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Bloomberg Businessweek USA April 10-23 2017

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April 10 — April 23, 2017 | bloomberg.com
SPECIAL DOUBLE ISSUE
North of the Border, South of the Wall
What the U.S. has to lose by cutting off Mexico
p62
vk.com/stopthepress
FRESH MAGAZINES EVERYDAY
СВЕЖИЕ ЖУРНАЛЫ НА АНГЛИЙСКОМ ЯЗЫКЕ В ГРУППЕ
VK.COM/STOPTHEPRESS
“WE DON’T LOSE LIBERTY
IN THIS COUNTRY
BECAUSE SOMEBODY’S SOFTWARE
IS NOT WORKING.
1
IT JUST ISN’T RIGHT”
PHOTOGRAPH BY HANNAH WHITAKER FOR BLOOMBERG BUSINESSWEEK
p44
“Time
is brain”
p34
“Not only did we
have this commonality
of startups, but
we both loved Jesus”
“We’ve exposed a
myth that Germans want
to be with Germans
and Brits with Brits”
p56
p18
Cover
Trail
April 10 — April 23, 2017
How the cover gets made
Opening Remarks What’s behind so many Wall Street pitches: Tortured data
8
Bloomberg View The ANC’s misguided loyalties • A fair EU approach to Brexit talks
10
Movers A Spotify-Universal Music duet Pepsi’s Kendall Jenner ad falls flat
13
“Soon to be replaced by a big,
beautiful wall.”
Global Economics
While all eyes watch the Fed, the Fed watches the Street
15
Guadalajara pitches itself as Silicon Valley’s sanctuary city
16
A print-only satirical weekly strikes fear into French politicians
17
“All together now,” Thomas Cook tells its multinational travelers
18
Companies/Industries
Putting a price on miracle drugs
21
Shipyards may bustle again as demand picks up for LNG tankers
23
Who’s to blame for sluggish U.S. car plants? SUV buyers
24
With new brands, H&M goes after older, more affluent shoppers
26
Politics/Policy
Russiagate: The Senate pieces the parts together
28
A change of mission for ICE’s community-relations officers
30
Technology
2
Lucrative hackathons help elite coders avoid the job grind
33
Why is a treatment for stroke victims slow in reaching most Americans?
34
Changing its name, Taser sells police on its body cams
35
China’s DJI rules the air with its civilian drones, but it may need more lift
36
Innovation: Synthetic cartilage that could transform joint replacement
37
Markets/Finance
Eyeing $100 million in savings, North Carolina’s treasurer fires fancy money managers
38
In Toronto’s hot property market, many buyers don’t wait for inspections
39
Active fund managers try a new twist on ETFs
40
Wall Street chatterers love disappearing messages
41
Features
COVER AND COVER TRAIL: PHOTOGRAPH BY KIRSTEN LUCE FOR BLOOMBERG BUSINESSWEEK
①
“We have a photo essay that
examines the area around a
55-mile stretch of the current
Mexican border fence.”
Buying Trouble Post-it creator 3M has struggled in the high-stakes ankle bracelet business
44
Plane Drain The F-35 fighter jet might be the U.S. military’s most expensive mistake
50
Entrepreneurial Spirit One of America’s fastest-growing churches nurtures startups, too
56
A Wall’s Limits A look at life and commerce along 55 miles of border fence in Texas
62
Etc.
The designer behind the revolutionary Nest thermostat has been tinkering with the camera
71
Fashion: Consider the white sock. Seriously
74
The Critic: The very long history of loan-sharking
75
Sport: All the stuff you’ll need to give stand-up paddleboarding a go
76
Survey: What could possibly go wrong during a team-building activity?
78
What I Wear to Work: Aday co-founder Meg He wears her clothing line’s silk shirts for rock climbing, too
79
How Did I Get Here? H&R Block CEO Bill Cobb went from marketing stuffed-crust pizza to helping us with our taxes
80
“Perhaps.”
“I have a thought: Maybe we
should put a picture of the fence
on the cover.”
“Your creativity never ceases
to amaze me.”
Index
People/Companies
SUPing in
Austin
T
Page, Carter
29
Parish Home Inspections
39
Patrick, Tim
37
Payless ShoeSource
13
Pence, Mike
29
PepsiCo (PEP)
13
Persson, Karl-Johan
26
Play With a Purpose
78
PNC Financial Services
Group (PNC)
58
Precidian Investments
40
Primark Stores
26
Procter & Gamble (PG) 33, 58
Putin, Vladimir
17, 29
T-Mobile US (TMUS)
46
Taser International (TASR) 35
Tesla (TSLA)
13
Thomas Cook Group
(TCG:LN)
18
3M (MMM)
44
Toyota Motor (TM)
24
Trump, Donald 13, 15, 16, 24,
29, 30, 52
Trusheim, Mark
21
21st Century Fox (FOXA)
13
Twitter (TWTR)
29
Two Sigma Investments
8
U
Q
Qualcomm (QCOM)
72
R
A
4
Abilla, Pete
78
ACA Compliance Group
41
Aday
79
Airbnb
58
Aite Group
40
AlixPartners
24
Allstate (ALL)
13
Amazon.com (AMZN) 26, 33
Andrews, Martin
21
Apple (AAPL)
16, 36, 41
AQR Capital Management
8
Arnott, Rob
8
Asness, Clifford
8
AT&T (T)
46
Autodata
24
Axon
35
B
Bank of America (BAC)
41
Bannon, Steve
13
Baumhauer, Judy
37
Bayer (BAYN:GR)
13
Berkshire Hathaway (BRK/A)
38
Bienaime, Jean-Jacques 21
BioMarin
Pharmaceutical (BMRN)
21
Black, Diane
30
BlackRock (BLK)
38, 40
Blackstone Group (BX)
38
Boeing (BA)
52
Bogdan, Christopher
52
Bould, Fred
72
Brunswick (BC)
46
Bryan, Garnier & Co.
26
Buckingham Strategic
Wealth
40
Buckley, George
46
Buddi US
46
Buffett, Warren
38, 58
Burr, Richard
29
C
Capital Lending Centre
Carson Dunlop
Carter, Ashton
Carticept Medical
Cartiva
Century 21 Leading Edge
Realty
Chapin, Steve
Charles River Ventures
Cisco Systems (CSCO)
Citigroup (C)
Clarke, Stephen
Clearasil (RB:LN)
39
39
52
37
37
39
46
72
16
41
40
58
Clinton, Hillary
Cobb, Bill
Cohen-Watnick, Ezra
Columbia Threadneedle
Investments
Comben, Christina
Comey, James
Correct Tech
29
80
28
40
78
29
46
D
D.E. Shaw
8
Daewoo Shipbuilding & Marine
Engineering (042660:KS) 23
Day Translations
78
DecisionWise
78
Deutsche Bank (DB)
41
Dimensional Fund Advisors 8
DJI
36
Dodge (FCAU)
24
Dudley, William
15
Dunford, Joseph
13
GlaxoSmithKline (GSK)
21
GlobalData
26
Goldman Sachs Group (GS) 41
Google (GOOG)
33, 46
Google Ventures (GOOG) 72
GoPro (GPRO)
72
Gordhan, Pravin
10
Gorkov, Sergey
28
Grannan, Dave
72
Greenspan, Alan
15
H
H&R Block (HRB)
Hainan China Agriculture &
Flight Service
Hana Financial Investment
(086790:KS)
He, Meg
Heinz, David
40
24
36
39
28
40
Facebook (FB)
17, 29, 33
Fadell, Tony
72
Fanatics
33
Fankhauser, Peter
18
Fifth Third Bancorp (FITB) 58
Fillon, François
17
Fillon, Penelope
17
Find a Tutor Near Me
78
Fisher, Sharon
78
FlipKey
58
Flynn, Michael
29
Folwell, Dale
38
Ford (F)
13, 24, 58
Foust, Lyden
58
Foxconn Technology
(2354:TT)
72
FPV Style
36
Freedman, Charles
15
Frost & Sullivan
36
G
Gartner (IT)
General Electric (GE)
General Motors (GM)
Gilead Sciences (GILD)
23
79
52
39
S
39
30
23
58
78
37
29
Safariland
35
Salesforce.com (CRM)
33
Samsung Heavy Industries
(010140:KS)
23
Sandoval, Aristóteles
16
Satellite Tracking of People 46
Saxo Bank
17
Schiff, Adam
28
Sears Holdings (SHLD)
33
Seeed Studio
36
Signal Digital
41
Sikhounmuong, Somsack 13
Smith, Lamar
30
Smith, Rick
35
Société Générale (GLE:FP) 26
Sovcomflot
23
Spark Therapeutics (ONCE) 21
Starwood Capital
38
State Street (STT)
40
Stryker (SYK)
34
Lacker, Jeffrey
42
Laroia, Rajiv
72
Le Pen, Marine
13, 17
Legg Mason (LM)
40
Li Shufu
24
Liberty Interactive (QVCA) 13
Light
72
Lockheed Martin (LMT)
52
Logitech International (LOGI) 72
Lyons, Jenna
13
33
40
V
13
24
8
8
72
72
15
23
23
36
Vanguard
8
Verizon Communications (VZ)
13, 46
W
Warburg Pincus
Warner, Mark
Weiss, Scott
WhatsApp
Wizeline
38
29
58
41
16
28
Sally
Yates
XYZ
Xerox (XRX)
33
Yates, Sally
28
Yellen, Janet
15
Zhejiang Geely Holding Group
24
Zuma, Jacob
10
M
50
Hennes & Mauritz (HMB:SS)
Hewson, Marillyn
Honda (7267:JP)
Horeau, Louis-Marie
HP (HPQ)
Hyundai Heavy Industries
(009540:JP)
26
50
24
17
16
23
I
IBC Advanced Alloys (IB:CN) 52
InCrowd
78
Inditex (ITX:SM)
26
InfoTrends
72
Intel (INTC)
16
International Business
Machines (IBM)
16, 33
IPro Realty
39
J.Crew
Jabil Circuit (JBL)
Jefferies Group (LUK)
Jenner, Kendall
Ma, Max
36
Macron, Emmanuel
13, 17
Manafort, Paul
29
Marrazzo, Jeff
21
Mattis, James
52
May, Theresa
18
McCabe, Daniel
40
McCain, John
29, 52
Medtronic (MDT)
34
Mercedes (DAI:GR)
13
Meyers, Jim
21
Microsoft (MSFT)
16, 33
Mitsubishi Heavy Industries
(7011:JP)
23
Moreno, Lenín
13
Morningstar (MORN)
24, 40
Mortgage Wellness Group 39
Muilenburg, Dennis
52
Musk, Elon
13
N
Nest Labs (GOOG)
Nunes, Devin
72
29
O
J
36
58
24
21
Kawasaki Heavy Industries
(7012:JP)
Keller Williams Experience
Realty
Kelly, John
Keppel (KEP:SP)
Kiessling, Will
Kosloff, Janet
Ku, David
Kushner, Jared
L
Marillyn
Hewson
F
K
80
E
Eaton Vance (EV)
Edmunds.com
EHang
Ekko Title
Ellis, Michael
ETrade Financial (ETFC)
Ralph Lauren (RL)
RBC Capital Markets
Renaissance Technologies
Research Affiliates
Rogers, Matt
Roku
Rosengren, Eric
Royal Dutch Shell (RDS.A)
Royal LePage West Real
Estate Services
Uber
UBS (UBS)
13
16
41
13
Obama, Barack
Ollerton, Seth
Oracle (ORCL)
Owl Labs
O’Reilly, Bill
30
78
16
58
13
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Corrections & Clarifications
In “A Miracle Drug Big Pharma Doesn’t Want”
(Companies/Industries, April 3-April 9, 2017), the
per-person price that Parsemus Foundation
expects to charge for its male contraceptive
Vasalgel in low- and middle-income countries was
incorrect. It should be $10 to $20.
MAIN: BOBBY SCHEIDEMANN FOR BLOOMBERG BUSINESSWEEK: HEWSON: ALBIN LOHR-JONES/BLOOMBERG; YATES: PETE MAROVICH/GETTY IMAGES
76
P
s,
Damn
,
c
Statistics
By Peter Coy
8
It’s hard to beat the
market, but there’s
always a new product
that tries anyway
Early
E
y in Ja
anuary
a
y in a Chicago hote
e
el,
g
b ll Harvey
y gave a rip-snortiiing
Campbell
H
presidentia
to the
p
d
al address
dd
h Americccan
Finance Ass
sssociation, the world’s leading
g
s
society
y forr research on financial ecoon
nomics.
To
o get published in jjournals, he
s
said,
there
e
e’s a p
powerful temptation
p
to
to
h data
a a until it confesses—that
o f
a
torture
th
he
is, to cond
duct
d
round after round of tests
in search of a finding
g that can be claimed
to be statistically
y significant.
cant.
t Said Harvey,
y,
a professor at Duke Universsity’s
y Fuqua
School
S
h l off B
Business:
siness “Unfortunately,
“Unforttunately our
standard testing methods are often illequipped to answer the questions that
we pose.” He exhorted the group: “We
are not salespeople. We are scientists!”
The problems Harvey identified in
academia are as bad or worse in the
investing world. Mass-market products
such as exchange-traded funds are being
concocted using the same flawed statistical techniques you find in scholarly
journals. Most of the empirical research
in finance is likely false, Harvey wrote
in a paper with a Duke colleague, Yan
Liu, in 2014. “This implies that half the
financial products (promising outperformance) that companies are selling to
clients are false.”
Most of us have a vague sense that
we’re being ripped off by investment
firms that charge hefty fees while
producing results that are no better
than you’d get throwing darts at a page
of stock listings. It’s troubling nonetheless to find out we’re correct. And it’s
important to understand the mechanics
of what has gone wrong.
The core of the problem is that it’s
hard to beat the market, but people
keep trying anyway. An abundance of
computing power makes it possible to
test thousands, even millions, of trading
strategies. The standard method is to see
how the strategy would have done if it
had been used during the ups and downs
of the market over, say, the past 20 years.
This is called backtesting. As a quality
check, the technique is then tested on
a separate set of “out-of-sample” data—
i.e., market history that wasn’t used to
create the technique.
In the wrong hands, though, backtesting can go horribly wrong. It once
found that the best predictor of the
S&P 500, out of all the series in a batch of
United Nations data, was butter production in Bangladesh. The nerd webcomic
xkcd by Randall Munroe captures the
ethos perfectly: It features a woman
claiming jelly beans cause acne. When
a statistical test shows no evidence of
an effect, she revises her claim—it must
depend on the flavor of jelly
j
bean. So
th statistician tests 20 fl
the
flavors. Nineteen
s
show
nothing. By
y chance there’s a high
correlation between jjelly bean consump-t
tion
and acne breakouts for one flavor.
T
The
final panel
p
of the cartoon is the
front page of a newspaper: “Green Jelly
y
B
Beans
Linked to Acne! 95% Confidence.
Only
y 5% Chance of Coincidence!”
It’s worse for financial data because
researchers have more knobs to twist in
ssearch of a prized “anomaly”—a
y
subtle
pattern in the data that
h llooks
k like it
could be a moneymaker. They can vary
the period, the set of securities under
consideration, or even the statistical
method. Negative findings go in a file
drawer; positive ones get submitted to
a journal (tenure!) or made into an ETF
whose performance we rely on for retirement. Testing out-of-sample data to keep
yourself honest helps, but it doesn’t cure
the problem. With enough tests, eventually by chance even your safety check
will show the effect you want.
Harvey’s term for torturing the
data until it confesses is “p-hacking,” a
reference to the p-value, a measure of
statistical significance. P-hacking is also
known as overfitting, data-mining—or
data-snooping, the coinage of Andrew
Lo, director of MIT’s Laboratory of
Financial Engineering. Says Lo: “The
more you search over the past, the more
ILLUSTRATION BY 731
O
g
Remarks
Also known as data-mining
or overfitting, p-hacking is
the technical term for forcing
data to bend to your will
likely
y it is you are
e going to find exotic pattternss that you happen to like or focus on.
T se patterns arre least likely
Thos
y to repeat.””
Su
uch tricks w
weren’t necessary
y when
W l Streeters could make a good
Wall
l
living
g charging for
f their stock-selection
-s
sk lls. That gig became
skill
b
scarcer when
h
i be
ecame clear that
a ffew could
o
o sit
consist tly beat a low
f
tent
w-cost index fund
that
track
ks, say, the S&P
S
500.
In
ndex funds a
are cheap
p because their
sp nsors don’t n
spon
need
d to h
hire expensive
p
stockpickers, bu
y aren’t perfect.
f
stoc
ut they
Stocks in the ind
h d by
ndex are weighted
market value, so Apple
l is 3.7 percent
of the S&P 500 w
while Rupert
p
Murdoch’s
News Corp. is jusst 0.008 percent. When
a stock gets hot fo
for whatever reason, the
index fund has tto buy
y even more of it,
which may not b
be the wisest choice.
Wall Street’s answer is today’s
d y most
stylish investme
yl smart b
ent style:
beta.
At the end of February, more than
$500 billion wa
d in equity
as invested
exchange-traded
f
d funds
in the U.S. that
use smart beta sstrategies, according
d
to
data compiled by
b Bloomberg.
l
b
“Beta” is
lingo for the retu
urn on investment you
get from owning a slice off the entire stock
market, as in a co
onventional index fund;
the “smart” partt refers to breaking
g the
link with market value. Stocks in a smart
beta index may be
b weighted
h d by anything
yh g
from company sales
s
or book value to
special-sauce ingredients
such
g
as “quality” (on the theory that
ll
d companies tend
d to
well-managed
o p
outperform
in the stock market)..
T
Trouble
is, fund managers have
g
gotten
too creative in the competition
c p ii
f investors’ dollars. To quote
for
q
the
b l
y, y
burlesque
strippers in Gy
Gypsy,
you
g
k There
h
gotta get a gimmick:
are
E
ETFs ffor more than a thousand
n
d
l
new indexes.
Creativity, alas,
d
d
doesn’t equall success. Vanguard,
th
b investment manager, callthe big
cculated
l d in 2012 that
h ETFs did
d d great
o
h
b
k
o
f
g
on their
backtests,
outperforming
th
k b
i
the market
by 10 p
percentage points
a year on average in the five
f
years
b
f
before
they went live, but then
underperformed the market by
y 1 perc
centage
point a year
y
in the five years
y
a
afterward.
The most complex
p
strattegies
suffer the biggest
drop-off from
eg
gg
th backtests,
their
b k
according
d g to an article
l in
the Journal
J
of Portfolio Management.
t.
Fg
Fights
have broken out over who
g up with
h spurious
is or isn’t coming
investment concepts. AQR Capitall
Management off Greenwich, Conn.,
w
f
which started as a quant hedge fund,
h
dl by
b managing other
h r
has grown rapidly
f
people’s money in smart beta funds.
I focuses on “factors” such as quality
It
y
and momentum that it says
y lead to reliia
able
outperformance.
p f
AQR’s founder
f
and chief investment officer, Clifford
Asness, is a billionaire. Rob Arnott, a
rival who’s CEO and founder of Research
Affiliates in Newport Beach, Calif., says,
“I think Cliff has done some outstanding
work over the years,” but adds that he’s
“insufficiently skeptical about the pervasiveness of data-mining and its impact
even in the factors he uses.
uses.”
d by emaill that
h “there
h
Asness responds
i little evidence” so far that AQR’s q
is
qual-ity-focused
y
fund is performing
g differently
y
now from how it did in backtesting. But
t
that’s
not much of a claim, says
y Robert
Novy-Marx,
y
a professor at the University
y
o Rochester’s Simon Business School
of
f AQR
Q and now
who once consulted for
consults for another group, Dimensional
F
Fund
Advisors. “Even if it p
performed
really
lly poorly,
ly y
you wouldn’t
ld k
know. There’s
h
j
just
not enough out-of-sample
-s p time to
make any
y claim one way
y or another.”
T
The
old adage applies: If asset
m
g
f
f
managers
and finance
professors
a
h ain’t they
h y
are
super-smart, why
s
h The
h b
super-rich?
big money is b
being
m
made by fi
firms that ignore fi
finance
theory.
y Renaissance Technologies
o n Long
g Island is dripping
g with
m h
d physicists
hy
mathematicians
and
but will not hire a ffinance Ph.D.
Two Sigma Investments is run by
d mathemah acomputer scientists and
ti i
ticians.
D.E. S
Shaw was founded by
ya
c
computational
l biologist.
b l
And
d so on.
Reflecting
g mathematicians’ disdain for
s
sloppiness
in finance, a 2014 essay
y in the
Journal of the American Mathematical
Societyy referred to backtest overfitting
g
a “pseudo-mathematics
as
p
m
and finannc al charlatanism.”
cial
ha la a
”
H a r ve y
y, w h o’s s i n c e c o m pleted
his term as president
of the
p
p
American Finance Association,,
h written that finance lags
has
g other
f
fields,
including
g g
genetics, in
m
making
certain that its findings are
s
statistically
y valid. “Many
y in our
f
g me,” have
profession,
including
s j
subjected
data to inadequate tests
i the past, he said in Chicago.
in
Th
h disgruntled
d g
l d some
That speech
p
l h
h
people,
he says now, b
but that’s
OK. “To push the field further, y
you
s
sometimes
have to be willing
g to be
very
y unpopular.” —With Saijel
j
K
Kishan
and Dani Burger
g r
9
Bloomberg
View
To read Eli Lake on the
Trump wiretapping
controversy and Barry
Ritholtz on the reality
of investing, go to
Bloombergview.com
Patience Is Running
Out in South Africa
The ruling African National Congress must
choose country over President Zuma
to safeguard the integrity of its institutions—its parliament,
judiciary, and central bank. It needs to dismantle the patronage
networks that sap its economic strength. It needs to tackle a
dysfunctional educational system that puts unqualified teachers
before struggling students. It needs to reform labor regulations that make it harder to hire workers and that privilege
well-connected unions. It needs to maintain its free press and
nourish a vibrant civil society that holds politicians to account.
Almost eight years of misrule suggest that neither Zuma
nor anyone close to him is up to these tasks. Voters may be
coming round to the same idea: They delivered a warning in
municipal elections last summer, rewarding the opposition
with unprecedented gains. The government had better pay
attention before voters’ patience is exhausted.
Europe’s Firm but Fair
Approach to Brexit
10
South Africa’s ruling African National Congress has a choice:
It can help President Jacob Zuma or it can help the country.
The party’s survival as a respected national force depends on
its doing the latter.
Support for the ANC has fallen amid charges of corruption
and incompetence. Now, Zuma is embroiled in a struggle with
his former finance minister, Pravin Gordhan, and other cabinet
members, claiming that Gordhan and his allies are seeking to
undermine him. Zuma’s firing of Gordhan on March 31 rattled
investors, sparking a downgrade of South African bonds to
junk status—a setback that raises the country’s debt burden
and could deter badly needed foreign investment.
Underlying this recent volatility is a deeper malaise.
Economic growth under Zuma has been anemic—less than
1 percent last year—and South Africa’s already high level of
unemployment has risen from 23.6 percent in 2009, when
he was elected, to almost 27 percent today. The national debt
has doubled. State companies and agencies are in disarray.
Business confidence has fallen, and the country has slumped
in global rankings of competitiveness.
Lately the plume of scandal that’s followed Zuma from his
first days in office has billowed into an all-encompassing cloud.
Last year, for instance, South Africa’s top court ruled that his
failure to repay taxpayer funds spent on upgrading his home
violated the constitution. South Africa’s former graft ombudsman reported Zuma may have dispensed favors and sweetheart contracts to friends who do business with his son. Still
to come is a possible judicial reinstatement of 783 charges of
corruption, racketeering, fraud, and money laundering.
Zuma’s response has been to fire up supporters with a toxic
brew of populist proposals—everything from strengthening the
power of the president and banning foreigners from buying
agricultural land to outright expropriation.
South Africa doesn’t need a stronger president. It needs
With talks on Britain’s exit from the European Union finally
about to begin, one procedural issue looms large: Do the
negotiations on three big subjects—exit terms, transitional
arrangements, and a future comprehensive agreement on a
U.K.-EU partnership—move in parallel or in entirely separate
stages? An understanding on how the talks should proceed is
needed at the start, and a formula suggested by the European
Council offers grounds for optimism.
The EU is concerned, in the first instance, that Britain settles
its liabilities and meets its other obligations to the EU when it
leaves. The U.K. wants that discussion to happen alongside talks
on future arrangements, so concessions in one area might be
traded against concessions in another. The problem is that the
European Commission has proposed an exit bill of as much as
€60 billion ($63.9 billion), a figure one British minister has called
absurd. If the EU presents these terms on a take-it-or-leave-it
basis, and the British government is unable to justify them to
its citizens, the talks could fail almost before they’ve begun.
The European Council, the body representing EU governments, issued draft guidelines to its negotiators. The overall
posture is firm but fair—and on this issue of sequencing, the
council isn’t ruling out compromise. Describing the first phase
of talks, the guidelines say the council will “determine when
sufficient progress has been achieved to allow negotiations to
proceed to the next phase.”
“Sufficient progress” is sufficiently vague to allow negotiators
to move on to other matters before exit terms are signed and
sealed. The greater the scope for compromise, the better the
prospects of a successful, mutually advantageous result. The
chances of Brexit ending well are poor. But if Europe’s leaders
adopt these guidelines, they’ll deserve some credit for choosing not to cripple the talks from the start. ROGAN WARD/REUTERS
Without room for compromise, the talks will
be doomed almost from the start
Movers
By Kyle Stock
2017
498k
“Stormy weather in
Shortville …”
Tesla CEO Elon Musk mocked
short-sellers in a tweet as his company’s
market value surpassed that of Ford.
MUSK: HECTOR GUERRERO/AFP/GETTY IMAGES; BREADBOWL: JAIMIE DUPLASS/HEMERA/GETTY IMAGES; MORENO: MARIANA BAZO/REUTERS; LYONS: MIREYA ACIERTO/GETTY IMAGES; BANNON: NICHOLAS KAMM/AFP/GETTY IMAGES;
NORTE: JOSE LUIS GONZALEZ/REUTERS; PEPSI: YOUTUBE; ILLUSTRATIONS BY OSCAR BOLTON GREEN; CHICKPEA DATA: USDA
1987
15k
Liberty
Interactive
Hummus fever is
agreed to
sweeping the country
buy General
as U.S. farmers are
Communication,
expected to plant
53 percent more
Alaska’s largest
acres of chickpeas
phone operator,
this year than in
for $2.7 billion.
2016. Consumers
and snackmakers are
Liberty will use
gorging on plantthe deal to help
based proteins.
it reorganize,
combining its cable assets with
its QVC-led home-shopping
business, two units that now
trade separately.
New York City’s
Eleven Madison Park
topped the annual
list of the World’s
50 Best Restaurants,
published by
Restaurant magazine.
Osteria Francescana
in Modena, Italy—
which is still pretty
tasty—slipped to
second.
A federal regulator
ordered Wells
Fargo to rehire
the manager who
reported the bank’s
widespread practice
of secretly opening
unwanted accounts
for customers. Wells
Fargo also has to pay
the whistle-blower
Removing a
major obstacle
to its IPO,
Spotify inked
a licensing deal
with Universal
Music Group.
nt
The arrangement
eep
lets Universal ke
new music off
er
Spotify’s free tie
for two weeks.
$7.2b,
a 20 percent
premium to its market
value. JAB has slowly
amassed a cupboard
of beloved brands,
including Krispy
Kreme Doughnuts,
Caribou Coffee, and
Jimmy Choo shoes.
Amazon.com
struck a
$50m
deal with the NFL to
stream 10 Thursday
night games in
the upcoming
season. They will
be available to
Amazon
Prime’s
60 million
subscribers.
$5.4m
Ups
JAB Holding
agreed to buy Panera
Bread for
On April 4,
Staples shares
surged almost
Lenín Moreno,
Ecuador’s former vice
president and ruling
party leader, was
declared the winner
of a close presidential
election. He’s slated
to take office on
May 24, though
Moreno’s opponent,
conservative
Guillermo Lasso, has
refused to concede
and is demanding a
vote-by-vote review.
15%
as the company
shopped for a private
equity buyer. The
talks come less
than a year after a
federal judge blocked
the company’s
$6.3 billion takeover
of Office Depot.
in damages, legal
fees, and back pay.
13
Downs
Verizon
s
Communications
says it will combiine
AOL and Yahoo!, two
s,
recent purchases
under the name Oath.
O
e
If Twitter jokes are
any indicator, the
ess is
rebranded business
already in trouble.
J.Crew Executive Creative
Director Jenna Lyons is
Di
leaving the struggling retailer
le
after
26 years. Sales at
a
comparable stores have fallen
c
ffor three consecutive years.
Lyons’s deputy, Somsack
L
Sikhounmuong, will become
S
hief design officer.
ch
French presidential candidate Emmanuel
Macron criticized far-right candidate Marine Le
Pen in a tense debate on April 4 in advance of the
April 23 vote, saying, “What you are proposing is
nationalism. …Nationalism is war.”
Eight states and New York City
sued the Trump administration
for delaying energy-efficiency
standards on consumer products
such as ceiling fans. The rules are
now scheduled to take effect six
months later on Sept. 30.
PepsiCo yanked an
ad from YouTube in
which model Kendall
Jenner hands a
soda to a riot officer.
The spot drew
widespread criticism
for trivializing the
Black Lives Matter
movement.
400
Number of stores that Payless ShoeSource plans to close,
according to its bankruptcy protection filing. Payless is the ninth
major retailer this year to seek Chapter 11.
or Trump removed his chief strategist, Steve Bannon, from the
principals committee of the National Security Council weeks after
intelligence officials criticized his participation. Marine Corps General Joseph
Dunford, chairman of the Joint Chiefs of Staff, was reinstated to the group.
Bannon will retain the highest-level security clearance.
Norte, a daily newspape
er
in northern Mexico,
abruptly closed after
27 years, citing recent
killings of journalists from
other news organizations.
More than
40 brands, including
Mercedes, Allstate,
and Bayer have
pulled ads from
21st Century Fox’s
O’Reilly Factor, after
the New York Times
reported the network
paid $13 million to
settle five sexual
harassment
claims against star
Bill O’Reilly.
Ralph Lauren will
close its New York
flagship Polo
store and cut an
unspecified number
of jobs in a bid to save
$140 million a year.
The fashion house
is also abandoning
a plan to build its
own e-commerce
platform.
U.S. auto sales
in March fell far
short of analyst
estimates, as lavish
incentives failed
to sway drivers.
Consumers
are on pace to
buy 16.6 million
vehicles in 2017,
down from the
17.6 million cars
and trucks they
bought in 2016.
More p24
Global
Economics
Guadalajara finds
G
d
a way around
the
th wall
ll 16
6
Le
L Canard
d doesn’t
do s
duck
d k controversy 17
? Brits
s and
d
What Brexit?
Germans are happy
y to
mingle
Mallorca
18
mi l on M
ll
April 10 — April 23, 2017
Th F d K
Swing
p I Eye on
S ck Market
Janet Yellen may be
b leaning
g toward the idea that Wal
Wall Street can be an early economic indicator
PHOTO ILLUSTRATION BY 731; PHOTO: SHANNA BAKER/GETTY IMAGES
“Animal spirits in finan
ancial markets wax and wane”
wa
William Dudley, president of the
he
Federal Reserve Bank of New York,
rk,
has long believed that Fed policymakers should pay more attention
to stock market swings. Now, with
the Fed lifting rates for the first time
in almost 10 years, Dudley, who also
serves as vice chairman of the Fed’s
Open Market Committee, has a chance
to put his ideas into practice.
The Fed has a dual mission: to keep
unemployment low and prices stable,
which it tries to accomplish mainly
by making changes in a key lending
rate, the federal funds rate. To assess
the economy, it examines data such
as monthly reports on the job market
and consumer spending. It doesn’t
put a lot of weight on stock prices,
which can be volatile, plunging and
soaring from day to day, sometimes
for no apparent reason.
rket swings can make
Yet mark
tors feel poorer or richer, influinvesto
ncing their willingness to spend
enci
money. Because that may give an
earlier signal on the direction of the
economy than statistics such as consumer spending, Dudley thinks the
Fed should factor what happens on
Wall Street into its monetary policy
deliberations. If it does—and with the
stock market up more than 10 percent
since Donald Trump’s election—the
Fed could raise interest rates higher,
or more quickly, this year than other
statistics might indicate.
“Animal spirits in financial markets
wax and wane, pushing asset values
up or down in a manner that can more
than offset the effects of movements
in short-term interest rates,” Dudley
said in a speech titled The Importance
of Financial Conditions in the Conduct
of Monetary Policy on March 30.
“The movements in many financial
markets following last year’s presidential election are a notable example of
this phenomenon.”
In the 1990s, while serving as chief
economist at Goldman Sachs Group
Inc., Dudley became intrigued with
work done at Canada’s equivalent of
the Federal Reserve. The country’s
central bankers had a communications
problem: Capital flows in international
financial markets were leading to
swings in the Canadian dollar, affecting the ability of businesses to export
goods and services to the rest of the
world. Those shifts could overwhelm
the Bank of Canada’s attempts to guide
the economy using its traditional tool—
tightening or loosening monetary
policy by raising or lowering the shortterm interest rate—according to
15
Global Economics
16
Charles Freedman, deputy governor
of the bank from 1988 to 2003.
Canadian businesses benefiting from
a weaker exchange rate, for example,
might not get the message the bank
was trying to send by raising rates.
“To get that point across, we developed a ‘monetary conditions index,’
which basically put the two channels
together,” so the public could compare
the economic effects of interest rates
with those of swings in the currency,
says Freedman, who’s now a scholarin-residence at Carleton University
in Ottawa. “Someone could look at
that measure and say, ‘Interest rates
haven’t moved, but the exchange rate
did move, and therefore market and
monetary conditions have eased—or
tightened depending on which direction we’re going,’ ” he says.
The idea caught on fast on Wall
Street, including at Goldman Sachs. In
an October 1996 speech at Princeton,
Dudley argued that “Fed officials should
evaluate carefully the implications of
changes in financial asset prices on
the performance of the real economy,”
according to a summary of his remarks.
He cited indexes that Goldman economists developed to track interest rate
and currency developments in several
countries. Those monetary conditions
indexes owed “a big debt to the pathbreaking work of the Bank of Canada, in
general, and Chuck Freedman, in particular,” he said.
In February 1998, after congressional testimony by then-Fed Chairman
Alan Greenspan, Dudley and his
Goldman team went a step further.
Greenspan told Congress that though
inflation-adjusted interest rates had
risen, “in virtually all other respects
financial markets remained quite
accommodative and, indeed, judging
by the rise in equity prices, were providing additional impetus to domestic
spending.” Those comments spurred
Dudley’s team to add a stock market
measure to their monetary conditions
index, transforming it into a “financial
conditions index.”
Dudley still relies on the index, and
there are signs Fed Chair Janet Yellen
is paying attention. Following the
FOMC’s March 15 rate hike, Yellen told
reporters “the higher level of stock
prices is one factor that looks like it’s
likely to somewhat boost consumption spending,” citing “some of the
more prominent analysts and indices”
that have showed overall financial
conditions are improving, despite
recent rate increases.
One of the analysts she was referring to was almost certainly Jan Hatzius,
who worked for Dudley at Goldman,
helping him to refine the financial conditions index and succeeding him as the
bank’s chief economist in 2005. Hatzius
says if the index continues to indicate
improving market conditions in the face
of Fed rate hikes, officials may decide
to speed up the pace of increases. “The
concern is that financial conditions
are quite easy and we are generating a
sizable positive impulse to growth at a
time when the economy seems to be at
full employment and inflation is close to
the Fed’s target,” Hatzius says.
Some members of the Fed’s ratesetting committee, such as Boston
Fed President Eric Rosengren, are
already making that case. He said in a
March 29 Bloomberg TV interview that
“we don’t want to grow so much faster
than potential at this point” and suggested the situation warranted four rate
increases in 2017.
Ultimately, the Fed will have to see
whether the boost in the mood of the
markets translates to an actual acceleration in consumption, Freedman says.
“Stock markets go up. That in itself is
not relevant,” he says. “What is relevant
is its effect on people’s willingness to
spend.” —Matthew Boesler
The bottom line If the Fed factored the stock
market into its inflation debates, the current
swings would argue for more rate hikes.
Mexico
Give Us Your Coders
Yearning to Be Free
Trump’s visa scare inspires Jalisco
to promote itself as a tech haven
“We’re tolerant and inclusive and
think talent has no borders”
“Poor Mexico, so far from God and so
close to the United States,” the Mexican
dictator Porfirio Díaz once lamented.
But Aristóteles Sandoval, the governor of the northwestern state of Jalisco,
believes that often uncomfortable
Silicon Valley del Sur
Foreign direct investment
in electronics and high-tech
in the Mexican state of
Jalisco, in U.S. dollars
$300m
$200m
$100m
$0
2014
2015
2016
DATA: JALISCO GOVERNOR’S OFFICE
proximity creates a unique opportunity
in the time of Donald Trump. Sandoval
has been courting tech companies in
the U.S., telling them that if the new
administration won’t issue visas to the
foreign engineers and coders they want
to hire, he’ll gladly find cubicles for
them in Guadalajara, the state capital.
“We’re tolerant and inclusive and think
talent has no borders,” says Sandoval,
sleeves rolled up and hair slicked back,
as he sits at his desk in Casa Jalisco, the
governor’s mansion. “Brilliant minds
will always have a place here.”
That should be interpreted as a dig
at President Trump, who’s alarmed
the tech industry with orders to ban
immigration from some mostly Muslim
countries and freeze the expedited processing of H-1B visas for skilled workers.
Sandoval, who toured San Francisco
and Silicon Valley in February, says he
talked with more than 40 executives,
from companies including Microsoft
Corp., who were “very interested.” The
companies declined to comment.
After being elected governor in 2013,
Sandoval set up a state Ministry of
Innovation, Science, and Technology to
promote Jalisco’s capital as a technology hub. As much as 40 percent of the
workforce in Guadalajara, which has a
population of 1.5 million, is employed
in the industry. Several U.S. tech companies already have research centers,
factories, or satellite offices in the picturesque city, which is a four-hour flight
from San Francisco.
Foreign direct investment in electronics and other tech segments totaled
more than $271 million in 2016, up from
$75 million the previous year, according
to data collected by Sandoval’s office.
“We have academia, private businesses,
and government. There’s an excellent
relationship among all. This communication allows us to plan better and
Global Economics
to America as migrant fieldworkers.
The 182 people on Wizeline’s payroll
in Guadalajara hail from more than
10 countries, including Egypt and
France. The open-plan office has a
Silicon Valley vibe, with pingpong and
foosball tables. Employees get around
on scooters and enjoy free meals.
Sandoval will brag about Guadalajara
for as long as anyone cares to listen.
“We have everything—great universities, golf courses, excellent shows, you
name it,” he says. The surfing paradise
of Sayulita is a four-hour drive west, and
there’s no shortage of tequila, which
has been made for centuries from the
agave plants that blanket fields not far
from the city limits.
The governor could be onto something, says Gary Burtless, a senior
fellow at the Brookings Institution who
researches labor markets. If he can
“siphon some of those would-be immigrants from the U.S., that’s great news
for Mexico.” —Andrea Navarro
Intel’s campus in
Guadalajara
The bottom line A Mexican governor is telling U.S.
tech companies to open offices in Guadalajara to
get around Trump’s immigration ban.
17
Elections
HECTOR GUERRERO/BLOOMBERG (2)
Software maker
Wizeline employs
182 in the city
receive more investment,” says Cesar
Castro, the Guadalajara-based logistics director at Jabil Circuit Inc., a
company based in St. Petersburg, Fla.,
that designs and manufactures electronics in Mexico, as well as in Singapore
and China, for Apple, Cisco Systems,
and HP, among others.
U.S. companies started setting up
factories in Jalisco in the 1970s to take
advantage of lower labor—wages are
about a third of those in Silicon Valley—
and government subsidies for construction licenses and property taxes.
Much of the activity is still in exportoriented assembly and manufacture,
but some software makers, including
International Business Machines and
Oracle, have campuses rivaling those
up north. Intel’s 25-acre engineering
center is its largest in Latin America,
employing 1,400 workers.
Sandoval hasn’t released details of his
plan to turn Guadalajara into a Silicon
Valley satellite, and it’s unclear just
how it would work. “The governor’s
openness is headed in the right direction,” says Jesús Palomino, who runs
Intel’s Guadalajara design center. “The
message is excellent, but how to go
about it will be a challenge.”
Mexican immigration laws wouldn’t
pose an obstacle for someone from,
say, India who wants to work in
Guadalajara for a company headquartered in Seattle, says Edgar Mayorga,
an immigration lawyer at Goodrich,
Riquelme y Asociados AC.
Bismarck Lepe, founder and chief
executive officer of Wizeline Inc., a
business applications and software provider based in San Francisco, says he
opened a Guadalajara office in 2013
because the U.S. had gotten “way too
expensive.” It was a return to his roots:
Lepe’s Mexican-born parents came
The Duck That Clipped
Fillon’s Wings
Paris’s top newsbreaker is satirical
weekly Le Canard Enchaîné
“Our job is to inform and distract
readers with newsprint and ink”
Political discourse around the world
tends to be driven by sober media
stalwarts like the Washington Post,
the Times of London, or Germany’s
Frankfurter Allgemeine Zeitung. In
France, the star of the show is an
eight-page weekly that features excruciating puns for headlines, irreverent
cartoons depicting political grandees
as dwarves or devils, fake news such
as imagined diaries—and real scoops
that have laid low countless power
brokers over the decades. On Tuesday
nights, before Le Canard Enchaîné
(“the Chained Duck”) hits the streets,
political and media elites across Paris
flock to the paper’s offices just a few
steps from the Louvre to get an
Global Economics
Giscard’s candidacy two years later.
In 1993 socialist Prime Minister Pierre
Bérégovoy committed suicide after
Le Canard reported that he’d gotten a
1 million-franc interest-free loan from
an industrialist—a scandal that led to
the party’s defeat in parliamentary
elections. “Fortunately, Le Canard is a
weekly,” President François Hollande
said at a February cabinet meeting—
according to the paper itself. “If it were
a daily, imagine the situation we’d be
in.” —Alexandre Boksenbaum-Granier
and Geraldine Amiel
The bottom line Le Canard Enchaîné can lay low
France’s rich and mighty with satire, bad puns,
and aggressive investigative reporting.
Travel
A German, a Swede, and
A Brit Walk Into a Hotel …
Thomas Cook ends segregation
by nationality on package tours
“Most people are now willing to
mix if the mix is right”
For decades, Thomas Cook Group Plc
had a policy of assigning each
European nationality its own hotels at
popular destinations such as Spain’s
Canary Islands and the beaches of
Greece. On March 28, Britain’s biggest
tour operator announced the rule
is history, just hours before Prime
Minister Theresa May formalized the
U.K.’s decision to quit the European
Union. From now on, Cook said,
Britons, Germans, Swedes, and other
continentals will be bunking together
while on holiday.
The change is the result of a survey
that showed that most Cook clients
would be happy to vacation with a
cross-section of travelers. “We’ve
FROM TOP: PHOTO ILLUSTRATION BY 731; PHOTO: PATRICK KOVARIK/AFP/GETTY IMAGES; ILLUSTRATION BY 731
18
early bead on scandals
rates of French 10-year sovereign
taking flight.
bonds and Germany’s benchMixing facts, half-truths,
mark bund hit a four-year high
and off-color jokes, Le Canard
amid growing concern about
(as everyone calls it) presents
a potential victory for Le Pen,
details of behind-the-scenes
who’s questioned France’s membership in the European Union
machinations that readers perand threatened to revive the
ceive as more accurate and
ffra
anc as the national currency.
less filtered than what’s pub“ we have to check Le Canard
“Do
lished by its mainstream
every Wednesday?” asks
rivals. As campaigning has
Pierre Martin, a trader at Saxo
picked up for presidential
Bank A/S in London. “Yes.
elections this spring, the
Undoubtedly.”
paper has broken dreamGoing into this election season,
shattering stories week after
Fillon
the biggest concern of the French
week. In January it reported that
political establishment was that fake
conservative presidential candidate
news might overrun Facebook and help
François Fillon had employed his wife
propel Le Pen to a populist triumph.
in a no-show job for years—sending his
Instead, Le Canard has garnered attencampaign into a tailspin and his poll
tion with investigative stories that have
numbers into the dumpster. Playing
hobbled the candidacy of the erstno favorites, Le Canard has also pubwhile favorite Fillon. The publication
lished details of a taxpayer-funded trip
followed its scoop on Fillon’s wife,
to Las Vegas by center-right candidate
Penelope, with another alleging that
Emmanuel Macron during his tenure
his children had similar arrangements
as economy minister, and targeted
in the Senate. And in March, Le Canard
nationalist leader Marine Le Pen, most
recently with an April 5 report on inves- revealed that a Lebanese tycoon had
paid Fillon $50,000 for an introduction
tigations of an associate for alleged
to Vladimir Putin.
misuse of public funds. “Le Canard is
The newspaper has something of
neither right nor left, but rather in the
the sensibility of the Onion in the U.S.,
opposition,” says editor-in-chief Louishammering away at the foibles and
Marie Horeau. “We’ve never been the
failings of the rich and powerful with
vassal of any party.”
Le Canard’s power is all the more sur- tongue-in-cheek stories and illustrations. But Le Canard does more than
prising in an era when online upstarts
spoof: Its 30 editors and reporters milk
such as Politico, the Huffington Post,
and BuzzFeed have an increasingly pow- a network of tipsters reaching into the
highest echelons of French society.
erful voice. While Le Canard’s closely
The staff-owned weekly carries no
watched Twitter feed, with almost
advertising, and controversial stories
400,000 followers, lights up every
Tuesday with a handful of teasers on
are often unsigned—making it harder
that week’s stories, anyone wanting to
for the elite miscreants exposed
each week to exact revenge. With a
read them must visit a newsstand. The
weekly circulation of about 400,000
century-old paper does have a website,
copies selling for €1.20 ($1.30) each,
but just barely: The landing page features its logo with the slogan “A palm
Le Canard in 2015 reported €25 million
in sales and profit topping €2 million.
in the cyber-sea … but only one” and
Founded in 1915, the paper has
little more than links to images of front
pages on which you can read headlines, a long record of political and business scoops. In the 1920s it took aim
but not articles. “Our job is to inform
at Banque Oustric—a shady collection
and distract readers with newsprint
of shaky investments assembled by a
and ink,” the website says.
tycoon named Albert Oustric—helping
The paper’s reports—typically sprinpush the bank into insolvency and
kled with political gossip and details of
taking down a finance minister impliprivate conversations such as Fillon’s
cated in the affair. In 1979 the paper
questioning by a judge about renovareported that conservative President
tions at a château he owns—are increasValéry Giscard d’Estaing had accepted
ingly credited with moving markets.
diamonds from the African dictator
As the Fillon story gained steam in
Jean-Bedel Bokassa, helping scuttle
February, the spread between interest
*CUSTOMER NATIONALITY DATA IS FOR 2016; DESTINATION DATA IS FOR THE 2016 SUMMER SEASON ONLY; DATA: THOMAS COOK
Despite Brexit,
Thomas Cook is
pushing for more
unity in Europe
exposed a myth that Germans want
to be with Germans and Brits with
Brits,” Chief Executive Officer Peter
Fankhauser told reporters in London.
“Most people are now willing to mix if
the mix is right.”
Cook, which has units in Belgium,
Britain, Germany, and Scandinavia,
found that 90 percent of the customers it polled have no problem rubbing
shoulders with sun seekers from
other countries. The company plans
to ensure that no single nationality
accounts for too great a proportion of
the occupants of most hotels, sprinkling in Nordic travelers—viewed as the
most congenial—to lighten the mood
where needed. The move suggests that
Britons have become less fretful that
early-rising Germans might lay claim to
the best sun loungers with strategically
placed beach towels and that continental tourists no longer view U.K. travelers as boorish beer swillers. For Cook,
the shift will likely help “fill empty
rooms in destinations in the western
Mediterranean where it boosted capacity too much” following terror attacks in
MBA
Programs
• Full-time
• Part-time
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grad.business.uconn.edu
Global Economics
Turkey, says Stuart
Gordon, an analyst
at Berenberg Bank
9m (est.) in London.
Germans
Britons
5.8m
As part of
Scandinavians
1.6m the change, the
Other Europeans 4.2m 176-year-old
tour operator is
… And Where to* expanding the
target audience
Greece
17% for packages sold
Balearic Islands
16% via two Nordic
Canaries
14% brands—family13% oriented Sunwing
Turkey
Other
40% and adults-only
Sunprime—as it
seeks to lure wealthier clients. Since
Sunprime opened the Monsuau Hotel
on Spain’s Mallorca to travelers from
Britain and Germany two years ago,
the 109-room hotel has garnered
customer feedback scores that are
among the group’s best. Fankhauser,
though, says there are limits to openmindedness. Magaluf, a Mallorca
resort known for British bachelor
parties, fish-and-chips shops, and Irish
pubs, will likely remain the province
Who’s Booking …
of vacationers from the U.K. And Cook
will continue to steer non-Germans
away from hotels across the bay in
Playa de Palma—sometimes called
“the 17th German state” and known
for Oktoberfest-style beach tents.
The policy shift doesn’t mean Cook
isn’t unaffected by Britain’s plans to
quit the EU. The slump in the pound
following last year’s referendum has
increased hotel costs, which Cook is
“trying to pass on to the customer,”
says Christoph Debus, who heads the
group’s airline operations. With fewer
euros to spend once they get overseas,
some Britons who would once have
booked a two-week break are vacationing for 10 days instead, he says. Brexit
has had “an impact,” Debus says.
“But it has been more in travel habits,
rather than people staying away.”
—Christopher Jasper
The bottom line Britain’s biggest tour operator
says most vacationers don’t mind rubbing elbows
with people from other cultures on holiday.
Edited by Cristina Lindblad and David Rocks
Bloomberg.com
“ I know my degree
will set me apart
in the corporate
competitive
landscape. ”
Leonard Borriello ’18 MBA
Companies/
Industries
Liquefied natural gas
is keeping shipbuilders
afloat 23
Trump wants more
auto plants, but sedan
sales are skidding 24
H&M grows up and
adds brands 26
PHOTO ILLUSTRATION BY 731; PHOTOS: GETTY IMAGES (3)
April 10 — April 23, 2017
Ho M ch Is
?
New one-shot med
edic
icines could eliminate years
ic
rss of costly care
e
“So $1 million upfront … that’s not much, if they’re healed for life”
Sofia Priebe, 14, is slowly going blind.
Her parents were devastated when
they were told there’s no treatment
for the genetic mutation that’s causing
her retinas to deteriorate. For the
dozen years since Sofia received that
diagnosis, her mother has lived every
parent’s nightmare—being powerless to
help her suffering child.
Now a gene therapy for a similar
form of blindness is expected to receive
U.S. Food and Drug Administration
approval this year, and Laura Manfre,
Sofia’s mom, is holding out hope that
her daughter may soon get treatment
as well. “We don’t really care what it
costs,” she says.
But how much is a miracle really
worth? A million dollars? Five million?
More? And who will pay and how?
It’s one of the most vexing challenges
confronting drug and insurance companies as modern medicine advances,
spurred by research on the human
genome. Spark Therapeutics Inc.,
which developed the gene therapy to
cure a rare form of childhood blindness called RPE65-mediated inherited retinal disease, is among the
first to face this question. Spark’s
treatment, voretigene neparvovec,
delivers a functioning piece of DNA
directly to the eyes to preserve
remaining sight and even restore some
vision. Other companies, including
GlaxoSmithKline Plc and BioMarin
Pharmaceutical Inc., have also been
grappling with the pricing problem.
Some new treatments, such as
Spark’s retina drug, are intended to
work with just one shot—promising
a lifetime cure from a single, costly
treatment. Insurers don’t dispute the
worth of cures in the pipeline but
say they’re not equipped to pay one
large sum upfront. The U.S. healthcare system is built around managing symptoms with prescriptions
that insurers pay reimbursements
for monthly: For example, medicines
such as cholesterol-lowering Lipitor
or acid-reflux drug Nexium are often
taken over a period of many years and
don’t deliver a permanent fix.
Insurers are “used to paying rent
for health, and we’re asking them to
buy a houseful of cure,” says Mark
21
Companies/Industries
22
Trusheim, a visiting scientist at MIT’s
for life,” Bienaime says, adding that
Sloan School of Management who’s
BioMarin hasn’t decided how to price
leading a working group to explore
its drug, which is going through trials.
financing models for upcoming drugs,
MIT’s Trusheim is considering
drawing from examples in the housing
more radical payment plans, such
market and activist hedge funds.
as having the U.S. government buy
Spark Chief Executive Officer Jeff
an entire company instead of paying
Marrazzo sees his company’s pricing
for its drugs. “The government could
decision as precedent-setting, as it
sell off the research and developwould be the first gene therapy “Why is it that there ment arm of a company, like
approved in the U.S. Spark
are not more cures? a Carl Icahn,” he says, referIt’s not because
has spent about $400 million
ring to activist investors
there are bad actors.
to create the treatment and
who take over corporations,
It’s an industry full
now wants to be compensated of people who
often selling off units that
react to incentive
for the efforts and huge risks
they deem peripheral. The
structures.”
it took during the research
idea is to then have the feds
—Spark CEO
and development phase. How Jeff Marrazzo
provide the drug to Medicare
the payment debate plays
and Medicaid patients and
out will determine not only
charge commercial insurers
whether patients will be able to gain
a cheaper price than they likely
access to these treatments but also how would have paid to a for-profit private
hard drugmakers will push to develop
company.
other transformative medicines. “Why
Other ideas that his group is invesis it that there are not more cures?”
tigating include government grants
Marrazzo says. “It’s not because there
or prizes to developers of cures, or
are bad actors. It’s an industry full of
volume-purchase commitments such as
people who react to incentive structhose used by the Bill & Melinda Gates
tures.” If compensation could be redeFoundation in developing nations,
signed to reward one-time treatments
which guarantee manufacturers that
over chronic treatments, “that’s where
a minimum amount of a drug will be
people would play,” he says.
bought if they successfully develop it.
One idea under consideration is
Trusheim’s group plans to publish its
to spread payments from insurance
recommendations by early next year.
companies to drugmakers over years,
When designing payment models,
like an annuity. Another is to have a
the size of the patient population
money-back guarantee, so if a drug or
matters: The larger the potential
treatment stops working for a patient,
impact, the more the system will strain
the manufacturer is on the hook to
to deal with the huge cost of one-time
refund part of the cost to the insurer.
cures. That’s what Gilead Sciences
Payback contracts, or “value-based
Inc. learned in 2015, when it launched
pricing” in pharma industry parlance,
a cure for hepatitis C at $84,000 for a
are already used in Europe. In the U.S. three-month regimen, or $1,000 a pill.
they’re trickier to execute, because
For anyone facing the prospect
there isn’t a single payer with which
of liver cancer or a liver transplant,
to negotiate and patients frequently
that $84,000 is a very good value,
switch insurance plans throughout
says Jim Meyers, Gilead’s executive
their lives. Jean-Jacques Bienaime,
CEO of BioMarin, proposes creating
legislation requiring patients to carry
Leadiant Biosciences’ pricey long-term
drug, Adagen, has an annual cost of about
the reimbursement obligation with
them when they change jobs or insurers, to ensure drugmakers continue
to be paid. BioMarin is working on a
gene therapy for the blood disorder
to treat the “bubble boy disease,” while the
hemophilia, which Bienaime argues
Strimvelis gene therapy by GlaxoSmithKline runs
is easily worth millions of dollars per
patient for a cure.
“The average cost of severe hemophilia A is about $500,000 a year, so
$1 million upfront would cover two
years—that’s not much, if they’re healed for a single-shot treatment.*
$320k
$634k
vice president for global commercial
operations. The price was in the ballpark of existing treatments, and
“there wasn’t a payer we spoke to in
market research that felt a price in
the $80,000 to $85,000 range wasn’t
acceptable,” he says.
The drug proved immensely
popular—far beyond Gilead’s
expectations—thanks to a quick
endorsement by the American
Association for the Study of Liver
Diseases. About 3 million Americans
have hepatitis C, and many wanted
the cure immediately. “We started to
see a flow of patients well above what
any of us anticipated, and a price that
made eminent sense to payers suddenly
didn’t make sense,” Meyers says.
Rather than winning kudos for
treating an intractable malady,
Gilead quickly became a poster child
for high drug prices, an image it’s
fought to shed for the past two years.
Meyers warns that the backlash has
already spooked others. “What I
hear is that they call it ‘the Gilead
HCV experience,’ and by that they
mean everything that it entails: the
publicity, scrutiny, the payers first
accepting then reacting, the Senate
Finance Committee,” says Meyers.
“I’ve heard, ‘Why bother?’ ”
Such market realities may already
be reflected in new-drug prices. When
GlaxoSmithKline brought its Strimvelis
gene therapy to market in Europe
last year for the “bubble boy disease”
that leaves children without an effective immune system, it picked what’s
arguably a bargain price: €594,000
($634,000) for the one-time treatment,
equivalent to two years of the enzyme
replacement therapy that patients
previously had to take for a lifetime.
Martin Andrews, Glaxo’s senior
vice president for rare diseases, notes
that the drug could have been valued
higher, but he says the company
had to bow to economic realities,
including the big deficits in European
governments’ health budgets. “We
didn’t want to have the world’s most
expensive therapy that nobody ever
used,” he says.
Spark has a few more months to put
a price tag on reversing progressive
vision loss. Employees are researching
court cases involving the value of sight.
“How has our judicial system awarded
for damages in the case of patients who
Hyundai
Heavy
Industries
20k
Shipbuilding industry jobs lost in the last year
SEONGJOON CHO/BLOOMBERG; *COST INFORMATION FROM GLAXOSMITHKLINE. STRIMVELIS ONLY AVAILABLE IN EUROPE
have lost their vision?” asks Marrazzo.
“That’s basically everyday Americans
sitting on a jury and answering this
question in a way that you can’t purely
do with hard and fast economics.”
Whether that will help its drug reach
the market without consumer or government blowback remains to be seen.
—Caroline Chen
The bottom line Spark Therapeutics has spent
$400 million developing a blindness cure. What’s
unclear is how to price the breakthrough.
Shipping
Finally, Some Good
News for Shipyards
Demand for vessels to transport
natural gas is expected to jump
“Gas is going to be the bright spot
for shipbuilders”
The global shipyard business has
fallen on hard times as China’s trade
has grown more slowly and demand
for offshore drilling platforms and oil
tankers has declined with the halving
of oil prices in the past three years.
Shipbuilders cut more than 20,000 jobs
in the last year alone. But now builders
of oceangoing vessels are seeing a
glimmer of hope from an unlikely
corner of the energy world: natural gas.
Contracts for vessels to transport
liquefied natural gas are picking up
amid an abundance of shale gas in the
U.S. and increasingly stringent global
curbs on pollution that are pushing
utilities and transportation operators
toward the clean-burning fuel.
LNG is made by cooling natural
gas until it becomes a liquid, which
can be carried over long distances in
specially built ships with insulated
tanks. Annual global LNG production
capacity is expected to increase
39 percent, to 377 million tons by 2019
from 272 million last year, according
to Bloomberg New Energy Finance.
Shipments of LNG could rise as much
as 5 percent a year from 2015 to 2030,
Royal Dutch Shell Plc estimates.
To move the fuel, the world may need
180 more vessels, which would benefit
shipbuilders with LNG expertise such
as Hyundai Heavy Industries Co.
and Daewoo Shipbuilding & Marine
Engineering Co., says Hana Financial
Investment Co. in Seoul. “Gas is going
to be the bright spot for shipbuilders,”
says Park Moo-hyun, a Hana analyst.
“We might see a spurt of orders as early
as in the second quarter.”
Asia is the largest destination for LNG,
with much of it bound for China and
India. China’s gas demand is expected
to more than double, to 450 billion
cubic meters, by 2030, according to
Shell’s LNG Outlook. Earlier this year,
China said it plans to halt, delay, or
eliminate no less than 50 gigawatts of
coal-fired power projects as part of its
move to clear the smog choking cities
from Beijing to Xi’an.
The world’s three biggest shipyards,
all based in South Korea, have as much
as 80 percent of the LNG tanker market,
Park says, but the entire industry could
use the help from growing demand for
gas. Declining orders for other types
of vessels and offshore rigs have led
to losses or profit drops at shipyards
including Hyundai Heavy, Samsung
Heavy Industries, and Singapore’s
Keppel, forcing them to trim production capacity and slash employment.
Japan’s Mitsubishi Heavy Industries
Ltd. is considering spinning off its shipbuilding operation, and Kawasaki
Heavy Industries Ltd. said it’s reviewing whether to continue in the business. Daewoo Shipbuilding, the world’s
largest shipyard, is waiting for a second
conditional lifeline from its two biggest
creditors to complete work on pending
orders and to help stay afloat. The
lenders say they’ll provide loans and
swap some debt for equity only if other
creditors and bondholders agree to
restructure their own debt exposure.
23
Companies/Industries
24
Better times could be ahead.
In March, Hyundai Heavy agreed to
build one LNG ship for a Norwegian
customer, and Daewoo Shipbuilding
secured a 414.4 billion won
($369.4 million) order from a European
client to build two LNG carriers, with
an option for two more. These are in
addition to orders for six such vessels
that Hyundai Heavy and Daewoo
Shipbuilding won last year.
Along with boosting the market for
tankers, the LNG boom has helped
shipyards gain contracts to build small
offshore facilities known as floating
storage and regasification units.
Demand is even picking up for LNG
tankers that run on LNG. In March,
Hyundai Heavy’s Hyundai Samho
unit received a $240 million contract from Russian shipping company
Sovcomflot OAO to build four crude
tankers powered by LNG—the first
carrier ships powered by the fuel.
One reason for such innovations: The
International Maritime Organization
has cut limits on sulfur in marine fuels
to 0.5 percent from 3.5 percent, effective 2020. LNG emits virtually no sulfur.
“We are just now entering the boom
era for LNG carriers,” Park says. “Not
all shipyards will benefit. Shipbuilders
that can deliver vessels that can help
operators lower costs will be the
winners. It’s all about cutting costs.”
—Kyunghee Park, with Dan Murtaugh
The bottom line The ailing shipbuilding industry
cut more than 20,000 jobs last year. Demand for
vessels to carry natural gas could ease the pain.
Autos
The Real Cause of the
U.S. Car Slide: SUVs
The consumer shift means more
U.S. car plants aren’t necessary
“Higher incentives have pushed
demand about as far as it can go”
Ford Fusion: down 37 percent.
Chevrolet Malibu: down 36 percent.
Toyota Prius: down 29 percent. As
those grim sales numbers suggest, the
U.S. auto industry was blindsided in
March by just how fast sedans have
fallen out of favor with Americans
Year-to-date change in sales
Top-selling SUVs in the U.S., as of March
Nissan Rogue
47%
Honda CR-V
32%
Ford Escape
6.6%
Toyota RAV4
5.8%
Ford Explorer
–1%
Top-selling sedans in the U.S.
Honda Civic
–6.5%
Honda Accord
–9.4%
Toyota Corolla
–9.7%
Nissan Altima
–13%
Toyota Camry
–13%
DATA: AUTODATA
enthralled with roomier sport utility
vehicles. The swerve in consumer taste
is just one of the forces—along with
slumping used-car values and a pullback in subprime auto lending—changing the equation for automakers as
President Trump leans on the industry
to build plants to boost hiring. That
will be hard to pull off, though: A
glut of both new and used vehicles
on the market has sparked an incentives battle, meaning new factories—
particularly for sedans—are the last
thing the nation’s carmakers need.
Automakers set a record in the U.S.
last year, with 17.6 million vehicles sold.
Analysts had projected the annualized
sales pace in March to hit 17.2 million
vehicles. Instead, adjusted for seasonal trends, it came in at 16.6 million,
according to researcher Autodata
Corp. “It shouldn’t be a surprise,” says
Morningstar Inc. analyst David Whiston.
“Once you hit peak sales, it seems like
you only have bad news ahead.”
Ample discounts have failed to spur
demand for such aforementioned
models as General Motors Co.’s
Malibu and Ford Motor Co.’s Fusion,
which are being surpassed by SUVs
as the vehicle of choice for American
families. Toyota Motor Corp.’s Prius
sedan model continued its slump
despite a thorough makeover in late
2015 that improved the esteemed
hybrid’s ride.
It was a markedly different story for
big SUVs and their smaller crossover
brethren, which are keeping the industry’s profits afloat. In March, sales
of crossovers including the Honda
CR-V, Chevrolet Equinox, and Dodge
Journey were up 11 percent, according
to Autodata. With an average sticker
price of more than $38,000, a truck or
SUV costs about $10,000 more than
the average car. The incentives needed
to sell them amount to an 8.8 percent
discount, compared with 11 percent
for cars, according to researcher
Edmunds.com Inc.
Still, dealer inventories are high in
the U.S., and even SUVs increasingly
need more and more discounts to
keep sales moving, as many brands try
to stay close to 2016’s record results.
“Higher incentives have pushed
demand about as far as it can go,” Joe
Spak, an auto analyst with RBC Capital
Markets, wrote in a recent report.
While industry sales probably won’t
fall by much, profits could slip as automakers cut production, causing them
to operate factories less efficiently. So
Trump will have a hard time getting
manufacturers to pony up for the
investment he’s been demanding, even
with consumer confidence strong and
unemployment low. “You’re not going
to see the U.S. get new plants,” says
Mark Wakefield, who heads the automotive practice for consulting firm
AlixPartners. “The market went from
pull to push nine months ago. We don’t
see it going upward from here.”
Since last year, GM has been
making cuts at passenger car plants
in Michigan and Ohio, eliminating
more than 3,000 workers who build
Chevy Cruze compacts and Impala
sedans. In January, after deciding it
didn’t need to boost output of its Focus
compacts, Ford canceled plans to build
a $1.6 billion factory in Mexico.
Wakefield projects overall sales will
slip by about 300,000 vehicles this
year, as a cyclical decline of 15 percent
to 20 percent begins. “When it drops, it
drops sharply,” he says.
That may be why Trump’s call for a
resurgence of auto plants in the U.S.
to fuel his “new industrial revolution”
is finding its biggest support from an
unlikely source: foreign carmakers
still building their U.S. presence. Volvo
Cars, the premium brand long known
for Swedish style and safety that’s now
owned by Chinese billionaire Li Shufu’s
Zhejiang Geely Holding Group Co.,
is erecting in Charleston, S.C., its first
U.S. assembly plant. Starting with
2,000 workers next year and creating
more than 8,000 jobs in the area, it
plans to make S60 sedans and another
model, with half of them for export.
Companies/Industries
The bottom line U.S. auto sales could slide by
300,000 vehicles this year, dimming Trump’s hope
that car plants will be opened.
Fashion
The Taming of a
Teen Emporium
Seeking a broader customer
base, H&M is creating brands
Hitting “a point where it becomes
challenging to keep up growth”
26
At the H&M store on Boulevard
Haussmann in Paris, teens comb racks
packed with velour tank tops as tourists
load up on cheap jeans to a soundtrack
of bouncy pop music. While the bustle
and bargains once appealed to Pierrick
Beringer, at age 35 he prefers quality to
quantity, so these days he’s more likely
to turn the corner to a store called COS,
where the pace is far calmer. “I like
the shape,” the hairstylist says, pulling
a thick-cotton T-shirt from a display.
“And it’s less well-known, so you don’t
see it everywhere.”
For H&M, that’s not a problem,
because both establishments are
creations of Hennes & Mauritz AB.
Faced with falling profit amid competition from rivals such as Zara and
Primark Stores Ltd., as well as online
players like Amazon.com Inc., the
Swedish retailing juggernaut is beefing
up its portfolio of niche brands. H&M
is betting outlets such as COS can help
for two-thirds of Inditex revenue, it
expand its appeal beyond budgetcomprises just one-third of the comconscious young shoppers. The plan
pany’s 7,300 stores. H&M, by contrast,
is to add 80 stores from the company’s
only started diversifying in 2007, when
half-dozen smaller brands this year, vs.
it created COS—or Collection of Style.
350 more H&M outlets. That includes a
It added three more youth-oriented
new concept called Arket, a higher-end
concepts in 2008 with the purchase of
shop with clothing, home goods, and
a Scandinavian retail group, then introa cafe serving Scandinavian-inspired
duced the premium women’s wear line
dishes. The first Arket store—the name
& Other Stories in 2013. Those brands
means “sheet of paper” in Swedish,
today make up less than 10 percent of
a reference to starting with a blank
the company’s almost 4,400 stores.
slate—is scheduled to open this fall on
While H&M doesn’t break out its
London’s Regent Street, followed by
revenue, Bryan, Garnier & Co. analyst
branches in Brussels, Copenhagen, and Cédric Rossi says sales from the smaller
Munich. “This isn’t like anything else
brands account for about 5 percent of
the total.
we have,” says H&M Chief Executive
The new concepts aren’t a bad idea,
Officer Karl-Johan Persson. “It’s a completely different expression.”
Rossi says, but it’s more important to fix
the flagship brand. He says Zara is more
The push beyond the flagship brand
fashion-focused, and with factories in
comes as H&M’s margins have been
narrowing. Goods from Asian suppliers, or near Europe, Inditex can respond
faster to runway trends than H&M,
priced in the strengthening U.S. dollar,
which ships most of its goods from
have become more expensive, pushing
Asia. “What’s absolutely necessary is to
net profit down to 9.5 percent of sales
return to growth in existing locations
today, vs. almost 26 percent in 2007.
at H&M,” Rossi says. “Without this, the
And with increasing competition, H&M
business isn’t sustainable.”
has had to resort to deeper discounts
H&M says it’s working to reduce lead
to clear its shelves. The company’s
times so fresh products get to stores
shares in March fell to their lowest
more quickly. And it says it’s automatlevel in four years after H&M reported
ing warehouses and improving data colinventory levels were up 30 percent
lection so shortages and overruns can
year-on-year. “When you’ve got a very
mature brand, you reach a point where be addressed more quickly—reducing
the need for margin-busting markit becomes challenging to keep up
downs. “We haven’t been as precise,
growth,” says Maureen
A COS store, more
exact, and flexible as we could have
Hinton, an analyst
minimalist than
H&M and targeting a been” in logistics, says CEO Persson.
at GlobalData Plc in
different niche
“We see big improvement potential.”
London. “You’ve got to
Longer-term, though, it’s smart to
find new markets and new customers.”
also find a broader customer base,
That has spurred the multibrand
says Anne Critchlow, an analyst at
effort, which largely emulates a stratSociété Générale SA in London. With
egy the world’s No. 1 fashion retailer,
Inditex SA, has pursued since 1991.
COS, & Other Stories, and now Arket,
the company can target different
The Spanish company owns Zara
niches at the top end—where customand seven other brands including the
ers have more resources and prices
Italian-themed Massimo Dutti, teenfocused Bershka, and Oysho lingerie
are higher, she says. Dresses at COS
stores. While Zara continues to account start at €55 ($59), compared with €10
at H&M, while the cheapest jeans at
COS are €69, vs. €20 at H&M. “Young
value fashion has become extremely
crowded,” Critchlow says. “Lifestyle
retailers have less competition.”
—Robert Williams, with Anna Molin
The bottom line As competition heats up and
margins narrow, H&M is emulating the multibrand
store strategy of its rival Inditex.
Edited by James E. Ellis and David Rocks
Bloomberg.com
COURTESY COS
Volvo’s U.S. sales have grown
53 percent since Geely bought it from
Ford in 2010. But like its U.S. counterparts, Volvo’s growth has come from
SUV models, which saw sales increase
31 percent last year, while its car deliveries fell by 7.1 percent. —David Welch
and Jamie Butters, with Melinda Grenier
Politics/
Policy
The
Investigators
In December, President Obama
ordered the CIA, FBI, and NSA to
conduct a review of hacking that took
place during the 2016 election. In
January they released a report that
pointed directly to Russia.
The FBI continues to dig into the extent
to which Trump associates had contact
with Russia. The Senate Intelligence
Committee is pushing on with its inquiry
into Russian interference and whether
Trump associates played a part.
Took $45K to sit with Putin at a 2015 gala
House Intelligence Committee
Mired in partisan squabbling over whether or not
to focus the probe in part on alleged misuse of
intelligence by Obama administration officials
Schiff (D-C
De
v
m
es
Nun (R-C
in
if.)
al
Ad
a
mir Put
adi
in
Vl
if.)
al
Chair
C
According to the
intelligence report,
the Russian president
ordered an operation
to influence the U.S.
election in Trump’s
favor and undermine
the democratic process
The two committee leaders vow not to politicize what
they pledge will be a thorough probe
urr
rd B (R-N
ha
.)
.C
DNC
hack
arner (DV
kW
a.)
Fake news
stories
Senate Intelligence Committee
Ric
28
How
Will
They
Know,
And
When
Will
They
Know
It?
The
Hack
Ma
r
April 10 — April 23, 2017
Chair
Federal Bureau of Investigation
In March agency chief Comey confirmed the
existence of an ongoing investigation of Russia’s role
and Trump campaign contacts with Moscow
Stateowned RT
network
Russian
trolls
Twitter
bots
Guccifer
2.0
Co
mes mey
Ja
The hacker name
under which
the DNC emails
were released
The FBI director may be
asked to testify before
the Senate as part of its
investigation
WikiLeaks
The U.S. Senate seeks to discover whether Trump associates knew of Russia’s interference
“This is not fake news. This is actually what happened to us”
ICE community
relations jobs are being
turned upside down 30
lly Yates
Sa
The Russian
Connections?
Since House Intelligence Chair
Devin Nunes canceled some House
hearings, there’s uncertainty over
when key figures will testify. The
Senate has scheduled interviews
with some 20 people so far.
ael Flyn
ich
n
M
Brought into the
White House by Flynn
Democrats want to
hear from the former
acting attorney general,
who warned the White
House over Flynn’s
discussions with
Russian Ambassador
Sergey Kislyak
Forced out as national
security adviser over
Russia contacts, wants
immunity to testify
Michael
Ellis
A lawyer in the
White House
J
Session
eff
Attorney general
recused himself from
the investigation
because of his contact
with Kislyak during
the campaign
Russian ambassador
who had contacts with
Trump associates
during the campaign
and the transition
Kushn
red
er
Ja
Former business partners
D
ger Stone
Ro
Trump lobbyist in 1980s.
Though no longer with
the Trump campaign, he
hinted in 2016 of coming
hacks of Democrats
p
Former Trump
campaign chair with
extensive ties to
Russia and Ukraine
has offered to testify
before the House
ald Trum
on
Trump son-in-law
with growing foreignpolicy role. Senate
wants to speak to
Kushner about his
meetings with Gorkov
and other
Russian contacts
gey Gork
er
ov
S
an
ul M afort
Pa
gey Kisly
er
ak
Works on the
National Security
Council at the
White House
s
Showed
Nunes intel on
surveillance
of Trump
associates,
according
to reports
S
Ezra
CohenWatnick
Chief of Russian
bank subject to U.S.
sanctions. Met with
Kushner, reportedly
at Kislyak’s request
rter Page
Ca
Briefly an adviser
to the Trump
campaign
Energy consultant
reportedly targeted
by Russian spies for
recruitment as
a source
By Dune Lawrence and Dorothy Gambrell
Inside a secure room at CIA headquarters in Langley, Va., about 11 miles from
Capitol Hill, there are several thick
binders filled with thousands of pages
of highly classified documents. It is this
intelligence, which likely includes transcripts from phone calls intercepted
by the National Security Agency, that
formed the basis of the report issued in
January by the U.S. intelligence community concluding that Russian President
Vladimir Putin covertly ordered his
government to intervene on behalf of
Donald Trump’s presidential campaign.
For the past several weeks, as part
of dueling investigations by the House
and Senate into Russian interference
in the election, teams of congressional investigators have made regular
trips to this room to pore over the
documents, which contain some of
the nation’s most sensitive secrets.
Sometimes they’re joined by lawmakers, including the chairmen of
both the House and Senate intelligence
committees. The work is laborious
and decidedly low-tech. No phones,
cameras, or recorders are allowed
inside. Weeks into the probe, investigators were still reading through the
documents, and Senate staffers were
negotiating with the CIA about putting
a computer in the room.
All of this comes against the backdrop of an ongoing FBI investigation
into links between Trump associates
and Russia, including whether crimes
were committed. It began even before
the election was over and, along with
the congressional investigations, casts
a cloud over the nascent administration. It’s not clear if any of this will
amount to a presidency-shattering
Watergate scandal, or calcify into the
kind of lingering Whitewater probe
that lasts for years without taking
anyone down.
What is clear is that this has the
makings of the kind of investigation that
Washington hasn’t seen in decades—
and it’s not likely to end anytime soon.
Armed with subpoena power, congressional investigators are looking to
answer a familiar Washington question
about Trump and his associates: What,
if anything, did they know, and when
did they know it?
29
Politics/Policy
goal will be to produce a bipartisan
report that puts to rest what could be
an existential question overshadowing Trump’s presidency: Does anything link him directly to Russia’s
interference? “We know that our challenge is to answer that question for
the American people,” Burr said.
—Steven T. Dennis
The bottom line Amid multiple probes, the Senate
investigation into Russia’s interference in the
election has become the main act.
Immigration
ICE Agents Go From
Advocate to Adversary
Trump plans to publicize crimes
by undocumented immigrants
“All it’s going to do is amp up the
chilling effect”
Over the past decade, Rudy Bustamante
spent a lot of time driving around
Phoenix, meeting immigrants anywhere they felt comfortable—schools,
churches, coffee shops. As a community
relations officer for U.S. Immigration
and Customs Enforcement, he’s had
the difficult task of trying to build trust
between immigrants and the federal
agency in charge of deporting those
who are here illegally.
Part of Bustamante’s job has been
to persuade immigrants to help ICE
find serious criminals while assuring them that they and their families
won’t face deportation for traffic violations or other minor offenses. Building
that trust hasn’t always been easy, as
in 2010, when Arizona passed a law
requiring immigrants to carry registration documents and giving police
broad leeway to question people.
“Rudy Bustamante
met with all the
different immigrant groups,”
says Michael
thousand
Nowakowski, a
Phoenix city counNumber of
cilman. “That diaunauthorized
immigrants
logue really helped
considered to
during those crises
be “removable
moments.”
criminal aliens”*
Bustamante’s
820
BILL CLARK/CQ ROLL CALL/GETTY IMAGES. PREVIOUS SPREAD: AP PHOTO (1); GETTY IMAGES (15). *DATA: MIGRATION POLICY INSTITUTE
30
House officials over their contacts
The questions begin with what
with Russians, including Flynn,
the government says was a massive
former campaign chief Paul Manafort,
Russian effort to undermine Hillary
onetime campaign adviser Carter
Clinton’s campaign and, in turn, boost
Page, son-in-law and senior White
Trump’s. The next question is whether
House adviser Jared Kushner, and
anybody in Trump’s orbit colluded
self-styled political dirty trickster and
with Russian attempts to influence the
Nixon aficionado Roger Stone. They
elections. The real political dynamite
also want to hear from several Obamawould be evidence that Trump himself
era officials, including Sally Yates, the
was involved. And then, as with any
Washington inquiry, there will be ques- former acting attorney general fired
by Trump, who reportedly warned the
tions about whether anyone tried to
White House that Flynn could be at
cover it up.
risk of blackmail from Russia.
There’s already been a request for
The committee already has received
immunity from Trump’s short-tenured
briefings from top intelligence officials
national security adviser, Michael
behind closed doors but plans to hold
Flynn, the retired U.S. Army lieutenpublic hearings as the investigation
ant general fired for misleading Vice
evolves. That’s tricky and potentially
President Mike Pence about convertime-consuming as it tries to figure out
sations with the Russian ambassawhat can be discussed in public. But
dor. The House Intelligence probe is
the senators say such hearings are key
facing its own credibility crisis after
to building public trust. “We simply
Devin Nunes, a California Republican
must—and we will—get this right,”
who served on Trump’s transition
Warner said at a March 30 hearing,
team, breached the panel’s protocols
where cybersecurity experts from
by briefing Trump directly on intellioutside the government detailed some
gence given to him by people inside
of Russia’s hacking operations.
the White House.
“This is not
innuendo or false
Warner said it’s clear Putin
The Senate comallegations.”
ordered a multipronged attack,
mittee, by default,
—Senator
including hacking Democratic
has become the main
Mark Warner
email accounts, with the stolen
event. Republican
data weaponized through leaks,
Chairman Richard Burr
and a massive propaganda and
of North Carolina and top
fake news campaign aided by thouDemocrat Mark Warner of Virginia
sands of internet trolls pushing fake
are trying to maintain a bipartisan
stories on Twitter and Facebook—all
approach to an investigation they
of it intended to help Trump and hurt
both say is among the most important
Clinton. “This is not innuendo or false
work they’ve done in their careers.
allegations,” Warner said. “This is not
The duo have vouched publicly for
fake news. This is actually what hapeach other, and despite pressure from
pened to us.”
Republicans (and Trump) to have the
Republicans have an incentive to
probes focus more on leaks and the
conduct of the Obama administration, cooperate with the probe, in part to
stave off repeated calls—from Senator
Burr, who supported Trump, insists
John McCain and others—for either a
he’ll abide by his duty to investigate.
select committee or an independent
Seven Senate staffers are working
commission to investigate. Launching
on the probe, one of the biggest in
Burr’s memory. But early hopes of a
that kind of effort from scratch would
speedy conclusion have been dashed,
take months just to get the necessary
security clearances, lawmakers say.
amid a continuous drip of disclosures
In the meantime, the FBI continues to
about contacts between Russians and
Trump’s associates. “It’s not something investigate ties between Trumpland
and Russia, as first publicly disclosed
that can be done quickly,” Burr told
reporters on March 29.
by Director James Comey in a House
Senate staffers have requested inter- Intelligence hearing on March 20.
views with 20 people, starting with
Burr said they will be sensitive
the intelligence officers who comto the overlapping investigations.
piled the Jan. 6 report. Lawmakers
Warner, ominously, noted the preceventually want to interview the
edent for simultaneous criminal and
committee probes: Watergate. The
web of Trump associates and White
Politics/Policy
Quoted
job is about to change. On Jan. 25,
President Trump signed an executive order calling for the creation of a
department within ICE, the Victims of
Immigration Crime Engagement, or
Voice, office. The almost two dozen
ICE community relations officers
across the U.S. will now be responsible for highlighting crimes committed
by members of the community they’ve
spent years trying to strengthen.
This is all part of Trump’s broader
strategy to focus on criminal aliens,
or “bad hombres” as he’s called them
since he first announced his presidential bid in June 2015. Throughout the
campaign, he made cracking down
on undocumented immigrants who
commit crimes a key part of his platform, despite research showing that
undocumented immigrants are less
prone to crime than U.S.-born citizens.
A new analysis of census data by the
Cato Institute estimates an incarceration rate among undocumented immigrants of 0.85 percent, compared with
1.53 percent for U.S.-born citizens.
By focusing on acts of crime, the
Voice program could undo years of
work building relationships between
ICE and immigrant communities, says
John Sandweg, former acting director of ICE under Obama. “When you
now task these guys with going around
trying to scare the general public, all
you’re doing is reinforcing the message
to those groups, ‘Don’t you dare call
ICE,’ because they think they’re going
to deport you,” Sandweg says. “All it’s
going to do is amp up the chilling effect
and make it that much harder for ICE
agents to do their job.”
Although Voice hasn’t been rolled
out yet, the broader shift in tone has
already started. In March, ICE began
releasing its first weekly list of crimes
committed by undocumented immigrants and the “sanctuary” jurisdictions
that refused to detain them on immigration charges. Voice will eventually
provide quarterly reports about “the
effects” of crime by the undocumented.
In a report released on March 20,
the Department of Homeland Security
listed the 10 largest sanctuary jurisdictions, including Los Angeles, New York,
and San Diego, along with the names
of undocumented immigrants released
and their “notable criminal activity,”
such as domestic violence and burglary.
To ensure victims are notified
“There were no agreements
tonight, and no agreements
in principle.”
Freedom Caucus chairman, Representative Mark Meadows,
after an April 4 meeting between key House GOP members,
Vice President Mike Pence, and other White House officials
to salvage the Republican health-care bill
when an offender is deported or
released into the community, DHS
is planning to put into operation a
system designed under Obama but
never formally launched, called the
Victim Information and Notification
Exchange, which will send victims
of immigrant crime updates via text
message and email.
Until now, victims had no way of
knowing whether ICE had deported a
perpetrator or released him into the
community. Part of the problem has
been a lack of funding, says Sandweg,
who says he backed the creation of
a notification program while at ICE.
The other issue has been complexities with privacy laws that limit interaction between certain state and federal
databases. As part of Voice, the Trump
administration will no longer extend
privacy rights to undocumented immigrants, breaking with past interpretations of the 1974 Privacy Act.
ICE declined to say how much the
program will cost or where the funding
will come from. In a Feb. 20 memo,
DHS Secretary John Kelly directed that
“any and all resources that are currently used to advocate on behalf of
illegal aliens” be reallocated to Voice.
Obama set up an English and
Spanish toll-free hotline for detained
immigrants and established the position of “public advocate” within
ICE to serve as an access point for
people in immigration proceedings
and for immigrant advocacy groups.
Immigration hardliners, such as Diane
Black, a Republican representative
from Tennessee, criticized the public
advocate as an “illegal alien lobbyist.” Texas Republican Representative
Lamar Smith said it was “further proof
that the Obama administration puts
the interests of illegal immigrants
ahead of the interests of Americans.”
Congress eliminated the public advocate position in April 2013.
Jessica Vaughan, director of policy
studies at the Center for Immigration
Studies, which advocates for less immigration, thinks eliminating these types
of services could free up funds for
Voice. “These resources were being
used almost exclusively on behalf of
people in this country illegally,” she
says. “Whereas people harmed by the
actions of people in the country illegally were getting almost no help.”
Jacinta Gonzalez, field director at
advocacy group Mijente, worries that
Voice will mean that community relations officers will no longer be a “point
of contact” for people detained. “If
they’re not even going to be pretending to talk to the community, it just
goes to show that they don’t really care
at all about the impacts their enforcement is going to have,” she says.
Nowakowski, the Phoenix councilman, holds out hope that the new role
for community officers like Bustamante
will still involve finding common
ground. “That’s where Rudy could be
that mediator to help somebody who
may have lost a loved one and thinks
all Mexicans are murderers,” he says.
“It’s having a person there who’s levelheaded who can actually tell both sides
of the story and help people heal.”
—Lauren Etter and Darius Rafieyan
The bottom line Under Trump’s Voice initiative, ICE
community relations officers will now publicize the
crimes of immigrants they once helped.
Edited by Matthew Philips
Bloomberg.com
31
A cheap stent that’s
hard to find, but really
works 34
The skies are getting
crowded for the No. 1
drone maker 36
Down with Taser, up
with Axon, and here,
have a camera 35
Innovation: Fake
cartilage that makes
joints good as new 37
April 10 — April 23, 2017
33
Hacking the Need
For a Full-Time Job
A small group of competitive coders make most of their living on prizes
ILLUSTRATION BY BRANDON CELI
“I have my time to myself and the freedom to work on whatever it is I want”
Peter Ma is looking around his San
Francisco condo and realizing he won
just about everything in it. His TV, home
theater system, 3D printers, phones,
tablets, computers, furniture—all were
either prizes or bought with prizes, like
the Amazon gift card that paid for his
leather couch. Stashed under Ma’s sofa
is a thick stack of 2- or 3-foot-long cardboard novelty checks, kept as trophies.
“The only non-swag I have are shoes,”
the 33-year-old says.
With his close-cropped goatee and
gray hoodie, Ma may look like thousands of programmers roaming the city,
but he’s part of an elite corps. He and
about a dozen friends travel the nation’s
circuit of hackathons, marathon coding
sessions that challenge contestants, typically, to create software. Often these
are corporate-backed team events offering winners serious cash. Competition
is fierce, and caffeine is plentiful.
Some hard-core hackathoners
have full-time jobs. Most are trying
to build a startup and use their winnings to supplement contract gigs, or
vice versa. The best can win tens of
thousands of dollars a month, though
much comes in the form of the swag
that lines Ma’s condo. They say the
trade-offs in pay and stability are
more than worth it.
“I have my time to myself and the
freedom to work on whatever it is I
want,” Ma says during a long waterfront lunch on a sunny Tuesday. He
says he’s considered full-time offers
from Google, Facebook, and Uber
Technologies but prefers living on
contract work and contest winnings,
as he has for three years. He’s entered
more than 100 hackathons, chosen by
the money at stake, proximity to the
Bay Area (unless flights are covered),
Technology
34
whether a contest will teach him new
skills, and which friends will be there.
Brian Clark, 27, is working on his
fourth startup idea and has supported
himself with hackathons for more
than two years. A mobile gifting app
he made for a hackathon sponsored
by Kmart and Sears Holdings Corp.
won him $6,000 for less than four
hours of work. Another time, when he
was broke and sleeping on a friend’s
couch in Oakland, he entered a hackathon out of desperation. “It was win
it or apply for a job,” he says. In a
contest sponsored by a laundry list of
tech companies, Clark and a partner
spent about a day coding a troubleshooting tool for app developers.
They beat 800 other teams and won
$33,000 in venture funding.
Corporations backed more than 1,000
hackathons in the U.S. last year, according to Devpost, a site for developers that
tracks the events. For companies such
as Microsoft Corp. and Amazon.com
Inc., the events are chances to show
off their latest virtual-reality headset or
voice-control software to talented engineers. The more developers interested
in working with a company’s tools, the
more successful those tools.
International Business Machines
Corp. alone holds hundreds of hackathons a year, online and in person.
“We know it feeds revenue somewhere down the line,” says chief developer advocate Willie Tejada. IBM’s
Watson AI XPrize, a three-year online
challenge to solve a problem of the
entrants’ choosing with AI technology,
carries a $3 million grand prize for
the team whose work is judged most
important in 2020.
A few days before each hackathon,
Ma spends a half-hour or so checking that his programs and gadgets are
up to date. That’s a habit he learned
after a glitch at a hackathon in Las
Vegas cost his team hours. He brings
his computer, iPhone, two Androids,
an internet-connected chipboard, and
sensors for temperature, humidity, and
touch, in case they’re needed for the
event. He doesn’t pack a toothbrush.
“You know how a soldier
goes to battle with a
sword? Our weapons
are our laptops”
“I bring the basics,” he says. “You know
how a soldier goes to battle with a
sword? Our weapons are our laptops.”
Clark packs his favorite blue fleece
blanket and a small pillow into a backpack along with his laptop. (He, too,
skips the toothbrush.) He preps by
writing a pitch for the project he plans
to build, tailored for the sponsors and
the technology they’re promoting.
In March, Ma and some friends
went to a pretty typical 48-hour
hackathon in Redwood City, Calif.,
hosted by Procter & Gamble Co. to
promote internet-connected plug-in
Febreze dispensers. (Clark skipped
it.) Sponsors included Google and
Amazon, both interested in connecting the dispensers to their respective
smart-home gadgets, Nest and Alexa,
as well as PARC, the famed Xerox
Corp. innovation lab. For a chance at
a $5,000 grand prize and other awards
that included PARC internships,
dozens of teams worked all weekend
to devise useful applications for the
Febreze units.
Hackers ate Chinese food and drank
Red Bull past midnight, napping under
tables or in corners in shifts for an hour
or two while their teammates kept
working. Some brought sleeping bags;
others rested their heads on backpacks.
Ma and his team used a methane
sensor to activate the Febreze plug-in
when it detected a certain amount of
gas. They lost. Ma says he overthought
the technical work and underthought
the idea. “We had three guys building
a fart app,” he says. “Ninety percent of
the customers are all women.”
P&G’s winners connected the scent
dispenser via Wi-Fi to a smartphone
app, allowing users to control Febreze
release along with other smart-home
functions, such as temperature and
lighting. “Hackathons allow us to have
access to some of the sharpest minds,”
says spokeswoman Lauren Thaman,
adding that P&G plans to do more.
Living off hackathons may be
getting tougher. Massive awards are
less common as companies such as
Salesforce.com Inc. shift from luring
developers with competitions toward
free online learning programs that keep
them in touch with participants.
Of course, some coders give up
hackathons for jobs, spouses, or
their health. Jay Zalowitz, a developer at online sports apparel retailer
Fanatics Inc. in San Francisco, says
he spent his mid-20s using contest earnings to fund a startup but cut back once
he got a full-time job. It usually takes a
couple of days to recover from a hackathon, he says, and given a full-time
salary, the money isn’t worth it.
Ma says he has no plans to give up
the freedom of the hackathon circuit.
“I can always get a corporate job,” he
says, slicing into seared branzino. “I
don’t need to. That’s the backup plan.”
—Lizette Chapman
The bottom line Semipro hackathon entrants
don’t make what their employed peers do, but they
have a lot more time to work on their startups.
Medical Devices
Nice Stent If
You Can Get It
Stroke-clearing clot retrievers
can be tough to find
“I was 95 percent back the next
day. It was miraculous”
Lee Bekemeyer collapsed on the driving
range at Stoneybrook West Golf Club
one morning in 2015, a massive stroke
choking off the flow of blood to his
brain. The 86-year-old real estate broker
couldn’t get up, move his right side, or
speak. One in eight patients with such
acute strokes dies within months, and
two in three suffer lasting complications such as paralysis, slurred speech,
and trouble walking or caring for themselves. Bekemeyer wasn’t one of them.
He was rushed 15 miles to Florida
Hospital in Orlando, a comprehensive
stroke center. After a CT scan, doctors
threaded a metal stent through an
artery into his brain, then expanded it
to snare and extract the clot, allowing
blood to flow freely again. The entire
process took less than two hours.
“I was walking to the bathroom that
night, and I think I was 95 percent
back the next day. It was miraculous,”
Bekemeyer says. “Not every hospital
has a team that does this.”
In the field of stroke treatment, the
maxim is “time is brain,” because every
minute with a clot costs a patient millions of brain cells. By that standard,
Florida Hospital is exceptional. Last
Technology
Blood Clot,
Begone
① A doctor threads
the metal stent into a
patient’s clogged artery
② The stent expands,
trapping the clot in
its mesh
FROM LEFT: COURTESY STRYKER CORP.; COURTESY AXON
③ The doctor removes
the stent, taking the
clot with it
year 81 percent of its stroke patients
were treated within two hours of
arrival, up from 22 percent in 2013,
according to Indrani Acosta, the
director of stroke care. Many who
might have been sent to a nursing
home went to a rehab center
instead, she says, while people
who would have gone to a rehab
center could go straight home.
That’s due in part to clot-retrieving
stents such as the one used on
Bekemeyer. They’re sold for about
$8,000 by companies including
Medtronic Plc and Stryker Corp.,
and according to a 2015 study published
in the New England Journal of Medicine,
60 percent of stroke patients treated
with a stent retriever functioned independently after three months, compared with 35 percent of those given
drugs alone. About 240,000 of the
700,000 Americans who suffer strokes
each year have blockages in arteries
large enough to be treated with these
kinds of clot-retrieving stents. But only
about 28,000 were treated with one last
year, says Stacey Pugh, vice president
of Medtronic’s neurovascular unit.
The stents, while relatively cheap
in hardware terms, are rare outside of
the roughly 150 specialized facilities
in the U.S. known as comprehensive
stroke centers, because they require an
in-house neurosurgery unit, minutesaving training, and space. As a result,
the devices have become a bit of a flashpoint among doctors who say more
facilities around the country should be
equipped to handle extreme cases like
Bekemeyer’s. The procedure just isn’t
available in many parts of the country.
“These treatments need to be available in the community, and access
needs to be fair,” says Lee Schwamm,
chief of stroke services at Massachusetts
General Hospital and a professor of
neurology at Harvard Medical School.
“We need them to be more equitably
distributed. Many are packed in big
cities, and there aren’t enough in suburban communities and strategic locations in less populated areas.”
Among America’s 1,100 or so hospitals equipped to deal with more minor
strokes, the priority is speedy injection
of a drug called tPA, which over the
past two decades has become the standard of care to break up smaller, less
accessible clots. If a paramedic thinks
a patient is suffering a stroke more
minor than what Bekemeyer experienced, it may not be worth passing
a couple of hospitals to head for a
bigger pool of stroke experts, as
Bekemeyer’s paramedic did.
“I can see the desire to open
more comprehensive stroke
centers, and we are moving
in that direction,” says Acosta of
Florida Hospital. “But our field is not
as big as the cardiology field,” which
numbers about 30,000 doctors in the
U.S. “There are fewer neurologists by
far”—roughly 16,000.
Efforts to bring the stents into the
mainstream have also been sidetracked
by the failures of early versions, which
cleared clogged arteries but also
resulted in some uncontrolled bleeding in the brain and some deaths. Three
major trials of those earlier techniques
failed as recently as 2013. Since the
2015 NEJM report, however, a flurry of
five positive studies, the most recent
one published in March, has led more
doctors to push for wider adoption.
Medtronic says its research shows
that stent-based clot removal also cuts
health-care costs. Initial treatment
including a clot retriever runs $45,761,
vs. $28,578 for treatment with drugs
alone. For the next 90 days, however,
those patients generate $5,000 less
in medical expenses, and over the
patient’s lifetime, Medtronic’s Solitaire
retriever could save $23,203.
“A stroke patient was a stroke patient
until two years ago. There was one
thing you could do for them, and that
was to give them tPA,”
says Medtronic’s Pugh.
“The health-care
system is evolving to
come into alignment
with the data. It needs
to evolve faster.”
An additional 350 U.S.
medical facilities are
equipped to perform
Axon Body 2
the stent procedure and are working to
receive certification as comprehensive
stroke centers. And a pending Stryker
study suggests that the stent treatment
may be effective as long as a full day
after the onset of a stroke, potentially
making it much more accessible for a
wider range of people.
Bekemeyer recommends it. He was
golfing again within a month of his
stroke and, at 88, continues to hit the
links several times a week. He navigates
a 19-step circular stairway to get to his
bedroom every night. And he allows
himself to marvel. “I would have
thought if I had a massive stroke the
way I did, I would be finished for the
rest of my life,” he says. “I would have
rather gone on out than to never fully
recover.” —Michelle Cortez
The bottom line Stents appear to double the
recovery rate for some stroke patients, but most
Americans don’t have access to them.
Policing
Forget the Taser,
Says Taser
With a new name, the company is
giving away body camera gear
“Oh, sure, there will be some legal
challenges”
Taser International Inc. has become
by far the leading U.S. supplier of police
body cameras, which departments have
rushed to adopt since the shootings in
Ferguson, Mo., and elsewhere led to
public demands for greater accountability. Interest in the cameras, and
the management of their footage, has
pushed the world’s best-known maker
of stun guns into cloud computing and
digital devices, sold under the Axon
brand. Now that business is becoming
the face of the $1.2 billion company.
The whole place will
be called Axon, and
b
as of April 6 the TASR
ticker on the Nasdaq
exchange is AAXN.
“The Taser brand is a
product brand,” says
Chief Executive Officer
Rick Smith. “People
don’t think of cloud
35
Technology
Police buy in …
About two-thirds of cops say they favor
the use of body cameras
82%
Oppose
33%
of police chiefs and
other administrators
say they want them
Favor
66%
… some more than others
Officers from certain backgrounds were
more likely to say body cameras would
help curb inappropriate police behavior
White
46%
Black
Hispanic
71%
53%
DATA: PEW RESEARCH CENTER
36
software or sensor devices and the
many things we now do.” He’s trying
to solidify Axon’s position and deepen
ties to local departments with a splashy
offer: a year of free cameras for any U.S.
police agency.
Body cameras and software to
manage footage marked Taser’s first
successful initiative to expand beyond
stun guns after years of failure. In 2011
almost all of its revenue came from
Tasers, but last year Axon made up
a quarter of sales. Axon says it’s won
contracts with 36 of the 41 major city
departments that have body cameras.
To guide its evolution, Taser brought
tech leaders onto its board. In 2013 it
bought a Seattle startup that became its
research hub. The Seattle office houses
115 employees, and Axon plans to triple
its space there. This year it bought two
artificial intelligence teams, which for
now are focused on automating the
labor-intensive redaction of body cam
videos for public release. But Smith
says the company’s long-term goal is to
automatically extract the video information needed to fill out police reports.
This could free officers from paperwork—and make Axon a required tool
for any department, replacing its traditional record management system.
“We are licking our chops at this idea,”
Smith says.
Rachel Levinson-Waldman, senior
counsel at the Brennan Center for
Justice, says police technology should
balance automation with human judgment. “We know that people get things
wrong, but so do computers,” she says.
Smith’s first step is to give more
cops cameras. About two-thirds
support using body cams, according
to a January study by Pew Research
Center, but Smith estimates only
about 20 percent have them. Hence
the one-year free trial, software
included: It’s partly a PR stunt, partly
a bid to end-run often baroque procurement processes.
The idea for the free trial grew
out of a loss. Last fall the New York
City Police Department, the nation’s
largest, chose Taser’s top challenger,
Seattle’s Vievu LLC, to supply its first
5,000 cameras. Losing the contract
sent Taser’s stock down 18 percent.
(It hasn’t rebounded.) Taser howled
at the decision, saying the NYPD’s
field trials were too small and offered
the department 1,000 cameras and
licenses as a “gift.”
Safariland LLC, which owns Vievu,
called the Taser offer a “desperate
attempt to circumvent the process
designed to ensure fair treatment of all
vendors.” It added, “If the NYPD had
wanted vendors to supply 1,000 free
cameras or any other provisions, the
NYPD would have spelled out that
requirement” in the request for proposals. The NYPD declined the deal.
Smith says Axon expects critics to
call the latest offer anticompetitive,
too. “Oh, sure, there will be some legal
challenges,” he says. “Luckily we have
plenty of lawyers from our Taser side of
the business.” —Karen Weise
The bottom line Taser, now Axon, is offering police
a year of free body cameras and related software,
an effort to make the gear irreplaceable.
Drones
How Long Can DJI
Rule the Sky?
The leading quadcopter maker
specializes to survive
“We have our own factories and
can do our own prototyping”
As dawn broke on China’s southern
Hainan Island, Yang Daozhu clambered
up a metal stepladder for a better view
over the cornfields, remote control in
hand. Wearing a blue surgical mask
and rubber boots, the 30-year-old was
soon steering a 120-pound DJI drone
back and forth above the yellow-tipped
stalks, flipping a switch to spray them
with a mist of pesticide. About 100 feet
away, a co-worker did the same from
the ground, occasionally climbing onto
a blue truck. By noon they’d covered
the same stretch of field it would have
taken four or five workers a week to
spray with traditional crank-operated
backpack dispensers.
This is a typical day for Hainan
China Agriculture and Flight
Service, a year-old company with
about 50 employees that’s sprung
up to fill a niche. “It’s harder to find
people to spray pesticides in the
old way,” says Zhang Yourong, the
farmer who manages these cornfields.
“Young people want to leave the farms
and find better jobs in cities now.”
Yang’s boss, former realtor Liang
Lvsheng, says he’s also interested in
using drones to map farms from the
sky, a way to spot pests or other problems more quickly.
Zoom out a little more, and a
broader business plan starts to come
into focus. Drones are becoming less
of a casual hobby and more like commercial and industrial equipment,
and DJI, the world’s leading maker
of the little buggers, is working a lot
harder to make sure it can meet the
market’s changing wishes. DJI makes
the Agras-MG1 drones spraying the
fields on Hainan, Matrice 200 drones
for industrial surveying, and Inspire
drones for high-end filmmaking, and
it’s got 25 percent of its 8,000 staffers
working on research and development
and engineering to make sure potential
rivals don’t spot an area it’s missed.
“Our iteration cycle is about six
months,” says Paul Pan, senior product
manager at DJI. “We can completely
control the supply chain. We have
our own factories and can do our
own prototyping.”
Eleven-year-old DJI more or less
invented the modern civilian drone
industry when it introduced its first
Phantom in 2012. Valued at $10 billion,
the Chinese company makes 60 percent
to 65 percent of all nonmilitary drones
COURTESY DJI (1); COURTESY CARTIVA (2)
DJI Agras-MG1
Technology
shipped around the world, according to
researcher Frost & Sullivan. It’s maintained its lead partly through smart
branding and partnerships, getting
photography-focused Phantom models
into more than 400 Apple Stores.
But it’s tough to maintain momentum
with hardware alone. Even Apple Inc.
is focusing more on software and services, such as music streaming and
its app store. And as with the smartphone industry, high-end drones such
as DJI’s may be vulnerable to cheaper
or more focused rivals, especially in
China. On the upper end, EHang Inc.
is working on people-carrying drones
that resemble George Jetson’s ship.
On the low end, startup FPV Style is
refining $100 indoor drones for kids.
FPV founder Max Ma says his prototype weighs less than an ounce, and the
finished product will be lighter.
“DJI has been brilliant at making
flying cameras, but that’s not all that
drones are or can be,” says Eric Pan (no
relation to Paul), head of Seeed Studio,
a Shenzhen hardware accelerator.
As a drone guides itself back and
forth across a soccer field near DJI’s
gleaming Shenzhen headquarters,
surrounded by skyscrapers, Paul
Pan is thinking about what comes
next. He’s been refining the AgrasMG1’s ability to fly a preset path and
adjust for wind. “Even for a farmer
with minimal training, this makes it
very easy to use and to spray evenly
and consistently,” he says. DJI is
also working with data services that
stitch together data from GPS and the
drones’ sensors to create 3D maps
of fields, allowing the programmed
paths to account for hills.
The market for drone hardware will
hit $6 billion this year and $11.2 billion
by the end of 2020, estimates
researcher Gartner Inc. The market
for software and services is expected
to grow a lot faster. So DJI is also
pushing developers to dream up new
apps and uses for its drone operating
system, says Michael Perry, director of
business development. The company
says it’s not making its OS available for
rivals’ drones. —Christina Larson
The bottom line China’s DJI says 25 percent of
its workforce is in R&D as it tries to extend its
dominance of the civilian drone business.
Edited by Jeff Muskus
Bloomberg.com
Innovation
Synthetic Cartilage
Form and function
Innovator David Ku
Cartiva implants are made of polyvinyl alcohol,
the main ingredient of contact lenses, and mimic
natural cartilage to treat arthritis. Unlike the
current standard of care—metal plates fused
with joints—they allow for a full range of motion.
Age 61
1.
Open After opening a
patient’s joint to be treated,
an orthopedic surgeon bores
a hole in one of the bones of
the joint.
Professor of mechanical
engineering and engineering
entrepreneurship at Georgia
Tech; surgeon
Origin Research
on blood flow
required Ku and his
students to create
material for artificial
blood vessels. The
company they
formed to further
develop the material
was acquired by
Carticept Medical Inc.
in 2008 and spun off
as Cartiva Inc. in 2011.
Funding Cartiva has
raised $35 million
from New Enterprise
Associates,
Windham Venture
Partners, and private
investors.
37
①
2..
Market U.S.-based
orthopedic surgeons
can use a $4,500 kit
from Cartiva to treat
arthritis in the big
toe. The kit includes
a ⅓-inch implant, a
drill, and tools for
compressing and
inserting the implant.
Plant The surgeon inserts
a compressed Cartiva
implant into the hole, where
it expands to remain firmly in
place without fasteners.
Next Steps
“It’s certainly transformative,” says Judy Baumhauer, an orthopedics
professor at the University of Rochester Medical Center. “With this advance,
we have an implant that doesn’t wear out or cause more troubles.” Cartiva
Chief Executive Officer Tim Patrick says the company is seeking Food and
Drug Administration approval to implant the cartilage in thumbs, and Ku is
working on other applications for his implants, including as replacement
blood vessel valves. —Michael Belfiore
Markets/
Finance
April 10 — April 23, 2017
Folwell
campaigning
on his
motorcycle
38
A big pension fund is firing pricey money managers but is stuck in some long-term deals
“We don’t own alternative investments. They own us”
If you had $90 billion to invest, how
would you do it? For Dale Folwell, it’s a
serious question. As the newly elected
treasurer of North Carolina, he’s by
law the one person who gets to decide
how to manage the state pension fund
for government employees, the world’s
26th-largest pool of public money.
Folwell, 58, became the state’s first
Republican treasurer in 140 years partly
on the strength of a simple investment
strategy he proposed: Instead of
paying money managers big fees, the
state should use a slim menu of cheap,
mostly indexed investments and
manage them in-house when possible.
The state paid $600 million in
outside managers’ fees, incentives,
and related costs last year, seven times
more for every dollar under management than it paid in 2000. Folwell envisions saving the fund a minimum of
$100 million a year in fees by the end of
his four-year term.
“It’s not emotional. It’s not political. It’s mathematical,” says Folwell,
a certified public accountant and
former state legislator—who’s also
been a mechanic and a national dirtbike racing champ. His calculation is
simple: Expenses come right off the
top of returns, and money managers
as a group struggle to beat the market
How to make an active
fund more like an
ETF 40
COURTESY DALE FOLWELL
Wall Streeters flock to
messaging apps for a
little privacy 41
after their fees. For example, in the
decade through June 30, 2016, about
85 percent of large-cap U.S. stock funds
trailed the S&P 500 index, according to
S&P Dow Jones Indices.
Folwell has already unloaded six
actively managed stock funds that
controlled $3 billion for the state and
charged combined fees of $17 million
in the fiscal year through last June. But
a wide-scale firing of Wall Street won’t
be easy, he says, because his two most
recent predecessors signed long-term
contracts with some private equity
and hedge funds. Such investments
are often called alternatives. Funds
operated by Blackstone Group LP,
Warburg Pincus, and Starwood
Capital Group are among those listed
in the pension system’s holdings.
“We don’t own alternative investments. They own us,” Folwell says. “I
think they increase complexity and
reduce value.” Folwell’s most recent
predecessor, Janet Cowell, declined
to comment. The treasurer who came
before her, Richard Moore, didn’t
respond to requests for comment.
One might think a public fund with
billions of dollars to put to work would
have some leverage to negotiate a discount. Not so simple, Folwell says.
Money managers he talks to keep citing
most-favored-nation clauses in their
contracts that say they can’t offer a
break to one client without providing
the same break to others. Even if he
wasn’t stuck in long-term contracts, it
might be difficult to unload huge stakes
quickly without needlessly incurring
fire-sale losses, because the funds tend
to hold illiquid assets.
In the election, Folwell won the
endorsement of the State Employees
Association of North Carolina, which
represents 55,000 public employees. “He doesn’t carry water for his
party,” says Ardis Watkins, a lobbyist
for the group. It had fought the plunge
into costly investments and advocated
making the terms of the deals with
managers public.
In February, Warren Buffett gave
a boost to Folwell’s argument. The
longtime Berkshire Hathaway Inc.
boss wrote in his annual shareholder
letter that pension funds and other
supposedly savvy investors had wasted
$100 billion over the past decade on
high-priced money managers.
North Carolina’s pension fund used
to have lower costs. In 2000 the state
was paying fees of just 0.1 percent of
assets, compared with 0.7 percent
now. Then it pushed into alternatives.
The underlying investment can include
everything from stakes in private companies to derivatives linked to barrels
of heating oil and bushels of wheat. “I
have $900 million worth of timber,”
Folwell says. In theory, such investments can provide a hedge against
inflation and the volatility of equities.
And at a time when bond yields have
been historically low, many big institutional investors have been eager to find
investments that might provide some
extra return to help meet their obligations. “The U.S. stock market has had
a good run, but it’s likely to be unsustainable in the long haul,” notes Josh
Lerner, a Harvard Business School professor. For pension funds, he says,
private equity in particular may seem
like one of the few ways to get a lift.
If North Carolina had owned a
vanilla stock-and-bond index portfolio instead of shifting into alternative assets, it would have earned an
additional $20 billion over the seven
years through June 2016, estimates
Ron Elmer, an accountant and indexing advocate. Elmer ran unsuccessfully
in the Democratic primary for North
Carolina treasurer last year before
throwing his support behind Folwell.
Four-fifths of the fees paid by North
Carolina’s pension fund last year went
to private equity, hedge fund, and other
alternative assets that accounted for
about one-fifth of the state’s investments. Investing in alternatives also
includes extra costs for such things as
sending state employees to annual fund
meetings, according to Folwell.
Since taking office, he’s been calling
money managers to ask about performance, costs‚ and whether they’d work
for less. During one call, he says, Robert
Kapito, president of BlackRock Inc.,
which manages about $15 billion for
the state, tested Folwell on his claim to
be a mechanic by asking where the gas
goes into a 1951 Cadillac coupe. Folwell
says when he replied that the fill pipe
is in the taillight, the BlackRock boss
said the treasurer had passed his test. “I
said, ‘We may talk with an accent, but
we don’t think with one,’” says Folwell.
“The purpose of these phone calls was
for the managers to pass our test, not
for us to pass theirs.” —Neil Weinberg
The bottom line The newly elected treasurer in
North Carolina thinks his retirement fund can do
better with simpler investments.
Real Estate
Buy Today. Take a
Close Look Tomorrow
Homebuyers in booming Toronto
decide to forget the inspection
“You don’t know what could be
behind the walls”
When a real estate market gets really
hot, buyers can feel like they have to
roll the dice. In Toronto, some are so
desperate to win bidding wars that
they’re rushing to make offers without
even getting an inspection.
The average price for a
detached home in Canada’s largest
metropolitan area jumped to
C$1.21 million ($905,473) in March, up
a third from a year earlier. In the same
period, Toronto-based home inspection company Carson Dunlop saw
a 34 percent drop in volume. Murray
Parish, president of the Ontario
Association of Home Inspectors, says
he’s seen a 30 percent decline at his
company, Parish Home Inspections.
“The bottom line is we are in
a shortage of supply,” says Tasis
Giannoukakis, a Century 21 Leading
Edge Realty Inc. broker based in
Toronto, adding that it’s not uncommon to see bids of as much as
C$200,000 over the asking price.
“That pressure is what’s causing
everybody to remove the conditions
on an inspection,” he says.
Home price increases in North
America’s fourth-largest city and its
suburbs have outpaced growth in
39
Markets/Finance
conditions, compared with 10 percent
to 20 percent previously.
Nicholas L’Ecuyer, a managing
partner at Barrie-based loan brokerage Mortgage Wellness Group, says
he doesn’t see skipping inspections as
a red flag for the market but as a necessary evil for buyers in bidding wars. It
doesn’t matter if inspections are inexpensive. “For about $400, everybody
wants to do it,” he says. “But they know
they can’t.” —Kim Chipman
The bottom line Toronto’s housing boom is
eclipsing those in San Francisco and Vancouver.
Buyers are feeling the pressure.
Investing
Trying to Make Active
Funds Cool Again
Will investors flock to new funds
that look more like ETFs?
“Active ETFs unnecessarily blur
the lines”
Daniel McCabe, chief executive
officer of Precidian Investments, is
trying to create a new kind of fund,
one he thinks will help active money
managers survive the unrelenting rise
of exchange-traded funds. It’s been an
uphill battle.
With $10 trillion in assets in the
U.S., actively managed mutual funds
are big business, but they’re losing
market share. For years investor
money has been flowing into ETFs,
most of which passively replicate
market indexes. Index ETFs had assets
of $2.5 trillion at the end of 2016, up
from $420 billion a decade earlier,
according to Morningstar Inc.
Precidian’s plan is to wrap active
management into something that looks
more like an ETF. In doing so, it won’t
replicate one of the key things many
people like about ETFs—that they’re
index funds, which over time tend to
beat most active managers. McCabe’s
bet is that investors who still want to
hire an active manager will be drawn
to Precidian by the other features of an
ETF, such as the ability to trade them
like a stock at any time of day. ETFs
also have operating-cost and tax advantages over traditional mutual funds.
MARK SOMMERFELD/BLOOMBERG; ILLUSTRATION BY KURT WOERPEL
40
Manhattan, San Francisco, Seattle,
hiding behind the walls,” says Shubha
and Vancouver, raising concerns that
Dasgupta, owner of Capital Lending
a correction may be coming. Robust
Centre, a Toronto-based mortgage
demand in Toronto is bumping against
brokerage. A move away from
the lowest supply of homes in more
inspections isn’t unique to Toronto.
than a decade. Buoyed by low interVancouver, Canada’s hottest real
est rates, the bidding wars have caused estate market until Toronto took that
many shoppers to leave once-standard
mantle last year, saw a surge in unconclauses out of their purchase offers,
ditional purchase offers in the first
such as a professional home inspection half of 2016, says Adil Dinani, an agent
in the area with Royal LePage West
and financing contingencies.
Real Estate Services.
Giannoukakis notes that homebuyers are generally savvier when it
When problems emerge after a purcomes to repairs and renovations than
chase, the financial burden typically
they were a decade or two ago, thanks
falls to the buyer who opts to skip an
inspection. Because the buyer “supto information on the internet and the
popularity of home-related TV shows.
posedly has the ability to see problems
and ability to negotiate either a lower
Still, the removal of conditions such
price or for work to be done, the law
as an inspection isn’t due to voluntary risk-taking but is “100 percent”
doesn’t see any reason really to protect
you,” says Michael Lamb, a real estate
a byproduct of multiple offers on the
lawyer and professor at the
same property, he says.
An inspector views
“When you are the only offer
University of Western Ontario.
the boiler of a
home in Toronto
Removing the inspection
on the table, you can submit
a conditional offer,” says Lorand
clause is a sign that “speculation has
entered the market,” says Marcus
Sebestyen, an agent with IPro Realty
Ltd. in Toronto, adding that he counSimon, an attorney and owner of Ekko
sels clients on the risks of skipping an
Title in McLean, Va. The last time
he saw a marked increase in waived
inspection. “But when competing with
inspections in his region was around
several other offers, you don’t have
2007, before the U.S. housing crash.
that luxury,” he says.
Even so, mortgage providers don’t
Even for do-it-yourself types, the
seem to see much of a problem with
potential pitfalls are many—faulty
the decline in inspections in Toronto.
pipes, eroding foundations, and
Banks are far less concerned about
termite infestations. Some are more
costly repairs that may arise later than
surprising. Alan Carson, co-founder
they are about the appraised value of a
of Carson Dunlop, says his team once
property, says Dasgupta, the mortgage
found a bathroom that seemed funcbroker. “The home inspection is really
tional, but none of the plumbing was
more for consumer protection,” he
connected. Then there was the house
says. “From a home value standpoint,
that came with a loaded rifle and a
the appraisal is really the key indicator
large bag of jewelry in the attic, as well
for the bank.”
as a “very sooty raccoon” jumping
The decline in inspections has
from a fireplace damper, he says.
spread to other parts of Ontario. The
“You don’t know what could be
city of Barrie,
about 105 kilometers (65 miles)
north of Toronto,
has “gone nuts”
in the last three
months, says
Peggy Hill, a
local broker with
Keller Williams
Experience
Realty. She says
80 percent to
90 percent of
the offers she
sees have no
Market performance
kept assets high,
but investors withdrew
$350 billion in 2016
Markets/Finance
A Growing Rivalry
$10t
Net Assets
$8t
Actively managed
mutual funds
$6t
$4t
$2t
Passively managed
exchange-traded funds
$0
1997
2016
DATA: MORNINGSTAR INC.
But Precidian faces a formidable
competitor in 100-year-old, $364 billion
asset manager Eaton Vance, which
beat it to the punch with a rival
product called NextShares. Precidian
also has to persuade the U.S. Securities
and Exchange Commission to sign
off on its novel approach. “We recognize that anything like this requires the
regulator’s approval,” McCabe says.
He’s been trying for three years with
Precidian. Eaton Vance’s NextShares
won SEC approval in December 2014.
The tricky problem for anyone trying
to make active funds that work like
ETFs is transparency. Say you want to
buy 100 shares of State Street Corp.’s
popular SPDR S&P 500 ETF at 11:59 a.m.
To determine a fair price for those
shares, market participants
need to know the value
of all the fund’s underlying assets at that time.
That’s not a problem,
because this ETF simply
owns the stocks in the
S&P 500 index.
But most active funds
like to be more discreet about their
holdings. They select stocks or bonds
to try to beat the market and don’t
want to give other traders a way to get
the jump on them. “It can be harmful
to the investors,” says Stephen
Clarke, president of the Eaton Vance
subsidiary behind NextShares.
Eaton Vance adopted a workaround:
NextShares funds get the tax and cost
efficiencies that come with trading
on an exchange, but their price is calculated at the end of the day, as with
regular mutual funds. Precidian’s solution involves hiring agents who can
see a fund’s holdings to calculate and
verify its underlying value. That value
would be made public every second of
the trading day, even though portfolio holdings would be revealed only a
few times a year. In April 2015 the SEC
told Precidian that it needed to solve a
long list of concerns about its approach
before it could get approval.
Eaton Vance wasn’t shy about pointing out its rival’s difficulties. It used
the Freedom of Information Act to
obtain a letter the SEC sent about its
concerns to McCabe’s lawyer—and
published it. During a call with industry analysts, Thomas Faust Jr., Eaton
Vance’s chairman, used it to question the viability of Precidian’s structure. “Nobody has ever done this in our
industry before,” McCabe says. At the
time, Faust said the company made the
letter public to help the market make
an informed judgment about potential
alternatives to its product.
Eaton Vance expects to spend about
$10 million this year on the NextShares
business, adding to about $16 million
spent over the past two years. It’s also
on the line to pay $9 million to creators
of patents underpinning the funds, regulatory filings show. The funds have
less than $100 million in assets.
Precidian amended its SEC filing
and is awaiting approval. On April 4,
it unveiled eight funds it hopes to sell.
Whatever the regulator decides, the
new funds will have to prove
they’re more than a marketing twist. “The trend
is clearly toward passive,
and ETFs are part of that
trend, so they’re jumping
on that bandwagon,” says
Larry Swedroe, director of
research for Buckingham
Strategic Wealth LLC.
And even when they’re traded on
an exchange, active funds still pay
someone to pick investments, so
they’ll cost more than index funds.
One NextShares fund charges 0.65 percentage points per year, a third more
than the average U.S. ETF. “Active ETFs
unnecessarily blur the lines and can
create undue confusion,” says Rich
Messina, senior vice president for
investment product management at
ETrade Financial Corp.
Even so, Wall Street companies
are willing to give the idea a shot.
UBS Group AG and Columbia
Threadneedle Investments
have rallied behind Eaton Vance’s
structure, with UBS announcing
last year that advisers in its network
could offer the funds. Asset manager
Legg Mason Inc. bought a stake in
Precidian last year. BlackRock Inc.,
the world’s largest money manager,
has requested regulatory approval to
sell funds using Precidian’s model.
“The market hasn’t picked a clear
winner,” says Spencer Mindlin,
an analyst at Aite Group LLC. “Or
whether there will be any winner.”
—Rachel Evans and Annie Massa
The bottom line Investors like being able to trade
ETFs all day, but that’s tough to do with funds that
need to keep secrets.
Wall Street
Traders’ New Favorite
Way to Swap Secrets
WhatsApp and Signal make
conversations hard to track
“Temptations and the rewards are
just too great”
Dirty jokes and not-safe-for-work GIFs.
Snaps of unsuspecting colleagues on the
trading floor. Screen shots of confidential client trading positions. All that—
and, on occasion, even legally dubious
information—is increasingly being trafficked over the new private lines of Wall
Street: encrypted messaging services
such as WhatsApp and Signal.
Traders, bankers, and money
managers are embracing these apps
to circumvent compliance, get around
the human resources police, and keep
bosses in the dark. And it’s happening
despite the industry’s efforts to crack
down on unmonitored communications, according to conversations
with employees at more than a dozen
Wall Street companies. On March 30
a former Jefferies Group banker
was fined in the U.K. for sharing
confidential data on WhatsApp.
“You’re really able to operate outside
of the bank,” says William McGovern,
a former branch chief of the Securities
and Exchange Commission who now
works at the law firm Kobre & Kim.
“We have seen in our investigations
that the ground is shifting under everyone, and technology changes are
driving a lot of it.”
41
Markets/Finance
The U.S.
Department of
Justice and
the FBI conducted
an inquiry into
the leak
Quoted
“ … I did not refuse or express
my inability to comment
and the interview continued.”
Medley provides
intelligence
on macroeconomic
policy for hedge
funds and other
investors, according
to its website
42
U.S. financial companies need to
keep records of all written business
communications, no matter how innocuous, say the SEC and the Financial
Industry Regulatory Authority. In some
cases, calls are recorded.
Representatives for Wall Street
banks, including Bank of America,
Citigroup, and Goldman Sachs
Group, say they have various policies in place to prevent unmonitored
communications and unauthorized
access to confidential information.
They routinely check emails and chats
on company devices, restrict personal
phones and messaging services on
trading floors, and require employees
to sign agreements prohibiting unmonitored communications for work. In
January, Deutsche Bank AG banned
text messages and services such as
WhatsApp and Apple Inc.’s iMessage
on company phones globally.
Nearly two dozen financial industry employees say those policies are
routinely ignored, and the use of personal phones for work is a fact of life.
No one would speak on the record
for fear of losing their jobs. The SEC
declined to comment on the widespread use of unauthorized apps.
Wall Streeters say they’ve turned to
messaging apps because they’re tired of
having their every word—work-related
or not—ingested into vast databases
and scrutinized for tone and taste as
well as legal red flags. Some clients also
prefer to use those apps to communicate; ignoring the messages would be
bad for business. Financial companies
have long grappled with new technologies and the need to comply with securities laws. (Bloomberg LP, which owns
Bloomberg Businessweek, offers message
and chat services that enable firms to
set up alerts and restrictions to help
enforce compliance.) But it’s gotten
harder for compliance to keep up.
At companies that ban personal
phones, trading desk employees will
sneak into hallways or stairwells to use
them. Popular texting apps, such as
iMessage, route conversations around
most monitoring systems. Others such
as Confide, Dust, and Signal can automatically delete messages once they’re
read. How messaging is used varies
widely on Wall Street. At big banks,
employees often use the apps to share
gossip and communicate with clients. A
“don’t ask, don’t tell” mindset prevails.
Several employees at one
multibillion-dollar hedge fund set up
a WhatsApp group chat to exchange
market intelligence with one another,
according to a person with direct
knowledge of the matter. The app
is particularly useful if there’s a big
market move and for money managers
traveling to far-flung places who need
to be reachable at a moment’s notice.
Occasionally messaging on personal phones has enabled conduct that
could be legally problematic, compliance experts say. At least one investment bank has debt salespeople who
routinely send screen shots of chats
showing one hedge fund’s positions
to another client in an attempt to win
more orders, a person with direct
knowledge of the matter said. At other
firms, traders send screen shots of
client lists and profit-and-loss statements to prospective employers.
“If you look the other way on this,
it’s only going to get worse,” says
Warren Small, who teaches a program
at Middlebury Institute of International
Studies for students seeking careers
investigating financial crimes. “With
financial transactions, temptations and
the rewards are just too great.”
In the Jefferies case, U.K. regulators
said they fined Christopher Niehaus
about $46,000 for sharing confidential
client information via WhatsApp as he
boasted to a personal acquaintance and
a friend about deals he had pending.
The messages came to light after an
unrelated complaint led him to voluntarily hand over his phone to Jefferies,
a person with knowledge of the situation said. Richard Khaleel, a spokesman
for Jefferies, and Niehaus’s attorney
declined to comment. Authorities said
none of the parties in the Jefferies incident traded on the information.
Banks have implemented software to immediately flag phrases
in company email and messaging
systems such as “check your phone,”
“sent you a text,” or “take this
offline.” Technology can only go so
far, however. Jack Rader, a managing director at ACA Compliance
Group Holdings LLC, which sets up
monitoring systems, says he sometimes encounters pushback from the
heads of sales and trading desks. That
raises a host of thorny questions,
says Erik Gordon, a professor at the
University of Michigan’s Ross School
of Business. “Are the firms really
doing what’s reasonable in trying to
stop this?” he muses. “Or are they sort
of wink-winking?” —Laura J. Keller
The bottom line Some mobile apps can make
messages permanently disappear, which may
help rogue traders.
Edited by Pat Regnier
Bloomberg.com
ANDREW HARRER/BLOOMBERG
Jeffrey Lacker, in a statement on his April 4 resignation as president of the Federal Reserve Bank of Richmond.
He wrote that in a 2012 conversation with an analyst from Medley Global Advisors, he unintentionally confirmed
confidential information the analyst had about the Fed’s policy options.
W EN 3M BOUGHT INTO
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he law enforcement community in Massachussetts
had a deal. In 2012 the state entered into a contract with the leading manufacturer of electronic
ankle monitors, the small GPS devices strapped
over the socks of parolees and people awaiting
trial to make sure they didn’t skip town or otherwise show up
in places they weren’t supposed to.
There were problems from the beginning, according to
corrections officials, offenders, and attorneys. For example,
the battery on the bracelets was prone to dying suddenly and
without warning. The internal antenna didn’t always perform
well underneath certain clothing or in certain buildings. The
devices sometimes relayed inaccurate navigational coordinates, leaving offenders in technical violation of the conditions of their release. Some offenders found themselves
having to walk outside in the middle of the night or stand in
the middle of a street to establish a satellite connection and
prove to authorities that they were where they were supposed
to be. A July 2015 article in Massachusetts Lawyers Weekly
recounted a criminal defense attorney’s tale of his client’s
device showing that he had walked across a lake.
What’s unusual
FIG. 3
about this chapter in
Massachussetts law
enforcement history
is not the heavy reliance on ankle monitors, which are in
wide use around the
world, or even that
1970s
there were some
glitches in the technology. What’s especially
Nixon announces the
notable is that the devices themselves were
war on drugs.
Prison populations
made by 3M Co. Yes, that 3M. The Post-it Notes
begin a long rise.
and Scotch tape company, a Fortune 100
T
mainstay with a market value of $115 billion, 350K
is also one of the world’s largest makers of
300K
GPS ankle monitors, a field it entered in 2010.
Corrections agencies around the world 250K
are desperate for cost-effective alterna200K
tives to overcrowded prisons, which is why
125,000 people are being monitored with 150K
1970
ankle devices in the U.S. alone. Peru is
considering putting ankle bracelets on more
than 20,000 inmates. In Norway, the Ministry
of Justice and Public Security is examining
the use of ankle monitors for asylum seekers.
Germany recently passed legislation allowing them to be used
A BRIEF HISTORY OF
1969
OFFENDER TRACKING
FIG. 1
Ralph Schwitzgebel
is awarded patent
No. 3,478,344—
a “Behavioral
Supervision System
with Wrist Carried
Transceiver.”
ORWELLIAN FANTASY HERE.
THIS WAS A MARKET...
THAT WE THOUGHT WE COULD
ADD INNOVATION TO”
to track Gefährder, or potential terrorists.
3M’s operations and sales in 200 countries have
allowed it to draw on deep networks to win government
contracts and move quickly into the top ranks of the
$6 billion offender-monitoring business, as it’s called.
But there’s evidence the company’s reach has at times
exceeded its technical capabilities, with sometimes disastrous results. Parolees and people awaiting trial have
been sent to jail because of false violation alerts generated by 3M monitors; equally troubling, authorities are
1980
sometimes so overwhelmed by alerts that they can’t tell
who’s in violation and who isn’t. You don’t have to be a
coddler of criminals to understand that this is a problem.
3M says it’s finally gotten a handle on it, but the
struggle to master this business has left the company
bruised. The company says it can’t comment on specific cases in which wearers claim their bracelets
falsely placed them in violation. In a written statement, it adds, “while many offenders violating the
terms of their probation claim innocence, their
guilt, along with the effectiveness of the system,
has been proven in various violation of parole
hearings almost every day.”
“We have a great business and a wonderful
technology,” says Raymond Eby, public security
business director at 3M’s Traffic Safety & Security
Division, which oversees the electronic monitoring division. “But it’s complicated—it’s probably
FIG. 2
the most complicated thing that 3M does, to be
honest with you.”
And also the thing with the highest human
stakes. It’s one thing to turn out simple but
DATA: BUREAU OF JUSTICE STATISTICS;
FROM TOP: THE RICHARD NIXON PRESIDENTIAL LIBRARY AND MUSEUM; COURTESY U.S. PATENT OFFICE; COURTESY ROBERT S. GABLE
46
“THERE WAS NO
FIG. 1: ROBERT GABLE’S BELT-MOUNTED TRANSCEIVER, CAPABLE OF SENDING AND RECEIVING TACTILE SIGNALS. FIG. 2: FROM U.S. PATENT 3,478,344, BEHAVIORAL SUPERVISION SYSTEM WITH WRIST
ingenious solutions for consumers and businesses. People love
you for that. It’s quite another to be at the center of matters
of public safety and civil liberties. When people go to jail with
your product bound to their bodies, you attract an entirely different kind of attention.
Long before 3M employee Arthur Fry delivered to the world
the sticky note in 1980, 3M had endured several near-ruinous
mistakes. In the early 1900s the founders almost bankrupted
the company by mistakenly digging up anorthosite, for which
they had no use, instead of corundum, a tough-as-diamonds
mineral they planned to sell for grinding wheels. Then the
1980s
company imported 200 tons of
Spanish garnet to manufacture
sandpaper, but discovered the
rock had been rendered useless
after a load of olive oil spilled
on it during an ocean crossing.
Eventually a factory superintendent discovered that the oil could be roasted off, salvaging
the shipment and redeeming the company.
Even Fry’s sticky note materialized only after a colleague
was unable to find a purpose for a not-so-sticky adhesive.
Fry, the oft-told story goes, was looking for a way to keep
slips of paper from falling out of his hymnal at church. It
turned out the adhesive was the perfect solution, and Post-it
Notes were born.
This quality of renewal and a proud embrace of failure
became central to 3M’s identity. Encouraging tinkerers and
dreamers became so ingrained in the 3M culture that in 1948
the company introduced its “15 percent program,” in which
employees are encouraged to use company time to pursue
risky ideas. The concept is now widely used in corporate
America—think Google Inc.’s “20 percent time.”
All of this has made 3M an archetype of innovation, featured in Harvard Business School case
1990
studies and lauded by management gurus. So when
Prison overcrowding
George Buckley, an engineering Ph.D. and former
reaches crisis level.
head of boats-and-billiards maker Brunswick
judges to release pretrial detainees or parolees if
State spending
Corp., took over as 3M’s chief executive officer in
they wore a monitoring device. The Department
on corrections has
December 2005, he was dismayed to learn that
of Homeland Security began electronically monitripled in just
three years.
the company he called “an engineer’s heaven” was
toring immigrants to ensure they would show up
floundering. 3M’s New Product Vitality
for court hearings. Some people, mainly
Index, an internal measure that tracks
sex offenders, were sentenced to wear an
FIG. 4
the share of sales that come from prodankle monitor for the rest of their lives.
ucts introduced in the previous five years,
Groups along the political spectrum, from
was at about 20 percent, down from about
the American Civil Liberties Union to the
30 percent in the 1980s, Buckley recalls.
Heritage Foundation, embraced the use of
Five months after taking the job,
ankle monitors. Advocates argued that the
Buckley stood before analysts at the
devices gave defendants freedom to work
Waldorf Astoria in New York City. He
and raise their families while under court
vowed to breathe “3M imagination” back
supervision; they would also reduce the
into the company and boost R&D spendmore than $50 billion in annual costs assoing. And, saying that no company can ever
ciated with mass incarceration.
be the sole fount of ideas, he promised to make complemenInside 3M, executives grappled with whether tracking people
tary acquisitions, a tool he’d used to turn around Brunswick.
was ethical and whether it conflicted with the wholesome brand
He also identified a set of new “emerging business oppor- 3M had cultivated for a century. They decided the technology
tunities” that aligned with what 3M called “the mega trends of ultimately made society safer and fit nicely within the company’s
society,” including energy extraction, pollution control, and food track-and-trace and security businesses.
safety. Early on as CEO, Buckley identified as uniquely prom“There was no Orwellian fantasy here,” says Buckley,
ising a trend he called “track and trace.” It already had deep who stepped down as 3M’s CEO in 2012 after reaching the
Jack Love, a
New Mexico judge,
markets a radiofrequency tracking
device inspired
by a Spider-Man
comic.
ANDREW LICHTENSTEIN/CORBIS/GETTY IMAGES
roots at 3M. In the 1970s the company introduced its magnetized “Tattle-Tape” strips, which were tucked inside the spines
of library books to prevent theft. In the early 2000s, 3M developed radio-frequency identification tags, or RFIDs, to track file
folders, buried utility lines, and other assets. It had also toyed
with fleet-tracking software, installing it in the cars of some
company salespeople. Buckley believed so strongly in the future
of tracking and tracing the world’s things that he preached to
investors gathered at the Waldorf: “It is my belief that within 10
years, every single thing of value on the surface of the Earth is
going to be tracked and traced, including you, your dog, your
children, your car, and anything that you own which is of value.”
Almost three years later, 3M was staggering through the
recession—fourth-quarter profits fell almost 40 percent in
2008, and the company laid off 4,000 employees. Buckley
turned to the Markets of the Future reports prepared annually
by the company’s strategic planning group. Ideas generated
for the report have included a smart device for dispensing
pills, reflective bicycle tires, reusable plastic Post-its, and
“anti-fatigue shoes,” according to an internal 3M presentation. In one of the reports, Buckley noted a trend: “We
concluded that security is unlikely to get better, so border
crossings, tracking of criminals—you can make rough estimates of where markets are going,” he says.
Offender monitoring had come of age by then. In 2010
authorities in the U.S. were electronically monitoring almost
twice as many accused and convicted offenders as they
had just five years earlier, according to the Pew Charitable
Trusts. Some were being monitored by RFID devices, but
more were wearing GPS monitors, which typically comprise
an ankle-affixed device with a built-in wireless modem programmed to record and store an offender’s location points
at selected intervals. The modem wirelessly transmits the
information to a data center—essentially by placing a wireless phone call—where it’s downloaded and analyzed by
corrections officers or contractors.
More and more states began passing laws allowing for
CARRIED TRANSCEIVER. FIG. 3: PRESIDENT RICHARD NIXON ANNOUNCES THE WAR ON DRUGS. FIG. 4: A FORMER GYM AT THE DEUEL VOCATIONAL INSTITUTION IN TRACY, CALIF., CONVERTED TO HOUSING.
47
mandatory retirement age of 65. “This was a market that was
growing, that was attractive, and that we thought we could add
innovation to. This is a typical 3M approach, and it is what 3M
is very, very good at.”
In August 2010, 3M announced the $230 million acquisition
of Tel Aviv-based Attenti Holdings SA. Founded by three former
Israeli Air Force pilots, the company was one of the world’s
largest manufacturers of GPS trackers; its devices were used in
Israel, the U.S., and several other countries, including Australia,
Singapore, and Sweden. “This acquisition will position our track-and-trace business as a leader in the
high growth electronic offender monitoring market,”
3M said in a news release announcing the deal.
On an investor call two months later, a stock
analyst questioned Buckley on how exactly Attenti
fit into the DNA of 3M, saying the newly acquired
company seemed far from the material sciencerelated companies that have been “the core strength
and bailiwick of 3M.” Buckley reminded the analyst
of his track-and-trace philosophy. “You might
remember that we got that library equipment business that tracks library books,” he said. “This is kind of in a way a
lateral extension of that—instead of tracking a book, you’re tracking a person. So they’re not that different as you might think.”
Except they were.
1998
Pro Tech Monitoring
becomes an early
“unable to connect” violauser of GPS for
tions, as the state probation
offender monitoring.
office calls them, became so
numerous that it became difficult for authorities to determine whether an offender’s device was simply being booted
off the cell network, or the offender was interfering with
the signal to avoid detection.
The sheer amount of data generated by GPS-tracking
devices creates problems across the industry and in every
state, but the number of alerts in Massachusetts has far
exceeded the norm, experts say. Documents reviewed by
Bloomberg show that in the 12 months ended in October
2015, 3M bracelets produced 612,492 violation alerts in
Massachusetts—more than 50,000 per month, from about
2,800 individuals wearing the devices. Almost 40 percent
of the alerts were due to a device
1994
LLC, known as STOP, FIG. 5
was illegal. After more
than two years of litigation, the parties reached
a settlement. The terms
haven’t been disclosed.
In 2014, 3M won a
contract in New Zealand
worth a reported
$80 million. Within a year
dozens of offenders had
been able to cut off the devices, including some who went on
to commit serious crimes. After 3M replaced the straps with
supposedly stronger ones, a man cut through a new strap with
scissors on a TV news broadcast. New Zealand’s prime minister
called the situation “ludicrous.” 3M says the company’s bracelets are designed to be cut off in emergencies.
In Germany, a report co-funded by the Criminal Justice
Programme of the European Union concluded that the
3M software used for the country’s electronic monitoring
devices was “too inaccurate” and resulted in “false alarms
or false zone transgressions.” The report also found that in
2014, “a firmware installation error on behalf of 3M resulted
The U.S. military’s
GPS system
is completed.
The government affirms
that it will be
available for
commercial use.
not being able to connect to the network
or the GPS not being detected. Roughly
1 percent of alerts resulted in an arrest
warrant being issued. Tom Pasquarello,
former director of the electronic monitoring program for Massachusetts, estimates that half those warrants were
potentially based on faulty or incomplete data. That would be
roughly 3,000 warrants. “There were people that were pulled
from their house in the middle of the night, that lost their kids,
people that lost their job,” he says.
The problem of glitchy ankle monitors became so pronounced
that the Massachusetts probation department set up an afterhours office in the lobby of a Boston police station so offenders could bring in their bracelets when problems occurred or
batteries died. In August 2015, Massachusetts Superior Court
Judge Heidi Brieger became so frustrated with the devices that
she vowed to stop sentencing anybody to them. “It is simply
administratively improper to run a system in this fashion,” she
said, according to a court transcript. “We don’t lose liberty in
this country because somebody’s software is not working. It
just isn’t right.”
Last May, nearly six years after entering the business,
FIG. 5: GPS SATELLITE ARRAY. FIG. 6: PRO TECH MONITORING’S DATA CENTER IN PALM HARBOR, FLA. FIG. 7: THE BUDDI US ANKLE MONITOR
FROM TOP: SCOTT KEELER/TAMPA BAY TIMES/ZUMA PRESS; COURTESY NASA
48
In 2011 the California Department of Corrections and
Rehabilitation began conducting a series of field tests on 3M’s
devices as part of a search for a single contractor to electronically
monitor 8,000 parolees. Even though 3M came in as the lowest
bidder, at $23.2 million, corrections officials notified the company
that it lost the bid “due to its GPS equipment failing” to meet
state requirements, according to court records. Among other
things, the state found that the device too often failed to obtain
a GPS signal, was unable to map offender locations accurately,
frequently ran out of battery power, and was easily manipulated
by wrapping the device in foil. 3M sued, saying the awarding of
the contract to Houston-based Satellite Tracking of People
in all active GPS-trackers being shut off simultaneously.”
But nowhere have the deficiencies of 3M’s monitors been as
acute as in Massachusetts. One of the most serious flaws with
the 3M device, according to numerous law enforcement officials
and attorneys, was that it was originally designed to work only
on T-Mobile and AT&T 2G networks, and it became even less
reliable as carriers upgraded their networks to 3G. Because it
wasn’t designed to work with Verizon’s network, offenders were
left wearing a state-sanctioned monitoring anklet that couldn’t
communicate on the network
FIG. 6
of one of Massachusetts’
largest and most effective
wireless providers. If an
offender’s device was unable
to connect to a network, that
would trigger an alert. These
“THERE WERE PEOPLE
THAT WERE PULLED FROM THEIR
multiple calls a night from probation officers because the unit
would lose its signal, she says. At around 2 a.m. on March 4,
Nelson answered a knock at the door and found two police
officers. “They said, ‘We have a warrant for Tyler’s arrest,’ ”
she recalls. The officers woke her son, handcuffed him, and
booked him into the Ash Street Jail in New Bedford. The
state of Massachusetts says an alert was generated because
Holdsworth had earlier entered an exclusion zone.
The next day he was found hanging in his cell. “I believe
that killed my son,” Nelson says. “Everything the bracelet
put him through.”
The electronic monitoring business has proved perilous
even for companies with deep roots in corrections. Many
of the bracelets on the market can be slipped off without
detection. Some offenders will risk triggering an alert by
cutting it off, or they’ll wrap it in aluminum foil to mask
OF THE NIGHT, THAT LOST THEIR
the GPS signal. Hackers can “spoof ” a monitoring device—
cause it to report that the wearer is one place when he or
she is actually somewhere else. But the most vexing issue
is the unmanageable number of alerts. Officers don’t want
KIDS, THAT LOST THEIR JOB”
to be too lax in responding to them, because any given
alert might be the signal that the offender is committing a
crime. But they don’t want to respond so frequently that it
becomes a nuisance to the offender or a civil liberties violation. There’s also the concern that the sheer volume of
alerts emboldens criminals, who might know that author3M began rolling out a new ankle monitor, the
ities struggle to distinguish meaningful alerts
Tracking Device 4, or TD-4. It’s designed to be
from noise.
2010
compatible with multiple cellular networks,
Many of the most innovative attempts to
including Verizon’s, and has better battery life 3M enters the business. improve location accuracy and bring down the
and improved location accuracy. 3M’s Eby says the
frequency of violation alerts come from smaller
company moved as quickly as it could. “Virtually
companies. Buddi US LLC, run by Steve Chapin,
everything we make, we have a reputation for
who was the CEO of Pro Tech when 3M bought the
the highest quality and always standing behind
company and stayed with 3M’s electronic moniour products,” he says. “It also means, unfortoring division for two years, sells a bracelet that
people worldwide have
tunately, we test, test, double-test, triple-test worn 3M ankle bracelets. remains charged for as long as five days and in
before it goes out the door.” The product rollout
some instances can track the wearer underground.
in Massachusetts was completed in December;
Buddi recently signed a contract with the governthe state says 91 percent of the units in the field are TD-4s.
ment of Colombia. Other companies have started using cell
Probation Commissioner Edward Dolan says he’s pleased
phones as a GPS-tracking platform, combined with Bluetooth,
with the new product. Before the upgrade, he says, “I
remote video, biometrics, or voice recognition to verify a percouldn’t distinguish whether an unable-to-connect was
son’s identity and location.
Eby says it’s one thing to develop a whiz-bang new techyou affirmatively doing something to disrupt the signal, or
it really was a signal issue. Now unable-tonology and another to scale it, sell it to a
connect is a nonissue, and only every once
government agency, and place it on thouin a while we have one.” The agency says
sands of people who want no part of it. “If
FIG. 7
unable-to-connect alerts have fallen to less
the standard is you only want to use technolthan 2 percent of all alerts and resulted in
ogy that has no limitations in terms of celluonly eight arrest warrants in February.
lar connectivity and GPS, you’re not going
to be able to have electronic monitoring at
And yet Tyler J. Holdsworth was wearing
a 3M bracelet when he died. Holdsworth,
all,” he says. “There’s not a technology that
who’d been a student at Franklin Pierce
will always stay connected to cell networks
University, was ordered by the Massachusetts
and will never have a GPS problem.”
Superior Court in 2015 to wear a 3M ankle
Other people say that doesn’t sound
2017
monitor until he could face trial for rape
like a great American innovator talking,
Monitoring companies
charges. (He denied the charges.) He encounnot with stakes this high. “Every business
now incorporate
tered constant technical malfunctions, including Bluetooth, remote video, has hiccups,” says George Drake, a former
corrections officer and president of consultat least one that resulted in him being jailed. “He
biometrics, and voice
had to walk around the neighborhood for three recognition to verify a ing firm Correct Tech LLC in Albuquerque.
person’s identity
hours because they couldn’t locate him,” recalls his
“But when it happens with an offender-trackand location. Buddi US
mother, Cynthia Nelson, of South Dartmouth, Mass.
ing company, the consequences are magnified.
has a bracelet
He quit a warehouse job because the monitor
If these people were making shoes, it wouldn’t
that can track in some
couldn’t locate him inside, and he often received
have made a difference to anybody.” subway stations.
HOUSE IN THE MIDDLE
COURTESY BUDDI
200k
49
DANGER
By Paul M. Barrett
THE F-35 FIGHTER JET HAS
SENSORS THAT SEE ENEMIES
OVER THE HORIZON, A
VR-STYLE HELMET FOR ITS
, AND DONALD TRUMP’S
ULL ATTENTION. IT ALSO
MIGHT BE A TRILLIONDOLLAR MISTAKE
ZONE
The ambition to create the version of the F-35 that I watched
on the tarmac at Patuxent River—one that can make short
takeoffs and vertical landings—was what got the fighter jet’s
development under way
in the 1980s. The Defense
Ad v a n c e d Re s e a r c h
Projects Agency (Darpa),
the Pentagon’s tech arm,
began working at the
Marine Corps’ behest on
an improved version of
the Harrier, a crash-prone
vertical-landing jet of
British design. According
Lockheed CEO Hewson
to a Pentagon history of
the F-35, Darpa quietly sought assistance from a research and
development arm of Lockheed Martin known as the Skunk
Works. By the early 1990s, the Darpa-Skunk Works collaboration had produced preliminary concepts, and the Marine Corps
began pressing Congress for funding. The Air Force and Navy
insisted that they, too, needed stealthy, supersonic fighters to
replace aging Cold War-era models. Out of this clamoring grew
a consensus that the only way to afford thousands of cuttingedge fighters was to build a basic model that could be customized for each service. “In terms of future tactical aircraft, this
was the program,” says Frank Kendall, a senior Pentagon acquisition official during the Clinton and Obama administrations.
“There was no other program.”
In 2001 the Pentagon declared Lockheed the winner of a
five-year competition against Boeing Co. for the opportunity
to build the F-35. At the time, the contract was estimated to
be worth $200 billion over three decades. Lockheed, which is
based in suburban Bethesda, Md., not far from the Capitol and
Pentagon, would assemble the plane in Fort Worth, in a milelong facility that’s produced military aircraft since 1942. In addition to the Marine Corps F-35B vertical-landing jet, Lockheed
agreed to manufacture the Air Force F-35A, which would take
off and land conventionally, and the Navy F-35C, designed for
aircraft carriers, with larger, foldable wings, more durable
landing gear, and a tailhook.
Not only was the F-35 going to offer a 3-in-1 cost savings for
the U.S. military, the plane was supposed to help knit together
the air forces of 11 American allies—including Britain, Israel,
Japan, and South Korea—that have lined up to buy it.
But this one-size-fits-all promise quickly led to problems.
For the F-35B, the Marine Corps variant, Lockheed incorporated a novel propulsion system with a 50-inch-diameter “lift
fan” positioned horizontally just behind the cockpit. When the
plane goes into vertical mode, doors on the fuselage open, allowing the fan to draw in air from above and blow it toward the
ground. Simultaneously, the plane’s main
engine in the rear swivels 90 degrees
to expel its exhaust downward. The
combined force of fan and engine
allows the plane to hover.
The lift fan made the common fuselage bulkier
than it otherwise would have been. That, in turn,
increased drag and decreased fuel efficiency and
range. Lockheed engineers also discovered they had to slim
the F-35B by thousands of pounds to make it light enough to
hover. The degree of commonality among the three versions of
the F-35—the shared features—turned out to be not the anticipated 70 percent but a mere 25 percent, meaning that hoped-for
economies of scale never materialized. A pattern of continual
reengineering resulted in billions of dollars in cost overruns
and yearslong delays.
Beginning in 2007, the Pentagon accepted delivery of scores
PREVIOUS SPREAD: COURTESY U.S. AIR FORCE; THIS SPREAD: COURTESY LOCKHEED MARTIN; ILLUSTRATION BY 731
52
pointy-beaked F-35B Lightning II idles
noisily on a runway at Naval Air Station
Patuxent River in southern Maryland.
Suddenly the plane roars to life and sprints
a mere 300 feet before abruptly lifting off
and soaring into a cloudless, late-winter sky
over Chesapeake Bay. A while later it zooms
back into view, slows to a hover over the runway
like a helicopter, then drops straight down to the
concrete, where it lands with a gentle bounce.
A U.S. Marine Corps test pilot is manning the
controls. If he were Air Force or Navy, his version
of the military’s highly anticipated new fighter jet
wouldn’t have this capacity to take off and land on a dime—
though it would come with other custom features. This is why
Air Force Lieutenant General Christopher Bogdan, who’s in
charge of overseeing the acquisition of the F-35, brought three
plastic models of the fighter jet to a December 2016 meeting
with Donald Trump at his Florida residence.
Bogdan, a tall former test pilot who speaks in a raspy, authoritative voice, has been working with Lockheed Martin Corp., the
plane’s manufacturer and the country’s largest defense contractor, since 2012. Nine days before their meeting, Trump had
called Bogdan’s program “out of control” in a tweet, so the threestar general knew that at Mar-a-Lago, the president-elect would
put him on the spot. But what he didn’t anticipate was Trump’s
eagerness to demonstrate his own knowledge of aviation. Trump
talked with pride about his personal Boeing 757, Bogdan says.
“Anything about airplanes, he’s excited about, and he told me
that the first time we met.”
Amid the gold-inlaid, high-ceilinged splendor of the Jazz Age
château in Palm Beach, Bogdan explained the F-35’s advanced
sensor system and stealth capability. Trump listened respectfully, but the next day he was back on Twitter, complaining about
the plane’s “tremendous cost and cost overruns.” To Bogdan’s
continued surprise, in the days before the inauguration, Trump
twice telephoned the general at his office in an austere Pentagon
annex in Arlington, Va. He wanted to discuss the allegations
he’d heard that the F-35’s performance fell short of existing
fighters. Bogdan hastened to reassure Trump that those claims
were “myths,” “misinformation,” or “old information”—none of
them worth believing.
On Jan. 30, his 10th day as president, Trump markedly
changed his tone. He took credit for knocking $600 million off
the price of the latest batch of 90 fighters and told reporters
the F-35 was “a great plane.” Since then, he’s made the F-35 an
emblem of his dealmaking prowess. During his Feb. 28 address
to a joint session of Congress, the president boasted he’d “saved
taxpayers hundreds of millions of dollars by bringing down the
price of the fantastic new F-35 jet fighter.”
In truth, thanks to Bogdan’s negotiations with Lockheed,
prices were going to fall with or without Trump’s intervention.
And the plane, discounts notwithstanding, is still on its way
to becoming the priciest military procurement in U.S. history.
Trump’s self- congratulation serves as a distraction from the
larger issue troubling the fighter jet: its performance. While
the Pentagon’s official line is that, after years of difficulties, the
F-35 is meeting high expectations, skeptics both outside and
within the military say it’s turning out to be a two-decades-inthe-making, trillion-dollar mistake.
of planes, even as Lockheed continued to make design changes
and address myriad deficiencies. The military “didn’t follow the
old rule of ‘fly before you buy,’ ” says Michael Sullivan, director of
defense acquisition oversight for the Government Accountability
Office, the auditing arm of Congress. Once new weapons are
in the hands of the military services, says Kendall, the former
Pentagon acquisition official, “there’s a lot of inertia to continue,
no matter what.” Michael Rein, a Lockheed spokesman, declines
to comment on what he calls the “ancient history” of this period.
The arrival of the Obama administration in 2009 brought
new scrutiny to the F-35 program. Ashton Carter, a physicist and
former Harvard professor of science and international affairs,
took over as the Pentagon’s chief weapons buyer, known formally as undersecretary of defense for acquisition, technology,
and logistics. (He went on to serve as secretary of defense in
2015 and 2016.) The dysfunction startled Carter. What was supposed to have been an economical plane at $50 million apiece
had doubled in price, he recalled in a talk at Harvard in 2014.
Part of the problem stemmed from a policy instituted in the
mid-1990s aimed at reducing red tape. “This was a notion of
trying to skinny down the acquisition bureaucracy,” says retired
General Norton Schwartz, who served as Air Force chief of staff
from 2008 to 2012. “In doing so, we regrettably lost much of the
systems engineering ability that existed in-house.”
The “cost plus” contracts the Pentagon signed with Lockheed
HOW THE F-35B
LANDS VERTICALLY
Doors open to draw
air into the lift fan
Relatively small wings
cut down on weight to
ease landing
The engine nozzle turns
down 90 degrees to
allow the plane to hover
and descend
only exacerbated the situation. The company received all its costs
and was eligible for a performance-based bonus on top of that.
Despite the program’s disarray, the military consistently awarded
Lockheed 85 percent of its potential fee. In his Harvard talk,
Carter described confronting the Pentagon program manager,
a Marine Corps major general named David Heinz: “He looked
me in the eye—I’ll never forget it—and he said, ‘I like the program
manager on the Lockheed Martin side that I work with, and he
tells me if he gets less than 85 percent, he’s going to get fired.’ ”
Instead, it was Heinz who was fired, in 2010. Carter switched
the Lockheed contract to a fixed-price arrangement under
which the government and contractor split the cost of overruns. Carter declines to comment for this article, but confirms his earlier account. (Heinz, now chief executive officer
of IBC Advanced Alloys Corp., an Indiana-based company that
supplies Lockheed with the housing for one of the F-35’s targeting systems, also declines to comment, as does Rein, the
Lockheed spokesman.)
With the program about seven years behind schedule, the
Pentagon estimates it will spend $379 billion over 40 years
to develop and acquire more than 2,440 of the warplanes.
Adjusting for inflation, that’s a 38 percent increase from the
initial 2001 estimate. Add more than $600 billion for upkeep,
and the total price tag approaches $1 trillion. But the aircraft
has already paid off for Lockheed. Having delivered 210 F-35s
so far—mostly to the Pentagon, but also to Israel and other privileged U.S. friends—the company is expected to derive more
than 20 percent of its revenue in 2017 from the jet.
For all its stumbles, the plane’s geographic and political heft
make it too big to fail. The three versions of the plane require a
total of some 300,000 parts, and Lockheed has parceled out the
subcontracting to all but five unlucky states—Alaska, Hawaii,
Louisiana, North Dakota, and Wyoming. Lockheed says the
F-35 directly or indirectly supports 146,000 jobs across the
U.S., ranging from minimum wage broom-pushers to engineers paid well into six figures.
Consider Arizona. In December 2011, Republican John
McCain, the state’s senior U.S. senator and chairman of
the Armed Services Committee, went to the Senate
floor to declare that the F-35 program “has been
both a scandal and a tragedy.” But less than a
year later, the lawmaker, himself a former Navy
pilot shot down over Vietnam, sounded mollified. The Marine Corps had decided to base a
squadron of 16 early-production
F-35Bs in Yuma, Ariz.
Joining Lockheed executives and Marine Corps
officers, McCain said at a dedication ceremony: “I am—after many
years of frustration and setbacks—encouraged that
the overall program is moving in the right direction.”
The F-35, he added, “may be the greatest combat aircraft
in the history of the world.” In addition to maintenance
jobs at the Yuma base, the plane provides work for 24 subcontractors in Arizona, supporting a total of 4,620 jobs,
according to Lockheed.
Across the country in Vermont, the independent Senator
Bernie Sanders has disparaged the F-35 in the Burlington
Free Press as an example of the Pentagon’s “long record of
purchasing weapons systems from defense contractors with
massive cost overruns that have wasted hundreds of
billions of taxpayer dollars.” Nevertheless, Sanders has
53
endorsed the idea of bringing 18 of the fighters to Burlington
International Airport in 2019 to replace a squadron of aging F-16s
flown by the Vermont Air National Guard. In the face of local opposition to noise and other environmental objections, Sanders said
at a town hall meeting in 2014: “My view is that given the reality
of the damn plane, I’d rather it come to Vermont than to South
Carolina. And that’s what the Vermont National Guard wants, and
that means hundreds of jobs in my city. That’s it.”
Lockheed says the jobs total in Vermont will exceed 1,400.
South Carolina won’t lose out: There’s a squadron of F-35s stationed at the Marine Corps air base in Beaufort. There are also
detachments in California, Florida, Maryland, Nevada, and Utah.
54
Since Lieutenant General Bogdan took over the F-35 acquisition program five years ago, by all accounts he’s kept it from
going further off the rails. A blunt, informal officer who leads
a 2,000-person bureaucracy devoted exclusively to the F-35,
Bogdan wears an olive one-piece flight suit to his office in suburban Virginia. He explains that the F-35’s stealthy profile and
matte finish are designed to allow it to succeed against foes with
sophisticated radar and surface-to-air missiles—the Chinese or
Russians, for example. “You’re the guy who’s going to knock
down the door by going very deep into enemy territory, survive,
and go against the very toughest threats,” Bogdan says. When
in stealth mode, the F-35 carries only two bombs and two airto-air missiles in an internal weapons bay. But once the opposition’s defenses are eliminated, the plane can be outfitted
with six additional weapons, three beneath each wing. “I can
go and wreak a lot of havoc,” Bogdan says.
He points to a three-week aerial exercise in February called
Red Flag, which pitted dozens of U.S. warplanes against one
another in mock battle over the Nevada desert. The F-35s, the
stars of the show, recorded a 20-to-1 kill ratio, meaning they
took out 20 opposing planes for each one they lost. And they
dropped 51 practice bombs, with 49 direct hits—a level of accuracy Bogdan calls “incredible.” Other military leaders share
his enthusiasm. “We can’t get into those aircraft fast enough,”
Lieutenant General Jon Davis, the Marine Corps’ aviation chief,
told a House Armed Services subcommittee in mid-February.
“We have a game changer, a war winner, on our hands.”
The F-35, in one of its most futuristic advancements, projects flight data—airspeed, altitude, heading, potential targets,
and warnings—onto the curved visor of the pilot’s helmet. It’s
almost a virtual-reality experience, pushing the skills of even
today’s Xbox-weaned twentysomethings. Six infrared cameras
mounted on the exterior stream real-time imagery, allowing the
pilot to “see through” the skin of the plane, including straight
down. In a process called “sensor fusion,” the main onboard
computer can meld data from the exterior cameras, the plane’s
powerful radar, and an “electro-optical” targeting system. “It’s
always looking in every direction,” says Major John Dirk, a Marine
Corps test pilot. The visor’s profusion of images and information
takes getting used to, he adds, but “I can see threats I wouldn’t
have been able to see before.”
Some experts warn that test flights and mock battles are different from the real thing—and that the military’s enthusiasm should
be viewed skeptically. “It’s groupthink,” says Pierre Sprey, who
worked at the Pentagon during the Vietnam War. He belonged
to a clique of aeronautical designers and engineers who called
themselves the “fighter mafia” and helped design two respected
aircraft: the F-16 Fighting Falcon, a maneuverable specialist at
air-to-air duels, and the heavily armored A-10 Thunderbolt II,
better known as the Warthog, which supports ground troops
by flying low and slow, strafing the enemy with a seven-barrel
Bogdan at Nellis AFB in Nevada in 2015
30-millimeter Gatling-type autocannon. “The F-16 and A-10 each
do one thing well,” Sprey says.
The Marine Corps’ “obsession” with short takeoff and vertical landing, he says, led to F-35 attributes that limit the plane’s
maneuverability—the stout fuselage, which increases drag, and
small wings, which cut weight but reduce the amount of lift the
plane can generate. If F-35s “face the best Chinese or Russian
fighters, they will be lucky if they can turn and run,” he adds.
One could question Sprey’s objectivity, given that the F-35 is
intended to put his creations, the F-16 and A-10, into retirement.
Not so J. Michael Gilmore, who served from 2009 to January
2017 as the Pentagon’s director for operational test and evaluation—the military’s chief weapons tester. Gilmore, who has a
Ph.D. in nuclear engineering, warned in a memorandum to the
Air Force last August that the F-35 will need support from other
planes “to locate and avoid modern threats, acquire targets, and
engage formations of enemy fighter aircraft due to outstanding
performance deficiencies.” According to Gilmore, the sensorfusion system fails to display some potential threats clearly, and
the plane’s electronic warfare capability—a reference to classified radar-jamming weapons—is weak.
In a separate 2016 annual report released in January, Gilmore
addressed the F-35’s protection of soldiers on the ground,
saying the plane “does not yet demonstrate close air support
capabilities equivalent to those of ” the A-10 and other older aircraft. He cited the F-35’s limited weapons load while in stealth
mode. The F-35 burns fuel fast, making it difficult for the jet
to circle above a battlefield for long, Gilmore wrote. And he
pointed out that test pilots aren’t unanimously enthusiastic
about all aspects of the newfangled helmet. “Symbol clutter,”
he wrote, obscures the visor representation of air-to-ground
strafing, making that function unusable.
Perhaps most troubling are the complexities of the autonomic logistics information system (ALIS), which hooks up to
the plane in the hangar and provides the information technology backbone for maintenance of each aircraft. ALIS requires
16 million lines of code, compared with 8 million for the F-35
itself. When ALIS malfunctions, which it does somewhat regularly, maintainers have “to use time-consuming workarounds,”
Gilmore said. Last April the GAO pointed out that all F-35 data
from across the U.S. fleet are “routed to a central point of entry
and then to ALIS’s main operating unit with no backup system
or redundancy. If either of these fail, it could take the entire
F-35 fleet offline,” threatening to ground the planes.
FROM LEFT: COURTESY U.S. AIR FORCE (2); COURTESY U.S. AIR NATIONAL GUARD
Lockheed’s Rein declines to comment on Sprey’s assessment.
As for Gilmore’s critique, the Lockheed spokesman refers to a
Jan. 17, 2017, written statement by Bogdan. “The basic design of
the F-35 is sound,” it said, but “we recognize there are known
deficiencies that must be corrected.”
“This plane has a long way to go before it’s combat-ready,”
says Dan Grazier, a defense analyst at the nonprofit Project on
Government Oversight in Washington. “Given how long it’s been
in development, you have to wonder whether it’ll ever be ready.”
In an interview, Bogdan responds to criticism of the F-35 with
equanimity. He stands by the overall reassurance he offered
President Trump but concedes the plane has kinks to be worked
out. ALIS, he says, “is nowhere near as good as it should be,”
and upgrades are under way, including building in the kind of
redundancy the GAO noted is absent. Meanwhile, he acknowledges, F-35 maintenance personnel do have to “do a lot of workarounds.” Bogdan also worries that ALIS could be hacked. The
planes themselves have been well-secured against cyberattack,
he says, but ALIS connects to other government networks that
are potentially vulnerable. This isn’t an abstract concern. A
Chinese businessman pleaded guilty last year in the U.S. to participating in a conspiracy with hackers from the Chinese military who prosecutors said stole plans for the F-35 and other
American warplanes. Beyond ALIS, Bogdan says the other sensor
and software glitches Gilmore and the GAO identified are being
addressed and will soon be fixed.
The knock on the F-35 that it’s not maneuverable obscures
a basic point about contemporary aerial warfare, Bogdan says:
Up-close dogfighting is a thing of the past. “This airplane is
very maneuverable,” he insists, “but it doesn’t have to be to
kill another airplane air-to-air.” Its sensors can identify a foe
long before the two pilots can see each other—and fire a missile
with deadly accuracy at that distance,
Bogdan says.
By contrast, close air support of
ground troops presents “a tricky
question,” he says. The F-35 “doesn’t
have all the capabilities it needs yet.”
One feature that will be added to new
planes—and retrofitted on older ones—is
the equivalent of a laser pointer for tracking
g
moving targets. Currently the F-35 has a surprisiing
weakness in its inability to zero in on swift-moving
i g
enemy vehicles, Bogdan says. Only F-35As hav
ve inter-nally mounted 25mm guns for ground strafing
g; in the
future, similar weapons will be added in ext
xternally
y
mounted belly pods on Bs and Cs. “When peop
ople
e are
complaining about close air capability of the F-35,” he
says, “they’re looking at what it can do today, and what it can
do today is limited. What it can do tomorrow is going to be very,
very good.” But not as good, he admits, as what the venerable
A-10 already can do. “We designed the F-35 to be a decathlete,”
he explains: versatile and adaptable, if not necessarily a medal
winner in any one event.
Grazier frames this another way: “You have a plane that at
best is a jack of all trades, master of none.”
On Feb. 3 the White House announced an $8.2 billion contract
with Lockheed for 90 F-35s, the latest and largest batch yet. Based
on a per-plane cost for the F-35A of less than $100 million, the
deal trimmed $728 million from the last purchase. That savings
exceeded the $600 million Trump took credit for after intervening with Lockheed CEO Marillyn Hewson.
Since late last year, Hewson has met with Trump at
Mar-a-Lago, Trump Tower in New York, and the White House.
But long before Trump began meeting, tweeting, or calling
Bogdan about the plane, negotiations between the Pentagon
and Lockheed were pointing to a significant volume discount.
Bogdan told reporters in December that the contract would be
valued at about $8 billion overall and that per-plane costs would
decrease—both of which happened.
The president has balanced his praise for the plane with the
admonition that Lockheed shouldn’t get too comfortable. He’s
warned that he’d consider substituting some F-35 purchases with
Boeing F/A-18 Super Hornets. During a Feb. 17 tour of a Boeing
plant in South Carolina, he said, “We are seriously looking at
a big order” of F/A-18s. Lockheed’s rival as the second-biggest
U.S. weapons contractor, Boeing has naturally tried to encourage Trump’s interest in the Super Hornet. “We’re excited to
work with the new administration to bring the right capability
to the war fighter,” says Dan Gillian, who heads the company’s
fighter jet program. First flown in the 1990s, the twin-engine
F/A-18 has seen action over Iraq and Afghanistan. It’s not really
comparable to the F-35. The Super Hornet, which is designed
to fly off aircraft carriers, lacks the F-35’s stealth characteristics and its array of advanced sensors.
Still, the president wants Lockheed and the Pentagon to know
he’s in touch with Boeing’s CEO, Dennis Muilenburg. When
Trump telephoned Bogdan for the second time, on Jan. 17,
Muilenburg was in Trump’s New York office listening in by
speakerphone. Bogdan says he didn’t think Muilenburg’s presence was inappropriate: “The things I talked about in front of
Mr. Muilenburg were clearly publicly releasable information. I
understand the rules.” (In mid-March, Trump selected a senior
Boeing executive, Patrick Shanahan, to serve as the Pentagon’s
second-ranking official. If confirmed by the Senate, Shanahan
would have to recuse himself from Boeing-related
matters for two years.)
m
Formalizing Trump’s fighter jet commentary,
Secretary
y of Defense James Mattis has
o
ordered
a Pentagon “review” of
th
nt to which the F/A-18
the exten
c ld “prrovide a competitive,
could
ffective fighter aircraft
cost-effe
l
ative.” But the review
alterna
doesn’t constitute an
existential threat
to the F-35. Mattis
limited the F/A-18
comparison to the
The F-16 (left) and the A-10
Navy’s F-35C carrier-based
model. The Navy is scheduled to
receive only 260 of its version of the fighter, with the majority
of planes—1,763—slated for the Air Force.
Lockheed’s Hewson has become something of a Trump foil.
At a Feb. 23 White House meeting with manufacturing CEOs,
the president complimented her—and himself. “She’s tough,
but it worked out well, I think, for everybody,” he said of the
recently agreed-upon Lockheed contract. “She cut her price
over $700 million, right? By over $700 million. Do you think
Hillary would have asked for $700 million?”
Bogdan, who’s announced he will retire in the coming
months, is already negotiating the next order of 130 F-35s. He
expects the total price to exceed $10 billion. Looking further
into the future, beyond the F-35, Lockheed’s Skunk Works is
again collaborating with Darpa on what the company’s website
heralds as “next-generation” planes that will “maintain U.S. air
dominance capabilities in the post-2035 world.” 55
56
57
58
or two days, the crowd sits in darkness in
plush theater seats, watching the church
stage. There are smoke machines and LED
screens, harnessed climbers scaling a scaffold “mountain” and raising their arms in symbolic victory over the startup world’s arduous
climb. There’s talk of destiny-defining “exits.”
Of Jesus and his disciples: “The most successful startup in history!” Of the parable of the talents, in which
two servants are lauded by their master for turning a profit
with money he staked them: “The first recorded instance of
venture capital and investment banking in history!” Of ancient
business elites: “A church is the oldest marketplace in the
history of the world.” Of the promised land of angel investing, where divinely inspired entrepreneurs dwell: “Because
God creates things, too!” Mark Burnett, the producer of The
Apprentice and Shark Tank, shows up to remind everyone
that “the Bible is full of merchants and people doing work.”
At last, near the end of Unpolished 2015, a faith and entrepreneurship conference hosted by Crossroads, an evangelical
church in Cincinnati, the marquee event begins: the final round
of a pitch contest. Organizers have selected three prospective
company founders out of more than 100 entrants, each of
whom submitted a minute-long video pitch deck. One of the
finalists, Lyden Foust, a 25-year-old ethnographer, presents
his entry on the LED screens flanking the church stage. With
his chiseled jawline, tightly trimmed beard, and three-button
henley, he looks like an L.L. Bean model, save perhaps for his
rectangular glasses. In a voice-over, he describes his vision
to divide the world’s cities by “vibe,” calling his idea “Google
Maps wearing a mood ring.” The cityscape of Nashville rolls
past, overlaid in swaths of color: blue for blue-collar neighborhoods, brown for yuppie ones, green for hipster, purple for
commercial, teal for family, yellow for artsy.
Th accelerator
The
l
and,
d across the
h street, the
h church
h
h
Every successful pitch deck, like every successful religion,
includes an origin story, and Foust’s is no different. He recounts
booking a place in Nashville through Airbnb Inc., only to find
the house situated between a strip club and a manufacturing
plant. While retrieving something from his car, he turned to see
a man pointing a gun at his face. “I just handed him my wallet,”
Foust says. The robbery led to an epiphany: Why not mine
social data to tell people what a neighborhood is really like?
The idea isn’t entirely new: An app that launched in 2014
with a similar aim (albeit a different crowd-sourcing methodology), SketchFactor, foundered after being widely criticized
for appearing to help white people avoid black neighborhoods.
But at this point, Foust’s product is pure concept. He has no
employees to build it, only a name, Spatial. The other finalists pitch a family-run app-development company and a boardgame-rental app; then the judging is turned over to the audience
of 1,200 aspiring entrepreneurs. Foust’s idea prevails, and Brian
Tome, Crossroads’ senior pastor, hands him an oversize check
for $3,000. Soon after, Foust will begin the next stage of the
church’s path to entrepreneurial success, applying for a spot
in a member-funded, Bible-based accelerator program, beginning in a few months, that’s designed to train startups in how
to raise money and grow.
Finally, the house lights come up. At the end of the aisles,
attendants await, holding pails overflowing with packets of
apple seeds. “God’s placed a seed in you. And he wants to see
it come to fruitfulness,” Tome says to the crowd, his spiked and
styled dirty-blond hair and untucked plaid shirt lending him
the air of an aging film star. Bowing his head, he prays, asking
God to lead everyone to “the right seed that will bring forth
the right fruit at the right time in every business.”
It’s a remarkable altar call: Those who feel inspired are to
take these seeds from the attendants and go forth, claiming
their spiritual destinies … as entrepreneurs. At the edge of the
waist-high stage, people mingle, hugging and holding hands.
Others bow their head or kneel under the outstretched hands
of strangers to receive prayer. Foust joins them, walking down
the aisle and asking for blessings and prayers at the start of his
entrepreneurship journey.
amed the fastest-growing
church in America in
2015, Crossroads has
been described by the
Cincinnati Business
Courier as both an entrepreneurial church and
a church for entrepreneurs. Indeed, it was originally a startup—or more
accurately an unofficial spinoff from Procter &
Gamble Co., the $65 billion conglomerate based
downtown, a few freeway exits south of the main
church. In 1990, Brian Wells, a brand manager
for Clearasil, started a singles Bible study with a
P&G power couple, Vivienne Lee Bechtold, then a
brand manager in beauty care, and Jim Bechtold,
a marketing executive. The group, which met at
the Bechtolds’ home, quickly grew to more than
100 people. Eventually the singles started marrying and having children, and Jim Bechtold asked
Wells one morning, while the two carpooled to
work, whether it made sense to start a church.
Over the next few months, a core of 11 people,
some of whom had helped build billion-dollar
consumer brands, reimagined church as one might expect P&G
executives to do. (The company more or less invented brand
management, and it’s been a prime breeding ground for business
talent—Microsoft ex-CEO Steve Ballmer, Intuit’s Scott Cook, HP’s
Meg Whitman, and GE’s Jeffrey Immelt, among many others, are
all P&G alumni.) They
gathered demographic
data on Cincinnatians’
churchgoing habits,
with a focus on the
city’s affluent east side,
which includes the
P&G enclave suburbs
of Hyde Park and
Oakley. They scoured
secular popular music
and TV comedies for
tips on how to keep
churchgoers’ attention. They settled
on a target demographic, 25- to 35-yearold males, figuring that
if they could get the
guy, they would get
his wife. They wrote
brand positioning
statements—a church
C ss
Crossroads
ds S
Senior Pastor
s
Tome
for friends who don’t
like church; a church
for people who’ve given up on church. Finally they built a slide
deck featuring a mix of data and Scripture and began raising
money from friends, family, and business connections.
In the spring of 1996, Tome led Crossroads’ first official
service, speaking before more than 450 people at a rented auditorium in a local junior high school. Five years later, its rolls
swelling, the church purchased a vacant big-box store, using
the homes of some senior leaders as collateral. Crossroads spent
millions converting the space into a 3,500-seat auditorium with
two balcony tiers and enough stage lights to rival a Broadway
theater. Today, the church has nine locations in the greater
Cincinnati area (with another opening soon), some 30,000 congregants, an annual operating budget of $33 million, and a staff
of 274 people, many with ties to P&G.
Among the employees is a 75-person “experience team,” the
equivalent of an in-house advertising agency, whose branding
efforts encompass direct-marketing campaigns, in-church clicker
surveys, and customized stage sets aligned with sermon themes.
The church also has a labs division—essentially a two-person
market-research team led by a corporate brand ethnographer.
Its eight satellite churches operate almost as franchises, all of
them mirroring the main branch’s tailored signage and other
brand imagery. Congregants all watch the same sermons, which
are telecast from the main church to the satellites with a brief
delay. Crossroads is even in the mergers-and-acquisitions game,
having lately acquired (its officials prefer the term “adopted”) a
church in Lexington, Ky., with 2,500 members and four locations.
In recent years, Crossroads’ version of the prosperity gospel
has begun to borrow from Silicon Valley’s. The church included
the pitch contest at Unpolished 2015, its inaugural entrepreneurship conference, and that same year some of its members created
a for-profit angel-investment wing, Ocean Capital, and the nonprofit Ocean Accelerator Inc., whose mandate is to “increase
God’s presence in the marketplace.” Ocean Capital’s first fund,
of $230,000, was seeded entirely by six Crossroads members.
Ocean Accelerator got an early boost from Crossroads’
annual Beans & Rice Week, when congregants forgo regular
meals in favor of beans and rice, then donate the savings to
the church. Traditionally, the money goes mainly to fighting
the city’s homelessness and heroin epidemics, but in 2015 the
church put $120,000 toward the accelerator, a significant share
of the program’s operating expenses. Selected entrepreneurs
would embark on five-month residencies, and each startup
would receive $25,000 from Ocean Capital. (The amount rose
to $35,000 in 2016 and $50,000 in 2017.) Also included were
free office space and access to dozens of spiritual and business
mentors from the church’s membership rolls, a who’s who of
Cincinnati’s—and America’s—corporate elite.
ne rainy morning in February 2016, Foust
and founders from eight other startups, some of them fellow Crossroads
members, are gathered before a whiteboard for a talk called “Developing
Intellectual Capital.” The speaker is Todd
Henry, a longtime Crossroads member
and motivational guru who promotes
himself as an “arms dealer of the creative revolution.”
Ocean Accelerator is across the street from the Crossroads
headquarters, in a converted car dealership owned by the
church. Among the participants in the accelerator’s second
cohort are an app offering restaurant discounts, a social network
for sports fans, a recruiting tool matching employees with companies according to cultural fit, a site connecting college athletes
with high school students for personal training, and an online
auction site for churches to sell used goods. Only one of the nine
startups is solely headed by a woman, who’s from London. For
a few weeks now, each team has been attending daily spiritual
seminars and weekly Bible studies, working from long tables in
an open-air room. They’re all preparing for Demo Day, a couple
of months hence, when they’ll stand on the Crossroads stage
and give five-minute pitches to an audience of venture capitalists and angel investors.
With Foust at Ocean is Will Kiessling, a 35-year-old developer
who left a job writing software for jet-engine tests at General
Electric Co. to become a partner at Spatial (since formally
renamed Spatial Labs). The two met years earlier at events in the
city’s startup scene but only really got to talking after bumping
into each other at church one Sunday. “Not only did we have this
commonality of startups,” Foust says, “but we both loved Jesus.”
Henry, dressed in a crisp white oxford and bluejeans, begins
his talk by asking how entrepreneurs might turn thoughts into
value. He cites Warren Buffett, who reportedly spends four
to five hours a day reading, as someone who wrests profits
from the market by analyzing what’s going on in the world.
We have this ability, Henry says, “to co-create new things,
to partner with God in transforming creation.” He points out
that pattern recognition is crucial for a successful startup,
as is understanding what he terms the law of the harvest:
“Many of us, especially as entrepreneurs, we live in perpetual harvest mode, constantly trying to reap gain, and some of
that is because our investors are telling us, ‘We want to see a
return,’ ” he says. “The problem is when you are living in perpetual harvest mode, you aren’t taking the time to go back
and plant seeds and cultivate seeds.” He calls on the entrepreneurs to see God as the source of wisdom and Jesus as a brilliant thinker with a “deep systematic understanding of life,”
skilled in the practice of pattern recognition.
This message resonates with Foust’s original concept for
Spatial, which was, in essence, to identify social media and
crime-data patterns to help people “navigate like a local” in
unknown cities. But as the accelerator unfolds over the next
three months, he runs into technical and ethical problems with
59
60
that goal. Early iterations of the service
more than 1,000 people. He’s wearing
compile a “heat map” of different areas
jeans and a tight-fitting gray T-shirt
in cities, using crime data on specific
emblazoned with the Spatial logo—the
neighborhoods in addition to social data.
company name in a sans-serif typeface,
The approach has clear racial impliwith the letters’ midsection blanked out
cations; not only are the sweeps of
by a horizontal bar—to pitch to 30 potencolor reminiscent of decades of redlintial investors.
ing in black neighborhoods, the data
The LED screen behind him displays
might have integrated biases prevalent
ominous, looping swirls of dark blue
on social media into Spatial’s mapping
ocean waves behind the Ocean logo.
platform. After a few months, Foust
The origin story he tells is familiar, but
and Kiessling drop crime data comhe explains how Spatial’s model has
pletely. “People were talking about not
evolved, describing its patent-pending
going to a certain part of a city because
algorithm, Luminate, which he says
it looked like there was a lot of crime
will create a layer of social data around
there. It made me realize that’s not what
cities, or a “third dimension of maps.”
I wanted people to do,” Foust says.
Among its possible markets, he says, are
More than the Bible, he credits Jane
travel booking companies, who might
Jacobs’s classic book The Death and Life
pay for click-thrus to vacation rentals
of Great American Cities for the insight.
and other services. He suggests that
Invoking Jacobs, he cites three quesSpatial could increase booking rates on
Refreshments
s
s at the main church
tions that best indicate neighborhood
sites such as Airbnb and FlipKey, which
safety: “Are there lights on the streets? Are there eyes on the he claims fail to turn 95 percent of their visitors into customers.
streets? And does the community know each other? None of “Think of the millions they are leaving on the table,” he says.
those things are in crime data. It wasn’t solving the problem.”
In recent weeks, as Spatial has begun promoting its soluInstead, Foust concludes that people want something much tion, Foust tells the audience, 10 companies have started using
simpler: quick and decisive answers about where to go. “They its data. These clients are mostly early stage startups, includcouldn’t care less about, ‘Is this an artsy area?’ It was less ing PoshPacker in Washington, D.C., a hotel-booking site that
about experience and more about ‘Can you just get me to the targets people who want a “hip and high-end-like travel experight place, right now?’ ”
rience.” Foust displays screen shots of maps from PoshPacker’s
As the product takes shape and Foust prepares to move site: Areas popular with the LGBT community are highlighted
from the concept phase to fundraising, a more explicitly spir- in puffs of purple. Orange puffs represent foodie zones. Foust
itual question begins to nag at him: “How do you raise money says PoshPacker has doubled its conversion rate since deploylike Jesus?” Foust has attended Crossroads for five years, but ing the Luminate algorithm (though the company will later go
his evangelical faith began when he was a child growing up in out of business). “The day of static maps is over,” he concludes.
a devout household on a tree farm in Paris, a town in northThe others go through their pitches, and afterward everyeast Ohio. He’s heard from other entrepreneurs how brutal one gathers in another cavernous auditorium to drink craft
fundraising can be. You’re going to have to sell your soul, beer with the investors. By design, no startup talks terms on
they warn. You’re going to have to lie.
Demo Day, says Scott Weiss, a retired corporate chief execuTo forestall this, he starts a reading group with five other tive officer who serves as Ocean Accelerator’s volunteer CEO
founders. The book they choose is secular: Venture Deals: Be and chairman. “Our core approach is developing the capaSmarter Than Your Lawyer and Venture Capitalist, by Brad Feld bility and training them to raise money,” he says. But, Weiss
and Jason Mendelson. For five weeks, every Friday afternoon, adds, “If you are a Christian and you want to produce in your
the participants meet, discussing term sheets and the ins and faith, Ocean teaches you how to raise money in a Christian
outs of investor control over startups. The book demystifies way and that there’s got to be an ethical standard to doing
the process for the group, but it doesn’t help with the concern that. … We teach them to pick your investors with care and
about integrity. After a few sessions, Foust decides that Jesus’ to be very careful, because you are going to be married a
first words in the New Testament, from Mark 1:15, best address very long time.”
his fears: “The time has come,” Jesus says. “The kingdom
of God has come near. Repent and believe the good news!”
or Crossroads, embracing the gospel of
In the verse, Jesus has just been baptized, and he’s emerging
Silicon Valley isn’t solely about money; it’s
from the desert to begin his ministry. Describing the passage
also about bringing the next generation into
later, Foust invokes the Greek translation, interpreting “time”
the church. Ocean Accelerator offers a way to
not as chronos, chronological time, but as kairos, the “right
reckon with two converging trends: growing
or opportune moment.” The word for “repent,” he continues,
anxiety about jobs and a decline in church
means “to turn away from” or “to change one’s mind.” The
attendance among young people. “Up until
etymology leads him to a decidedly contemporary exegesis of
the millennial generation, there was inherent
the verse. “The kingdom of God was Jesus’ startup,” he says. faith in large corporations, social enterprises, and governments
“A new future he was selling to people. And that’s the same to drive employment,” Weiss says. “But this millennial group
thing I’m saying as a startup founder—a moment of time has has come along and said, ‘No, no. It’s actually my responsibilcome, and there’s a new future for us.”
ity to create jobs.’ ”
Buoyed by this insight, Foust arrives in April to present
In his sermons, Tome, the senior pastor, frequently menat Demo Day. Following an early morning group prayer, he tions job growth and lionizes entrepreneurs. “A business
strides onto the stage at Crossroads in front of an audience of endeavor is close to the heart of God and every bit as important
as anything else on God’s green earth,” he recently preached.
Sitting in the church lobby a few weeks later, he describes
entrepreneurship as an ancient practice with Biblical roots.
Jesus constantly used business metaphors in his parables, he
says, and founded the “first multinational corporate entity.”
The emphasis appears to be working: According to a survey
Crossroads conducted in the fall, 43 percent of adults who’d
joined the church in the previous two years were age 18 to 35.
And the accelerator’s startup classes are showing some early
financial promise. Fifteen of the 19 startups that have gone
through Ocean in its first two years have survived, raising a
combined $6 million and creating 66 jobs.
In keeping with their goals of appealing to younger generations and tapping into the widest possible market, Weiss
and the other officials are working to diversify their roster of
startup founders. At the close of 2016, Ocean announced its
next seven companies. Two of the startups are led by women,
and four are international—one of these, Owl Labs, which is
building a prosthetic hand that incorporates machine learning, is headed by three entrepreneurs from Sudan.
These founders may soon have a larger investment pool
from which to draw. Ocean Capital is planning this summer to
raise $1.6 million for a new fund, its third. With the money, it
will seed three more accelerator classes, keeping the program
running until at least 2020. Crossroads is also increasing its
commitment; having donated nearly a quarter of a million
dollars to Ocean Accelerator for the program’s first two years,
the church plans to give an additional $420,000 in 2017. (The
money will also help cover the next Unpolished conference,
which the accelerator is taking over.) Secular organizations are
getting in on the action, too: the foundation of PNC Financial
Services Groupis donating to the accelerator, and Fifth Third
Bancorp is the lead sponsor of Unpolished 2017.
n the months after participating in Ocean, Foust and
Kiessling gain admittance to another accelerator, a
highly competitive secular one, TechStars Mobility,
in Detroit. The experience is much different: for one,
they sleep on bunk beds in a house shared by founders from 12 other startups. For another, Foust later
recalls, “God never came up.”
The pace is breakneck: The first month, called
Mentor Madness, requires the pair to talk with 150 different people
about Spatial. The second month consists of dozens of sales presentations. By the time Foust takes the stage for TechStars’
Demo Day, following the third month’s arduous vetting
process, Spatial’s business model has shifted yet again,
to target the automobile navigation market.
The work he and Kiessling have put in—fueled by the
$120,000 stake they received for winning entry to the
accelerator—pays off in a more polished product and
presentation. The robbery anecdote remains, but the
colored swaths are gone; instead, hexagons appear in
response to a driver’s commands. A request for familyfriendly educational events, for example, produces teal
hexagons and info on a museum show. A request for a bar
with sunset views prompts a digital assistant to suggest
a steakhouse on the 72nd floor of a skyscraper downtown: “Would you like me to route you there?” she asks.
Then comes the big reveal: the Ford Motor Co. logo,
filling an entire slide. Foust announces a partnership
with the automotive giant, and the auditorium erupts
in cheers. The news comes as Spatial is preparing to
kick off its first fundraising round. Originally the plan is
to raise $500,000, but the deal with Ford’s Smart Mobility subsidiary helps Foust’s company meet that target almost immediately, and more people want in.
A few weeks on, in late September, I meet with Kiessling
in a tiny conference room at Ocean, where Spatial is renting
space temporarily. As we talk, he points to a clear-glass dryerase board where financial scenarios have been hashed out.
“We raised more money and got more people to agree to give
us money than we thought we could get,” Kiessling says. “Now
it’s kind of like, we have to go back.” To let more people in,
Spatial will have to dilute the equity percentages Foust originally offered, without giving up too much of his own equity—
and control—in the process. “How do you negotiate that, and
do that in kind of a biblical way?” Kiessling asks.
Foust is away in Detroit, renegotiating the terms. He
recounts later that things went smoothly: “Everyone unanimously said yes, because from an investor standpoint it was
less risky.” At other points in the process, he says, “Investors
offered us a lot of money, and they were in it for the money and
not for our vision, and we had to turn down some money.
We retained our vision, and we didn’t sell our soul and didn’t
have to lie to raise money.”
By the end of October, Spatial has attracted more
investment—$1.8 million, including $190,000 from Ocean
Capital—than any other Ocean Accelerator startup. Foust and
Kiessling reopen the round one more time for two investors
eager to get in on the ground floor, bringing the total raised
to $2.1 million. A few months later, Spatial opens an office in
Cincinnati’s Over-the-Rhine neighborhood, where many of the
city’s startups are located, and hires three more employees.
The company also has an office in Detroit; while there, Foust
and Kiessling sleep on the same bunk beds they did over the
summer. And Foust is flying regularly to Palo Alto, establishing
a footprint for the company and meeting potential clients there.
He won’t say what deals might be in the works, but the
immediate goal isn’t to build Spatial into the next unicorn
or make a lucrative exit. “I feel like now, even more so than
before, I’m having to submit to God’s will, because it’s getting
bigger and bigger. You think when you raise a bunch of money,
you’d become more confident, but that’s not the case. It gets
harder,” he says. “Now we have a bunch of people who believe
in us and work for us, and we have to make sure they are taken
care of as well.” —With reporting supported by the McGraw Center for Business
Journalism at the CUNY Graduate School of Journalism
Weiss, center, at an O
Ocean Accelerator meeting
61
62
As the Trump administration evaluates bids to
prototype a wall along the
U.S.-Mexico border, topography will present as big a
challenge as political opposition. Corralling often wild
land beneath miles of concrete isn’t easy, as can be seen
in these photos taken of a
55-mile stretch of fence in the
Rio Grande Valley of South
Texas between tiny Peñitas
and Brownsville, the last
major town before land gives
way to the Gulf of Mexico.
The actual border is
formed by the Rio Grande.
No barrier can be built in
the middle of the muddy
green waters, and the banks
of the river are a flood plain
governed by international
treaty. The fence that’s here,
a product of the U.S.’s 2006
Secure Fence Act, is a porous
collection of concrete and
steel barriers set as far as
2 miles north of the actual
border and punctuated by
gaps to allow access for the
thousands of private landowners whose acreage runs
to the river’s edge.
Cordoned off from the
rest of the U.S., these patches
between the fence and the
river have sprouted their own
ecosystems. In border regions
such as this one, which facilitate more than half a trillion
dollars of trade every year,
life must go on. Workers still
harvest the crops, tourists
still enjoy butterfly sanctuaries, and families still play with
their children. —Lauren Etter
North of the Border,
By Kirsten Luce
A U.S. Customs and Border
Protection agent stationed
outside a break in the fence on
private farmland in Peñitas. Only
some of these gaps, which occur
about every quarter mile, are
regularly manned.
South of the Wall
1
2
64
1
Each morning undocumented
laborers form a caravan of vehicles that travels to the south side
of the wall, where they harvest
crops—here spinach in Donna,
Texas—before returning north at
the end of the day. Border guards
leave them alone to maintain good
relations with landowners. Until
the introduction of widespread
irrigation in the late 1890s, this
area was covered with wild cattle
ranges and mesquite trees.
2
3
David Fox and his dog Jesse
James hunt doves on private
land owned by Damian Mathers
in Brownsville. When building the fence, the government
gave some landowners their own
gates (the Mathers gate is in the
background).
On a busy work morning, traffic
into the U.S. builds at a bridge
(foreground) connecting Reynosa,
Mexico, to Hidalgo, Texas. Vehicles
heading south and pedestrians
3
4
65
4
take the other bridge. Some
6.5 million cars, 470,000 trucks,
40,000 loaded rail containers, and
16,000 buses crossed the U.S.
southern border last year along
the dozens of official crossings like
this one.
Ariana Rios (center), 8, of Mission,
Texas, plays with cousins at
Anzalduas Park south of the border
wall. The public playground used
to be open from sunrise until
sundown but now closes at 5 p.m.
because of a growing influx of
migrants fleeing drug violence in
Central America. They’re often
ferried by the Zetas drug cartel,
which controls the Mexican side
of this border region, and usually
end up here at night. The asylum
seekers surrender themselves to
agents and hope for a lawyer and
protection. Border officials want
the park cleared of townspeople to
reduce confusion.
Abram-Perezville, Texas. The Rio
Grande floods seasonally. The wall
reinforced existing levees. This
extra flood protection, paid for by
the federal government, was the
reason some locals signed on.
67
1
2
68
1
Border Patrol agents watch a car
fire in a field south of the wall just
next to the Anzalduas International
Bridge. The agents had pursued
the vehicle, which they believed
was loaded with drugs. The driver
attempted a “splashdown” into
the Rio Grande, but the vehicle
crashed, then burst into flames.
The driver fled and made it across
the river to Mexico.
2
3
Joel Contreras, a Hidalgo County
deputy constable, closes a gate.
Locked gates stop cars but
aren’t much of a deterrent for
people who simply walk up, over,
and through them in a matter of
seconds if no agents are around.
Migrants line up alongside the
Anzalduas International Bridge
as they wait to be processed by
agents from Customs and Border
Protection. Because there has
3
4
69
4
to be some U.S. soil between the
wall and the river, people from
south of the border will always
have a place to walk to for intentional apprehension. Last year
137,000 family members and
unaccompanied children crossed
the southwest border, up from
about 80,000 the year before.
Of those, almost all came from
El Salvador, Guatemala, and
Honduras.
In a field south of the border wall
in Hidalgo, a Customs and Border
Protection agent collects a ladder
that had been camouflaged
with green paint and discarded
during a pursuit. Agents regularly dispose of ladders to keep
them from being reused by other
border crossers.
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Design
A
72
fter more than a year of work, Rajiv Laroia was
on the verge of a breakthrough. By the summer
of 2014, with the help of five or so engineers,
he’d developed a digital image-making system
that could achieve the resolution, depth of field,
and focus control of a clunky digital single-lens
reflex camera (commonly known as a DSLR) in a device just
a fraction of its size. At least that was the plan: Although they
had the technology locked down, Laroia and his team still
faced the daunting task of fashioning it into a product people
would actually want to buy.
Laroia, now 54, and his business partner, Dave Grannan,
53, envisioned a product that would look “more akin to a
smartphone or tablet than a DSLR, or even a point-and-shoot,”
Grannan says. The camera, which they dubbed the L16, was to
be the first product from Light, the company they’d founded.
Even more than the technology involved—16 tiny lenses acting in
concert by means of a unique computational-imaging process—
the real achievement would be to create a standalone camera
compact enough to carry around. The team asked themselves,
“What are other things that have done what we’re trying to
do here—take something traditional that hasn’t changed in a
long time and reboot it?” recalls Light’s senior vice president
for marketing and product design, Bradley Lautenbach. That’s
when they thought of Fred Bould.
Bould’s biggest claim to fame is his work on the Nest thermostat, the revolutionary energy-saving smart home device that
won raves from designers and users alike when it was released
in 2011. Nest won the top award given by the Industrial Designers
Society of America, and it was inducted into the permanent collection of the Cooper Hewitt Smithsonian Design Museum not
long after Nest Labs, the company that made it, was acquired by
Google Inc. in 2014. The eponymous founder of Bould Design
BOULD DESIGNS
Some of his firm’s many hits
doesn’t have the name recognition of a superstar such as Apple
Inc.’s Jony Ive or Swiss designer Yves Béhar, but his 10-person
Silicon Valley company has become a go-to for entrepreneurs
who dream of reinventing entire product categories.
Bould, 53, is soft-spoken and bald, and his standard-issue
chunky glasses and black T-shirt make him instantly recognizable
as a designer with minimalist leanings. His father was a mechanical and electrical engineer, and though Bould earned a master’s
degree in product engineering from Stanford, his true interest
was in applying that knowledge to the design world. More specifically, he wanted to call the bluff of people who responded
to his design ideas by saying they couldn’t be done. “What you
mean to say,” he recalls wanting to tell them, his tone more dry
than arrogant, “is that you don’t feel like doing the engineering.”
Bould started his company in 1996, and in those days,
software-obsessed Silicon Valley was even more resistant to
manufacturing objects than it is now. For years he was essentially a solo practitioner, working on a mix of tech products
and more traditional industrial design. In the early 2000s,
Bould designed the Squeezebox, a streaming audio player
created by the startup Slim Devices (later acquired by Logitech
International SA). A few years later, in 2010, Bould got an email
from Matt Rogers, a fellow graduate of his alma mater, Carnegie
Mellon University. Rogers wanted to meet with him to discuss
a project idea for his new company, Nest Labs, which he’d cofounded with Apple veteran Tony Fadell. They asked Bould
about his design process and knowledge of manufacturing,
and then the next day they called to say they’d like to work
with him. The whole process was “surprisingly straightforward,” Bould says. They worked together on various Nest products until the Google acquisition—Fadell calls Bould a “great
partner”—at which point, Bould says, they parted amicably.
“A lot of thermostat makers were kind of phoning it in,” Bould
GoPro Hero
cameras
Logitech Squeezebox
streaming players
Light L16 camera
Nest Protect
smoke
detectors
Roku 2
streaming
player
Hunter Douglas
PowerView Pebble
remote controls
Nest thermostat
Etc.
says, cheerfully deflecting credit for the product’s success onto
Fadell. “It grew out of a need.” Since then, he’s added designers and scaled up his company’s capacity, working on various
versions of Roku Inc.’s digital-media streaming player and consulting on later models of GoPro Inc.’s Hero camera.
When the Light team approached him in 2014, Bould
recalls, they “more or less came to us with a box of parts.”
The only mandate: The device had to be pocket-size. “Today
there are 1.5 billion people who have smartphones, and
every one of them considers him- or herself a photographer,” Grannan says. “It’s grown the pool.” The ubiquity of
the mobile phone camera, along with the parallel rise of social
media, has made the device the dominant picture-making tool
of our time. About 1.3 trillion digital images will be produced
this year, estimates market-research company InfoTrends,
a fourfold increase since 2010. But a phone camera’s technical limitations make it unsatisfying for a serious photographer. Most notably, its single tiny lens (or even the two
lenses in the iPhone 7) limits a smartphone’s
smartphone s ability to zoom
unconcealed, treating them as a design feature rather than a
flaw. Bould displays an early foam model: a rectangular object
with a bunch of cones protruding from the front, each representing the scope of field the lenses capture. One of the biggest
challenges of designing the L16 was figuring out how to get
people to hold the thing without blocking this array, which
meant focusing not only on what the object looked like but
also on what it felt like.
As convenient as smartphones are, Bould points out, they
remain awkward for taking pictures. “Probably there are
10 people dropping their phones as we speak,” he says. Anson
Cheung, Bould’s studio director, hauls out a big crate full of later
models of the L16 printed on the company’s rapid-prototyping
machine. Earlier versions were more sharp-angled and boxy.
When the designers—five in all, fully half of Bould’s design team—
noticed users wrapping their fingers over the corner to reach
the shutter-release button, they smoothed the hard angles into
rounded contours to make the grip more natural. Later still, they
added a gentle depression along the bottom for the thumb. Most
PHOTOGRAPHS BY ULYSSES ORTEGA FOR BLOOMBERG BUSINESSWEEK
“Today there are 1.5 billion people who
have smartphones, and every one of them
considers him- or herself a photographer”
or capture decent images in low-light situations.
That’s where Light comes in. Laroia first got the idea for
the L16 after his previous startup, a wireless telecommunications company called Flarion Technologies, was acquired by
Qualcomm Inc. in 2006. He decided to take up photography
in the free time he suddenly had, and though on formal expeditions he’d bring his DSLR gear—including a bag filled with
pounds of lenses, flashes, and, from time to time, a tripod—he
had to settle for his smartphone camera in more impromptu
situations. Frustrated, Laroia started speaking to fellow photographers, who felt the same way. He was a novice at optics,
but since the experts weren’t solving the problem, Laroia concluded he’d have to start looking into it himself.
So far, Laroia has attracted $35 million in funding from
backers including Google Ventures and Charles River Ventures,
which eventually introduced him to Grannan. As soon as the
L16 became available for presale in October 2015, it attracted
ecstatic camera-world buzz; the blog PetaPixel called it “a revolutionary new point-and-shoot camera that aims to transform
the way we think about cameras.” Although priced at $1,600—
three times as expensive as most entry-level DSLRs—the L16
reached its investors’ 30-day sales target in about 30 hours.
The company has declined to specify what that figure is, but
Light representatives have indicated it’s in the neighborhood
of at least $10 million.
As with any boundary-breaking product, the L16 went
through a number of design iterations. The first thing casual
observers will notice about it is the curious collection of circles
on its outward face—the lens modules. “Often with technology
products, designers spend a great deal of time trying to hide
that kind of thing,” Bould says. Instead of disguising this weird
array with darkened glass or rearranging the components in
a more visually pleasing pattern, he left these technical guts
of the camera’s body is metal for durability, but the designers
covered the edges where the fingertips touch the device with a
thermoplastic rubber that’s warmer. Taken together, these elements mimic the feel of holding a traditional camera, encouraging users to grip it with both hands.
Although the presale period vastly exceeded Laroia and
Grannan’s expectations, aspects of the production process for
the L16 have been less successful. “The hardest thing about
being a Silicon Valley hardware startup is getting Tier 1 manufacturers to take your business,” Grannan says. Many top factories only take orders in the millions of units from established
giants, not in the thousands from startups. Chinese megafactory Foxconn Technology Co. eventually agreed to handle
final assembly, part of an arrangement that included a small
investment in Light and an agreement to license a subset of the
L16’s technology for use in smartphones. The resulting products won’t match the L16 for quality, but they will noticeably
raise the baseline smartphone-photo image resolution.
The preordered L16s will finally start shipping this month,
and Grannan is planning an aggressive push after that: taking
new direct orders by May, then rolling out to specialty online
sellers, mass online sellers, and ultimately brick-and-mortar
retail by the end of 2017. But the camera’s design is still a work
in progress—Bould will have to see what works and keep tinkering from there. “How can we really connect the new technology with the old user? Because users are all old,” he says
with a chuckle. “We don’t get a new population every time
we launch a new product. You have to work with preexisting
behaviors.” Technology may be fast, but design is slow. “A lot
of times what happens when new technology comes along,
you’re tempted to say, ‘Well, let’s do everything new,’ ” Bould
says. “It’s important to step back and say, ‘What do we want
the experience to be?’ ” 73
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74
S O
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The Critic
Etc.
BEWARE OF SHARKS
Charles Geisst is stronger on the history of predatory lending than on the economics. By Peter Coy
ILLUSTRATION BY BRANDON CELI
A
t what point does a
lender (good) become
a loan shark (bad)?
The question has exercised philosophers—and
unhappy borrowers—from antiquity to
the present. In Loan
Sharks: The Birth of Predatory
Lending, finance professor
Charles Geisst recounts the
debate in the U.S. from the late
19th century through the Great
Depression. The history illuminates today’s debates over, say,
what the Consumer Financial
Protection Bureau should do to
control payday lenders, though
Geisst is shy about drawing conclusions that might be useful
to policymakers.
Loan sharks thrive where traditional banking is absent. They
fill an unmet need, albeit often
in a heartless, exploitative way.
But one thing you’ll learn from
the book is that there’s never
been consensus on what’s a fair limit for
interest rates. “In Rome it was 12 percent,
in Elizabethan England 6 percent, and
in the United States, it has ranged from
6 percent to 40 percent,” Geisst writes.
That said, a few principles seem to have
been widely accepted over the decades.
One: It’s fair to charge higher rates for
riskier loans. Two: It’s less fair in cases
where the borrower is judgmentally
impaired or uninformed—say, a recent
immigrant who may not understand what
the words “floating interest rate” mean.
In the U.S., the largely rural populist movement put up the first organized
opposition to predatory lending. The populists favored high inflation, which would
make high-interest loans easier to pay
back over time. The members of the progressive movement, who succeeded the
populists in the early 20th century, tended
to be better educated, better organized,
and more urban. They worried that high
inflation would raise their cost of living.
Recognizing that nature abhors a vacuum,
the progressives organized kinder, gentler
lending channels such as charities and
various mutual-aid organizations, including credit unions, benevolent societies,
and Morris Plan Banks, named after the
lawyer Arthur Morris, who began making
small installment loans to upstanding citizens of modest means.
About this time, in 1907, the Russell
Sage Foundation was formed “for the
improvement of social and living conditions in the United States.” Recognizing
that state usury laws capping interest
rates at 6 percent or 7 percent were
too restrictive for legitimate lenders
to make a profit on small, risky loans,
and therefore left illegal loan sharks to
fill the gap, Russell Sage’s researchers
devised the Uniform Small Loan Law.
The model legislation allowed
licensed lenders to charge as much
as 40 percent interest a year as
long as they provided ample disclosure of their terms to borrowers. By the 1940s, 31 states and the
territory of Hawaii had enacted the
law, helping put loan sharks out
of business.
Geisst blames poor lending
practices—not loan-sharking precisely—for the stock market crash
of 1929. Investors borrowed
heavily from their brokers to buy
shares, which happened outside
the regulated banking system.
“Broker loans had become a form
of shadow banking, a term that
became widely used eighty years
later during another financial
crisis,” he writes. When lending
abruptly dried up, interest rates on
loans shot to as high as 20 percent
in a single trading day.
The conclusion of many of the
people Geisst features in his book
is that the best way to fight loan
sharks is not to outlaw them but rather
to give borrowers cheaper and safer
options. But Geisst himself, a former
investment banker who now teaches
at Manhattan College, never fully
embraces this prescription. He sometimes describes high-interest lending as
the disease itself, not just a symptom:
“Loan sharking in its many forms has
caused stock market panics, structural banking problems, and often has
impeded economic recovery after severe
economic downturns.”
Loan Sharks has its flaws, but it’s valuable for the history alone. Unfortunately,
Geisst ends his narrative at the Great
Depression, without explaining why,
and relegates the 80 years since to a
five-page postscript, leaving himself in
debt to readers with an interest in the
present. If only there were some way for
us to collect. 75
!
P
U
S
s
’
f
r
u
S
oarding your ne w
Make stand-up paddleb
David Wolman
leisure-time activity. By
WHAT IS IT?
Exactly what it sounds like: You stand up on
a board and paddle around. Part of what makes
paddleboarding so fun is that it’s not that hard.
The boards are longer and wider than the ones
for surfing, so they’re more stable. Sure, you
may be a little wobbly at first, and beginners
should steer clear of big waves. But for most
people, a mellow float across a placid lake
should be more than doable on Day One.
WHAT
STUFF WILL I NEED?
For first-timers, all you’ll need is a bathing suit and
some sunscreen—you should be able to rent everything
else from your local sail/canoe/surf shop for $25 per hour, give
or take. If you want to make paddleboarding a habit, however,
consider buying your own gear.
THE BOARD
There are three main types:
Foam: Versatile and sturdy, and you won’t have to dip into your kids’
college fund to afford one. Try California Board Co.’s 10'6" board ($550;
keepersportsstore.com).
Inflatable: These are great if storage is an issue. Look for ones that pump
up tight (15 to 25 pounds per square inch) for maximum stability. We like
Waterman’s 10'9" BK Pro ($1,199; c4waterman.com).
Wood or fiberglass: The flashy stuff, best for tackling bigger waves or
longer excursions. Go for Three Brothers Boards’ 11'4" Irish Twin ($1,249;
threebrothersboards.com).
Make sure to note the weight capacity, typically specified by the manufacturer,
which will vary depending on the material, dimensions, and shape of your
board. If you’re too big for your board, you’ll ride too low in the water, making
it tough to move around.
THE PADDLE
Some boards come with a paddle—and sometimes with a leash, a fin, and a roof
rack as a package deal, so pay attention when you’re buying. If you’re
purchasing a paddle separately, aluminum or alloy is fine (Red Paddle Co.
alloy, $140; redpaddleco.com), carbon fiber is better (Aqua-Bound Malta,
$325; aquabound.com), and wood is way cool (Shaw and Tenney SUP, from
$429; shawandtenney.com).
THE OTHER STUFF
Personal flotation device: This doesn’t have to be the bulky straitjacket
you recall from childhood trips to the lake. The Dakine Waistbelt PFD
($100; dakine.com) clips on like a fanny pack.
Leash: If—or, let’s face it, when—you fall, this will keep your board from
shooting away and hitting an innocent bystander. Most board
manufacturers offer some variety of leash, starting around $20.
Roof rack: Have board, will travel with the Thule SUP Taxi
($270; thule.com).
Sunglasses: These are essential—glare can get intense out on the
water. You’ll want a pair that’s OK getting wet, such as the Oakley
Flak 2.0 XL ($150; oakley.com) or the more stylish Smith Drake
($219; smithoptics.com).
,
“A ll th at ‘s it s
a
w
ff
stay’ stu
th it ”
to ta ll y w o r
Sport
Etc.
HOW
CAN I MAKE
SURE I DON’T
LOOK LIKE AN IDIOT?
WHERE
CAN
I DO IT?
Bend, Ore.
Located on
the southwestern edge of this
outdoor-sportscrazy town, the
elegant Tetherow
resort offers easy
access to the mountain lakes of Willamette
National Forest, the
Deschutes River, and a
man-made whitewater park
if you want to try your luck
with some waves (from $179
per night; tetherow.com).
Keeping stable on the board
is all about using your core
muscles, so think about doing
some Pilates before you get out
there, or at least banging out a few
crunches. Once you’re on the water,
get yourself situated in the center of the
board, sitting with one leg on either side
and your paddle laid perpendicularly in
front of you. Now get on your knees: If you’re
feeling tentative, paddle around like that for
a while just to get the hang of it. To stand,
push up slowly against the board while gripping the paddle. You’ll want your feet roughly
shoulder-width apart, and your knees should
remain slightly bent. Stay loose. Place your dominant hand on the top of the paddle’s shaft, with
your other hand about halfway down—you want the
curve of the paddle face bending toward the front
of your board. Now stroke! And unless you’re one of
those people who likes to be rescued, pay attention
to the wind and the current, and stick close to shore.
77
Sausalito, Calif.
The upscale-but-unpretentious Cavallo Point hotel offers
easy access to Richardson Bay, off
San Francisco Bay. Paddle among the
houseboats, say hi to the sea lions, or
cruise across to Tiburon for lunch at one
of its bay-view restaurants (from $379 per
night; cavallopoint.com).
Chicago
The chic Hotel Lincoln is perched on the
western edge of Lincoln Park, just a short
stroll from the shores of Lake Michigan, where
the paddleboarding is plentiful (from $159 per
night; jdvhotels.com).
Kohala, Hawaii
The Fairmont Orchid is tucked into quiet Mauna
Lani Bay on the Big Island’s northwestern coast. It has
sheltered waters for first-timers and access to the open
sea for those who feel more confident (from $299 per
night; fairmont.com).
PHOTOGRAPH BY
BOBBY SCHEIDEMANN FOR
BLOOMBERG BUSINESSWEEK
Austin
Lady Bird Lake, smack in the middle of the city, is a favorite
paddleboarding spot for Austinites. South Congress Hotel is in
the heart of the nearby SoCo neighborhood, just south of the lake,
and is a perfect spot for post-float people-watching (from $249 per
night; southcongresshotel.com).
HOW M A N Y P
Burlington, Vt.
The view from the Hotel Vermont, on the shore of Lake Champlain,
can’t be beat. Just a 15-minute drive south, Oakledge Park is an ideal
jumping-off point for an expedition (from $199 per night; hotelvt.com).
EOPLE PADDLEBOAR
D?
0.9 2.8
million
in 2009
Naples, Fla.
Naples Beach Hotel & Golf Club should suffice. Weave in and around Inner
Doctors Bay or out into the Gulf of Mexico. Paddling south to Naples Pier and
back is a great four-mile round trip (from $319 per night; naplesbeachhotel.com).
million
in 2014
he
:T
rce oor
u
So utd tion
O da
un
Fo
Etc.
Survey
y
What’s Your Most Awkward Team-Building Experience?
Watch where you point that paintball gun. By Katie Morell
“At a previous job, our boss would sometimes take us
bowling. This time, though, he wanted to go paintballing. I’m
not a good shot, and I wasn’t aiming for him, but my paintball went awry. The next thing I knew, he was on the floor.
The game was stopped, the ambulance came, and people
started talking about potential liver rupture and damage to
his kidneys. He was OK—a preexisting condition had flared
up. After the event, he told me it wasn’t my fault, but I felt
horrible and left the company six weeks later.”
Christina Comben
Content manager, Day Translations Inc.,
Valencia, Spain
Pete Abilla
Founder and chief executive officer,
Find a Tutor Near Me, Salt Lake City
“We took a group of 120 people,
divided them into teams, and set them
loose on a scavenger hunt around a
theme park. Each team had a differentcolored bandanna, and they were
running around completing missions
when a security guard misinterpreted
one bandanna for a gang symbol.
He made that team follow him to a
side alley, where he could ask them
questions about what they were doing.
They were allowed to continue but had
to take off the bandannas.”
Sharon Fisher
CEO, Play With a Purpose, Orlando
“We like to
o combine
o
service
elements into
o our
o teama
building activities. In June
ne 2015
my staff met at the Boston
Harbor dock to board a boat to
a nearby island to do some
cleanup. While talking with a
colleague, I stepped back and
fell into the water, scraping my
back on a post as I went down.
I cut myself pretty badly, the
water was freezing, and it was
over my head. I was wearing
jeans and a sweatshirt and felt
weighed down. The thought of
drowning came to mind, and
I panicked. Thankfully, my
team sprang into action and
pulled me up.”
Janet Kosloff
CEO and co-founder,
InCrowd Inc., Boston
“At a previous company, I was participating
in a manager-training meeting. We were
divided into teams and tasked with hoisting
each other through an imaginary window—
basically, a rope stretched 3 feet off the
ground—in an allotted time. One team had to
lift an obese woman. Everyone in the room
saw the struggle, and she ended up crying.
Some people were kind to her, but most
ignored the awkward situation and pretended
it didn’t happen.”
Seth Ollerton
Content marketing manager, DecisionWise, Provo, Utah
ILLUSTRATION BY PING ZHU
78
8
“I was working for a health-care company
that had its team-building event at a Native
American casino in Southern California.
The company hired an outside consultant
to facilitate the event, and they were doing
a great job until one of the facilitators, a
white guy with blond hair and blue eyes,
came onstage dressed like a Native
American. Many servers working the event
were Native American and were offended.
Casino management stopped the event
and kicked us out.”
What I Wear to Work
What do you do
for a living?
I’m the co-founder
of Aday, a clothing
line that makes
high-performance
pieces that are
also the most
comfortable clothes
in your wardrobe.
Etc.
Cool jacket.
I love that it’s dressy but not
too dressy. It’s got a silk lining,
which I like because it’s a
luxury just for yourself.
LIZZIE FORTUNATO
What do you keep
in your backpack?
I always have my
laptop and passport
and an overnight kit.
I pack for emergencies.
Who knows if I’m going
away for the weekend?
ISABEL MARANT
Is that shirt from
your brand?
Yes. It’s a
reinvented
And you can work
silk fabric
out in that?
from Italy.
I wear it to go rock
climbing a lot.
People stare at me,
of course. But it’s
machine washable
and dries quickly, so
it works perfectly.
79
ISHARYA
ADAY
ADAY
PHOTOGRAPH BY B. O’BRIEN FOR BLOOMBERG BUSINESSWEEK
Tell me about
your leggings.
They’re our bestselling pair, made
in Portugal at the
same place Michael
Phelps’s swimsuits
were made for
the Olympics.
Tell me about your shoes.
They have a cool textured surface
that’s crocodile-y but not.
They’re the right combination of
statement-making and practical.
EVERLANE
MEG HE
ADAY
ALEXANDER WANG
Who’s the dog?
That’s Forrest. He’s a
rescue, a toy Australian
shepherd, we think.
He’s pretty much the
unofficial Aday mascot.
29, co-founder, Aday, New York
Interview by Jason Chen
BILL COBB
President and chief executive officer, H&R Block Inc.
Education
“I suddenly started
to view a larger
world. It was
my nonbusiness
courses: sociology,
Russian history. I
realized that there is
more to life than the
New York area.”
St. Rose High School,
Belmar, N.J., class of 1974
The Wharton School
of the University of
Pennsylvania, class
of 1978
Northwestern University
Kellogg School of
Management, Evanston,
Ill., class of 1979
1979–83
With his father, William,
on the Pizza Hut
corporate jet, 1996
“These were the
days of stuffedcrust pizza, and
we did a fun
ad with Deion
Sanders and Jerry
Jones about eating
a slice backwards.”
“I took a wrong turn. The Nasdaq was
going crazy, and I jumped for money,
which is the worst decision you can make.
The product didn’t work, and it was one
of those cut-your-losses [situations].”
Product manager,
Colgate-Palmolive
1983–86
Marketing director, Jeno’s
Pizza Frozen Food
1987–95
Marketing director,
vice president for new
business, VP for colas,
PepsiCo
1995–97
SVP and chief marketing
officer for Pizza Hut,
PepsiCo
“The culture of Pepsi-Cola
was defined by ‘We hate
Coke.’ I did a bunch of
Super Bowl advertising,
including the one about
the kid who got sucked
into a Pepsi bottle on
the beach. Pepsi had big
budgets, and it was a lot
of fun.”
“That was my first international
assignment, and I just loved it. I
had to have a broader business
perspective, and that has
helped me greatly.”
In a
promotional
shot for EBay,
2003
1997–2000
SVP for international
marketing, Tricon Global
Restaurants
2000
Head of sales and
marketing, Netpliance
2000–08
With his wife and
three sons in Bay
Harbor, Mich., 2015
“I had no idea what anybody was talking
about for the first two weeks. I said to
myself, Look, you’ve had a successful
career, you have confidence in yourself,
you’re going to figure this out.”
SVP of global marketing,
general manager for
international, president
for North America, EBay
2011–
Present
President and CEO,
H&R Block
Life Lessons
2008–2010:
Semiretired, joined the
board of H&R Block
“We’re looking to reinvent virtually
everything we do. This tax season
we’re introducing H&R Block With
Watson, an in-store experience that
ingests a client’s first conversation with
a tax pro about recent happenings—
home purchases, marriages, births—
and highlights the tax implications.”
lear
n from it and fix it.” 3. “Communicate early, often, and broadly.”
Work
Experience
g,
At Wharton
graduation
80
“I was 27. It was a
$200 million company with
national advertising, and I
got to lead a team. Then it got
sold to Pillsbury.”
on
1. “There are so many leadership books on hiring, but it’s all about the chemistry you build on the team.” 2. “Have a no-blame culture. When things go wr
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How Did
id I G
Get
et H
Here?
Courtesy subject (5)
Etc.
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