John Hempton specialises in spotting fake accounts in public accounts.
That altered his whole perspective on listed companies. “It was an eye-opening experience,” he recalls. “My working assumption now is that they are not telling the whole truth.”
And so, largely by accident, John Hempton became a seeker of accounting fakery.
In 1999, he joined Kerr Neilson’s Platinum Asset Management to analyse financial stocks. He made money for the firm almost immediately – which he sees now was a problem. “You think it’s easy. So your risk management is awful.”
Risk management matters to short-sellers because they risk so much. When you ‘go long’, buying a stock and holding it the way most investors do, you can only lose what you’ve spent. When you short-sell, you can go on losing more money essentially forever if the accounting fakery is not discovered.
And as he notes, a clever faker at the head of a listed company can inflate their accounts, use the inflated stock to buy more assets and keep growing that way.
This dynamic, says Hempton, can propel a company a long way, as it is alleged to have done for Autonomy. Autonomy bought a host of companies and might have kept going if HP had not made an offer too good to refuse. “Frauds can last 20 years,” Hempton reflects, “and they can burn you off.” At Platinum, he got burnt, quickly lost the fortune he’d made and started to learn how to control risk and make shorting work.
He made more money before too long, from shorting corporate disasters like Lernout & Hauspie, the Belgian speech recognition technology company that went bust in 2001; and US insurer Conseco, which entered bankruptcy in 2002. He shorted the subordinated debt of US subprime lenders and regrets not shorting supposedly safer debt as well.
[breakoutbox][breakoutbox_title]What unlisted companies should look for[/breakoutbox_title][breakoutbox_excerpt]Listed company fraud mostly revolves around inflating earnings…[/breakoutbox_excerpt][breakoutbox_content]Listed company fraud mostly revolves around inflating earnings. Unlisted companies face a different sort of fraud, says John Hempton – employees stealing from you.
His favourite example: US headphone manufacturer Koss. Its former vice-president of finance was charged in 2009 with stealing US$34 million over five years. Her technique, he says, was relatively simple: inflate the invoices from the actual US$25 million a year to US$32 million and pocket some of the difference.
Double-entry accounting makes fraud difficult, but this simple technique worked surprisingly well. “There was no way she’d get caught because the accounts balanced,” Hempton notes. “I don’t know how you would spot that as an accountant.”
The vice-president was eventually exposed only because she made large top-ups of her credit card from company accounts.[/breakoutbox_content][/breakoutbox]
In theory, Hempton retired from Platinum in 2007; in practice, he couldn’t stop reading accounts and thinking about likely fakes. He dived back into investing a year later, founding Bronte Capital with Maher just as the global financial crisis broke.
Bronte goes long on conventional value stocks but also shorts what Hempton calls “an enormous range of ratbags, scoundrels and scum”.
In 2009, Hempton scored what remains his most public victory over fakery. Uneasy about the activities of funds management group Trio Capital, he voiced his concerns to his old boss, the then Treasury secretary Ken Henry, and sparked an investigation. Trio was revealed as a fraud.
Hempton’s aim now? “To have an easy life,” he says. He analyses, blogs and spends plenty of time on the beach. He believes he’s getting close to turning short-selling into a true business process, applying everything he’s learnt over the past 21 years. He’s finding the one fraud per week that he needs in order to make decent investment returns.
Hempton says self-employment is much less wearing than life in the tough regimen of a firm like Platinum. “I wear board shorts, a singlet and flip-flops. It’s kind of nice working for yourself …
“The real lesson of Bronte is that there are so many frauds out there that you can manage them, industrialise them and have an easy life.”
