Playing dirty

Written by: Marco de Novellis Posted: 23/06/2022

BL78_techwashing1As 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.

Famous tech disputes

WeWork – WeWork promoted itself as an innovative tech firm in the lead-up to its failed IPO, but the co-working-space provider fails to meet the core qualifications for a tech company.
Theranos – Theranos lied about the capabilities of its blood-testing technology, ultimately defrauding investors out of millions of dollars.
Deliveroo – Deliveroo listed itself as a tech stock when it went public, but the food delivery firm’s app-based logistics technology isn’t unique, nor is it created in-house. A disastrous IPO saw Deliveroo shares slump by 30%.
Tesla – Tesla says it develops advanced AI, but experts claim the carmaker simply adds smart elements to existing pieces of software to make them AI-enabled. The tech looks trendy, but at its core is an established technology that’s not unique to Tesla, critics claim.
Meta – In a case of reverse-techwashing, Meta has been accused of saying its technology doesn’t do something that is actually does, playing down how powerful its algorithms are in connecting customer data.

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.”

Five things ‘real’ tech companies have in common

1. Low variable costs Scalable virtual models that can be grown with little additional cost
2. Low capital investments Tech firms are asset light because of low requirements for land, buildings and warehouses
3. A lot of customer data and customer intimacy Data enables targeted ads and the sale of tailor-made products
4. Network effects The bigger the network, the more valuable the company
5. Ecosystems that boost expansion with little cost Tech firms leverage what they know about their customers’ tastes and preferences to deliver more services.
Source: Harvard Business Review

BL78_techwashing_ShelleyDeKlerkQ&A: Shelley de Klerk, Associate, Appleby

Shelley de Klerk is an Associate in Appleby’s Corporate and Dispute Resolution team in Guernsey. She’s worked on commercial disputes covering administrative, commercial, banking and data privacy issues and supported multinational companies, focusing on data protection, commercial contracting, cyber and TMT law.

How is techwashing allowed to happen?
Tech advancement has two drastically opposing parts. The technical side is made up of objective certainties, but practical implementation is filled with vague, subjective interpretations. Whereas one entity might consider tech capability to be the latest version of a messaging app, its rival could interpret it as investment in a purpose-built, powerful platform running algorithms to improve efficiency and reduce cost. Where there is a grey area, there is space to fib.

What questions should investors ask before investing in a tech firm?
You need to look at what they’re actually producing. Where do they hold their intellectual property? Who is building it? What market are they aiming for and do they operate efficiently in that market? For tech-enabled businesses, ask: are profit-generating functions supported by technology? How exactly is that technology used? What is the tech strategy for business-critical operations? How often does the business review its tech standing in the market and update it? How regularly and efficiently does it test its tech security? Where’s the documented budget for tech and innovation? How regularly does it assess its practices against best industry standard? If a company uses buzzwords but has no clearly documented continuous culture to understand and stay on top of technology, and there’s no indication in the budgets and financials that the company is doing so, the chances of techwashing go through the roof.

Can investors protect themselves against techwashing?
The number-one general protection is to do your homework, dig past the marketing jargon and find the objective certainties behind the prospectus. Some protections are found in regulation, and limited relief can be found in traditional legal remedies. But these were not designed with techwashing in mind – there are no express legal protections against techwashing specifically. Practically, investors’ best legal protections are found in the fine print. Most protection comes down to clauses governing dispute resolution, warranties, indemnities, liability, insurance, representations and undertakings. Given the nature of tech, the chance of something going wrong is high. Many investors don’t pay enough attention to tech, cyber and data protection in their due diligence and are taken in by sales language, agreeing to terms (warranty and liability clauses) that don’t cover them effectively for harm arising out of techwashing, data and cyber security breaches, as well as the related reputational harm.

What’s the most common misconception about techwashing?
Techwashing can also be about saying technology doesn’t do something it actually does – potentially a bigger issue. Governments in unregulated nations use fancy tech such as tracking bracelets to monitor the spread of Covid-19 but, ultimately, the data is used for more than that. It can be difficult or even impossible for the average person to know what’s really happening with their data. People can unknowingly give up their liberties, without due consideration, simply by using the latest tech.

 


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