Golden Age of Fraud? Lessons from SunRun, Super Micro and More.
Hi Everyone,
This is going to be something that’s near and dear to my heart, but probably not yours. And that’s fraud and short selling.
With Trump winning the Presidency. A consensus has formed that short-selling is now impossible because the Securities and Exchange Commission (SEC) and other regulators will be neutered. Meanwhile, fraud will run rampant.
Below, I will argue why that’s not the case, and why today is probably one of the best environments for short selling (although you should never actually short companies, including frauds because it’s not worth the brain damage).
The SEC. Can’t Kill What’s Already Dead
Last week, SEC Chair Gary Gensler announced that he would resign before Trump took office. While Trump hasn’t nominated someone for the post yet, the assumption is that whoever he picks will have a “light regulatory touch”.
Except that Gensler and the SEC have operated with no “regulatory touch” for much of the last 4 years. Since Biden nominated him to the commission, we’ve had the SPAC mania/bubble, the Gamestop / meme stonk bubble, low-float Chinese pump-and-dump frauds, proliferation of 2 and 3 times levered ETFs, and the widespread use (and abuse) of non-GAAP metrics (just to name a few issues).
It’s been mainly up to activist short sellers and journalists to find and highlight instances of corporate fraud and other wrongdoings. Because during all of this time, the SEC has been completely missing in action.
A better question is what has the SEC done during his time at the helm? The most significant that I can think of is greater disclosures on climate change from publicly listed companies. However, these new rules are stuck in the courts and will likely be rescinded the minute a new SEC Chair is confirmed by the US Senate.
So in short, Gensler and SEC have been no-shows for the last 4 years and it’s hard to think of someone coming in that’s even more incompetent and inconsequential.
SuperMicro - Blazing Red Flags
SuperMicro is a company that was for a short while one of the hottest stocks in the markets.
SuperMicro buys chips (they are Nvidia’s 3rd largest client for instance) and creates server racks plus all the support and services necessary to install and run them.
The company was an early and large beneficiary of the “AI” trade. Revenue grew from $3.5 billion in 2022 to almost $15 in 2024 (430% increase in 3 years) and EPS ent from 21 cents to $2.01 (955% increase).
The stock went from under $4/share to peaking at $122.90/share (adjusted for stock splits).
So what’s the problem? This business has always been crappy, low-margin, and highly cyclical. The company was included in the S&P 500 in March (close to the all-time high) but enthusiasm started to die almost immediately. The bloom came off the rose in August when famed short activist Hindenburg released a short report on the company.
The stock experienced a further big fall at the beginning of November when the company’s auditors, Ernst & Young, resigned (aka quit) due to the allegations raised by Hindenburg, could not rely on the company’s financials, and disagreed with its governance/board independence.
The company has managed to find new auditors (and avoid being delisted), so the stock has rebounded 100% off the lows. But make no mistake, this company is likely headed back to its pre-AI lows.
Hidenburg’s thesis is that the company is cooking the books and improperly inflating revenues. And that both sales and accounting staff are under extreme pressure from management to “make the numbers”.
The biggest irony of this whole saga? The company was convicted of doing all of this back in 2018, and its shares were temporarily delisted. And yet the company culture never changed and many of the people that were “fired” in 2018 were just rehired shortly afterward.
But as long the share price rose and everyone got rich, investors ignored the red flags and failed to do any due diligence.
Lesson: As long as the stock price keeps going up, investors ignore red flags (even blindingly obvious ones).
Cassava Sciences - Regulators Might Be Toothless, But The Courts Aren’t
Cassava Sciences is a biotech fraud that was down than 80% yesterday and its days are numbered.
At its peak, the company’s market cap was over $5 billion. Even last week, the market cap was over $1.5 billion.
It’s a perplexing story. The company claimed that they were working on a cure for Alzheimer’s (a field that has been plagued with corporate and academic fraud).
And yet every biotech specialist, hedge fund short seller, and journalist familiar with the industry concluded that the company was a complete fraud.
The “research” was led by a CUNY medical professor, Dr. Hoau-Yan Wang, who is now on trial for falsifying data and defrauding the National Institute of Health (NIH).
The company’s founders, Remi Barbier and Dr. Lindsay Burns were fired by the company’s Board of Directors (likely to save their own skin) this June. A new independent CEO was brought in and he came clean this morning that the entire venture was a sham.
Throughout this entire 3+ year saga, the SEC and FDA have been completely MIA. So what changed? I think it’s that the legal risk simply became too great (no executive wants to spend time in jail). So the Board of Directors and new CEO did the right thing (in the end) and finally came clean.
Lesson: Even though the regulators have been missing in action, the US justice system and courts are not (although they move at a glacial pace).
SunRun - Fraud Can’t OutRun Bad Economics
Full Disclosure: While in the past I have been short SunRun equity, at the moment of writing this I am no longer short the stock. But that can change at any time post-publication.
SunRun is a company that I’ve written about in the past. It’s a residential solar company that has never come close to sniffing profitability. The business’ terminal value is zero.
After rallying over the summer to more than $20/share. The company’s shares collapsed with the election of Trump and his promise to end many of the renewable/green tax credits.
But that’s only half the story. The company continues to light money on fire. Cash flow from operations was negative $156 million in Q3 (versus negative 63 million in Q3 of last year). Cash flow from investing was negative $764 million (versus negative 741 million in Q3 of last year).
Year to date, the company has burned through $2.4 billion in cash flow from operations and investing activities. And yet if you read the headlines to their Q3 news release, you’d never know.
But at the end of the day, no amount of fraud (or non-GAAP metrics) can overcome economic gravity. This company is headed for bankruptcy and equity holders will be wiped out (although when exactly that happens is hard to tell).
Again, the SEC is completely MIA when it comes to regulating the use of non-GAAP metrics but it doesn’t matter. Reality will do its job for them.
Lesson: Fraud can go on for longer than you think, but it can’t defy (economic) gravity forever.
Tesla - The Power Of Having Friends In High Places
Full disclosure: I currently have a very small short position in Tesla. This may change after post-publication.
And there’s Elon Musk and Tesla. The “OG” Meme Stonk and Elon who seemingly viewed it as his mission to break as many laws and regulations as humanely possible. With regulators and prosecutors circling, he threw all of his financial and political support to Trump. And it paid off big time with Trump winning.
In the aftermath of Trump’s win, Tesla shares have rallied ~50%. While the shares haven’t regained the 2021 highs, they’re now up ~250% off the 2022 lows. The rise is likely due to the belief that not only will he (and Tesla) gain access to lucrative government contracts Will likely be immune to any (Federal) prosecution and regulations.
Elon is now “best friends” with Trump and has been very involved in his transition. He and Vivek Ramaswamy have been given the “DOGE” (Department of Government Efficiency) and tasked with finding waste and government spending to cut. Although DOGE isn’t a real department (that would require Congress). And why does a “government efficiency” need 2 leaders?
Elon is at the top of the world right now and the lesson hasn’t played out (yet).
But let’s look at another example from ancient history (well 20 years ago):
That’s right. Enron’s Ken Lay and Jeff Skilling were close friends and confidants of George Bush. They also bankrolled all of his political campaigns and were instrumental in his political rise.
But when Enron collapsed, they became massive political liabilities. So Bush and his administration cut them loose and abandoned them. The lesson is obvious, you can be best of friends as long as you aren’t a political liability, at which point they will always prioritize saving their own skin.
Meanwhile, Tesla’s actual business continues to erode. Their model lineup is the oldest in the industry and the Cybertruck is a colossal failure. Elon’s close relationship with Trump has likely antagonized a large portion of his core customer base.
Trump has vowed to cut the Federal EV tax credit which will be a tough blow for the whole EV industry. Meanwhile, the legacy OEMs (GM, Ford, etc.) have very large and profitable ICE model lineups to fall back on.
The combination of low margins, high fixed costs, and huge capital expenditures means that automakers have a long history of going bankrupt very quickly. If Tesla implodes (and corporate wrongdoing is uncovered) don’t for a second think that Trump won’t throw Elon to the wolves.
Lesson: You only stay in politicians’ good graces as long as you’re useful. Once you’re a massive political liability, it’s adios.
Conclusion
So to wrap up, corporate fraud is prevalent these days so it’s hard to see how it can get any worse. The SEC has been largely irrelevant for a long time now, but that doesn’t mean you have to either.
Keep a look out for big red flags, although it’s much easier to see them in hindsight. The wheel of justice still works (in the US at least), but they move slowly and as an equity investor, you’ll likely have been wiped out long before.
Keep a close eye on the audited financial statements. And compare and contrast those with what management is telling you (with their non-GAAP metrics). The bigger the gap, the more quickly you should run away.
And finally, just because a company or its executives are in politicians’ good graces, that shouldn’t make the company a buy (on their own). Politicians, like the public, are fickle and one day you can be on the top, and the next not.
Hopefully, you enjoyed this article, and stay safe in these crazy markets.
Disclaimer: This newsletter and/or any other articles that I publish should not be construed as investment advice. None of the strategies or securities mentioned should be considered as an investment recommendation to buy or sell. I am not an investment advisor and I highly recommend that anyone considering this investment strategy or any of the securities first consult with a registered investment advisor to assess both the suitability and risk of any strategies or securities that are mentioned.