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Random Thoughts
A Legal Scam,
Blessed by the SEC & FASB
by
Gaurang Bhatt, MD
 In
any genuine democracy there are checks and balances to prevent the abuse
of power. The internal checks are between the executive, legislative and
judicial branches. These failed before the Iraq war when the supine
congress gave the president a blank check. The judicial branch, which
despite its much touted independence and lifetime tenure has been a
handmaiden of the power elite throughout the history of the republic,
plumbed new depths of irresponsible collusion when it interfered wrongly
and injudiciously in the 2004 presidential election.
The two non-governmental guardians of democracy and the republic are a
free press and an informed and alert electorate. Due to the
consolidation of the press in large corporations, the fourth estate has
become a vested interest catering to the need of the owners and
indirectly to the benefit of the advertisers and the prurient interest
of the readers and viewers. All of us notice how the details of the wars
in Iraq and Afghanistan barely make the evening news or front pages
which are hogged by celebrity sex scandals, violent crimes, reality
shows and feel good stories. The stress of earning a living and poor
attention span, deteriorating education and limited time handicaps the
apathetic public. The electorate has historically been the weakest link
in all states past and present.
The present article details a legal scam in the stock markets. Tyco,
Enron, Worldcom, Adelphi and other scandals highlight how the executives
and directors illegally enriched themselves to the detriment of
employees and shareholders. Sarbanes Oxley was supposed to put an end to
that but the recent scandal of backdating options to a lower price to
guarantee a windfall profit for the insiders, shows that there are more
loopholes that need to be closed.
There is an even bigger legal scam that most investors are unaware of.
The Financial Accounting Standards Board allows earnings to be legally
manipulated by using changing and inconsistent standards for reporting
earnings. It has finally ruled to expense options but still permits
companies to report earnings pro-forma or use other shenanigans and once
again the financial institutions, publications and reporters acquiesce
silently in this scam. What is even worse is that while the insiders are
unloading their cheap option related stock at high prices, they are
using the precious cash of the company to buy back large quantities of
the inflated stock. This allows the price to remain high and the
insiders are absolved from bailing out when the stock tanks some moths
later. The stock price is often taken higher by this strategy, even as
the intrinsic value of the company deteriorates. The market makers
passively follow along, thus facilitating the distribution of this
overvalued security to mutual funds, whose managers are generally immune
to financial losses from buying overvalued securities as they follow the
herd instinct. Ultimately foolish individual investors jump on this
bandwagon and soon after the party comes to an end.
In the meantime the insiders have wasted corporate cash by buying the
inflated company stock, which they reissue as options at a cheaper price
to the same insiders who made the disastrous decision full of conflict
of interest. The cycle is repeated every few years. The SEC bears equal
responsibility for this legal scam, since it changed its former rule
that stock acquired by option exercise had to be held for three years
before it could be sold. The new rules allow the executive or director
to sell the stock on the same day that it is acquired and in fact impose
a tax on the paper profit on the day of the exercise, thus promoting the
behavior by the insider to minimize risk.
Brokerage houses and investment banks put out buy recommendations on
stocks oblivious to its intrinsic worth or disparity between price and
earnings growth, by using inflated discounted cash flow evaluations and
assuming and projecting the inflated current temporary annual growth to
infinite time. These same brokerage houses and investment banks may hold
conflict of interest large long or short positions in the securities
they praise or pan and also have a subsidiary that is a specialist or
market maker in the same security.
The whole enterprise stinks and is rife with conflict of interest, that
the regulating body like the SEC blithely ignores to the detriment of
the unknowing investor duped by public proclamations of strict
oversight. The investors have been brainwashed to reject Graham and
Dodd’s value investing to rely entirely on momentum and technical
trading which can be triggered by large capital to become a
self-fulfilling prophecy. This is how major large American institutions
make their profits and occasionally end up wrong to go belly up like the
eight billion dollar hedge fund recently. Thus for the ignorant
individual investor the market becomes a casino but with much greater
personal financial consequences.
October 1,
2006
Image under license with
Gettyimages.com
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Random Thoughts
The Week of October 1, 2006
Gandhi without blinkers: Follow the Mahatma – but
which one? by Rajinder Puri
Baluchistan Vs Pakistan by Ramesh Menon
Musharraf's Leadership by Bluff by Col. Rahul K.
Bhonsle
Mumbai 7/11 Train Bombings: Pakistan's
Involvement Proved by Dr. Subhash Kapila
A Legal Scam, Blessed by the SEC & FASB by
Gaurang Bhatt, MD
Mandate Minimum Agenda by J. Ajithkumar
A Killing Most Foul by Dr. Amitabh Mitra
Education in India is coming to Spectacular
Crossroads by Kusum Choppra
Death Lurks in White by VK Joshi
The Witty Side by Melvin Durai
Exercise may be Injurious to Health by
Neeta Lal
Baby Battles by Yvonne Barlow
Mother's Identity Crisis by Charumathi Supraja
Migrating in a Man's World by Nitin Jugran
Bahuguna
Battling Black Magic by Gagandeep Kaur
Theatre for Change by Marili Fernandez-Ilagan
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