‘We find it highly unlikely’

Block (SQ) continues to be placed in a square penalty box by Hindenburg Research.

Block shares fell another 4% in pre-market trading on Friday, following a 15% drop on Thursday, as Wall Street continued to sift through a new piece of short-seller research from Hindenburg. The digital payments outfit continues to be a top five trending ticker on the Yahoo Finance platform.

Hindenburg Research filed fraud allegations against the company, which was founded and led by billionaire Jack Dorsey.

The investigation accused Block of a “willingness to facilitate fraud against consumers and the government, avoid regulation, dress up predatory lending and reimbursements as revolutionary technology, and mislead investors with inflated statistics.”

Block hit back, but not as hard as investors wanted – leaving questions about the company’s operations floating around.

“We intend to cooperate with the SEC and investigate legal action against Hindenburg Research over the factually inaccurate and misleading report they shared today regarding our Cash App business. Hindenburg is known for these kinds of attacks, which are solely designed to allow short sellers to profit from a declining stock price. We have reviewed the full report in the context of our own data and believe it is intended to mislead and confuse investors. We are a highly regulated publicly traded company with regular disclosures and have confidence in our products, reporting, compliance programs and controls. We will not be distracted by typical short-seller tactics,” Block said in a statement.

Dr. Greg Werner poses for a photo with his Square (now Block) credit card reader in his New York office on Jan. 5, 2015. (AP Photo/Seth Wenig, File)

Dorsey did not respond to Yahoo Finance’s request for comment. Hindenburg Research did not respond to repeated attempts to discuss its new research.

Here’s the mood on Wall Street:

Truist analyst Andrew Jeffrey: “We have known Block’s management team for years and are confident in the way the [company] discusses, manages and discloses details of its Cash App business. While we believe that Cash App has some form of fraud like any other P2P payment app, we find it highly unlikely that one of the most sophisticated fintechs in the US is running rampant on systematic fraud. We also emphasize that the majority of the Cash App’s gross profit is generated by Cash Card (5x gross profit $), which requires a legitimate bank account. While anyone can order a card, it still needs to be authenticated like any bank card, including SSN and/or driver’s license verification. To the best of our knowledge, it is not possible to access the full functionality of the Cash App by using a fake SSN. To the extent that Cash App Fraud exists, we believe authentication requirements are sufficient to ensure core profitability is not materially impacted. In addition to allegations of fraud, the negative piece reiterates a common argument that the Durbin arrangements for small banks will come under scrutiny. Any change to the Durbin exemption may negatively impact Cash App’s exchange earnings. That said, we don’t see policymakers eliminating the Durbin split because it would marginalize thousands of little ones [financial institutions] and the communities they serve. Notwithstanding the foregoing, we recognize that increased research into fraud on any neobanking platform may lead to a review of business practices and slow user growth. We argue that this is materially reflected in yesterday’s 15% sell-off (SPX +30bp) and SQ’s ~20x estimated EBITDA multiple for 2024.”

Citi analyst Peter Christiansen: “We have read the activist short-sellers report alleging improper compliance standards related to setting up a Cash App account and ongoing fraud monitoring, among other things. While Block, like any other financial institution , has no control over what people do with their money , the report raises two key questions: (i) Do (or did) Cash App fraud/KYC checks meet both regulatory and industry standards; and (ii) if not, are Cash App’s growth profile, revenue retention, and engagement is a result of a mass user’s perception that the platform has inadequate fraud/KYC controls (i.e., fraud/KYC controls are seen as a product feature). Given the Block’s mission to serve the disadvantaged, proportionality is also a very relevant consideration. We had hoped that Block’s response/refutation would be more detailed and believe that ‘examining legal action’ probably won’t be enough to allay investor concerns.”

Keybanc Analyst Josh Beck: “In summary, we see no merit in the disparaging claims and rather view the report as observations made by a relatively novice outsider in the industry who is unfamiliar with the standard practices and principles within the FinTech industry or with the wider legal construct. 1) Key metrics related to Cash App are defined in a logical manner similar to the wider technology universe, MAU were 51 million exiting 2022, which are defined as an active transaction that has had at least one financial transaction using a product or service within Cash App, in accordance with peers and other third-party data sources (which tend to track only app-based activity, not purely financial activity such as a card transaction). 2) Fees generated from sources such as interchange- or direct deposit fees are standard practice in the bra nch. Cash App has ~18 million card users, with an exchange-based revenue model, a standard model in the financial services and FinTech industries. Direct deposit fees provide users with faster access to funds, an industry-wide intrinsic money movement. 3) Block compliance processes are robust and consistent with industry standards. As a financial services provider, Block is subject to numerous laws and regulations, including, but not limited to, payment regulation (e.g., registered with Treasury’s FinCen), CFPB, AML (a collection of policies, procedures, reports, and controls led by Block’s chief compliance office) and a clearly formulated acceptable use policy. We believe that Block fully complies with applicable regulations and laws and prevents the maximum amount of fraud possible within a company that is inherently subject to, but not immune to, instances of fraud, which is simply the reality of being of a financial services company, as highlighted by the respected Nilson Report release, which cited $32.3 billion in card fraud in 2021 at issuers, merchants and acquirers.

Yahoo Finance Ines Ferré contributed to this story.

Brian Sozzi is the editor-in-chief of Yahoo Finance. Follow Sozzi on Twitter @BrianSozzi and further LinkedIn. Tips on the banking crisis? Email to brian.sozzi@yahoofinance.com

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