Fraud, Part II

  By Guest Blogger Doug Rowat

Last week, I finished two-time Pulitzer Prize–winner John Carreyrou’s well-researched book Bad Blood: Secrets and Lies in a Silicon Valley Startup, which details the collapse of the now-famous blood-testing startup Theranos and the fall of its charismatic CEO Elizabeth Holmes.

As Carreyrou impressively documents, Holmes lies like a rug. Amongst the litany of cover ups that the company was accused of, perhaps the most amazing was its construction of an entirely fake laboratory in advance of a visit from then–Vice President Joe Biden. As an example of how well Holmes duped politicians, celebrities, rich investors and the public in general, Biden, after touring the fake lab, heaped praise on Holmes and then called the facility “the laboratory of the future.”

As the corruption details continued to emerge, Theranos’s valuation dropped from more than US$9 billion at its peak to less than zero in the span of just a few years. Holmes now faces fraud charges from the US government, which could see her serve 20 years in prison.

You may remember that I wrote last year about my interest in sports card collecting and I highlighted that it had become a big and profitable business. But, in one of life’s ironic moments, at the exact same time that I was reading Bad Blood, I was also witnessing the sports card hobby get rocked by its own massive fraud scandal.

At the heart of the fiasco is PWCC auctions, a hobby heavyweight that’s being accused of knowingly auctioning trimmed sports cards (trimming cards is a BIG no-no in the hobby). The company is also accused of shill bidding, which is a method of artificially inflating auction results.

Like Theranos, PWCC is now under investigation by the FBI and the story has gained so much traction that it’s made both the New York Times and the Washington Post:

https://www.nytimes.com/2019/06/14/your-money/sports-card-alteration-fraud.html

https://www.washingtonpost.com/sports/2019/07/18/baseball-card-collectors-suspected-rampant-fraud-their-hobby-now-fbi-is-investigating/?utm_term=.49c13c14c49f

In unintended comedy, the company’s website still advertises trust and integrity as being “the bedrock of the PWCC marketplace.” No doubt poor Kenny Dryden wishes that they’d remove his old Canadiens goalie picture:

Source: PWCC

YouTubers have also nicely summarized what has rapidly become an unbelievable soap opera:

https://www.youtube.com/watch?v=CDGDjgt8Owk

Sadly, I knew that fraud was one of many risks for the hobby:

You also need to be fully aware of the risks of your investment. For instance, I know that sports card companies can easily disrupt the market by producing too much product. This is what happened in the mid-1990s when the sports card market was on life support due to oversupply. I’m also fully aware that fraud and counterfeiting are ongoing problems.

I also argued that any alternative investment, whether it be collections of whiskey, wine, coins, stamps, jewelry, movie posters, artwork, etc., must be kept to a small weighting of overall assets as most of these collectible markets are made up of close-knit communities where any scandal can send prices reeling.

When it comes to the bulk of your investments, I’ve also emphasized that the best overall protection against fraud is to own a balanced and global portfolio made up of fully diversified exchange traded funds (ETFs):

… management fraud and misconduct, or even just incompetence, doesn’t matter to ETF investors. Over-concentrated investors (or employees) who owned Enron, at its peak the fifth most valuable corporation in America, saw their investments devastated. It was made worse, of course, by the fact that [former Enron CEO Jeffery] Skilling was at the same time living it up in his Houston mansion. Broad-market ETF investors, meanwhile, felt barely a portfolio murmur and quickly moved on with their lives.

The chart below indicates the number of Bloomberg news stories mentioning the keyword “fraud” over time. As you can see, we’re in a relatively quiet period for fraud-related topics. This is not to say that fraud isn’t an issue—just ask Volkswagen, Wells Fargo or, for some Canadian context, SNC-Lavalin investors—but the overall fraud level is, to be fair, relatively low at the moment.

Bloomberg news stories with keyword ‘fraud’ – past 20 years

Source: Bloomberg

But everything moves in cycles. It’s only the calm before the next storm. So, reduce concentration risk and protect yourself from the next big fraud-cycle by owning ETFs. And own these ETFs across several different asset classes.

The best protection against fraud? Balance and diversification. After all, Enron only hurt those who owned too much of it.

Now excuse me while I check my Connor McDavid rookie cards for trimming.

Doug Rowat, FCSI® is Portfolio Manager with Turner Investments and Senior Vice President, Private Client Group, Raymond James Ltd.