CONFLICT OF INTEREST
We have been very diligent and busy here at Markowski Investments the past few years. Through our newsletter, the “Markowski Monthly”, and via the many radio and television appearances we make, we have tried to expose any malevolent actions or events that could adversely affect the American people. For the past few years we have been beating the drum against the large investment houses and banks regarding their conduct and nefarious business practices.
The United States is now “officially” in a recession and every media outlet and politician from coast to coast are searching for a scapegoat to place blame. We at Markowski Investments were in the microscopic minority who predicted the many events that transpired over the past few years. Our ability to predict these events we feel, gives us the right to point fingers, not the entities that were actually stirring the cauldron of our demise.
We can state unequivocally that blame can be placed squarely on the shoulders of Wall Street itself. However, their ability to, “get away with it” is reliant upon the incessant greed of the American people. In this issue we are going to focus on some issues and points that will shed some light on where and how our nation’s economy has weakened. All of this, in the hope that will not let it happen again.
PART ONE:
IPO’S Steve Kris is a small fish in the investment world, but he made a big splash in the IPO market.
In late 1999, as the red-hot software firm VA Linux Systems was preparing an initial public offering, investors were clamoring for shares. Among them was Mr. Kris, head of a small Denver investment firm called Ascent Capital. But Ascent drew only a modest allocation of 2,500 shares from the lead underwriter, Credit Suisse First Boston.
Mr. Kris pressed a CSFB salesman for more, and the salesman made a plea to a CSFB allocation official. Ascent “has done $100,000 in business in the last week” and “will do close to $1 million all in this year,” the salesman’s e-mail said, adding that Ascent was sure to be a buyer on the open market once Linux started trading.
Bingo. CSFB allotted Ascent 17,950 Linux shares at the offering price, seven times as many as before. The stock soared a record 698% on its first trading day, bringing Ascent paper profits of $3.8 million.
That very day, Ascent traded big blocks of other stocks through CSFB at astronomical commissions. In contrast to normal fees of a few cents a share on such trades, Ascent paid CSFB $2.70 a share to trade 50,000 shares of Citigroup — handing the underwriter a $135,000 commission, CSFB trading records show. Ascent also traded blocs of Compaq, Kroger, Kmart and AT&T through CSFB at far-above-normal commissions.
The next day, the CSFB salesman thanked the allocation official. “Ascent ended up doing $500,000 in commissions with us yesterday. Thanks again for your help with this account,” wrote salesman Robert Paglione in an e-mail.*
The raging bull market of the late 90’s had many little interesting facets to it. One being, the extraordinary levels that initial public offerings would rocket up almost instantaneously. This “boom”, was brought about by underhanded and illegal deals that gave the American people the impression that it was okay to buy a stock with a market capitalization in the billions. Companies that had no assets, no revenue, no plan, nada!
Now, thanks to trading records, e-mails and interviews with dozens of investors and current and former employees it is possible to get an inside look at how some of this IPO trading worked.
The Kris episode is part of one investigation that is being conducted by the Securities and Exchange Commission. It is illegal for any firm to arrange to have favored investors share their quick IPO profits with the underwriter, in deals that amounted to illegal kickbacks.
Another investigative track looks at whether underwriters illegally gave bigger IPO allotments to investors who promised to do some “after-market” buying, picking up more shares once the stock went public. This action is actually a form of price-manipulation. This action turns the stock into a pyramid scheme where the last people in get holding the bag.
The 1999-2000 IPO market gave birth to 637 public companies whose peak values totaled $400 billion. Most of that has since vanished. Small investors lured in by those first-day frenzies often ended up being the big losers.*
“The public is taking things at face value, and in the meantime there is a set of under-the table deals going on that completely distorts the expectations of the individual investor’s decision to buy,” Samuel Hayes, professor emeritus at Harvard Business School.
PART TWO: PRO FORMA
In the past few years, companies increasingly have prettied up their earnings announcements by highlighting what their results would have been absent unpleasant blemishes, while granting less prominence to their actual results. That practice, which can be found in all industries, remains perfectly legal.
By contrast, there have been occasional instances where companies announced their pro forma results without simultaneously disclosing how they calculated them or what their actual results were under generally accepted accounting principles.
For instance, it is common for companies to cite vague categories such as restructuring charges, merger-related expenses or “unusual” charges without further details to describe expenses excluded from their pro forma results.
During the many media appearances, one of the most frequent topics of discussion is the use of “Pro Forma” earnings. My suggestion to the American people is whenever you hear the words “Pro Forma”; one should replace it with the word imaginary.
Honest methods of accounting are becoming extinct. Corporations have the ability to disguise their weaknesses to investors in order to keep their stock prices at ridiculous levels. The “misadventures of Enron” is an excellent example of this. However, Enron was neither the first nor the last perpetrator of cooking the books.
Turn CNBC on during their much-hyped “Earnings Season Reports”. What an investor will see are “journalists” acting as mouthpieces. Whatever press release the company puts out they read. How about a little investigation folks? These press releases with their crooked numbers read like advertisements to purchase stock.
Take a look at the balance sheet of a corporation, if it reads like an ancient Greek textbook they are probably cooking the books. These magical accountants who hide weakness in corporate America may make a lot of money pulling tricks; however, they are weakening our nations core.
In order for a market economy to work we need honest accounting. Weaknesses need to be exposed and dealt with. If assets are invested in companies that are un-deserving it causes inefficiencies in our economy that lead to the weak economic environment that has reared its ugly head. When the nation as a whole makes bad investments and attempts to keep companies on life support we end up with a situation that mirrors Japan or worse yet the old Soviet model. For capitalism to survive we must have honest accounting. The events of the past couple years have thrown our country into a “hangover state” that will take time to work through. Much like a cancer bad businesses needs to be cut out and cut off.
PART THREE: WALL STREET ANALYSTS
During the first five months of the year 2000, The Wall Street Journal carried over 3000 articles with the words “analyst” or “analysts”. Many of these players in the big show we like to call on Wall Street are bonafide superstars, Henry Blodget, Mary Meeker and Ralph Acampora to name a few. These people have the genuine power to drive stock prices. Their words can move markets quickly and dramatically. What these “analysts” fail to realize in their predictions is the number one physics law of the equities markets, efficiency. The stock market is very efficient and companies will eventually trade at what their fair value is. No matter how many appearances an “analyst” makes on CNBC or is quoted in a major publication this basic law of equities will come home to roost. The bottom line is that the business of Wall Street is marred in conflicts of interest. The party that suffers from these improprieties is the individual investor.
There are two different types of analysts, “buyside” and “sellside”. The guys you see on television or read in the papers are “sellside” This means that they work for an investment bank or large brokerage firm, they issue reports in order to tell their brokers/salespeople to do. “Sellside” research is pumped out on a daily basis driving markets in whatever direction they deem fit.
“Buyside” analysts work for portfolio managers. The reports by these guys are used to decide which stocks to purchase for their funds or clients. “Buyside” research is thought to be the most reliable and honest because the portfolio manager is depending on it for his or her own buying decisions. This is different then “sellside” because there is no sale to slick over or deal to be done that drives their work. These reports are not available to the general public.
The reason why the public is subjected to such lousy information is the inherit conflict of interest that exists today. Actually performing the “profession” of doing your homework and researching stocks has fast become left to the interns. There is supposed to be a “Chinese wall” keeping the analysts away from the investment banking sharks. This wall was supposed to be there to protect investors to what has happened over the past three years. With the bull market out of control the “wall” was blown up. With so much deal making and money to chase analysts have been drawn into the client chasing game going after new issues and investment banking clients. The bottom line is that these guys act as a public relations firm for their investment banking clients.
The environment today is very corrupt as far as big brokerage firms are concerned. However, lets not forget about our “buyside” people. They have a vested interest in your success as an investor, so motivation is never cloudy. The only way to feel truly comfortable in the equities markets is to work with a quality portfolio manager. Until honesty, and proper due diligence return to the “sellside” shut your ears and close your paper.
PART FOUR: GREED
Why did Americans buy stocks with little to zero inherent value to them? Why was it so easy to convince Americans that we were in a “New Economy”, where stocks never went down and earnings meant nothing?
ANSWER: THE SAME THING THAT KEEPS ATLANTIC CITY AND LAS VEGAS BUSY…GREED
America is a market economy where making money and success are attainable to individuals that apply themselves and work hard. This we believe to be true. Nothing in life is easy, success is wrought by hard work. Whether it is relationships in life such as marriage and friendships, your career, or health, they all involve work. That is life, pure and simple.
I get a laugh with all these get rich quick scheme infomercials that air with regularity on late night television. The same holds true for those “magic” pills individuals can consume and look like a body builder in just a few short weeks. The problem, is that Americans buy into this nonsense. The same way that Americans thought that for some reason if they listened to CNBC and traded online they to could be the next Warren Buffet.
The thing I find interesting is that the idea that hard work equals a just reward is ruled out in cases of money. People believed that they were going to get rich quick in the stock market. However reality and history dictate that time, patience, are the necessary ingredients to the end result. Greed will destroy a portfolio and will destroy an economy.
The greed that swept across America during the 1990’s caused our consumer debt to swell. The average American now holds over $10,000 in credit card debt. It also has affected our judgment on world issues such as our safety. We had our embassies blown up in Africa, we had our base blown up in Saudi Arabia, and the U.S.S. Cole attacked in Yemen.
Where was America?…
Probably checking the price of Cisco and Amazon.
We as a country decided to focus on the material, and acquiring as much material as possible. As long as the stock market went up many Americans would ignore a Chinese tank burrowing down Interstate 95. This lack of focus and failure to build a strong foundation for the future has set us back and we are paying for it now.
PART FIVE: THE FUTURE
We by no means are perennial pessimists. We will as a country get over the mistakes of the past nine years. It will take some time but it can and will be accomplished. America has to wake up and not believe the garbage that is fed to them. Everyday, business news programs and commercials fill the airwaves with garbage and half-truths, do yourself a favor, ignore them. Big brokerage houses are not soft and cuddly.
Our country must get our consumer debt back to manageable levels. One third of our GDP is consumer spending, if that continues to rise and our manufacturing sector continues to head backwards we are going to be completely dependent on foreign countries. If we get our heads on straight and build up our nest eggs, we strengthen as individuals and a nation. Last but not least, cut out the stupidity! Do we really need companies that sell pet food or toothpaste online?
THE IMPORTANCE OF TIME
Wall Street wisdom holds that, “the best way to preserve your capital is to invest responsibly to make it grow.” Let’s assume that an average investment professional might compound your capital at 10% a year. At 10% your capital increases:
2.6 fold in 10 years
6.8 fold in 20 years
17.6 fold in 30 years
45.8 fold in 40 years
If, for example, a proficient investment professional were able to compound your capital at about 20% per year, note the significant difference:
6.2 fold in 10 years 38.4 fold in 20 years
283.3 fold in 30 years
1,447.6 fold in 40 years
Far greater wealth!
SPOTLIGHT HENRY BLODGET
Henry Blodget, who became a lightning rod for critics of conflicts involving Wall Street analysts, will soon leave Merrill Lynch & Co. with a hefty paycheck and his troubles seemingly behind him.
Well, not all of them.
Despite Mr. Blodget’s well-publicized departure, the New York state attorney general’s office is investigating some of his actions as an Internet-stock analyst for the big Wall Street securities firm as part of its broad probe of analyst conflicts of interest, according to people with knowledge of the matter.
At issue for state investigators: whether Mr. Blodget misled investors with some of his stock recommendations, and whether that can translate into criminal or civil securities fraud charges against Mr. Blodget and Merrill, the people close to the matter say.
It’s unclear how much information the attorney general’s office has gathered in the matter, or whether it is leaning toward bringing charges. A spokesman confirmed the existence of a general probe into analysts’ conflicts, but declined to comment on the specifics of Mr. Blodget’s case. Mr. Blodget, who announced his decision to leave Merrill in mid-November with a severance package estimated at $5 million.
