Harry Newton's In Search of The Perfect Investment
Newton's In Search Of The Perfect Investment. Technology Investor.
AM EST Tuesday, September 26, 2006: Don't be suckered
in by great past performance. It has nothing to do with the future. Great performance
(and fortunes) can (and do) turn on a dime -- especially with a leveraged
gamble on volatile, illiquid markets, like natural gas futures.
Sadly (at least for them), investors in Amaranth, who have now lost 65%
of their money, may not be able to get out for years and years. Meanwhile, because
Amaranth never had a high water mark in its contracts with its investors, those
investors will keep paying Amaranth fees -- annual fees and performance fees --
and even BEFORE Amaranth makes up the losses -- if they ever can.
invest in hedge funds WITHOUT a high water mark.
+ Don't invest
in hedge funds who borrow money and make leveraged bets with your money.
+ Don't invest
in funds of funds.
+ Don't invest
in hedge funds whose trading strategy is a mystery.
According to one
report, investors in Amaranth may have to wait as long as four years
to retrieve what is left of their money. Amaranth, which managed $9.5 billion
at the end of last month, had placed stringent restrictions on investors redeeming
their capital.. Investors, of which 60% are funds of hedge funds, had
to commit to keeping their money in place for at least a year. The company also
has the right to restrict the amount of any redemptions it pays out in any quarter
to 7.5% of total funds, the consultant said.
cannot get out of Amaranths funds will be forced to pay performance fees
as soon as its funds start making money again, because the firm does not use
a high water mark. Other hedge funds, which use a high water mark,
do not charge performance fees until the fund has made up any losses to investors.
Amaranth earns its performance fees every quarter. If its positions recover
in the last three months of the year, Amaranth will earn an estimated 20%
of any performance despite the losses of $6 billion last week.
high water mark in scandals. Bernard Ebbers heads to prison today
to start a 25-year term for his role in the WorldCom accounting
fraud. Bernie will be out when he's 91 -- if he serves all his time or
doesn't die. I never thought Bernie was a serious crook, just a very stupid
The backdating of stock options: The FBI
is now conducting 52 inquiries into alleged cases of companies backdating options.
But over 100 cases have been reported. The FBI is one of half a dozen state
and federal agencies looking into the H-P matter, on top of what the FBI says
are 486 investigations into corporate fraud so far this fiscal year, up from
423 in 2005, according to Bloomberg. Twenty of these involved alleged fraud
of more than $1 billion, and the FBI has also opened 1,160 securities-fraud
cases, up from 1,139 last year. See below.
Cablevision gave backdated options to a dead exec.
Cablevision Systems Corp. awarded options to an executive after his 1999 death,
backdating them so that they appeared to have been granted while he was still
alive. The executive's estate benefitted. Why? To motivate a reincarnation?
Who knows. I don't make this stuff up.
huge jump in bond prices: Or a huge fall
in interest rates -- same thing. Look at the yield on 10-year treasury notes:
This chart means that 10-year treasury notes are now paying 4.56%. Prices
have risen as investment money has flocked into "Cash is King"
vehicles -- away from the market. How high might bond prices go from here? Your
guess is as good as mine. It seems to depend on how bad investors feel the economy
will become in coming months. If the slump in real estate causes a hard landing
for the economy, bonds could go even higher. I can't (and won't) make that call.
you for all the good wishes: You
have all assured me that I'll stop crying, settle into smiling and anticipation
of grandchildren. It seems other people have had daughters get married, have
children and live happily ever after. And I thought I was the first! Damn,
now I'm crying again...
does the press know?
* Fortune, 2/19/1996: "By the time you read this story, the quirky cult
company...will end its wild ride as an independent enterprise."
* Time Magazine,
2/5/96: "One day Apple was a major technology company with assets to
make any self respecting techno-conglomerate salivate. The next day Apple
was a chaotic mess without a strategic vision and certainly no future."
10/16/95: "Having underforecast demand, the company has a $1 billion-plus
order backlog....The only alternative: to merge with a company with the marketing
and financial clout to help Apple survive the switch to a software-based company.
The most likely candidate, many think, is IBM Corp."
* Wired, "101
Ways to Save Apple," 6/97: "1. Admit it. You're out of the hardware
* Fortune, 2/19/1996:
"Apple's erratic performance has given it the reputation on Wall Street
of a stock a long-term investor would probably avoid."
* The Economist,
2/23/95: "Apple could hang on for years, gamely trying to slow the decline,
but few expect it to make such a mistake. Instead it seems to have two options.
The first is to break itself up, selling the hardware side. The second is
to sell the company outright."
has its merits and and its profits: This
piece appeared in Saturday's New York Times. It's totally engrossing.
Joe Nocera wrote it:
were people who are just curious about things, said Andrew J.
Redleaf, with a tone of mock innocence.
48, runs Whitebox Advisors, a $1.8 billion Minneapolis hedge fund that has
had sparkling returns since he started it in 2000. Mr. Redleaf is one of
those hedge fund guys who write letters to investors that are filled with
big ideas about the market. Hes also funny, cynical, cranky and unabashedly
that professor really be right? he continued. The professor he was
referring to was Erik Lie of the University of Iowa, who published a study
last year that essentially set off the options backdating scandal. Although
Mr. Lie did not name names, his work showed, indisputably, that there were
simply too many cases where options were granted to top executives just
before a nice run-up for it to be happening randomly. He suggested that
companies had to be backdating option grants to enrich executives.
in turn, piqued the interest of the Securities and Exchange Commission and
The Wall Street Journal, which began looking at individual companies. At
this point, 115 companies have been identified as being under some sort
of investigation, either by the S.E.C., the Justice Department or an internal
investigation. So far, executives from two companies that backdated options,
Converse and Brocade, have been indicted. This week, Cablevision revealed
that it gave backdated options to a deceased executive making it
appear as though he had received the options while still among the living.
A few months
ago, Mr. Redleaf and several of his Whitebox colleagues decided to do their
own options backdating study. They ran 6,000 companies and 60,000
options grants through their computers. They looked at a 40-day window:
20 days before the options were granted and 20 days after. And sure enough
they discovered several hundred companies whose pattern of granting options
at the precise moment the stock was about to jump was eyebrow-raising, to
say the least. And while Whitebox Advisors does not have absolute proof
that options backdating took place, neither did Mr. Lie. It was statistical
is quick to express outrage at executives who backdated options. Of the
series of recent Wall Street scandals, Mr. Redleaf told me: This is
by far the worst. It is a direct transfer of wealth from stockholders to
be honest here. Hedge funds dont do deep dives into options backdating
just to satisfy their curiosity or to gain justice. Rather, they do it to
find an edge and to use that edge to get richer than they already
are. What Mr. Redleaf has begun to do with this options backdating information
raises a question that is being asked a lot these days about hedge fund
operators. Is he an activist, helping to make the market a better place?
Is he a holdup artist? Or is he both?
When you ask
the folks at Whitebox Advisors how they make money, they have a hard time
explaining it in laymans terms. Relative value arbitrage,
Mr. Redleaf replied when I asked him to describe his fund. Generally,
he continued, we focus on mispriced securities that have a relationship
to each other like a companys stock and bonds. That,
he added, tends to cause us to skew towards distressed companies.
instance, a companys bonds will send up an early warning signal that
there may be internal problems, even as its stock remains buoyant. In that
mispricing is an opportunity for a smart hedge fund guy who sniffs it out.
Sometimes, though, the hedge fund guy wont be willing to just sit
on his hands while waiting for the market to catch up with his insight.
Thats when he becomes an activist.
year, for instance, Whitebox was among a number of hedge funds that were
holding General Motors bonds. We were betting that they would cut
the dividend because we thought it was inevitable, Mr. Redleaf said.
He also felt, though, that cutting the dividend was the right move for G.M.
to make so he went to Detroit and met with members of G.M.s
finance team to press that case. Sure enough, in February, when General
Motors cut its dividend in half, the bond market applauded, and Whiteboxs
G.M. bonds were suddenly more valuable.
became interested in options backdating because of another, more controversial
bond play that Whitebox and a number of hedge funds began using a few years
ago. When a company fails to file its financial documents on time, its bonds
are technically in default. For decades, though, bondholders have generally
looked the other way when that happened.
did not. Instead, it took to buying up bonds below par
that is, bonds trading below their face value of companies that had
failed to deliver their financial documents on time, usually because of
an accounting problem.
and other activist bondholders would tell the company that since it was
in default on its bonds it was liable for the full face amount immediately.
Sometimes, the company would wind up paying off the bonds. Other times,
it would negotiate an agreement, usually a one-time payment to the bondholders
in return for a waiver. Either way, Whitebox won.
argues that what he is doing is being vigilant in asserting our rights,
unlike mutual funds and other big institutional investors that have ill-served
their investors by not fighting for everything they are entitled to. Of
course, most companies dont see it quite that way. They view Whitebox
as taking advantage of a technicality to make a quick buck.
that are caught backdating options, of course, have huge accounting problems.
Options that have been backdated require a different accounting treatment,
and companies usually have to restate their financials for the years during
which they were backdating. This almost inevitably means that they will
also not be able to file their current quarterly or annual report on time.
Which therefore means their bonds will technically be in default. Which
therefore means the bondholders can squeeze them.
Is it any
wonder Mr. Redleaf suddenly became interested in options backdating?
Once he had
his list of potential options abusers, Mr. Redleaf and his team shorted
about 80 of them. But Whitebox also went into the marketplace and bought
bonds of some of the companies in question. (In other cases, it already
owned the bonds.) And then the firm got to work.
case of Affiliated Computer Services, a Texas-based technology outsourcing
company with over $4 billion in 2005 revenue and 50,000 employees. It was
one of the first companies to be fingered as a possible options backdater,
and instigated an internal investigation in March. In July, when the company
released its quarterly results, it also said that while the investigation
wasnt complete, it didnt think it would have to restate results.
We do not believe that any director or officer of the company has
engaged in the intentional backdating of stock options grants, it
shot back in a letter he sent to the company in early August. There
were 14 grants between November 1995 and March 2005, he wrote to Darwin
Deason, the chairman of the board. Every single grant was better than
a random day for the period, a 1-in-16,384 occurrence. He added, if
we look at the stock return for the 20 days after the grant, the award days
were in the 91st percentile, a result very consistent with backdating but
hard to square with legitimate methods.
of receiving the letter, A.C.S. announced that its previous statement about
options backdating can no longer be relied upon strongly
implying that things were worse than it had claimed a few weeks earlier.
A few days later, a lawyer working for the companys audit committee
contacted Whitebox to see what the firm had found. Last week, A.C.S. announced
that it had missed the deadline for filing its annual report the
exact event Whitebox was hoping would result from its letter.
also reported that because of that missed deadline it may face covenant
compliance issues, meaning that it may be in default of some $2 billion
worth of loans. The company said it would seek a waiver. You know what that
means: money in the pockets of Whitebox Advisors.
for Affiliated Computer Services wouldnt comment on its option backdating
investigation except to say that it was a coincidence that the company made
its tougher announcement so soon after getting the letter from Mr. Redleaf.
She also wouldnt comment on Mr. Redleafs tactics.
the half-dozen companies I called for this column all of whom received
similar letters from Whitebox, and several of whom face the prospect of
having to pay off their bonds at full value because they missed filing deadlines
only one spokesman was willing to say what they undoubtedly all feel.
That was Jeff Luth of Amkor, a company whose options problems caused it
to fail to file its quarterly report last June and is now dealing
with the consequences.
think opportunistic hedge funds should hold Amkor hostage for a financial
windfall, he said. We believe it siphons off corporate assets
to the detriment of our shareholders.
that also describe options backdating? As Mr. Redleaf pointed out: By
cheating on options grants these companies filed phony financial statements
and they used those phony financials to borrow money from bondholders. Shareholders
have the right to fire management. All bondholders can do is try to get
their money back.
Mr. Redleaf is meting out may be harsh. And it may be a hold up. But its
hardly undeserved. Eventually, he said, the market punishes
Marriage is a relationship in which one person is always right,
and the other is a husband.
One day, a man came home and was greeted by his wife dressed in a very Sexy
nightie. "Tie me up," she purred, "and you can do anything
So he tied her
up and went golfing.
be super literal:
Boudreaux tries out for the tigers....
Boudreaux, a college
freshman at LSU fresh from the swamp tries for the football team.
Can you tackle?"
asked the coach the first day of practice.
dis," Boudreaux told him, and proceeded to run smack into a telephone
pole, shattering it to splinters.
said the coach. "I'm impressed. Can you run?"
sure I can run," said Boudreaux. He was off like a shot, and, in just
over nine seconds, he had run a hundred yard dash!
exclaimed the excited coach. "But can you pass a football?"
his eyes, hesitated for a few seconds and replied,"Mais, Coach",
he said, "if I can swallow it, I can probably pass it."
next of kin:
Father O'Malley rose from his bed. It was a fine spring day in his new
Texas mission parish. He walked to the window of his bedroom to get a deep
breath of the beautiful day outside. He then noticed there was a jackass lying
dead in the middle of his front lawn. He promptly called the local police
This is Sergeant Jones. How might I help you?"
best of the day te yerself. This is Father O'Malley at St. Brigid's. There's
a jackass lying dead in me front lawn. Would ye be so kind as to send a couple
o' yer lads to take care of the matter?"
replied, "Well now father, it was always my impression that you people
took care of last rites!"
There was dead
silence on the line.
Father O'Malley then replied: "Aye, tis certainly true, but we are also
obliged to notify the next of kin."
This column is about my personal search
for the perfect investment. I don't give investment advice. For that you have
to be registered with regulatory authorities, which I am not. I am a reporter
and an investor. I make my daily column -- Monday through Friday -- freely
available for three reasons: Writing is good for sorting things out in my
brain. Second, the column is research for a book I'm writing called "In
Search of the Perfect Investment." Third, I encourage my readers
to send me their ideas, concerns and experiences. That way we can all learn
together. My email address is .
You can't click on my email address. You have to re-type it . This protects
me from software scanning the Internet for email addresses to spam. I have
no role in choosing the Google ads. Thus I cannot endorse any, though some
look mighty interesting. If you click on a link, Google may send me money.
Please note I'm not suggesting you do. That money, if there is any, may help
pay Claire's law school tuition. Read more about Google AdSense,
here and here.