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Harry Newton's In Search of The Perfect Investment Technology Investor. Auction Rate Securities. Auction Rate Preferreds.

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9:00 AM EST Thursday, July 3, 2008: Tomorrow celebrates the adoption of the Declaration of Independence on July 4, 1776. That great document declared independence from the Kingdom of Great Britain. We didn't like the Brits occupying us, just like the Iraqis and Afghanis don't like us occupying them. This weekend I will celebrate the idea that our new administration -- democratic or republican -- will extricate us from these ruinous wars. I hate to tally the cost in lives, resources and focus. It's been horrendous. While we have fought these wars, we have taken the eye off pressing domestic problems, including our being wedded to oil suppliers who hate us and a crumbling domestic infrastructure that has seen costly levy breaches in the Midwest and New Orleans, and a major bridge collapse in Minnesota.

At least five people died when this bridge IN Minnesota collapsed.

I remain supremely optimistic. You can't not be. That's the history of America. Someone in Washington will get the message that it's time to stop expensive adventures and printing dollar bills, with devastating consequences for hyperinflation, stagflation and our currency, the dollar.

There is much talk that stocks are getting "cheap" -- as measured by rising P/E ratios. Don't be fooled. Earnings estimates haven't been ratcheted down. When they are, stocks won't look so cheap, as measured by their P/E ratios. The economy is not doing well. Cash remains king.

Bargains in real estate are emerging -- but only intermittently. The BIG bargains will come when the banks wake up one morning to find they have far too many foreclosed properties on their balance sheet, and unload at firesale prices. Figure another six to 12 months.

Meanwhile stay away from, or short financials.

The cockroachy auction rate securities scandal: Massachusetts is suing UBS for fraud relating to its sale of auction rate securities. But it won't be the last. On February 21, Bloomberg reported:

Massachusetts Secretary of State William Galvin asked nine fund companies for information about failed auctions that left investors unable to sell their holdings, his office said in a statement yesterday. Ohio Attorney General Marc Dann may file lawsuits after state funds bought the securities, spokeswoman Jennifer Brindisi said yesterday in an e-mail.

I'm guessing companies including Citigroup, Lehman Brothers, Merrill Lynch. Deutsche Bank, UBS and Morgan Stanley are next in line. I have a little inside information as a result of my other web site,

UBS and Lehman are the worst cockroaches. Daily it gets worse for them. From today's Bloomberg:

Lehman's Hedge-Fund Deals Leave Public in Dark: Jonathan Weil

July 3 (Bloomberg) -- So let's say you're a big shot at Lehman Brothers Holdings Inc., trying to keep your firm from becoming the next Bear Stearns Cos. The stock has tanked. The market has doubts about your balance sheet. What do you do?

One step to avoid would be any action that might create needless public uncertainty about your company's finances, because investors' greatest fear is of the unknown.

So what does Lehman do? It sells billions of dollars of assets to a newly formed hedge fund that:

1) counts Lehman as a significant investor;

2) is run by seven recently departed Lehman executives;

3) is operating out of Lehman's office space, three floors down from the office of Lehman's corporate secretary.

You don't need to know much more about Lehman's transactions with the fund, R3 Capital Partners, to see the problem.

There's no way for outsiders to ascertain whether Lehman's dealings with R3 were at arm's length, as Lehman and R3 say they were. And the last thing Lehman needs is for skeptical investors to be worrying about whether it is engaging in any opaque related- party transactions.

Lehman isn't providing much information about its dealings with R3, and hasn't mentioned the fund in its Securities and Exchange Commission filings. Some details about their relationship have been trickling out in news reports, including a June 18 article by Bloomberg News reporter Yalman Onaran.

Here are the basic facts I was able to gather:

Unidentified Investor

As of June 12, one fund managed by R3 had raised $1.08 billion from a single unidentified investor and was seeking to raise $4 billion more from others, according to a Form D disclosure that R3 filed with the SEC.

Lehman has invested about $1 billion in R3, said Thor Valdmanis, a spokesman at R3's public relations firm, FD. (After he told me this, Valdmanis asked me not to use the information, saying he wasn't authorized to divulge it.)

Later, in a written response to my questions, R3 said it "is a wholly independent fund and has raised money from a variety of outside investors'' and that Lehman "is one of several passive, minority investors in the fund.''

A Lehman spokeswoman, Catherine Jones, declined to say whether Lehman was the unidentified investor cited in R3's SEC filing. Jones said Lehman "has sold approximately $4.5 billion of assets to R3 since its inception in May 2008,'' all of which "were previously managed by R3 Capital team members when they worked at Lehman.''

'No Control Rights'

Jones declined to say whether the $4.5 billion was how much R3 paid for the assets or the value at which Lehman had been carrying them on its balance sheet. She also declined to say whether Lehman will treat R3 as a related party for accounting purposes. Companies must disclose the effects that any material related-party transactions have on their financial statements, under generally accepted accounting principles.

"R3 is an independently managed fund in which Lehman Brothers is a limited partner and holds a passive, minority stake in the general partner,'' Lehman said in a July 1 statement read over the telephone by Andrew Gowers, a spokesman. "Lehman Brothers has no control rights, and all transactions are on an arm's-length basis.''

So, what are we supposed to make of all this? Beats me.

We have no idea if Lehman recorded gains or losses on these sales, how much money R3 paid for the assets, where it got the money to buy the assets, or the fiscal quarter in which the sales occurred. We don't know whether Lehman plans to disclose any of this. There is no way to determine with the information available whether this is a related-party deal.

Lack of Clarity

Even with more information, the relationship might not be transparent. The trouble with related-party deals -- if that's what these are -- is that they "cannot be presumed to be carried out on an arm's-length basis, as the requisite conditions of competitive, free-market dealings may not exist,'' as Financial Accounting Standard No. 57 says.

Under the accounting rules, if Lehman's stake in R3 were 20 percent or greater, this would lead to a presumption that Lehman could exercise significant influence over its policies. In that case, R3 probably would be deemed a related party.

As for the space R3 occupies on the 39th floor of the Time & Life Building in midtown Manhattan, it's in the middle of a 10- floor block Lehman began subleasing from Time Inc. last year. R3 and Lehman say the fund is paying rent to Lehman at market rates.

Letter From CEO

R3's chief executive officer, Rick Rieder, a 21-year Lehman veteran, sent me a letter explaining that the name R3 comes from the phrase "Reading, wRiting and aRithmetic.''

He wrote that the fund's creation "was in discussion for years,'' that he won't take a bonus from R3 this year, and that "a substantial portion of future profits'' will go to a new foundation to support "improvement in urban education in this country and abroad, a cause I have long supported.''

That's all nice stuff. What's important about R3 to Lehman investors, though, is how the transactions affect Lehman's financial statements. Lehman is scheduled to file its second- quarter earnings report with the SEC later this month.

"Based on the information that's publicly available, you can't tell whether these are related parties, although there are indications there could be significant influence,'' said Douglas Carmichael, the former chief auditor of the Public Company Accounting Oversight Board, now an accounting professor at Baruch College in New York and a litigation consultant.

And there lies the problem: You just can't tell. That won't keep investors from forming their own conclusions. If Lehman doesn't like what they decide, it will have only itself to blame.

(Jonathan Weil is a Bloomberg News columnist. The opinions expressed are his own.)

And, for your reading pleasure, another Bloomberg story this morning

UBS May Post Writedowns, Raise Cash, Citigroup Says (Update3)

By Stuart Kelly and Elena Logutenkova

July 3 (Bloomberg) -- UBS AG may post $6.9 billion of additional writedowns and seek to raise more capital, Citigroup Inc. said, a day after Chairman Peter Kurer (of UBS) told a newspaper the largest Swiss bank won't need more funds.

The Zurich-based company, which wrote down $38 billion over the past three quarters, still carries $83 billion of "risk exposures that are likely to require further markdowns,'' London- based Citigroup analyst Jeremy Sigee said in a note today.

Sigee, who rates UBS a "hold'' with a "high risk'' caveat, estimates the company may post a loss of 4.5 billion Swiss francs ($4.4 billion), and announce writedowns of as much as 7 billion francs when it reports second-quarter earnings Aug. 12. JPMorgan Chase & Co. analysts yesterday said UBS may need to mark down its assets by a further 5.1 billion francs.

Sigee blamed a slump in financial markets for asset price declines, and said UBS may need to raise more capital, either from asset sales or from shareholders. Kurer, in remarks published by Swiss newspaper Finanz & Wirtschaft yesterday, said the bank won't need more funds. ...


Banks and securities firms have turned to investors for $322 billion to replenish reserves after $403 billion of writedowns and credit losses tied to the collapse of the U.S. subprime mortgage market. UBS trails only Citigroup in credit losses and capital raising after turning to investors for $29.5 billion since the credit crisis started a year ago.

Speculation financial firms would need more funds helped drive an index of European banking shares down 8.3 percent in the previous five days. ...

UBS is also facing a U.S. probe into whether the Swiss bank helped affluent customers evade American taxes. A federal judge this week granted a request from prosecutors to let the Internal Revenue Service issue a summons to UBS for information about clients with secret accounts at the bank.

"We see further pressure on the private bank franchise from the group's weak capital position and ongoing high-profile tax probes,'' Sigee said. He estimates that clients probably withdrew a net 11.3 billion francs from UBS's wealth management unit in the second quarter.

Wimbledon continues today. Federer will play Nadal in the final on Sunday and Nadal will win. Predicting tennis is as successful as predicting the stockmarket -- which is right up there with astrology. Here is the TV schedule. All times listed are Eastern Standard Time (L) = Live (T) = Taped

Thursday, July 3 7:00 am - 12:00 pm Semifinals (Ladies') ESPN2 (L)
Thursday, July 3 12:00 pm - 5:00 pm Semifinals (Ladies') NBC (L)
Thursday, July 3 8:00 pm - 10:00 pm Semifinals (Ladies') Tennis Channel (T)
Friday, July 4 7:00 am - 12:00 pm Semifinals (Gentlemen's) ESPN2 (L)
Friday, July 4 12:00 pm - 5:00 pm Semifinals (Gentlemen's) NBC (L)
Saturday, July 5 9:00 am - 2:00 pm Semifinals (Gentlemen's) ESPN2 (L)
Saturday, July 5 12:00 pm - 5:00 pm Semifinals (Gentlemen's) NBC (L)
Sunday, July 6 9:00 am - 3:00 pm Semifinals (Gentlemen's) NBC (L)
Sunday, July 6 3:00 pm - 4:00 pm Semifinals (Gentlemen's) ESPN2 (L)

The Wisdom of Age
An older man approached an attractive younger woman at a shopping mall.

'Excuse me; I can't seem to find my wife. Can you talk to me for a couple of minutes?'

The woman, feeling a bit of compassion for the old fellow, said, 'Of course, sir. Do you know where your wife might be?'

'I have no idea, but every time I talk to a woman with large breasts like yours, she seems to appear out of nowhere.

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 on this site. Thus I cannot endorse, though some look 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 Michael's business school tuition. Read more about Google AdSense, click here and here.

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