our s and P. Five hundred for his spire

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<v Speaker 1>as as I guess it was called. Man, anyone who

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<v Speaker 1>knows Jack Bogel knows that that's like, you know, I'm

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<v Speaker 1>gonna say this, that's borderline insulting. I mean, he's so

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<v Speaker 1>anti trading. He wants you to will win the fund

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<v Speaker 1>and like never touch it for twenty five years. And

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<v Speaker 1>he said he wanted to come down and talk to

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<v Speaker 1>me about and I said, fine. He seemed like a

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<v Speaker 1>nice person. And he came into my all of a

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<v Speaker 1>sudden the Monday morning, and he was not a nice person.

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<v Speaker 1>He was the nicest person I've ever met in my life.

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<v Speaker 1>And I said to however, Nathan, Mr mos Nate, they

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<v Speaker 1>proposing you sent me last week doesn't work, but has

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<v Speaker 1>these three flaws, and you're gonna have to get them

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<v Speaker 1>fixed before you can never do anything with it. The

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<v Speaker 1>way he told me the story later was he got

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<v Speaker 1>back on the train and fixed the three things and

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<v Speaker 1>got on the next train to stay stree Bois says

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<v Speaker 1>he doesn't remember what those three things were. Wasn't that

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<v Speaker 1>the big concern was you're gonna just rack up costs

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<v Speaker 1>for the linehold people if you'd let this thing trade

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<v Speaker 1>all the time. You know, Eric, I'm sorry, but A

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<v Speaker 1>just taking his toll. Hey. He remembers the meeting though,

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<v Speaker 1>but a nice meeting. We parted friends, and I like that.

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<v Speaker 1>You know, you can have different ideas with people in Jonathan,

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<v Speaker 1>what our ideas ideas or Diamond doesn't and friends are

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<v Speaker 1>much more important. So whether or not it was on

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<v Speaker 1>that train ride back from meeting with Bogel, Most goes

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<v Speaker 1>back to the drawing board, or more specifically, back to

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<v Speaker 1>his days of running the Pacific Commodities Exchange. And there

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<v Speaker 1>you had these warehouses that would store the commodities. Let's see,

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<v Speaker 1>you had like soybean oil, and you would take your

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<v Speaker 1>soybean oil in store it in the locker, and you

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<v Speaker 1>get a receipt, and the receipt then you could trade

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<v Speaker 1>with somebody without having to move merchandise. So Most thought, well,

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<v Speaker 1>what if we took that model of commodity warehouse receipts

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<v Speaker 1>and instead of the actual physical commodity, we just made

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<v Speaker 1>it in the sp So this concept of the receipt

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<v Speaker 1>trading back and forth, that trading does nothing to the

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<v Speaker 1>soybean oil sitting in the warehouse or in this case

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<v Speaker 1>the stocks. That is a way to keep the investors

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<v Speaker 1>from incurring costs from people who are trading. Most in

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<v Speaker 1>Bloom now have their idea. It's been vetted. Now they

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<v Speaker 1>have to name it, and they go with spider SMP

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<v Speaker 1>for the snp F and d R for depository receipts.

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<v Speaker 1>And to me, that is the heartbeat of the e

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<v Speaker 1>t F and that's what made it a very special product.

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<v Speaker 1>And you have to know that at this time Nate

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<v Speaker 1>Most and Steve Bloom aren't the only people thinking about

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<v Speaker 1>index is being able to be traded like that. There

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<v Speaker 1>were several other types of versions, but most of them

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<v Speaker 1>had a variety of issues. And just like any invention,

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<v Speaker 1>you know, Steve Jobs and Wozniak weren't the only two

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<v Speaker 1>guys in a garage. There were plenty of people in

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<v Speaker 1>Silicon Valley working on things like that. They just happened

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<v Speaker 1>to just get the right way to do it. And

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<v Speaker 1>in this case it was the creation redemption mac is.

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<v Speaker 1>I think that gave spy its edge. That creation redemption

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<v Speaker 1>mechanism is ultimately what they put into the SPY filing.

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<v Speaker 1>They followed it with the SEC and then they had

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<v Speaker 1>to wait. And this is where a superhero comes in.

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<v Speaker 1>Spider Woman. I got that nickname right around the time

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<v Speaker 1>we launched Spiders. You may remember her from episode one.

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<v Speaker 1>Her name is Kathleen Moriarty. My legal assistant, Debbie Ferraro,

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<v Speaker 1>gave me a present. It was a front cover of

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<v Speaker 1>a comic book with like the Hulk going after some

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<v Speaker 1>huge monster, and she doctored it all up and she

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<v Speaker 1>made the Hulk me, and she made the Monster of

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<v Speaker 1>the SEC, and she changed all the numbers to make

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<v Speaker 1>SEC things and you know, sort of tongue in cheek,

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<v Speaker 1>and then she wrote Spider Woman on the top of it,

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<v Speaker 1>and it's still in my office. Next time on Trillions,

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<v Speaker 1>we'll hear more from Spider Woman about what it was

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<v Speaker 1>like to actually design Spy. People were afraid that a

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<v Speaker 1>lot of arachnophobes would be turned off and not want

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<v Speaker 1>to buy the E t F, but we ultimately called

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<v Speaker 1>it Spider anyway. Oh and in case you are wondering

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<v Speaker 1>what Jack Bogo thinks of ETS, well, in E t

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<v Speaker 1>F it is just another form of index fun, a

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<v Speaker 1>sort of bastardized forum for the one of a better word.

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<v Speaker 1>Thanks for listening to Trillions Presents until next time. You

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<v Speaker 1>can find us on the Bloomberg Terminal, Bloomberg dot com,

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<v Speaker 1>Apple podcast, and where else you listen to podcasts. Trillions

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<v Speaker 1>Presents is produced by Jordan Belle. Francesca Levy is the

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<v Speaker 1>head of Bloomberg Podcast