Beware of the rise in whistleblower tips…

From the desk of Miles Everson: Happy Wednesday! I hope you’re having a great week so far. Every Wednesday, I talk about various topics about investing. My intention is to help you achieve better gains for your investment portfolio and boost your financial well-being as a result. Today, let’s talk about whistleblower tips and how these can impact your portfolio and investing strategy. Eager to know more? Continue reading below to know!

Beware of the rise in whistleblower tips… Traditionally, short sellers have made their money by betting against companies they think will perform poorly… and most of the time, these investors bet on businesses they believe are engaged in fraudulent activity. This type of move makes sense since a company’s stock could drop double digits (sometimes overnight) if it is accused of fraud. This scenario played out exactly in 2015 when Citron Research, a renowned short seller, published a report alleging that Valeant (now known as Bausch Health) engaged in sham transactions to inflate its drug sales. While this is a well-established tactic, short sellers have taken it a step further. Aside from publishing short reports and carrying out trades of that nature, these investors are participating in the U.S. Securities and Exchange Commission’s (SEC) Whistleblower Program… in exchange for cash. Simply said, these short sellers are sharing their research directly with the SEC and if the regulator finds a company guilty of fraud and fines it, whistleblowers can collect up to 30% of the proceeds.  The SEC’s program had a record year in 2023, as whistleblower tips went up by 50%. This may sound like a good thing for both the SEC and short sellers, but it’s definitely a red flag in today’s business climate. Here’s why… Blow the Whistle and Earn Some Cash Since its launch in 2011, the SEC’s Whistleblower Program has awarded more than USD 1.9 billion to over 397 people. The way this program works is simple: Once the whistleblower reports suspicious activity to the SEC and the regulator finds that a company is indeed guilty of any wrongdoing in its investigation, the informant will be entitled to a portion of the collected fines. As mentioned above, whistleblowers can make up to 30% of the monetary proceeds, incentivizing individuals to come forward and report on alleged malpractices. Since short sellers look for potential fraud, they’re one of the SEC’s best tipsters. Just take a look at short seller Carson Block, for example. Block runs Muddy Waters Research, an investment research firm.  Block was early to the whistleblowing party as he began sending his tips soon after the SEC started its whistleblower program. In 2022, he received USD 14 million for the research his firm published about Chinese media company Focus Media in 2011. In that report, it was alleged that the company’s chief executive helped organize an insider deal that benefited Focus Media executives. The SEC did not have the company on its radar until it received Block’s tip, ultimately leading the media company to settle with the regular for USD 55.6 million. With tipsters like Block winning big payouts, it’s unsurprising to see short sellers join the bandwagon. In the fiscal year of 2023, the SEC received more than 18,000 tips, compared to 2022’s 12,000. While this is a sign that the SEC’s program is profitable and low-risk, it’s also a signal that shows companies are under financial stress today. Short sellers are sharing more tips because more companies are under financial pressure than at any point in time since the SEC launched its program.  While not all of the tips the SEC receives will result in sanctions and fines, it’s still a warning that lots of public companies are struggling… even in ways that aren’t visible to most investors. The bottom line? In times like these, investors have to be more careful than usual when scouring the market for opportunities. After all, you definitely don’t want to get caught holding the bag when a company is accused of fraud or when it’s unlikely to survive the next few years. Hope you’ve found this week’s insights interesting and helpful. SPECIAL ANNOUNCEMENT: Hi! As you may have noticed, I often mention my friend and colleague, Professor Joel Litman. Thousands of investors worldwide (including most of the best ones) rely on Professor Litman’s unique approach to investment research and his firm’s Uniform Accounting database. Though Joel spends much of his time advising the big investment firms and some of the largest US businesses, he believes, as I do, in the power of independent decision making when it comes to personal finance. For those Freebirds among us who make our own investment decisions, Joel and his team have created a fantastic tool: The Altimeter. Lately, as competing forces of excitement around AI, fears of economic downturn, and uncertainty about Fed policies have wreaked havoc on the market, I’ve leaned on Joel’s steady advice and data-driven approach to investment research more and more. This is where the Altimeter comes in. Professor Litman and his team designed this tool to show you the true value, profitability, and outlook of over 6,000 companies in their database. Information about the companies in their database is updated in real time so you can make informed and up-to-date decisions about your stock picks and portfolio. In today’s volatile market, the Altimeter is the most trustworthy and reliable way to optimize your portfolios. If you’re not familiar with Joel’s approach to research and the incredible tool he’s built around it, take a look here. Stay tuned for next Wednesday’s The Independent Investor! If there’s one thing you need to know about private equity (PE), it’s this: PE firms never meant to run “forever funds.” Learn more about why private equity’s game plan no longer works in next week’s article!