Wednesday, June 25, 2014

Just How "Rigorous" Should a "Rigorous Inspection" Be?

Many years ago, I worked for an automotive manufacturer. It was a common saying that "all new cars are alike, but every used car is different."

What we meant by that was that the differences between two brand-new Maximotor Mojomodels were generally insignificant. But once those two Mojomodels were a few years old, they could be very different, depending on whether one owner had driven many more miles, or had the car serviced less regularly, or had driven nothing but short in-town runs, or lived in an area with high use of road salt, or... or... or.... Those differences were potentially endless, and could be critical.

Which is why buying a used car could be fraught with peril. Even if you were armed with the latest Consumer Reports, and knew that Maximotor Mojomodels were highly rated for reliability, safety, and durability, could you be sure that this Mojomodel -- all shiny with fresh polish, "only" two years old, with "only" 20,000 miles on the odometer, and tricked out with all the options available -- was really a good buy?

When I bought my first car, I hired an independent mechanic to go over two possibles for me, because, honestly, it could have been a bunch of mice running around on a wheel that made the car go, as far as I knew. I had my heart set on a cherry-red Fiat, but on Terry's recommendation, ended up with a lime-green Subaru that served me well for several years.

But what if you don't know a good independent mechanic? That's why I thought CarMax was a great idea when it was introduced in the early '90s. It dealt head-on with many "used-car dealer" stereotypes. Go to its site (here) and right at the top you'll see that "All of our used cars are CarMax Quality Certified and include a 5-day Money-Back Guarantee". Deeper in the site, and in TV commercials, the company trumpets its "125+ - point inspection" that "checks the core systems of every car".

Wow, I feel better!

Alas, it appears that "Quality Certified" may not mean what you or I think it means.

According to a Christopher Jensen article in today's New York Times, " a coalition of 11 consumer groups has asked the Federal Trade Commission to investigate" whether CarMax ads are deceptive. 
The groups say CarMax does not fix vehicles that have been recalled before it sells them, even though the retailer’s ads promise that the vehicles have had a rigorous quality inspection.

It should be noted that while the "National Highway Traffic Safety Administration requires new-car dealers to fix recalled new vehicles before they can be sold", this is not true of used-car dealers or used cars. (Did you know that? I certainly didn't.) The Times article notes that NHTSA "is seeking such authority from Congress." (Given how quickly Congress takes action these days, I'm not holding my breath.)

According to a CarMax spokesperson, "CarMax provides the necessary information for customers to register their vehicle with the manufacturer to determine if it has an open recall and be notified about future recalls."

Which is probably just as far as they need to go, legally.

The CarMax spokesperson is right that "automakers did not give retailers like CarMax the authority to carry out recalls at their facilities", but there is nothing preventing CarMax from taking a vehicle on its lot that is subject to a recall to the nearest authorized dealership, having the recall repair done, and then bringing it back to the CarMax lot.

Sometimes, going just as far as you need to go isn't far enough. Especially if you are trumpeting that the "foundation" upon which your business is built is "INTEGRITY" (their caps, not mine).

Thursday, June 19, 2014

Do The Right Thing, Even If You Don't Want To... And It Just Might Be Profitable, Too

It's depressing when someone has to be dragged kicking and screaming to do the right thing... and then turns around and makes a ginormous profit on the process.

This thought first occurred to me last month, during the uproar over basketball's L.A. Clippers owner Donald Sterling's racist remarks -- while the NBA promptly assessed a $2.5 million fine (relatively speaking, chump change to a billionaire), if the forced sale of his team goes through, he stands to profit to the tune of more than $1.5 billion. Which is real money by anybody's standards. (What will actually happen is anyone's guess, as the matter continues to be locked in the courts.)

And here's another example: today's New York Times reported -- as did most other major media outlets -- that the U.S. Patent and Trademark Office had stripped the Washington Redskins football team of six of its trademarks because the name is "disparaging" to Native Americans (full article, by Ken Belson and Edward Wyatt, here).

An attorney for the team was dismissive:  "We have seen this story before. And just like last time, today's ruling will have no effect at all on the team's ownership of and right to use the Redskins name and logo." (Full statement, as .pdf, here)

"Just like last time" refers to a 1999 trademark office decision cancelling the trademark registrations, which was reversed on appeal by a federal district court judge in 2003.

Even if the current Patent Office decision were to be upheld, it wouldn't stop the team from continuing to sell Redskins' glasses, T-shirts, blankets, and assorted other paraphernalia, although it would make it harder for them to rein in the counterfeiters.

Washington Redskins owner Dan Snyder has said that he would "never" change the name, and that "Redskins" was "never a label. It was, and continues to be, a badge of honor" (from a letter to the Washington Post, published 9 Oct 2013; available here).

The truth is that the world has changed since 1999. More of us understand the power of words, and especially of slurs. If it were my team, knowing that a great number of people who could be described as Redskins consider it a slur and not a "badge of honor", I'd have changed the name as soon as I was made aware of the problem. Snyder clearly needs some more convincing.

And if Snyder is smart -- and not just an insensitive racist -- he's busy meeting with marketing and branding folks right now, thinking up a new name and a new logo. Because all his team's biggest fans will be lining up to buy blankets, glasses, T-shirts, and all the other tchotchkes with the new name and logo, making a satisfying ka-ching sound in the football team's cash registers, and in Snyder's pockets. Sigh.

Tuesday, June 17, 2014

We All Knew It. And Now There Seems to be Proof.

There's a flurry of activity in the stock of Company X, for no apparent reason. And then, after the fact, after the acquisition (or merger) has been publicly announced, then it all makes sense: Insider trading, we think.

But the evidence is seemingly all anecdotal. So maybe it just looks bad, and that's why the Securities and Exchange Commission isn't prosecuting right and left.

Three professors (two from New York University and one from McGill) have done the math, however, and the evidence is overwhelming. In fact, they say, as many as a quarter of all deals involving public companies may also involve insider trading.

Their study, reported by Andrew Ross Sorkin in the DealBook section of today's New York Times (full article here; full 81-page report with some really dramatic charts, here), makes for depressing reading:
...[We] document pervasive directional options activity, consistent with strategies that would yield abnormal returns to investors with private information. This is demonstrated by positive abnormal trading volumes, excess implied volatility and higher bid-ask spreads, prior to M&A announcements.

Isn't it possible that this is simply coincidence? The authors, who studied deals between 1996 and 2012, scoff: the probability of similar actions occurring randomly is about "three in a trillion." Remind me to buy a Lotto ticket tonight.

As Sorkin writes,
The results are persuasive and disturbing, suggesting that law enforcement is woefully behind — or perhaps is so overwhelmed that it simply looks for the most egregious examples of insider trading, or for prominent targets who can attract headlines.

In other words, in the words of an income-tax professor of mine, "Be aggressive, but don't be stupid." (He would add that if you had to think about whether something was aggressive or stupid, "it's usually stupid.")  Just don't be so aggressive that the SEC has to notice, and you should be fine.

And by the way: while the SEC focuses largely on stock trading, the study suggests that much of the most questionable activity occurs around options. 

As you might expect, the study found that "the bigger the deal and the more trading volume in the stock of the target company, the more likely there will be insider trading." Not -- perhaps surprisingly -- because there were more bankers and lawyers involved with the deal (and therefore more people to leak information to the media and others). But simply because "the anticipated abnormal stock price performance upon announcement is larger" and because it's easier to hide the illicit trading in a bigger pool.

We all knew it was probably happening. Now we know for sure. Sigh.

Monday, June 16, 2014

How Much Harder Can We Make It to be Poor?

Once again, I find two unrelated articles resonating in my head: an opinion piece in Sunday's New York Times  Sunday Review section, "No Money, No Time, by Maria Konnikova (here) and a Jessica Silver-Greenberg and Michael Corkery article (here) in today's Times, "Bank Account Screening Tool is Scrutinized as Excessive".

The Silver-Greenberg / Corkery article begins with the account of a young woman who has been unbanked, because she "is one of more than a million Americans who have been effectively blacklisted from the mainstream financial system because they overdrew their accounts or bounced a check — mistakes that routinely bedevil young and low-income consumers, financial counselors say."

The young woman in question did pay back "the roughly $700 that she owed, [but] a record of her youthful transgressions remains in a vast private database, preventing her from opening a new account."

Such databases, used by Bank of America, JPMorgan Chase and other big banks, were intended to weed out serial fraudsters. Now, regulators say, banks are screening out potential customers and swelling the ranks of the so-called unbanked — the roughly 10 million households in the United States that lack even a basic bank account.

According to today's article, the New York attorney general's office is looking into the practice. A single error has significant consequences, as "negative marks typically stay in the databases for at least five years".
Without access to a checking account, many have no choice but to rely on costly alternatives for even the most basic transactions, like paying bills, withdrawing money and wiring funds. At first blush, the fees can seem relatively small: $15 to cash a check, for example, or $1 to place a money order. For people already living on shaky financial footing, however, the costs can quickly add up, eroding a chunk of their paychecks before they even have access to their cash.....

Such fees can make saving money, which is critical to building wealth and long-term financial stability, almost impossible, financial counselors say.

So here's another way we make it more difficult for the working poor to "bootstrap" themselves out of poverty. Thanks, banks.

And it's not just the additional cost (and the time required to get to the check-cashing storefront or the payday lender). There are other risks as well:
For low-income Americans who may already be living in crime-ridden neighborhoods, carrying around money from a check casher can be dangerous. When the Pew Charitable Trusts conducted a two-year study of 1,000 families in Los Angeles that lacked bank accounts, researchers found that one in five lost money — on average $729, or the equivalent of two weeks of household expenses.

All of these can trap the poor. But there's more to the story, I know, since I'd also read the Sunday Review piece on the relationship between money and time. Konnikova spoke with a Harvard economist, who explained that there are really three types of poverty:
..."There’s money poverty, there’s time poverty, and there’s bandwidth poverty." The first is the type we typically associate with the word. The second occurs when the time debt of the sort I incurred starts to pile up. [The reporter had mismanaged her deadlines, and therefore had to ask for an extension to complete this piece.]

And the third is the type of attention shortage that is fed by the other two: If I’m focused on the immediate deadline, I don’t have the cognitive resources to spend on mundane tasks or later deadlines. If I’m short on money, I can’t stop thinking about today’s expenses — never mind those in the future. In both cases, I end up making decisions that leave me worse off because I lack the ability to focus properly on anything other than what’s staring me in the face right now, at this exact moment.
In other words, being short of time is one thing when you're rich -- you can buy someone else's time to take the pressure of yourself (think a nanny to keep an eye on your kids, an event planner to organize your next social event, a landscaping service to mow your lawn). But if you're poor? No such luck. And the stress of that bandwidth poverty can lead you to making very bad decisions.

So the poor don't just make the same mistakes that we all make: they make worse ones. Konnikova continues with examples drawn from a research game run by the economist and two psychologists, with participants assigned to be "poor" or "rich":
...When the experimenters showed players a preview of the next round’s questions, the rich ones took advantage of the edge, performing better over all, while the poor acted as if they couldn’t see the previews at all. They were so focused on operating under scarcity that they couldn’t think their way through to a strategy — or, indeed, even realize that an opportunity to do so was available. 
We all have only a limited attention span. When all the pieces of your life are held together with duct tape, and that tape keeps threatening to split, that's where your attention goes. Not on what you could do two years from me if you husbanded your resources more carefully. I'm tired of hearing the poor called "shiftless" when we've allowed the game to be stacked against them.

Monday, June 9, 2014

Do You Really Want to Know What's Going On in Your Organization? Or Are You Just Pretending?

Three articles in the last four days in the New York Times provide a great explanation of why I'm so hung up on Trust and Transparency.

I have, of course, been following the story of GM's recall of more than a million vehicles for an ignition switch defect that has been responsible for at least thirteen deaths (earlier blogpost, here). And the story keeps unfolding.

On Friday, Bill Vlasic reported that GM's lawyers went so far as to hide product flaws from each other (full article, here):
Employees were discouraged from taking notes in meetings. Workers’ emails were examined once a year for sensitive information that might be used against the company. G.M. lawyers even kept their knowledge of fatal accidents related to a defective ignition switch from their own boss, the company’s general counsel, Michael P. Millikin.

As a result of GM's internal investigations, at least three senior company lawyers have been dismissed (but not the general counsel).

Sunday's paper carried a great column by Gretchen Morgenson on the internal investigation and CEO Mary Barra's report to her employees and to the world:
...In her remarks, Ms. Barra projected an earnest and urgent desire to reform the company’s culture, which she said was permeated by "bureaucratic processes that avoided accountability." That culture meant no one took responsibility for faulty ignition switches in Chevrolet Cobalts and other cars that were ultimately responsible for at least 13 deaths.

Ms. Barra told her audience that she wanted to make sure this sort of thing never happened again at G.M. I believe her. But the depth of the dysfunction at this company, as detailed in the report, makes it hard to see how she can keep that pledge.

The report ...says G.M. officials showed a “pattern of incompetence” that led to inaction on the defects, Ms. Barra said.

That’s the mild version. The report exposes a mind-set throughout the company that was so self-absorbed, so bent on self-preservation and self-protection that it routinely put its customers last.
The key to success at GM, apparently, was finding someone else to blame, known internally as the "GM Salute": "a crossing of the arms and pointing outwards toward others, indicating that the responsibility belongs to someone else, not me." (Relatedly, there's the "GM nod": "when everyone agrees to a plan of action after a meeting 'but then leaves the room with no intention to follow through'.")

And then there's an article, today, by Matthew Wald, exploring how the siloization of decision-making can help create perfect opportunities for management disasters like this one.
In the case of G.M., the crucial insight was that a faulty ignition switch could cause vehicles to lose power and deactivate the air bags. The link between the ignition and the air bags was not a secret; it was an intentional goal of the design, to protect people in parked cars from being injured by air bags that were deployed mistakenly.

The investigation commissioned by G.M. from Anton R. Valukas, a former United States attorney, turned up a memo from August 2001 written by an engineer named Jim Sewell, pointing out that if the ignition power was lost, the "S.D.M. would also drop," a reference to the sensing diagnostic module, which determines whether the air bags are deployed.
But the recalls didn't begin until this year, thirteen years after that memo. How is that possible?

Wald quotes a Columbia University sociology professor with a difference example of poor management response to product flaws that ended in disaster: "Both [NASA's] Challenger and Columbia [space shuttle disasters] had a long incubation period with early warning signs that something was seriously wrong but those signals were either missed, misinterpreted or ignored." If the culture encourages you to look away from potential problems and focus on your own self-preservation... well, how much more likely is a disaster?

The GM engineer who first identified the problem focused on a different, seemingly "non-safety" complaint (cars stalling out). (But I'm not sure how a car suddenly stalling out when under way can be considered a "non-safety" issue....) A little more transparency, a culture that encouraged sharing of and joint solution of problems, should have brought this issue to light much earlier. 

But the fact that GM lawyers kept secrets from each other leads one to conclude that there was much more than the "pattern of incompetence" that CEO Barra acknowledged: it sounds much more like a culture of "We don't want to know."

Tuesday, June 3, 2014

What Do Drug Companies Make?

It sounds like a trick question, doesn't it? And at one level, it is.

Andrew Ross Sorkin, in a DealBook column in today's New York Times, asks the question a little differently: Do drug companies make drugs, or money?

He begins with a passionate-sounding quote from the CEO of Valeant Pharmaceuticals:
I just want to emphasize that this is an industry where it is composed of really great people, working to do good things for patients, for doctors and actually for society, and when I look at our employees, there is sort of a noble purpose to working in the pharmaceutical industry.

Wow - I can almost hear the banners snapping in the breeze and a brass band playing something triumphal, can't you?

Alas, it's mostly an auditory illusion.

The reality, as Sorkin lays out, is that Valeant is "among the least innovative" of the drug companies. That's not to say it hasn't been profitable. Its CEO has achieved success "by sharply cutting research and development budgets, arbitraging tax domiciles — Valeant left the United States for Canada’s lower tax rates in 2010 by merging with Biovail — and buying rivals so he can cut their costs, too, while they take advantage of his lower tax rate."

Now Valeant has set its sight on Allergan, whose stock "is up 290 percent in the last five years."

Now what I hear is lip-smacking, because "Valeant, desperate for ways to increase its revenue, needs a cash cow to milk until it can find the next one."

Allergan invests five times as much of its revenue in research and development as does Valeant, and Valeant has already been quoted as planning to cut 20 percent of the combined companies' workforce.

There's no question that pharmaceutical companies have a right -- and an obligation -- to be profitable, just like any other company. The questions arise when profitability becomes an end in itself. How many "good things" are you still doing "for patients, for doctors and actually for society" at that point?