Short seller Hindenburg Research published a scathing report about Block, formerly known as Square. I read through the report. No, Block did not blatantly commit financial frauds or cook the book. (Sigh of relief!) But the report blasted Block’s poor compliance of the CashApp that enables criminals and an unprofitable business model. Well, this sounds like a pretty common problem for high growth tech companies, doesn’t it? The truth is that there is almost always a tradeoff between growth and proper compliance, especially for Fintech companies. If you ask users to go through the proper KYC/AML process, you will be compliant but the added friction will cause a lot of customers to churn during on-boarding. The customer acquisition cost could become too high to make your business viable. But if you let customers sign up without proper KYC/AML, your app will inevitably invite fraudulent and criminal actors and eventually you will get into all kinds of trouble with regulators. Balancing between growth and proper compliance is an intricate form of art. Hindenburg also said in the report that Block understated its customer acquisition costs. Poor compliance plus high customer acquisition costs sounds like a recipe for disaster.
I have a very mixed feeling about this report. On the one hand, I don’t think the problems Hindenburg pointed out are unique to Block. Many tech companies have similar compliance and profitable growth challenges and the hope is that over time, things could be improved. But on the other hand, Block has been around for a long time and the company has a $36B market cap, they should have had their act together by now. I don’t have any frame of reference to know how bad their KYC/AML compliance is but Block is losing a lot of money on the GAAP basis and is facing a lot of competition. It’s unclear what’s going to happen after this report but we can be sure that investors’ appetite for unprofitable growth and regulatory risks is waning in today’s environment and companies need to adjust to this new reality.