Category: Regulation

Trading With Artificial Intelligence – Benefits and Pitfalls

Posted on by phoffman@channelchek.com

ChatGPT-Powered Wall Street: The Benefits and Perils of Using Artificial Intelligence to Trade Stocks and Other Financial Instruments

Artificial Intelligence-powered tools, such as ChatGPT, have the potential to revolutionize the efficiency, effectiveness and speed of the work humans do.

And this is true in financial markets as much as in sectors like health care, manufacturing and pretty much every other aspect of our lives.

I’ve been researching financial markets and algorithmic trading for 14 years. While AI offers lots of benefits, the growing use of these technologies in financial markets also points to potential perils. A look at Wall Street’s past efforts to speed up trading by embracing computers and AI offers important lessons on the implications of using them for decision-making.

This article was republished with permission from The Conversation, a news site dedicated to sharing ideas from academic experts. It represents the research-based findings and thoughts of, Pawan Jain, Assistant Professor of Finance, West Virginia University.

Program Trading Fuels Black Monday

In the early 1980s, fueled by advancements in technology and financial innovations such as derivatives, institutional investors began using computer programs to execute trades based on predefined rules and algorithms. This helped them complete large trades quickly and efficiently.

Back then, these algorithms were relatively simple and were primarily used for so-called index arbitrage, which involves trying to profit from discrepancies between the price of a stock index – like the S&P 500 – and that of the stocks it’s composed of.

As technology advanced and more data became available, this kind of program trading became increasingly sophisticated, with algorithms able to analyze complex market data and execute trades based on a wide range of factors. These program traders continued to grow in number on the largely unregulated trading freeways – on which over a trillion dollars worth of assets change hands every day – causing market volatility to increase dramatically.

Eventually this resulted in the massive stock market crash in 1987 known as Black Monday. The Dow Jones Industrial Average suffered what was at the time the biggest percentage drop in its history, and the pain spread throughout the globe.

In response, regulatory authorities implemented a number of measures to restrict the use of program trading, including circuit breakers that halt trading when there are significant market swings and other limits. But despite these measures, program trading continued to grow in popularity in the years following the crash.

HFT: Program Trading on Steroids

Fast forward 15 years, to 2002, when the New York Stock Exchange introduced a fully automated trading system. As a result, program traders gave way to more sophisticated automations with much more advanced technology: High-frequency trading.

HFT uses computer programs to analyze market data and execute trades at extremely high speeds. Unlike program traders that bought and sold baskets of securities over time to take advantage of an arbitrage opportunity – a difference in price of similar securities that can be exploited for profit – high-frequency traders use powerful computers and high-speed networks to analyze market data and execute trades at lightning-fast speeds. High-frequency traders can conduct trades in approximately one 64-millionth of a second, compared with the several seconds it took traders in the 1980s.

These trades are typically very short term in nature and may involve buying and selling the same security multiple times in a matter of nanoseconds. AI algorithms analyze large amounts of data in real time and identify patterns and trends that are not immediately apparent to human traders. This helps traders make better decisions and execute trades at a faster pace than would be possible manually.

Another important application of AI in HFT is natural language processing, which involves analyzing and interpreting human language data such as news articles and social media posts. By analyzing this data, traders can gain valuable insights into market sentiment and adjust their trading strategies accordingly.

Benefits of AI Trading

These AI-based, high-frequency traders operate very differently than people do.

The human brain is slow, inaccurate and forgetful. It is incapable of quick, high-precision, floating-point arithmetic needed for analyzing huge volumes of data for identifying trade signals. Computers are millions of times faster, with essentially infallible memory, perfect attention and limitless capability for analyzing large volumes of data in split milliseconds.

And, so, just like most technologies, HFT provides several benefits to stock markets.

These traders typically buy and sell assets at prices very close to the market price, which means they don’t charge investors high fees. This helps ensure that there are always buyers and sellers in the market, which in turn helps to stabilize prices and reduce the potential for sudden price swings.

High-frequency trading can also help to reduce the impact of market inefficiencies by quickly identifying and exploiting mispricing in the market. For example, HFT algorithms can detect when a particular stock is undervalued or overvalued and execute trades to take advantage of these discrepancies. By doing so, this kind of trading can help to correct market inefficiencies and ensure that assets are priced more accurately.

Stock exchanges used to be packed with traders buying and selling securities, as in this scene from 1983. Today’s trading floors are increasingly empty as AI-powered computers handle more and more of the work.

The Downsides

But speed and efficiency can also cause harm.

HFT algorithms can react so quickly to news events and other market signals that they can cause sudden spikes or drops in asset prices.

Additionally, HFT financial firms are able to use their speed and technology to gain an unfair advantage over other traders, further distorting market signals. The volatility created by these extremely sophisticated AI-powered trading beasts led to the so-called flash crash in May 2010, when stocks plunged and then recovered in a matter of minutes – erasing and then restoring about $1 trillion in market value.

Since then, volatile markets have become the new normal. In 2016 research, two co-authors and I found that volatility – a measure of how rapidly and unpredictably prices move up and down – increased significantly after the introduction of HFT.

The speed and efficiency with which high-frequency traders analyze the data mean that even a small change in market conditions can trigger a large number of trades, leading to sudden price swings and increased volatility.

In addition, research I published with several other colleagues in 2021 shows that most high-frequency traders use similar algorithms, which increases the risk of market failure. That’s because as the number of these traders increases in the marketplace, the similarity in these algorithms can lead to similar trading decisions.

This means that all of the high-frequency traders might trade on the same side of the market if their algorithms release similar trading signals. That is, they all might try to sell in case of negative news or buy in case of positive news. If there is no one to take the other side of the trade, markets can fail.

Enter ChatGPT

That brings us to a new world of ChatGPT-powered trading algorithms and similar programs. They could take the problem of too many traders on the same side of a deal and make it even worse.

In general, humans, left to their own devices, will tend to make a diverse range of decisions. But if everyone’s deriving their decisions from a similar artificial intelligence, this can limit the diversity of opinion.

Consider an extreme, nonfinancial situation in which everyone depends on ChatGPT to decide on the best computer to buy. Consumers are already very prone to herding behavior, in which they tend to buy the same products and models. For example, reviews on Yelp, Amazon and so on motivate consumers to pick among a few top choices.

Since decisions made by the generative AI-powered chatbot are based on past training data, there would be a similarity in the decisions suggested by the chatbot. It is highly likely that ChatGPT would suggest the same brand and model to everyone. This might take herding to a whole new level and could lead to shortages in certain products and service as well as severe price spikes.

This becomes more problematic when the AI making the decisions is informed by biased and incorrect information. AI algorithms can reinforce existing biases when systems are trained on biased, old or limited data sets. And ChatGPT and similar tools have been criticized for making factual errors.

In addition, since market crashes are relatively rare, there isn’t much data on them. Since generative AIs depend on data training to learn, their lack of knowledge about them could make them more likely to happen.

For now, at least, it seems most banks won’t be allowing their employees to take advantage of ChatGPT and similar tools. Citigroup, Bank of America, Goldman Sachs and several other lenders have already banned their use on trading-room floors, citing privacy concerns.

But I strongly believe banks will eventually embrace generative AI, once they resolve concerns they have with it. The potential gains are too significant to pass up – and there’s a risk of being left behind by rivals.

But the risks to financial markets, the global economy and everyone are also great, so I hope they tread carefully.

Is Your Bank Prepared for a US Debt Default?

Posted on by phoffman@channelchek.com

War Rooms and Bailouts: How Banks and the Fed are Preparing for a US Default – and the Chaos Expected to Follow

When you are the CEO responsible for a bank and all the related depositors and investors, you don’t take an “it’ll never happen” approach to the possibility of a U.S. debt default. The odds are it won’t happen, but if it does, being unprepared would be devastating. Banks of all sizes are getting their doomsday plans in place, and other industries are as well, but big banks, on many fronts would be most directly impacted. The following is an informative article on how banks are preparing. It’s authored by John W. Diamond the Director of the Center for Public Finance at the Baker Institute, Rice University, and republished with permission from The Conversation.  – Paul Hoffman, Managing Editor, Channelchek

Convening war rooms, planning speedy bailouts and raising house-on-fire alarm bells: Those are a few of the ways the biggest banks and financial regulators are preparing for a potential default on U.S. debt.

“You hope it doesn’t happen, but hope is not a strategy – so you prepare for it,” Brian Moynihan, CEO of Bank of America, the nation’s second-biggest lender, said in a television interview.

The doomsday planning is a reaction to a lack of progress in talks between President Joe Biden and House Republicans over raising the US$31.4 trillion debt ceiling – another round of negotiations took place on May 16, 2023. Without an increase in the debt limit, the U.S. can’t borrow more money to cover its bills – all of which have already been agreed to by Congress – and in practical terms that means a default.

What happens if a default occurs is an open question, but economists – including me – generally expect financial chaos as access to credit dries up and borrowing costs rise quickly for companies and consumers. A severe and prolonged global economic recession would be all but guaranteed, and the reputation of the U.S. and the dollar as beacons of stability and safety would be further tarnished.

But how do you prepare for an event that many expect would trigger the worst global recession since the 1930s?

Preparing for Panic

Jamie Dimon, who runs JPMorgan Chase, the biggest U.S. bank, told Bloomberg he’s been convening a weekly war room to discuss a potential default and how the bank should respond. The meetings are likely to become more frequent as June 1 – the date on which the U.S. might run out of cash – nears.

Dimon described the wide range of economic and financial effects that the group must consider such as the impact on “contracts, collateral, clearing houses, clients” – basically every corner of the financial system – at home and abroad.

“I don’t think it’s going to happen — because it gets catastrophic, and the closer you get to it, you will have panic,” he said.

That’s when rational decision-making gives way to fear and irrationality. Markets overtaken by these emotions are chaotic and leave lasting economic scars.

Banks haven’t revealed many of the details of how they are responding, but we can glean some clues from how they’ve reacted to past crises, such as the financial crisis in 2008 or the debt ceiling showdowns of 2011 and 2013.

One important way banks can prepare is by reducing exposure to Treasury securities – some or all of which could be considered to be in default once the U.S. exhausts its ability to pay all of its bill. All U.S. debts are referred to as Treasury bills or bonds.

The value of Treasurys is likely to plunge in the case of a default, which could weaken bank balance sheets even more. The recent bank crisis, in fact, was prompted primarily by a drop in the market value of Treasurys due to the sharp rise in interest rates over the past year. And a default would only make that problem worse, with close to 190 banks at risk of failure as of March 2023.

Another strategy banks can use to hedge their exposure to a sell-off in Treasurys is to buy credit default swaps, financial instruments that allow an investor to offset credit risk. Data suggests this is already happening, as the cost to protect U.S. government debt from default is higher than that of Brazil, Greece and Mexico, all of which have defaulted multiple times and have much lower credit ratings.

But buying credit default swaps at ever-higher prices limits a third key preventive measure for banks: keeping their cash balances as high as possible so they’re able and ready to deal with whatever happens in a default.

Keeping the Financial Plumbing Working

Financial industry groups and financial regulators have also gamed out a potential default with an eye toward keeping the financial system running as best they can.

The Securities Industry and Financial Markets Association, for example, has been updating its playbook to dictate how players in the Treasurys market will communicate in case of a default.

And the Federal Reserve, which is broadly responsible for ensuring financial stability, has been pondering a U.S. default for over a decade. One such instance came in 2013, when Republicans demanded the elimination of the Affordable Care Act in exchange for raising the debt ceiling. Ultimately, Republicans capitulated and raised the limit one day before the U.S. was expected to run out of cash.

One of the biggest concerns Fed officials had at the time, according to a meeting transcript recently made public, is that the U.S. Treasury would no longer be able to access financial markets to “roll over” maturing debt. While hitting the current ceiling prevents the U.S. from issuing new debt that exceeds $31.4 trillion, the government still has to roll existing debt into new debt as it comes due. On May 15, 2023, for example, the government issued just under $100 billion in notes and bonds to replace maturing debt and raise cash.

The risk is that there would be too few buyers at one of the government’s daily debt auctions – at which investors from around the world bid to buy Treasury bills and bonds. If that happens, the government would have to use its cash on hand to pay back investors who hold maturing debt.

That would further reduce the amount of cash available for Social Security payments, federal employees wages and countless other items the government spent over $6 trillion on in 2022. This would be nothing short of apocalyptic if the Fed could not save the day.

To mitigate that risk, the Fed said it could immediately step in as a buyer of last resort for Treasurys, quickly lower its lending rates and provide whatever funding is needed in an attempt to prevent financial contagion and collapse. The Fed is likely having the same conversations and preparing similar actions today.

A Self-Imposed Catastrophe

Ultimately, I hope that Congress does what it has done in every previous debt ceiling scare: raise the limit.

These contentious debates over lifting it have become too commonplace, even as lawmakers on both sides of the aisle express concerns about the growing federal debt and the need to rein in government spending. Even when these debates result in some bipartisan effort to rein in spending, as they did in 2011, history shows they fail, as energy analyst Autumn Engebretson and I recently explained in a review of that episode.

That’s why one of the most important ways banks are preparing for such an outcome is by speaking out about the serious damage not raising the ceiling is likely to inflict on not only their companies but everyone else, too. This increases the pressure on political leaders to reach a deal.

Going back to my original question, how do you prepare for such a self-imposed catastrophe? The answer is, no one should have to.

The Limits to the Artificial Intelligence Revolution

Posted on by phoffman@channelchek.com

What Will AI Never Be Good At?

Artificial intelligence (AI) is a true disruptive technology. As any informed content writer can tell you, the technology creates efficiencies by speeding up data gathering, research, and even graphics that specifically reflect the content. As an example, it is arguably quicker to use ChatGPT to provide a list of ticker symbols from company names, than it is to look them up one by one. With these small time savers, over the course of a week, far more can be produced as a result of AI tools saving a few minutes here and there.

This presents the question, what are the limits of AI – what can’t it do?

Worker Displacement

Technological revolutions have always benefitted humankind in the long run; in the short run, they have been disruptive, often displacing people who then have to retrain.

A new Goldman Sachs report says “significant disruption” could be on the horizon for the labor market. Goldman’s analysis of jobs in the U.S. and Europe shows that two-thirds of jobs could be automated at least to some degree. In the U.S., “of those occupations which are exposed, most have a significant — but partial — share of their workload (25-50%) that can be replaced,” Goldman Sachs’ analysts said in the paper.

Around the world, as many as 300 million jobs could be affected, the report says. Changes to labor markets are therefore likely – although historically, technological progress doesn’t just make jobs redundant, it also creates new ones. And the added productivity allows the masses to live wealthier lives. This clearly was the end result of the  industrial revolution, and years after the computer revolution, we are at a high rate of employment and have at our fingertips much which we never even dreamed.

The Goldman report says the use of AI technology could boost labor productivity growth and boost global GDP by as much as 7% over time.

There are few reasons to expect that the AI revolution won’t also provide more goods and services per person for a richer existence. But, what about the disruption in the interim? I was curious to know what artificial intelligence is not expected to be able to do. There isn’t much information out there, so I went to an AI source and fed it a bunch of pointed questions about its nature. Part of that nature is to not intentionally lie, I found the responses worth sharing as we will all soon be impacted by what the technology can and cannot do.

Limitations of AI that Will Persist

Artificial intelligence has come a long way in recent years and the speed of progression and adoption is accelerating. As a result, applications have become increasingly sophisticated. But, there are still many things that AI cannot do now and may never be able to do.

One thing that AI cannot do now and may never be able to do is to truly understand human emotions and intentions. While AI algorithms can detect patterns in data and recognize certain emotional expressions, they do not have the ability to experience emotions themselves. This means that AI cannot truly understand the nuances of human communication, which can lead to misinterpretation and miscommunication.

Another limitation of AI is that it cannot replicate the creativity and intuition of humans. While AI can generate new ideas based on existing data, it lacks the ability to come up with truly original and innovative ideas. This is because creativity and intuition are often based on a combination of experience, emotion, and imagination, which are difficult to replicate in a machine.

AI also struggles with tasks that require common sense reasoning or context awareness. For example, AI may be able to identify a picture of a cat, but it may struggle to understand that a cat is an animal that can be petted or that it can climb trees. This is because AI lacks the contextual understanding that humans have built up through years of experience and interaction with the world around us.

In the realm of stocks and economics, AI has shown promise in analyzing data and making predictions, but there are still limitations to its abilities. For example, AI can analyze large datasets and identify patterns in market trends, but it cannot account for unexpected events or human behavior that may affect the market. This means that while AI can provide valuable insights, it cannot guarantee accurate predictions or prevent market volatility.

Another limitation of AI in economics is its inability to understand the complexities of social and political systems. Economic decisions are often influenced by social and political factors, such as government policies and public opinion. While AI can analyze economic data and identify correlations, it lacks the ability to understand the underlying social and political context that drives economic decisions.

A concern some have about artificial intelligence is that it may perpetuate biases that exist in the data it analyzes. This is the “garbage in, garbage out” data problem on steroids. For example, if historical data on stock prices is biased towards a certain demographic or industry, AI algorithms may replicate these biases in their predictions. This can lead to an amplified bias that proves faulty and not useful for economic decision making.

Take Away

AI has shown remarkable progress in recent years, but, as with everything that came before, there are still things that it cannot do now and may never be able to do. AI lacks the emotional intelligence, creativity, and intuition of humans, as well as common sense reasoning and social and political systems. In economics and stock market analysis, AI can provide valuable insights, but it cannot assure accurate predictions or prevent market volatility. So while companies are investing in ways to make our lives more productive with artificial intelligence and machine learning, it remains important to invest in our own human intelligence, growth and expertise.

Paul Hoffman

Managing Editor, Channelchek

Sources

OpenAI. (2021). ChatGPT [Computer software]. Retrieved from https://openai.com

https://www.cnbc.com/2023/05/16/how-generative-ai-chatgpt-will-change-jobs-at-all-work-levels.html

How to Determine When a Biotech Stock Could Expect Market-Moving News

Posted on by phoffman@channelchek.com

Does the FDA Provide Information that Helps Pharmaceutical Stock Investors?

Investors with a “Stocks on the Move” or “Market Movers” window open sometimes witness a stock climb double or triple digits during a single trading day. It often turns out that it’s a drug company that just passed an FDA milestone. When this happens, these companies have the potential for large movements. The natural question investors ask is, how does one become more aware that there may be an extreme movement in a biotech, or pharmaceutical stock? For wisdom on this subject, I turned to Robert LeBoyer, the Senior Life Sciences Analyst at Noble Capital Markets. Below, cutting through many complex details and variables, is what I discovered from the veteran equity analyst.

The key is to first understand the framework of the FDA approval process. This will help an investor understand the significance of activity and even where to find key dates and imminent decision periods. Especially toward the end of the process, it is especially then when there are events that could rocket the company stock or cause it to retreat. These are PDUFA calendar deadlines and advisory panel meeting dates. Below is an outline of the process and key dates that may allow investors to position themselves to take advantage of any big jump (or even sudden decline) in a biotech’s stock price.

Understanding The FDA Approval Process

The FDA is responsible for regulating the safety and efficacy of drugs and medical devices in the United States. The review process for new drug applications falls under the legally required format called the Prescription Drug User Fee Act (PDUFA).

PDUFA requires the FDA to collect fees from drug developers to fund the review process, in exchange, the FDA has an obligation to answer the application within ten months. The PDUFA legislation has improved the process for companies seeking FDA approval helping to speed the review process. The fees collected are used to hire additional staff and overall improve the FDA’s review process. This avenue has many benefits. It accelerates the process for the companies that are seeking approval as the FDA can afford greater resources, it benefits the taxpayers as the FDA is then subsidized by those that use its service to review potential products, and it helps those with medical conditions that may benefit from a new drug or class of therapy coming to market sooner as a result of the FDA having greater resources.

The first step is pre-clinical testing in animals for indications of effectiveness and toxicity in a laboratory. If satisfactory, it clears the way for the company to submit an investigational new drug application (IND) to the FDA. The overriding goal of pre-clinical testing is to demonstrate that the product safe to then be tested in humans. The IND application outlines what the sponsor of the new drug proposes for human testing in clinical trials. Once reviewed and granted the company can move to clinical trials.

Clinical Trials

Clinical Trials are done in three phases designed to determine the drug candidate’s safety, characterization, and proof of efficacy.

Phase 1 studies (typically involves 20 to 80 people).

This phase involves testing the drug candidate on a small group of healthy volunteers to assess the drug’s safety and determine the appropriate dosage range. The primary goal is to verify safety and to identify any potential side effects.

Phase 2 studies (typically involve a few dozen to about 300 people).

This phase involves testing the drug on a larger trial group of patients that have the condition the drug is intended to treat. In this phase, the developer determines the drug’s efficacy, optimal dosage, and potential side effects. The primary goal is to assess and characterize the drug’s effectiveness in treating the targeted condition. Stocks will sometimes move on Phase 2 effiacy results.

Phase 3 studies (typically involve several hundred to about 3,000 people).

This final clinical study phase involves testing the drug on an even larger and intentionally diversified group of patients with the very condition the drug is intended to treat. These clinical trials are randomized and controlled to confirm the drug’s safety and efficacy in comparasin to existing treatments, a placebo, or both. The primary goal is to demonstrate statistically significant benefit, as defined by the trial parameters.

The announcement of Phase 3 results is a huge milestone, and by itself ordinarily impacts a stock’s price.

According to the Congressional Budget Office (CBO) only about 12 percent of drugs entering clinical trials are ultimately approved for introduction by the FDA. But it is costly; estimates of the average R&D cost per new drug range from less than $1 billion to more than $2 billion per drug. So in addition to being expensive, it’s an uncertain process – many potential drugs never make it to market. This is why full FDA approval, which isn’t automatic after a successful Phase 3 clinical trial, can create an huge upswing, even when expected.

Several things can go wrong during the three phases; these include unexpected side effects or toxicity, lack of efficacy, or failure to meet the primary endpoints of the clinical trial. The developer may even find that it is less effective than current medications. These issues can lead to delays in the approval process, additional studies, or even the termination of the drug’s development.

However, if the clinical trials are successful, the company is ready to file a New Drug Application with the FDA.

FDA Panels are experts with knowledge specific to what is being reviewed (Source: FDA)

New Drug Application (NDA)

There is a pre-NDA period, just before a new drug application is submitted to the FDA. At this time the company may seek guidance from the FDA on the new drug process.

The Submission of an NDA is the formal step that asks the FDA to consider the drug for approval to market. The FDA then has 60 days to decide whether the application gets filed for review. If the FDA files to review the NDA, an FDA review team is assigned to evaluate the sponsor’s research on the drug’s safety and effectiveness.

The FDA review includes a product label approval which includes how the drug can be used. This is very important because the drug can only be marketed within the label indications. The FDA also will inspect the facilities where the drug will be manufactured as part of the approval process.

FDA reviewers will either approve the application or instead issue a complete response letter.

PDUFA Calendar

The FDA PDUFA calendar is a schedule of dates for upcoming PDUFA decisions. These dates are important to investors in biotech and pharmaceutical companies because they represent the time period when the FDA will make a decision about a new drug application. If a drug is approved, it can eventually generate significant revenue for the company, while rejection can lead to a decline in the stock price as investors are disappointed.

Updates direct from the FDA on their calendar and meeting schedule can be subscribed to here.

Advisory Panel

In addition to PDUFA dates, there are other FDA events that can trigger movement in biotech and pharmaceutical stocks. These events include advisory committee meetings, which are meetings where a panel of experts provides recommendations to the FDA on whether to approve a drug or not. These meetings can provide insight into the FDA’s thinking and can influence the stock price.

A schedule of FDA Advisory Panel meetings can be found here.

Advisory committees make non-binding recommendations to the FDA, which generally follows the recommendations but is not legally bound to do so.

Other events that can impact the stock price include Complete Response Letters (CRLs), which are letters from the FDA that outline deficiencies in a drug application and can delay approval. Additionally, FDA inspections of manufacturing facilities can impact the stock price if there are concerns about quality control or manufacturing processes.

Take Away

Investors looking to grow their watch list to include biotech stocks that are in line to receive positive news that could drive the stock value way up or even disappointing news that would weigh on the price, could pay attention to the FDA approval process.

The process is an important tool for biotech and pharmaceutical companies, investors, and analysts. PDUFA dates represent the time when the FDA will make a decision about a new drug application, and can have a significant impact on the stock price. However, there are other FDA events that can also impact the stock price, such as advisory committee meetings, CRLs, and manufacturing facility inspections. It is helpful to stay informed about these events to make knowledgeable investment decisions in the biotech and pharmaceutical industry.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.fda.gov/advisory-committees/advisory-committee-calendar/april-28-2023-meeting-oncologic-drugs-advisory-committee-meeting-announcement-04282023

https://www.fda.gov/drugs/information-consumers-and-patients-drugs/fdas-drug-review-process-continued#:~:text=Phase%201%20studies%20(typically%20involve,application%20(NDA)%20is%20submitted.

https://www.fda.gov/about-fda/fda-track-agency-wide-program-performance/fda-track-pdufa-meeting-management#subscribe

Taming AI Sooner Rather than Later

Posted on by phoffman@channelchek.com
Image: AI rendering of futuristic robot photobombing the VP and new AI Czar

Planning Ahead to Avoid an AI Pandora’s Box

Vice President Kamala Harris wasted no time as the newly appointed White House Artificial Intelligence (AI) Czar. She has already met with heads of companies involved in AI and explained that although Artificial intelligence technology has the potential to benefit humanity, the opportunities it allows also come with extreme risk. She is now tasked with spearheading the effort to preemptively prevent a Pandora’s box situation where, once allowed, the bad that results may overshadow the good.

The plan that the administration is devising, overseen by the Vice President, calls for putting in place protections as the technology grows.

On May 4, Harris met with corporate heads of companies leading in AI technology. They included OpenAI, Google and Microsoft. In a tweet from the President’s desk, he is shown thanking the corporate heads in advance for their cooperation. “What you’re doing has enormous potential and enormous danger,” Biden told the CEOs

Image: Twitter (@POTUS)

Amid recent warnings from AI experts that say tyrannical dictators could exploit the developing technology to push disinformation, the White House has allocated $140 million in funding for seven newly created AI research groups. President Biden has said the technology was “one of the most powerful” of our time, then added, “But in order to seize the opportunities it presents, we must first mitigate its risks.”

The full plan unveiled this week is to launch 25 research institutes across the US that will seek assurance from companies, including ChatGPT’s creator OpenAI, that they will ‘participate in a public evaluation.’

The reason for the concern and the actions taken is that many of the world’s best minds have been warning about the dangers of AI, specifically that it could be used against humanity. Serial tech entrepreneur Elon Musk fears AI technology will soon surpass human intelligence and have independent thinking. Put another way; the machines would no longer need to abide by human commands. At the worst currently imagined, they may develop the ability to steal nuclear codes, create pandemics and spark world wars.

Image: White House Press Release

After Harris met with tech executives Thursday to discuss reducing potential risks, she said in a statement, “As I shared today with CEOs of companies at the forefront of American AI innovation, the private sector has an ethical, moral, and legal responsibility to ensure the safety and security of their products.”

The sudden elevation of artificial intelligence as needing to be managed came as awareness grew as to just how remarkable and powerful the technology has the potential to become. This broad awareness came as OpenAI released a version of ChatGPT which already had the ability to mimic humanlike thinking and interaction.

Other considerations, and probably many not yet conceived, is that AI can generate humanlike writing and fake images; there are ethical and societal concerns. As an example, the fabricated image at the top of this article was created within three minutes by a new user of an AI program.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.whitehouse.gov/briefing-room/statements-releases/2023/05/04/statement-from-vice-president-harris-after-meeting-with-ceos-on-advancing-responsible-artificial-intelligence-innovation/

Fairness Opinions, Understanding a Transaction’s Full Value

Posted on by phoffman@channelchek.com
Image Credit: Jernej Furman (Flickr)

Why Companies Get a Fairness Opinion Before Entering a Financial Transaction

How important is a fairness opinion (FO) when a company is evaluating a merger, acquisition, spin-off, buyback, carve-out, or other corporate change of ownership? Part of the due diligence of a large financial transaction is to engage for a fee, an experienced expert to create a fairness opinion that, among other things, advises on the valuation of the proposed transaction. And possibly recommends adjusting some terms to align the transaction with what the expert sees as fair. 

Understanding Fairness Opinions

When companies are considering impactful transactions, they may be required to get an objective opinion on whether the terms of the deal are fair. If it isn’t required, it is still a good idea to help reduce risks inherent in large transactions.

A fairness opinion is a professional assessment of the fairness of a proposed transaction. An independent third-party advisor, such as an investment bank, usually provides it. The goal of a fairness opinion is to provide an impartial evaluation of whether the transaction is fair to all parties involved based on various financial and strategic factors. The analysis involves evaluations of the impact of synergies, overall asset value, current market worth, dilutive effects, structure, and other attributes that a non-experienced executive may easily overlook.

Who Provides Fairness Opinions

Investment banks are the most common providers of fairness opinions. Choosing an institution that has extensive industry-specific experience and knowledge in valuing a transaction or strategic opportunity could save the client many times the cost of the service.

For example, Noble Capital Markets, an investment banking firm with 39 years of experience serving clients in a variety of industries, provides as one of its opinion services, FOs to companies considering a transaction. Francisco Penafiel, Managing Director and part of Noble’s investment banking & valuation practice, explained why getting an opinion from a reputable investment bank can avoid expensive problems.  Mr. Penafiel said, “FO’s should be provided by independent third parties, but it’s highly recommended for companies to have the assistance of advisors with a sound reputation, credibility, and significant industry experience.”

Why should the advisor have an intimate understanding of the industry? Penafiel explained, “it’s also important for the advisors to have knowledge of the regulatory compliance factors that affect the process as well as to be fully independent to avoid any conflict of interests.” He believes most often, investment banking firms, with platforms that include many years of experience, are best suited to run analysis that is deep and thorough, and are necessary when rendering these opinions

“Noble has helped clients over the years with their valuations needs, we’re now witnessing an increased demand for FOs because of the benefits they bring to the companies involved in a transaction. It also goes a long way to demonstrate that management and boards fulfilled their fiduciary duties, reducing risks of litigation,” said Penafiel.

The SEC has shown that they approve of and, in some cases, could require an FO. Recent regulations applying to de-SPAC transactions make fairness opinions the standard as de-SPAC transactions have an inherent conflict of interest between a SPAC’s sponsor and the stockholders. The third-party FO provider allows for impartiality and transparency to benefit all parties, especially investors.

Steps in Creating an FO

To provide a fairness opinion, an investment bank will typically conduct a thorough analysis of the deal’s financial and strategic aspects. This analysis may involve evaluating the company’s financial statements, projecting future earnings, analyzing the transaction structure, and reviewing comparable transactions in the industry. The investment bank will also consider the prevailing market conditions, economic climate and the impact on interest rates and the effects of any regulatory or legal issues on the transaction.

After completing its analysis, the investment bank will issue a formal report summarizing its findings and conclusions. The report will typically contain a detailed explanation of the fairness opinion, including the methodology used, the assumptions made, and the supporting evidence. It will also provide a valuation of the company, which may be used as a reference point for negotiating the deal’s terms.

It’s worth noting that a fairness opinion is not a guarantee that the proposed transaction is fair. Rather, it’s a professional opinion based on the information available at the time of the analysis. The ultimate decision about whether to proceed with the transaction lies with the parties involved, who must consider various factors beyond the scope of the fairness opinion.

Take Away

 Obtaining a fairness opinion is a critical step for companies considering major transactions. It provides an objective evaluation of the transaction’s fairness, which can help the parties involved make informed decisions. Investment banks are well-positioned to provide fairness opinions, given their extensive experience and expertise in financial analysis and valuation. By engaging an investment bank to provide a fairness opinion, companies can gain a valuable perspective on the proposed transaction, which can help them negotiate more effectively and ultimately achieve a better outcome.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://noblecapitalmarkets.com/opinion-practice

https://core.ac.uk/download/pdf/160249385.pdf

https://www.investopedia.com/terms/f/fairness-opinion.asp

http://edgar.secdatabase.com/1680/121390023011399/fs42023ex23-4_heritage.htm

The Fed Pulled no Punches Criticizing Itself and SVB

Posted on by phoffman@channelchek.com
Image Credit: Alpha Photo (Flickr)

Silicon Valley Bank is Back in the News as the Fed Explains the Mess

Silicon Valley Bank’s management, the board of directors, and Federal Reserve supervisors all ignored banking basics. At least that is the determination of the Federal Reserve itself. The review and report of the situation, created by the Federal Reserve Board of Governors, relieve fears that the broader U.S. banking system is fragile. But it does highlight other problems that may need to be addressed by those responsible for a sound U.S. banking system.

Silicon Valley Bank was considered the “go-to bank” for venture capital firms and technology start-ups. But it failed spectacularly in March which set off a crisis of confidence toward the banking industry. Federal regulators seized Silicon Valley Bank on March 10 after customers withdrew tens of billions of dollars in deposits in a matter of hours. The speed of withdrawals was attributed to high levels of communication through social media.

The opening paragraph of the introductory letter by the Federal Reserve in DC said:

“Silicon Valley Bank (SVB) failed because of a textbook case of mismanagement by the bank. Its senior leadership failed to manage basic interest rate and liquidity risk. Its board of directors failed to oversee senior leadership and hold them accountable. And Federal Reserve supervisors failed to take forceful action, as detailed in the report.”

The plain-spoken letter and more formal report was critical of all involved, including regulators who are supposed to be evaluating bank management and processes for adequacy.

The lengthy report has four key takeaways:

  • “Silicon Valley Bank’s board of directors and management failed to manage their risks.”

[Editor’s note] Banks present-value their assets (investments and loans) and their liabilities (deposits) then report valuations at regular Asset/Liabilty management meetings. When a depositor locks in a CD and rates rise, the value to the bank of that deposit rises as it is present valued to higher market rates. The same for loans, and the investment portfolio if it is designated marked-to-market. Proper interest rate risk management for banks is stress testing for risk and profitability if rates rise or fall.

  • “Supervisors did not fully appreciate the extent of the vulnerabilities as Silicon Valley Bank grew in size and complexity.”

[Editor’s note] Regulators don’t tell banks how to manage their business, but regulators are supposed to check that a suitable plan is in place, it was created by competent managers considering the bank’s complexities, and that it is being followed.

  • “When supervisors did identify vulnerabilities, they did not take sufficient steps to ensure that Silicon Valley Bank fixed those problems quickly enough.”

  • “The board’s tailoring approach in response to the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA) and a shift in the stance of supervisory policy impeded effective supervision by reducing standards, increasing complexity, and promoting a less assertive supervisory approach.

[Editor’s note] SVB’s CEO lobbied for this roll back of Dodd Frank which set ratios and loosened the reigns on regulatory scrutiny of larger banks.

In its criticism of its own lack of oversight, the report stated “The Federal Reserve did not appreciate the seriousness of critical deficiencies in the firm’s governance, liquidity, and interest rate risk management. These judgments meant that Silicon Valley Bank remained well-rated, even as conditions deteriorated and significant risk to the firm’s safety and soundness emerged.”

The Fed also said, based on its report, it plans to reexamine how it regulates banks the size of SVB, which had more than $200 billion in assets when it failed.

The Fed’s release, which includes internal reports and Fed communications, is a rare look into how the central bank supervises individual banks as one of the nation’s bank regulators. Other regulators include the Office of the Controller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC). Typically these processes are confidential and rarely seen by the public, but the Fed chose to release these reports to show how the bank was managed up to its failure.

It probably won’t be long before Silicon Valley Bank is used as a college case study in what not to do.

Paul Hoffman

Managing Editor, Channelchek

Source

https://www.federalreserve.gov/publications/files/svb-review-20230428.pdf

https://www.federalreserve.gov/newsevents/pressreleases/bcreg20180706b.htm

Minutes and Other Indicators are Now Showing Less Agreement on Policy by the FOMC

Posted on by phoffman@channelchek.com
Image Credit: Federal Reserve (Flickr)

The March FOMC Minutes Show the Fed is Less Aligned

We may be entering a period when we have a Federal Reserve that is split on the direction of monetary policy. This could be the case as early as the May 2-3 FOMC meeting. At least, that is one indication that arose from the just-released minutes of the Committee from the March 21-22 meeting. U.S. economic activity was strong leading up to the meeting, then the collapse of two banks occurred. The concerns that followed prompted several Federal Reserve officials to consider whether the central bank should pause its aggressive pace of hiking interest rates.

Split Federal Reserve

The minutes offer insight into what may follow this year. Over the past ten sessions, the FOMC minutes showed the central bank’s focus has been on quickly tightening policy to squelch persistent inflation. Now after nine consecutive interest-rate hikes and quantitative tightening, the conversation has shifted from wondering how fast they can move to whether and when the Fed should pause. At least, it has for some of the Committee members. Soft landings are seldom successfully orchestrated by monetary policy changes; more often, they set the stage for a recession.

In public addresses since the March meeting, Fed officials have appeared to be somewhat split on the way forward. Chicago Fed President Austan Goolsbee, for example, said on April 11 that the Fed needs to be cautious. “We should gather further data and be careful about raising rates too aggressively until we see how much work the headwinds are doing for us in getting down inflation,” Goolsbee said.

Less concerned about a recession and more concerned about winning the war on inflation, Cleveland Fed President Loretta Mester said last week she believes the correct move is for the Fed to continue tightening “a little bit higher” before pausing as the economy and inflation adjusts.

Bank Failure Considerations

The March monetary policy meeting was surrounded by uncertainty for both Fed watchers and some FOMC members. The meeting took place only days after the collapse of Silicon Valley Bank and Signature Bank. Other indicators of a strong economy pointed to an aggressive move from the voting members. But, with the banking sector wounded or perhaps worse, it remained a nailbiter up until 2 pm on March 22 when the Federal Open Market Committee announced a quarter-point interest-rate hike.

While all has since been quiet related to U.S. banks, at the time, the extent of the problem was far from known. The potential economic impact it could have, led Fed staff to project a mild recession starting later in 2023, according to the minutes. This tells financial markets and others impacted by Fed moves that some Fed officials were seriously considering holding steady on rates.

The minutes show, the combination of “slower-than-expected progress on disinflation,” a tight labor market, and the view that the new emergency lending programs had stabilized the financial sector, allowed the central bank to again raise rates. The minutes indicated, “Many participants remarked that the incoming data before the onset of the banking sector stresses had led them to see the appropriate path for the federal funds rate as somewhat higher than their assessment at the time of the December meeting.” Reading on, the minutes said, “After incorporating the banking-sector developments, participants indicated that their policy rate projections were now about unchanged from December.”

Take Away

Although they are released several weeks after each meeting, the Fed minutes are always closely watched for clues as to how central-bank officials are feeling and where monetary policy is likely heading over the next several weeks or months. The indication from these minutes, behind a backdrop of Fed regional president addresses, indicate a less than unified Fed. Unless there is a good deal of unexpected trouble within the banking sector or economy or a clear tick up in economic measures such as employment, the May 3 post-meeting announcement on policy will be tough to forecast.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.federalreserve.gov/newsevents/pressreleases/monetary20230412a.htm

https://news.yahoo.com/wall-street-split-on-feds-next-move-as-financial-sector-buckles-after-bank-failures-150737804.html

https://www.barrons.com/articles/march-fed-meeting-minutes-today-cf27aa2?mod=hp_LATEST

The Seemingly Endless Global Battle Over Investment Research Will Soon End

Posted on by phoffman@channelchek.com
Image Credit: Matt May (Flickr)

How Should Brokers Be Compensated for Investment Research?

Most U.S. investors have not heard of the European Unions Markets in Financial Instruments Directive, referred to as MiFID or MiFID II. But the large U.S. brokers and investment banks certainly have, and they are bumping up against a July end to a “no-action” relief letter from the SEC. At issue is that the directive, which came into effect in January of 2018 in the E.U., doesn’t synch with how brokerage business is conducted in the U.S. The U.S.-based brokers have been provided time, but over five years, there is very little evidence of movement to comply.  

Background

If U.S. broker-dealers (BDs) continue their business model of providing investment research to clients that is now “bundled” with other services, not charged as a separate service, they are in compliance with U.S. security regulations and don’t risk their status as a BD. However, if they follow MiFID with their international clients in order to be in compliance with Europe, they would be acting, under U.S. rules, as an Investment Advisor (the Advisers Act). This is because if they are subject to E.U. jurisdiction, under MiFID II, unless an exemption is met, research that investment managers receive from brokers is considered a prohibited “inducement.”

Research distribution in the U.S. by BDs has historically relied on a definition of “Investment Adviser” under the Advisers Act (related to research distribution). This definition looks to the condition that the investment advice is incidental to the firm’s broker-dealer business and (that the broker-dealer is not receiving “special compensation.” Hard dollar payments in exchange for investment research is considered  “special compensation” for investment advice (ie., equity research). A 2017 dated SEC no-action letter and then another in July 2022 provided a window of relief from this conflict. It provided time to sort through what is allowed under different business types for those falling under both U.S. regulation and MiFID II oversight.

With fewer than three months until the SEC “no action” July 3 deadline, Wall Street firms are quiet on how and whether they may adjust their businesses. The choices would seem to be to either not provide the service of bond and equity research as part of the bundled service by acting strictly as a BD (compliance with MiFID II), or to register as an Investment Adviser that then subjects traditional U.S. brokers to additional rules and licenses.

Where We Are Now

The SEC no-action letter has allowed U.S.-based BDs to accept payments from clients where MiFID applies. This protection will soon end. If they continue the practice, they will be violating the Advisers Act, as they are not Investment Advisers.

Come July 3, they face a choice of registering, moving research teams into registered affiliates, or even cutting off clients subject to MiFID regulations from any research produced in the U.S.

In March, SEC Chair Gary Gensler and senior staff met bank representatives and industry associations to discuss the issue. But the SEC ultimately refused to alter its long-held stance, on the Advisers Act.

Take Away

Broker-dealers in the U.S. have less than three months to adjust their position on compensation methods of clients bound by MiFID II. The clock is ticking, and they are now staring down the barrel of a difficult decision. Should they transition to Investment Adviser status and charge separately for research, or should they stop providing research to affected clients altogether?

Securities Research available on Channelchek is always without cost. Sign up here to receive access and top-tier equity reports in your inbox, each day, before the market opens.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://www.ft.com/content/2400b520-afa3-45ec-9767-a35805b4f98a

https://corporatefinanceinstitute.com/resources/economics/markets-in-financial-instruments-directive-mifid/

https://www.kslaw.com/news-and-insights/broker-dealer-research-mifid-related-hard-dollar-sec-investment-adviser-status-relief-to-end-in-july-2023#:~:text=On%20July%2026%2C%202022%2C%20William%20Birdthistle%2C%20Director%20of,letter%20to%20escape%20classification%20as%20an%20investment%20adviser.

https://www.bing.com/search?q=gensler+mifid&filters=ex1%3a”ez3″&pglt=41&cvid=988d16616d5d413e99ae8b9a7aed6c84&aqs=edge..69i57j0l3j69i64.4027j0j1&FORM=000017&PC=LCTS&qpvt=gensler+mifid

The CFA Institute Makes First Major Change to Program Since Inception

Posted on by phoffman@channelchek.com
Image Credit: WOCintech Chat (Flickr)

CFA Exam is Evolving to Better Reflect Employee, Employer, and Candidate Needs

The CFA Institute is making the most significant changes to its program since first introduced back in 1963. All of the changes are designed to better serve employers, candidates, and charterholders. The designation is considered the gold standard in the investment profession, so modifying the program must have involved much thought and debate. Six additions will be rolled out for those beginning the journey toward a CFA this year. The end result will be expanded eligibility, hands-on learning, a more focused curriculum, additional practice available, the ability to specialize, and recognition at every passed level.

What is a Chartered Financial Analyst?

A Chartered Financial Analyst (CFA) is a professional designation awarded to financial analysts who have passed a rigorous set of exams administered by the CFA Institute. The CFA program is a globally recognized, graduate-level curriculum that covers a range of investment topics, including financial analysis, portfolio management, and ethical and professional standards.

To become a CFA charterholder, candidates must pass three levels of exams, each of which are administered once a year. In addition to passing the exams, candidates must also meet work experience or school requirements.

Eligibility

The institute is selective in who can be a candidate. In the past, those with a degree and working in the business, needed to be sponsored by two people; first, a current CFA member, and the second the prospective candidate’s supervisor. For students, the requirement was that they be in their last year of study and be sponsored by a professor in lieu of a supervisor.

The policy that had been in place is that students with just one year remaining in their studies may seek CFA candidacy. The purpose of the new policy, according to Margeret Franklin CFA, President and CEO of the CFA Institute, is to “provide students with the opportunity to Level 1 of the CFA program as a clear signal to employers that they are serious about a career in the investment industry by getting an early start in the program.” This is the first of the revisions in the program and has been in place since November 2022.

Job Ready Skills

This new feature recognizes there is a difference between textbook understanding and work. The upcoming study and test material is designed for charterholders to be able to add value much earlier to their employer by imparting practical skills. A practical skills module will be added beginning with those scheduled for the February 2024 Level 1 exam. Level II candidates taking the test  in May 2024 will also be tested on this new material. Level III candidates will see this material in 2025.

The impetus for this addition, according to the CFA Institute’s website, is it, “allows us to meet the expressed needs of student candidates, providing them with the opportunity to prepare for internships and investment careers, while also addressing industry demand for well-trained, ethical professionals.”

Expanded Study Material

Candidates are told they can greatly increase their chances of success taking the exam if they correctly answer 1,000 practice question during study, and score at least 70% on a mock exam. The Institute has added as an extra (not part of the basic study package) three new elements for preparation.  

To increase the percentage of successful candidates, the CFA Institute now offers a Level I Practice Pack. It includes 1,000 more practice questions and six additional mock exams to go with the study materials that is standard with registration.

The add-on also provides six additional, exam-quality mock exams. The questions are prepared by the same team that create the exams each year.

More Focused

The CFA has branded itself with the promise that 300 hours of study per level is what is needed for success. They recognize that most candidates put in much more time, and the success rate for this tough series of exams is low. The Institute has streamlined study to make more efficient its Level I material beginning with those sitting for the Level I exam in 2024.

To be more efficient, the Institute presumes Level I candidates have already mastered many introductory financial concepts as part of their university studies or career role. To avoid duplication and to streamline Level I curriculum content, they have moved some of this content. It is available separately as reference material for registered candidates.

The content that has been moved to “Pre-Read” incudes topics like the time-value of money, basic statistics, microeconomics, and introduction to company accounts.

Choose Your Specialty

Starting in 2025, candidates will be able to choose one of three specialty paths to be tested at Level III. The reason for the addition is the CFA curriculum has always prepared candidates for investment and finance buy-side roles. This choice allows the CFA credential to grow and develop to meet the needs of a broader group of individuals and employers.

The CFA traditional path has been to prepare the candidate for a portfolio management role. This traditional path is still included. The Institute is also adding concentrations in private wealth management, and private markets. There will only be one credential, the Chartered Financial Analyst, but three areas of specialty.

Recognition at Every Level

While the goal of every candidate is to earn a full-fledged CFA designation, each level is a significant achievement. Now, CFA Institute awarded digital badges will recognize success at the first two levels.

The digital badges, to be used on social media when rolled out later in 2023 will be accompanied by marketing and awareness-building with employers, to improve the visibility and value placed on progress through the CFA program. The goal is for candidates to be distinguished in the market, have one-click social sharing, with instant verification to employers and colleagues to boost credibility and solidify a candidates’ accomplishment.

Overall the change, is to signal to the market that completing Levels I and II are substantial achievements, with tangible recognition of a candidate’s commitment to the industry through their learned skills and experience, professionalism and ethical practices.

Take Away

The world investment world is changing, and the CFA Institute is responding in order to better serve those that benefit from this prestigious designation. Candidates will now have more choices, more study material available, and the ability to take credit for their rigorous studies beginning after passing Level I.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://300hours.com/cfa-requirements/#:~:text=The%20CFA%20Institute%20is%20the,the%20other%20your%20current%20supervisor.

CFA® Program The Next Evolution (brightcove.net)

Real Risks to TikTok Users

Posted on by phoffman@channelchek.com
Image: Congressional Hearings with Byte Dance (TikTok) CEO, C-SPAN (YouTube)

Should the US Ban TikTok? Can It? A Cybersecurity Expert Explains the Risks the App Poses

TikTok CEO Shou Zi Chew testified before the House Energy and Commerce Committee on March 23, 2023, amid a chorus of calls from members of Congress for the federal government to ban the Chinese-owned video social media app and reports that the Biden administration is pushing for the company’s sale.

The federal government, along with many state and foreign governments and some companies, has banned TikTok on work-provided phones. This type of ban can be effective for protecting data related to government work.

But a full ban of the app is another matter, which raises a number of questions: What data privacy risk does TikTok pose? What could the Chinese government do with data collected by the app? Is its content recommendation algorithm dangerous? And is it even possible to ban an app?

This article was republished with permission from The Conversation, a news site dedicated to sharing ideas from academic experts. It represents the research-based findings and thoughts of, Doug Jacobson, Professor of Electrical and Computer Engineering, Iowa State University.

Vacuuming Up Data

As a cybersecurity researcher, I’ve noted that every few years a new mobile app that becomes popular raises issues of security, privacy and data access.

Apps collect data for several reasons. Sometimes the data is used to improve the app for users. However, most apps collect data that the companies use in part to fund their operations. This revenue typically comes from targeting users with ads based on the data they collect. The questions this use of data raises are: Does the app need all this data? What does it do with the data? And how does it protect the data from others?

So what makes TikTok different from the likes of Pokemon-GO, Facebook or even your phone itself? TikTok’s privacy policy, which few people read, is a good place to start. Overall, the company is not particularly transparent about its practices. The document is too long to list here all the data it collects, which should be a warning.

There are a few items of interest in TikTok’s privacy policy besides the information you give them when you create an account – name, age, username, password, language, email, phone number, social media account information and profile image – that are concerning. This information includes location data, data from your clipboard, contact information, website tracking, plus all data you post and messages you send through the app. The company claims that current versions of the app do not collect GPS information from U.S. users. There has been speculation that TikTok is collecting other information, but that is hard to prove.

If most apps collect data, why is the U.S. government worried about TikTok? First, they worry about the Chinese government accessing data from its 150 million users in the U.S. There is also a concern about the algorithms used by TikTok to show content.

Data in the Chinese Government’s Hands

If the data does end up in the hands of the Chinese government, the question is how could it use the data to its benefit. The government could share it with other companies in China to help them profit, which is no different than U.S. companies sharing marketing data. The Chinese government is known for playing the long game, and data is power, so if it is collecting data, it could take years to learn how it benefits China.

One potential threat is the Chinese government using the data to spy on people, particularly people who have access to valuable information. The Justice Department is investigating TikTok’s parent company, ByteDance, for using the app to monitor U.S. journalists. The Chinese government has an extensive history of hacking U.S. government agencies and corporations, and much of that hacking has been facilitated by social engineering – the practice of using data about people to trick them into revealing more information.

The second issue that the U.S. government has raised is algorithm bias or algorithm manipulation. TikTok and most social media apps have algorithms designed to learn a user’s interests and then try to adjust the content so the user will continue to use the app. TikTok has not shared its algorithm, so it’s not clear how the app chooses a user’s content.

The algorithm could be biased in a way that influences a population to believe certain things. There are numerous allegations that TiKTok’s algorithm is biased and can reinforce negative thoughts among younger users, and be used to affect public opinion. It could be that the algorithm’s manipulative behavior is unintentional, but there is concern that the Chinese government has been using or could use the algorithm to influence people.

Meet the Management Information

Can the Government Ban an App?

If the federal government comes to the conclusion that TikTok should be banned, is it even possible to ban it for all of its 150 million existing users? Any such ban would likely start with blocking the distribution of the app through Apple’s and Google’s app stores. This might keep many users off the platform, but there are other ways to download and install apps for people who are determined to use them.

A more drastic method would be to force Apple and Google to change their phones to prevent TikTok from running. While I’m not a lawyer, I think this effort would fail due to legal challenges, which include First Amendment concerns. The bottom line is that an absolute ban will be tough to enforce.

There are also questions about how effective a ban would be even if it were possible. By some estimates, the Chinese government has already collected personal information on at least 80% of the U.S. population via various means. So a ban might limit the damage going forward to some degree, but the Chinese government has already collected a significant amount of data. The Chinese government also has access – along with anyone else with money – to the large market for personal data, which fuels calls for stronger data privacy rules.

Are You at Risk?

So as an average user, should you worry? Again, it is unclear what data ByteDance is collecting and if it can harm an individual. I believe the most significant risks are to people in power, whether it is political power or within a company. Their data and information could be used to gain access to other data or potentially compromise the organizations they are associated with.

The aspect of TikTok I find most concerning is the algorithm that decides what videos users see and how it can affect vulnerable groups, particularly young people. Independent of a ban, families should have conversions about TikTok and other social media platforms and how they can be detrimental to mental health. These conversations should focus on how to determine if the app is leading you down an unhealthy path.

Block Inc. Versus Hindenberg Research, Who’s Correct?

Posted on by phoffman@channelchek.com
Image Credit: Hindenberg Research (YouTube)

The Details of the Hindenberg Research Report Include Serious Allegations

A legal face-off may be brewing as Block (SQ), the other company co-founded by Jack Dorsey, calls on the SEC for what Block calls an “inaccurate report.” The report Block (formerly Square) is referring to was released by Hindenberg Research on March 23. The research contends that Dorsey’s fintech company showed, “willingness to facilitate fraud against consumers and the government, avoid regulation, dress up predatory loans and fees as revolutionary technology, and mislead investors with inflated metrics.”

What is each side claiming, and what is the responsibility in releasing a report that may take Hindenberg into a fight with a company with a $44 billion market cap?

Who’s Involved?

Block is a financial technology company specializing in mobile payments founded in 2009 by Jack Dorsey and Jim McKelvey. The company’s flagship product is a small, square-shaped credit card reader that plugs into a smartphone or tablet and allows businesses to accept credit and debit card payments. Block has added other financial products and services, including point-of-sale software, payroll processing, and business loans.

Hindenburg Research provides investors with investigative research and analysis for the purpose of helping them identify potential risks or fraudulent practices in publicly traded companies. They are described as a short-selling, research-based firm. The Research is often considered within the context of its short-position investment strategy.

Image: Block’s flagship product – Nat’l Museum of American History Smithsonian Institution (Flickr)

What is Hindenberg’s Claim?

The research firm with a reputation of looking below the surface for trouble at firms, says Block is not what it claims to be. According to the Hindenberg report, the Dorsey-founded firm claims to have developed a frictionless and magical financial technology. The mission of this technology, the report quotes Block as saying is to empower the “unbanked” and the “underbanked.”

Hindenberg says that over two years of investigation that involved dozens of interviews with former employees that Block has systematically taken advantage of the demographics it claims to be helping. This refers to the stated mission of helping the underbanked. Instead, the research firm says this stands in conflict with, “the company’s willingness to facilitate fraud against consumers and the government, avoid regulation, and dress up predatory loans and fees as revolutionary technology, and mislead investors with inflated metrics.”

The two years of investigation also indicated that  Block severely overstated its user counts and has understated its customer acquisition costs. This information, the report says, is based on former employees’ estimation that 40%-75% of accounts they reviewed were fake, involved in fraud, or were additional accounts tied to a single individual.

They claim a key metric that investors use to value the company are unclear. That is, how many individuals are on the Cash App. The report accuses the company reporting of misleading “transacting active” metrics filled with fake and duplicate accounts. Hindenberg says, “Block can and should clarify to investors an estimate on how many unique people actually use Cash App.”

Hindenberg said the app is used for illegal activity and points to all the rap songs written about engaging in illegal activity, activity made possible with the help of the app. The research company even made a compilation video to demonstrate this point (link to video under “Sources” below).

A line in one of the songs is, “I paid them hitters through Cash App.” Heritage contests that Block paid to promote the video for the song called “Cash App” which described paying contract killers through the app. The song’s artist was later arrested for attempted murder.

According to the Hindenberg report, Block’s Cash App was also cited “by far” as the top app used in reported U.S. sex trafficking, according to a leading non-profit organization. Multiple Department of Justice complaints outline how Cash App has been used to facilitate sex trafficking, including sex trafficking of minors.

Beyond alleged facilitation of payment for crimes, the platform, former employees contend,  is overrun with scam accounts and fake users. Examples of obvious distortions of user numbers is that “Jack Dorsey” has multiple fake accounts, including some that appear aimed at scamming Cash App users.  “Elon Musk” and “Donald Trump” who have dozens of accounts in their names. Hindenberg contends they tested this flaw, “we ordered a Cash Card under our obviously fake Donald Trump account, checking to see if Cash App’s compliance would take issue—the card promptly arrived in the mail,” they gave as an example.

Block’s Response

Not to be dissed, management at Block called out the threatening press release. “We intend to work with the SEC and explore legal action against Hindenburg Research for the factually inaccurate and misleading report they shared about our Cash App business today.”

The Dorsey founded firm suggested that the research firm wrote the report for dubious reasons and that it may be part of an orchestrated reverse pump and dump, “Hindenburg is known for these types of attacks, which are designed solely to allow short sellers to profit from a declined stock price. We have reviewed the full report in the context of our own data and believe it’s designed to deceive and confuse investors.”

The company than comforted stakeholders saying, “we are a highly regulated public company with regular disclosures, and are confident in our products, reporting, compliance programs, and controls. We will not be distracted by typical short seller tactics.”

There’s Smoke, is There Fire?

Are the initial disparaging claims against Block’s business accurate? Is there merit to what Block says of Hindenberg Research? As Block may be seeking a legal remedy, it is unlikely that either party will be very vocal from here.

For investors, it’s logical that both parties cannot be right at the same time. One of the parties is overstating truth. If Block is indeed working with the SEC, this truth should eventually surface.

Paul Hoffman

Managing Editor, Channelchek

Sources

https://youtu.be/StjWk3Mj-M4?t=8

https://hindenburgresearch.com/

https://investors.block.xyz/news/news-details/2023/Blocks-Response-to-Inaccurate-Short-Seller-Report/default.aspx

Will Banking Issues Infect Other Industries?

Posted on by phoffman@channelchek.com
Image credit: Dan Reed (Flickr)

Fragile Investor Confidence Could Create Greater Repercussions, Says Moody’s

Bankdemic?

Moody’s Investors Service is cautiously optimistic bank problems will not spill over into the broader economy. However, in a new report, this top-three rating agency said they believe the financial regulators have acted in a way to prevent ripple effects from stressed banks, but they admit there is a good deal of uncertainty in both investor confidence and the economy as a whole. Moody’s wrote that “there is a risk that policymakers will be unable to curtail the current turmoil without longer-lasting and potentially severe repercussions within and beyond the banking sector.”

The reason for the rating services concern is, “even before bank stress became evident, we had expected global credit conditions to continue to weaken in 2023 as a result of significantly higher interest rates and lower growth, including recessions in some countries.” Moody’s said that the longer financial conditions remain tight, the greater the chance that industries outside of banking will experience problems.

Moody’s outlined three channels by which bank problems could become contagious to other sectors.

Source: Moody’s Investor Service

Three Spillover Channels Risks Defined

The first and most possible channel would be the problems encountered by entities with direct and indirect exposure to troubled banks. These can come in different forms. Financial and nonfinancial entities in the private and public sectors could have direct exposure to banks via deposits, loans, other transactional facilities, or direct holdings of weakened banks’ stocks or bonds. Unrelated, they may rely on a troubled bank for services essential to their business.

As it relates to this first channel, the rating agency wrote, “Monitoring and evaluating the direct and indirect links at the entity level will be a key focus of our credit analysis over the coming weeks and months.” Moody’s mentioned Credit Suisse by name in their note, saying the consequences of the UBS takeover are still unfolding, “Given the size and systemic importance of Credit Suisse, there likely will be varied consequences of its takeover for a range of financial actors with direct exposure to the bank.” The rating agency also believes the rapid completion of the deal appears to have avoided widespread contagion across the banking sector.”

The second channel Moody’s indicates could be most potent. It is that broader problems within the banking sector would cause banks to have stricter lending practices. Moody’s says that if this occurred, it would impact customers that are “liquidity-constrained.” The domino impact would then be that investors and lenders may become more cautious, “with particular regard to entities that are exposed to risks similar to those of the troubled banks.”

From this scenario, there is a potential for shocks from interest rate risk, asset-liability mismatches, a large imbalance of assets or liabilities, poor governance, weak profits, and higher leverage.  

The third risk is seen as policy risk. For policymakers whose main focus is taming inflation, the bank problems pose additional challenges to steering the economy to a soft landing. Policy actions and expectations will continue to serve to shape market sentiment. Moody’s baseline case forecasts that it expects policy responses to be rapid if risks emerge. This could help keep entity-level issues from becoming systemic problems. Moody’s note recognizes that policy and implementation are challenging, and there are risks of policy missteps, limitations, or unintended consequences.

“One key policy challenge is how policymakers will address both inflation and financial stability risks,” Moody’s explained that inflation is still high and labor market strength continues. “the failure to rein in inflation now could lead to de-anchoring of inflation expectations and increased nominal bond yields, forcing even more tightening later to restore monetary policy credibility.”

Moody’s wrote that the actions taken by the central banks, and financial regulators show that they recognize the importance of agility and coordination to address arising problems while not acting in a way to add more stress and create a systemic crisis.

Take Away

The recent downfall of a few banks demonstrates how pulling liquidity out of an overly stimulated economy can cause withdrawal pains. Whether the new, tighter credit conditions will tip the economy into a deeper economic downturn as the spillover effect spreads to other sectors remains to be seen. If it occurs, Moody’s expects it would come from the interplay between preexisting credit risks, policy actions, and market sentiment. But, its role as a rating agency is to highlight possible risks. This is not a forecast, there forecast is that regulators and policymakers will have eventually succeeded to contain any ripple effects.

Paul Hoffman

Managing Editor, Channelchek

Source

https://www.moodys.com/research/Credit-Conditions-Global-Policymakers-have-responded-promptly-to-bank-stress–PBC_1362240?cid=B3FDB92CC8E17352