Edwin Dorsey of The Bear Cave Newsletter did a really interesting interview with Michelle Leder.
Michelle Leder is the creator of the website Footnoted where she digs through company filings looking for red flags.
She is also the author of Financial Fine Print - Uncovering a Company’s True Value, a book about finding out exactly what to look for in the footnotes of a company’s SEC filings.
Michelle talks about what she looks for when she goes through SEC filings. She gives a lot of great insights during this interview that I summarized below.
Michelle says there are no accidents in SEC filings. Everything is in there for a reason. Sometimes you just don’t know the reason at the time.
"There are no accidents in SEC filings. Everything that is in there is in there because some attorney or some accountant or some combination of the attorney and the accountant basically said you got to get this in there so that when the plaintiffs’ bar comes around you can say no, on page whatever, it was disclosed and you didn’t read it."
- Michelle Leder
Michelle doesn’t spend a lot of time looking at the financials because she is more interested in the words used to describe the financials.
She always starts at the risk factors when reading a 10K.
Michelle encourages you to go back and look at Footnote 16 in Enron's 1999 10K and challenge yourself to see if you could tell that Enron was such a screwup.
Here is the footnote below from Enron’s 1999 10K:
Other things that Michelle looks at in filings besides the risk factors are:
1. The summary compensation table if you have an S1 filing because this compensation table is shown for the first time in the S1.
2. The related party transactions section which would be in the S1 or the Proxy Statement.
Here are some red flags in SEC filings:
1.A company has significant risk factors.
2. There is language that seems particularly unusual.
3. The mention of going concern.
4. A situation where a company has a significant chunk of their revenue tied to one revenue stream. She mentions Robinhood as an example. Robinhood has 80% of their revenue coming from one area that is currently in the regulatory crosshairs.
5. Michelle says that the biggest red flag when looking at a 10K is when a company creates a metric that you've never heard of before or if a company changes a metric. For example, this year they may use EBITDA but the next year they may use adjusted EBITDA. Or this year they may use widgets as a measure but next year they may use widgets excluding something. Or this year they may use widgets plus A plus B plus C but next year they may use widgets plus A plus B plus C plus D plus E plus F plus G.
It’s worth it to pay attention to filings that are done late on Friday right before the weekend. Michelle calls this “The Friday Night Dump".
Here are some green flags or good things to find in company filings:
1. Modest salaries and no crazy related party transactions. For example: Warby Parker's compensation table in their S1 showed modest salaries and there were no crazy related party transactions. This was the opposite of WeWork's S1 a couple years ago.
Michelle doesn’t find 13F filings that useful because they’re filed 45 days after the quarter-end. They also don’t include all of the fund's holdings. Fund managers also know that everyone is looking so they can prepare.
Michelle thinks that a lot of the laws that the SEC is adhering to following are dated back to the market crash of 1929 and in some ways, Michelle believes the SEC needs to catch up to some of the changes that have happened to the market.
Michelle ended the interview with three of her favorite footnotes:
1. Aubrey McClendon sold his antique map collection to Chesapeake Energy, the company that he was Chairman and CEO of, for $13 or $14 million. The filing also said that they knew it was worth this amount because the party who appraised the antique map, bought the antique map collection from him and was their consultant.
2. One company bought what they referred to in company filings as a “shack” that would be used for entertainment. This by itself was understandable because companies acquiring small amenities for entertainment is reasonable but when the CEO left the company, the company sold that "shack" back to the CEO for a bargain basement price. It turned out that that "shack" was a 5,000 SQ FT house by the lake.
3. Quest Communications hired a CEO who had to move from San Francisco to Denver. His daughter, who was in high school at the time, stayed behind in San Francisco which was understandable. What wasn’t so understandable was why the company would fly her from San Francisco to Denver by using the company jet when Denver and San Francisco are both big cities with several flights in between both cities.