A dodgy deal helped make him a billionaire. It worked, until now; Excerpt from my book – Calamity No. 1: Loss of Reputation and/or Wealth

By Whitney Tilson

Thursday, November 19, 2020
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1) What a cautionary tale this is from the Washington Post: A dodgy deal helped make him a billionaire. It worked, until now.

I wonder how many ambitious young people looking to set up their own investment firm would turn down a $1 billion seed investment, even with highly dubious terms? Excerpt:

Over the past five years, Robert F. Smith became one of the nation’s most prominent billionaire philanthropists.

During that time, he put up $20 million for Smithsonian’s National Museum of African American History and Culture. He donated tens of millions more to national parks, breast cancer research, Carnegie Hall, and paying the student debts of a Morehouse College graduating class. This spring, he pushed Treasury Secretary Steven Mnuchin and Ivanka Trump to have $10 billion in government coronavirus relief set aside for lenders in low-income neighborhoods.

Throughout this munificence, though, Smith had a secret: He’d played a role in what federal prosecutors allege was the biggest tax evasion scheme in U.S. history, an effort by his longtime associate, Texas billionaire Robert Brockman, to hide $2 billion from tax authorities in an offshore scheme featuring a computer program called Evidence Eliminator and code names such as “Redfish” and “Snapper.”

Smith, whose code name was “Steelhead,” according to prosecutors, has admitted to hiding profits in offshore accounts and filing false tax returns for 10 years. He is cooperating with investigators and faces no charges. But his complicity in the alleged tax crimes has stunned the many who had seen a role model in the charismatic 57-year-old entrepreneur, often ranked as the wealthiest Black person in the United States.

These two sides of Smith – the impressive generosity on one and the admitted tax evasion on the other – may be hard to reconcile. But they are inextricable, according to documents reviewed by the Washington Post, including charity filings with tax authorities and Justice Department court filings.

Both aspects stem from a deal Smith and Brockman made 20 years ago, one that joined the unlikely pair in a venture with vast ambitions. Smith, the determined son of Denver schoolteachers, was then an aspiring financier; Brockman was older and far wealthier, a man who had already made a fortune with a company that sold software for the automotive industry.

Brockman’s offer set Smith up with his own private equity firm, Vista Equity Partners, and more than $1 billion in capital to invest, according to Smith’s statement to prosecutors. That arrangement eventually allowed Smith to become a billionaire himself.

But the partnership also entailed an offshore trust to “willfully conceal” $200 million of Smith’s earnings from tax authorities, according to Smith’s agreement with prosecutors. While that account in recent years has become the source of much of his charity, it also ran afoul of rules requiring the disclosure of offshore accounts for tax purposes, according to the court documents.

It was a Faustian bargain, in other words, but at the time Smith saw mainly its benefits. It would be more than a decade before its downside would be revealed.

2) I write about this topic in my upcoming book, The Art of Playing Defense. Here’s an excerpt:

Calamity No. 1: Loss of Reputation and/or Wealth

If you’re in the professional world – if you are, for example, a doctor, lawyer, or businessperson – your greatest asset other than your brain is your reputation. You will have a reputation for how hard you work, your sense of decency, and most important, your integrity. Whatever your reputation, it will follow wherever you go.

Cherish and protect it because, as Warren Buffett once said:

It takes twenty years to build a reputation and five minutes to ruin it. If you think about that, you’ll do things differently.

I want employees to ask themselves whether they are willing to have any contemplated act appear the next day on the front of their local paper, to be read by their spouses, children, and friends, with the reporting done by an informed and critical reporter.

You need to be especially careful of your reputation if you’re a public figure, on whom the scrutiny is greater. I am extremely sensitive to this danger because I send an investing-related e-mail to more than 75,000 people every weekday, an education-related one to 7,500 folks every week, a coronavirus-related one to nearly 5,000 people every other day, and a few every day to 250-1,000 recipients on various subjects, ranging from politics to adventure sports to what my family and I are doing. In addition, I regularly speak on live television, at conferences, and to reporters.

Thus, multiple times a day I run the risk that I will write or say something off the cuff that goes viral and ruins my reputation. I’ve made some small mistakes that have really scared me.

Right out of college, as I was helping Wendy Kopp launch Teach for America, I was interviewed by a reporter for the Harvard Crimson. In making a point about teacher shortages in low-income communities, I said, “Many school districts just need warm bodies.”

This crude and foolish comment was, of course, featured prominently in the article.

Wendy was so mad at me – deservedly so – that she never let me speak to the media again.

Years later, I sent an e-mail to my school-reform e-mail list in which I commented on the then-Mayor of Newark, New Jersey, Sharpe James, who was facing corruption charges. Being certain of his guilt (he was later convicted and served time in prison), I sent around an article about his indictment with the comment, “Hang him high!”

A few minutes later, someone e-mailed me back saying, “Whitney, did you really mean to use language related to lynching when referring to a black man?”

Of course not! I was horrified by what I’d written and immediately sent an apologetic follow-up e-mail.

Another time, I was on Bloomberg TV talking about Taser, a stock I was betting against. In explaining why, I said that the company had no patents or valuable intellectual property.

About a week later, I received an e-mail from Taser’s law firm saying I had defamed the company because it did, in fact, hold numerous patents, and it demanded a retraction.

I had screwed up again. By not being careful with my words, I had exposed myself to substantial legal costs at the very least.

Fortunately, I was able to resolve the issue by replying with a letter apologizing for my mistake, pledging never to speak publicly about the stock again, and pointing out that if they forced me to publicly issue a retraction, it would only draw attention to an otherwise obscure interview that almost no one had seen. I never heard from them again, so it ended up being a low-cost lesson early in my career to be very careful when publicly criticizing a company.

Almost every day, I see a public figure in trouble for something they said or wrote (usually an off-the-cuff remark).

I don’t want this to happen to me, so now I proofread every mass e-mail before I send it and always try to be well-prepared when I speak on television, in front of an audience, or to a reporter.

Another way to ruin your reputation is to do something unethical or illegal (which can lead to a loss of freedom – i.e., going to prison).

Consider the fate of David Sokol, a former top executive at Berkshire Hathaway (BRK-B) who was once rumored to be Buffett’s successor. He discovered a publicly traded chemical company called Lubrizol that he thought would be a great acquisition candidate for Berkshire Hathaway, so he brought this idea to Buffett, who agreed and eventually acquired the company.

However, inexplicably, Sokol had personally bought Lubrizol stock beforehand, thereby profiting from Berkshire Hathaway’s acquisition. As soon as Buffett found out what Sokol had done, he had no choice but to immediately fire him and report what had happened to the U.S. Securities and Exchange Commission (“SEC”). The SEC ultimately took no action, but it didn’t matter – Sokol’s reputation was destroyed, and his career was over, all for an insignificant profit. For a single moment, he let greed overshadow his integrity, and he was ruined.

It’s critical to be disciplined and thoughtful about ethical gray areas and never engage in borderline (much less illegal) behavior. It’s simple in concept but can be tricky in practice, and there’s no room for error. One mistake can ruin your life.

Over the nearly two decades I ran a hedge fund, there were so many opportunities to break the law and/or ruin my reputation. Most of these situations were pretty clear, but some weren’t.

For example, what if I talk to the CEO of a small company, and I suspect (but am not sure) he might have given me material nonpublic information? Or if I talk to a reporter who I think (but am not sure) is writing an article that might cause a stock to move sharply? Or if I’m preparing an in-depth presentation of a stock idea at a major conference that I think (but am not sure) could move the stock materially?

Can I trade these stocks? To this day, I don’t know the answer. So I just didn’t.

Here’s a specific example related to the stock for which I’m perhaps best known, Lumber Liquidators (LL). I bet against the stock and pitched it at the Robin Hood Investors Conference in late 2013. Then, in early 2014, I heard from someone in the industry that the company was sourcing and selling Chinese-made laminate flooring tainted with formaldehyde, a health hazard and clear violation of U.S. environmental regulations. Once I’d tested the product and verified my source’s story, I wanted to bring attention to what this company was doing, both to protect American consumers and because I thought it might crush the stock (and therefore benefit my short position).

“Who better,” I thought, “than 60 Minutes to break this story?” So I contacted a producer I knew there and, to make a long story short, they agreed it was an important story and started working on it.

At that point, I didn’t know for sure if 60 Minutes was going to run the story, what it would say, or when it might air. But by December 2014, when Anderson Cooper interviewed me at length, I was pretty sure that they were going to do a major story that could devastate the stock (which is exactly what happened in March 2015), so I could have made millions of dollars had I further increased my short position.

But I didn’t. I worried that the knowledge I had about 60 Minutes working on the story constituted inside information. To this day, I’m not sure if it did, but I didn’t want to find out the hard way – and, to me, it didn’t pass the front-page-of-the-local-paper test. So I didn’t trade the stock at all until after the story aired.

I can’t emphasize strongly enough that no amount of money is worth jeopardizing your reputation.

Best regards,

Whitney

Whitney Tilson
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About Whitney Tilson

Prior to creating Empire Financial Research, Whitney Tilson founded and ran Kase Capital Management, which managed three value-oriented hedge funds and two mutual funds. Starting out of his bedroom with only $1 million, Tilson grew assets under management to nearly $200 million.

Tilson graduated magna cum laude from Harvard College with a bachelor’s degree in government in 1989. After college, he helped Wendy Kopp launch Teach for America and then spent two years as a consultant at the Boston Consulting Group. He earned his MBA from Harvard Business School in 1994, where he graduated in the top 5% of his class and was named a Baker Scholar.

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