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2006-05-26 :: Enron Lessons Don't Sink In

The market had a great day today.  The volume was much less than the last two weeks, but we did go into the holiday weekend on a happy note in terms of the broad market’s rally from earlier lows. 

Unfortunately, we had an ugly juxtaposition in terms of corporate greed this week as we saw
that executives from Enron and Fannie Mae get their punishment while several other companies have been targeted for their presumed practice of backdating executive option granting to recent stock price lows.

Below, I’ve cut/paste a story that outlines my current disgust with this sector of corporate America.

From Business Week Online:

Backdated Options, Future Rules?

By David Henry

(Exerpt from a longer story) …

Last week, the Center for Financial Research & Analysis [CFRA], an accounting research firm that red-flags stocks for institutional investors, said in a report it had looked at 100 companies that issued a lot of options and found 17 companies that on at least three occasions had awarded options at, or close to, 40-day lows in stock prices. CFRA said that while the 17 have the “highest risk of having backdated options,” it has not confirmed any backdating.

NO PROOF.

The 17 companies were American Tower (NYSE: AMTnews) [AMT], Broadcom (NASDAQ: BRCMnews) (BRCM), Brocade Communications (BRCD), CNET Networks (NASDAQ: CNETnews) [CNET], Delta Petroleum (DPTR), F5 Networks (NASDAQ: FFIVnews) (FFIV), Juniper Networks (NASDAQ: JNPRnews) (JNPR), McAfee (MFE), Medarex (NASDAQ: MEDXnews) (MEDX), Mercury Interactive (NASDAQ: MERQnews) (MERQ.PK), Microstrategy (MSTR), Openwave Systems (NASDAQ: OPWVnews) (OPWV), Rambus (NASDAQ: RMBSnews) (RMBS), RSA Security (NASDAQ: RSASnews) (RSAS), Semtech (SMTC (NASDAQ: SMTXnews) ), Sepracor (NASDAQ: SEPRnews) (SEPR), and Zoran (ZRAN).

Monday, Joe Osha, an semiconductor industry analyst at Merrill Lynch (NYSE: MERnews) , reported in a note to clients that the stock prices of six companies in the Philadelphia Semiconductor Index had surged by an average of at least 14% in the 20 days following options grants in 1997 through 2002.

FAR-REACHING CONSEQUENCES.

The six were KLA-Tencor (KLAC), Marvell Technology (MRVL), Novellus Systems (NASDAQ: NVLSnews) (NVLS), Linear Technology (NASDAQ: LLTCnews) (LLTC), Broadcom (BRCM), and Maxim Integrated Products (NASDAQ: MXIMnews) (MXIM).

None of the companies or individuals named in the reports has been proven to have done anything illegal.

As you can see from the lists above, two of my favorite companies (BRCM and MRVL) are being implicted.   Additionally, the full list from Merrill includes Teredyne and Intel.  Management has a fiduciary duty to act in their shareholders best interest.  It sure looks like a repeat of the Enron/Fannie Mae corporate greed scenario to me. 

From my years in this business, one thing I’ve learned is that news stories like these have legs that will keep the stock price of a company hindered for a period of time; if the story turns out to be true (e.g., Enron, Worldcom, Tyco) then the  shareholders are better off selling  and moving on instead of holding the stock hoping for a rebound that might neve come, or that might come years in the future.

Next week, we’ll be analyzing this scenario and deciding whether to liquidiate holdings of these four companies based upon this assumption.

[Getting Off Soapbox]

The graphic above is one you seem a lot here recently:  VIX – Volatility Index.  As you can see, our oversold position has abated and we are now at the level where we were in January when that major rally started.  Clearly, the upward strength is lessening, but it still seems as if we have some room to run.  As we move into next week, we have a major event Tuesday afternoon as the minutes of the Fed’s meeting earlier this month are released and we get to see if the Fed is becoming more or less interested in increasing interest rates.

The market will likely either rally or drop in a fairly strong manner depending upon what people interpret.  If it looks like they are going to pause, then you’ll see the market move up; if they seem to be set to increase the rate hikes for the foreseeable future, then look for the market to drop in spite of the still-oversold position.

Next week has the potential to be as active as this week.  As always, we will do our best to capitalize on any trends we see that will benefit our clients’ portfolios.

Have a nice Memorial Day weekend!

Mark