Fun with FOIA 1

Disclosure: Short WRLD.

I don’t often write about World Acceptance Corporation, a position that was the subject of a detailed report last year but has since become relatively difficult to borrow. With potential CFPB enforcement action expected within the next few months, the stock is discounting uncertainty around the scope, severity, and consequences of the Bureau’s oversight. It remains a modest position, and I anticipate that an eventual wind-down/dissolution of the business remains probable, with varying potential equity recovery depending on the nature of the enforcement action.

I have little to add on the exact nature of the CFPB’s theories of legal liability, although I have previously speculated that credit insurance, repeated refinancing, fee disclosures, and collection practices represent potential sources of concern. However, as an illustration of what is becoming an increasingly popular step in the investment process, I thought I would share a recent response from the CFPB regarding inquiries into that very question.

Under the Freedom of Information Act (FOIA), government agencies are required to provide a wide variety of information generated by their operations, subject to several limitations. In particular, there is an exemption allowing agencies to withhold records compiled for law enforcement purposes. Investors and analysts have cleverly used this exemption as a way to confirm the existence of undisclosed SEC investigations.

Cable Car submitted a FOIA request to the CFPB requesting copies of the NORA letter and response from WRLD. Under the law enforcement exemption, the agency must demonstrate that disclosing material would reasonably be expected to impair the enforcement process. Cable Car argued unsuccessfully that disclosing the CFPB’s theories of legal liability would not negatively impact an enforcement proceeding and sought redacted copies of the documents in the alternative. The latter request was unfortunately denied on the amusing basis that “release of any non-exempt information would produce only incomplete, fragmented, unintelligible sentences composed of isolated, meaningless words.” The semiotics of such a document might still be interesting, but I digress.

PDF iconRead the CFPB response to Cable Car’s FOIA request.

Even when a FOIA request is denied, the response can be illuminating. Over the past few weeks, there have been unfounded rumors floated in the marketplace that World’s CFPB review was nearing an imminent resolution without material consequences to the company. On the contrary, the CFPB’s response indicates that an enforcement action remains reasonably anticipated. The FOIA response stated:

“Premature disclosure of the Bureau’s theories of liability, as well as the recipient’s responses to those theories, could reasonably be expected to interfere with reasonably anticipated enforcement proceeding.”

Precedent enforcement proceedings have been initiated several months after a NORA response, so the rumor never made much sense to begin with. I believe a reasonably negative outcome for World Acceptance remains reasonably likely.


Healthcare Cost Inflation

Disclosure: Short EXAS.

CMS has preliminarily determined not to change the reimbursement rate for Cologuard.

Turing Pharmaceutical’s decision to dramatically increase the price of Daraprim in order to achieve investment returns and fund incremental research drew widespread condemnation this week. Turing became emblematic of wider biotechnology industry practices that collectively contribute to healthcare cost inflation. Optimal drug pricing is a more nuanced question than the immediate outrage suggests, but the systemic problem is not limited to pharmaceuticals.

Even government payors do not always feel empowered to consider cost-effectiveness when establishing reimbursement rates. Unlike the niche commercial toxoplasmosis market served by Daraprim, CRC screening is in large part a publicly financed benefit recommended for almost everybody over the age of 50. Americans are now being asked to pay more for non-invasive screening.

The transformation of Exact Sciences from a heavily promoted penny stock with a failed DNA-based CRC detection technology at the end of the last decade to the multi-billion dollar company of today was premised on what now appears to have been a remarkably foresighted decision:

The company took a decades-old screening test, licensed expensive diagnostic biomarkers not reimbursable for screening on their own, and then spent millions demonstrating that, predictably, administering diagnostic assays to screening populations catches a few incremental early-stage cancers at a very high cost with a large number of false positives.

They then successfully lobbied a government agency to increase the price for the combination by 23x over the predecessor test.

It seems that decision will stand.

Last night, CMS released its preliminary 2016 payment determinations. The rationale for new code 81528 was thin:

CMS Recommendation: Crosswalk to codes 81315 PLUS 81275 PLUS 82274.
Rationale: We believe that the 2015 pricing of code G0464 is the correct reimbursement rate, and this molecular pathology test is replacing that code. Commenters recommended other formulas. While we appreciate the comments that payment of this test should be based on various mathematical equations, it is our belief that the crosswalk to the current 3 codes best represent this test. The Clinical Laboratory Diagnostic Test Panel also agreed.

While there is another comment period before the rates are finalized later this year, there is very little else to say about how much the reimbursement rate exceeds both the unit cost of the test and the cost of gaining equivalent life-years through more efficient screening modalities.

I stand by Cable Car’s analysis and thank the staff at CMS for their consideration.


Reconsideration Update 10

Disclosure: Short EXAS

As promised in my previous post, you may now download Cable Car’s public comment in response to statements made at the Public Meeting in July. Comments are normally available only through a FOIA request, but in the interest of transparency I wanted to share my views more broadly. I believe Kevin Conroy made several statements at the Public Meeting that are not accurate and deserve a public accounting. The comment letter discusses the legal basis for the reconsideration request, claims regarding compliance and cost-effectiveness, and additional cost analyses. Exact Sciences shareholders can take comfort in the fact that the company has impressive operating leverage, irrespective of the Medicare payment rate. The incremental cost per test in recent months appears to be less than $100.

Following the preliminary determination on the reconsideration request expected sometime in September, there will be an additional 30-day comment period before the 2016 fee schedule is finalized.

CMS Panel

This morning, CMS convened the first meeting of an advisory panel on Clinical Laboratory Diagnostic Tests. Steve Phurrough, the CMS Medical Officer who asked Conroy several questions at the Public Meeting that are addressed in my letter, chairs the panel but is not a voting member.

The panel was established under the Protecting Access to Medicare Act (PAMA), which is also changing the rate-setting process for the clinical lab fee schedule beginning in 2017. Since the PAMA rulemaking is not yet complete, the purpose of this initial meeting was to provide input into the new codes for 2016 that were discussed at the Public Meeting in July. The panel’s recommendations are advisory and non-binding.

The bulk of today’s debate involved highly technical, controversial determinations regarding the most comparable tests, from a methodological standpoint, to use for several new test codes. Cost-effectiveness concerns were not mentioned at all.

Disappointingly, the panel’s brief discussion (starts at 1:26:30) of code G0464 resulted in an 11-0 vote, with 1 abstention (likely the representative from the Mayo clinic) from the 12 panel members present, in favor of maintaining the current crosswalk. More accurately, there was no discussion. The panel did not discuss their reasoning at all; the only comment was from one individual who questioned why code 81315 had no connection to colon cancer and such a high reimbursement level before voting to include it in the crosswalk anyway.

The panel members are all very well-respected scientific experts, but it does not appear that they devoted much, if any, deliberation to the substance of the reconsideration request. In particular, despite asking many clarifying questions regarding the most appropriate factors to consider for other tests, in the case of G0464 there was no debate whatsoever about the appropriateness of considering a test’s purpose, rather than its methodology, in assigning a crosswalk.

It is unclear whether or not the panel had the opportunity to review the reconsideration request in full or the further comment letter. As the panel’s recommendation is non-binding, I strongly urge CMS to take all available information into account in reaching its determination.

 


Is your high water mark net or gross of fees?

Cable Car does not deduct previously earned incentive fees from the high water mark. Most of the industry does.

A few recent conversations with current and prospective clients reminded me to clarify one area in which Cable Car’s standard fee structure is differentiated in favor of clients. Cable Car already offers qualified and non-US clients an unusually aligned fee model, with no management fee and a 30% incentive fee. This performance-based fee is typically crystallized quarterly, subject to a high water mark of previous performance.

The way in which the high water mark is calculated can have a material impact on the net returns received by clients. For example, suppose a $100,000 investment had gross returns of 20% during a period, for a gross account value of $120,000. After deducting a 30% incentive fee, the client’s net return would be 14%, for a balance of $114,000.

In this example, Cable Car’s high water mark for future periods would be $120,000, the gross amount before fees. By contrast, many hedge funds calculate the high water mark only after deducting the performance fee. The high water mark for these funds would be $114,000.

Cable Car Calculation Example

Period Starting Value Gross Return Fee Ending Value New HWM
1 100,000 20,000 6,000 114,000 120,000
2 114,000 2,000 - 116,000 120,000
3 116,000 (10,000) - 106,000 120,000
4 106,000 24,000 3,000 127,000 130,000

Industry Standard Example

Period Starting Value Gross Return Fee Ending Value New HWM
1 100,000 20,000 6,000 114,000 114,000
2 114,000 2,000 600 115,400 115,400
3  115,400  (10,000) - 105,400 115,400
4 105,400 24,000 4,200 125,200 125,200

With the same $36,000 in gross returns over 4 periods, Cable Car’s total incentive compensation would be only $9,000, versus the headline figure of $10,800 under a fee structure with net compounding.

For a concentrated and relatively volatile strategy, Cable Car’s approach limits the risk to clients that performance fees are crystallized at inopportune times. Cable Car is not compensated until it has “earned back” the prior incentive fee. In practice, this means that for positive gross returns, the total incentive fee over a long period of time may be significantly less than the headline fee as a proportion of the gross returns earned in the account. Depending on the actual pattern of returns and timing of fees, a 0/30 model may offer a significant long-run discount when compared to the traditional 2/20 fee model. Due to the effect of compounding as an investment grows, the absence of management fees under this structure results in the potential for significantly better net returns for clients over time.

For example calculations, questions, or comments, please don’t hesitate to contact Cable Car for more details. Depending on client needs, management fees may be more appropriate in the future to support investments in additional infrastructure as the firm grows. Cable Car’s fee structure is negotiable for large, long-term capital commitments.


(click to expand)

What fees does Cable Car charge?

For US investors who are not qualified clients, Cable Car charges a flat annual management fee equal to 3% of the account value, billed daily in arrears by the custodian.

For non-US investors and qualified clients, Cable Car waives the management fee and charges a 30% incentive fee, computed quarterly by the custodian on the net profit and loss in the account and subject to a high water mark of previous performance.

Please see Item 5 in the firm’s brochure on Form ADV for more information.

Management fee Incentive fee
Non-Qualified 3% None
Qualified None 30%


Cable Car Presentation at the Clinical Lab Fee Schedule Public Meeting 1

Disclosure: Short EXAS.

On Thursday, July 16, I presented Cable Car’s reconsideration request regarding code G0464 on the Clinical Lab Fee Schedule before the annual Public Meeting at CMS. The slide presentation is now available for download. You can view my prepared remarks and those of the other speakers on Youtube [starts at 24:45] or in the player embedded below.

I will publish a further comment and rebuttal to Kevin Conroy’s presentation after the public comment window ends in August.

I appreciate having had the opportunity to share my perspective with CMS.


Q2 2015 Letter and Presentation to CMS

Cable Car’s Q2 2015 Letter has been published.

The Cable Car Composite returned +22.7% versus +0.3% for the MSCI ACWI in the second quarter of 2015.

On Thursday, July 16, I will be presenting the reconsideration request to CMS at the annual Clinical Lab Fee Schedule Public Meeting. The presentation and prepared remarks will be made available on the website afterwards.

Please view important disclosures regarding performance reporting.


Your Capital (still) at Risk Part 12: Legal Consequences 2

Disclosure: Short PLUS. This content is not directed toward persons with residence or place of business in the United Kingdom. By accessing, transmitting, or reviewing this material, you acknowledge that the author has represented his honest opinion and made statements of fact believed to be true at the time of publication. No content herein should be construed as a recommendation to take action with respect to any security.

Part 1: Short Plus500
Part 2: Bucket Shop
Part 3: Customer Lifetime Value
Part 4: Companies House Inconsistencies
Part 5: Audit Opinions
Part 6: Unlicensed Activity
Part 7: Whois Plus500?
Part 8: Scalping
Part 9: Worldwide Web
Part 10: Competition
Part 11: Unanswered Questions
Part 12: Legal Consequences

Customer complaints suggest Plus500 often treats users unfairly and in possible violation of law. I believe Plus500 will face material legal consequences for its treatment of customers, marketing activities, and disregard for local regulatory requirements.

After publishing this series, I have been contacted by several former Plus500 customers who believe they were defrauded by the company. One individual in the Netherlands shared a long and extensively documented complaint, which was submitted to the FCA and the Financial Ombudsman in April.

The current AML-related inquiry by the FCA is unlikely to be an isolated event. In light of the company’s actions toward its customers, I strongly suspect that the additional scrutiny stems from multiple such customer complaints.

When a gambler visits a casino, the gambler gambles with the knowledge that the house has an edge. When a novice trader trades with Plus500, the trader knows the odds do not favor long-term success at highly leveraged CFD trading. However, the trader expects that the platform is organized in a way that is fair and objective, and that prices will accurately reflect developments in the underlying securities. A review of customer complaints suggest several ways in which this may not be the case.

In this post, I’ll use a case study of complaints from a single Dutch affiliate forum to set out a few ways in which it appears the company has crossed the line. Thank you to MM for translation assistance. The forum in question is hosted by affiliates of Plus500 and offers Netherlands-based customers of Plus500 a Dutch-language venue to discuss their experience.

Note that many customer complaints are by novice traders. They sometimes mix legitimate concerns with misunderstandings of typical financial contract terms. That does not change the basic facts of their complaints. Suitability considerations and regulatory requirements generally place the burden for properly documenting the terms and conditions of a trading platform on the company, not its users.

I’m sure affiliates will explain away some behavior documented below as being part of industry norms, but the argument is not that Plus500 is necessarily the worst offender among all platforms. Being mostly fair, or fair to most users, is not sufficient. If Plus500 has in fact manipulated its platform to the disadvantage of some users, there will be significant consequences. At a minimum, Plus500 takes advantage of inexperienced traders. If the customer complaints are accurate, it also cheats them.


  1. Arbitrary expiry procedures
    Customers note that Plus500 sets arbitrary expiration dates for contracts that do not match the underlying instruments and are not always clearly communicated or adhered to. Expiry terms are not well-documented, and Plus500 sometimes expires existing contracts early, without prior notice. Contract expiry typically occurs on a weekend at the last Plus500 quoted price on Friday (not necessarily the relevant underlying price)—this is how Plus500 records profits on Saturdays. Plus500 retains sole discretion to roll contracts to the next expiry. Customers opening positions in a new contract do not have transparency into which futures series is used to determine opening prices.

    Trader Rokil
     complains about an unannounced early expiration in Coffee, resulting in a loss. Trader Fredkroket says this happened to him in Bitcoin as well.

    Trader Snarf complains about an expiry date unexpectedly set one week before the expiry date of the underlying front-month contract at CME. Administrator Armijn admits he also missed an expiry date once and lost money because it was written in fine print on the second page of an instrument. Trader Navras replies with the same experience.
    Plus500 retroactively changed the expiry date of an outstanding Bitcoin contract, resulting in a loss for Trader Peacock. Trader Linda mentions a similar experience with Facebook. She claims her trade history on that instrument was erased.


    Trader Freedom Capital
    on an English-language website describes how a Bitcoin contract with a November 30, 2013 expiration date was closed in mid-November and replaced with a daily expiration (with higher costs) without notice. 

  2. Inopportune cancellation of withdrawals
    A basic principle of dealer-model CFD brokerage is that customers cannot owe the brokerage more money than they have on deposit. However, because Plus500 takes a long time to process withdrawals, it sometimes uses the delay to its advantage. Customers have reported withdrawn amounts, which were already debited from their Plus500 accounts but had not yet been transferred, being cancelled and returned without warning, placing the funds at risk to cover open positions. Other customers have reported suspicious timing of rejected withdrawal requests, despite proper documentation, that occurred within minutes of new positions being opened.


    Trader Thomasson
     reports funds he had already withdrawn were returned to his account to cover a margin deficit. The withdrawal was still ‘pending’ but had already been debited from the account for several days when he went below margin. Plus500 used the withdrawn funds to cover the margin deficit, but this amount was insufficient so the positions were closed at a total loss of both the withdrawn amounts and other monies on deposit.

  3. Difficulty closing positions
    Several users have reported unexplained, system errors that prevent positions from being closed while in a profit position. In other instances, profitable positions remain open and exposed to market risk because Plus500 chooses not to make quotes available on the platform at its discretion.

    Trader GBG could not close a USDRUB position at a profit one hour before the stated closing time of the market. He tried unsuccessfully for an hour, the market closed, and the next day his position changed to a loss and could once again be traded. Plus500 support responded that the ruble was unavailable for trade due to ‘low trading volume’ despite external trades taking place in the underlying. GBG has complained to the FCA and changed brokers.

    Trader Verlangen complained that he could not close his position at a profit; the close button did not work. After his trade entered a loss position, he could close it again.

  4. Miscellaneous platform inconsistencies and policies
    Traders cite a variety of arbitrary rules and actions by the company that work to their detriment, including closed accounts, price divergence from the underlying, and different withdrawal limits for different users. Some traders claim prices quoted on Plus500 demonstrate higher volatility than the evolution of the underlying, resulting in additional losses for leveraged traders. As discussed in Part 8, traders worry about the definition of “scalping” in the User Agreement. While Plus500 appears to ultimately resolve scalping complaints in favor of the users who push back (after several months, in the case of two different Singaporean users), how many more inexperienced traders simply go along with it when they are told that their profits are illegitimate?


    Trader Linda
     concludes that with a definition like “a systematic trading strategy” Plus500 can call just about anything scalping. Plus500 support is quoted: “Please note that scalping has no specific time definition. A trader is considers as scalper when using a systematic trading strategy of holding short-term positions. Please be aware that when examining a scalper we look at the overall trading activities, rather that just on a certain position.”


    Discussion about scalping
    ; traders worrying if trades under ten minutes are considered scalping.Trader Ikbener somehow managed to open two accounts and made EUR 4,500 from his sign-on bonus. The profitable account was closed, and he was not allowed to collect the profit.
    Trader Johanserv
    complains about inexplicable differences between quotes at Plus500 and on other financial sites.


    Trader Pokemon
    asks about the minimum amount of money he can withdraw. Administrator Armijn and Linda figure out that it is different for all users. For the administrator himself, the minimum has increased over time; he speculates that it might reflect higher bank costs. Trader Linda concludes that it is completely unclear how and why Plus500 determines the minimum withdrawal sum for various users.


    Trader Vijo
    complains that Plus500 closed his account after two years of trading, without announcement or reason, and made a new one for him while not transferring all of the money or positions on his old account. Plus500 support stated that his new account was reopened at Plus500′s Cyprus subsidiary, Plus500CY. The miscalculation of money in the old account was never fully explained.

The message to Trader Vijo from Plus500 support, dated February 23, 2015, confirms that Plus500 has been transferring UK-regulated client accounts to Cyprus, as reported on LeapRate and Business Insider last week. Trader Vijo’s experience confirms that Plus500 has been attempting a regulatory arbitrage for months before the recent voluntary action. Why would Plus500 transfer EU clients to Cyprus while under investigation by the FCA? This action strongly suggests the company is trying to take advantage of the EU passporting mechanism from a jurisdiction with less stringent oversight. Full email reproduced from the thread below:

Hello, 

We reviewed your account and would like to inform you That as you already agreed by accepting the New User Agreement, due to a regulation change – from The Financial Conduct Authority (FCA) to the Cyprus Securities and Exchange Commission, your old account was closed on 02.16.2015 and the balance of (€ -157.67) was Transferred to a new account with the same email address, but under the new regulation. 

You can still have access to your previous account under the email: old_mail@emailadres.nl and your old password, for information and taxation Purposes, for 30 days after the opening of your new account. After That period the old account (old_mail@emailadres.nl) will be closed and you will be trading into account: mail@emailadres.nl. 

This change did not have any effect on your account’s trading only the change in e-mail. 

Your current account is exactly the same as the old one, simply under a different regulation. 

Regards 
Erikka 
Customer Support 
Plus500 CY Ltd 
1 Siafi Street 
3042 Limassol

In addition to the above individual experiences, the customer complaint to the FCA documented an extensive list of ways in which the Plus500 User Agreement is inconsistent with Dutch Law and the UK’s Unfair Contract Terms Act. It also highlighted numerous ways in which the trading platform is risk-enhancing and unsuitable for novice traders. Minimum order sizes and thresholds are in some cases larger than the tick size of the underlying instrument. Default order sizes are very high relative to customer account balances. Plus500 also upgrades most users to a “Gold account” after a short period of activity, setting the default order size and leverage limit to a much higher level.


I am not an attorney, but I have four theories of how legal liability could attach to Plus500 as a result of these and other actions, some of which were referenced in Part 9. While customers have been contacting journalists, short sellers, and the FCA, they really should be in touch with a competent multi-national law firm. The allegations just among Dutch customers alone appear sufficient to support a class action suit. This is a situation where a determined prosecutor or advocate could make a real difference for customers who have lost money unfairly.

  1. Class action complaint by customers: I recognize that the United States is a much more litigious society than Europe. Here, there would already have been multiple shareholder derivative actions based on all the things people were upset about at the AGM. However, the allegations documented above are serious and warrant investigation. If a court determined that Plus500 acted abusively, restitution and punitive damages could be significant.
  2. Foreign regulatory fines and claims: Plus500 operates without a license in many parts of the world, as detailed in Part 11. Any customer losses attributable to the platform are in theory null and void, as the company operated without authorization and could not enforce its user agreement. While it might be difficult or impossible for a foreign regulator or court to enforce a judgement upon Plus500, the risk remains. Plus500 operates using currencies and the international banking system in ways that may bring it into the regulatory net of other countries, including the US.
  3. Local marketing violations: Plus500 notes in the Admission Document that its affiliates may run afoul of local securities marketing requirements. It does not note explicitly that it accepts affiliate marketers located in jurisdictions where it is not authorized to operate, including the United States. Affiliates who receive revenue sharing arrangements are in effect participating in a multi-level marketing scheme and receiving up to 30% of the turnover of an unlicensed broker-dealer. The US SEC and Department of Justice are not likely to look kindly upon US persons profiting from the operations of a foreign securities firm that is not authorized to operate in the US, while using US means of commerce to promote that entity. Local authorities have been notified.
  4. UK or Cyprus regulatory fines or loss of registration: So far, the FCA has not shown itself to be particularly punitive. At the AGM, Plus500 said there was no evidence that the FCA will issue a fine for Plus500′s AML procedures. However, if the allegations by customers are true, there may be meaningful consequences for other behavior.

With that, I will reiterate the question I raised in Part 10: Would you do business with Plus500?


Your Capital (still) at Risk Part 11: Unanswered Questions 9

Disclosure: Short PLUS. This content is not directed toward persons with residence or place of business in the United Kingdom. By accessing, transmitting, or reviewing this material, you acknowledge that the author has represented his honest opinion and made statements of fact believed to be true at the time of publication. No content herein should be construed as a recommendation to take action with respect to any security.

Part 1: Short Plus500
Part 2: Bucket Shop
Part 3: Customer Lifetime Value
Part 4: Companies House Inconsistencies
Part 5: Audit Opinions
Part 6: Unlicensed Activity
Part 7: Whois Plus500?
Part 8: Scalping
Part 9: Worldwide Web
Part 10: Competition
Part 11: Unanswered Questions
Part 12: Legal Consequences

Cable Car remains short Plus500 with a revised price target of 52 pence (GBP 0.52). Plus500 faces material legal liabilities and has yet to address its undisclosed Belize activities, filings inconsistencies, and misrepresentations regarding customer losses.

Below, I will address the wholly inadequate response from Plus500, which was published in an RNS last Wednesday.

Before I do, however, I have one small mea culpa. In publishing such a large volume of material, I inadvertently neglected to translate Plus500′s stated cash balance of $88 million from USD to GBP. As a result, I published a price target that was too high. Using the updated cash balance of $92.2 million and an exchange rate of 1.53 GBPUSD, Plus500 has approximately GBP 0.52/share of cash on hand today. The per-share lifetime value calculations in Part 3 are similarly expressed in USD and are thus too high by the same factor. Consequently, I now value the cash plus potential earnings from the current customer base at GBP 0.84-0.98. This estimate is based on the potential profitability of the customer base as of Q1 2015 using 2014 ARPU and margins. It does not include remediation costs, reduction in trading activity, or loss of users due to the ongoing account freeze, all of which are likely to be significant.

I regret the error. If any other aspect of this series is factually misrepresentative, I will gladly correct the record.

I continue to believe that if the questions raised in this series are not adequately addressed, the company will ultimately cease to continue as a going concern and hence reiterate the stated cash balance as my price target. In addition, I believe Plus500 will face material legal consequences from its marketing activities, geographic presence, and treatment of customers. More details are in Part 12.


The company’s statement is reproduced below:

The Board is aware of recent press and blog commentary regarding Plus500′s accounting policies and business model and rejects the assertions made as misrepresentative and baseless. The Board reiterates that the Company’s accounts, along with those of its subsidiary, Plus500UK Limited, have received unqualified audit opinions from PwC and the directors are comfortable with the disclosures made therein.

 

In response to the specific issue raised in respect of the restatement of Plus500UK’s subsidiary accounts and the implication that Group revenue is substantially over-stated or a substantial amount is generated in unlicensed jurisdictions, we clarify that both assertions are incorrect.  The application of the new Financial Reporting Standard 102 resulted in the reallocation of gross revenues attributable to Plus500UK’s customers to Plus500 in the Company’s 2014 results. This also required the 2013 results to be restated.  The reallocation has no impact on Group consolidated revenue.

While I was hardly expecting a detailed, 10-part follow-up to the questions raised by this series, this response is rather anemic. Plus500 has addressed one concern raised in the report. Now what about all the others?

Notwithstanding PwC’s unqualified audit opinion, I question how the Board could possibly be comfortable with the 15 inconsistent disclosures identified in part 4, which have been forwarded to the FRC for review. Presumably, PwC did not also audit Geostrading, the mysterious Belize-based subsidiary the company has yet to acknowledge. Are the directors also comfortable with the historical operations of that entity? With respect to revenue generated from unlicensed jurisdictions, perhaps the Company could clarify how its purported European revenue in 2010-13 exceeded the gross revenue recorded at Plus500UK, the only licensed subsidiary at the time. Are any members of Plus500′s affiliate program related parties?

The basis for each statement made in this series has been painstakingly documented; I stand behind every assertion and challenge the Board to identify any claim that is baseless. I further pledge to correct any misrepresentation, as noted above.


With regard to the restatement of Plus500UK subsidiary revenues, I speculated in Part 4 that there were several possible reasons for the restatement:

  1. Revenues at the Group level were overstated.
  2. The inter-company agreement was modified or terminated.
  3. The FAS 102 transition (FAS 102 is a modified form of IFRS that replaced a previous UK GAAP standard) required revenues to be reported net of payments to the parent, instead of gross.

The company says that the third explanation, which I suggested was the most charitable possibility, is the case. Very well then. Net revenue presentation in the subsidiary will unfortunately reduce transparency and make it more difficult to reconcile Group revenues going forward, but if that’s what accounting rules require then so be it.

The subsidiary accounts remain somewhat puzzling. PwC’s own summary of the differences among old UK GAAP, FRS 102, and IFRS does not suggest any inventory or financial asset fair value reporting changes that appear to require restating a cost of sales item as an offset to turnover. It is also unclear why the adoption of FRS 102, which did not modify revenue recognition, would result in a switch from gross revenue to net revenue reporting in the first place. The variable treatment of “introductory commissions” is also odd considering the only categories of funds payable to the Parent under the inter-company agreement are 78% of dealing spread revenue above $300,000, 5% of credit card transactions, and the profit/loss on offsetting hedge transactions. Credit card transactions are reported as a separate cost item. Why is the bulk of introductory commission recorded as a reduction in revenue while a portion is recorded as a distribution cost?

In any case, investors will ultimately have to trust that the accountants know what they’re doing here. I’ve highlighted why their work deserves scrutiny.


Additions and amplifications

Brevity is clearly not my strong suit: the latter half of this series received noticeably less traffic than the first few posts. If you’re still with me, there are several very important points raised in the latter half of the series that I would like to emphasize and update.

  • In Part 6, I documented the magnitude of revenue reported from customers outside of regulated jurisdictions (line C). The amounts were particularly egregious in 2010-11 when Plus500UK was the only regulated subsidiary, but even in 2013 the extra-legal amount significantly exceeds revenue reported at Plus500AU (approximately $3.2 million). To be clear: $67 million (27%) of the company’s reported revenue from 2010-2013 came from customers in locations where Plus500 did not have legal authorization to operate. This is significantly more than disclosed in the Admission Document and annual filings.
  • In 2013, estimated revenues from customers in Europe were also disclosed. They have been added to lines D and E in the table below. Similar geographic disclosures were not made in 2014, so it is no longer possible to track the contribution from unregulated jurisdictions and Europe overall. However, the inconsistency in Plus500′s disclosures remains. For the period from 2010-13, Plus500 claimed European customers generated $40 million more gross revenue than was actually reported by Plus500UK.
  • I cannot think of a charitable explanation for this. One or more of the following must be true: Group revenue was overstated, customers in Europe were served by an unregistered subsidiary, or the geographic disclosure deliberately overstated the proportion of revenue generated in regulated jurisdictions.
Comparison of Group and Plus500UK turnover 2010 2011 2012 2013
A. Group reported revenue 24,211  50,028  56,127 115,088
B. Plus500UK reported revenue, translated into USD 1,553 28,993 44,692 99,864
C = A – B. Revenue generated elsewhere 22,658  21,035  11,435 15,224
Plus500UK as % of Group reported revenue 6.4%  58.0% 79.6%  86.8% 
D. Stated revenue from EEA/Gibraltar customers 18,667 42,874 49,785 103,832
E = D – B. Missing revenue from regulated customers 17,114  13,881  5,093 3,968 
  • In Part 7, I focused on 10pips.com, an unlicensed Plus500 clone that operated until mid-2010. It turns out it was not the only one. MeVideoCY also operated a very similar site called Omitrade.com from 2009 until at least March 2011. Not only is this site unregistered and undisclosed by the company, but there are several violations of securities advertising rules on the site, such as referring to sign-up bonuses as “free”. How many other unlicensed sites did Plus500 operate? Is Plus500 operating unlicensed websites today?
  • A correspondent reminded me that in Part 7, I omitted Norway from the long list of regulatory authorities that have warned against Plus500.

In Part 8, I commented that I have no way to asses the merits of individual claims of unfair treatment on the Plus500 platform. In Part 12, I try to remedy this by investigating some specific allegations of abusive practices and considering the potential consequences in more detail.

 

On to Your Capital (still) at Risk Part 12: Legal consequences –>


Your Capital at Risk Part 10: Competition 22

Disclosure: Short PLUS. This content is not directed toward persons with residence or place of business in the United Kingdom. By accessing, transmitting, or reviewing this material, you acknowledge that the author has represented his honest opinion and made statements of fact believed to be true at the time of publication. No content herein should be construed as a recommendation to take action with respect to any security.

Part 1: Short Plus500
Part 2: Bucket Shop
Part 3: Customer Lifetime Value
Part 4: Companies House Inconsistencies
Part 5: Audit Opinions
Part 6: Unlicensed Activity
Part 7: Whois Plus500?
Part 8: Scalping
Part 9: Worldwide Web
Part 10: Competition
Part 11: Unanswered Questions
Part 12: Legal Consequences

Plus500 claims to be a client of Interactive Brokers. I haven’t been able to verify that.

If you’ve read this far, I hope I have at least conveyed why I take statements from the management of Plus500 with a grain of salt. Given the company’s history of unlicensed operations, inconsistencies in its filings, and its exaggerated marketing claims, I want to leave you with one simple question—would you do business with Plus500?


Neither would I. And I was surprised by the notion that my own custodian would. In Dan McCrum’s piece after the Swiss Franc peg was was removed in January, Gal Haber told the Financial Times that Plus500 uses Interactive Brokers when it needs to hedge. This immediately struck me as odd—Interactive Brokers has a competing CFD offering. Unlike Plus500, Interactive Brokers charges a fixed commission rather than a spread-based fee, and my understanding is that although the firm acts as principal, it makes offsetting trades in the underlying instruments. In other words, Interactive Brokers is not a bucket shop.

Why would Interactive Brokers facilitate the growth of a competitor? Why wouldn’t Plus500 have hedging relationships with the major banks (e.g. Barclays) that hold its customer balances? Moreover, the size of the notional exposures Plus500 claims to need to offset, even occasionally, would make Plus500 a very significant client for Interactive Brokers.

Given the business risk associated with working with a company that has admittedly operated outside the law in some jurisdictions—including places like Singapore and Hong Kong where Interactive Brokers’ business is growing rapidly—it seems like a questionable business decision for them to maintain a client relationship with Plus500.

Since Cable Car’s clients custody with Interactive Brokers, I care a great deal about their reputation. Naturally, I relayed some of my concerns about Plus500 to the company. The response was interesting. Interactive Brokers is a large firm, and its US representatives may not have complete visibility into every client worldwide, especially if the client may have been referred by an introducing broker. That being said, they could not confirm that Plus500 is a client.

Whether or not Plus500 works with Interactive Brokers, they clearly don’t trade enough to merit much attention. This stands to reason. The simplest explanation for why Plus500 was profitable during the Swiss franc debacle is that they simply didn’t hedge at all. Amusingly, the Plus500 hedging policy document is an empty redirect to the homepage. Customers were net long EURCHF; Plus500 was net short. Any negative customer equity balances did not reflect money Plus500 owed to any third party. Instead, Plus500 would have booked the customer’s entire account balance as trading revenue.


 

This concludes my series on Plus500. I look forward to feedback from readers and clarifications from the company. If there are any errors or omissions in these posts, please do not hesitate to let me know so that I may correct them. Thank you for reading.


Your Capital at Risk Part 9: Worldwide Web

Disclosure: Short PLUS. This content is not directed toward persons with residence or place of business in the United Kingdom. By accessing, transmitting, or reviewing this material, you acknowledge that the author has represented his honest opinion and made statements of fact believed to be true at the time of publication. No content herein should be construed as a recommendation to take action with respect to any security.

Part 1: Short Plus500
Part 2: Bucket Shop
Part 3: Customer Lifetime Value
Part 4: Companies House Inconsistencies
Part 5: Audit Opinions
Part 6: Unlicensed Activity
Part 7: Whois Plus500?
Part 8: Scalping
Part 9: Worldwide Web
Part 10: Competition
Part 11: Unanswered Questions
Part 12: Legal Consequences

Gotham City Research is on my mind as I write this. I have no affiliation with Gotham and have never met Daniel Yu, but he’s been in the news lately for comments about Plus500.

In addition, Gotham keeps me mindful of the fact that the Internet is global. Even though British libel judgments are unenforceable in the United States, I have no wish to be sued for expressing my opinions in good faith. I have written these blog posts in a deliberately restrained manner and intentionally not directed my comments at UK persons.

Plus500, on the other hand, has no such qualms about making its marketing materials accessible in jurisdictions where it is not authorized to operate, including the United States. The company states in the Admission Document (p.47) that it has run afoul of advertising regulations:

In the past, the Group has been in breach of, or may have been in breach of, and there is a risk that going forward the Group may not be in full compliance with or may be in breach of, the laws and regulatory requirements regarding the promotion of investment activities in some of the jurisdictions in which it advertises. Any non-compliance with such applicable laws or regulatory requirements could subject members of the Group or its directors and/or employees to disciplinary action, criminal penalties, civil lawsuits and/or fines. Further, there is a heightened risk of the FCA imposing a sanction on Plus500UK as a result of repeated instances of non-compliance with the financial promotions regime. Any such action could have a material adverse effect on the Group’s reputation, business, financial condition and operating results.

The Admission Document (p.46) notes that activity by its affiliates could subject the company to similar risks:

Further, the Group has not investigated the local laws and regulations which may apply to its affiliates’ activities or the relationship between the Group and its affiliates, and the Group has no visibility or control over whether the affiliates are conducting their advertising activities in accordance with such laws and regulations. There is a risk that liability for activities of affiliates which are in breach of local laws and regulations could attach to the Group and result in civil, criminal, regulatory or other penalties being imposed upon the Group or its directors, or that such activities could result in or contribute to action being taken against the Group by a regulator in any relevant jurisdiction.

Unfortunately, most affiliates use free web-hosting services or Domains by Proxy registrations that make it very difficult to ascertain the identity and location of their owners. However, in at least one instance there appears to be evidence that a Plus500 website, or one operated by an affiliate, is hosted in the United States. The screenshot below is from domaintools.com:

500traders.com Hosting Data

The hosting provider in question, A Small Orange, operates a web server in St. Louis that hosts several gambling-related domains, likely for the same affiliate marketing customer. Not only are several of these domains advertising services illegal under US law, they also appear to violate ASO’s terms of service. ASO did not respond to a request for comment. In an interesting coincidence, ASO’s parent company is Endurance International Group (EIGI, no position), the most recent target of Gotham City Research.

A full reconciliation of Plus500′s marketing activities to local investment promotion regimes is beyond my limited resources, but suffice it to say that 500traders.com is hardly the only Plus500 marketing website that could attract customers from jurisdictions where the company is unlicensed.


Crazy Marketing

The Whois record for 10pips.com suggests a possible undisclosed related party. “yossi sh” does not appear to be a real person, but crazymarketing.com is one of 65 domains registered to a Vadim Drabkin, who attended the same university, Technion, as the Plus500 founders. We already know that 10pips.com was operated by Plus500; it is unclear why it is now registered to one of Plus500′s affiliate marketers. Note the @investhead.com email address. Investhead.com is currently a defunct website, but it redirected to 10pips.com in 2011 and later displayed affilliate advertising for Plus500, among others, until late 2012. This indicates that Vadim Drabkin has been acting (and possibly being compensated) as a member of the Plus500 affiliate program while also controlling one of Plus500′s assets.

In short, one of Plus500′s affiliates owns a domain name that was operated by the company.

 

Domain: 10pips.com
Record Date: 2014-01-11
Registrar: GODADDY.COM, LLC
Server: whois.godaddy.com
Created: 2008-08-22
Updated: 2013-03-29
Expires: 2014-08-22

Record:
Domain Name: 10PIPS.COM
Registry Domain ID: 1515596000_DOMAIN_COM-VRSN
Registrar WHOIS Server: whois.godaddy.com
Registrar URL: http://www.godaddy.com
Update Date: 2013-03-29 14:17:07
Creation Date: 2008-08-22 05:51:28
Registrar Registration Expiration Date: 2014-08-22 05:51:28
Registrar: GoDaddy.com, LLC
Registrar IANA ID: 146
Registrar Abuse Contact Email: abuse@godaddy.com
Registrar Abuse Contact Phone: +1.480-624-2505
Domain Status: clientTransferProhibited
Domain Status: clientUpdateProhibited
Domain Status: clientRenewProhibited
Domain Status: clientDeleteProhibited
Registry Registrant ID:
Registrant Name: yossi sh
Registrant Organization:
Registrant Street: Dubnov 7
Registrant City: Tel Aviv
Registrant State/Province: Not Applicable
Registrant Postal Code: 61400
Registrant Country: Israel
Registrant Phone: 972545885555
Registrant Phone Ext:
Registrant Fax:
Registrant Fax Ext:
Registrant Email: rotem@investhead.com
Registry Admin ID:
Admin Name: yossi sh
Admin Organization:
Admin Street: ben yehuda
Admin City: tel aviv
Admin State/Province: Not Applicable
Admin Postal Code: 55555
Admin Country: Israel
Admin Phone: 972545885555
Admin Phone Ext:
Admin Fax:
Admin Fax Ext:
Admin Email: yossi@crazymarketing.com
Registry Tech ID:
Tech Name: yossi sh
Tech Organization:
Tech Street: ben yehuda
Tech City: tel aviv
Tech State/Province: Not Applicable
Tech Postal Code: 55555
Tech Country: Israel
Tech Phone: 972545885555
Tech Phone Ext:
Tech Fax:
Tech Fax Ext:
Tech Email: yossi@crazymarketing.com
Name Server: NS1.INVESTHEAD.COM
Name Server: NS2.INVESTHEAD.COM
DNSSEC: unsigned
URL of the ICANN WHOIS Data Problem Reporting System: http://wdprs.internic.net/

 

On to Part 10: A concluding thought about the competition –>