Playing dirty

As digital transformation increasingly takes hold of the financial services sector, firms are racing to demonstrate that their systems are faster and more automated than their competitors’. But over-promisers should be on their guard about the perils of techwashing

When American drinks company Long Island Iced Tea changed its name to Long Blockchain Corp, its stock price skyrocketed. But the switch to a blockchain-based business model had come out of the blue and the company had no existing business tied to blockchain; neither did it have any experience with the cutting-edge technology.

As a result, Long Blockchain Corp has fallen foul of ‘techwashing’ – a phrase that was coined by Chris Clark, CEO and founder of Jersey-based technology consultancy Prosperity 24/7, to describe when a company creates a false impression about its own profitability by leveraging modern technology.

Long Blockchain Corp was ultimately accused of deceiving investors and delisted from the Nasdaq stock exchange. In July 2021, the US Securities and Exchange Commission charged three individuals with insider trading on allegations that they bought shares in the company ahead of the bogus name change.

As tech companies continue to attract multibillion-pound valuations, and buzzwords such as artificial intelligence (AI) and blockchain gild the surface of marketing campaigns and business plans, investors must be on their guard for the signs and dangers of techwashing.

In the headlines

For Clark, who has decades of experience implementing digital transformation within organisations, the logic behind techwashing is clear: tech firms are more attractive to investors.

“If you are a tech-enabled business, you should be more efficient and more effective, and generate more profits and higher exits,” he says.

Healthtech company Theranos, for example, raised more than $700m in investment and achieved a $10bn valuation before false claims about its blood-testing technology were exposed. Theranos founder Elizabeth Holmes was convicted of defrauding investors in January this year.

Another example is WeWork. When the co-working-space provider attempted to go public, it was valued at $47bn. Its CEO, Adam Neumann, talked up the company’s tech credentials. But because of concerns over its business model, WeWork’s IPO failed, its value dropped to $10bn and Neumann resigned.

According to a recent Harvard Business Review article, academics argue that WeWork fails to meet any of the qualifications that enable a tech company such as Uber or Amazon to achieve exponential growth and profits.

These include a scalable virtual model that can be grown with little additional cost, ecosystems that boost expansion (think Uber’s use of its platform to introduce Uber Eats), and minimal physical assets such as land and property.

But techwashing isn’t always nefarious and there’s a fine line between puff advertising and fraud. “In today’s ever-increasing competitive market, companies dressing up legacy software to make it seem more innovative are becoming more prevalent,” explains Simon Florance, Counsel in Carey Olsen’s Guernsey dispute resolution and litigation team.

When companies use trendy labels to make what they do sound more innovative, that’s techwashing, he adds. But when firms such as Theranos make claims that go beyond the capability of their existing tech, that’s a more sinister fraud.

What drives companies into techwashing, says Florance, is the prevalence of technology and the competitive, unregulated environment of the tech industry.

“You have start-ups and SMEs competing for clients and investors in an industry dominated by mega-giants such as Amazon, Apple and Microsoft,” he says. “As the pie is a lot smaller than it once was, people are scrambling for a bite of it, and you don’t always have the oversight of regulators in relation to the technology that companies are selling.”

Clark argues that the impact of the Covid pandemic and the shift to remote working has been the likely cause of even greater techwashing. 

“Companies may be innocent but unconsciously incompetent. There’s a perception that if you work remotely and use Zoom and Teams, you’ve gone through digital transformation.”

That, Clark explains, does not constitute a tech business. Implementing digital transformation, he says, isn’t a tick-box activity, but something holistic, constant and requiring significant investment. 

The Government of Jersey, for example, is spending more than £60m upgrading its digital systems.

Tech credentials

To recognise techwashing, investors must first establish whether a company is fundamentally a tech business – one that builds the technology itself – or a tech-enabled business, which doesn’t create technology but uses it in an innovative way.

Tech businesses are techwashing if they misrepresent their own product. To identify whether tech-enabled companies are techwashing or not, Clark points to the balance sheet. 

When doing due diligence, he says, investors should look for markers of long-term investment in three areas: people, technology infrastructure and security.

“The first red flag is if there’s been no investment in training or engaging staff, because you can’t do digital transformation without driving cultural change,” he says. 

“Then, if an organisation hasn’t invested in its IT or cyber security, alarm bells should be ringing.”

With a tech-enabled business, investors should expect to see a correlation between these investments and productivity and profitability. If those indicators aren’t visible, you may have a case of techwashing.

Martin Keelagher, CEO of Agile Automations, which provides AI-driven automation services to financial organisations, recognises that the phenomenon is a challenge for investors without a tech background.

“The reality is that techwashing can be seen in some of the largest listings of late as businesses attempt to increase valuations and align themselves with other high-growth propositions in the sector,” he says.

Keelagher recommends investors work with specialist investment teams who have a knowledge of the tech industry, as well as getting independent advice from third parties.

Investors can use tech to fight techwashing, Keelagher explains. “AI tools can look at a sector, analyse the available data, create a benchmark and, by spotting a deviation from the norm in an investment proposition, assess the likelihood that the proposed data is accurate or not.”

Although AI is only as effective as the data it pulls in, quantitative investing – using analytics and computer modelling to construct investment portfolios – can be especially useful when it comes to techwashing.

“It’s not fool-proof, but it’s an objective way of approaching investing, which relies less on your personal reaction to companies that big-up a product,” Florance says. 

“As AI gets more sophisticated, it will do this investigatory work at lightening speed and offer greater protection.”

Legal protection

There are legal protections for investors, regulation covering funds and advisers, warranties, and insurance on transactions. Certifications – ISO 27001, an international standard related to data security, or ISO 9001, focused on quality management – can provide a level of reassurance.

However, to wipe out techwashing completely will be a challenge. In extreme cases, investors lose millions. Where ‘light’ techwashing occurs, Clark explains, more investment is often required to develop the organisation’s technology.

Even when an investment opportunity is rejected, the cost of due diligence alone is substantial. 
“That’s where money is lost that could impact the performance of a fund, but it’s seen as opportunity cost and likely wouldn’t end in litigation,” Clark notes.

One solution would be to fully regulate the tech sector. “But that would be a massive undertaking by governments worldwide and difficult to draft given how fast technology is evolving,” Florance argues.

“Tech by its nature is multi-jurisdictional and that makes it very difficult to regulate. With techwashing – like fraud – it’s difficult to introduce rules that cover all possible scenarios. And once you do, you always have people trying to work around them.”

Investors can take steps to recognise signs of techwashing, but some form of ‘washing’—whether it’s greenwashing, cloudwashing or techwashing – is here to stay.

“Investors are always looking for the next big thing,” Keelagher explains. “If you’re a business looking to secure an investment, how do you stand out in a crowded market? You simply throw in the buzzwords of the moment.”