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THE WORST 20:
A Connoisseur’s Collection
Of Dir ty Rotten Scoundrels
The Worst 20: A Connoisseur’s
Collection of Dirty Rotten Scoundrels
By The Editors of Personal Finance
The Bad Side of Tech
The Bad Side of Consumer
Energy the Wrong Way
Cleaning Out Your Portfolio
KCI Communications, Inc., 7600A Leesburg Pike, West Building, Suite 300, Falls Church, VA 22043-2004. Subscription and customer services: P.O. Box 3808, McLean, VA 22103-
9823, 800-832-2330. It is a violation of the United States copyright laws for any person or entity to reproduce, copy or use this document, in part or in whole, without the express
permission of the publisher. All rights are expressly reserved. 2008 KCI Communications, Inc. Printed in the United States of America. PRS0408-TG. The information contained
in this report has been carefully compiled from sources believed to be reliable, but its accuracy is not guaranteed.
Successful investing isn’t simply a matter of picking the
Each month, or at a minimum each quarter, take your
very best stocks; it’s also important to avoid the big los-
brokerage statements and go down the list of your invest-
ers. And it’s not just the small, unheard of stocks that are
ments and review. Sure, you may not be too happy about
risky: Think back to the 2002 blowups of mega-cap stocks
some of them, but by cleaning house and getting more
—it doesn’t take many losers
diligent, you’ll have fewer dogs and more wealth in the
like that to wipe out gains elsewhere in your portfolio. The
key to avoiding the real losers is to buy only stocks that
In this era of extreme corporate greed, it’s a good
you can understand and to constantly review and reassess
idea to keep an eye out for companies that don’t have
their shareholders’ best interests in mind. The unfortu-
One of our favorite sayings is: Never invest in anything
nate truth is that some managers care more about lining
you can’t explain in the time it takes for someone to light a
their own pockets with excessive compensation rather
cigar. This is the boiled-down lowdown on how we make
than paying out money to shareholders—the real
our investment decisions. And it’s true for stocks, bonds and
owners of every publicly traded stock. Even worse, a
funds. If we can’t figure out what’s going on behind the
growing parade of once-trumpeted corporate managers
scenes, why and how we’re going to get paid, then there’s
are finding themselves the subject of legal investigations
no way we’re going to stick one dime into the deal.
and even jail time. These companies, too, need to
In addition to buying what we can understand, we also
keep vigil over all our holdings in Personal Finance
In this report, we review 20 stocks that have
review everything in the Growth, Income and Advantage
fundamental problems and should be avoided like the
plague. Some on our list are corporate frauds waiting
If we can’t say we’d buy every pick all over again, it’s
to happen, while others are vastly overvalued Wall
time to sell. This doesn’t mean that you can plan on plenty
Street favorites. If you have one of these wealth-destroy-
of turnover. It means we don’t buy, then wait and hope that
ers in your portfolio, consider selling out or at the very
a stock will work out. And while some stocks might be in
least taking a hard look at why you own the company
the portfolio for years, each of them has to earn its keep
and the risks you’re taking by keeping the stock in
Big pharmaceutical stocks are among the most popular
stocks touted on Wall Street. The familiar refrain is that
they’re stable earners and have the benefit of hugely posi-
(NYSE: PFE) may be a Wall Street favorite, but it’s
tive demographic trends. Simply put, as Americans age, the
also one of the most vulnerable drug stocks around. The
drug companies stand to benefit through higher sales of
company’s executives and board members keep touting the
drugs; seniors spend far more per capita on drugs than
stock. But what have they been doing with their own cash or
should I say the cash given to them by shareholders?
But big pharma is far from the investment panacea that
They’ve been touting to the media while voting with their
feet. During the past few years, they’ve sold thousands upon
many suppose. Big pharmaceuticals face a number of key
thousands of their shares while buying only a few hundred.
fundamental headwinds in the next few years. Take, for
What about all the sales and its pipeline of products?
Pfizer has one of the most anemic sales growth numbers of
When new drugs are approved for sale by the Food and
its major and minor peers. And it’s also estimated to have
Drug Administration (FDA), the company that developed
the most vulnerable pipelines for new products. Yet the
the drug is sheltered from competition for a number of
company still commands one of the highest valuations—
years. That’s because newly discovered pharmaceuticals
based on its book—of business and historical sales of any
are protected from competition by patents; the idea is that
of the other drug companies in the market.
the profits will be higher on patent-protected drugs, allow-
And Merck’s Vioxx
—pulled from the market because of
ing the pharmaceutical companies to recoup all those bil-
potentially deadly side effects and then reauthorized under
lions in research and development costs.
far stricter guidelines—isn’t the only drug of its kind on
But patents expire, and when they do, the generic man-
the market. There are others, and the two leading drugs
ufacturers move in for the kill, eliminating the high prof-
behind Vioxx are Celebrex
, with nearly $2 billion in rev-
itability of patent-protected drugs. The problem is that
enues, and Bextra
, with almost a billion in revenues. Both
most of the major pharmaceuticals are faced with billions
of dollars in patent expirations in the next three to five
Pfizer is in deep trouble, too. Not only will it have to
years. What’s worse, they don’t have new drugs under
come clean about these drugs, which could mean losing
development that will be able to replace the profits lost to
around $3 billion (nearly 10 percent of its average revenues
for the last five years), but there’s also the same litigation,
regulatory and liability costs that will be much more.
Instead of developing new drugs, Pfizer
and others have
And it’s going to get worse for Pfizer. Merck is trying to
tried to manipulate the patent laws to extend rights, while
fight the dangers of Vioxx, as nothing is certain yet.
often unsuccessfully creating enough new drugs to replace
Meanwhile, Pfizer has balked at baring all. Instead, it’s
the old. This is catching up with the group. Regulators and
continued to step up its defense of Celebrex, saying quite
world courts are cracking down on such practices.
publicly that there’s nothing wrong with that drug.
But the problem goes deeper than patent expirations.
We came across some studies about Bextra. Some
During the past few years, several high-profile drugs have
time ago, it was profiled in a study presented by the
been pulled from the marketplace because of concerns
American Heart Association (AHA). Even before the AHA
over side effects and health safety. When these drugs are
announcement that Bextra has been directly connected
pulled, the trial lawyers smell blood in the water—safety
to heart and stroke deaths, it was directly linked with
and health concerns can and do give way to multibillion-
dollar settlements against big pharmaceutical names. This
SJS, according to the Medterms dictionary, is a sys-
additional legal risk is a major headwind for the group.
temic, bodywide allergic reaction with a characteristic
Clearly, big pharma is a group to avoid. Let’s look at a
rash involving the skin and mucous membranes, includ-
ing the buccal mucosa or the inside of the mouth. The
disease is caused by a hypersensitive allergic reaction to
lating the rules and the patent processes to keep older
one of a number of immunologic stimuli, such as drugs
drugs from going off patent. Therefore, it’s been hampering
competition for lower prices and greater access.
The SJS skin rash consists of erythematous or red
That’s coming to an end, though, and with no thanks to
papules, vesicles and bullae. There may also be iris lesions.
the US government. It’s the European Union (EU) that put
The mucosal lesions include conjunctivitis and oral and
the stop on AstraZenaca, citing the company’s abuse of the
genital ulcers. The most-frequent complications of SJS are
patent rules that enabled it to keep drugs like its Losec
keratitis, uveitis and perforation of the globe of the eye—all
from going off patent. And Astra is just one on the
of which may result in permanent visual impairment.
European Commission’s list for investigations and pending
In addition, hepatitis, intestinal bleeding, pneumonia,
rulings and judgments. Sell AstraZeneca.
arthritis, fever and myalgia are potential SJS side effects.
The diagnosis includes other diseases that can result in skin
and mucous membrane lesions. Diseases like pemphigus
vulgaris and other illnesses may mimic SJS. The diagnosis
You’ve likely read and heard about the Vioxx mess at
of SJS is usually made when the characteristic rash appears
(NYSE: MRK). The pain-relief drug is part of a family
one to three weeks after exposure to a known stimulus and
of chemicals known within the pharmaceutical industry as
it can’t be explained by another diagnosis.
The treatment depends in part on the suspected precipi-
COX-2 inhibitors are drugs that selectively block the
tating cause. Any drug—e.g., one of the sulfa drugs, peni-
enzyme cyclooxygenase-2. Blocking this enzyme impedes
cillin or anticonvulsants, especially phenytoin—should be
the production of the chemical messengers called
discontinued. Infectious agents like herpes should be iden-
prostaglandins, which cause the pain and swelling of
SJS has a fatality rate of 30 percent—big in anyone’s
The problem is that the drugs also have some side
book—and Pfizer evidently knows that. Now doctors are
effects, ranging from the minor to the extremely serious.
catching on, and lawyers will figure it out soon.
On the serious side, COX-2 inhibitors tend to produce
So Pfizer has a bigger problem than Merck. It has two
blood clots promoting blockages that increasingly result in
drugs that have nexuses being forged to deaths, either
heightened risks of heart attacks and strokes. There has
through blood clotting and blocking that causes heart
also been some heavy concern by the developers and
manufacturers of these inhibitors about these side effects.
Pfizer is still valued at a little less than four times rev-
However, the nexus between the drug and deaths were
enues and three times its net book of assets. If both Bextra
and Celebrex have to be pulled, revenues are toast, as is a
Merck acknowledged internally the troubles based on its
big chunk of its patents. Sell Pfizer.
own studies and some sponsored by it and others. Finally,
when these studies came to the public, Merck feared a
massive liability risk. The release of these studies brought
an initial storm in the media, and lawyers brought a mas-
(NYSE: AZN) must be thinking that its for-
sive class action suit against the company.
mer name—Imperial Chemical Industries
But that’s old news. Merck’s shares have suffered.
with some extra sovereign powers over the laws the rest
of us must endure. But thankfully for us as consumers,
Moody’s has already downgraded its debt—only by a
and even for some astute investors, the company and oth-
smidge—and Merck’s rating is Aa3 with a negative outlook
ers like it in the big pharmaceutical industry are getting a
(down from Aaa). S&P has also downgraded Merck’s debt.
That’s hardly a big move. Yet, as with other companies that
AstraZenaca is one of the giants in the patent prescrip-
headed down the path of doom, this is only the beginning.
tion drug market. It makes a host of products that its mar-
Moody’s and S&P will drag their feet on downgrading one
keting company and doctors continue to push worldwide.
of their better customers until it’s too late for bondholders.
But the trouble is that the company, and others such as
Right now, you should go through your portfolios, including
Pfizer, isn’t developing new drugs to replace those that are
your pension accounts and other managed accounts such as
or should be falling off patents. Instead, it’s been manipu-
mutual funds, to see if you have exposure to Merck bonds.
The shares are still expensive: They’re trading at more than
SCD is one of the most common inherited blood dis-
17 times trailing earnings and nearly 4.5 times trailing rev-
eases. It primarily affects African-Americans. It’s estimated
enues, which could be cut substantially. Vioxx represented
that in the US, some 50,000 African-Americans are afflict-
$2.5 billion in revenues in 2003, which is 10 percent-plus of
ed with the most-severe form of sickle cell anemia. Current
the company’s trailing annual revenues.
estimates are that one in 1,875 US African-Americans is
Even with Vioxx back on the market, it’s not likely to sell
as well as it once did. And Merck will still face litigation costs
In addition, the drugs are also used to treat myeloprolif-
and liability to users and their lawyers. Merck could end up
erative disorders, which are malignant diseases of certain
in the low teens or worse as valuations measure catch up to
bone marrow cells, including those that give rise to the red
the pricing of the stock in the markets. Sell Merck.
blood cells and types of white blood cells and platelets that
are crucial to beneficial types of blood clotting.
The myeloproliferative disorders include myelophthisic
anemia, leukemia, leukemoid reaction, myelofibrosis and
other illnesses. The myeloproliferative disorders are in con-
There’s a small study in Germany at the University of
trast to the lymphoproliferative disorders, which are malig-
Ulm that’s pointing out some major trouble for Bristol-
Both of these disorders cover a lot of patients inside the
Back in the early 1990s, Bristol-Myers developed, test-
US and around the world. But there’s trouble with Hydria,
ed and brought to market a series of drugs under the
name hydroxyurea. The drugs were patented under the
Bristol-Myers discovered from its own studies—dis-
names of Hydrea
. They were used to
closed in 1996—that the drugs were causing threatening
treat a series of illnesses and disorders, such as sickle
side effects, e.g., skin lesions and malignant cancers.
This has continually been confirmed in various private
Sickle cell disease (SCD) is a disorder of the blood
and public studies yet to be fully disclosed to the world-
caused by an inherited abnormal hemoglobin—otherwise
known as an oxygen-carrying protein within the red blood
However, the FDA confirmed the nexus of the deadly
cells. The abnormal hemoglobin causes distorted—or sick-
side effects and mandated that Bristol-Myers place a dra-
led—red blood cells. The sickled red blood cells are fragile
matic warning on the use of its drugs. The warnings were
and prone to rupture. When the number of red blood cells
put into some effect in 2000 and were initially made
decreases from rupture, anemia is the result. The irregular
under common FDA rules to disclose the warnings to doc-
sickled cells can also block blood vessels, causing tissue
tors and not directly to users or prospective users. Sell
The Bad Side of Tech
We’re not anti-technology. In fact, inside the Personal
Other problems loom on the horizon. Rising invento-
Growth Portfolio, we’ve held and continue
ries during the last few quarters suggests that the compa-
to hold several promising technology stocks. But the tech
ny is having trouble selling its wares. And AMD
stocks that Wall Street pushes aren’t necessarily the names
company’s only real competitor in the chips for PCs,
that are going to be kind to your portfolio.
business has started to gain some market share in certain
When it comes to investing, technology and greed go
together like expectation and disappointment. People seem
Finally, Intel has accounting issues because of the com-
to buy nearly any story of a company or a market that
pany’s use of stock options to pay employees. Options cost
involves the slightest hope of a big payoff.
money after all. The Financial Accounting Standards Board
Technology isn’t just new electronic gizmos; it’s nearly
is debating whether to enforce potentially mandatory
any advancement that enables commerce to grow. That
expensing of options paid to employees. At the same time,
often means new hardware for computing or entertainment
companies already doing so are cutting back.
and such. But it also means new products that enhance the
According to a recent S&P 500 analyst survey, member-
listed companies expensing options paid to employees (as
Like more and more of the newer companies that we
a line item cost on income statements) have severely cur-
put in our articles and in the Growth Portfolio—from tech-
tailed the options’ amount. And the cutbacks are hitting
nological wonders to staid real estate companies—we have
those in the executive suites just as much. Sell Intel.
to understand the companies’ missions.
In addition, we need to know what they do and how
they’re going to make more money doing it; otherwise
they’re a bet, not a buy. And we also want to avoid the over-
(NSDQ: MSFT) is another company that’s a
touted Wall Street favorites that are hopelessly overvalued.
real favorite on the Street but hasn’t been a great invest-
Let’s review two of the most vulnerable stocks in the space.
ment in recent years. The company’s primary business is
operating systems and its Windows
But already there are key future competitors for the
Windows operating system in the form of open-source prod-
Let’s begin with the chips and electronics companies—
ucts like Linux
—they’re free and, at least according to some
stocks that are in nearly everyone’s portfolio either directly
tech experts, less prone to crashing than Windows itself.
or through a fund. This represents the biggest dichotomy
But even if Windows remains a cash cow for Microsoft
between the companies Wall Street likes and the compa-
for as far as the eye can see, we’re not happy about the
The consistent champ (from Wall Street’s perspective) is
way the company treats shareholders. Several quarters ago,
(NSDQ: INTC) with 45 Wall Street analysts covering
Microsoft decided to start paying dividends as a way of
the stock and only four selling. For company sales, product
returning some of the billions in cash on its balance sheet
areas were negative for the past two years with only its
chip products climbing an anemic 13 percent.
But Microsoft’s yield remains a paltry 1.4 percent, and
Regardless, the company’s stock is valued at more than
the company retains more than $30 billion in cash on the
3.5 times its crummy trailing sales. Adding to the woes, the
books. Meanwhile, the stock continues to trade at a heavi-
company experienced major delays in releasing its latest
ly inflated premium to annual sales—Microsoft trades at
processing chip for PCs—the backbone of the franchise.
more than five times trailing sales. Sell Microsoft.
The Bad Side of Consumer
P ersonal Finance
isn’t calling for a major retrench-
. And in most cases, these other companies
ment in consumer spending. But it’s clear that not all
sell their players at significant discounts to iPod.
companies selling goods to consumers are alike.
Moreover, Apple may need to learn how to share,
Although many will benefit from increased retail sales,
thanks to a new French copyright bill. The regulation
would disbar the monopoly-esque hold Apple has had
One of the most vulnerable groups are the auto manu-
on the MP3 world through its popular iPod and iTunes
facturers. At first glance, automobile sales look impressive
products by requiring all music players and online stores
and have been on a steady uptrend since the early ‘90s.
Even the 2001 recession couldn’t keep autos down.
Right now, iPods can only play selections downloaded
But anyone who’s been to a car dealership lately
or imported to the iTunes software. Fortunately for Apple,
knows that the major manufacturers have been offering
the rule has been watered down since its original intro-
the most-attractive deals in years. Everyone’s heard the
duction via a loophole that allows it and other download
advertisements for zero-percent financing and thousands
companies to ink deals with major artists and labels for
of dollars in manufacturer rebates. There’s no doubt
exclusive distribution rights to their libraries.
these deals sell cars. But there’s a cost: You won’t make
However, this bill is still music to the ears of companies
, which may finally have a chance to
Even worse, these “free money” deals are borrowing
even the playing field. The ball is now in Apple’s court:
sales from the future. Consumers who weren’t looking to
Does it comply with the new law or withdraw from the
buy a new car have been lured by zero-percent financ-
French market? At any rate, it’s not good news for Apple.
ing deals; they won’t need a new car for a few more
Meanwhile, despite all the potential competition and
years. That adds up to lost sales revenue.
challenges, Apple’s stock continues to trade at three
And with heavy debt burdens, rising loan delinquen-
times sales and more than 19 times trailing earnings,,
cies and moderating sales growth, the Big Three can’t
expensive by any measure. Sell Apple.
afford to offer any more attractive terms for consumers.
Although a company may have a hot, profitable prod-
uct, the consumer arena is famous for its vicious compe-
tition. Yesterday’s hot fads can easily become tomorrow’s
(NYSE: F) is having trouble selling cars at a prof-
it. The company can only sell cars by offering zero-per-
cent financing deals and huge rebates. And incentives
from a few years ago still haunt Ford: Consumers have
become used to the super-cheap car deals they received
Although the latest whizbang gadgets might generate a
a few years ago. They’re now unwilling to pay full price.
lot of hype, they don’t necessarily generate solid profits.
The company is even more heavily in debt with more
Of all the technology products released during the past
than $167.8 billion in long-term debt supported by a
few years, none has generated more hype than the iPod
market capitalization of less than $14.9 billion. The new
music player manufactured by Apple
laws on fuel economy should also hurt Ford.
iPods allow users to download and play songs in elec-
One way Ford has managed to keep sales up is by sell-
tronic format. iPods can also be configured to allow
ing SUVs to an eager public. But the growth in SUV traffic
music to be played via car stereos or home sound equip-
is causing concerns for regulators in terms of safety and
ment. And newer versions feature a color screen that’s
emissions. This will bring some new costly requirements
capable of downloading video clips from the Internet.
for Ford to meet in its product offerings. In safety, look for
Although a useful technology, iPods aren’t that
new standards for lower bumper heights and headlights as
unique. Similar players are manufactured by a variety of
well as softer body structures to be more compliant with
companies around the world, including Korea’s Samsung
normal cars in the event of a collision.
Next is the real whopper: The Corporate Average Fuel
including paying heavy fines. This is good for us on the
Economy standards will soon include SUVs in the mix,
road but bad for the makers. And it’s just one more rea-
making manufacturers either lighten up the vehicles,
son to avoid Ford.
reduce engine power or resort to other alternatives—
Media and entertainment are two of our favorite
At the time, local chains had little competition for
groups, but there are good and bad companies in
viewers; TV wasn’t introduced until the late ’40s and
the sector. And some of the most often recommended
wasn’t popular until the ’50s. Even relatively small the-
names in the US just aren’t the best investments in the
aters could rely on a steady stream of films from prolific
group. Let’s examine one of the most vulnerable in the
Hollywood studios. But eventually, all that changed:
Television news, cartoon features and variety shows
began to supplant the short feature films that filled
screen time in the ’30s and ’40s.
Fast-forward 50 years and the industry is facing new
We’re almost getting jaded by the scandals of Wall
challenges. Moviemakers are going digital, so theater com-
Street and those committed by the executives of many
panies will need to pay up for digital projection equip-
leading companies. At least you can trust the local newspa-
per to print the truth. Take that back—maybe you can’t.
Concurrently, new technologies such as DVDs, on-
From writers who literally concoct sources and dream
demand video and significantly more-sophisticated stereos
up stories to publishers who fabricate subscription numbers
and televisions are reducing the relevance of cinemas; con-
and circulation, the print media can no longer hide behind
the First Amendment when it comes to their businesses.
Since 2002, theater attendance has been steadily declin-
Media companies are already dropping, including
ing. And even the most-optimistic analysts put growth at
(NYSE: BLC) for tweaking their num-
around 2 percent during the next few years. But during the
bers. Tribune lied about subscriber numbers just to keep
past five years, the number of hours spent watching movies at
advertising revenues flowing. Now the Feds are cracking
home has ballooned by more than 11 percent.
down with new audit rules and standards for newspapers
Even worse for theatres, the cost of advanced home-the-
and magazines. More truth, less fiction and a few more
atre audio and video technologies is falling, while theaters’
surprises are in the works for US print media companies.
costs are rising. A movie in most major metropolitan areas
is easily $10, making matinee prices no bargain either.
(NYSE: RGC) operates nearly 500
cinemas, with a total of 6,200 screens, in 40 states
around the US. The company will have a tough time
The local, independent movie theater was once a cen-
maintaining its growth rate during the next few years.
terpiece of American life. Before television, movie theaters
And with more than $2 billion in debt, Regal doesn’t
offered more than full-length feature films; cinemas
have a lot of flexibility to pay up for new digital theatre
showed newsreels, cartoons and short comedy features.
equipment. Avoid Regal Entertainment
Financial stocks have been at the epicenter of a lot of the
numerous investors for billions of dollars. But the compen-
fraud perpetrated on investors during the past few years.
sation that went back to the victims was reportedly only a
Several years ago, it was the Wall Street firms that main-
little more than $400 million and some requirements to
tained buy ratings on Enron
right up until
better separate investment bankers from researchers. In
they filed for Chapter 11. And some months later, we found
addition, the payout to victims of Citi’s misleading research
out why: The major Wall Street firms allowed the lure of
is smaller than what our government received from the
investment banking revenues to taint their research at the
expense of millions of individual shareholders.
Part of the deal makes the firms contract with other com-
The financial shenanigans didn’t stop there. It also
panies to provide their clients with research on the compa-
appears that some of the largest and most widely held
nies they recommend. This just allows a few other Wall Street
mutual funds in the US were allowing hedge funds to
—to pocket millions from the deal.
trade their shares after the official close of the market.
Morningstar is the same company that recommended a
This certainly allowed those funds to make a quick buck
host of funds only to benefit itself rather than its investors.
on the funds. But it all came out of the pockets of indi-
Morningstar isn’t pure. It takes advertisement revenues
from the same funds it recommends. And the company is a
Most recent, a new scandal has emerged, this time from
direct financial advice provider—not exactly what I call
the insurance sector. It seems that some of the larger insur-
ance brokers weren’t fighting for the best deals for their
But that’s only the beginning. Suit after suit is being filed
corporate clients; these brokers were accepting fees from
against the company, looking for the squandered cash of its
insurers to steer business their way. Yet again, some of the
investors. And what’s the company going to do to make
oldest and largest firms on the Street took money out of the
you more cash while it’s battling it out on the legal front?
Not much. Take your cash and your account where they’ll
Of course, not all financials are disasters waiting to hap-
value you and your business. Sell Citigroup.
pen. But with these legal risks swirling over the group, here
are a few high-profile, vulnerable names to avoid.
(NYSE: HRB) has never been on our good
list. It’s continually being exposed of its various financial
(NYSE: C) is at the top of the offender list on
crimes against many an investor and customer.
Wall Street. It laughed at not only its shareholders but also
From the Securities and Exchange Commission (SEC) to
victims of its cunning sales and banking operations.
state authorities throughout the US, H&R Block has been
Salomon Smith Barney
, a division of Citigroup, was
wrung up on charges left and right. But the company still
investigated for conflicts of interest between its investment
banking and research divisions. The company continued to
One problem with H&R is that it needs to prey on the
tout companies, not because of any fundamental improve-
lower end of the credit-scoring public to survive, let alone
ment in their business but because “buy” ratings on stocks
thrive. This includes so-called refund anticipation loans—
helped to drive higher investment banking revenues.
loans that are then paid back once the customer receives a
One of the more high-profile analysts under investiga-
federal tax refund—at very high interest rates. Already it’s
tion was Jack Grubman, who was at one time a real star on
been caught a few times by regulators, and there are still
the Street. Grubman was charged separately with conflicts
of interest and was later banned from the securities indus-
At one point, the company was processing and prepar-
ing more than 10 percent of all filings with the IRS. That
But Citi got away with it by writing a relatively small
wasn’t good enough, though, for the brothers; they wanted
check to settle with the government. These guys took
Subsequently, the company spooled up brokerage and
It seems the lessons learned during the past several years
lending services that sought to capitalize on the trust
are that you can’t make money fraudulently, as eventually
they’d built from tax preparation. The company then
someone—whether the SEC or people like Eliot Spitzer—
greedily fleeced many small customers with its predatory
lending. This attracted the attention of the SEC and
That doesn’t seem to hinder Ken and his pals at the
brought on several individual and class action lawsuits—
bank though. The company has been in my sights for
including some from various state attorneys. Today—on
some time now. Just a few years ago, its accounting ills
the brokerage and financial services front—the company
garnered it attention when the bank literally made up the
continues to defend itself against a number of suits, and
bulk of its earnings by shifting its bad debts onto an
the National Association of Securities Dealers forced arbi-
Enron-like, off-balance sheet facility. Then it took profits
tration actions, many of which are far from settled.
back with the phantom sale of these bad debts. And
The company could have focused on being a solid citi-
Bank of America has continued to play with its financials
zen, helping individuals deal with the filing obligations.
But instead, greed took over. The rest is now left to the
Don’t forget the Parmalat mess either. This Italian-based
courts—to stop H&R block from perpetually causing finan-
company is just as crooked as Enron, if not more. It used
cial harm to an unsuspecting public.
Bank of America for lending and bond issuance, too. The
The more-recent crimes surround Enron—yes, Enron.
list of its thrilling and chilling clients involves multiple
Even after most was known about the company, H&R
financial crimes, and it’s getting longer and longer.
Block was shoveling Enron bonds into the accounts of its
Yet, Ken doesn’t care. He continues bilking shareholders
investors and customers, telling them they were completely
for millions—and he’s not alone. Check out Parmalat’s fil-
safe. Of course, they got to pocket a nice chunk of change
ings and you’ll see how much is literally being withdrawn
in doing so. Avoid H&R Block like the plague.
from the company by the bank’s top honchos. Like other
bankers/charlatans, including Citibank’s Sandy Weill and
Bank of America
David Komansky, none are going to see any
personal chills from their actions. Sell Bank of America.
Bank of America’s
(NYSE: BAC) profits jumped to a
record $21.1 billion. This helped cement CEO Ken Lewis’
Marsh & McLennan
An even fatter deal than his 2004 bonus, this one allows
We have two major concerns about Marsh &
him to take nearly $12 million out of the shareholder’s
(NYSE: MMC). First, the company’s mutual
pockets, $5 million more than the prior year’s bonus. That’s
fund unit, Putnam Investments
, was at the center of an
almost a 300 percent gain over the last five years in his
investigation spearheaded by Spitzer. The company
multimillion-dollar compensation deal, excluding perks.
allowed fund managers to market-time their funds—a
Wait—there’s more. Ken did have to grovel a bit when it
practice which tends to reduce long-term returns for fund
came to disclosing his good news, as it also included a
holders. In 2003, Putnam settled most of these charges,
$300 million hit in litigation fees during the past couple
paying a fine of around $110 million.
years or so. This didn’t include the near $70 million the
But although Putnam is the sixth-largest fund manager
company paid to settle charges it helped Enron and its
in the US, this is a fairly small chunk of the company’s
management bilk investors and lenders.
overall business. Marsh held up OK in the stock market
The really big news is that Bank of America settled
because it’s supposedly profitable and unrelated insurance
charges that it enabled Enron to fabricate financials by
brokerage business still makes up the largest chunk of the
misleading the market over its underwriting of Enron
securities. The bank is shelling out $69 million—again,
But the insurance scandal that hit in late 2004 changed
chump change. But it’s much more than we’ll get out of
that perception. It seems that Marsh, the largest insurance
broker in the US, may have been accepting kickbacks from
This is just the start, too. What about the personal
insurance companies in exchange for sending business
finances of the brokers and bankers at Bank of America?
their way. So not even that brokerage business was safe
After all, they were in on the fix. Don’t forget that manage-
ment knew full well the bank’s financing—it knew the
And nothing illustrates the changing role of the director
occurrences over at Parmalat
more than the recent scandal at Marsh. The pace of devel-
opments has been startling. Soon after Spitzer brought
American International Group
action against Marsh for taking kickbacks and rigging
bonds, it became apparent the company’s current manage-
(NYSE: AIG) is also under investigation by the SEC
ment wouldn’t be able to contain and address the problem.
on a number of issues. The first is that the company
There just isn’t a credible explanation for kickbacks.
appears to have colluded with the major insurance brokers
Spitzer met with the outside directors and discussed
to garner more business. The company paid special com-
the problems they faced. Much has been made of the
missions to companies, like Marsh & McLennan, to make
fact that Spitzer signaled that some management changes
sure they sent business AIG’s way.
were necessary. Urging the directors to think long and
But that’s really only one piece of a very large puzzle.
hard—very long and hard—about the leadership of their
AIG is also under investigation for selling products that
company wasn’t subtle advice. However, the directors
help companies smooth their earnings streams. These prod-
were faced with an even-more-compelling reason for
ucts were designed to look like insurance to auditors, but
change: Marsh’s stock had dropped almost 50 percent.
really they amounted to nothing more than loans. These
Although it would have been better for the board to
special loans and a few accounting tricks can help compa-
be more proactive at the outset, at least it’s moving
nies appear more profitable than they really are.
quickly now. The removal of CEO Jeffrey W. Greenberg
Meanwhile, AIG continues to be one of the most
was inevitable, and the selection of Mike Cherkasky was
favored stocks on Wall Street. Trading at almost twice the
brilliant. Mike, of course, came from Kroll
, which was
company’s book value and paying out a dividend yield of
grabbed by Marsh. Although he may be better skilled at
less than 0.9 percent, there’s no reason to own AIG, espe-
securing companies, his real asset to the board and for
cially with its unresolved legal woes. Sell AIG.
shareholders lies in his past at the District Attorney’s
It was there that he helped put Spitzer’s career in gear.
Mike was Spitzer’s boss and mentor for a while.
(NYSE: FNM), with more than $1 trillion in
Therefore, the choice for Mike may well have been the
assets, received an unwanted report card from the Office of
bit of heavy lifting that just once in a while a board actu-
Federal Housing Enterprise Oversight (OFHEO). OFHEO’s
report was a troubling and critical report of Fannie Mae.
Marsh has received low marks for corporate governance,
In 2003, Fannie Mae’s rival, Freddie Mac
, had serious
at least up until recent actions in the executive suites. The
management problems, fired its top management and
scandal here should be a message for directors at other com-
restated its earnings. Like Freddie Mac, Fannie Mae has a
panies that receive low marks for governance and independ-
special status as a corporation; it’s chartered by Congress
ence. They should ask why their corporate governance is
rated so low and ask whether this will lead to other prob-
After Freddie Mac’s financial fiasco came to light,
lems. They should also start asking questions and making
OFHEO started investigating Fannie Mae. With the
changes. The time for outside directors to think long and
issuance of OFHEO’s report regarding Fannie Mae, it
hard about their management is now. They really don’t want
appears the problems at the two mortgage giants are simi-
to have a special board meeting with Spitzer. Sell Marsh &
lar. And the OFHEO might feign surprise. However, it
should have been disclosed long, long ago.
The markets have reacted strongly to OFHEO’s report, and
Fannie Mae’s stock has been reeling. More bad news may be
ahead for Fannie Mae investors: The company disclosed that
Like Marsh and McLennan, Aon Corp
(NYSE: AOC) is an
the SEC has opened an informal inquiry into its accounting.
insurance broker and was named in the recent lawsuits and
Among other things, OFHEO concluded that Fannie
investigations brought on by Spitzer. What’s even worse is
used various mechanisms to misrepresent its financials,
that Aon doesn’t have the financial resources or personal ties
including applying accounting methods that don’t comply
to Spitzer that may help Marsh save itself. Aon has a lot of
with generally accepted accounting procedures, or GAAP.
debt and a market capitalization of about half of Marsh. Sell
Similarly, they violated or at least took advantage of
Aon; the legal woes are just beginning for the stock.
Financial Accounting Standards Board Rule 113, which
that huge loss suggests there may be more skeletons lurk-
With a financial restatement looming in the future for
Fannie Mae, it’s almost inevitable that legislative steps will
And the core lending business isn’t looking very healthy
be undertaken to strengthen the regulatory oversight over
either. Fifth Third is starting to feel the pinch of a more
both Fannie Mae and Freddie Mac. The sooner this hap-
competitive market for customer deposits in its core
pens, the better it will be for both investors and the US
Midwest markets. As interest rates rise, banks in the region
mortgage and housing markets. Sell Fannie Mae.
have started to get more aggressive in raising the interest
rates they pay to checking and savings account depositors.
Fifth Third Bancorp
In fact, Fifth Third has already significantly boosted its
checking and savings interest rates, a move that’s been
Fifth Third Bancorp
(NSDQ: FITB) is a regional bank-
matched by some of its key Midwest competitors.
ing group based in the Midwest that does everything
More important, Fifth Third hasn’t been able to fully
from commercial lending and investment services to
compensate for the higher cost of deposits by charging
mortgage loans—but not very well. Although we aren’t
more for lending money. That means the bank’s net interest
necessarily bearish on the regional banking group in
margin, the difference between the interest income Fifth
general, Fifth Third has a long history of mishaps and
Third receives from its loan book and the cost of
Some companies have had no trouble managing interest
Fifth Third’s net interest margin at the end of 2004
rate risk yet, but Fifth Third reported a more than $320 mil-
stood at 3.62 percent. By the end of 2005, the ration
lion exceptional loss in late 2004 in its securities and inter-
stood at 3.23 percent. Although that’s still a healthy ratio,
est rate swaps portfolio because of rising interest rates.
on the margin it has the effect of reducing the profitability
Given just how little prevailing bonds yields rose in 2004,
of Fifth Third’s lending book. Sell Fifth Third Bancorp.
Energy the Wrong Way
bonuses for management and the boards. And the rest will
be blown on crazy investment deals while little investors
Because of high energy and oil prices, the main-
get squat (unless they cash out of their shares and take the
stream oil companies have continued to report huge—
gains for the near term while they still have them).
no, huge isn’t big enough word—super-huge windfalls
ExxonMobil is the most-recommended oil company on
of revenues recently. The cash hordes that have been
Wall Street, and high oil prices have been great news for the
quickly accumulated by the big integrated oils now
company. But it pays a paltry 1.8 percent dividend to its
shareholders, only a tiny fraction of its ever-growing cash-
In the past, companies like ExxonMobil
pile. We’d much rather see the company up its dividend
and its peers have blown the cash on various ill-con-
payout rather than blowing this cash on another ill-fated
ceived or ill-executed schemes. But if you’re an
scheme. But given Exxon’s track record, this seems unlikely.
investor, you should demand that it be paid out in cash
In the longer term, there are better ways to play the energy
group. ExxonMobil has underperformed our favorite energy
More than likely, most of the cash will be paid in fat
plays during the past five years, despite a more than tripling
of oil prices. Other companies have fared much better than
worth of Tyco’s cash through improper loans from the com-
that. And in Personal Finance,
we prefer to focus on compa-
pany and fraud. And Kozlowski was already one of the
nies that pay us to hold them. That’s not ExxonMobil; sell the
most highly paid executives in corporate America, even as
he was supposedly bilking shareholders for hundreds of
millions. They also inflated Tyco’s profit by more than $5.8
billion from December 1999 through June 2002.
Tyco has some fine businesses in its conglomeration, but
Most investors remember the troubles Tyco
who knows how long they’ll be there. Tyco recently announced
had in the past. Tyco was involved in a number of
a breakup of its major divisions. Shareholders are filing suits
accounting shenanigans, and senior management was
to prevent the breakup, but the outcome is anyone’s guess.
about as crooked as it comes, more or less stealing money
You could trust the new CEO, Ed Breen, but give his team
directly from the company’s coffers.
more time to prove itself. Recovering from the misdeeds of
At the epicenter of Tyco’s near collapse was former CEO
past senior managers is no easy task, especially when cutting
Larry Dennis Kozlowski. Kozlowski and the company’s
loose profitable divisions. We can always come back if the
CFO Mark Swartz made off with as much as $600 million
company fixes itself up and its falling profits. Sell Tyco.
Cleaning Out Your Portfolio
(NYSE: RGC) Negative
Bank of America
Marsh & McLennan
American Int’l Group
Fifth Third Bancorp
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