Posts Tagged ‘investment’
“The opposite of knowledge is not ignorance, but deceit and fraud”*…
In follow-on to our last look at corporate fraud, a provocative piece by Byrne Hobart…
This paper has been getting some attention lately for its eye-catching estimates: 11% of publicly traded companies are committing securities fraud every year, with an annual cost of over $700bn…
[There follows an illuminating discussion of lessons that can be drawn for the follow-on to Arthur Andersen’s collapse after the implosion of Enron, the rules/regulations developed then to prevent similar public company frauds, and a consideration of whether corporate fraud has waned– at least among publicly-traded companies– and is perhaps a little less wide-spread than the paper argues…]
But since fraud is a human problem, and not purely a matter of better accounting standards, it’s not likely to have just gone away. But if the rate of accounting problems among big publicly-traded companies is lower than the 11% number cited in the paper, the question isn’t “why did it disappear?” but rather “where did it go?” And we can take our list of trends against fraud and invert them:
• Sarbanes-Oxley does apply to private companies, but only on the penalty side, not the disclosure side. But accounting frauds in private companies are often less visible; many investments go to zero, anyway, and it’s less embarrassing for everyone involved not to say why.
• There are no short-sellers in private markets. There have been efforts here, but they don’t work out because the market doesn’t clear (“everyone wanted to short Theranos, Dropbox and WeWork”). The closest you can get to shorting is to pass on a round and then brag about it later. Big deal: I didn’t invest in FTX, either.
• There’s less data available on private companies, though the rise of alternative data tools means it’s easier to get decent proxies.
• Startups are not expected to return capital. It’s a bad sign if they do. They’re often valued either based on strategic considerations or starting with a multiple of sales—a dollar of sales is much easier to fake than a dollar of earnings or cash flow, so the incentive to do so is strong.
• The idea market in startups is liquid when it comes to successes, but it would be pretty tacky for a VC to write a long blog post explaining why they passed on a live deal. (That memo may exist internally, but to the extent that it’s shared it’s in the form of a quick summary over Twitter DM or Signal.)
JPMorgan Chase’s writedown of their fintech acquisition Frank is a great case study in all of these forces. The NYT has a good story digging into the details: Frank’s founder is a serial exaggerator whose self-promotion veered into fraud (once again, if the rate of continuous improvement in public perception to be maintained exceeds what the fundamentals can deliver, compound interest works its ruthless magic). The company was valued at a high multiple of what turned out to be a flexible metric, total email addresses captured. And there were alternative datasets that could have pointed to problems: given the likely number of student aid applicants in the US, Frank’s numbers implied that it had reached near-dominant market share in the category with little marketing. Meanwhile, its monthly site traffic was not enough to have acquired that sizable a customer list over Frank’s entire existence. So it could have been caught, if the buyer had been looking for fraud. But one paradox of frauds and cheats in general is that lying is less than half the work—most of the effort is in appearing not to need to lie. The more impressive a company looks, the more embarrassing the basic due diligence questions are.
A down market and a series of high-profile failures might give private markets the same kind of natural experiment that Arthur Andersen’s failure did for public markets. Due diligence checklists will get longer and more thorough, and new funding rounds will feel more like a cross-examination and less like a party. One reason for a high base rate of fraud is that at least some of it stems from inattention rather than malice—the Arthur Andersen study finds that most of the frauds were fairly minor, and could be more the result of poor internal metrics than of intent to mislead. But either way, standards will get higher, and private companies will need to step up their efforts accordingly…
Has the primary locus of corporate fraud moved from public to private companies? “Where Fraud Lives and Why,” from @ByrneHobart.
[Image above: source]
* Jean Baudrillard
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As we do due diligence, we might recall that it was on this date in 2016 that the Centers for Medicare and Medicaid Services (CMS) sent a letter to Theranos after an inspection of its Newark, California, lab. The investigation, which took place in the fall of 2015, had found that the facility did not “comply with certificate requirements and performance standards” and caused “immediate jeopardy to patient health and safety.” This followed on three exposes on Theranos in the Wall Street Journal (in October [here and here] and December of 2015) and a critical FDA report. Things unraveled from there: in March, 2018, Thearnos, CEO Elizabeth Holmes, and President Sunny Balwani were charged by the FCC with fraud. Three month later, a federal grand jury indicted both Holmes and Balwani on two counts of conspiracy and nine counts of wire fraud, finding that the pair had “engaged in a multi-million dollar scheme to defraud investors, and a separate scheme to defraud doctors and patients.” Theranos closed in 2018. Holmes was convicted and sentenced to 11 years in prison for her crimes (a sentence she is appealing); Balwani, to 13 years.
Theranos was a private company, funded by investors including Henry Kissinger, Betsy DeVos, Carlos Slim, and Rupert Murdoch.
Elizabeth Holmes found guilty (source)
“Fortune favors the brave”*…
Cryptonauts
History is filled with almosts. With those who almost adventured, who almost achieved, but ultimately, for them it proved to be too much. Then, there are others. The ones who embrace the moment, and commit. And in these moments of truth . . . they calm their minds and steel their nerves with four simple words that have been whispered by the intrepid since the time of the Romans. Fortune favours the brave.
Adam Tooze been mulling these lines ever since he first saw the commercial for crypto.com done by Matt Damon during a football game back in the autumn of 2021:
Now he unpacks the backstory…
The phrase “fortune favors the brave” is generally attributed to Pliny the Elder, the obsessive scholar and Roman Fleet commander. He uttered it on the fateful night of August 24 79 AD when the volcano Vesuvius erupted and buried Herculaneum and Pompeii. As recalled 25 years later, at the request of Tacitus, by his nephew Pliny the Younger, Pliny the Elder ignored the advice of his helmsman and steered directly towards the eruption, hoping to pull off a famous rescue. Instead, he was overwhelmed, lost control of the situation and finally, in ridiculous circumstances, succumbed to the fumes, becoming one of the thousands of casualties…
You might say that evoking Pliny’s famous phrase was more apt than Damon or crypto.com realized.
…
But Vesuvius does not belong only to the classical tradition. In the 18th century, the volcano would become one of the quintessential sites of the romantic sublime…
A fascinating “close read” of an influential TV spot, its intellectual antecedents, and its (intended and unintended) message: “Fortune Favors the Brave: the making of crypto ideology, Vesuvius, and the romantic sublime,” from @adam_tooze.
* Pliny the Younger, “quoting” Pliny the Elder
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As we iron out the irony, we might recall that, on this date in 2008, the Dow Jones Average fell 8%, continuing a slide that had begun with the collapse of Lehman Brothers and other smaller financial firms. The DJI was at 8,149.09, roughly the midpoint (in both timing) of the sub-prime lending crisis and the Dow’s 54% fall to 6,469.95 (in March, 2009) from its peak of 14,164 on October 9, 2007. The recovery, of course, took much longer.
“Location, location, location”*…
Adam Tooze on the biggest vulnerability in the global economy…
In this precarious moment – in the fourth quarter of 2022, two years into the recovery from COVID – of all the forces driving towards an abrupt and disruptive global slowdown, by far the largest is the threat of a global housing shock…
In the global economy there are three really large asset classes: the equities issued by corporations ($109 trillion); the debt securities issued by corporations and governments ($123 trillion); and real estate, which is dominated by residential real estate, valued worldwide at $258 trillion. Commercial real estate ($32.6 trillion) and agricultural land add another $68 trillion. If economic news were reported more sensibly, indices of global real estate would figure every day alongside the S&P500 and the Nasdaq. The surge in global house prices in 2019-2021 added tens of trillions to measured global wealth. If that unwinds it will deliver a huge recessionary shock.
In regional terms, as a first approximation, think of global real estate assets as split four ways, with the US, China and the EU each accounting for c. 20-22 percent and 35 percent or so belonging to the rest of the world.
The housing complex is at the heart of the capitalist economy. Construction is a major industry worldwide. It is one of the classic drivers of the business-cycle. But beyond the constructive industry itself, the influence of housing as an asset class is pervasive. Compared to equities or debt securities, residential real estate is owned in a relatively decentralized way. Homeownership defines the middle class. And for the majority of households in that class, those with any measurable net worth, the home is the main marketable asset.
Middle-class households are for the most part undiversified and unhedged speculators in one asset, their home. Furthermore, since homes are the only asset that most households can use as collateral, they pile on leverage. For households, as for firms, leverage promises outsized gains, but also brings with it serious risks in the event of a downturn. Mortgage and rental payments are generally the largest single item in household budgets. And household spending, which accounts for 60 percent of GDP in a typical OECD member, is also responsive to perceived household wealth and thus to home equity – the balance between home prices and the mortgages secured on it. For all of these reasons, a surge in mortgage rates and/or a slump in house prices is a very big deal for the world economy and for society more generally…
More background and an assessment of the outlook: “The global housing downturn,” from @adam_tooze.
For Tooze’s follow-up piece on the risk inherent in the $23 trillion US Treasury market, see here.
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As we mortgage our futures, we might recall that it was on this date in 1914 that the Federal Reserve Bank of the U.S. was opened. In actuality a network of 12 regional banks, joined in the Federal Reserve System, they oversee federally-chartered banks in their regions and are jointly responsible for implementing the monetary policy set forth by the Federal Open Market Committee.
In that latter role, they are central to the housing market in that they set interest rates and purchase mortgage securities from Fannie Mae and Freddie Mac (Government-Sponsored Enterprises in the mortgage market). At this point the Fed owns about a quarter of the mortgage-backed securities issued by Fannie Mae and Freddie Mac.
The Federal Reserve Banks in 1936 (source)
“You’re mugging old ladies every bit as much if you pinch their pension fund”*…
Who benefits from the commercial biomedical research and development (R&D)? Patients-consumers and investors-shareholders have traditionally been viewed as two distinct groups with conflicting interests: shareholders seek maximum profits, patients – maximum clinical benefit. However, what happens when patients are the shareholders?…
Adding investments by governmentally-mandated retirement schemes, central and promotional banks, and sovereign wealth funds to tax-derived governmental financing shows that the majority of biomedical R&D funding is public in origin. Despite this, even in the high-income countries patients can be denied access to effective treatments due to their high cost. Since these costs are set by the drug development firms that are owned in substantial part by the retirement accounts of said patients, the complex financial architecture of biomedical R&D may be inconsistent with the objectives of the ultimate beneficiaries…
It has been estimated that of the total $265 billion spent annually on biomedical research worldwide, over a third – $103 billion comes from public sources. Nevertheless, as public input capital is allocated predominantly into early stage research, nearly all output – medicines – is ultimately brought to the market by private firms. Importantly, these firms are not independent agents. They have owners-shareholders to report to. Until the end of the previous century the major type of owners-shareholders were individual households. At the turn of the millennium, however, they have been displaced by institutional investors, the largest of which are public retirements schemes or quasi-public funds, such as occupational pensions.
First, government money underwrites the basic R&D that goes into drug discovery and development, then public pension monies fund the private companies that bring those drugs to market. As the private companies are solving for highest profits, as opposed to optimal public health, those drugs are often priced out of the reach of the very people whose pension contributions funded their development. Drugs “priced out of reach” is certainly not a new phenomenon; AIDS drugs (to take one example) were priced by Western pharma companies at prices that rendered them inaccessible to most citizens of low-income countries in Africa and Asia. The pensioners in wealthy nations were, effectively, living off of the misery of those in poorer companies.
But the dynamic has continued, deepened– and come home to roost. Now patients in high-income countries are denied access to effective treatments due to their high cost, while these costs are being set by the drug development firms, owned in substantial part by the retirement accounts of those same patients, and benefiting from direct and indirect governmental support.
Investing in one’s own misery– the painful irony of pharma funding: “Pension and state funds dominating biomedical R&D investment: fiduciary duty and public health.”
[Image above: source]
* Ben Elton, Meltdown
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As we untangle unintended consequences, we might send healthy birthday greetings to Charles Value Chapin; he was born on this date in 1856. A physician and epidemiologist, he was a pioneer in American public health. He co-founded in first bacteriological laboratory in the U.S. (in 1888) in Providence, were he was Superintendent of Health– a position he held for 48 years. In 1910, he established Providence City Hospital where infectious disease carriers could be isolated under aseptic nursing conditions; his success inspired similar health control measures throughout the U.S. A professor (at Brown) and prolific writer, his impact on health policy and practice was so broad that he was hailed as “the Dean of City Public Health Officials.”
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