Year: 2019

Cruising Down the Information Highway

Technology ,
information highway

It is virtually impossible to explain what the world was like, pre-internet, to a younger generation that is so totally enmeshed in it. The cultural and economic effects of the internet permeate everyday life in many different ways. Unless you are familiar with the world in the days before the internet it may be difficult to get some perspective. 

Personal computers did not really become a mainstream reality until the 1980s. As the market developed through the 1970s, many people looked at computers as computational machines. We had just put men on the moon using slide rules. At that time, much of the focus was on big computers solving far more complicated problems.

There were certainly articles that showed people were thinking about computer applications for business. Word processing and basic bookkeeping applications were introduced. Bar codes made controlling inventory easier. Suffice it to say that the pre-internet world functioned well enough to invent the internet and help it develop.

CompuServe

By the mid-1990s, I was an early member of CompuServe. At the time, CompuServe offered little more than a series of simple bulletin boards, labeled by subject, where anyone could post a message or reply to one. I would dial-in after dinner for an hour or so most evenings.

I read through a lot of posts and comments for several years. At no prior point in history could any one person be exposed to so many different voices emanating in so many different places funneled into their home.

Originally there were no pictures attached but there was little doubt that both still pictures and moving pictures would be coming soon. The technologists assured us that there would be an ever growing amount of bandwidth (traversing fiber-optic cables, they thought) so that we could send all the bits of data that were collected anywhere in an instant. 

I remember discussing CompuServe and the “world wide web” with my students. There was a general feeling that it was a positive development. The students (and many of the “experts”) saw the internet as a way to give a lot of people access to a lot of information. A lot of people believed that all this information should be free and available to everyone. Terms like “information highway” were commonplace.

There were ongoing projects to put all the books in the Library of Congress “on-line”. There were predictions that the internet would provide walking tours of the great art museums of the world; that people would “sit” in lectures and watch performances in concert halls remotely in real time or from a catalog.    

It was obvious then that the internet would evolve to the point where my students could sit through the same course in freshman Economics at Harvard, Yale or the London School of Economics without leaving home. I, and others, saw education as something that would be available to the masses who would sit in front of a screen in their pajamas. I was surprised when the students rejected that idea.

I had this discussion with several classes over a period of a few years and year after year the students seemed reluctant to get their education at home and give up the “college experience”. It took a while for me to understand that they were referring to the interpersonal relationships that they were having with their classmates. (Do I have to spell it out?)

Dotcoms

When the internet finally opened for business in earnest with the dotcoms in the late 1990s there was certainly a sell side perspective. A lot of people saw the internet as a tool for advertising and direct to consumer distribution. Early websites were the equivalent of the Sears or LL Bean catalogs reproduced as pages to a website with a telephone number if you wanted to place an order.   

Pioneers like Jeff Bezos did the math. Selling anything direct to consumers eliminated the costs of a typical retail operation starting with the rent and retail employees. Bezos sold books because the bookstores with which he competed had high inventory costs and low inventory turn-over.

As early as 1995 a lot of people were beginning to predict the demise of retail stores and the malls they occupied. That trend is certainly evident today but it has been 25 years in the making and the parking lot at the local mall was still overcrowded on the day after Thanksgiving this year.

Napsters

I think the first truly disruptive website was Napster. The internet was specifically intended to facilitate the dissemination of information. When the recording industry pushed back against Napster it was saying that it “owned” the information and wanted to control it and people started to look at information a little differently.

Throughout the 1990s, as people were thinking about the internet, its uses and effects, no one was thinking about what has become known as “social media”. Facebook and the other social media platforms have become all pervasive in commerce and in social interaction and very few people saw it coming.  

information highway

Social media is also personal media. The various social media platforms allow access to the marketplace for new businesses, new writers, musicians, artists and entertainers. They also allow any individual to post: “this is who I am; this is what I can do; this is what I charge.”  That describes a labor market far different from the labor market that existed before. 

Love it or hate it, Facebook and the other platforms have demonstrated that what consumers do and what they like can be collected, analyzed and used as a powerful marketing tool. That data is also on the information highway, just going in the opposite direction. Very few people in the 1990s were thinking about all that customer data that is now so valuable.  

I hope that students a generation from now appreciate the contribution to marketing made by the Kardashians. As a group they have ingeniously dominated social media, literally day after day. They have used that daily media attention to sell billions of dollars worth of very high mark-up goods and develop a very valuable brand.

Finally, the social media platforms have demonstrated that they can lie to consumers with impunity, sell products and suffer no consequences. I am amazed how much snake oil is sold on even the “better” platforms. The amount of bad or patently false information available on the internet is frightening.

Fact checkers seem to have gone the way of the farriers. I have read articles that have been “published” on websites that are so factually incorrect, I question how the authors got out of high school.  

What I think is missing from this discussion of marketing to the masses, is the fact that the internet has facilitated one-on-one conversations that would not otherwise have occurred. I began to use LinkedIn as a way to distribute this blog and sell my book in mid-2015. Since that time I have connected with almost 5000 people from all over the world.

Of those 5000, I find myself constantly having telephone conversations with a small but interesting few. I speak with people involved with businesses from all over the world. I ask them a lot of questions. I cannot think of a better way for me to keep abreast of what is going on in the marketplace. 

The internet is not going away. Every year it reaches more and more people. Each year it handles more and more commerce. But it is still a new media. All of the information it delivers still needs a human filter to be valuable. It still needs some common sense which is in short supply. It is great to be cruising down the information highway, but somebody needs to ask where we are going and if we really want to go there.

If you’d like to discuss this or anything related, then please contact me directly HERE

Or you can book a time to talk with me HERE

The Great VC Con Game

Capital Markets, Investors
The Great VC Con Game

I speak every week with people looking for funds to start or expand their business. With investment crowdfunding, the process has actually become relatively easy and inexpensive. Most people come to me to use crowdfunding as a first choice to fund their business. They appreciate the opportunity to fund their business on their own terms.

Sadly, some report that they spent upwards of $25,000 and more than a year flying around the country attending conferences and pitching to dozens of venture capitalists. If they had called me sooner, I would have told them to save their money.

Pitch Decks

There are a plethora of books and articles and an industry of vendors hawking “pitch decks that work”. Few actually do. When I see a pitch deck I can often tell which “guru” it is trying to follow. 

Unfortunately, most of these experts know nothing about what motivates investors to write a check. One in particular who seems to post on LinkedIn every few hours actually offers the worst advice that I could imagine. 

Logically, investors in your company should really want your company to succeed.  If you want their money, it would seem natural that you would tell potential investors what you intend to do with their money in order to make more money.  Yes, it really can be that simple.

Compare that to the pitch decks that follow the “find a problem and solve it” template. They often minimize the focus on projected revenues and profits. They often leave out the details of how the company will execute its business plan to get there. From an investor’s point of view, return on their investment (ROI) rules.

VCs actually fund a very small number of businesses (in the low 1000’s) every year. Most of the money available for venture capital investment is concentrated into a handful of large funds. Some of the available capital will flow to “serial entrepreneurs” because venture capital is a fairly closed network of people and money.

I was introduced to my first venture capitalist when I made my first visit to Silicon Valley in the mid-1970s. There were a lot more trees and open space on the way to Sand Hill Road back then.

At that time VCs in Silicon Valley were a very small group of very smart people. Many were MBAs or had MBAs on staff to crunch and re-crunch the numbers. This was no small task in the years before VisiCalc.

These VCs were using their own money and the money of a select group of wealthy investors to help small tech companies get their business up and running.  Their goal was to hand these companies over to the investment bankers specifically for a public offering. 

Investment bankers wanted these companies to be profitable before an IPO.  After the offering, research analysts affiliated with the investment bankers were going to project growth in earnings per share. That assured that the IPO investors were almost always going to make a profit from their investment post-offering.  Everybody would win.

San Francisco

I moved to San Francisco in 1984 to work with a law firm that represented a London based VC fund. The fund was making investments in 1980’s era hardware and software companies, companies with cutting edge ideas and those in more traditional businesses as well.  I sat through a lot of pitches. Very few of those companies got funded even though the pitches were well thought out and supported by real facts and research. 

I remember listening to one of the partners in Sequoia Capital being interviewed on TV discussing what they liked about Apple when it was still at the venture capital stage.  I recall that it was more about Steve Jobs’ focus on the design and packaging as it was the tech.  It was more about gross profit than market share.  

Today it seems like “gross profit” is a curse word in the venture capital community.

Investing has always been rooted in mathematics. Today’s VCs have chosen to ignore the traditional math and have created a new math, to line their own pockets, even as the companies in which they are investing continue to fail.

Dotcom

Beginning in the 1990s and especially as the dotcom era heated up, a lot of people who worked in around Silicon Valley, thought that they should become venture capitalists. Some had been founders of the earlier tech companies. Some claimed to have the connections and insight to bring more than money to these portfolio companies. 

The net result was a de-emphasis on the actual, achievable projections of income and how a company might execute to get there. It was replaced with a mindset that said “this is a great idea; millions of people will come to our website and buy our product”. Translated, that means: “Profits? We don’t need no stinking profits?”  

The investment bankers bought into this because it enabled them to make a great deal of money. They took a lot of companies public without real earnings. They then used convoluted reasoning and research to predict share prices in the hundreds of dollars. 

The analysts looking at the dotcom companies created a metric called “growth per share”. I asked one of the prominent tech analysts if they had ever seen that metric in a peer-reviewed journal. Of course they had not.

In the current market bull market post-2008 the VCs have moved the goal posts even further to feather their own nests. Rather than find more and more good companies to fund, they are increasingly conducting multiple rounds of financing on a smaller and smaller group of companies. Most are destined to failure because they cannot operate profitably.

Venture Capitalists

VCs like other money managers get an annual % of the amount of money invested in their fund. The best way to attract new investors is to demonstrate success. If a VC invests in a company at $1 per share and the company goes public at $10 per share then the VC’s success is easy to calculate. If none of the companies in a VC’s portfolio actually go public, the VC’s success is harder to demonstrate.

To solve the problem, VCs have created a metric called “pre-revenue or pre-earnings valuation”.  You will not find it in peer reviewed journals. It is the closest thing finance has to an oxy-moron.

It works like this. Ten VC funds each invest in a seed round of 10 companies. Then some will invest in a Series A round of some of the companies in the other VC’s portfolios, then others will invest in the Series B round, etc. In the end, these VC funds have cross funded each other’s deals at different levels.  Each level is priced higher than the one before.

In the seed round a VC invested $10 million for 10 million shares of the outstanding shares of each company.  By the Series C, D or E round those shares are being sold to the other VCs and now cost $50 each. 

Does that make the original shares purchased in the seed round worth $500 million?  If the company has now issued 200 million shares, is the company worth $10 billion? Not in the real world and especially not if the company is still not profitable.

However the VC can now claim that its original investment is worth much more and use that “fact” to attract more investors into its fund. The VC will receive a % of the amount invested yearly for a decade or more. 

WeWork and the other unicorns will be the subject of business school case studies for at least the next generation. They are the most recent example of what may be the oldest theorem in finance: you can fool some of the people all of the time.  

Capital for new and smaller ventures is essential to the entire system of finance.  Investment crowdfunding is actually a response to the failures of VCs in the dotcom era. The arrogance displayed by VCs in this current market has probably done more to cement the place for investment crowdfunding than anything else. It is up to the crowdfunding platforms and professionals not to make the same mistakes. 

If you’d like to discuss this or anything related, then please contact me directly HERE

Or you can book a time to talk HERE

Power To The People

Law ,
power to the people

I started this Power To The People article in longhand on a yellow legal pad which is something that I rarely do any more. I would have been doing something else but the utility company, Pacific Gas & Electric (PG&E) had made a business decision to turn off my power and 1 million of my neighbors throughout northern California.

There were, at that moment, several wildfires burning in northern California that started from sparks emanating from PG&E’s equipment. By turning off the power PG&E was saying that they did not trust that their equipment was not a threat to public safety. 

There was good reason for PG&E’s managers to lack trust in the equipment the company was using.  Much of PG&E’s equipment is worn out, outdated and has been failing frequently for years often with catastrophic results.  It cannot be reasonable for any company to know that its equipment is dangerous and allow that dangerous equipment to stay in use.

In 2010, a PG&E gas line that snaked through a residential neighborhood south of San Francisco, ruptured and blew up killing 7 people, injuring many others and causing hundreds of millions of dollars in property damage.  The regulator’s investigation revealed that the incident was caused by PG&E’s failure to follow accepted industry practice when constructing the section of pipe that failed which is pretty straightforward.   The regulator noted other specific deficiency’s and also “a systemic failure of PG&E’s corporate culture to emphasize safety over profits.”

Camp Fire

More recently, in 2018, the Camp Fire killed 85 people and caused as much as $20 billion in property losses. The town of Paradise California was all but destroyed.  It appears that this fire was ignited by a PG&E transmission line.  A number of other smaller fires have been ignited by PG&E equipment over the years.

power to the people

When the power went back on last week a lot of people had questions. Intentionally turning off the power to 1 million customers is a big deal. 

Early on the company was trying to pat itself on the back for avoiding a greater disaster. It claimed it was left with little choice given the “historic” winds that were blowing over its transmission lines. But that was not the whole story. 

Management 

It seems that PG&E’s management had identified the power lines most in need of intervention, developed a plan to deal with those areas and then failed to execute. Management knew that their failure to remove trees and brush from the vicinity of certain transmission and distribution lines significantly increased the likelihood that their equipment would spark and ignite a fire. 

The “official” reason for PG&E’s failure to remove the brush, that they knew they had to be remove, may change with time as the lawyers get involved. For now, it seems that the company is saying that it could not hire enough “skilled” labor to get “all” of the brush removed. 

In sum, PG&E turned off the power and now argues it was the correct course of action because it is “better to be safe, than sorry” even if they created the unsafe situation in the first place. If there was a real danger of additional fires because of defects in their equipment, then arguably, turning off the power was a reasonable act. But it would have been far easier just to cut the trees and remove the brush that the company knew it needed to remove.

It would be even more reasonable for PG&E to replace or bury the transmission and distribution lines so they could not spark in the first place.  That would require a multi-year, multi-billion dollar solution that does not seem to be on the table even though it is long over-due. 

Monopoly

What makes PG&E different from other companies is that it is a sanctioned and regulated monopoly. If you live in its service area, they are the dominant regional source of gas and electric power. There is no competition. You pay what they charge.

Public utilities are regulated. PG&E must operate within the guidelines of multiple regulators. The California Public Utilities Commission approves the rates it can charge.

At the same time, PG&E is a public company owned by its shareholders. Shareholders have expectations that management tries to satisfy. In this case, the shareholders want steady dividends.

The current problem at PG&E can be summed up in one sentence: The management deferred maintenance and new equipment costs so that they could maintain profitability and continue to pay dividends to its shareholders.

In the traditional view, power utility company shares were suitable investments for “widows and orphans” because they paid a steady dividend and because they were selling electric power which was always in demand. That traditional view may no longer be sustainable. 

The funds that PG&E had allocated for brush removal, but did not spend, went directly to its bottom line. But for its current bankruptcy status, those funds would have been available to pay shareholder dividends. In the last 10 years aggregate dividends paid out to PG&E shareholders are in the neighborhood of $7 billion.  

PG&E’s monopoly to provide power was granted by the State with the expectation that PG&E would deliver the power while at the same time taking the proper steps to do so without ruptured gas pipes or electrical fires.  When you are dealing with fires that cause death and destruction, the standard of care exercised by the management should be very high.

I can appreciate that the 85 deaths at the Camp Fire last year were on the minds of the managers who pulled the plug this year. But who has taken responsibility for those deaths?  PG&E’s response to the Camp Fire deaths and its liability from it has been to file for bankruptcy.

If that same fire had been started by an arsonist, incarceration of the arsonist would be the desired result. Who will go to jail for the Camp Fire 85?    

Law students learn that corporations are legal “fictions”; entities created by law that can own property or operate a business in its own name while shielding the shareholders from personal liability for the corporation’s acts.  But that does not free the managers of any corporation from penalties if they are grossly negligent and people get killed.  

PG&E managers know that its equipment sparks fires. They know that they can reduce the fire danger by cutting trees and clearing brush.  They failed to execute this in the year after the Camp Fire because they refused to throw enough money at it to get it done. Instead they just turned the power off.  

Forgive my choice of words, but if killing 85 people last year doesn’t light a fire under management’s ass to get it right this year, then what will?   There is no way to look at this and not understand that whatever else it has done, management has demonstrated that it lacks what it takes to run this company. 

To understand the immediacy of the problem, consider that the fire season in northern California has just begun and will run into next spring. PG&E equipment can and in all probability will spark dozens of fires in the next few months.  More lives may yet be lost this year and no one from PG&E is confident that they have a fix for the problem next year. The fix costs money and PG&E is in bankruptcy.

The massive prophylactic blackouts are certainly no long term solution. Repeated outages and business disruptions hit smaller businesses and their employees the hardest. If thousands of small businesses are repeatedly closed for a week at a time, many will not survive. Many employees taking that much unpaid time off are going to have difficulty paying their rent.

Obviously a long term solution is necessary.  The need for natural gas and electricity in California will continue to increase with its population in the next 20-30 years. However California generates electric power in the future, that power will still need to be distributed and it is the distribution system that is already over worked and failing.  

The management, the shareholders and the customers all have skin in this game. Because PG&E’s problems will be resolved in the bankruptcy court, it is logical to believe that the senior managers who are most culpable for the losses will get golden parachutes or large, unearned bonuses. The shareholders will get what is left over of the business, and the customers will get nothing and pay the costs of any restructuring. That is how bankruptcies work. Something more is needed. 

If part of the problem has been paying dividends to shareholders with money that should have been used for maintenance, then it makes sense to eliminate the shareholders. I am still a free market capitalist, but this is a monopoly, a market aberration caused by government intervention, so a free market solution is not necessarily wise. 

PG&E might come out of bankruptcy owned by the State, or as a quasi-private corporation modeled after other government owned power companies like the Tennessee Valley Authority (TVA).  The TVA is a one example of a how the government generates and sells electric power. Its business model clearly works at least to the point that it delivers power without causing massive fires in its service area.

The TVA is a product of the Great Depression. It was intended to be an integral part of the economic development of the area.  And yes, detractors claimed it was Socialism when it began.

PG&E might also emerge from bankruptcy as a co-op which would essentially be owned by its customers.  Those customers want cheap, consistent power without interruptions or fires.  They are more likely to take a longer view than any managers looking at paying a dividend to shareholders every quarter.

Both of these ownership models have been used successfully by power companies in other parts of the country.  Either would be a reasonable approach for a company that should be spending money on maintenance and infrastructure rather than dividends.

I suspect that a lot will be written about these outages and their effect on the economy and on the residents both in the fire zones and the blackout zones.  In my mind one obvious truth is that the managers of PG&E are really not up to the task. The search for their replacements should be the first order of business.

If you’d like to discuss this or anything related, then please contact me directly HERE

Or you can book a time to talk HERE

Sex in Economics

Capital Markets, Economics ,
sex in economics

When I was teaching Economics back in the 1990s, I was fortunate to have students who had gone to high school in dozens of different countries. These students had different experiences and had functioned in markets that were often driven by local custom and culture. Their questions and comments helped me to understand a lot about the expanding global marketplace.

When I wanted to create an example to illustrate the application of a theory that I was trying to explain, I always tried to create one that everyone would understand regardless of their country of origin. Consequently, I often talked about sex. 

I admit up front that this may have contributed to my being ranked as one of the more popular members of the adjunct faculty at the university. It also seemed to keep the students awake, which, when teaching a subject like Economics can be task number one.

Economics

Classical economics teaches that consumers are rational. It teaches that because most consumers have a limited amount of money to spend each month, they will organize their spending accordingly. First, they will allocate their funds to necessities (rent, food, clothing, and transportation) and then to items that are necessary but which can be put off (dentist, auto repairs). Any funds that are left over can be spent on items that the consumer may want to buy, but could literally live without (sporting events, vacations). 

In order to get the most “bang” from the bucks they have, consumers should be good shoppers.  They should compare the prices of like products and purchase the least expensive ones that suit their needs. In theory, it is a rational process throughout.

Most consumers acknowledge they should allocate some of their monthly earnings to savings, but few will. Most also acknowledge that they should spend no more than they earn each month.  In practice, that effectively went out of style with the advent of the credit card.

Today, the market is awash in consumer debt, a factor that the classical economists could not consider.

I tried to focus the students on the underlying question: “How could they induce consumers to make an irrational decision to buy their product?”  These were, after all, business school students. 

For most products the answer is advertising. The modern “in your face” daily onslaught of ads that encourage people to purchase products were also not considered by the classical economists for obvious reasons.  The textbook I used, followed the classical view, which, to my thinking, might not give students the whole picture.  

The purpose of any advertisement is to make consumers purchase the product. Many ads will stress a product’s “value” which speaks to our rational side.  But even those ads will frequently feature attractive people making the pitch.  Using actors who are “attractive” does not change the message. But it is likely to get more eyeballs on the ad. 

Sex Sells

Indeed much about advertising is rooted in sex. There is a constant, undisputed theme in advertising: “sex sells”.

sex in economics

I could not, in my mind, conjure up a source of more irrational behavior than the human sex drive. It is not “just the things we do for love”. Sex and our desire for it motivates a huge portion of the spending that people do, even if they have limited funds that might rationally be spent elsewhere. 

For example, sex is at the root of the global fashion and cosmetics industries. These represent trillions of dollars of annual commerce.  And it is not new. Evidence of consumers’ desire for fashion, cosmetics and adornments goes back into pre-history. 

Why would anyone teach that consumer purchases were rational when so much of it was driven by irrational emotions?  And this does not even touch purchases that are made based on other emotional responses such as fear, greed or envy. I thought that perhaps the rational consumer of the textbook who was focused on the price might be a myth. 

I caught up with Richard Posner’s Sex and Reason (1992) a few years after it was published. His well researched and well presented book came to the conclusion that the human sex drive was rooted in our biology and that acting upon it was perfectly rationale behavior.  

I still have difficulty in reconciling the perfectly rational price theory with less than rational human behavior.  Over time I have come to believe that the latter might actually be underestimated as the determining factor for our purchase decisions. In this regards, I think that business school students might need a lot more sex, at least in their curriculum. 

I liked to challenge my students. I asked the class why so many consumers would reach for a fragrance that was priced at $350 per bottle. People buy fragrances to attract a partner for sex. Would not a fragrance that cost $60 get the job done? 

Vegas Baby

I would ask: If a sex worker in Las Vegas charges $500 to perform a sex act when a sex worker in Brazil might charge $20 for the same service, what can you infer from this data? Yes it is about overhead and what the market will bear, but it is also an introduction to globalization. Change sex worker to software developer and you will see what I mean.

sex in economics

Cable television and the internet itself were once brand new technologies that were slowly beginning to find acceptance from the general public.  In both cases each got an early shot in the arm from one source, pornography.

On cable, networks like HBO screened soft core porn after midnight. It is what made the cost of cable acceptable to many new viewers and indeed what attracted many new viewers. Data at the time suggested that a lot of people liked to watch in bed. If you need a reference go to Wikipedia and look up Sylvia Kristel. 

I think that everyone knows that there is a lot of porn on the internet, but not everyone appreciates how large a business it represents. MindGeek, parent of Pornhub, does not report its revenues but measuring them in the billions would not seem inappropriate. It may not be as large in gross sales as Amazon, but MindGeek’s cost of goods is minimal. 

Sex is even prevalent in finance. I wrote an article about crowdfunding back in 2015 when it was still new and I was just beginning to look at it with a critical eye.  Investment crowdfunding was and is about getting people to look at your offering.

I wrote at the time: “If eyeballs are what you need to successfully crowdfund a company, it would seem logical then that the easiest company to crowdfund might be one selling a line of lingerie. No crowdfunding consultant worth his/her fee would likely tell the company not to include its product catalog in its presentation to investors if that catalog had pictures of models wearing lingerie.” About one year later a lingerie company in London started a crowdfunding campaign that followed that advice and raised all of the funds that they were seeking.  

Sex, Drugs and Rock n’ Roll

The music industry certainly uses sex to make sales. I grew up at a time when Elvis Presley appeared on television from the waist up because much of the audience had “issues” with the way in which he moved his hips.  Currently, it’s obvious that much of the music and entertainment industries have seen that portion of the audience as far out of the mainstream. A music video without some sexual reference? Hard to find near the top of the charts.  

A few years back, I caught an interview of Mick Jagger that was being conducted by a business reporter. Jagger has flaunted sex and sexuality throughout a very long career. The Rolling Stones were starting a tour and the topic was the economics of touring.

mick jagger

Jagger suggested that the tour itself would probably net the band over $100 million, not counting the record sales. The reporter asked how the band could achieve that kind of financial success from traveling around and playing music. Let’s face it, very few musical groups have had that kind of sustained success.

Jagger responded that he had just paid attention in school. The response made me smile. He is a graduate of the London School of Economics.    

I hope that my students were paying attention too.

If you’d like to discuss this or anything related, then please contact me directly HERE

Or you can book a time to talk HERE

Hey FINRA- Look Over Here

Capital Markets, Law , ,
Finra

FINRA, the stockbrokerage industry’s regulator, often does an absolutely atrocious job of policing its members. It was not always so, but in the last few years FINRA has clearly turned a blind eye to some really outrageous conduct that is going on right under its nose.

There are two distinct types of scams that have been prevalent in the stockbrokerage industry for decades. The first involve bad investments that come down to the registered representatives from the corporate level. These scams would never be sold to investors if the firms had conducted an adequate due diligence investigation.

FINRA has a fairly high bar for its member firms when it comes to due diligence on a private placement. It tells its member firms that they may not rely blindly upon the issuer for information concerning a company, nor rely on the information provided by the issuer and its counsel in lieu of conducting its own reasonable investigation.

In the late 1980’s and early 1990’s a company called Towers Financial was selling pools of consumer debt through dozens of FINRA firms. It was ultimately revealed that the company never owned the debt and it was just a Ponzi scheme. About 200,000 investors lost close to $250 million.

The lesson of Towers Financial was that it is virtually impossible to conduct a due diligence investigation on a company claiming to hold large amounts of consumer debt without a full audit of its books.   Most companies of that size would have an audit as a matter of course. Towers was an exception. A lot of people suffered because of it. FINRA (the NASD back then) never suggested (or mandated) that its members should have been concerned about the lack of an audit. 

Fast forward to the mid-2000s. A company called Medical Capital also claimed to have pools of consumer debt which it really did not have. FINRA members helped the company raise over $1 billion from thousands of unsuspecting customers. It too was a Ponzi scheme and it too was unaudited.

FINRA did very little in the way of enforcement and again refused to simply direct its members to require an audit of any pool of consumer paper. An audit is the only way any firm can verify what the issuer is claiming.  Several of the state securities administrators raised the same questions but the brokerage industry refuses to get the point.

Last week I looked at another company for whom about 60 FINRA member firms raised a little over a $1 billion. Was it audited? No. Is it a Ponzi scheme?  No one has said so officially yet, but there are red flags everywhere. I would hope that FINRA would be all over it, but I know that they will not.  FINRA refuses to see these types of scams even when you rub their noses in them. When public customers keep losing a billion here and a billion there the regulator is clearly asleep.

Case on point.

When I was filing claims on behalf of public customers with FINRA for arbitration, it was never my practice to send a copy of the complaint to FINRA’s enforcement division.  I would only do so if I thought the offending conduct on the part of the broker or the firm was particularly obvious, onerous or both. The very last time that I sent a copy of an arbitration claim to FINRA enforcement they bobbled the ball.

The claim was on behalf of an elderly investor who had forked over about $600,000 to purchase interests in a private placement which would own an office building in the mid-West. Within a year the investors discovered that the roof leaked and that they were on the hook to replace it.  The FINRA member firms that sold the offering had not bothered to have the building inspected as part of their due diligence investigation. Most people would never buy a home without an inspection report.

The offering also described the sponsor as a “successful” developer when in fact his only prior development had ended in bankruptcy with many of the sub-contractors unpaid. The sponsor did not even hold a degree from the school listed in the private placement disclosure documents.

I documented all of this in the claim with appropriate exhibits and sent a copy to FINRA’s enforcement department.  The FINRA staffer who responded told me that the due diligence that the firm had conducted was just fine and that he felt no further action against the firm was necessary. 

I composed a response that expressed my feelings that the FINRA staffer was a ****** idiot. My partner at the time correctly decided that he would not allow me to send the letter because, in his words, you can’t fix stupid. 

Another case on point. 

A little more than a year ago I was asked to look at a series of arbitration claims that were being filed at FINRA against a small group of small brokerage firms located in the New York, Long Island and New Jersey metro area.  The attorney who sent them to me wanted my help in preparing the claims for hearing and my testimony as an expert witness (yes, I still do that) regarding the substance of the claims and the supervision of the brokers. What I discovered was conduct that was obviously intentional and truly disgusting on the part of the brokers and the firms.

There are apparently dozens of disparate customers voicing the same complaints against these firms. It was obvious that the brokers were cold-calling older businessmen and retirees in the mid-West. Quite a few listed their occupations as farmers.

The customers were complaining that the brokers had sold them on the idea that they were superior stock pickers who were and who would continue to make substantial returns for their clients.  Yes, I know that most readers of this blog would not fall for that, but apparently hundreds of public customers did.

Once the accounts were opened each customer complained that they had lost money because the brokers had churned their accounts and had made unauthorized trades. Of all of the claims that customers can make against their stockbrokers, these two in particular, excessive and unauthorized trading are the easiest allegations to prove or disprove. 

In the stockbrokerage industry a broker cannot enter a trade in a customer’s account without the customer’s prior approval. In the normal course of business a broker will get permission from the customer to buy or sell a security, hang up the phone and enter the order.  So there should always be a record of the phone call showing the time it began and the time it ended and also a time-stamped record of when the order was entered and when it was executed.

I asked the attorney if the firms had produced records of the phone calls where the brokers and customers had spoken prior to every trade. Not a one.  Obviously the firms and especially the Compliance Directors know that the trades were not authorized.

Churning or excessive trading has been a problem in the brokerage business for at least as long as my tenure in it.   If you are “investing” in a company then you are betting that the share price will move up as the company’s earnings improve. In the normal course it will take until the company’s next quarterly report before you and the market know if you were correct, often longer.

Investors will usually buy a stock and hold it for three or six months or longer. If your portfolio is worth $1 million, then you might turn over (buy and sell) its value two or three times a year. More than that is always suspect.

Traders, on the other hand, buy and sell stocks every day. That is why they gravitate to firms that charge very low commissions per trade. When you see a customer at a full commission firm turning their account over more than once every other month, they are either really foolish or the broker is crooked and taking advantage of them. In the records that I reviewed the customers were paying hundreds of dollars in commissions for each trade.

According to FINRA’s own Brokercheck™ reports there are today ten or so firms in New York, Long Island and New Jersey that have multiple brokers with multiple claims from public customers whose accounts may have been turned over more than 50 times a year, generating millions of dollars in commissions. FINRA tells customers to always look at the Brokercheck™ reports, but apparently its own staff fails to do so.

I see all these scum brokers ripping off unsuspecting customers just by reading the arbitration claims. The Compliance Directors and owners of these small firms certainly see them. The clearing firms are getting paid for every trade so they must see it too. Some of these claims are from 2015 and the brokers are still at their desks churning accounts every day.

Back in the mid-1990s the NY Attorney General published a report on small firms in NYC, Long Island and New Jersey that were churning accounts. The report suggested that several were associated with organized crime. Different firms are involved today, but the ones that allow these brokers to make unauthorized or excessive trades are still stealing money from public customers. They may or may not be “organized” but they are certainly criminals.

What will it take for FINRA to take its head out of the sand and close down these firms and bar these brokers, compliance directors and firm owners from the securities business? FINRA gives a lot of lip service to enforcement. This repugnant conduct calls for action.

(PS- If FINRA enforcement or any state securities administrator would like a list of these miscreant firms and brokers, just let me know). 

If you would like to discuss this or any other related topic, then please book a time with me here

Crowdfunding after ICOBox

Capital Markets, Investors, Issuers, Law , ,
Crowdfunding after ICOBox

SEC Complaint: ICOBox and Nikolay Evdokimov

I have been a huge fan of the potential of investment crowdfunding since the SEC’s first experiments in the late 1990’s allowing issuers to use the internet to sell their securities directly to investors.  There was a lot of discussion among issuers, regulators, and the traditional Wall Street firms at the time. However, very few investors were included in those discussions.  There was a clear consensus that investors were entitled to the same “full disclosure” that the purchasers of any new issue would receive. 

The JOBS Act in 2012 codified the use of the internet as a way of offering new issues of securities to the public. Nothing in the Act, or the subsequent regulations suggested that investors who purchased securities on a crowdfunding platform would not be entitled to the same disclosures.  The SEC’s very first enforcement action against an offering done on a crowdfunding platform, SEC. v. Ascenergy, confirmed this. 

The SEC has been doling out sanctions against people associated with the Woodbridge Group of Companies, a high end real estate developer and apparent Ponzi scheme. Woodbridge claimed to have a wealth management company in its group that raised money for mortgages and bridge loans.  The wealth management company hired dozens of highly commissioned salespeople.  Many of these salespeople claimed to operate “financial” firms that looked like legitimate financial firms.  The salespeople were telling investors on their websites that these investments were “safe” and “secure”. 

SEC Complaint: ICOBox and Nikolay Evdokimov

In all, Woodbridge raised more than $1 billion from several thousand individual investors. The SEC noted that one of the salespeople they sanctioned was a self-described “media influencer” who made frequent guest appearances on radio, television and podcasts nationwide touting the safety, security and earning potential of Woodbridge securities to unsuspecting investors. He also touted Woodbridge’s securities on the internet through his own website.

Crowdfunding After ICoBox

The JOBS Act clearly anticipates that securities offerings will be posted on

SEC Complaint: ICOBox and Nikolay Evdokimov

The JOBS Act clearly anticipates that securities offerings will be posted on platforms and websites and investors will be solicited by e-mails. What those postings and e-mails say is regulated. There are things that you can and cannot say to potential investors. There are also things that you must say.

Regulators understand the difference between “posting” and “touting”.  Unfortunately, not everyone in the crowdfunding industry understands this.  Regulators are beginning to take action against the crowdfunding platforms that do not follow the rules. 

This month the securities regulator in Kentucky entered a Cease and Desist Order against a company called Kelcas Corporation which was making false claims about oil wells it was drilling. The Kentucky Order calls out a specific string of e-mails with a representative of the company selling the investment to a potential investor. 

The Order repeatedly notes that the company was using LinkedIn to identify and connect with potential investors. It refers to a post on LinkedIn, specifically seeking investors for an “oil well investment opportunity”. Posts like these are common on LinkedIn and other social media platforms.  No one is suggesting that LinkedIn has any liability for allowing this post or others like it, at least not yet.

Crowdfunding after ICOBox

A day or two after the action in Kentucky against Kelcas, the SEC brought an enforcement action against a crowdfunding platform called ICOBox.  According to the SEC’s complaint, ICOBox raised funds in 2017 to develop a platform for initial coin offerings by selling, in an unregistered offering, roughly $14.6 million of “ICOS” tokens to over 2,000 investors.

The complaint further alleges that ICOBox failed to register as a broker but acted as one by “facilitating” initial coin offerings that raised more than $650 million for about 35 companies that listed their offerings on its platform.

The investors who put up their funds to invest with Woodbridge, Kelcas and ICOBox and the 35 companies listed on ICOBox were sold unregistered securities issued under the same SEC rules. In each case the internet was the primary vehicle by which investors were solicited and the primary vehicle used to provide the fraudulent information to the investors.

What separates LinkedIn from ICOBox or any other website or crowdfunding platform that connects private placements with potential investors? In reality, and as a matter of law, not very much.

It comes down to the SEC’s use of the word “facilitate”.  It does not mean that the facilitator actually sells the securities. Both federal and state statutes govern not just the sale of securities, but specifically how they are offered and to whom they are offered.

In the case of ICOBox the allegations are that the platform was actively involved in marketing of the offerings that they listed.  ICOBox promised to pitch the offerings to their media contacts, develop content for promotional materials and promote the listed companies at conferences.  The SEC included this in the complaint because the SEC thinks these acts constitute “facilitation”.

ICOBox is not the only crowdfunding platform that has helped to promote the offerings it lists. I get e-mails all the time from platforms inviting me to look at specific listings.  A lot of those e-mails and a lot of the offerings they promote make outrageous claims and promises.

The SEC also complained that ICOBox claimed it was “ ensuring the soundness of the business model” of the listed companies. Other crowdfunding platforms claim to “vet” or “investigate” the companies they list.  Many of those platforms have no idea what they are talking about. These platforms are lending their reputation to each offering. That also facilitates the offerings.  

Where does that leave LinkedIn? LinkedIn does not claim to investigate any offerings posted on their site.  It does however sell paid advertising.  Does LinkedIn have a duty to refuse to carry ads for securities offerings that it thinks are fraudulent?  What if LinkedIn ads generated the most sales leads for an offering or if the ads were specifically targeted at people LinkedIn identified as “real estate investors”? 

LinkedIn joined the ban on ICO ads by the major social media platforms in 2018, not because ICO ads caused cancer, but because they were largely fraudulent.  Would LinkedIn refuse to accept an ad from a small real estate syndicator if they had a reasonable belief that the sponsor did not own the property they were selling? 

What would a jury tell the “little old lady” investor who handed a few hundred thousand dollars to a scam like Woodbridge if the investor was introduced to the company on LinkedIn and testified that the company was brought to her attention by a LinkedIn “influencer” whom she followed? 

I read the ICOBox case as a clear warning from the SEC to the crowdfunding platforms to get their act together.  If the platform stays within the regulatory white lines, then regulators should leave it alone.

Unfortunately, it is apparent that many crowdfunding platforms have no idea what the rules require. They are setting themselves up to be defendants in enforcement actions by regulators or civil actions by disgruntled investors. Platforms that do not have a securities lawyer on staff or on retainer will be easy targets.

If you would like to discuss any of this article further with me then please contact me directly here

Crowdfunding After ICOBox

The Troubling Tale of Tether

Capital Markets, Investors , ,
the troubling tale of tether

I had intended to stop writing about crypto currency.  Despite the massive buzz in 2016 and 2017, crypto has largely shown itself to be irrelevant to any serious discussion about finance or economics.  

The same people who were screaming back then that bitcoins would be trading at $100,000 each are still “certain” that it will happen “soon”.  The promised institutional investors never materialized and probably never will.  The bitcoin ATMs promised for every street corner must still be on order. 

The “un-hackable” online wallets and accounts still get hacked.  People who invested good old fiat currency in more than 1000 “alt-coins” saw those coins disappear into thin air. 

There were and still are people who favor crypto currency because they hate banks. Many have moved on to other battles against the establishment.  Some, having fattened their own wallets as crypto currency consultants, now have very high limit American Express cards. 

There are still people who defend crypto currency despite the fact that there have been so many scams and losses. A common argument is that the losses in crypto are not significant compared to consumer losses caused by banks.  That follows the same logic as the sentence “Ted Bundy killed more than 30 people and I only killed one”.

Perhaps the most disappointed people in the crypto world will be the many who favor crypto currency because of what they see as a lack of transparency and over-concentration in the traditional banking system.  I cannot imagine how they must feel when they realize that the future of crypto currency may be in the hands of Facebook. 

Lawyers no longer have to lecture on the Howey test or lament that they cannot do what they do without more guidance from the government. The best lawyers work with the regulators to “tokenize” this project or that, even when those projects could likely raise money without tokens.

Whatever becomes of the crypto or token market it is a lot cleaner than it was because regulators became more and more active, not because crypto investors have gotten any smarter.  But there is still a lot of crypto-trash to clean up.

The enforcement action of the month involves an action by the New York State Attorney General (NYAG) against iFinex Inc. which operates of the Bitfinex trading platform and Tether Limited, issuer of “Tether” a self–styled crypto currency.  Both, apparently, are controlled by the same people.

Tether bills itself as a “stable coin”.  Its original white paper claimed that “each issued into circulation will be backed in a one to one ratio with the equivalent amount of corresponding fiat currency held in reserves by Hong Kong based Tether Limited.”

On its website the company still claims “Every Tether is always 100% backed by our reserves, which include traditional currency and cash equivalents” and “Every Tether is also 1-to-1 pegged to the dollar, so 1 USD₮ is always valued by Tether Ltd. at 1 USD.”

IFinex Inc. says it issued more than $1 billion worth of Tether.  The New York State Attorney General believes that the reserves may be short by $700 or $800 million or more and wants to see the books. 

People have actually been questioning the accuracy of the reserve figure for some time.  The company promised and then refused to provide any kind of audited financial information.  

The original white paper notes that Tether, Ltd. “as the custodian of the backing asset we are acting as a trusted third party responsible for that asset. This risk is mitigated by a simple implementation that collectively reduces the complexity of conducting both fiat and crypto audits while increasing the security, provability, and transparency of these audits.”

It should be cheap and easy to prepare a certified audit because the company should be able to easily demonstrate how many coins it issued. The reserves are all held at banks and should be easy to prove.  Instead of an audit the company offers a letter from their law firm that says that it looked at some account statements and it seems that there are adequate reserves.  The letter did not satisfy the New York Attorney General.

The idea behind stable coins was intended to fix a problem created by other crypto currency like bitcoins which were susceptible to volatile shifts in their exchange rate with US dollars.  Given that bitcoins were a intended to be “currency”, merchants take on a substantial risk every time transactions were denominated in bitcoins, instead of dollars.  It is a problem best solved by eliminating the bitcoins rather than adding the Tether to the transactions.

Actually the only thing new about stable coins is the name. The financial markets already have a class of securities that are pegged one-to-one to the US dollar and backed by cash or cash equivalents. We call them money market funds. 

Money market funds are registered with the SEC under the Investment Company Act and subject to specific disclosure and custody rules like other mutual funds. Issuing a stable coin on a blockchain is remarkably similar to buying a money market fund from a mutual fund company using a book entry system. Mutual funds are required to provide timely, accurate information to the public.  The management at Tether does not believe that they should be required to do the same.  

Bitfinex and Tether have had problems in the past. In early 2017, Bitfinex accounts were thrown out of Wells Fargo Bank.  At the time, many people in crypto saw this as “retaliation” by a legacy bank against the brave new world of crypto currency. The bank no doubt looked at it as a refusal to assist or participate in an obvious scam. 

In late 2017, Bitfinex announced that hackers had stolen $31 million worth of Tether from its own wallet.  No investigation was ever reported. Management did not even raise a fuss.

Jordan Belfort, the infamous Wolf of Wall Street called Tether a massive scam.  His comment got some press at the time. Most people in crypto just refused to see anything related to crypto as a scam in 2017.  That is largely still true and unfortunate.

IFinex and the other defendants argued that the Judge should refuse to let the NYAG look at their books because they never did any business in the State of New York.  The NYAG has presented the court with evidence that they did. Sooner or later the Judge will question everything the defendants tell her.  

In the meantime, Bitfinex claims to have raised another $1 billion by selling a new crypto currency token called the LEO.  As I said the best securities lawyers are now working with the regulators when they want to issue anything that purports to be a crypto currency.  It does not seem that any regulator, anywhere, reviewed the LEO paperwork.  The NYAG told the court that LEO offering “has every indicia of a securities issuance subject to the Martin Act, and there is reason to believe that the issuance is related to the matters under investigation.”

Sooner or later the Judge will want to see the records that prove that the reserves are indeed in the bank. No one, and I mean no one, should seriously expect that the reserves will be there unless the proceeds from the sale of the LEOs are meant to replenish them.  That will not solve the problem because the people who bought the LEOs were not told the reserves were missing or that their funds would replenish them.

Over the years I have read thousands of prospectuses and other documents that are given to investors when they purchase any new security. Among other things, the documents disclose specific risks that may adversely affect the investors’ returns.  I have seen those “risk factors” go on for pages and pages.

Still there is one “risk factor” disclosed in the original Tether white paper that I cannot recall ever having seen before.  Management at Tether Ltd. deemed it necessary to disclose to the initial buyers of Tether stable coins that: “We could abscond with the reserve assets.” Perhaps they were already thinking about it.

I have written about investment scams before, and as I said, I really do not think crypto is worth writing about. What makes Tether interesting is the potential magnitude of the loss. 

The NYAG says that as much as $850 million may be missing from the reserve account.  After that money was allegedly already gone, the company may have raised another $1 billion with the LEOs.  It is more than possible that a year from now the crypto industry will be staring at a $2 billion loss because the management of Tether just absconded with all of it. 

I actually wonder if the crypto zealots will consider that to be a “significant” loss.  

Want to discuss further? You can contact me directly on Linkedin or right here

 The Troubling Tale of Tether

Globalization in the Era of Amazon.com

Capital Markets ,
globalization in the era

Globalization

Western capitalists have always had a love/hate relationship with globalization.  When they are exploiting resources in under-developed markets they love it. When capitalists in those markets produce finished goods that are very competitive and sell across borders they hate it. 

Trade routes have been “global” going back into antiquity. They existed and flourished because goods that a merchant could bring back to his home market that were scarce or novel would often sell at a premium.  From the beginning global trade epitomized the capitalist mantra: “buy low, sell high”. 

Carrying gold to far away markets or bringing goods home always entailed a certain amount of risk. Over the centuries commercial banks evolved to handle long distance payment processing. Insurance syndicates evolved to assume the risk of loss during transport.

With every cargo container that is off-loaded in any port, there is a need to settle the bill for those goods.  There is today, a large, interconnected global system of cross-border finance that perpetually creates accounts and instruments that need to be funded and then funds them.  

The international network of commercial and investment banks provide the capital needed for commerce and trade. They do so by identifying, quantifying and syndicating risks. The investors who are ultimately providing the funding for all of these transactions want to eliminate as many risks as they can and be well compensated for the risks that they take. 

Vast sums are continually transferred globally from computer to computer to computer, instantly converting Dollars to Euros to Yen. Information about changing exchange rates and other market information is published constantly and available to all instantaneously. This inexpensive infrastructure allows new capitalists to enter the market.  

Globalization in the last 40 years has moved manufacturing jobs to places where the labor is cheap. Millions of employees in the US and other Western capitalist countries have lost their jobs. Millions of people elsewhere have been raised out of poverty in the past few decades because they will work for a few dollars per day and that is enough to sustain their families. 

In our modern, manufacturing era globalization will always be about cheaper labor, cheaper overhead and cheaper taxes.  When a manufacturer in the Rust Belt packs up and begins to manufacture in Mexico or the Philippines it is about the bottom line and little else. The capitalist view will always be to lower costs, increase margins and provide more profits for the shareholders.

Global shipping has never been quicker, safer or cheaper.  The development of overnight package delivery in the 1970s enabled the “make it here, sell it there” economy to become dominant. The factory to consumer supply chain has never been more efficient than it is today. 

We live in a truly global marketplace.  People all over the world, can and do, directly communicate with each other.  Social media has reduced the cost of global advertising and made it available to even the smallest businesses everywhere. 

A great many of the goods bought by US consumers are manufactured elsewhere. Consumers often do not know where the goods they purchase are manufactured and rarely care.  American consumers should want to purchase whatever they need at the best price possible and indeed most strive to do so.   

Global advertising is cheap; global shipping is cheap and efficient.  Economics teaches that all of this efficiency should bring prices down.  So why aren’t goods sold on-line to US consumers much cheaper?  How much should a US based on-line retailer be able to mark-up the price of goods manufactured elsewhere? 

Manufacturing

Let’s assume that a pair of woman’s shoes is manufactured in a country where labor, materials and overhead are cheap. The manufacturer is focused on manufacturing shoes for export to the US for sale to US consumers. This particular pair of shoes is sold by the manufacturer for $15 which includes the manufacturer’s profit. 

In the traditional pricing model, the $15 cost would be marked-up several times by two or three layers of middlemen, aggregators and handlers.  Using “keystone” pricing the retailer might buy the shoes at wholesale price of $40 and sell them to the public for $80. The gross profit covered the retailer’s cost of rent, overhead and employees at its storefront.

Amazon

Amazon eliminates all that brick and motor expense.  Consequently, people expect to pay less on Amazon than comparable goods at the mall.  But how much less should they pay?  Amazon passes some of that saving on to the consumers in the form of lower prices but not all of it, which is why Amazon makes so much money. 

As the internet makes it easier and easier to purchase goods sourced in other countries and have those goods delivered to your home in the US, the increased competition for each purchase should also drive prices down further. We may be at the cusp of a truly global retail market, the ramifications of which may be disruptive in ways some people will find to be disturbing.

The shoe manufacturer was content with a $15 sales price because it was profitable.  Assume that Amazon is selling the shoes for $55 (30% less than retail at the mall.) The manufacturer can use the internet to sell the same shoes, “factory direct to consumers” in the US for a retail price of $30 where Amazon cannot compete.   

Each unit will be generating substantially more profit to the manufacturer than before. The significantly lower price should result in the sale of many more units. You do not need to be an economist or MBA to see where that is likely to lead.  

That same manufacturer can also aggregate with other manufacturers and offer a website similar to Amazon.  The site might aggregate 10’s of thousands of SKUs of goods that are the same or similar to those already being sold on Amazon.

The logistics are the same. The goods will go to distribution centers in the US where they will be sorted, stored and shipped to consumers.  It is a model Amazon perfected that others can and will adopt. 

Consumers will browse the website, pay by credit card and the goods will be delivered the next day.  These are the same goods from the same factories at much less than the Amazon price because the company infrastructure runs at a fraction of the US cost and because the middleman mark-ups have been eliminated. 

Competition

If there are dozens of these cut-rate Amazons available to consumers, they will compare prices and buy some items at one site and some at other sites.  Inevitably, there will be an app that will compare the prices for you, put the best price on top and allow you to buy it with the same click of the button.    Therefore, instead of a delivery from Amazon you might get deliveries from several sites.

As this marketplace develops and other manufacturers and product aggregators compete with Amazon, the price US consumers pay for these goods should come down substantially. This should be good news for US consumers, but perhaps not.

The lower prices and convenience of home delivery offered by Amazon has begun the slow death knell of the local malls and main street storefronts. The exponential growth in online shopping spurred by the cut-rate competitors in the market should hasten the end of brick and mortar retail altogether.  That will put a lot of people out of work.  

Amazon is located in Seattle and employs over 600,000 people, most of who are in the US. Most of those salaries and operational expenses are spent in the US.  If the next generation of Amazon’s competitors operates from Manila, Mumbai or Capetown, that giant sucking sound that you hear will be trillions of dollars leaving the US economy.

New technology is often deflationary because it brings efficiency that lowers costs.  Amazon will fill its warehouses with robots and its trucks will deliver parcels without drivers. Many companies will follow suit.

Tens of millions of jobs will be lost to robotics at the same time globalization will move a lot more jobs out of the US. The salaries earned in other countries represent a lot of the money that US consumers would have spent if they had earned it. This confluence of two broad and sweeping deflationary trends is already evident and potentially very disruptive.

It means that if you buy a home today it may be worth a lot less in 30 years. It means that if you own a shopping mall, it will probably go bankrupt as many already have done. It means that debtors (including the US government) will be paying off their debts with dollars that are more valuable and harder to acquire than the ones they borrowed. It means that the price of gold should be substantially less than it is today.  All of these will disrupt the lives and businesses of a great many people.

At its core, globalization is about competition. All capitalists know that competition is part of the game that keeps everyone on their toes.  Competition and globalization have winners and losers and it is only the losers who hate them.

Are All Lawyers Stupid Like You?

Law ,

I remember when I was asked that question and who asked it.  We were in a very small hotel room at the Dallas-Fort Worth airport.  The speaker was trying to sell my client 3 pieces of real estate and was objecting to what I thought were some pretty standard clauses in the purchase contract that I was insisting upon.  He was way too loud and sitting just across this tiny table in this tiny room. 

I was already tired, frustrated and annoyed. I had flown to Dallas with my client on an overnight flight. My back was sore. I did not think that my client was all that determined to buy these parcels in the first place.

My only reaction to the asshole’s question was to give his lawyer a dirty look. The intended message was “he is your client, you calm him down.” The lawyer said nothing; he just reached into his pocket for a roll of antacids. 

Over the years I have seen many lawyers pull out a roll of antacids. I carried them myself for a great many years. They spent the night on my dresser, next to my watch and wallet, ready to go into the pocket of my suit jacket the next day. There was always a back-up roll in my desk.

Lately I have read a lot of articles about stress and lawyers. Much of it addresses young lawyers who are trying to balance their personal and professional lives. Lawyers tell ourselves that we have to work longer and harder to be successful.  If you make that decision, then I see no reason to stress about it. 

You would expect high levels of stress in some professions, like surgeons and police officers. In my experience for many lawyers the stress seems to come from one of two places: paying the bills or the interactions with other lawyers.  

Most lawyers do not work in big law firms in big downtown high rise offices. Most lawyers work alone or in small practices.  The “average” yearly income for a lawyer in the US was under $120,000 per year which means that a great many lawyers earn a lot less.

Law school does not really prepare you for the business side of a small law practice.  There is often a disconnect between what an attorney would like to charge and what the market will bear.  Most of the really important things that I learned about the economics of a successful small firm, I learned from other lawyers by watching what they were doing successfully.   

The business side of a law practice is an omnipresent reality that lawyers at both small firms and large ones cannot escape. If the cash register is not ringing, or ringing enough, it can certainly add to any lawyer’s stress.

Sometimes I think that lawyers view too much of the practice of law to be basically adversarial. Too often an attorney will look at the attorney on the other side of the case or negotiation as an enemy combatant.

I could usually tell in the first phone call or meeting with opposing counsel whether they were seeking common ground to settle or staking out their turf.  Sometimes the decision is client driven; more often I think it is the lawyer’s personality that dictates their approach. 

I understand that litigators can be somewhat combative by nature.  Every time two lawyers oppose each other in a courtroom one of them will be the loser. And nobody wants to be the loser, ever. They do not cover losing very well in law school either.

Sometimes an opposing counsel can be just a pain in the ass. They do not respond to e-mails or return phone calls. They are just time wasters who slow down and back-up cases and that also adds to the stress.

Lawyers shoulder a lot of responsibility. Clients count on lawyers to keep them out of jail, get their taxes right, plan their estate, secure custody and visitation rights for their children and a lot more. These are weighty matters and add to the stress that so many lawyers seem to feel.

As I said, I seem to be reading more and more articles lately on the subject of lawyers and stress. Lawyers do recognize the problem of stress and the effect that it has on their practice and their lives. Stress at work can cause stress at home and when they overlap they often feed on each other.

Some lawyers exercise to deal with the stress. I frequently went out and swam for a while the day before a hearing. Swimming is good for stress and if you are doing laps you can tune out everything but your own thoughts.  I also did Tai Chi for a while, but I could not shed my type-A personality enough to get real benefits from it.

Despite the rise in articles about lawyers and stress, there seems to be a deafening silence about the way a great many lawyers actually deal with it; self medication. 

In 2016 the American Bar Association together with the Hazelden Betty Ford Foundation published a study that indicated that one in three practicing lawyers are problem drinkers, based on the volume and frequency of alcohol consumed. That is more than double the amount of problem drinkers among surgeons and other “high stress” positions.

And before you dispute that one in three lawyers is much too high, consider that this study does not include lawyers who self-medicate with marijuana, cocaine, uppers, downers or opioids. If the number of lawyers who are “impaired” every day is less than one in three it is not much less.   

The ABA and state bar associations publish information about the problem on their websites and will make referrals to treatment programs.  Some states have programs for other lawyers to step in and take care of an attorney’s cases and clients if an attorney checks into an alcohol or drug rehab program.  But that is just a band-aid and it does not deal with the real problem.

People who have a drug or alcohol problem lie. They lie to their family, clients and partners.  That may sound obvious, but I could not find articles that seemed to treat this fact with appropriate alarm when applied to lawyers. 

What happens when an in-house counsel gets a lengthy memo on a potentially expensive tax issue from an attorney who just copied a memo he wrote two years ago without checking to see if the rules or regulations had changed, because he was too “impaired” last night to do the research?  

What is the potential liability to a 100 partner law firm if 30 of the 100 are “problem drinkers”?  And how does the stress the attorneys feel flow down to paralegals and support staff?

On any day in many courthouses around the country there may be 100 cases on the morning motion calendar. That might necessitate the appearance of 200 lawyers. If 60 out of those 200 lawyers are “impaired” is it any wonder that the calendars are crowded and cases move along at a snail’s pace?

Like a lot of people with a drinking problem the legal profession as a whole is in denial about this. There was some press when the ABA study was released in 2016, but very little in the way of action since. 

Alcoholism and drug addiction are treatable. I would have thought there would have been more of an affirmative outreach for lawyers to get lawyers who need help into treatment, rather than just posting a phone number for a treatment center.  Lawyers should see the effects of the drinking in their colleagues more than anyone else.

Aside from the pure human decency of helping people in need of help, the fact that so many impaired lawyers may be practicing every day and the impact it must surely be having is mind boggling. If lawyers do not act to clean up their own profession, then the most important part of any law practice, clients’ trust, will be lost. 

It would be foolish for lawyers to allow that to happen because they failed to address the “problem drinkers” among them squarely and practically. It would be so foolish that people might start calling lawyers as a whole “stupid”.

Investment Crowdfunding Can Offer Better Investments Than Stockbrokers

Capital Markets, Investors, Issuers , , , ,
Investment Crowdfunding

Investment Crowdfunding

Someone in the crowdfunding industry should put that sentence on a coffee mug and send me one.

I have been writing about and working in investment crowdfunding for more than 3 years.  I find it interesting to watch this fledgling industry mature.  It is certainly attracting more and more new money every year and is past the point where it can be ignored by any company in search of investors.

I have looked at a great many offerings on a great many crowdfunding platforms.  I read a lot to keep abreast of new offerings and industry developments. I take the time for conversations with platform owners and their lawyers and several of the better investment crowdfunding marketing executives.

I also speak with a lot of companies who are considering investment crowdfunding to raise capital.  Any company that would raise capital in this new DIY crowdfunding marketplace wants to know if it spends the money to list its offering on a crowdfunding platform will enough investors show up and invest?  From the company’s perspective, little else really matters.

The JOBS Act was intended to be a different approach for corporate finance using the internet instead of a stockbroker to reach potential investors. The internet allows companies to reach a lot of prospective investors, very cheaply. Success or failure in investment crowdfunding is more about what you have to say to those potential investors than anything else.  

Selling securities issued by your company to investors is not the same as selling your product or service to potential customers. Investors will have different expectations and will respond to different things.  

People who sell securities for a living will tell you that any new issue of a stock or bond needs two things: good numbers and a good story. Investors want a return on their investment. 

So the best stories are always about how much money the investors will make and what the company will do to provide that return.   

There are two distinct branches of investment crowdfunding. First, there are the private placements sold under Reg. D to institutions and other larger, accredited investors.  This marketplace is healthy and growing rapidly.  Professional money-raisers have caught on that they can use investment crowdfunding, to substantially reduce the cost of capital and use that savings to enhance investor returns.

Reg. D offerings have been sold through stockbrokerage firms since the 1980s.  Most are sold to institutional investors.  Some are sold to individual, accredited investors. Minimum investments of $50-$100K or more per retail investor are common. 

Many of the retail Reg. D offerings will fund some type of real estate (construction or purchase), energy (oil, gas and alternative energy) or entertainment (films, music, and games) project. There are professional sponsors; people who package and syndicate these projects, often being paid to manage the business on behalf of the investors after the funding.

The costs of selling a Reg. D offering through a stockbrokerage firm, including commissions, run 12%-15% of the funds raised. That would be up to $1.5 million for each $10 million raised.. Most Reg. D offerings sold through brokerage firms just raise an additional $1.5 million and dilute the investors’ return.  Using investment crowdfunding a company can raise that same $10 million and not spend more than $100,000 in legal and marketing costs and frequently a lot less. 

The Reg. D crowdfunding platforms compete with stock brokerage firms for projects to fund and for investors to fund them.  The same institutions and accredited investors who have been purchasing Reg. D offerings from their stockbrokerage firm for years are catching on to the fact that they can get good offerings and better yields without the need to pay the very high commission.

The other branch of investment crowdfunding is the Reg. CF or regulation crowdfunding. This allows offerings which can help a company raise up to $1 million from smaller, less experienced investors. Reg. CF allows smaller businesses to sell small amounts of debt or equity to small investors.

The Reg. CF market was the SEC’s gift to Main Street American small businesses. There are always a great many small companies that could benefit from a capital infusion of a lot less than $1 million, the Reg. CF upper limit.

To put down a layer of investor protection the SEC required that these portals that are dealing with small investors become members of FINRA. FINRA dutifully set up a crowdfunding portal registration system and has audit and enforcement mechanisms in place.

As a reward for joining FINRA, the SEC allows Reg. CF portals to be compensated by taking a percentage of the amount the company raises which the Reg. D platforms cannot. Several of the portals also take a “carried interest” in every company in case the company is eventually re-financed or sold.

The SEC looks at Reg. CF as a tool of corporate finance for small business. It provides a mechanism where a great many small businesses should have access to a pool of capital every year, potentially a very large pool. It provides for a market structure for these small offerings and incentivizes the portals help raise that capital. All in all, not too bad for a a government regulation.

Sadly, the Reg. CF industry is still foundering. There are still fewer than 40 registered portals operating and several have closed up shop.  So why are these portals not successful? Because the people who operate them are not listing better investments than stockbrokerage firms.

When I first looked at investment crowdfunding there were a lot of people proclaiming that it would “democratize” capital raising.  They believed that the crowd of investors could discern good investments from bad ones and that the crowd would educate each other as to the pros and cons of each.  That was never true.

The Reg. CF portal websites are full of bad information and consequently, bad investments.   “Comments” about any offering that lists on a portal, if any, are always overwhelmingly positive.  Investors will not do any due diligence or other investigation of the company because they do not know how.

The Reg. CF portals compete with banks, which are the primary source of funding for small business.  Here too, a Reg. CF portal can have a competitive edge.  When you borrow from a bank you do so on the bank’s terms. On a Reg. CF platform you can set the terms of your financing.  Done correctly, you can get the capital infusion you want for your company without giving up too much equity or pledging your first-born child to the lender.

What the portals should be offering investors are bank-like products that stress the ROI that investors reasonably might expect to receive.  The portals should be telling investors how each company mitigated the risks that the investors might face. Instead, too many portals and too many people in the Reg. CF marketplace are still selling fairy tales and lies.

The big lie, of course, is that by buying equity in any of these companies an investor might hit the proverbial home run.  Suggesting that investors can or should think of themselves as VCs is patently absurd for any company that I have seen on a Reg.CF portal.  I always tell people who ask that if even one valuation on a Reg. CF portal seems very outlandish, then they likely cannot trust that the portal operator knows what they are doing. I would question anything told to investors by any company that lists on that portal.

If a company wants to raise $1 million on a Reg. CF portal, it might end up with 2000 distinct investors each investing an average of $500.  To secure subscriptions from 2000 people, the company might need to put on a marketing campaign that will put its offering in front of hundreds of thousands of investors if not more.  Success or failure of your fundraising campaign will depend on what you say to these people. 

The cost of the marketing campaign is the major upfront cost of the offering. The good news is that marketing seems to be more data- driven and more efficient as time has gone by reducing the cost of the marketing.

Sooner or later these  Reg. CF portals will wise up to the idea that they cannot succeed unless the investors can make money. They, too, could offer better investments than stockbrokers, but do not seem to have bought int the idea.    

Until that happens, I expect more portals to fail and close up shop and the SEC’s “gift” to small business to remain largely unwrapped.