would it be great if we could predict water who is going to happen to our company was going to happen to an economy two years in advance well we can lead brewer of the integrity institute tonight right here on public exposure welcome back to the show lim thanks know we've been kind of talking a lot and for people who have not heard you before we do have to go back just a little bit you were in wrong whistleblower i was i was a mid level executive had a group working for me that briefed on these deals that ultimately some of which ended up at the center of this disaster that brought down the company and what did you do at enron yeah so i actually headed up a risk management group inside the legal department that actually looked to make sure that there were contracts to cover all of the trades of all of the commodities that they traded so natural gas wind power water water water of course in the ten years or so since then you have started something called the integrity institutes and research think tank of sorts and we focus on predictive modeling i'm just a stiglitz who was the nobel prize winner in economics in the early two thousand it's really said that our future is in predictive modeling and that model should be based on how they how well they predict and so we knew early on that with sufficient data sort of like a corporate jet no more  genome that enough data and analysis that data we could actually predict outcomes so that has been our focus for the last twelve years you're using some big words there let's see if we can simplify the ok when you talk about predictive modeling what exactly do you mean so what we is if you think about looking at the markers of disease or factors the it lead to type two diabetes for example we might look at your diet we might look at sort of your exercise your intake of sugar hereditary aspects of it and those patterns if you identify enough of them you can predict certain outcomes and so that's really what we've done we've looked at over eight hundred thousand financial statements quarterly and annual financial statements we only use publicly available data so every public company that has been listed on one of the u s exchanges between one thousand nine hundred five and two thousand and eleven they have filed financial statements with the f c c and we have analyzed those financials to identify that pattern of behavior that exists in companies that fail and these black swans in particular and we've identified what that pattern of behavior is within financial statements we're going to get to black swans and we may not get to in this show because there's so much that we have for this show so we hope we're going to stick around for not necessarily part two but something that's that's even different but why why the integrity institute why the integrity index what does that mean so of course most people think of integrity as this moral aspect we really look at it as structural integrity and what companies must do to withstand market forces so a few weeks ago we saw that j p morgan lost you know an enormous amount of money and today they're still around but to a lot of companies if they lost two billion dollars overnight they would be out of business and so the structural integrity of the company is really important in its ability to withstand these market is a business is it personal integrity to well certainly as the f d i c said to us if a bank is cheating on their financial statements they're probably doing risky loans that may be cheating on loans as well but it's we're not judging moral integrity quite a long time ago lee iacocca who was then the chairman of chrysler came out and he was he was one who was a chairman of the board in a c e o of a company that came out personally and stood behind the value of his company and that did an awful lot ken lay was the chairman and wrong he did something of a similar nature and actually let's go to the clip of ken lay talking about integrity right now iran is a company that deals with everyone you know with absolute integrity we play by all of the rules we stand by our word between what we say we say what we mean we want people to leave a transaction with enron thinking that they've been dealt with in the highest possible way as far as integrity and their truthfulness and really really doing our business right so ken lay talks about integrity is this the kind of integrity that you're talking about well i think ken lay believed that his company had moral integrity certainly i would argue that ken lie lived a life like many c e o s that are insulated from the day to day operations of the company and so the moral integrity of the c e o i've never met jamie diamond of j p morgan but i have to believe that he lives a more a life we don't judge more ality that is not the nature of our operations or ted it is to judge whether or not the company has the structural integrity to withstand market forces so we got this note here money ball for main street is that what we're talking about you know so for those who have seen the movie moneyball it really was to take the statistics of baseball and look at it a little bit different through a different lens and be able to compete in a market against in that case the new york yankees and so what we've found is that if we look at the same information the same financial information that every analyst looks at but we look at it through a different lands we can actually hit the bull's eye and predicting these things these black swans and corporate failures and allegations of securities fraud one to two years in advance with eighty one to eighty five percent accuracy would you repeat that allegations of security preferred you can predict tell us about that so originally what i wanted to do after i left enron was to predict the future and wrongs of the world that failed virtually without warning when when like m f global suddenly people lose their life savings in some cases and so it's sort of like a nuclear attack like fukushima you can't necessarily predict those because they're so far and few between so you have to predict something that is a leading indicator to that and that generally tends to be allegations of securities fraud a class action law firm facebook has now got a class action lawsuits against it post i p o you know they're only like a week old publicly right but there was some there was some information that was withheld from the public and so there was a class action lawsuit filed against them so our model is designed to look at those leading indicators because they lead to these corporate failures and that is when allegations of securities fraud are logged against a company generally speaking the company can lose forty percent of its value for truly overnight oh so that if i if i knew that the company x is likely to commit securities fraud that i may no necessarily want to invest in  yeah it would be a risky bet less you were doing derivatives where you were going to do puts or something like that but the average retail investor would not necessarily want to do that right it would be like getting on a ride at the pew all affair or something and finding out you know if you knew that that ride was not safe would you get on it and the likelihood is no you would not get on that so does the integrity of the investment advice now we do not we are not an investment firm we really are sort of in this business of empowering retail investors and individual investors to be able to quantifiably understand the risk factors of a financial stake and not from you but don earnings per share and all of those acronyms that are used so clearly in the market but really is my money going to be safe in the long term i'll make the risk based on whether or not i want to get on that ride or not so facts is facts are facts as facts all right so the of the index itself it has happened by the time of the by the time that the public will see the show so we as i mentioned looked at eight hundred thousand financial statements quarterly and how do you look at that many financials to yeah you have a really smart research team that's for sure we've got people from carnegie mellon i'm working with dr all over who is the former chairman of fight go who is a physicist from mit and one of the original creators of  so that's our personal credit score ok thanks so right they predict whether or not we're going to default on our loans so we have a really really smart tame and so the model itself after twelve years of research has been done for about a year and so now what we're doing and what's going to be launched by the time the show is our website and that interface where you can go for free you can actually get and you can get all of this that you've done for free yes you can thank you yeah so it's actually we have what we call a free to feed model that allows the general public to go to the website they can punch in any company name and they can actually get access to a star running like hotels dot com and so the integrity and x ratings the the data behind that is then quantified into a score of the stars of sorts so you know this will be integrity index dot com  and you have excuse me yes all right so it's integrity institute dot com we've got that up on the screen you probably want to go to that right you know right now if maybe not right now go after the show and then you're going to find out some information that you can find out as well  you know i was is in preparation for the show i was looking at you know just what is the value of this but then found this guy andy taylor turner turned turner any turner who is the former russell investments  executive among other things and here's what he said about the value of this in the next let's go to means a rating system that told us about the likelihood of fraudulent behavior or future downgrades on the basis of changes in accounting that would be extremely valuable to investors right so any turn or the value of the index he says it's basically it's invaluable it's tremendous information to have i guess why don't we have this already  interesting because when we met with the securities and exchange commission i thought that this would be my day sort of in the sun where they would say thank you so much and actually the gentleman who heads up this group that we met with said you should have never had to build this model we should have but the fact is that the f c c is understaffed and they are underfunded and so as a result it means that people like myself and our hard working team had to come together and say we're going to do something to change the world there there was there with there's a columnist for the rolling stone and he writes from in other places too when he talked about the f c c you know any talk specifically about so many s c c employees actually going to work for the firms that they that they regulate he wrote about that yeah so it's called regulatory capture and it's this revolving door and the writer you're speaking about is matt tyee who is in a huge supporter and has endorsed the integrity and acts and what he has identified are these weaknesses within our public policy that allow these examiners inside the s e c to actually go to work for these companies but it was worse than that they were actually shredding documents investigative documents as they walked out the door to go to work for the company from the securities and exchange commission my employees me you as a member of the public was doing that who can i trust you know well we hope that the integrity index is the first moment in time where we can mark where we return to that age of integrity where we say you know i don't necessarily know that i can trust this company and i certainly don't understand its financial statements they get more and more complicated to read and understand but i can certainly understand if it has one star five stars yeah well that's for sure but why are you different i mean again why should i trust what comes out of the integrity institute as opposed to any other company which i don't trust well i think that the proof is going to be in the putting right so our model has predicted well actually all of the big ones it's predicted we're going to talk about some of those predictions but first we're very fortunate to have lynn brewer with us who is the founder of the integrity institute be sure to go to the web site integrity institute dot com wrong always please correct it you talk about predictive modeling and you talked about the scores of failures basically that your model has predicted tell us about some of those so we rate companies from one to one thousand and basically look at their financial statements in three areas so governance which is what the board oversees the compensation of the top five executives and then the financials of the company and we look at ratios within that and then we score those ratios from one to one thousand and one is very risky and one thousand is really really good and what we found interesting is that there's a handful of penny stock that stay in business and they rate very very very high really what we also found is that one hundred percent of companies that scored below twenty five over this historical period of time between one thousand nine hundred eighty two thousand and eleven one hundred percent of failed one percent one hundred percent so we know that if you score below twenty five on a historic average there's a high probability you're going to fail below fifty we found that ninety nine point nine percent of the companies failed the two that survived were m global which of course is on its way out and the other one is discover financial services which took tarp money and has yet been has not repaid the tarp money so you know without that our money it probably wouldn't be around one got a government bailout and the other one has political friends is that fair all right i said that you said that i hope it's a moral issue that we don't get our rights you don't you don't get into that understand ok so you talk about  governance financials and compensation the compensation i have questions about why would executive compensation be an important factor so what we do is we want to make sure that employees are loyal to the company but not too loyal where they would overlook things and that's where these incentives so the risk what we call risk culture right what is the culture within the company and their incentives to take risk and that's that risk appetite right now how hungry and my how much am i willing to take risks in order to move forward in the company and then there's this risk oversight that's the board of directors and the controls on that kind of thing well there's this gap where the motive and opportunity exists and if you incentivize someone to take enough risk that's what they'll do and they will take more risk than you have sufficient controls on to manage that risk and that's where the failures occur so so compensation is one of those incentives it motivates people to do certain things well we have just gone through here in the united states where actually and across the world a circumstance where we've seen high executives being paid remarkable sums of money but it all seems most of it seems to be in the financial services sector enron was a power company that turned into itself into a financial services company really are we looking at a series of bad actors that are mostly in financial service and i would like to say that but our model indicates that there's about five hundred and one companies at very high risk with about seven point three trillion dollars at risk now here's the good news is that we've actually signed a definitive agreement with a group called pegasus global holdings that actually will work with consulting firms to help companies become stronger but what we have found is that companies that have low margins you know if you think about a wal mart for instance which is just gotten its own scandal in mexico and pain bribes in order to grow that company how do you do that if your margins are the same right it doesn't matter how many stories you put in you still are going to have the same margins and the other group that we see a bias towards in the model is financial services that are highly leveraged when you're highly leveraged and you're highly in debt that's why this country is in the state that it's in because people borrowed more than they actually earned or could pay back and that put the default rates on mortgage loans very very high you know there was more to it than that there wasn't there and then with stockholders derivatives and and well not in the mortgage derivatives that were unexplainable and basically there was a trade of air there was nothing that was done for the public by those companies right i mean i think it's dynamic but it speaks to when i wrote my book about enron i said look to enron to foretell the future because i believed that we were heading and a way that everyone wants to live the american dream and everyone wants to see that and we're a competitive race by nature  so you know we've been given enormous opportunity here in the united states but we also that comes with its risks when we talk about executive compensation and i'd like to ask you a question about a couple of individual companies and you know where it gets to the point where you can't say something to say i can say that but goldman sachs there's you know that's one whose name it seems like in so many criticisms of the u s government it seems that goldman sachs is is there a lot yeah goldman sachs appears to have from what you read in the media and i've read the media very close relationship and internal ties to the administration but that's one of the reasons that this model works is because it looks at the political capital that a c e o must gain in order to retain his position of power and goldman sachs has been sued for securities fraud every single quarter it has been public oh so that would speak to a risk culture that the company as that very very very high risk i think we've got goldman sachs at a pretty high probability that they at fail sense dodd frank was passed and whether or not the political side if it's a major bank fails and we have some concerns that too big to fail we'll have to step in and correct about and and you know who knows whether that will happen before the election or not but it will certainly be interesting and i heard those words it will certainly be interesting so we'll just have to go on to integrity institute dot com and them sign up and become a free member and look for ourselves and so that's what i'm going to encourage people to do when you talk about failure and then we bring in the u s government and it's too big to fail or these just american companies just working in the united states we have only rated at this point in time because remember we're trying to produce these predict these black swans and that leading indicator are allegations of securities fraud by a class action law firm so that's what a black swan is that rare occurrence that we simply didn't expect and it's based on a book entitled black swan and predicting these rare occurrences and so what we really want to do is be able to give investors sufficient time to get on another train and that's what the integrity index does it gives investors a heads up when there may be trouble because as i've said to a lot of people in their seventy's is at least this gives you a barometer and so if the stock does begin to falter and you're reading the stuff in the news don't expect it to come back because if it falls it could become one of these black swans and if it has been alleged to have committed securities fraud is number the number of times that goldman sachs has then it has a culture that engages in risky behavior if that's the case then why would i want to continue to stay invested in a company investors i don't know goldman sachs at one time maybe a year ago was trading at two hundred dollars a share today it's one hundred or even less i don't i don't we don't have a stock price variable built in our model so stock price doesn't matter we don't we don't look at the stock price i'm personally i'm not a big enough investor to in my own mind to be concerned except i have a pension and i suspect my pension fund invest somewhere you know pension funds are the they're the thing that gives me the greatest concern since leaving enron because our entire social welfare in this country and i don't mean that term negatively but the welfare of our people depends that we sustain our pensions because you know as we've heard over and over and over social security is going broke well pension funds in this country are underfunded meaning they have more liability than they can afford to pay so who's going to end up when the music and without a chair and this musical chairs and the reason is because these pension funds are investing in these black swans so one of the things we're focused on is working with pension funds to help them understand and give them a heads up so they don't write it all the way down when i met with joe dear who was then washington state investment boards leader executive director he said we lost one hundred three million dollars on enron i mean he knew to the penny how much they had lost on i don't know so that we have  brothers you know you have too many of these big failures and these pensions are heavily invested in these companies you know well when when that joe dear says we lost one hundred three million dollars that could be my money ok so this is you are bonnie it is my money and so you've got people in new york city who cannot afford to retire you have people with emphysema who have been firefighters their entire life who should be able to retire but their pension fund campaigned out anymore to go back to andy turner it's where he's talking about this concept that i don't understand called alpha let's go to that right now from what i've seen you know the predictions from the integrity and they can definitely be used to generate  to have to have a long term perspective because one of the things that's clear is that even if we've correctly identified the firm that's in trouble and is cooking their books it may take two three years for that to be uncovered so they may be able to continue to maintain that facade for a while so what so alpha is a term that investment institutional investors use that they want you to prove that you can reach out with your model meaning if i your model proved to me that i could get better returns with last risk because it's that risk reward right the more the risk the greater the reward and so what we have started to do was work with institutional investors to redefine what does alpha mean it's not quarter to quarter it's you will make more by losing the last and so the index if i can identify where the land mines are i will ultimately make more because i won't stay in those companies invested and ask i want to ask you if there is a way to improve your score and it seems like that there is but i want to tell you that my impression of the stock market is been that it is become more of a trade of art where i'm not looking so much on the performance of the management but instead i'm looking at the intangible appeal of the stock itself and so if i buy shares of facebook from someone else that other person and i are trading money but nothing happens to create any employment nothing happens to do anything unless i do it myself and that's a huge trickle down so i my question is is is in terms of the integrity index are you giving investors in pension funds and anybody again an accurate view of the company's performance well i think that's a complicated question that you just asked and so the well ok so first of all we don't give you a sense of the company's performance other than to say this company is at high risk for allegations of securities fraud it's a predictive indicator it is one of  many lenses you should use so so i think that that's important ultimately i think that someone somewhere has captured our stock markets they aren't being used the way they were originally they were designed to raise capital facebook needed more capital so they went public the unfortunate thing is there is this assumption that information is perfect and if i rely on that perfect information i will make perfect decisions which we know in the exuberance and the failure of the facebook i p o that that's not the case we have thirty seconds left i think this is a phenomenal tool why did you build it to take what i had learned  run and actually change the world and actually change the world where that is going to be the last word so you yourself should go to the integrity index and it is at integrity institute dot com where the founder of it is with us and we're actually