No. 1 Forensic Accountant: The Coming Collapse | Anthony Scilipoti

I hate calling things bubbles, but I

think we're in a period of extreme

euphoria where you read and speak to

investors and they say that the numbers

don't matter and the financial

statements no longer matter because this

is changing the world. I say, well, I've

seen this before. You know, I saw that

Nortell was changing the world and

Lucent and Cisco and 360 networks. They

were building out the infrastructure of

the internet that we're using today.

But those companies don't exist anymore.

>> Anthony Schilapati is a forensic

accountant who saw what others missed,

predicting the collapse of both Valiant

Pharmaceuticals and Nortell long before

it happened. He spent decades reading

what companies don't want you to see,

the footnotes. Now he's spotting

familiar warning signs in today's AI

boom.

>> What are the red flags you look for?

It's not red flags. We call them

flammable items. So, it's a three-stage

process. The first stage is

>> This episode of the knowledge project is

forformational purposes only. The views

and opinions expressed by Shane Parish

or our guests are solely their own.

Nothing in this conversation should be

considered investment advice, financial

guidance, or recommendation to buy or

sell any security. Always do your own

due diligence, or consult with a

qualified financial adviser before

making investment decisions. It's time

to listen and learn.

>> I want to start with how you got into

forensic accounting.

>> I was an accountant and I was working at

Arthur Anderson doing the normal audit

sort of preparatory work and I uh found

it unfulfilling uh because the work I

would do I would find interesting or

concerns with the accounting or

otherwise and the clients it didn't end

up ending anywhere. So, uh, what ended

up happening was the there was some due

diligence work to do where we could do

actually look at transactions, companies

calling us to say, you know, we want to

spin out this business or we want to

make this acquisition. And then I asked,

put my hand up, said, listen, can I do

that sort of work? And then I started

doing it and I loved it. I saw some huge

fulfillment. And then it's all about

people you meet. I met a a gentleman

named Al Rosen and he was head of

accounting at York University and he was

a forensic accountant. He had his own

practice. He taught taught us to pass

the the the Yuthi at the the exam or the

CPA exam at the time and um I said you

know I'd like to work with you and he

said well you get your CA work done and

then we'll think about it. And uh that's

what I did. And so then I toutelaged

under him for some four years. And uh

that that really uh made it happen.

>> You weren't on the Enron file, were you?

>> I was not on the Enron file. I left

Arthur Anderson in 1997. Couldn't even

spell Enron at the time. And uh it's

it's a very sad thing what happened.

>> What did happen at Enron?

>> They essentially had a number of

offbalance sheet exposures. So they

would enter into derivative type

contracts where that were tied to an

energy price for example or even the

company's own stock price and it'd be

like this debt only comes due if the

stock price falls to X. This debt only

comes due or this derivative transaction

we'd entered into and Ron was an energy

trader. um you know so if the price of

electricity in kilowatt hours rises to a

certain amount well then there this debt

is no longer due. If it falls to this

level then they're they have to pay uh

some counterparty and so those were

those those risks were essentially

offbalance sheet. So those were not

sitting on the company's liabilities.

They were all contingent and at the time

the accounting rules were such that the

this these numbers were not included on

the liabilities. They were just in the

notes. And so all of a sudden so people

weren't paying attention because nobody

read that reads the notes. And so then

all of a sudden things started to

happen. There was a change and movement

in commodity prices. Okay, this is now

we're dealing with the dot. There was a

lot of a lot of changes that happened in

the economy. We we had a we had a a uh a

recession in the early 2000s, right? And

so that led to a lot of movements in

commodity prices that triggered the

derivatives. Surprise, surprise, they

can't make the payments. It's done.

>> And they weren't required to reserve or

put away in reserves any amount of

>> well, if it wasn't on the balance sheet,

then investors and wouldn't wouldn't

have noticed that that there was not

enough assets per perhaps to cover. and

and why the implication to Arthur

Anderson which I think is important and

then it's near and dear to my heart is

you know the auditors at Arthur Anderson

they're working on the file they ended

up signing off on all these things well

when essentially the proverbial hit the

fan all of a sudden they were asking

questions and the regulator asked for

the working papers of the auditor that

the papers of which they would support

the audit work and they knew perhaps

that they didn't do enough work so they

shredded the documents. So all of a

sudden they became guilty because of

their actions

>> and so it was found in the courts um

upon appeal that uh Arthur Anderson was

not guilty but that was way after the

fact because Arthur Anderson was already

was brought to its knees and it was

over. became a scapegoat for everything

wrong with uh with with accounting at

the time and uh look change needed to

happen. Arthur Anderson was around the

world all the partners were folded into

the other firms.

>> What are the limitations on audits?

>> The limitations?

>> Yeah. Hey, the limitations are you're

hired to be a independent to give your

independent opinion and attest that the

financial statements present fairly in

all material respects in accordance with

some set of accounting standards and/or

standards that's associated with a

contract for example. And the challenge

is time because you have to do this

quickly, pressures on costs and

essentially think about it this way.

It's like I tell you, look, I I just

prepared my report card. I got an A. I

now hand it to you and say, look, it's

an A. And if you say that it's an A,

I'll pay you X amount of money. So, look

at your situation. You come back and

say, well, it's actually not an A. It's

kind of a B+.

Uh, how much am I paying you again?

>> Yeah.

>> What do you mean it's a B+? Do you think

that question that the way I answered

that question couldn't have been this

way or the other way you know and this

is it ties into so many things you know

AI and so forth business is judgment

people run companies they don't run

themselves the decisions associated with

a business transaction end up being

reflected on those financial statements

but when the group that's making the

decision in the business to do something

well then they come back to the office

and show up in the in the accounting

department and say, "Hey, we just did

this. You know, can you guys figure out

how to account for it?" And all of a

sudden, the accountants are like, "God,

what do I do now? How do I do this?"

Because then they and by the way, when

you do this, I want it presented as as,

you know, as bright as possible so that

our investors and all our stakeholders

are really excited by the results like

don't present it badly.

>> You you said a lot of people don't read

the footnotes or the financial

statements. Is that changing in a world

of AI where you can sort of like

download the financial statement, pop it

into AI and say, "What do I need to

know?"

>> I think it's actually exacerbating the

situation.

>> Oh, spend a few beats on that

>> because now read the financial

statements, Anthony. I just put it into

AI. I asked Chat GPT to tell me, "What

about this? Look for that. Look for

that." And there's there's all the

instances of those things. and then I

just read it and it's all there. Well,

did the AI miss it? Did the AI

understand the linkages between each of

those sightings? If I'm if I'm looking

at, for example, I was looking at a

company recently and I was looking at it

was capitalizing costs. Okay, this is a

REIT. And if it capitalizes cost versus

putting them through the income

statement, if it goes through the income

statement, it makes their operating

earnings look poor, lower, and their net

EPS ultimately. But if they put it on

the balance sheet, well, you know,

that's an investment in the future and

everything looks okay, right? And so

there's a gray area. Was it an operating

expense or was it a capital item? And so

I was first thing I looked for was

capitalized interest. And so it gave me

all the quotes and then capitalized

costs and it gave me all the quotes. So

then you think that that's enough, but

you have to then and I and I was showing

one of my guys this. I said, "So then

let's go to the income. Let's actually

pull up the statements where it told us

to go because AI made it faster. I now

no longer needed to flip the 300 pages,

but it it gave me where to go. So now I

went there and now I could say well that

means if that is what's happened then we

need to look at this other note to see

what you know the implications of that

and then we got to look at the cash flow

statement to see how it's actually

impacting what ends up being reported as

as cash flow and so those linkages come

it the AI makes me get to the answer

perhaps more quickly but it's my if I

don't already know where I want to go

then AI just gives me information, but

that information doesn't help my

decision if I didn't start with where I

want to get to.

>> And it sounds like that information

doesn't help your decision if you don't

know the second, third, fourth order

consequence.

>> 100%. This is I love it. If that's where

investors go and that's where they're

going, everything is going to AI. The

the bottom level of being an analyst,

the junior analyst is is going to be

replaced by an AI. the one that said,

"Find me all the references of, you

know, where the company capitalized

costs." That the AI can do. I get it.

But you need someone with experience to

know what which of those references

matter and to what that means to the

business.

And this brings about a number of

challenges because well if that junior

person doesn't learn

doesn't get on the in on the ground

floor they'll never learn to be able to

make all those connections

>> and the only way to learn is sort of

like being in the weeds and not being in

a

>> Yes. In fact, it ties to so many things.

I I with my own children I've seen

growing up when we went to school and we

were in elementary school, we would be,

you know, we'd have to do the math

tables and and recite them.

>> Yeah. 2 * 2 is four and so on. I

remember I was struggled with my with my

nine times table and then my 12 times

table and so I had to memorize them and

get them going. But then my children

came along and they were using a

calculator and apparently that was okay.

I went bananas. I said, "You're not

going to use the calculator. You need to

learn it without the calculator and then

you can use the calculator, which is the

same with AI. You need to understand how

the financial statements are prepared,

understand the linkages, develop mental

models so that when the AI gives you

information, you can you can digest it

and make decisions. Reminds me of this

funny story. When I started university,

uh, I ended up in first year calculus

and for whatever reason, the professor

who was supposed to teach that class

couldn't teach it. So, the dean of the

math department took over. And on the

first class, in the first like minute,

he said, "There'll be no calculators in

this class." Oh,

>> nobody of course listened to him cuz

graphing calculator, you're like, "Oh my

god, this makes my life so much easier."

would show up to the final exam which is

like I think 80% of your final mark.

>> Yeah.

>> And on the front page it's no

calculators and he did not grade that on

a curve and it was not pretty for most

students.

>> I taught at university for about uh 14

years at York and uh truly one of a very

fulfilling time uh in my life and uh I

still love doing guest lectures. I

remember I I I would always start the,

you know, I would go over the outline

and I and I would tell the students, I

said, "So, assignments are due at the

beginning of class.

>> If they're handed in after the 8:30

start time, it's a zero. It's a zero."

And invariably

at some whether it was the first and

usually the first or second assignment,

somebody would show up and hand it in

late and I would say it's a zero.

>> Yeah. and they would whine and say it's

how can you do that and you're so

draconian and I say well you think in

the real world when an RFP is required

and you've signed with the contract with

a client that they demand the report by

9:00 a.m. on Monday and you show up at

9:05. How's that look?

And somehow it's okay. So, it wasn't

okay in my class. And and ultimately, I

think you you build respect because

people see that there's a rule and it's

followed and then people have respect

for the rule.

>> There's this sort of like weird

dichotomy I think with students right

now. And dichotomy is probably not the

right word. There's this weird

path where students are coming out and

they're more powerful and capable than

ever because they use AI by default

>> and so they can get more output than

somebody who's maybe been in their

career 15 20 years and I I use my

14year-old as an example. You know, in a

world where he never had to show up to

work, he's a mid-level employee at most

companies based on output. If you never

saw him, he can give you the the exact

same output that a mid-level employee is

going to give you if everything goes

right. But the minute something goes

wrong, he doesn't quite understand all

the nuances and all the and AI the I

guess the race for him is like will AI

catch up quicker, you know, because he

uses AI by default. And I sort of think

about this as like making a recipe,

right? Like if I pull out a cookbook and

I make a recipe and I do everything

perfectly, you wouldn't be able to tell

the difference between me and the chef.

Like the food, maybe it's not plated as

well, but it's going to taste great.

It's going to taste the same. You'd be

like, "This is amazing." But if

something goes wrong, if the oven's too

hot, if I don't stir enough, I don't put

enough salt in. I don't know why it

didn't go right. But the minute a chef,

the chef who created that recipe, who's

got all the experience, who did the, you

know, who's made it hundreds of times,

they taste it, they're like, "Oh, your

oven said 375, but it's actually 350.

You stirred this too much. You let this

boil. You They instantly know what went

wrong." Yes. And I wonder if in a world

of AI, that's the nuance. And I I was

talking to Steve Schwarzmann about this

in a different context. But he basically

said, you know, a lot of the analysts

coming up, they know the numbers, but

they don't know what the numbers mean.

>> Correct. Experience teaches you

judgment. And and you talk about this in

your book. It's all about the mental

models. I I I believe that strongly. The

experience teaches you what the numbers

mean as we've spoken about. And when you

have experience, you say, "I've seen

that before."

>> And a lot of the things I see happening

today link back to things I've seen when

I started my career over the last 30

years. And I think that's something that

the AI can't quite do unless you tell it

where to look because it doesn't know

the link that I'm thinking about, right?

But if I if I can make the initial

stage, it can help me get there quicker

and more accurately. But if I don't if I

don't already have a model of what I'm

looking for, it's not going to get

there.

>> What are you seeing today?

>> We're talking now equity markets. Is

that

>> Yeah. I think we're in uh what seems to

be, you know, and I I hate calling

things bubbles, but I think we're in a

period of extreme uh euphoria where the

numbers, the fundamentals, and

fundamentals is thrown around in the

investment industry like the the word

love is thrown around among humans. You

know, the fundamentals, well, someone

looks at the chart and sees that, you

know, it did a double bottom. Well,

that's the fundamentals. And someone

else says, you know, that they're

looking at the RSI or some other things

or someone else says they're just

looking at cash flow or someone's

looking at the multiple related to

earnings. And those are the

fundamentals. Well, at the, you know,

historically, and if we follow what what

Buffett says, the company is the present

value of its future cash flows. And how

do you develop those cash flows? Well,

you need to do a forecast on what it's

what what it's going to drive the

business. And so, that's what I think

the fundamentals are. And so when a

company today is not generating much in

free cash impact negative and yet the

market wants to trade it at a multiple

of its revenues

well then the company's valuations is

extracted from its current fundamentals

and trading based on some future

expectations. I've been asked you know

if you could have anything what would it

be? and I'd say tomorrow's newspaper

because then I'd know what was going to

happen and I would be able to invest on

that. And so we're all trying to do the

most the impossible figure out what's

going to happen tomorrow. And all I know

is I've seen that when you read and

speak to investors and they say that the

numbers don't matter and the financial

statements no longer matter because this

is changing the world. I say, "Well,

I've seen this before." You know, I saw

that Nortell was changing the world and

Lucent and Cisco and 360 networks. They

were building out the infrastructure of

the internet that we're using today.

But those companies don't exist anymore.

They built what they built and that

still exists, but they no longer exist.

Either bankrupt or folded into other

companies. Cisco still exists today, but

has never traded at it at its historical

uh valuation. And yet, it's a it's it's

a multiples bigger than it was back then

and by earnings and by revenue.

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I guess what you're saying is the same

is we know this is the future, but it's

also the same in that we don't know who

the winners are going to be.

>> That's right. And and I think right now

the reason why I think we're in a in a

very high-risisk situation is because

the cost of the risk is priced very low

and that's when the risk is highest. And

so how do we look at that? When you look

at the uh the high yield bond spread,

the spread between the 10-year bond and

the high yield bond in the US, okay,

that's the non-investment grade bonds.

Well, that's the tightest, near the

tightest it's ever been,

>> which means that investors are willing

to lend money to non-investment grade

companies at a spread over what a

government bond is at a rate, which is

the tightest it's been practically in

history. So there's no risk priced into

the bond market. And then in the equity

markets, we use VIX, which is a measure

of volatility of the of the S&P 500. And

that is trading at a benign level. It's

not the lowest it's ever been, but it's

at a benign level. So in essence, what

investors are saying is there's no risk.

Everything's fine. Isn't that the

age-old wisdom of like don't fight the

Fed, though? For sure. the future is is

pretty clear at least in the short term.

But the implications of that are we I I

don't proclaim to know but interest

rates are coming down. I mean all the

governments want interest rates down,

>> right? They they want interest rates

down because because debts have have

continued to balloon in a period which

has been relatively buoyant uh by

historical standards and interest rates

uh they perceive interest rates are

going to go down. That's going to keep

on the buoyancy. Well, the central bank

and if you followed Powell despite all

the pressures coming from Trump to cut

rates, I mean Powell is going to cut

rates because he's concerned about

either the employment situation, right,

or the economic situation more broadly

>> or political pressure.

>> There's supposed to be a separation. And

it seem, you're right, but it seems like

he's actually noticing that because the

now all of a sudden we've seen some some

more strain in the in the employment

market. And that I think is what's

leaning him to believe, okay, now it's

time probably to start cutting rates.

>> What happens when we cut rates and

markets are at all-time highs? It could

become a situation of where you sell the

news because everybody was moving the

market up in anticipation of it

happening because the belief is as we

when we cut rates we provide more lowerc

cost capital to companies they put that

capital to work and it generates return.

Every company is only as good or as

stable or as strong as its customer

base. And if we're seeing that the

customer base of uh you know, let's call

it the average Joe, and I call that Joe

Sixpack. Uh he's a buddy of mine. We all

have a buddy, Joe Sixpack. And so if Joe

Sixpack is struggling,

then ultimately, how is everything going

to trickle down and create growth?

>> You know, I have a hard time reconciling

this, right? Because the the the

territory, the boots on the ground is a

lot of people are struggling. seems like

more people than at least in my adult

lifetime with the exception of maybe the

2008 financial crisis. And we have

markets at all-time highs.

>> Yep.

>> And we have inflation, core inflation

actually going up and we also have

governments uh with high unemployment

pushing interest rates down. And we have

this this really I don't make macro

predictions, but we have this really

interesting setup. And then on top of

that, like just from my like how I sort

of approach things, you have the

greatest investor of all time who has

built up uh I don't

>> what's yeah 400 billion by now or 350

billion. His largest cash holding as a

percentage of market cap I think ever. I

struggle to reconcile all of these

things into some coherent view of like

>> the the thing about the markets and

companies is they'll continue longer

than you and I will be alive. And so

when you're investing, it just depends

on your horizon.

And I think what's happening today is

investors have learned

and rightly so that every time the

market falls, it rallies back.

>> And I like the comment you made, Shane.

I'm not here to predict markets. Uh it's

a fool's game. Uh I don't know, you

know, I I wish I knew then I just buy

futures and make tons of money or short

them. But what instead I know is I'm

looking at the underlying companies and

except for some of the mag seven that

are growing to earnings, the smaller and

midcaps are not. When Walmart is telling

you that there's a problem with its

sales forecasts and Target is struggling

and Lululemon can't sell the same number

of pants and Starbucks is considering to

changing some of its pricing and some of

its its business model. you know, this

is Joe Sixpack and and Stevie Weinbox

that stepped up from Joe Sixback. You

have Stevie Weinbox in the middle. Um,

and I think they're the ones that are

struggling. And so it tells me that this

can continue and and markets can

continue going up for for any number of

amount of time because it's a function

of how much liquidity is in the market

as well. People have are if investors

have lots of cash, they'll continue to

invest. the people that you're seeing

that are making the most money today um

are not those that historically necess

in general I'm speaking the ones that

you hear about that have made money

historically we talk Ray Dalio we talk

about you mentioned of course Warren

Buffett and there was a there's a quote

that was that I that I learned uh over

time and it says during raging bull

markets knowledge is superfluous and

experience is a handicap

Because

if you have the the benefit of knowing

what happened in all the other blowups,

you know how painful it could be. But if

you've never experienced it and every

time something went wrong, it just

rallied back like nothing happened,

well, you think it's going to continue.

>> I guess the argument against that is

this time it's different, which is what

we always

>> which is the most dangerous words in in

life and in finance. one day want to

write a book that's that that marries

finance with life because it's it's it's

it's one and the same.

>> I remember this interview Alish

Schroeder did and she hasn't done many

interviews and one of the most

illuminating things that I remember from

that interview is that Buffett when he

was looking at patterns he wasn't trying

to identify what's different this time

he's trying to focus on what's the same.

>> Yes.

>> Talk to me about that. And so what I see

is the same. We actually put, you know,

I I transitioned the the forensic

accounting knowledge and and skill set

into what is today Veritas. And so

that's an independent equity research

firm and then later into also an asset

management arm. And all of that started

because we wrote a cell report on

Nortell in in 2000. And people thought

we were crazy. And you know, at the time

I was 29 years old. So, I didn't realize

what I was actually doing. It's amazing

when we're young. But

>> you didn't realize the impact of what

you were doing.

>> I didn't like where

>> you knew the accounting.

>> I knew what I was looking at, but didn't

realize that if you dropped said pebble

into the water, what happens? And then

when John Roth gets quoted in the

newspaper that we're hurting his ability

to raise capital and clients are

cancelling and you know employees are

contacting us upset because of the

things we're saying and it's like I

didn't mean to hurt anybody. I'm just

saying the truth hence the name Veritas.

So let's link to what I think some of

the the the linkages from the past. So

at the time you had Nortell and you had

Cisco and you had Lucent and they were

building out various components parts of

the internet and what they would do was

they needed customers. Well the

customers needed to raise money cuz if

you're going to build infrastructure

you're not going to generate cash flow

for some time. So they would raise money

from equity holders and eventually get

some debt but the powers that be at

Lucent and Nortell would also offer

them. So they would say buy this $10

million worth of product and why don't

you pay me over some extended period of

time. Oh, and by the way, we'll give you

a line of credit so that you need 10

million from us of of cable. Uh, but

we'll you can also you need to buy some

routers from Cisco. You know what? We'll

give you some line of credit so you

could do that because Nortto could

borrow money could could had a great

balance sheet could raise money

whatever. And so that's what was

happening. Well, ultimately when the

equity market started to wobble and

there was no one left to continue to

make sales to, right? Well, then now all

of a sudden Nortell didn't get paid on

its debts and the wheels came off and

then the 360 networks and JDS unif

mentioned they went by the wayside. And

so what ended up sort of now let's take

that and think about what's happening

today. So you have the likes of the

Nvidias of the world and let's say

Microsoft and you have Open AI and such

and Nvidia is investing in Open AI.

>> Mhm.

>> And Microsoft is an investor in Open AI.

Microsoft offers cloud services to Open

AI. So it's a customer. So OpenAI

becomes a customer of Microsoft. But

Microsoft gave it the money so that it

could actually pay it back. Nvidia

invests in OpenAI and Nvidia is a a a

supplier of chips to open AAI. So it's

all circular. What's going on here?

There's a new company that just went

public earlier this year, Cororeweave,

who is its largest customer. Coreeave

provides data transaction like analysis

of on chips, right? It's a data farm for

the large AI users like Microsoft. Its

largest customer is Microsoft. Microsoft

hasn't invested in it, but Nvidia

supplies pretty much all its chips.

Well, Nvidia is a large or is a

meaningful investor in Coreave. Corewave

goes public.

It's trying to close its its equity, its

financing. on the last moment, Nvidia

buys $250 million worth of shares of

Cororeweave so that it could close the

deal. These are, you know, JP Morgan

gives them a loan so that they could

just before they go public and then they

go public and repay the loan to JP

Morgan who's the one of the lead

underwriters, JP Morgan. No one's doing

anything bad. No one's cheating. It's

just these are all the same type of

symptoms of things that were going on

way back some 25 years ago. All these

things don't mean anything. Nothing

means anything until it means something.

I say, you know, the things that we're

talking about right now, these little

things, if you will, you know, in the

time of 2000s, just like we talked about

Enron, that didn't have the disclosure.

So, the key wrinkle to everything I

brought up, and that's why now I want to

take it to the accounting is the

financial statements of Nortell

>> didn't show that long-term loan as a

part of current assets. It showed it as

part of long-term assets. So, when the

simple calculation of current ratios,

they would only take well current

assets. And so, this long-term asset

that wouldn't show up as part of the

liquidity calculation. It also wouldn't

show up as part of operating cash flow.

And if it's not part of operating cash

flow, then operating cash flow looks

better. And no one would look at

long-term receivables.

>> And what they would because they're

taught in their CFA, how do you

calculate free cash flow? Operating cash

flow less capex. But this is the problem

with when you just create the ratio and

invest by ratio. The ratio needs to be

adapted to the company, the life cycle,

the industry, the business model. If the

company's selling things at a long-term

receiv over a period of extending beyond

one operating cycle, but it's part of

its normal operations, that should be

part of operating cash flow. And in

fact, after after Nortell, Fazby changed

the rules and then long-term receivables

became part of operating and short-ter

and and and current assets. And that's

something we wrote about. We said this

is wrong. You need to the free cash flow

is actually negative because this number

needs to be shown. So they're extremely

vulnerable to something going wrong if

the customer can't make payments. And

today, now let's look at the accounting

today. Nvidia would make that investment

in in core. It's such a small

meaningless dollar amount to the balance

sheet of Nvidia

>> that the num amount of disclosure is

irrelevant. It it's a it's a related

party. Now, we only own 5% so that's not

material to to Nvidia and the dollar

amount to Nvidia's total balance sheet

is also immaterial. So, it doesn't

matter. But if this is happening over

hundreds of transactions where it's

making investments like this in its own

customers, then what ends up happening

if all of a sudden it runs out of the

ability to get cash or the customers end

up having problems selling services with

the chips that it buys, then kind of

things start to fall uh fall apart.

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you you know that's an investment in

your customers.

>> Again, it is it is fantastic business

savvy. You want if I'm trying to create

a new paradigm which is AI then I in

order to foster that paradigm I need to

invest in it

>> as a as the key player in it. And what

ends up happening if you see that my

name as a key investor and and a leader

in this industry is making an investment

in this company. Well, then what does

everybody else do? Warren Buffett tells

you he's buying something. What does

everybody do? They go buy it. Well, if

Nvidia is buying something, what do all

the private equity firms do looking

around? Well, that's a good one.

>> There's another one. It's on Corenser

Weave, like the AMD equivalent, which is

private now. So I would imagine they

would all

>> exactly

>> pile into that.

>> You got it.

>> Yeah. This Nortell report I want to come

back to this for a sec. So you dropped

this report and you happen to be

correct.

What responsibility

you know remember the Superman quote

with great power comes great

responsibility.

>> I tell you Spider-Man.

>> Spider-Man. Spider-Man. Yeah.

>> I love that quote.

>> And I wonder about these things like

when you're right it's great but what

about when you're wrong? And that's one

of the things uh you know we're

celebrating our 25th anniversary this

year and uh I developed 10 uh rules

investing rules and they they relate to

life as well but uh one of them is being

negative sounds intelligent.

>> Being negative typically is looking at

facts. It's looking at numbers. It's

presenting them to you in a way that

says, "Wow, that seems really

compelling. If I want to sell you

something that is you know that so

that's the negative side. If I want to

sell you the positive side well then I

got to sell you the dream. AI is going

to change the world. People are going to

be no are no longer going to need to

work. We're it's going to replace jobs.

Margins are going to go higher. There's

going to create you know it's it's going

to improve health care services. All the

the phenomenal things that could

potentially happen. And so you'd see

that and then you're willing to invest.

It's you're buying a dream. But if I

tell you, yeah, but a lot of this is

based on all these intricate

transactions where there's no disclosure

about you go, ah, that doesn't matter,

Anthony. Look, we're changing the world,

buddy. I like to say none of these

things matter until they matter. And

then when they matter, they matter a

lot. You know, with great power comes

great responsibility. You're right. This

should not be interpreted as I'm telling

that something's going to blow up. I'm

just saying that there are some

linkages, things we've seen in past

euphoric times. Things could continue

for any number of periods. I I don't

know. But we're getting to a point, as I

said earlier, where there's very little

cost to risk today.

>> What are the 10 investing rules?

>> Oh, now you're going to put me on the

spot. I I I don't I I don't remember all

of them. Uh

>> why don't you give me some of them? The

number one rule, and I borrow this from

from Warren, and so if he ever, you

know, he's not going to pay attention to

listen to me, but I did reach out to

him. His number one rule is don't lose

money. And my concern with don't lose

money is any investment requires the

absorption of risk. And so if you're not

willing to take some level of risk,

which means potentially to lose money,

you won't make money either. So you

don't want to invest with a from a from

a position of fear.

>> You want to invest I think so my number

one rule is avoid embarrassing loss. You

want to avoid the loss of a company

potentially blowing up. If the company

might you know if it looks like it's a

little bit expensive and it might and it

might go potentially go down 5% or

something or 10% or 20. Okay, you can

deal with that. But if you're investing

in a company where if something goes

wrong, you could wake up one day and

it's down 20 or 50%. That's the one you

don't want to have in your portfolio

because investors will never invest with

you again.

And you'll also be scarred because

people make investments. This is why

it's so difficult to be to be a

long-term sound investor because

emotions get in the way, which is one of

my rules. emotion has no place in

investing. Another rule is uh don't

trust management. I'm sure there's many

management teams and I run my you know

we're a operating business uh private

company and it's not that they you know

you you shouldn't trust anything they

say but again it's it's a mindset. Uh

everything you do is is about how you

pos you you present your your mindset

going in. And so if you go in with the

mindset of don't trust, then you'll be

curious. Then you're going to ask

questions. It's not that you you think

that they're bad people. I didn't say

they're bad people. I said just don't

trust. Verify and then trust. And then

another rule would be that you have to

read the notes to the financial

statements first before you actually

read the statements. The notes to the

financial statements tell you how the

company modified the accounting because

it ch it made accounting choices. We

decided to account for this these type

of transactions in this way so that when

you look at the financial statements

once you know how they're prepared you

can better interpret them. Accounting is

a language. If I said to you tomorrow

you're going to speak Spanish. Oh you

know you could do AI and you figure it

out and you're going to learn it. But

the nuances of the language, an

individual who did a PhD in that

language, they're going to understand

way more about the language than you

are. The same like reading the financial

statements. The more you understand of

what went into them and how they're

prepared, the better you're going to

interpret them. What are the red flags

you look for? I like the way you you

posed the question because it sets up

what I we've learned over time. The

problem with red flags is it gets to

your point that you started at before

where you don't want to be crying wolf.

And so I've learned to temper because

you could be wrong.

>> Mhm.

>> It's not red flags. We call them

flammable items.

>> Okay.

>> So this goes to the pro our process.

It's a three-stage process that we use

and we teach because one of our we have

Veritasu and so we teach investors how

to make better investment decisions. And

so the the first stage is you understand

the business and the control

environment. Okay, again understand and

understand the accounting that's being

used so that when you study the

financial statements, everything else,

they all make sense and you understand

sort of the the the structure, how is

management compensated, what stage of

their life cycle are they at? Because

those are all sort of constraints and

opportunities within the business. So

then you look for a flammable item. For

example, companies generating negative

cash flow. That could be by itself a red

flag in the normal way. This this type

of I would call forensic analysis is

taught unless you know. So if a

company's generating negative cash, it

may actually be a fantastic thing.

They're investing in an AI startup that

is going to be a huge opportunity. and

they've shown over time that the return

on invested capital is in excess of 20%

or 50% or whatever it is. And so they're

investing in something. Yes, it's

negative cash flow today. But I'm not

investing for the cash flow today. I'm

investing for the cash flow tomorrow. So

you see that as a red flag, you don't

invest in it. And unless you understood

the first part, which was the fact that

where they are in their life cycle, type

of business, etc., that is now not a red

flag. It's just a flammable item by

itself. Not a problem. It depends. And

then you get to the third bucket, which

is the spark. And so you're always

looking for a spark because let's use

that same negative cash flow. Well, if

all of a sudden a new competitor comes

into that company's operating space,

okay, and is able to take market share,

>> now all of a sudden that negative cash

flow is a problem. If you notice in the

financial statements when you look at

that negative cash flow, the company's

taken on very expensive debt. Again,

very expensive debt by itself doesn't

mean anything because if the potential

return on invested capital is higher

than that cost of capital, it's all

good. But if a new peer comes in play,

now all of a sudden that model may not

work. And now you have a blowup. In my

podcast, the FactFinders, I I

interviewed uh an individual who we've

used before, private investigator, and

he's the one that got me onto this this

way of this mental model. And uh he

says, you know, if the CEO uh beats his

wife and runs stop signs, kicks his dog,

doesn't get along with the neighbors,

probably could be a problem. But that's

not going to show up in the financial

statements. That's not going to show up

in any interviews. You got to kind of

follow things that are going on. What is

that organization stand for? How are

they operating? What are their values?

But not just what they write down. The

culture and the values are not what you

read on the financial statements and in

their in their press releases. We wrote

about Valiant. We said sell Valiant.

Okay? We're the only cell on on Valiant

in 2012 2013. The company didn't blow up

until 2015. Okay? But they and they

would talk about their integrity and

their, you know, how they were changing

the world with the with the drug

reformulations they were doing and so

forth. But if you look deeper, they were

just manipulating the accounting and

changing the pricing on on drugs and

creating a fraudulent network of

onlineies.

>> Valiant's a good one because there's a

lot of uh well-known investors in that.

>> Yeah. How did so many well-known

wellrespected investors go wrong? People

who are known for their due diligence,

people who are known for their leg work.

I know I sat with them talked to them

before the c before it's a situation

where someone is such a masterful

spinner of a story and is

>> are you talking to the CEO

>> the CEO and the management team sold you

had Mike Pearson.

>> Yeah.

>> And was executing and you know he comes

he came from a great pedigree. He was

not taking a salary and everything was

tied to the stock price. you know, he he

was, you know, for tires tirelessly

working in the company and he'd proven

because what ends up happening is price

creates narrative.

>> Mhm.

>> So all of a sudden you don't believe it

day one,

>> but then you see that they made an

acquisition. It didn't seem like it was

going to work, but then it works and the

stock price goes higher and then they do

something else and it kind of seems a

little bit strange. And then they

changed their accounting and and they

changed the way they rec they they

present their op their uh non-gash gap

metrics which is things we noticed like

that's another huge flammable item. The

company says you know they're reporting

their they use an adjusted IBIDA and

they calculate it in a certain way and

then the following year they calculate

it a different way. Well that's a non

audited number. It's a it's whatever

management wants and you know the

markets just believe it. And so that's

something that Valiant was notorious

about, but didn't matter because the

stock price just kept going higher. And

as the stock price keeps going higher,

it's very difficult. Okay, in in the

money management industry, when you're

underperforming, it is so difficult to

stay the course. M

>> you saw this you know in the financial

crisis that movie about you know the big

short like those individuals were became

clients of ours like I know Porter

Collins if he ever listens here and and

Danny and so forth like we we befriended

each other during during this time of

madness and afterwards it was like they

were crazy like you end up looking at

yourself going I'm crazy I'm seeing this

and nobody cares it becomes so difficult

When you're on the other side now,

you're trying to make money and raise

money from clients because investors now

are saying, "Well, wait a minute. You're

up five or you're down five, market's up

20. You don't know what you're doing.

What are you doing?" And, you know, it's

hard because that's how you earn your

living. That I think becomes the becomes

the problem. And with Valiant, it just

went on for so long.

And you need to look at the market

conditions at the time because the

people are running a business but the

business is operating in a certain

economic environment. Well, you had

brand new bond market activity. QE. No

one ever heard of QE before the early

2000 or 2010s. The bank, the the central

banks were buying longdated bonds to

keep interest rates low. Well, now all

of a sudden, what does that do to a

company like Valiant that's making

that's growing through acquisition and

needs capital? Well, they could borrow

money at very low rates. And if that's

the case, then their IRR, cost of

capital, etc. The hurdle rate is very

low. So, they look really great. all

these transactions that may not have

made made any sense in other time

periods when risk-f free rates were not

you know in the 1 or 2% range all of a

sudden they make sense if I had to go

back in time we should have said buy

valiant

at the beginning because we had studied

biovail so bio valiant bought val

biovail biovail was a Canadian company

>> that was run by Eugene Melnik

And we wrote a cell report on on that

company in in the early 2000s. And and

the company ended up being a figment of

its former self. And but it had

something it had some formulations for

of drugs which were elongated in their

uh release. So they they would buy a

drug and then repurpose the the the

formulation. So there'll be slow release

etc. And then they and they also had

phenomenal tax structure where they were

set up in Barbados and Barbados is like

heaven. So the more money you make as

income, you pay a lower percentage tax.

Imagine that. So what Valiant did was

they bought that structure when they

bought Biovail.

>> And so that allowed them to extract all

the cost of tax. So many interesting

things they did. They set up their head

office in Quebec province in Canada,

French speakaking. Well, the case, which

is the largest, one of the largest

pension plans in Canada, right? Their

mandate is not just to make money for

its pensioners, okay? And there, this is

the civil pension fund, one of and I

think second largest in Canada behind

CPP. And one of their mandates is to

invest in Quebec-based companies and

foster growth. It's a phenomen. I used

to think it was a problem, but actually

I've changed my way. I think CPP should

do the same. CPP should be encouraged to

invest in Canada. The US pension plan

should buy US companies. Encouraged to

do that. Anyway, so in this case, you

set up in Quebec, you know, you've got a

set flow of capital that's going to come

from this Quebecbased pension plan. And

I remember meeting with the with the

leaders at the case at the time talking

about this and they're like, "We don't

want to own it. We're we we agree with

you, Anthony. We're worried about all

this stuff." But these are the

subtleties that you need like every

again when you see it's a flammable. You

didn't even know that was a flammable

item unless you know from the first

page, oh, they're set up in Quebec. And

you go, why did that happen? which is

part of the mental model of being

curious to say nothing happens without a

reason. If you notice something and you

go, "Well, that seems really weird. No

one else does that." And most people

just say, "Well, it's okay. It doesn't

matter." Well, actually, that's what

matters.

>> Is complicated just in general like a

red flag for you? I remember Buffett and

Munger got entailed with something with

the SEC in the early '7s. I think it was

their structure was just it was uh

legal. It was rational. It was not

transparent if I recall correctly. It

was incredibly complicated

and they ended up simplifying it, but

they weren't doing anything wrong.

>> So again, I've, you know, sat with

management teams and you go through

their 10K and then you see a list of all

their operating subsidiaries and you see

the different places that they're

operating. Again thing about investing

today is there's so much pressure on the

analysts to cover more stocks.

>> The money management fees today are a

fraction of what they were even a decade

ago.

>> Right?

>> So the companies that are doing the

investing, the fixed cost of doing

investing, like paying the audit, doing

the back office, all that stuff, yes,

it's come down a bit, but it's still

there.

>> Yeah. All that's been squeezed is the co

the the cost of the money management. So

they're having to look for shortcuts and

that means just give me the number,

Anthony. Just give me that one number. I

just want that one number and then you

get the one number that management gives

them and then they just accept that and

move on.

>> I was talking and I'm not going to

mention who I was talking to a

well-known CFO once about earnings

management.

>> Yes. and they said, you know, we would

call analysts after the earnings call

and we would, you know, legally, but we

would definitely lead them uh to what

numbers to expect for the next quarter

even if we weren't and we would

sometimes manipulate that if we wanted

to. And I always thought that that was a

bit nefarious, but I mean this is how

people work and how the world works. So

just being, you know, to I think you

asked the question, is being complicated

a a problem? Well, it's just why is it

happening? And you go back to nothing

happens without a reason. Then you point

to some company operating in the British

Virgin Islands that's listed on the list

and go, what does this company do?

>> Yeah.

>> And management starts sweating and say,

why are you asking that? I don't know.

You have your answer before you ask a

question. Do you get to a point where

things are like too complicated? People

don't even know what's going on. Like it

it always starts with like this one

thing makes sense and but over you know

30 40 years you end up with this

structure that nobody even internally

probably understands.

>> You know they they interviewed um fast

Andrew Fastau who is the CFO of of Enron

and he's done many an interview on this.

Also I I because when we do our training

we have a few of these interviews that

we that we quote and it's companies

don't start out as being crooked. They

have to convince someone to buy a

product okay or a service. So money

comes in to the company in some fashion

or time and then gets converted into

something that adds value.

The problem becomes outside stakeholders

come in and say, "Well, I need you to

make X because you want my money. Well,

I'll give you my money so long as you

give me this return." Well, that works

until there's a problem. And now there's

no CEO that wants to disappoint.

So, it's very simple. The CFO comes to

talk to me. I'm the CEO. And he says,

"Look, I know uh Anthony, we were going

to make a dollar, but we're coming in at

95." And I say to him, "You get back to

your room and find me 5 cents."

>> Yeah.

>> You like your job. You like your kids

going to private school. You like your

stock options, how much they're worth.

You see all these employees we have,

they we give them stock as a part of

their compensation every quarter. Like

that's a problem. We can't disappoint.

And then it starts

>> and it starts slowly.

>> It always starts slowly. And look, there

>> that was what Andy said in in the I

think correct those interviews. It's

like, you know, it started with a little

bit and I figured next quarter I could

bring it back

>> and it's just, you know, that's the

thing. Life is a dangerous thing this

way. Whether we push something even in

life, right? You know, well, look, if I

smoke a bit or drink a bit or tell this

little lie, you know, no one notices and

I'm I'm okay. Well, then maybe I do a

little bit more of each one of those

things and no one notices and then it's

all good, right? But then switching

gears a little bit, do companies that

report free cash flow on their press

releases or in their financial

statements tend to outperform?

>> I don't have that data.

>> What would be your guess? It's not a

common metric to report.

>> My guess is I would say not necessarily

no. I would say no.

>> What do you think of ibida? IDA is the

mother of all disastrous

measures.

>> Why?

>> Because of what investors want to

believe that it is and that it's

something that is cash flow that it's

something that can be compared to de

total debt and it is not. It is purely a

operating performance metric

calculated before interest, tax,

depreciation and amortization. That's

it. Now what runs into a problem is well

what do I do with stock options? What do

I do with joint venture gains? What do I

do with gains on investments that I made

that I happen to sell this year? What do

I do with the charges that I took on

that acquisition that I bought this year

that I included in my ibita the profits

but at the cost that associated with

that operate that transaction should I

include that in ITA

>> aren't those onetime costs

>> if making acquisitions is part of my

business model

>> I no longer one-time costs this gets us

back to we have a course called the

secrets of free cash flow and that's

been our most watched uh and taught

course and that's because it started we

said it earlier we said free cash flow

is operating cash flow less capex but

it's not it depends every every answer

that someone asks you what is what

should it be well it depends

>> depends on the company

>> you got it how should I calculate it

well it depends what decision do you

need to make you always start with the

facts before you think about a

transaction and how you're going to

account for it it's all about the facts

the constraints and the objectives,

right? The facts determine what did I

sell, what did I buy, from who, at what

cost, under what terms, etc. So, those

are the facts broadly. Then I have the

constraints. Well, I'm a private

company. Who uses the statements? Well,

just me and my partners. Who cares where

I put it? It's less less important. But

if there's an outside onlooker on this,

well, now it matters because they're

looking at it. I now have outside

investors. I have debt. I have a debt

covenant. All of those things. I'm

public now. I have the SEC. Those are

all constraints. I operate in the US. I

got FASBY, PCAOB. I operate in Canada. I

have IFRS. I have CPAB. And the last is

the objectives. I want to sell my

business this year. And my business

sells on IBATA. Buddy, I'll tell you how

I'm going to account for it. My business

investors want free cash flow. I'll tell

you how we're going to account for it.

It's those three points.

When I teach accounting, I teach those

three things.

>> That's fascinating. I want to talk stock

options for a little bit. You brought

that up. I want to come back to this.

Like, how should investors think about

stock options today? And then how would

you change accounting rules to better

account for stock options? Two separate

questions, but

>> Shane, you're good.

>> I hate them personally in public

companies. However, I I understand why

companies want to use them. I mean, my

take is there, you know, if you look at

most buybacks, they're just covering up

stock options.

>> Correct. Very good.

>> So, that's an expansion.

>> I think that uh stock options what they

do every it comes down to human

motivation. So if I am going to

compensate you on the stock price, then

you're going to make decisions that move

the stock price. In my early classes

when I teach um I I always say that

economy and economics reality is way

over here as far as I can see with my

hand and the accounting is way over

there as far as I can go with my hand.

Because if for example,

you know, I'm going to take a very