Feedback: Is a Lot of Fraud-based Bankruptcy on the Horizon?

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A number of you seemed surprised and impressed by Anne Eberhardt’s Notice of Appearance. We asked and Anne answered,

PETITION: What is one notable trend you expect to see in ’18 that not enough people are talking about?

The fallout from the effects of the collapse of trust. When even the auditors of the auditors’ audits are cheating (see DoJ’s press release of January 23, 2018, announcing the arrest of several former partners of a Big Four CPA Firm, accused of hiring PCAOB staff to provide confidential regulatory information to help the Firm improve its audit inspection results), you know we’re headed for a disaster of biblical proportions: fire and brimstone, rivers and seas boiling, forty years of darkness, human sacrifice, dogs and cats living together…mass hysteria.

There has been a rash of thematically-on-point news on this front in the past week.

Regarding General Electric ($GE),

“The two largest proxy-advisory firms are recommending that General Electric Co. fire KPMG LLP as its auditor after 109 years, in light of accounting issues at the industrial giant.”

Regarding PriceWaterhouseCoopers,

“The Federal Deposit Insurance Corp. could collect the largest damage award ever against a global public accounting firm when a federal judge decides what to award the agency after a verdict against PricewaterhouseCoopers.”

Relating to Longfin ($LFIN), a charade among charades in the blockchain/cryptocurrency space:

“But in the last 10 days, the shares have fallen about 80%. There were several triggers: A number of prominent short sellers made public attacks on Longfin; the company’s shares were added and then days later removed from the Russell 2000 Index; and on Monday the company said the SEC was conducting an investigation called In the Matter of Trading in the Securities of Longfin, which hasn’t resulted in any conclusions.”

And Mozido, a once-high-flying tech startup:

“Michael Liberty advertised that Mozido, the start-up he founded which once boasted a valuation of $5.6 billion, would revolutionize mobile payments and bring financial services to 2 billion unbanked adults worldwide. But securities regulators claim Liberty hyped up Mozido while raising $55 million that mostly went into his own pocket.

The Securities & Exchange Commission has sued Liberty for fraud in federal court in Maine, saying Liberty stole most of the $55 million he purportedly raised for Mozido from 200 individual investors.”

And then there is Theranos, the fraudulent “unicorn” helmed by Elizabeth Holmes that has fallen on some tough times of late. Per The Wall Street Journal last night,

“Blood-testing firm Theranos Inc. laid off most of its remaining workforce in a last-ditch effort to preserve cash and avert bankruptcy for a few more months, according to people familiar with the matter.”

And:

Once its cash falls under that threshold, the terms of the Fortress loan agreement allow the New York private-equity firm to seize the company’s assets and to liquidate them, she said.”

What exactly did Fortress Investment Group LLC lend Theranos $100 million against? Is there even IP here? The blood testing tech was a fraud; the Zika test isn’t working. What gives here?

At least Ms. Holmes has been focused on “burn rate” and conserving cash with an eye towards giving the Zika trials a fighting chance:

“Until Tuesday, Ms. Holmes still had two personal assistants and two security guards who drove her around in a black Cadillac Escalade SUV, according to the people familiar with the matter.”

What. The. F*ck.

We are sure that there will be at least a handful of high profile fraud-based bankruptcies that emerge in due time. Mark our words: 60% of the time it happens every time.

Toys R Us & Executive Compensation (Long Anger)

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Last week there was an uproar about Toys R Us' motion seeking approval of a proposed executive incentive plan. Then the Official Committee of Unsecured Creditors (UCC) came in, negotiated down the sweetheart arrangement, and filed a statement in support of the company's motion. We wrote about it all here. Since then, the bankruptcy court held a hearing and despite continued objection by the United States Trustee for the Department of Justice, the court approved the plan. Color us unsurprised. Also color us impressed by the company's sequencing.

There is 100% strategy embedded in the Company's plan, just weeks before Christmas, to get approval of its incentive plan. Note that we also highlighted that the company recently filed its store closure motion and that it only sets forth procedures for closures rather than specifically identifying closures. To date, only UK stores have been identified for closure. We suspect the US number may surprise people; we suspect a lot of employees will be losing their jobs; we suspect people will be pissed and that the incentive plan will reemerge as an issue in that context. On the bright side, at least Toys R Us was able to bring this Xmas's "hot toy" to the market. Oh, wait, that was Walmart($WMT). Womp womp.

All of which brings us, albeit circuitously, to General Electric ($GE). In 2015, former CEO and Chairman Jeff Immelt "earned" $37.25mm which included an 8% bonus increase (to $5.4mm) and a 9% salary hike ($3.8mm). In 2016, Immelt's comp stacked up to a smaller-but-still-impressive $21.3mm. When Immelt retired earlier this year, some figured that he walked away with $211mm. Ironically, by leaving earlier than he originally planned, he presumably got to take advantage of GE's (relatively) higher stock price prior to its utter and disastrous capitulation a few weeks later. 

Then this week, adding insult to injury, GE cut 12,000 jobs in its power equipment division, a 4% reduction of GE's total workforce. Why? Disruption, that's why. The division "has been hit hard by the rise of renewable energy." Notably, the energy business of Alstom - which services coal producers - is part of that division. Immelt, using his infinite "business judgment" (which is to say nothing of the Baker Hughes transaction), purchased Alstom in 2015 for a whopping $10b. Awesome. Timing. Bro. 

What are the ramifications for Immelt? Well, certainly none. He nearly got a new gig as the CEO of the highest valued private company in the world. And once the new tax plan goes into effect he can bequeath his ill-earned wealth to his family free of the shackles of the estate tax. We're sure that seems fair to those 12,000 people looking for jobs on the eve of Christmas. 

Smoke Em if You Got Em, Connecticut

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Unsustainable Pension Obligations + Mass Exodus (Aetna OUT, General Electric OUT) + Massive Municipal debt + Busted Hedge Funds and Corresponding Loss of Tax Revenue + Increased Taxes = a total sh*tshow of a situation in Connecticut. Meanwhile, Hartford hangs on by a thread. Now, the budget-less state seeks to impose new sales taxes and cigarette taxes to close the gap. Nothing like a tax on those who can least afford it. Also, short Altria and Philip Morris.