Politics. Lack of funding is always the primary excuse a bureaucracy has not done its job properly. It is more than that, however. There must always be a willingness. Until last week, both had been absent from the Securities and Exchange Commission for more than a decade.
It is true, funding has been below post-financial crisis levels since 2015. Worse, levels have gyrated between 5 and 10%YoY. For the bureaucracy, predictability is often as important – even more so – than the absolute level of appropriation.
Leaving aside their budget authority, the SEC probably has a million reasons for its hesitancy. One of them, however, has got to be their tendency toward selective prosecution of high-profile individuals – guaranteed to make the front page – to send a message to the less known.
The approach worked. The prosecution of Ivan Boesky and Mike Milken, celebrities in the “Greed is Good” era of the 1980s, sent compliance officers into overdrive designing training and processes to stay on the right side of the law.
Then it didn’t. Martha Stewart may very well have been mixing Material Non-public Information into her cake batter, but James Comey’s – yes that James Comey – pursuit of the case in 2005 was so relentless, not to mention novel, that it was considered overreach by both the public and Congress.
Budgets were slashed and the lesson was learned. Prosecuting the high profile invited significant risk to the agency. In other words, famous people have political power all their own that is not to be underestimated.
For the CEO with a big dream, little reality and a consistent need for public market capital, the formula is simple; inoculate yourself against enforcement with celebrity status that would place the SEC on the defensive in the court of public opinion. Forget the requisite omnichannel media company of Martha Stewart. Today it can be accomplished with a subreddit, a Twitter handle and a self-congratulatory podcast, preferably all dedicated to how your company alone will save the planet.
As luck would have it, NKLA’s Trevor Milton is a man with a record and no fan base of vehicle owners – because there are no vehicles – and thus a viable target for enforcement. It helps too that his communication with shareholders has made some of Elon Musk’s antics look like they were reviewed by 50 lawyers at Debevois and Plimpton.
As NKLA is such low-hanging fruit, the SEC’s move can hardly be called courageous. It does, however, represent an important return of enforcement at a time where corporate compliance in some sectors has deteriorated to the point of absurd.
Policy. Since early spring, the SEC has signaled their escalating interest in SPACs. Of concern has been the accounting for warrants which most SPACs have moved to correct. The other issue, the one that found its target with Mr. Milton, is the presentation of potentially misleading information, either through SEC filed documents or in more casual communication with the public.
Indeed, entering the public markets through the SPAC door has become an excuse from some wild tales. Mr. Chamath Palihapitiya’s one pager that circulated in October 2020 projected total CLOV membership of 273k by 2021 year-end and top line revenues of $880 million. Because the revenue math for pure play MA is simple; (membership*monthly PMPM payments) *12) only one of his statements could have been close to true. (In this case, it was likely revenue which is generally not considered as important as member growth.)
In S-4 files in October 2020, Mr. Palihapitiya’s SPAC declared, “To date, we already have contracts with physicians through which approximately 200,000 lives may be aligned with our DCE under the program.” At a sell-side conference in November, CEO Vivek Garipalli reiterated the 200k DCE aligned beneficiary figure and declare 2022 would be “a half a million plus.”
These promises disappeared once the merger became effective and were replaced in March with “access to up to 200,000 Medicare beneficiaries through its contracts with Participating Providers.” By May the company backed up even further and said, “we believe we will end 2021 with between 70,000 - 100,000 total aligned beneficiaries.”
It is important to note here that virtually nothing about the Direct Contracting Program changed between October 2020 and May 2021. For 2Q 2021 the company should turn in a membership number of about 66,400 and MA revenue of about $201M. Direct Contracting is difficult to predict due to unclear accounting treatment but of the 2400 physicians associated with CLOV’s DCE, about 1500 meet CMS’ criteria for inclusion. Of that 1500, about 500 have billed Medicare for the most common primary care HCPCS code, 99213, on behalf of 84k beneficiaries.
Of course, the formal filings contained oodles of disclaimers no one read. But SEC has always warned that applying disclaimers to your forward-looking statements does not give anyone a license to, well, lie. This being the golden age of overcommunication, the SEC case is relying heavily on Mr. Milton’s declarations in podcasts and Twitter; a reminder that whipping up your fan base with crazy ideas on social media is not excused from the law.
We were near the end of our infatuation with the rich and famous anyway – see e.g., Oscar awards viewership – but the SEC will now be a limiting factor in expanding the reach of charismatic financiers like Mr. Palihapitiya who, at least in the case of CLOV, seem to have few qualms about misleading investors.
Power. The Street has already baked in the unquantifiable risk associated with SPACs and the companies they spit out. Even for those names associated with more cautious SPACs are getting punished. In a few cases, like SHCR, the companies probably were not completely prepared for public ownership and the next several quarters may justify the market’s bias.
In others, where use of the SPAC makes sense in the context of an urgent need for growth capital and lots of it, like CANO, the bias will not be a permanent one. A few quarters of solid earnings, tightly managed operations and the pack will start to separate. Keeping a close eye on the higher quality names, as we are doing, like CANO, CMAX, perhaps Talkspace and maaaaybe FORE’s P3 Health Partners, should be rewarded.
Then there are de-SPACed companies that have so elevated the expectations of their flock while obfuscating the performance of the company, the sell-side has left them for dead. The only thing to be done is to rip a page from Martha Stewart’s playbook, place your self on the side of the angels and rally “retail” – of late to be found on r/reddit and Discord – to your side - which has the added benefit of avoiding the wrath of the SEC.
It didn’t keep Martha Stewart out of jail and it probably won’t work here either. Wall Street’s penalty box for those that willfully mislead can endure for years without the reckoning via a “turnaround narrative.” The C-suite must be expelled, expectations lowered and sell-side analysts convinced.
It is hard to foresee a return from the wilderness as long as “retail” parrots management’s complaints about short-sellers while continuing to claim “hypergrowth mode.” When the sorting of the SPACs begins, it is worth keeping this in mind.
Have a great rest of your weekend.
