Numbers Don’t Lie, But Those Who Use Them Sometimes Do
Every so often court cases pop up in the news that serve as good reminders of all the ways a due diligence exercise can go wrong, and now is one of those times. At 221B Partners, we couldn’t help notice the similarities between two cases currently in the news in which fabricated numbers feature prominently.
The first of these is a federal criminal case set to go to trial in Chicago this week involving charges of fraud against four executives of Outcome Health, a company which sold advertising to drug companies via tablets and screens set up in doctors’ offices. Prosecutors allege that from 2011 to 2017 company leaders, including co-founders Rishi Shah, who served as CEO, and Shradha Agarwal, who served as president, defrauded advertisers by routinely overstating the number of doctors’ offices in its network. As a result, the complaint alleges, the company under-delivered on its promises regarding reach to potential customers and essentially charged advertisers for services that were not fully provided. The defendants have pled not guilty.
The complaint claims that the company’s leaders provided numbers they knew to be false to clients, auditors, and even their own accounting department by fabricating lists of locations where the company had supposedly installed devices. It thus was able to inflate its revenue.
Discouraged from conducting their own study
Perhaps most tellingly, the defendants “discouraged clients from conducting their own internal studies of the performance of Outcome’s advertising campaigns” and instead encouraged them to allow Outcome Health to choose the company conducting the studies, the complaint states.
This lack of transparency should have been a red flag for clients. But perhaps they looked the other way given the glowing press coverage enjoyed by the company’s millennial founders and a company valuation that had reached $5.5 billion by 2017, not to mention an investor list that included a fund co-founded by Illinois Gov. J.B. Pritzker and units of Goldman Sachs and Google.
The company’s fortunes headed south later in 2017 when The Wall Street Journal ran a story, based on information from a company analyst, about the company’s questionable business practices. From there, things unraveled quickly, with investors suing company leadership for providing falsified information and advertisers heading for the exits.
Impressive figures don’t add up
As the Outcome Health trial kicks off in Chicago, another high-profile case involving allegedly fraudulent numbers has begun in Delaware, this one a federal civil action filed by banking giant JPMorgan Chase against Charlie Javice. Javice is the founder and former CEO of Frank, which she designed to help guide college students through the federal financial aid process. During negotiations with the bank, Frank allegedly told the bank that it had a user base of around 4.3 million customers and bragged about its associations with 6,000 U.S. institutions of higher learning. JPMorgan was so impressed with the company it bought Frank for $175 million in September 2021.
By now you’ve probably guessed that the numbers Frank reported didn’t stand up to scrutiny. JPMorgan learned this the hard way: its first clue came when it sent advertising emails to 400,000 addresses provided by Frank. It discovered that just 28 percent were delivered successfully. JPMorgan’s own investigation found that Javice had hired a data scientist to manipulate the account data, creating millions of fake users, according to the complaint. JPMorgan estimates the actual number of confirmed Frank users at around 293,000.
As detailed in this column by Ron Lieber of The New York Times, the bank really should have known better. As a powerful institution that makes billions of dollars working with numbers, it should have realized that those provided by Frank did not add up. For instance, to achieve a customer base of more than 4 million Frank would have had to capture an enormous percentage of first-time students each year, meaning those least familiar with the financial aid process and most in need of help.
While that’s not impossible, other evidence also cast suspicion on Frank’s data. College financial aid expert Mark Kantrowitz found that at the time of the JPMorgan acquisition, Frank’s website was visited by just 67,000 users, far fewer than one would expect for a company boasting 4.3 million subscribers. The company’s supposed relationship with 6,000 institutions of higher learning has also come into question as that would include virtually every postsecondary school in the country eligible to accept federal financial aid. Some schools contacted by Lieber about their relationship with Frank said no such relationship existed. Javice has yet to file a response to the complaint as of this writing.
These cases have obvious similarities beyond the fact that both involve investments by well-heeled sources in companies run by relatively inexperienced founders. In both cases the numbers, and in particular the fudging of numbers, is at the heart of the allegations against the founders.
A little skepticism goes a long way
As investigators, it is second nature to us to be skeptical, including when we hear numbers that really stand out. The old adage “if it seems too good to be true it probably is” comes to mind, but cases like these are more complicated than that because the stories told, and sold, by these entrepreneurs seemed plausible enough at first. Only under scrutiny did those stories start to fall apart.
For investors and customers with questions about any business, getting under the hood is often the only way to learn what is really going on, and if the business avoids transparency or provides data that seems suspect, you owe it to yourself to keep asking questions, or to turn to professionals who can help you get answers.