“Short Sellers Don't Exist to Fix the Problems. They Exist to Shed Light on the Problems”

In an interview with ProMarket, Fahmi Quadir, the short seller whose bet against Valeant in 2015 helped expose the company’s misdeeds, talks about short selling and its role in exposing corporate fraud.

In the summer of 2015, Fahmi Quadir pushed her employers at the New York hedge fund Krensavage Asset Management to short the stock of the pharmaceutical giant Valeant. Quadir was then a 25-year old equity analyst and fairly new to Wall Street, and Valeant was the poster child of the pharmaceutical industry, a $90 billion giant whose CEO, J. Michael Pearson, was championed by the likes of Pershing Square’s Bill Ackman as the next Warren Buffett.

Yet Quadir realized that Valeant’s business model, which was based on purchasing smaller pharmaceutical companies, slashing R&D spending and then hiking the prices of their drugs to exorbitant levels, was unsustainable. The stock peaked that August, with investors like Ackman doubling down on the company and its CEO, but then fell more than 90 percent as politicians and the press caught on to Valeant’s tactics and regulators launched criminal investigations into its drug pricing and accounting practices—a stunning reversal that turned Valeant from industry trailblazer into the “Enron of pharma.”

Quadir’s successful bet against Valeant, which was at the center of an episode of Netflix’s Dirty Money, has made her into a rising star and allowed her to launch her own hedge fund, Safkhet Capital, when she was only 27 year old. It also affirmed her belief that short sellers, often reviled by other market actors, can fulfill an important function by exposing corporate frauds. Safkhet, she explained when it launched in 2017, focuses on identifying frauds and accounting vulnerabilities that would make a stock lose most of its value. Among the companies she sees as vulnerable is Tesla, which she recently bet against.

Following her recent Stigler Center event, we sat down for an interview with Quadir about short selling, regulatory capture, and the dangers involved with exposing corporate fraud.

[The following conversation has been edited and condensed for clarity and length]

Q: You said short sellers can improve the world by identifying frauds that harm shareholders. How often do you spot fraudulent behaviors? Do they impact only shareholders, or broader society as well?

I would say every company that I’ve been shorting and am currently shorting, it’s fraud that harms not just shareholders, but primarily direct customers—in your words, broader society. Maybe this is naïve, but I believe that you can’t run a good business by taking advantage of people.

One place that we focus on, for example, is predatory lending. Yeah, it could be very profitable, as far as yields for investors, to investment companies that are engaged in predatory lending because these individuals are desperate for capital—they’ll accept and sign whatever it is. It’s almost like signing their life away. [But] ultimately, when you’re at a point where these individuals start to default and your company is dependent on growing your lending base, it doesn’t add up. The fundamentals, at some point, will start to collapse because it’s not long-term. It’s not a sustainable business.

There are companies in the predatory lending space that have become very excellent at collecting on defaulting consumers. In those cases, we have avoided shorting those companies. We disagree with their business practice and business model [but] as a short seller, ultimately, we have to be able to make a profit. I need to go after those lenders that are unable to collect.

There’s a mix here. We’re not just looking at companies that have exclusively engaged in financial misrepresentation on their statements because that’s usually not a good way to make money on a short. So many companies, nowadays, are engaged in some level of misrepresenting information to shareholders. For us, it’s about business models that are broken and exploitative.

Q: Deceiving consumers is not unique to these companies, though.

Absolutely. Wall Street is complicit in this whole cycle. As far as Wall Street rewards, it’s about margins, it’s about quarterly income. It’s not about what is this company actually doing for society, and what do the actual fundamentals of the company look like. No one cares anymore.

That’s what makes my job difficult. If I try to go after every company that was engaged in some level of exploitation, then I wouldn’t have time in the day, because I think most companies are—but again, that’s reflective of the markets today.

Q: You’ve had a lot of success shorting Valeant. But if we look at the aftermath of the Valeant scandal, did drug prices go down?

Yes, the prices are different. The FDA, after everything that happened with Valeant, has taken a strong stance as far as approving generics for drugs where there have been single-price monopolies for years, where there’s no patent protection. For a lot of those drugs where Valeant had these obscene margins and had taken multifold price increases over the past few years, like Syprine, there’s now generic competition. Those profits are falling off a cliff. There have been tangible actions that have been taken.

Again, that’s not enough because it doesn’t address the systemic issues related to drug pricing and how drugs are reimbursed in the US. It doesn’t fix the system. Short sellers don’t exist to fix the problems. They exist to shed light on the problems and show what companies are doing. Then, hopefully, something is done.

Q: Do you find that short sellers have a lot of success in changing industries in a way that benefits society?

I would hope so. That over the long term, by virtue of the companies that short sellers expose, the downfall of these companies will lead to stricter regulations or protections put in place.

Unfortunately, short selling, though it’s one tool that can be used against exposing corporate crime or making the markets better, ultimately there has to be real repercussions other than just the share price declining.

The thing is, we don’t see prosecutions for corporate crime in the US. Whether it’s the financial crisis, Wells Fargo, Valeant, whatever it is, we’re not really seeing executives getting their comeuppance for engaging in these sorts of practices. It’s actually become a difficult market. The CFPB has been basically made defunct.

Q: By the current administration, you mean.

Yes. Even though we’re exposing and we’re collecting information on companies in the US that are taking advantage of consumers where the CFPB could take action, we can’t bet on the fact that the CFPB will step in. Unfortunately, that’s just the reality of the times. We have to be sure that when we’re shorting these companies that the consumers themselves will start to realize the game that’s being played.

Q: Does the regulatory approach of this administration help frauds go on undetected for a long time?

Yeah, but someone else could say that during past administrations. We went through the crisis and no one went to jail for it. As far as prosecuting corporate crime, white-collar fraud, this didn’t happen no matter who is in the White House. On that front, I don’t know if much will change.

My fear is that limiting corporate reporting and transparency is definitely dangerous. Reducing regulation can be dangerous. Defunding organizations that are critical to protecting consumers is dangerous. All of that, of course, can cause problems.

Ultimately, in order for us to see less fraud in the market, there needs to be real repercussion to engaging in fraud. Unfortunately, there’s never really been a good sign of that.

Q: Which industries today are the most exploitative in your opinion?

Student lending. Student loans, the levels of student indebtedness is higher than it’s ever been, and the incomes are not growing proportionately to the level of debt, so I think it’s incredibly dangerous. Any market that is lending to these students that are taking on this level of debt is absolutely at risk. That whole market, for me it’s difficult to look at. There’s not an easy way to short student debt.

Q: Once you’ve identified a problematic company and established your position, you approach institutional investors and the media in order to “spread the word,” right? How do you engage with the press?

With journalists, we’ll typically engage on background or off the record. We’ll share information, and I would say most of the time journalists will not publish the information.

It’s more that they have to independently investigate whatever we send them. If anything, the worst-case scenario is that we get more conviction, or we get told that we’re wrong.

Q: Assuming they can verify your claims, why wouldn’t journalists publish anything?

The editor might have their reason not to put the story out. It could just be that they are not interested, and they don’t think their readers would be interested, or they don’t want to upset somebody.

Q: How often do you think that this is the case, that upsetting somebody is the issue?

It’s always an issue, because journalists, they need to be alert. They can’t burn bridges, because they need to have sources on all sides. If it is going to be a story that is, let’s say, skeptical of a company or critical of a company, then it has to be a rock-solid piece. They can’t just publish every bit of information. We have to respect that as short sellers.

Q: Do you think there are cases where you’d have something that is close to rock solid, and still journalists won’t go for it?

Absolutely. We know from our own experiences and what we see from other investigative journalists that we all get dragged through the mud for nothing, just for asking questions. For investigating one company that [we] shorted, they have broken into our servers and tried to intimidate, tried to collect some sort of blackmail. They’re not just doing this to us. We know that they are doing this to journalists who’ve been looking into them.

Specifically, there is actually a journalist we’d spoken to regarding this company, and they’ve actually impersonated that journalist and approached me to try and get more information. We understand those risks significantly.

Q: From your experience, how important is the media’s role in casting light on and pressuring regulators to take enforcement actions?

I wish it was not the case, but it is the case, especially if you have certain journalists that you know regulators are reading. That is the most effective way to get things moving as far as investigations.

Q: How many of the frauds you are looking into involve the big four accounting firms?

Auditors should also be held accountable. I wouldn’t say that they’re necessarily engaged in the fraud themselves. They’re not the ones actually cooking the books, but they are complicit in that they aren’t looking deep enough.

A lot of the companies that we look at, they have entities across the world. All of these entities may have their own accounting firms or auditing firms. The company that’s traded publicly in the US, they’ll have their US auditor, but the US auditor is only looking at the statements that have been reported up to the top company and not all of those local filings.

As a short seller, we go and we get those local filings. What we find is some of those auditors don’t even exist. They were fired. Then we’ll see the local filings simply don’t add up. Is PwC, or whatever auditing firm, looking at the top company level, or at these statements? They’re not.

Q: Looking to the other side?

They’re looking to the other side. They’re complicit in their laziness, which in and of itself, I think that should be criminal. If they did spend the time, then they would find the issues, and then the company will say, “Bye. We’ll get the other guy in.” There was one company that we were looking at that was publicly traded in the US. The audit partner was dead for multiple quarters.

Q: How did you find that out? That he was dead?

Just googled it.

Q: During your Stigler talk, you mentioned you were being followed.

Yeah.

Q: You are fairly young. Why would you, at 27-year old, want to go into a business where you’re being followed?

Because the satisfaction that I get from investigating these companies and actually seeing them lose money, decline in share price, or potentially go to jail, that satisfaction is much greater than the risks I feel with being followed or being intimidated.

Q: You also mentioned that hedge fund people, because of the risks that they have to take, all have a chip on their shoulder. What is yours?

There is no one out here that looks like me. I didn’t go to Booth. I didn’t go to any business school. I didn’t work at any investment bank. I didn’t work at a big ticket firm. For me, everything I do, I have to prove myself, especially with everything that happened with Valeant.

That’s almost like a double-edged sword, because so early in my career, I was associated with the single biggest loss for the hedge fund community. People will say I’m just lucky. That’s the chip on my shoulder.

For more on this, check out Fahmi Quadir’s interview on the Capitalisn’t podcast: 

Disclaimer: The ProMarket blog is dedicated to discussing how competition tends to be subverted by special interests. The posts represent the opinions of their writers, not necessarily those of the University of Chicago, the Booth School of Business, or its faculty. For more information, please visit ProMarket Blog Policy.