Power to Truth: CASI webinar with Francine McKenna and Anat Admati

When CASI co-faculty director Anat Admati first crossed paths with Francine McKenna more than a decade ago, she immediately recognized a kindred spirit with a common mission: to unearth the truth and empower it for the greater good. McKenna spent 20 years in public accounting, including roles at KPMG Consulting, PricewaterhouseCoopers (PwC), and BearingPoint before moving into investigative journalism and teaching. Her highly respected newsletter, The Dig, examines accounting, auditing, and corporate governance issues at public and pre-IPO companies. Her work has appeared in leading financial publications such as Dow Jones/MarketWatch, Financial Times, Wall Street Journal, and Forbes and has been cited in congressional testimonies and academic research.

McKenna came to Professor Admati’s Finance, Corporations, and Society course as a guest speaker and emphasized the need for dependable and trustworthy corporate accounting and auditing in today's complex financial landscape. She and Admati extended the discussion in a new webinar series, Power to Truth, which examines these important issues and explores how we can ensure that business and government best serve society.  Admati asked McKenna to share what she sees as some of the most concerning trends happening across corporate America. 

McKenna spoke about her 15-year experience using Twitter as a tool to distribute her writings on corporate accountability, highlighting that contrary to expectations, many issues have worsened over the years. She noted a disturbing increase in corporate fraud, even after the enactment of the Sarbanes-Oxley Act in 2002, which was supposed to curtail such misconduct. Rather than abating, corporate fraud expanded, and a troubling trend emerged: a shift away from investment strategies that tend to promote true value creation.

“Investing is now all about trends and momentum. It's about capturing the trade, it's about meme stocks, it’s about hype,” she declared, “and the more prevalent use of what we call non-GAAP metrics or alternative metrics in order to report their earnings.”

McKenna explained that these alternative measures make it challenging for investors to decipher the genuine financial health of companies. She emphasized the importance of Generally Accepted Accounting Principles (GAAP) as a standardized, consistent framework amid the proliferation of custom metrics used by companies to craft narratives and manipulate investor behavior.

Admati then asked McKenna for her thoughts on the challenges posed by privately held companies that choose to remain outside the public sphere to avoid stringent disclosure regulations. Francine McKenna pointed to the rise of privately-owned "unicorns" with billion-dollar market caps, highlighting their reluctance to go public due to the regulatory constraints it entails. 

“You have private companies that are in the shadows, with supposedly sophisticated investors supporting them through the process. You have very little disclosure, and in many cases, they're focused on growing revenue and not producing profits because they can always raise money from other investors who are trying to capture the trend, maybe find an exit strategy, if and when they go public, or just hand off their shares to the next gullible investor.”

In response to a question about red flags in financial reporting, McKenna drew from her experience at MarketWatch to discuss the worrisome practices she may have observed during her time reporting on corporate earnings. She saw a growing trend where companies used alternative metrics and dubious strategies to hide the true impact of their operations and financial decisions. CEOs, in particular, were often guilty of what she called a double standard: taking credit for actions that were costly investments, while simultaneously avoiding responsibility for the expenses associated with those decisions.

“They were erasing the costs of those strategic activities, whether it's restructuring, whether it's layoffs, whether it was things that we all had to endure such as the pandemic. They were erasing the impact of how they made decisions to handle the costs so that they would continue to get paid.”

Admati turned to focus on auditing, especially by the “Big Four”, Deloitte, Ernst & Young (EY), KPMG, and PricewaterhouseCoopers (PwC). Last July, the Public Company Accounting Oversight Board (PCAOB) released a report that found audits conducted by global accounting firms have grown increasingly flawed. Admati asked, “How do you think we can trust auditing?”

McKenna emphasized auditors’ crucial role in ensuring the integrity of financial reporting, as a check on management's compliance with generally accepted accounting principles (GAAP). The auditors' primary function is to provide investors and shareholders with an objective and independent assessment of financial information, free from self-serving motives.

“When the auditors don't do their job when they become too close to management, then you've lost that oversight. You've lost that independent and objective view on whether the financial information is something that investors should trust, should count on, [and] use to make decisions.”

Despite these challenges, Mckenna said she doesn’t want to dissuade people from entering the field of public accounting. She wants those who join auditing firms to stay true to their commitment to uphold the core values of independence and objectivity. However, she said the companies “are so big and so focused on profit-making that they focus on the commercialism side of the business rather than the professionalism, or the dedication they should have to serving the public.” 

The discussion shifted to two recent books that focus on the crypto industry, one by Zeke Faux titled Number Go Up: Inside Crypto's Wild Rise and Staggering Fall and another, Going Infinite: The Rise and Fall of a New Tycoon by Michael Lewis, which centers its attention on  Sam Bankman Fried and the FTX scandal. 

Francine McKenna highlighted the contrasting approaches of the two authors. Zeke Faux, a professional journalist, wrote his book intending to uncover the facts and understand the intricacies of the crypto industry, particularly the stablecoin Tether, and its connections to human trafficking. As he delved deeper into the subject, he stumbled upon the unfolding FTX story, ultimately presenting a more investigative and fact-driven narrative.

In contrast, Michael Lewis, known for his captivating storytelling in books like The Big Short, had initially planned to create a character-driven narrative around Sam Bankman Fried, as he had done in previous works. However, concerns have arisen about whether Lewis, who does not explicitly identify as a journalist, was too close to the subject and potentially sympathetic to Sam Bankman Fried.

“So, you have two different books, one written by a professional journalist and one written by a very popular, famous, nonfiction storyteller. And we are now seeing the stark reality of how our knowledge of business and financial events was shaped by perhaps someone who is not seeking the truth, but someone who just wanted to tell a good story.”

Admati added to the commentary by reflecting on her initial admiration for Michael Lewis, who was both an explainer and a storyteller in his financial books. She referenced Lewis's epigraph from The Big Short, where he questioned why Lehman Brothers had been allowed to succeed prior to the financial crisis to the point of presenting us with stark choices. In the case of Lewis’ recent book, Admati expressed her deep disappointment.

“As the details of Michael Lewis’s book came out, we learn [he] recommended investing in FTX based on one conversation with Sam Bankman Fried asking what could go wrong, which, of course, we saw a lot did go wrong. [Lewis] was asserting that there was a good business there without really being able to prove any of that to people, so he's making statements that really can be misleading to the public on the truth that matters here.”

“Zeke Faux's book starts quoting Sam Bankman Fried telling him “I won't lie to you,” and declaring that “this statement was a lie.”

McKenna talked about her struggle with the crypto industry as a whole, especially when there was so much money involved as well as bipartisan support.

“My question is, why did we let this industry get so big? Why did we let firms like Coinbase go public when the underlying business models seem to be built on cotton candy? They were pushing the limits. They were really anti-regulation.”

She spoke about discussions at both the US Treasury and the Federal Reserve over whether stablecoins presented a systemic risk to the banking system.

“At that point, it was too late to stop the train. Instead, you were looking through the tunnel and seeing the headlights of a train coming at you. And I thought, why didn't they put a stop to this before it even started?” 

Admati said that despite her vocal criticism of banking regulators, in this case, she felt they had used their tools effectively to discourage banks from getting heavily involved in the cryptocurrency industry.

Francine McKenna added that while the big banks were discouraged from direct involvement, the crypto industry found ways to insinuate itself in the banking system. She cited examples of the failures involving banks like Silicon Valley Bank and Signature Bank, which had significant ties to the crypto industry. She also pointed to FTX's acquisition of banks and the emergence of new banks catering to the crypto sector. She ended the discussion with a cautionary note. 

“I call it a whack-a-mole. The banking regulators continue to try to dissuade the large banks from getting involved [and] they continue to deal with failures of smaller banks that get over their skis. But there's always someone to step up and take that risk, with money flowing through [the system] because of speculation.”