Browsing December 10th, 2008
The Perils Of Peddling Faulty Microwave Ovens
Retail investors historically have had very short memories. I’d crash your computer if I recounted all the scams and cons I’ve seen in the three decades I’ve represented individual investors, yet somehow Wall Street’s systemic fraud and dishonesty never seems to lead to a shortage of customers. Even the dot.com fraudulent research scam didn’t lead to a massive client exodus.
But Wall Street might have exploited its customers one time too many. According to a survey by Prince & Associates, a whopping 81% of investors with $1 million or more of investible assets plan to change investment advisers. An even larger number, 86%, plan to tell other investors to avoid their adviser. A mere 2% of investors plan to recommend their broker to other investors. So much for those client referrals…
Admittedly, not all “investment advisers” are brokers at the big Wall Street firms, but “wealth management” has been one of their major focus areas these past few years. And $1 million in investible assets wouldn’t even get you a meeting with the receptionist at the top-tier multifamily offices.
I suspect one of the tipping points might have been the marketing of auction rate securities, which Wall Street sold as cash equivalents but were in fact quite risky. Amazingly, these securities were aggressively sold to Wall Street’s most wealthy - and profitable — customers. Brokers were under considerable pressure to move those microwave ovens.
One of the few growth businesses in the months ahead will be conflict free multifamily offices with established and unblemished track records serving the interests of their clients. Indeed, marketing tools multifamily offices might want to consider are the state attorney general ARS complaints against the big brokerage firms, such as Massachusetts’ARS lawsuit against Merrill Lynch. These easy-to-understand complaints unquestionably offer some of the most impressive insight into the conflicted workings of Wall Street ever written.
Lessons From Lehman
I’m still trying to make sense of Lehman’s disclosure yesterday that it will post a whopping $2.8 billion loss in the second quarter and raise $6 billion in equity by selling shares at a 20% discount to book value, but one lesson is already readily apparent: the best and brightest analysts aren’t working at the major Wall Street brokerage firms.
Lehman’s projected loss amounts to $5.14 a share, a mind-boggling deficit given that Wall Street analysts were expecting a loss of no more than $1.28 a share. Lehman’s planned fund raising will dilute the holdings of existing common shareholders by 30 percent.
As best I can tell, the loss gives some credence to warnings by hedge fund manager David Einhorn, who repeatedly has charged that Lehman hasn’t adequately marked down some of its assets. While it isn’t entirely clear to me that Lehman plans to write down some of the assets whose value Mr. Einhorn has questioned, the hedge fund manager was indeed correct in predicting a massive earnings train wreck. As Mr. Einhorn so elegantly puts it: “(Lehman) just raised $6 billion of capital that they said they didn’t need to replace losses they said they didn’t have.”
Individual Lehman shareholders should be concerned how Mr. Einhorn – who has a short position on Lehman’s stock – knew with such certainty that the company’s asset values would have to be aggressively written down. Admittedly, it’s quite possible that Mr. Einhorn is just way smarter than the Wall Street analysts who cover Lehman’s stock and is better versed on how to read a balance sheet. But Mr. Einhorn’s public statements indicate that he based his analysis on Lehman’s valuation methods, which possibly suggests we are dealing with basic accounting issues.
Lehman previously maintained that Mr. Einhorn’s criticisms had “no basis in fact.” The merits of that defense are increasingly hard to believe.
New Exchanges to Rescue?
Bear Stearns Announces Third Hedge Fund Collapse; A Sign of Things to Come?
Bear Stearns has dropped another bombshell announcement. A third hedge fund, the Asset Backed Securities Fund, has apparently lost so much money its no longer profitable for the bank to run it…and that’s saying something considering Wall Street’s reputation for squeezing fees out of investors. At its peak, the fund had $900 million of investor assets, which is now valued at $500 million. This brings the grand total of investor loses under Bear Stearns’ watch to well over $2 billion in three hedge funds alone.
This latest hedge fund to shutter, Bear Stearns claims, only had 0.5 percent of is assets tied to sub prime mortgage related securities. This begs the question of exactly what constituted the other 95 percent of invested assets. Were these also illiquid securities or is the market for all asset backed securities (including commercial lending) worse than anyone could imagine? No one has ever accused Bear Stearns as being a pillar of transparency, but if the market is in such jeopardy then a great many more portfolio managers may be going the way of Ralph Cioffi, the now departed portfolio manager who oversaw the other two collapsed Bear Stearns hedge funds.
My inclination is that this is partly another example of the dubious nature of Wall Street’s credit valuation methods. Bloomberg reports that the Asset Backed Securities Fund’s portfolio was valued at $900 million as late as August of 2007, but spiraled downward losing as much as 21 percent in November alone. Would August’s valuation been the same had the funds assets been valued based on more pragmatic (read: honest) method? Did the hedge fund managers’ strategy waver in any way during the funds history? And did Bear Stearns park any of its own bad assets in the funds as it is alleged they did with the other two funds under Cioffi’s supervision? These are the types of questions that investors should be asking.
They say where there’s smoke, there’s fire. And in my thirty years working on behalf of defrauded investors nowhere is that more true than on Wall Street. At Bear Stearns, there’s a raging inferno. Rest assured, we will be paying close attention and working with clients to determine the real story behind the Asset Backed Securities Fund and its spectacular losses.