2019 First Quarter Commentary

Enron in the year 2000 was a fraud hidden in the plain sight of public disclosure.  The professional investment experts who recommended buying the stock couldn’t explain, or understand, how the company made its money.  In short answer, it didn’t make any money.  Enron made itself look like it was making billions, until it came crashing down.  Its CEO, Jeff Skilling, was later sentenced to 24 years in prison, later reduced, so that at age 65 he’s just been released.

Of note, Enron fooled the nascent socially responsible investing community.  Every environmentally managed mutual fund owned the stock.  Enron was the electric and gas utility that didn’t pollute: it traded only financial claims on energy.

Lehman Brothers was a similar sort of bad deal, on Wall Street. During the financial crisis of 2008. Lehman masqueraded as a bank worth saving.  It actually wasn’t a bank and so they didn’t save it.  Lehman became the poster child for, financially, making something out of nothing.  In the end, it was a nothing.  And yes, anyone paying careful attention could have seen it coming.

Over the past couple of years, Theranos, the medical testing startup once highly acclaimed, was also revealed a scam, with lawsuits in progress to prove it.  Promising a new diagnostic test based on a single drop of blood, in reality, the test Theranos claimed to have developed wasn’t accurate.  That didn’t stop some big corporate names from buying into the myth, as did its all-star board of directors, including the former CEO of Wells Fargo bank, former Secretaries of State and James Mattis, former Secretary of Defense.  It was Wall Street Journal’s reporter John Carreyrou who first broke the story, as was recently told in HBO’s documentary The Inventor.  In March 2018, the U.S. SEC filed fraud charges against Theranos and its now 35 year-old former CEO Elizabeth Holmes, who awaits trial and could face 20 years in prison.

Tesla, I expect, will meet a similar fate.  The company operates a business, in automobiles, solar installations and batteries, that we all hope might bring a brighter future for our world.  In reality, we can’t overlook Tesla’s many burdens despite its pioneering role in bringing electric cars to market in a big way.  Tesla’s funding needs are large, its competition strong and numerous managers have departed.

What Tesla has going for it are customers who are fanatically loyal and goals dramatically ambitious, aiming to overthrow the fossil fuel-based economy.  Its leader is Elon Musk, a modern-day P.T. Barnum who fakes it until he makes it, while the harsh reality is billions of dollars in losses, kept afloat by a free-spending investor base.  However, as I write on the cusp of Tesla’s two billion dollar stock offering, needed to keep the business going, operations aren’t going well and poor finances are finally catching up with it, in the form of vendors who demand payment in the courts and sales falling at a double-digit percentage rate.

The truth in these cases is that they became frauds hidden in plain sight.  At first, we might have an investment theory.  We might wish for it to be true, about how it will work.  And it might seem to be working for a time and we feel good to be associated with a good cause or what goes up – the perpetrators of frauds rely on investors’ perceived indicators of success to be proof of success.

When I was an auditor at the U.S. SEC, I helped uncover many frauds where everyone, victims included, were happy with the situation right until the very end, when something happened to derail the fantasy.  In our analysis, if we can’t find fundamental truth in what’s wished for, your wishes probably won’t turn out true after all.