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HEDGE FUNDS, FREE MARKETS AND CRYBABIES By Mike Gasior This month's edition of this newsletter puts me into the somewhat uncomfortable position of appearing to defend the behavior of billionaires. And while no one would ever confuse me for Cesar Chavez, it has always been my habit to rise to the defense of the "little guy" if some bigger guy is giving them the shaft. I've never liked bullies and fully expect that I will never like bullies. If there is any saving grace, it's that there are no actual "little guys" involved here at all. And as much as I may take up the cause of the occasional billionaire this month, the other side of the equation is generally populated by only multi-millionaires. What has come to my attention in the past few months, that I feel compelled to address, is what I feel is a bad rap that some hedge fund managers have been taking in the press recently. The crowning moment was the piece that 60 Minutes did a couple weeks back detailing the lawsuit between Canadian drug maker Biovail and hedge fund SAC Capital Partners. Many of you who have attended my seminars have likely heard me criticize the way 60 Minutes covered the Orange County and Barings disasters of a decade ago, and I don't think they did a particularly good job on the Hillary Clinton cattle futures story either. It troubles me when I see, what I consider, one of the better news outlets butcher a topic that I have in-depth and detailed knowledge about. I wonder if they are doing precisely the same thing with subjects where I wouldn't know the difference. As is usually the case, I just want my readers to know the real story and be armed with the facts to understand where the mainstream media has gotten it all wrong once more regarding a financial news story. First let me take care of some business before we roll. VIDEO COMMENTARY IS ON THE WEBSITE As I freely admit, I came into the investment business as a fixed income guy, and my heart has always remained connected to the bond market. For that reason, I have a particular personal interest in the topic for this month's video commentary: Asset-Backed Securities. Most of Main Street America doesn't understand that there is almost no loan that they take out that is actually held by the financial institution who gave the money to them. Almost all the time that loan (home, car, credit card, student loan, etc.) is sold off into a secondary market and packaged with other loans into an ABS. This market has exploded in the past 20 years and I talk this month about the history of this growth as well as giving some insight into how these securities are created. You can view this topic as well as all past video commentaries by visiting the following link: http://www.afs-seminars.com/v-commentary.html OFFSHORE SESSIONS FOR 2006 Finally, I am so excited about the slate of programs I will be presenting this year in both Bermuda and Grand Cayman and wanted to remind everyone of the offerings. It is easily the widest range of topics that we've offered in years, and oddly are timed to coincide with the beginning and end of the hurricane season. Okay, I'm kidding about the hurricane season, but I'm not kidding about the impressive array of very timely sessions. These sessions begin next month in Grand Cayman and the list and dates of these courses are as follows: Mortgage & Asset Backed Securities Derivatives Providing Services to the Hedge Fund Industry Securities Operations, Processing & Accounting Due to the limits of the meeting rooms we were able to secure in both Bermuda and Grand Cayman, the number of attendees is unfortunately capped at both locations. We will take registrations on a "first come, first served" basis and will try our best to accommodate everyone. Please register via the website, or by calling my offices at (860)347-6568. I look forward to seeing you there. You can also view a schedule of all upcoming U.S. and offshore sessions at this link: http://www.afs-seminars.com/schedule.html SHORT SELLING, SHORT TEMPERS AND SHORT SIGHTEDNESS Perhaps it is just the teacher in me, but before I take us any deeper into the bowels of this month's subject, I need to be certain that everyone has a basic understanding of the concept at the heart of the story: short selling. Simply stated, short selling is the strategy one
uses to make money on anything you think may decline in price. This
could be a stock, a bond, a commodity or a currency. Literally ANYTHING
can be sold short. The only For example, let's pretend that I think Microsoft stock is ripe for a decline in price. I might "borrow" 1,000 shares of Microsoft from someone who owns it and sell it at Microsoft's current stock price of about $27.29, and then take into my brokerage account $27,290. If my thinking is correct and Microsoft drops in price to $20 in the next month, I can now buy the shares back (to return them to whomever I borrowed them from) for $20,000 and pocket the remaining $7,290 as my profit from the short sale. I feel I should also explain here that the person
"lending" me their shares of Microsoft is not some pal
of mine who is doing this out of the kindness of their own heart.
A better way to understand and conceptualize what Short selling and has been around for nearly forever and has always been the technique one uses to profit in a declining marketplace. Securities lending has been around as long as short selling and has always been a terrific (and safe) way to bring in some income on securities you might own that are only sitting around and collecting dust anyway. I personally have short sold many different securities over the past 20+ years and have even made some decent cash on a few of those trades. It has also always made sense to me that the CEO of any company who has lots of people short selling their stock short might be a little ticked off since these short sellers are betting on the stock declining. Fair enough. To lots of people the whole idea of betting on something bad happening to someone else smacks of being un-American or maybe just plain evil. Just so you all know this, there have been many studies over the years that have proven one thing. The more vocal a company is about how wrong the short sellers are about the company's situation or prospects, the more probable there might actually be some fire to go with the smoke. Back in 2002 a hedge fund by the name of Gotham Partners published a critical report about a New York insurance company and disclosed right on the first page of the report that the fund was short the insurance company's stock. The insurance company immediately reacted to the critical report in the press, and according to some people, asked New York Attorney General Eliot Spitzer to investigate Gotham for possible market manipulation. Well nothing ever came of a Spitzer investigation of Gotham, but in 2004 the Attorney General and the SEC began an investigation of the insurance company on many of the issues first brought to light in the report of 2002. Some people even argue that short sellers can act as somewhat of a canary in the coal mine, since some of the first people to see trouble at Enron were the "shorts". This now brings us to a couple of the stories I want you to understand better. "INVASION OF THE LOCUSTS" This tale is truthfully a quite simple one. The largest stock market in Germany is Deutsche Börse and like the New York Stock Exchange is now, it is a publicly traded company. The CEO of the Deutsche Börse was a politically connected fellow by the name of Warner Seifert. Like many board members and CEO's around the world, Mr. Seifert was voted out of office about a year ago. Pretty simple. No? What raises the profile of the story is the voters who voted Mr. Seifert out of office were some hedge fund managers. Not pension fund managers. Not insurance company fund managers. Not even mutual fund managers. Hedge fund managers. So Mr. Seifert, being a connected guy (and apparent crybaby) voiced his dissatisfaction with losing this election to Gerhard Schröder, who was still Chancellor of Germany. The Chancellor then proceeded to make public statements that the activities and behavior of these hedge fund managers were like "locusts" and that perhaps more regulation was necessary for these largely unregulated investment managers. Here's the deal though, and it doesn't actually even involve short selling. It simply involves securities lending. When I borrowed those Microsoft shares earlier in the newsletter, United States securities laws state that the person who lent me the shares continues to be able to vote their shares while I have them out on loan. Oddly, German securities laws actually allow the person who borrows the shares to vote for those shares on company matters while they have the stock borrowed. So, some hedge fund managers who thought Mr. Seifert was doing a fairly poor job running the Deutsche Börse simply borrowed some shares and voted against Mr. Seifert. Perfectly legal and no particularly big deal. Unless of course you're Mr. Seifert, who has a book out now titled "Invasion of the Locusts" and is calling on Europe's financial ministers to protect the Continent from this insidious, insect-like attack. You can probably see where I surmise Mr. Seifert's crybaby tendencies. One must ask themselves some simple questions at this point: Are hedge fund managers just like locust and are they actually the new scourge of the investment landscape? Or should Germany revamp its securities laws to prevent money managers of all ilk from pursuing this open and legal strategy? Probably without even having to inquire what my opinion is, most of you already knew it would be the latter. SOME SMOKE AND SOME FIRE If this story is something that interests you, I encourage you to do some simple searching on the Internet for the principals in the lawsuit and you will find voluminous amounts of information to satiate your appetite for knowledge. In my telling of the story, however, I want to quickly isolate the important facts, and here they are. SAC Capital Management LLC is a substantial hedge fund run out of Greenwich, Connecticut by a gentleman by the name of Steven A. Cohen, thus the "SAC" naming of his fund. While precise information about hedge funds is sometimes difficult to come by, much in the way of rumor (or legend) floats around regarding the secretive Mr. Cohen and SAC. For example: --Mr. Cohen reportedly earned about $500 million last year, give or take a few million either direction. --SAC is rumored to have around $10 billion under management and on any given day accounts for 3-ish percent of all trading on the New York Stock Exchange. --Investors in SAC supposedly have been enjoying 40-ish percent annual rates of return thanks to the trading activities of Mr. Cohen and company. --Starting back in 2003, SAC decided they didn't like the price of Canadian drug company Biovail and started short selling the stock. Now, to begin the discussion of Biovail, let me just state for everyone's sake that Biovail is suing SAC, Gradient Analytics, and Bank of America for allegedly conspiring to drive down Biovails stock price to benefit SAC's short position. Basically, Biovail is accusing SAC of feeding negative information to Gradient and Bank of America in the hope that the two organizations might write something negative about Biovail. Now let me share with you some information about Biovail in much the same fashion as I did about SAC, with one extremely significant difference. All the information I will list below was obtained at Biovail's own website on its "Investor Relations" page. You can confirm the information yourself by visiting the following link: http://www.biovail.com/english/Investor%20Relations/Latest%20News/default.asp?s=1&state=showarchived --November 13, 2003 - The Company issues a statement that a class action complaint has been filed by investors in Biovail securities that the company and some of its executives have violated the Securities Act of 1934. --November 20, 2003 - Biovail announces that they've gotten a letter from the SEC initiating an informal inquiry into all the company's accounting and financial reporting practices for the entire year of 2002 and all the quarters to date for 2003. --December 10, 2003 - The Company announces that their Chairman and Chief Executive Officer, Eugene Melnyk sold 2.7 million shares of his Biovail shares, which represent 10% of everything he owns. --March 3, 2004 - Biovail announces that top-line earnings have grown 4.5% during the past year. Unfortunately, a year prior, the company had forecasted that they expected 30% earnings growth for 2003. Oops. If you saw the 60 Minutes piece on this whole matter, it was difficult to come to any conclusion other than the plunge in Biovail stock could ONLY have been the result of the short selling activity of SAC, and the shoddy analytics performed by Gradient and Bank of America. Just like the story of Mr. Seifert and the Deutsche Börse, one is required to examine the situation and ask themselves a couple of questions. The first question will require us to first make a rather long series of assumptions in order to answer. First we must assume that SAC fed the negative information to Gradient and Bank of America and that the information that they supplied was materially false. Second, we must assume that Gradient and Bank of America proceeded to publish negative reports on Biovail, even though the analysts writing the reports knew the information was false, or just didn't care whether it was or it wasn't? Finally, assuming that all the previous assumptions are true, we can ask the question if it was actually the short selling activity that caused Biovail stock to plummet? The second question luckily requires no assumptions at all. The question is whether announcements about class action lawsuits, declining revenue growth, missing earnings guidance numbers, SEC investigations and massive stock sales by the company CEO could possibly lead to the price of a stock declining? I think you see where I'm going here. With most mathematical equations, the more unknowns you plug into the calculation the more difficult (or impossible) the calculation becomes to solve. The simplest explanation for any particular problem is always going to be the one requiring the fewest assumptions. For that reason, I would have to imagine that most of us would think that the second question more probably leads us to the correct answer than the first question. Another company suing a hedge fund manager is Overstock.com, who is blaming Rocker Partners and Gradient for its stock price woes. It would be ridiculous to think that Overstock's declining stock price might have anything to do with the fact that they haven't had even one profitable year since 1999, so I'll avoid such crazy talk. I'm not even sure what bugs me the most in this
whole mess. One thing that's sure is that I'm massively disappointed
in the job that 60 Minutes did covering the "story" since
they completely avoided one side of the If you take nothing away from the stories I've shared with you, remember one thing clearly. The more vocal or litigious the company is in the responding to the activities of short sellers, the more probable that there is likely something serious for investors to be worried about. "GUILTY PLEASURES" I've admitted many, many times in this newsletter that I am developing an old farty side of myself that can make me feel somewhat uncomfortable at times. Then there are other times when I truthfully have to wonder whether or not I'm actually the one doing the changing, or is it society that is changing around me, while I remain remarkably the same. This is my boggle for this month to share with you. The story begins a few weeks ago when I was pretty revved up for the return of The Sopranos on HBO. I own seasons one through five on DVD and have probably seen every episode of every season at minimum three times each. Waiting two years for season six has been a bear. I was at a Saturday birthday party for a classmate of my daughter's, chatting up another one of the fathers about a host of benign topics. Let me also add that I really like this guy and we've gotten pretty friendly during the past three years. With my pending anticipation about The Sopranos, I inquired whether he was feeling pumped up about the season premier the next evening. He replied "Actually, I watch Desperate Housewives on Sunday nights." "No sh**. Really?" was my response with a squished up face. "Yeah. I consider it one of my guilty pleasures." He answered back. Now clearly, I have heard the expression "guilty pleasure" thousands upon thousands of times in my lifetime, but for whatever reason the term resonated in my head that morning. I guess I had never thought of even using such a descriptive terminology to explain why I might watch any television program. Then, just a few days later, I was supposed to be meeting someone and they explained they may be a few moments late because they were going to be stopping at Starbucks for some sort of latte that sounded awful to someone like me who has never drank coffee. So I ask them "Isn't that kinda out of your way?" "Oh, I stop there every morning about this time" they responded. "Everyday!?" I ask with the squished up face again. "Most definitely. Starbucks is my biggest guilty pleasure" came the defense. At this point the coincidence is more than palpable to me having felt pretty weird about the Desperate Housewives instance. I wasn't even sure what to think of the whole situation either. Is this where society is today, that prime-time, network soap operas and $4 cups of coffee are now "guilty pleasures"? Or am I now just hanging around old farty types who in turn make me feel old farty myself? Now before I go any further here I must state for the record that I led a somewhat undisciplined and quite fun life as a younger adult, and the crowd I tended to hang around with was a bit faster and wilder than average. With that said, had I asked my friends of 20 years ago what their "guilty pleasures" were, I could at least be assured that there certainly going to be real pleasure involved and they would definitely be guilty of something either legal or religious. Snorting a few lines of coke in a public restroom would have been an answer a few past friends might have offered. They would have definitely found it pleasurable and they would have been guilty of probably several different statutes. Drinking a fifth of Jack Daniels before work might have made the list. Better still, drinking a fifth of Jack Daniels DURING work. Maybe having intimate relations with a perfect stranger, or an even guiltier pleasure, intimate relations with someone you outwardly cannot stand. This would have been the answer I know would be number one among some people. Best of all, maybe snorting a few lines of coke in your office restroom, finishing off the fifth of Jack Daniels at your desk and then having intimate relations with someone from work you barely know in the server room at lunch. NOW we're cooking like Betty Crocker! While none of the above would have necessarily been on my own personal list of "guilty pleasures", these were definitely some fun people to hanging around with. So while I resist casting any judgments toward anyone in particular, does anyone out there have a cast of characters in the fabric of their lives like the crew that I had 20 years ago? Or has the world around me just evolved (devolved?) to the point that listening to Clay Aiken albums, watching The Ashlee Simpson Show or drinking overpriced coffee are now actually the extent of "guilty pleasures"? I look forward to hearing your thoughts. Drop me a note at: YOUR MARCH BRAINTEASER The brainteaser for this month is one that I've had kicking around for a couple of years and is an extremely popular one among some particularly cruel potential employers to ask job candidates. Considering the number of accountants, auditors, actuaries, analysts and technology professionals who subscribe to this newsletter, it is likely that many will be uncomfortable with the esoteric nature of the question. I beg your indulgence for once and enjoy having a problem that cannot be solved with an HP calculator or a Google search. You situation is as follows: "You are a prisoner in solitary confinement serving a life sentence without possibility of parole. It is Friday afternoon and you absolutely must have a cigarette. The only person who can give you one is the guard outside your cell. What do you do to get a cigarette?" Now obviously there are an endless number of ways this question can be answered, but I'm looking for the best answer. There is an answer preferred and THAT answer can be viewed by visiting the following link: http://www.afs-seminars.com/brainteaser_Mar2006.html Also, you can view the answer for last month's brainteaser by going to the link below. I haven't included the answer in the body of this newsletter since one of the words in it may cause some of your corporate email filters to sound the alarm. The link for last month is: http://www.afs-seminars.com/brainteaser_Feb2006.html Copyright 2006, Michael Gasior. All Rights Reserved. Copyright 2006, Michael Gasior. All Rights Reserved. |
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March
2006 Newsletter
