To explain the mechanism simply.

Suppose you had a index of 100 companys each with a market cap of 1 G$ for a total of 100 G$. You have passive investors owning 20 G$ of that index, amounting to 20% of the total, 20% of each company, and 200 M$ per company.

You then rotate out a company for a new one also worth 1 G$. The index is still 100 G$, but to match the index you are contractually required to sell your 20% ownership of the old company and are contractually required to buy 20% ownership of the new company.

However, the newly added company only released 5% of its shares to the public and the founder kept hold of the remaining 95%. Those fund managers are contractually obligated to buy 20% of the newly added company, but only 5% is available. Like a short squeeze, where the squeezer buys and holds supply so there are not enough purchasable shares to cover the shorts (obligated ownership), this is a financial divide by zero.

To get the remaining 15%, which they are contractually obligated to acquire, they must purchase from the founder. As they are in violation of their contract if they fail to acquire the remaining 15%, the founder now has complete control to dictate any price they want.

That is the scheme described: how to short squeeze retirement funds who do not even have shorts for fun and profit.

Note that this is a minor variation on my post on the same underlying topic here: https://news.ycombinator.com/item?id=47392325

This is wrong in multiple ways.

First: 5x5 is 25, not 20. So it's 25% rather than 20%

Second: they only have to buy the 25% of the listed shares.

To take your 1 Trillion example: if SpaceX has a total market cap of 1T, but only 500b get listed on NASDAQ, and the free float is 5%, the index will weigh SpaceX at 25% of the listed shares, which means it will be weighted at 500 * 0.25 = 125b.

And also note that index ETFs have tracking errors all the time (that's why arbitrage traders still have business!), and the ETFs themselves could also track the performance of SpaceX via derivatives instead of buying the stock. And I think, there are many investors of SpaceX who would like to sell some shares. Fund managers won't have an issue finding their phone numbers.

Yes, when SpaceX gets added to the index, it's going to skyrocket for just that reason. The other reason why SpaceX stock is going to skyrocket is because of the "infinite potential". After all, Elon is going to be God-Emperor of Mars, and how much is a piece of that worth?

The OP knows this and wants a window to profit from this squeeze. For the general public index owners, the sooner it's added to the index the better, minimizing the time that traders can front run this squeeze ahead of them.

Perhaps better it's not added to the indices at all, but as long as it's inevitable, the sooner the better.

But the real scenario is going to be different in two ways: Market capitalization of the new company will only be a small fraction of the index total, even after it's been inflated as indicated. And not all investors in companies on the index are index funds, which brings down the number shares needed to align a fund.

Maybe they propose the rule change because it adjusts for some other problematic effect of the existing index rules? The discontinuity might seem acceptable because it is unlikely to be reached according to their simulations.

> To get the remaining 15%, which they are contractually obligated to acquire, they must purchase from the founder. As they are in violation of their contract if they fail to acquire the remaining 15%, the founder now has complete control to dictate any price they want.

I can't imagine "any price they want" is quite right here. At the very least, shouldn't we expect underwriters and other stakeholders (in this case Nasdaq, Inc.) to negotiate option-contracts as part of the IPO deal to cover their future obligations?

Yes, it might be a "worse" deal than those initial 5% - though we don't even know that - but then institutional investors time horizons are typically much longer than 6 months. Unless you think SpaceX goes straight down to 0, it seems like a risky but calculated, long-term investment.

I agree they could be more transparent about it, but maybe they will send out a notice in the prospectus update?

>That is the scheme described: how to short squeeze retirement funds who do not even have shorts for fun and profit.

How many retirement funds use the nadasq 100 as the benchmark? The only thing that's really objectionable is the 5x multiplier, and so far as I can tell that's confined to the nasdaq 100 index. If the funds use a sane index without such shenanigans, it won't be affected nearly as much, and the whole debate just turns into the perennial question on whether [company] is overvalued and whether passive investors are being taken for a ride.

> To get the remaining 15%, which they are contractually obligated to acquire, they must purchase from the founder. As they are in violation of their contract if they fail to acquire the remaining 15%, the founder now has complete control to dictate any price they want.

This is not correct and I'm surprised this comment is upvoted to the top. The float is the float, nobody goes to buy shares that aren't available in the float.

Who is contractually obligated to buy?