a16z Podcast - 16 Minutes on the News #7: Apple Card, BEC Scams Federal Indictment

Episode Date: August 25, 2019

with @illscience and @smc90 This is episode #7 of our news show, 16 Minutes, where we quickly cover recent headlines of the week, the a16z way -- why they're in the news; why they matter from our vantage point in tech -- and share our experts' views on these trends. This week we cover, with the following a16z experts: Apple releasing a credit card, and what it means beyond the card features itself, what it means for consumer credit (and recession risks), and the financial ecosystem overall -- with new a16z fintech general partner Anish Acharya; BEC frauds and scams indictment and the FBI bringing a massive federal grand jury indictment, one of the biggest of its kind, and what it means and how to prevent this type of cyber fraud -- with a16z operating partner for security Joel de la Garza; ...hosted by Sonal Chokshi. The views expressed here are those of the individual AH Capital Management, L.L.C. (“a16z”) personnel quoted and are not the views of a16z or its affiliates. Certain information contained in here has been obtained from third-party sources, including from portfolio companies of funds managed by a16z. While taken from sources believed to be reliable, a16z has not independently verified such information and makes no representations about the enduring accuracy of the information or its appropriateness for a given situation. This content is provided for informational purposes only, and should not be relied upon as legal, business, investment, or tax advice. You should consult your own advisers as to those matters. References to any securities or digital assets are for illustrative purposes only, and do not constitute an investment recommendation or offer to provide investment advisory services. Furthermore, this content is not directed at nor intended for use by any investors or prospective investors, and may not under any circumstances be relied upon when making a decision to invest in any fund managed by a16z. (An offering to invest in an a16z fund will be made only by the private placement memorandum, subscription agreement, and other relevant documentation of any such fund and should be read in their entirety.) Any investments or portfolio companies mentioned, referred to, or described are not representative of all investments in vehicles managed by a16z, and there can be no assurance that the investments will be profitable or that other investments made in the future will have similar characteristics or results. A list of investments made by funds managed by Andreessen Horowitz (excluding investments for which the issuer has not provided permission for a16z to disclose publicly as well as unannounced investments in publicly traded digital assets) is available at https://a16z.com/investments/. Charts and graphs provided within are for informational purposes solely and should not be relied upon when making any investment decision. Past performance is not indicative of future results. The content speaks only as of the date indicated. Any projections, estimates, forecasts, targets, prospects, and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others. Please see https://a16z.com/disclosures for additional important information.

Hi everyone. Welcome to the A6 and Z podcast. I'm Sonal and this is our seventh episode of 16 Minutes, our news show, which in addition to our regular podcast show in this feed is where we cover recent headlines of the week, the A6 and Z way, why they're in the news, why they matter from our vantage point in tech and share experts views on the trends involved. You can catch up on past episodes at A6NZ.com slash 16 minutes or subscribe to the 16 minutes show directly wherever you get your audio. And to be clear, none of the following should be taken as in investment advice, please be sure to see A6NZ.com slash disclosures for more important information. This week, we cover two topics. We briefly discussed the latest news from the front lines of cyber fraud, where the FBI made a huge number of arrests for VEC scams in what was described as one of the largest cases of its kind in U.S. history. But first, we go deep on the new Apple credit card. What it means, beyond the headlines. Okay, so the first news item we're covering this week is that Apple released a credit card and it was actually announced a while ago

but only became available this week to U.S. iPhone users. And let me quickly summarize the news and then I'll introduce our A6 and Z expert. They're partnering at Goldman Sachs as the issuing bank and master card for the global payments network. The card, which is of course coated white,

is made of titanium, but that's still heavier than other plastic cards in the market. And by the way, a funny little anecdote here is that Verge reported by a Mac rumors that Apple is advising against keeping the card in a leather wallet or in direct contact with denim as such fabrics, and I quote, might cause permanent discoloration that will not wash off. That part's pretty LOL.

That said, it is news that Apple, a tech company, is moving into financial services. And this matters in the bigger picture of credit, which drives personal finance and our economy overall in so many ways for better or worse. So let me quickly also summarize some of the salient details here. There are no typical credit card fees, such as sign-up fees, late fees, international fees, annual fees, overdraft fees, et cetera. And there are other features such as greater transparency into interest paid. so on. So that's a quick context. And now let me welcome our A6 and Z expert to put that news in context. Our newest general partner for fintech, Anisha Charya, who is most recently VP of product at Credit Karma. Welcome, Anish. Thank you. Excited to be here. Excited to have you

on here. Longtime listener, first time guest. I'm excited. So the real question here, why does this news matter and why the hell should we care? I'm not supposed to cuss anymore. You can with me. So the least interesting way to think about, this is Apple released a new credit card. Because, you know, a credit card is a credit card. There are more interesting credit cards with better rewards. There are credit cards that have fancier designs. And a lot of the discussion has been about that, and it's just sort of a distraction in my view. So what do you think the real significance here is? Well, I think there's two things to talk about. First of all, whenever Apple enters a category, it's worth looking

carefully at what they're doing because they've reinvented existing categories over and over again. If you take a look at the actual features of the card, they've taken a bunch of things that credit card companies do sort of behind the scenes to the detriment of consumers, like charge fees for being late, charge fees for overdrafts, charge fees whenever you swipe the card internationally, as well as giving you a terrible FX rate. So these are all lines of business that credit card companies have historically monetized. And it's mostly been invisible to consumers and really has done them a bit of harm.

So Apple has actually changed all of that. The second thing they're doing is showing you how much interest you're actually paying. So if you actually just pay the minimum amount that your card company asks you to pay every month, it is going to take you years and years and potentially even decades to pay that card off. And that trade-off has never been clear to consumers. Consumer credit card debt is over a trillion dollars right now. We're starting to approach historical highs.

There's never been a better time for us to be thinking and talking about credit card debt. And the first step is a product that's really transparent. So that's sort of level one of what's interesting. I have a quick question. The transparency feature, that seems like something that's very easy for other credit card companies to do. So A, why haven't they done that yet? And B, can't they just quickly copy this now?

Yeah. So it's really interesting. There's this sort of innovator's dilemma and it looks a lot like SMS did 10 years ago. Like messaging, yeah. That's right. If you look at what happened with carriers, they knew that SMS was going away. But there was some powerful executive whose name was attached to the SMS revenue line and they they would not let it go away.

And as a result, carriers missed messaging. Right. So basically the innovator's dilemma in the classic context of disruption theory where an entrenched business does not want to disrupt its core business when there is a new business on the horizon because even if they know it's coming,

they are actually making money off their core business. You're essentially cannibalizing yourself in order to go into the new area. Exactly. Powerful internal stakeholders don't want to see it happen. So it doesn't. And by the time they realize

that Apple's got a significant edge by offering this transparency, it may be too late. Okay. So now let's go back to the next level. Yeah, so least interesting is that it's a new credit card. But I think the most interesting thing here is that Apple is actually unbundling the credit card. Tell me what that means, because I feel like people in tech talk a lot about cycles of bundling and unbundling,

whether it comes to things like cable and TV or media, software packages. I mean, the phrase comes up in lots of different contexts. What does bundling and unbundling specifically mean in this context? So there's a few aspects of the credit card. There's a physical piece of plastic that I have in my wallet. There is a payment network that processes the payment when I swear. swipe that piece of plastic, and then there is a debt provider beneath it that typically provides me with this unsecured debt that I've made a commitment to pay back.

So what this means in terms of unbundling is that Apple actually owns the customer relationship, they've partnered with MasterCard to handle the payments, and then they have partnered with Goldman to handle all of the debt. If tomorrow they decide, hey, Goldman, we're going to replace you with Capital One, or more importantly, Goldman and Capital One, we're going to allow you to compete to see who can give the customer the lowest-priced debt, all of a sudden those companies have very little leverage to say no. It's like they're almost white-labeled, essentially. Exactly.

We did a wonderful podcast a couple years ago on B2B2C business models, where we actually go in a lot of depth around the challenge of that kind of thing. So on that note, why then are Goldman and MasterCard incentive to work with Apple on this? And has Goldman actually ever had a consumer-facing line of business like this ever? Well, I think there's a short-term, long-term trade-off happening here. The street has really wanted to see Goldman grow their business. business. Goldman typically has not been a big consumer lender. They dip their toe in it with the launch of personal loans via Marcus over the last two years. So great brand Apple, huge footprint.

It's a great way to drive growth in the short term, but it may be a Pyrrhic victory. Okay. Let's talk about the connection between Apple's new credit card and Apple wallet. So there's been a lot of, you know, hype, quite frankly, over the years around digital wallets and there's been many forms. Can you help orient where this fits in that sort of arc of where we are in the wallets space, digital wallet space? Yeah, my partner, Alex, has done a ton of thinking and published some important work on the wallet, so it's worth referencing that.

One of the things that's happening here is Apple is offering 3% cashback for purchases from Apple and 2% when you use Apple pay, 1% if you use a physical card. So you effectively double from 1% to 2% if you're using their payment mechanism. And the word is that the fee that Apple charges merchants is on the high side, the interchange fee. If they can then start to take a portion of those fees at scale

for whenever people are spending money, it becomes a very large business. If Apple becomes your default payment instrument, if Apple effectively white labels the way that you get debt, if Apple owns all aspects of the consumer product experience around financial services, they've talked about pivoting to being a services company. There's no bigger segment of the industry

that's more backwards and has more opportunity for product innovation than money. So what do you make of the fact that they have no points? And how does a role of kind of loyalty programs play into all this? The thing is the cashback. Cashback is actually the simplest form of points. It's largely the same thing. Some of the most popular cards out there are cashback cards

because you don't have to navigate some crazy matrix of blackout dates and conversion rates. So it's very Apple of them to actually go after the thing that's most clearly understood by consumers, which is cashback. If you take a look at what's happening with credit card companies, they effectively have to acquire customers by using messages that they can put on billboards. So what are things that you can put on billboards?

You can put eye-popping rewards rates, cashback rates. Some of them do it using a big brand presence like American Express. So this has really been a way to drive customer acquisition for credit card companies. But the question is, are customers actually receiving value from it? How many are using their rewards and how many are overpaying for the rewards because they've got a really expensive line of credit card debt that they actually revolve on month after month after month. So I think the reorientation opportunity here

is to things that are actually in consumers' financial benefit versus things that look good on a billboard. Then let's go into the tech, because the elephant in the room or maybe the opportunity in the room that we haven't really talked about here is that this is really one of the first, maybe not the first times.

A significant tech company is really moving into financial services. So let's talk about what that means on the technology side. and just to quickly summarize some of those tech aspects. First of all, Apple Card uses machine learning, and they also have geolocation with Apple Maps to clearly label where and when people made a purchase. You also already mentioned transparency and interest paid, and while apparently 74 of the top 100 U.S. merchants already accept Apple Pay,

including Target Taco Bell and HIV supermarkets in the Midwest, the budgeting feature is actually not integrated with other credit cards in an Apple Pay account, which is something that David Pierce pointed out in the Wall Street Journal. But the point is that Apple is giving users weekly and monthly spending reports that help turn wallet into a budgeting app that can help them keep track of purchases. So I think one of the most interesting opportunities on the tech side is today a lot of product features are built in a functional way. And if you take a look at a relationship with money, it's actually much more emotionally oriented than functionally oriented. That's such a good point. Yeah.

And ironically, all of the financial services products that have existed in the past, and now the technology companies are sort of making the same mistake are highly functional. Here's your budget, here's what you spent money on, here's what the end of the month looks like. So I think actually the real product inflection point here is to start to lean into that emotion, to acknowledge that emotion, and start to help people make financial decisions they feel good about versus make sense in some abstract, classically rational sense. And when it comes to the product features, guess what? Most people don't like to budget because most people don't like to diet. It's the same concept. Nobody actually wants to be reminded every week that, hey, you want to be.

went out for Mexican last night, and you blew your calorie limit out of the water. So the magic product feature here is not a budget. The magic product feature here is actually helping to automate all of the small financial decisions to help you achieve a better outcome. Angela has spoken about this. Alex has spoken about this. A lot of great founders have talked about the concept of self-driving money. Tell me more.

That's fascinating. Self-driving money means not having to actually make all of the decisions to optimize your financial life. So, if you look at how much we're overpaying on our mortgages, our credit cards, or personal loans, there are better products that we could get today that we just don't have because we either don't know about them or it's too high friction to apply for them. So I think that the orthodoxy is that we need to tell people to stop drinking Starbucks every day to save money.

That's actually not true. If we can just use technology to efficiently price all the financial products they have, we put a lot more money back in Americans' pockets. Speaking of putting money back into America's pockets, what do you make of the headlines from analysts at Nomura that Goldman could lose money here if losses come? Because basically the analyst is assuming that Goldman has to spend about $350 to acquire each new user, which means it would only break even after four years. But what happens if a recession comes before that, then they would lose revenue, especially because the margins are already tight to begin with. So how do I tie that back into the Apple News? Because Goldman Sachs is approving the subprime borrowers. Yeah. I think the story here is that traditionally credit cards have the whole approval process that is very onerous. Not everyone gets approved. Apple has clearly been pushing their partner to approve a larger set of people. In the future, there will be no credit card application. That's retrograde that we even need that. And everyone should have access

to some form of payment and unsecured debt, even if it's a low credit limit. There's many orthodoxies which are not true when it comes to money. One of the orthodoxies that's not true is we have this believe that there are people who are credit worthy, who have great credit scores who are good people. And there are people who never pay their bills and have bad credit scores. And when there is a recession, things are going to go haywire. It's overblown. The truth is for people who have a lot of fluctuation in their means or limited means, they're always living in a recession. So the variability that you see while it exists, it's not as high as the perception is. And often people who have these great credit scores are on the edge of being wealthy, end up being

ones who get in trouble. So I think that there's a broader discussion about quote-unquote subprime credit card sort of customers and, you know, how do you think about them? And I think that we take an overly negative view. We should actually be thinking about them in a more holistic sense. All right. So Anish, bottom line it for me. How should we think about this news and its broader significance in the financial services ecosystem? Bottom line, it's not just another piece of plastic in your wallet. It has the opportunity to fundamentally change the way that we think about our money. This product has the opportunity to change Americans' relationship with their credit cards,

with their debt, and potentially with their money more holistically. Fantastic. Well, thank you for joining 16 minutes. You're welcome. Okay, so for the next segment of 16 minutes, we are going to be talking about the news this week about a type of fraud, BEC scams, where the FBI recently made a huge number of arrests and 14 arrests were made in a 252-count federal grand jury indictment that was unsealed justice past Thursday, and it named 80 defendants charged with defrauding victims of up to

$10 million in what was described as one of the largest cases of its kind in U.S. history. The type of fraud is BEC, which stands for business email compromise, and just to quickly summarize a bit more of the stats and context of why this matters here. Just in the period from 2013 to 2018 and five-year period, $12 billion of losses were due to this kind of fraud. And this kind of fraud is growing at a rate of 123% year over year, which is basically more than doubling every year. And it costs about $300 million per month. So it's very costly and dangerous in that context and a big effing deal. So I'm now going to introduce Joel De LaGarza, who's actually becoming a bit of a regular, unfortunately, on 16 minutes to talk about all the security news

and whatnot. Joel, let's talk about this news and what it is and why it matters. Yeah, absolutely. So this is actually one of the simplest and just kind of most ridiculous. easy forms of fraud. Business email compromise is basically a form of fraud where I create an email address that seems somewhat similar to someone you may know and be working with in your company. So I could create a fake email address for your CEO or your CEO-O, make it sound like their name, and I send email messages into your company asking people sort of lower down the stack to send me money. Is this like spearfishing? It is even more simplistic than spearfishing. The way it typically works is people in the workplace are generally conditioned to

respond very quickly to anyone above them who sends them an email. So in the way that emails are typically displayed in an email client is that you just see the name of the sender. Right. And so when your CEO sends you an email saying, I need money, I can't get into my work account. Can you please route the money to this address? People tend to do it and they do it to the extent of losing $300 million a month. I feel shocking that they would do that. So it goes back to sort of the everything that's old is new again, right? This is the oldest form of fraud, right? It's the walking around asking people to give you money and seeing who will give you a dollar out of their pocket. Can you tell me a little bit more about why this matters in the context of all

the other frauds and cyber crimes that we've talked about on this podcast? Oh yeah. Well, I think broad strokes, if you sit back and you take a look at the way that fraud is evolving, in the very beginning of online fraud attacks were super sophisticated. They used custom malware. You had all these different intermediaries. A whole industry popped up to support them. A whole business is We're dedicated to actually solving and finding the malware that created this fraud. As we've actually gotten better at technical security, we patch our systems, web application vulnerabilities are harder to find. Fraud is now just asking individuals to send you money, right?

Like you said, everything old is new again is basically back to basics. We're back to social engineering, and that's the most effective form of fraud that exists. Okay, so bottom line it from me, Joel, how should we think about this news? So the interesting thing about this fraud is that it's able to grow at such a rapid rate, and it sort of creates this new fraud at scale category that we've never seen before. for. And I think that fraud in its current form is going to continue to grow and scale in ways like this in very simple, trivial ways that can hit multiple people and steal lots of money. It's just an incredibly low effort to do. You create an email that looks like someone that's

already out there in the public domain, and you start sending messages to people that work inside their country to send you money. And is technology going to be able to fix this if it's a social engineering problem? So, you know, obviously there are things that technology providers can do. They can flag email messages to say they're coming from outside of your company. They can actually give you warnings to say, be careful. We've seen other scams that look like that, and we're seeing a lot of providers start to do that. I think ultimately this is the kind of problem that gets solved with knowledge, that gets solved with information. You know, it's one of those things where the users ultimately kind of the last line of defense in a lot of attacks like

this. And if someone asks you to send the money and you send the money, there's not a whole lot that technology can do there. Making people aware of these frauds tends to be the most effective way to prevent them, and it's the path that I advocate. So education, basically. Absolutely. Knowledge is power. Thank you. Thank you.