Category Archives : Opinion


Don’t buy Bitcoin. 3

Clearly, what the Internet needs right now is another opinion on Bitcoin (no position).

On the other hand, gentleman, what if we gave a war and EVERYBODY came?

Gary Larson, The Far Side (1982)

With hundreds of newly formed funds, commentators proclaiming the birth of a new asset class, and the general public beginning to take notice of the world’s largest confidence game, it is a fait accompli at this point that huge sums of capital will be allocated to cryptocurrency. That is unfortunate. Generally lost in today’s breathless predictions that a proportion of the world’s wealth will flow into cryptocurrencies, especially Bitcoin, is any reasoned discussion of whether it should.

Aside from some excitement about the potential applications of distributed ledger technology, which are legitimate if somewhat overhyped, there appears to be widespread acceptance that the bulk of these allocation decisions are circular. Capital is flowing into the sector primarily because prices are rising. In turn, prices are rising because of the anticipated inflow of capital. Indeed, many cryptocurrencies are deliberately structured to increase in price as their use increases, a virtuous cycle that proponents hope will reflexively result in increased acceptance. They are not incorrect, which is all the more reason we should hope they do not succeed.

Advocates of Bitcoin correctly hypothesize that the price of Bitcoin must be stratospheric if even one percent of global savings were allocated to it. Yet who in their right mind actually thinks that would be a good idea? Bitcoin’s defining characteristic is extra-legality, and its primary function is to enable transactions that are impossible within a regulated system. Whatever you think of its technological usefulness or lack thereof today, Bitcoin has indisputably been the leading new payment tool of criminals for the past few years. Whether that seems more like a feature or a bug to you, it has resulted in a distribution of resources concentrated in the hands of money launderers, offshore tax evaders, drug dealers, and various other people who have no business managing the world’s money supply. To top it off, the largest holdings are controlled by an anonymous cadre of individuals so mysterious that there is half-joking speculation that its pseudonymous creator could be Kim Jong-un, Vladimir Putin, or various other unsavories. Surely, enormously enriching this group of people is not a desirable outcome. Other digital currencies suffer from the same problem; widespread adoption represents an extraordinary redistribution of wealth to private hands, who are in many cases some of the worst elements of society.

By now, it has been widely demonstrated that the price of Bitcoin, much like a low-float stock, is being actively manipulated through wash trading, abusive margin policies on offshore exchanges, and frequently outright theft. Bitfinex, an exchange in Hong Kong which has had its access to the banking system rescinded and bears hallmarks of a Ponzi scheme, has been a key contributor to the rise. Credible allegations suggest that over $800 million of purported transaction volume on the exchange, which is unlicensed, has resulted from the creation out of thin air of a pseudo-dollar equivalent called Tether, issued by a Bitfinex affiliate. A substantial proportion of the price increase in Bitcoin this year may be attributable to transmission effects from Bitfinex. Critics of Tether question whether dollars actually back the issuance of Tethers, as the company claims, but this may be the wrong question to ask. From appearances, Tether’s liabilities are not so much end-user claims on it as they are claims on Bitfinex that represent customer deposits, never to be recovered. Like most bucket shops with aggressive margin policies, Bitfinex can be expected to convert its customer balances to owned capital over time. The new Tethers being created may well represent Bitfinex’s historical and anticipated takings from its customers. Perhaps you feel little sympathy for gamblers, but it’s the less educated and the desperate who most often end up left holding the bag. Buying Bitcoin today and contributing to its price increase directly facilitates the continuation of an inequitable wealth transfer.

With that backdrop, I don’t see how any responsible fiduciary can argue with a straight face that Bitcoin is an acceptable part of a customer’s portfolio. The introduction of regulated, exchange-traded futures next week promises to make it easy for many more institutions to trade Bitcoin, or something like it, and there is so much volatility that there are sure to be profitable trading opportunities as a result. No doubt it is futile to suggest that any member of the financial industry ought to deliberately avoid an opportunity to profit due to ethical concerns. But curmudgeon that I am, I think the better course of action is not to participate.

Certainly one would be foolish to short Bitcoin outright, given how demonstrably easy it is to manipulate the price to almost any level. Perhaps investing one percent of the world’s wealth in put premiums is a more reasonable course of action. Otherwise, what if we gave a war and nobody came?


Throwback

Disclosure: No position in EXAS.

Remember Exact Sciences?

In 2015, I argued unsuccessfully in a series of public comments and an oral presentation that the proposed Medicare reimbursement rate for the company’s Cologuard test was too high. While Cable Car’s investment positioning at the time was validated by a subsequent advisory panel decision, the public policy outcome was not what I had hoped for. I believed then and continue to believe that the company cleverly exploited technicalities in the process for establishing new codes on the Clinical Lab Fee Schedule to receive a payment rate far exceeding the level that would be cost-effective in population screening.

The rate-setting process was reformed by a rulemaking mandated by the Protecting Access to Medicare Act (PAMA), which with effect from January 1, 2018 is supposed to establish market-based reimbursement rates. PAMA was intended to reduce costs to Medicare by basing future reimbursement amounts on the rates determined by commercial payors. At least in theory, commercial payors can conduct thorough cost-effectiveness analyses and determine payments through competitive forces in the marketplace. In practice, there are issues with this approach as well. During the draft rulemaking, Cable Car submitted a public comment noting that for some tests, like Cologuard, the price in the commercial population and the price for the Medicare population really should not be the same. Unfortunately, CMS received over 1,300 comments on the proposed rulemaking and did not specifically address this concern.

Disappointingly, it now appears that an additional loophole in the data collections process under PAMA will enable Cologuard to receive another 3 years of above-market reimbursement. Thanks to a provision in the final rule inserted after comments from the lab industry, the definition of “applicable information” used to determine reimbursement rates excludes any test where the company appealed a reimbursement rate from a commercial payor. EXAS appears to have challenged a significant proportion of its test volume during the relevant period, delaying payment outside the collection window and enabling the company to report only favorable reimbursement rates.

During the relevant time period, EXAS had an average commercial reimbursement rate I estimate from its financial filings at about $321 per test. Yet based on the interquartile range and weighted median data published by CMS, more than 75% of the test volume submitted under PAMA was reimbursed at or above $508.87. I believe the company’s policy at the time was to appeal virtually every commercial reimbursement that came in significantly below the Medicare rate. Even when those payment decisions were resolved in the payor’s favor, they were excluded from the data submitted under PAMA.

PAMA imposes stiff civil monetary penalties for misrepresentations and omissions by reporting laboratories, and importantly I’m not suggesting that EXAS knowingly misrepresented the commercial reimbursement for Cologuard. Instead, it appears they once again took advantage of the rules as written. They made a great return on investment for their 2016 lobbying spend.

Although past experience suggests it will have limited impact on policy, I have written another public comment to CMS to shine light on this situation, primarily in hopes of improving the PAMA data collection process in the future and ensuring that data was accurately collected this time. Exact Sciences CFO Jeff Elliot was kind enough to give me time last week, but provided the following statement:

Exact Sciences disagrees with the assumptions and assertions in your comment letter, and we noted multiple factual inaccuracies. While we would encourage you to check your facts and your analysis further before submitting your letter, we don’t intend to respond on a point-by-point basis.

I have made every attempt to avoid factual inaccuracies and will gladly make corrections if requested.

Although EXAS is trading near all-time highs, I have not held a short position for more than two years. There was some public discussion of the likely impact of PAMA earlier this year which briefly excited some short sellers. I take no pleasure in having known better.

PDF icon Read the public comment


Gambling with financial products 5

Disclosure: Short Plus500.

At root, what illicit online brokerages have in common is the promotion of trading activity as a form of gambling rather than investment.

In my last letter, I mentioned that the Times of Israel has recently drawn attention to abuses within the online brokerage industry in Israel. The Times kindly asked me to provide a perspective on ways to detect potentially abusive firms. My opinion piece has a dual audience: it lists a few quick tips for individuals who may be considering a new brokerage relationship, and it provides a longer list of potential red flags for regulators and the broader industry to consider.

Over the past year, Cable Car has communicated with more than a dozen regulators around the world regarding Plus500 and other abusive online brokerages. It has become clear that, like the online gambling businesses they emulate, many brokerages take advantage of very aggressive regulator shopping, while operating with impunity and little oversight in many jurisdictions.

Operating a broker-dealer generally requires licensing, capital requirements, and strict regulatory supervision. Despite laws on the books prohibiting online brokerages from accepting local clients without registering, many countries defer to a brokerage’s home regulator for enforcement. Scandalously, the home regulators often refuse to supervise conduct that occurs outside their borders. In some cases this confers an artificial air of legitimacy on the worldwide activity of companies that may be conforming to requirements only for clients in regulated jurisdictions.

The Times noted in its initial exposé that some brokerages target customers in impoverished parts of the world with hopes of quick riches. Others seek customers in countries with significant demand for investment but less developed securities markets and regulatory apparatus. When a brokerage based in Israel or Cyprus violates local law in Qatar or Sudan, local authorities have few resources to do anything about it. When a brokerage flaunts regulatory requirements in more established markets like Hong Kong or Singapore, the local authorities may investigate, but to-date they have done little more than warn potential customers.

The United States, ever the world’s policeman, has been relatively effective at bringing enforcement actions against some of the worst offenders who operate within its borders. Hopefully we will see more actions in the future. Yet smart brokerage operators avoid the small handful of countries that have refused to tolerate illegal conduct by overseas firms, such as the United States, Canada, and New Zealand. Even the US has been reluctant to bring enforcement actions against companies that make only indirect use of US means of commerce. In my view, a great deal of responsibility rests with the Israeli Securities Authority to take a more active role in supervising the worldwide actions of its companies.

Below is an excerpt from the op-ed. Please read the whole piece on the Times of Israel website. Comments are welcome.


As the online brokerage industry faces increased regulatory scrutiny in Israel and around the world, it is essential for regulators and prospective customers to understand what separates a legitimate brokerage firm from the “wolves of Tel Aviv.” At root, what illicit online brokerages have in common is the promotion of trading activity as a form of gambling rather than investment. It is no coincidence that many brokerage developers got their start in the online gambling business, and gambling firms have recently diversified into online trading.

Although the bulk of industry criticism has focused on trade in binary options, many binary brokers at least have the virtue of explicitly describing client positions as wagers. Spread betting, a form of contract for difference (CFD) trading popular in the UK, is similarly upfront about what customers are really doing (allowing the results to be taxed as gambling losses rather than capital gains).

Far more insidious, in my view, is the way in which other brokers offering complicated financial products blur the lines between trading for investment purposes and trading for entertainment. Gambling may have its place, but it should not involve financial products. It harms the integrity of capital markets when companies encourage financially unsophisticated individuals to take risks they may not fully understand or have adequate resources to bear.

Complex derivatives like binary options, CFDs, futures, and other leveraged financial instruments were originally developed for professional investors to manage risk and lower tax and transaction costs. They were never intended as gambler’s chits. The risks of binary options, CFDs purchased on margin, and highly leveraged forex trading are wholly unsuitable for all but the most sophisticated individual investors.

Existing laws governing customer suitability, registration requirements, false advertising, and contract fairness already prohibit much of the industry’s conduct, but they have not been adequately enforced across national boundaries. It is not enough for brokerages to simply be registered. There is an urgent need for coordinated international regulatory enforcement to protect the public. Jurisdiction shopping is common, and companies facing sanctions in one country sometimes simply move customer accounts to another.