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RETAIL FIRST LOOK: SENTIMENT RULES

RETAIL FIRST LOOK: SENTIMENT RULES

SEPTEMBER 9, 2009

 

TODAY’S CALL OUT

Anyone who thinks that they can hide behind duration mandate and not at least acknowledge how near-term sentiment impacts their stocks is simply not being intellectually objective. 

 

Our analysis below breaks down over a hundred retail-related companies and triangulates buy-side sentiment, our sell-side ratings factor, and the delta in insider buying/selling. The visuals clearly flag areas of both risk and opportunity.

 

We break out the analysis into four charts/segments to avoid the visual from being illegible. We look at 1) apparel/footwear retail, 2) brands, 3) specialty retail, and 4) all other. We could write pages interpreting the charts, but we’ll let you make your own conclusions. Some of our initial take-aways are as follows:

 

  1. Bearish Callouts: These are names with low short interest, high sell-side factors, and no positive momentum with insiders buying. TJX, GPS, GCO, NKE, WWW, COH, CVS, KR, MAT, and FGXI.
  2. Bullish Callouts: Hated across the board. High short interest and negative sell-side factors. We omit any names where management is selling, and of course, look for instances where the opposite is happening. UA, BKS, VLCM, EK, ETH, LIZ, KSWS, and COLM. WFMI would be on this list of the insider selling factor was not the highest in the entire group (!).

 

Let us know if you’d like any additional depth or color on the analysis.

 

RETAIL FIRST LOOK: SENTIMENT RULES - Apparel Ftwr Retail

 

RETAIL FIRST LOOK: SENTIMENT RULES - Apprl Ftwr Brands

 

RETAIL FIRST LOOK: SENTIMENT RULES - Specialty Retail Companies

 

RETAIL FIRST LOOK: SENTIMENT RULES - Other

 

 

LEVINE’S LOW DOWN

Some Notable Call Outs

 

  • While the Street continues to reward GPS for its turnaround of Old Navy, lean inventories, and steady margins, the company is quietly experimenting with its direct brand, Piperlime. The multi-branded shoe site launched women’s apparel today. The offering consists of about 65 premium and designer contemporary brands. The offering is denim heavy, but also includes a wide range of sportswear. Free shipping and free returns are also included with each order. We wonder if this is now GPS’ in-house laboratory for testing fashion and then using the data in real time to influence the company’s vertically integrated merchandise.

 

  • The numbers and raw data associated with Walmart are always staggering and sometimes worth repeating. In this case, I stumbled across some data on Walmart’s private label brand “Great Value”. At an estimated $10 billion in annual sales, the brand would be the 39th largest retailer in the U.S if it were to stand alone. This makes it bigger then Bed Bath and Beyond, Whole Foods, amazon.com and Family Dollar. The brand is also very close to the amount of business P&G does with Walmart on an annual basis, which was just under $12 billion in fiscal ’09. We know the numbers are huge, but when we get a nugget like this it just acts as a reminder of the power and scale that Walmart exerts.

 

  • In yet another example that consumers continue to be driven by price, Craigslist debuted at No. 25 on the annual STORES Favorite 50 online retailers list ahead of well-known retailers like Gap (No. 28) and Zappos.com (No. 38). With consumers increasingly accustomed to shopping both traditional and non-traditional channels for best prices, it should come as no surprise that the other newcomers included Footlocker’s Eastbay.com (No. 27) and SierraTradingPost.com (No. 39).

 

 

MORNING NEWS 

 

-Online retailer Yoox Group has decided to push ahead with an initial public offering despite the uncertain financial markets - Shareholders of the Bologna, Italy-based e-tailer approved the IPO on Tuesday. Yoox is expected to list on the Milan Stock Exchange STAR segment for small companies by yearend. In the first half of 2009, Yoox’ revenues rose 46.6%. Geographically, Italy accounted for 27.6% of sales; Europe, excluding Italy, for 49.8%; North America for 14.9%, and Japan for 5.9% of revenues. The nine-year-old company operates its own online stores, yoox.com and thecorner.com, and runs e-commerce sites for designer brands, from Marni and Diesel to Emporio Armani and Emilio Pucci. During the first half, Yoox developed online stores for Moschino, Bally and D&G, bringing the total stores to 13. <wwd.com/business-news>

 

-Message at WWDMAGIC: High Fashion at Value Prices - Apparel and accessories retailers and manufacturers at the trade show here found common ground in the new reality — consumer frugality — and in how to deal with it. Although major challenges persist as the economy struggles for consistent traction, the three-day show at the Las Vegas Convention Center last week appeared more upbeat. But price sensitivity and cost-cutting remained key themes. <wwd.com/retail-news>

 

-Many online consumers come face to face with ads on Facebook - Online social networks like Facebook and MySpace accounted for more than 20% of U.S. online display advertising in July, says comScore Ad Metrix. MySpace and Facebook account for more than 80% of advertising on social networks. <internetretailer.com>

 

-Maidenform Brands, Inc., a global branded marketer of intimate apparel, has entered into a license agreement with Komar Company -  The license agreement grants Komar the exclusive right and license to manufacture, market, sell and distribute women's and children's sleepwear, women's long underwear and women's swimwear under certain Maidenform brands to select retailers in the U.S., Canada and Mexico.  <prnewswire.com>

 

-Indonesia's man-made fiber sector has been given a boost - Three major manufacturers having invested US $7.1 million on new factories and machinery which will help lower production costs. The three fiber manufacturers are PT Teijin Indonesia Fiber Corp PT Indonesia Toray Synthetic and PT Sulindafin. The new machinery will run on cheap gas instead of costly electricity. According to Secretary General of the Indonesian Synthetic Fiber Producers Association, new machines can cut from 5 to 10% of the current energy costs incurred by the companies. These three companies had purchased the new machineries under the technology up-gradation program initiated by the government, which entitles them to claim a subsidy of 10% on total investment. He said that there were 18 synthetic fiber manufacturing companies in Indonesia in 2007, out of which only 12 were operational. The sector had been experiencing a 10% hike in production costs because of the surge of crude oil prices.  <fashionnetasia.com>

 

-Report says Dick's Sporting Goods Top of Mind for Sporting Goods Shoppers - Full-line sporting goods retailers like Dick’s Sporting Goods and Sports Authority are top of mind when consumers think about where to shop for sporting goods, including footwear and apparel, but the larger and broader mass merchant stores like Wal-Mart and Target rise to the top when consumers are prompted with retail store names.  Data from the SportsOneSource 2009 Where America Shops report. Full-line sporting goods retailers are at the top of list, with Dick’s Sporting Goods (42%) and The Sports Authority (32%) at the top of the list for unaided awareness levels.  Both retailers ranked ahead of discount/mass merchant giant Wal-Mart (28%), indicating that when in the market for sporting goods, the first thought would be to go to a full-line retailer rather than an a other type of retailer. Foot Locker (21%) was the mall specialty retailer mentioned most often and Cabela’s (10%) was the most often mentioned outdoor retailer on an unaided level. Combining the unaided and aided awareness responses, Wal-Mart received the largest number of respondents (86%) indicating they were aware of the retailer, Foot Locker was second (85%) and Target was third (82%).  However, Foot Locker was the top-ranked retailer in awareness among teens and young adults. A bit surprising given the focus of the retailer, Foot Locker actually had a higher overall awareness level with females than males when assessing the adult (over 25 years old) survey demographic.  Only five retailers, including Dick’s Sporting Goods, Bass Pro Shop and Cabela’s, received higher awareness levels from males over the awareness level received by females. <sportsonesource.com>

 

 -Anna Sui for Target - Anna Sui for Target, part of the retailer’s Designer Collaboration series, channels the well-dressed women of “Gossip Girl” and debuts in 600 select Target stores out of more than 1,700 units, and on Sunday at target.com/annasui. Designer Collaborations taps established talents to create collections inspired by a muse, creative element or collaborative partner. Alexander McQueen launched the effort in March with McQ Alexander McQueen for Target, inspired by Leila Moss, lead singer of The Duke Spirit. Sui had wanted to design for Target for some time but “couldn’t figure out what the concept would be,” she said. When the retailer approached her with Designer Collaborations and the muse element, the project began to make more sense. <wwd.com/retail-news>

 

-After being sold by K-Swiss Inc. in May, Royal Elastics is repositioning itself under new ownership - John Bondoc, who previously worked at Royal as creative director and now heads REH, the investment group that bought the brand, said he has sharpened the demographic focus of the label. “We needed to tweak the brand identity,” he said. “Now, it’s younger, [directed at] the 15- to 25-year-old consumer, who is typically a creative-minded person in art, sport or fashion. It’s a lifestyle. The inspiration has to come from being young.” To help reacquaint the Royal Elastics team with the culture it’s targeting, Bondoc opened a design studio in a loft in downtown Los Angeles. “A lifestyle brand has to be embraced by the culture,” he said. Bondoc said he also was taking price points down. While the brand had sold for $80 to $250, the spring line will range from $60 to $80, with some signature product topping out at $110. “The idea is to cut off the extremely expensive end and add a lower-priced shoe,” he said. That move was made possible by one of the brand’s investors, a China-based footwear factory. Bondoc said he realized as he was putting together investors to buy the company that a strategic partner that could also produce more value-oriented shoes was imperative. <wwd.com/footwear-news>

 

-True Religion Nugget on Credit Card Division - True Religion, the Vernon, Calif.-based premium denim brand, stopped using factors in mid-July, opting to expand its own credit division and work closely with international distributors as well as small boutiques that pay with credit cards or cash on delivery. <wwd.com/retail-news>

 

-For Neiman Marcus Inc., it’s been one tough year of mounting losses and declining sales - The luxury chain Tuesday reported a $168.6 million net loss for the fourth quarter ended Aug. 1, including noncash pretax impairment charges of $143.1 million, compared with a net loss of $35.7 million in the prior year’s quarter, when there were $31.3 million in charges. On an operating basis, the company lost $192.1 million in the last quarter, versus a $6.2 million loss a year earlier. With the nation’s affluent dramatically curtailing their store visits and purchasing less per visit, Neiman’s total revenues in the quarter fell to $768 million, compared with $1.03 billion in the prior year. Comparable revenues decreased 23.4%. Neiman tightly managed expenses, resulting in a total reduction of $183 million, which included the elimination of approximately $100 million of non-variable costs from our expense structure this year. <wwd.com/menswear-news>

 

-A new home range, the Country Living Collection, hits 1,200 Kmart stores and 500 Sears stores this week - The line features modern and traditional styles from the pages of the Hearst-owned lifestyle magazine. The collection includes fashion bedding, kitchen textiles, tabletop and bath ranges, as well as furniture. Items retail from $6.99 for washcloths to $279.99 for furniture. "The addition of Country Living to our portfolio increases the options available to our Sears and Kmart customers in both look and style, and in a broader range of products that our customer has already told us she wants," says Doug Wurl, vice president and general merchandising manager for home fashions at Sears Holdings Corp. "The magazine's reach, coupled with the accessibility of our stores and online channels, create the potential for a true national brand with elevated design sensibilities and enormous appeal." Country Living magazine offers more than 11 million readers content on decorating, gardening, entertaining and travel.  <licensemag.com>

 

-Burberry Group plc is set to join the most exclusive club on the London Stock Exchange, the FTSE 100 - The FTSE 100 is a listing of the companies with the highest market capitalization on the LSE. As of Tuesday’s close, Burberry’s market capitalization was 2.2 billion pounds, or $3.63 billion. The figure has tripled over the past year. Burberry is the only fashion and luxury goods company currently in the FTSE. By contrast, L’Oréal, PPR and LVMH Moët Hennessy Louis Vuitton are listed on the CAC 40, the benchmark French stock market index. On Tuesday, Burberry’s shares closed at 5.08 pounds, or $8.38, up 0.5 percent on the previous day. “Burberry is so fortunate to have such a strong momentum, both at a corporate and brand level,” Burberry chief executive Angela Ahrendts told WWD on Tuesday. “The team remains focused on pursuing our core strategy, which we believe will continue to deliver shareholder value.” <wwd.com/retail-news>

 

 

RESEARCH EDGE PORTFOLIO: (Comments by Keith McCullough): BBBY

 

09/08/2009 03:23 PM

SELLING BBBY $36.52

Just doing a little housekeeping; making some sales in names we bought well on last wednesday's lows. We can always buy a stagflation victim lower. KM

 

 

INSIDER TRANSACTION ACTIVITY:

 

GPS:

  • Eva Sage, EVP, HR, sold 100,000shs (~$2.1mm) upon exercising the right to buy 100,000shs accounting for 100% of total common holdings.
  • Sabrina Simmons, EVP, CFO, sold 40,000shs (~832k) upon exercising the right to buy 40,000shs accounting for 60% of total common holdings.
  • Robert Fisher, Director, sold 277,013shs ($4.9mm) roughly 2% of total common holdings.

 

TJX:

  • Ernie Herrman, SEVP, Group President, sold 6,658shs ($241k) roughly 7% of total common holdings.
  • Jerome Rossi, SEVP, Group President, sold 1,331shs ($47k) less than 5% of total common holdings.

 

PSS: Matt Rubel, Chairman, CEO & President, sold 100,000shs ($1.6mm) under 30% of total common holdings.

 

SKS: Stephen Sadove, Chairman & CEO, sold 100,000shs ($598k) less than 10% of total common holdings.

 

CHS: John Burden, Director, purchased 10,000shs ($610k) adding approximately 20% to total common holdings

 


The Creditor

“It does not matter how slowly you go so long as you do not stop.”
-Confucius

Finally! Last night, someone had Steve Forbes give Larry Kudlow a tutorial on our two factor global macro model: Chinese Demand and The US Dollar. At the end of Forbes walking through our Burning Buck thesis, Kudlow actually cited Confucius – well done Larry, you’ve evolved!
 
What this means is that consensus on the US Dollar is finally registering as bearish enough. What are this morning’s confirmations of our 6-month old Burning Buck thesis?
 
1.      Wall Street Journal – Dollar Down is a front page story this morning

2.      UBS - the world’s 2nd largest currency trader is “cutting their US Dollar” forecasts this morning (thanks for the Early Look!)

3.      China, Russia, and even the United Nations are calling for a redo of Bretton Woods!

 
As Forbes pounded home last night, this isn’t rocket science (maybe that’s why the hockey head got this right!). It’s been politically unacceptable for Washington to confront while in the moment. Now, as the STAGFLATION 101 tutorial takes its time morph into Wall Street’s storytelling, President Obama is going to have to deal with this political football. He is more of a basketball guy. Unfortunately, on his currency bench, all he really has to defend the Dollar is a Squirrel Hunter.
 
Understanding that his glaring partisan political views perpetuate his being allowed to understand Forbes’ Burning Buck revelations, Kudlow and many other raging Republicans are definitely going to take the Democrats to task on this – as they should. Bush was held liable for a cycle high August of 2008 US CPI (Consumer Price Index) reading of +5.3%. Remember $150/barrel oil? Goldman’s analyst would rather you wouldn’t – so would the politically polarized US Federal Reserve. Politicians are perpetuating price volatility, not “traders”…
 
At the end of the day, this isn’t about political parties. This is about the most politicized monetary policy that this country has ever seen. Both Bush and Obama signed off on a Burning Buck. This isn’t about being a Republican or a Democrat. This is all about having The Creditor’s pay the Debtors bills.
 
Again, Forbes was much more eloquent than my arthritic hockey knuckles can be in the morning in explaining that America’s Creditor is CHINA. So, I’d like to thank him for explaining that. The Creditor is no longer interested in sponsoring Lehman leverage ratios of 40:1, or the bonuses embedded therein. Nor are they interested in seeing the Fed’s balance sheet ramp for the 4th consecutive week to a new high of $2.09T US Dollars.
 
Back to stagflation – let me be clear that this one isn’t global this time. It’s very much a pending US problem. It’s born out of Burning the Buck. As the US Government torches the US currency, they’ll import inflation in Q4. As inflation accelerates sequentially and growth remains stagnant, that’s called stagflation.
 
I know, I know – some of the Big G (government) Keynesians aren’t going to like this. Don’t worry, they got run-over being blind to it in the 1970’s as well. However, be sure that The Creditor has done the required reading on global economic history. That’s why the Chinese are buying gold and selling US Dollars. They aren’t paid by Hank Paulson and Co’s Wall Street of Gordon Gekko past to be willfully blind.
 
The Creditor’s stock market closed up for the 6th consecutive session last night, taking the Shanghai Composite Index to 2,946. Yes, Chinese shares have corrected -15% from their YTD high, but don’t forget that they are still +62% for 2009 to-date. The metaphor of American style leverage, the Dow Jones Industrial Average, is only up +8.2%, lagging almost every major stock market index in the world.
 
The Creditor’s New Reality trading partners continue to prosper alongside strengthening domestic currencies. Germany, Australia, and Hong Kong are all within 1% of their YTD stock market highs. At the same time, all of these countries do not sponsor the USA “Great Depression” emergency rate of ZERO percent for their respective countrymen’s savings accounts, nor do they sign off on Burning their local Bucks.
 
Germany reported 0% Consumer Price inflation for the month of August this morning. The way that this is going to work from here is that Germany’s white hot Euro ($1.45) is going to import consumer price deflation for their domestic savers. Again, stagflation is going to be a US centric problem – not the world’s problem. That’s why Gold can rage higher at the same time that US Treasuries hold a bid.
 
US Treasuries aren’t going down because the bond market doesn’t smell a sustained level of US growth going up. Gold is going up because the world’s reserve currency is burning. The combination of the two doesn’t enthuse The Creditor. The Creditor will be looking elsewhere to invest their savings as a result. When it comes to selling down their US exposures, “it does not matter how slowly” they go, so long as they don’t stop.

If the US Dollar stops going down today, I expect stocks and commodities that are priced in those Dollars to stop going up. Will the SP500 make a lower-high? We will have to see about that. My intermediate term Range Rover target to the upside for the SP500 remains 1041. I have my first level of support at 1016. Next stop after that is 1008.
 
Best of luck out there today,
KM


LONG ETFS

VXX – iPath VIX We bought volatility on its lows on 9/3 ahead of last Friday’s employment report.

XLV – SPDR Healthcare We’re finally getting the correction we’ve been calling for in Healthcare. It’s a good one to buy into. Our Healthcare sector head Tom Tobin remains bullish on fading the “public plan” at a price.

EWH – iShares Hong Kong The current lower volatility in the Hang Seng (versus the Shanghai composite) creates a more tolerable trading range in the intermediate term and a greater degree of tactical confidence.  

CYB – WisdomTree Dreyfus Chinese Yuan
The Yuan is a managed floating currency that trades inside a 0.5% band around the official PBOC mark versus a FX basket. Not quite pegged, not truly floating; the speculative interest in the Yuan/USD forward market has increased dramatically in recent years. We trade the ETN CYB to take exposure to this managed currency in a managed economy hoping to manage our risk as the stimulus led recovery in China dominates global trade.

TIP – iShares TIPS The iShares etf, TIP, which is 90% invested in the inflation protected sector of the US Treasury Market currently offers a compelling yield. We believe that future inflation expectations are currently mispriced and that TIPS are a efficient way to own yield on an inflation protected basis, especially in the context of our re-flation thesis.

 
SHORT ETFS
 
DIA  – Diamonds Trust We shorted the Dow on 9/3.  In the US, we want to be long the Nasdaq (liquidity) and short the Dow (financial leverage).

LQD – iShares Corporate Bonds Corporate bonds have had a huge move off their 2008 lows and we expect with the eventual rising of interest rates that bonds will give some of that move back. Shorting ahead of Q4 cost of capital heightening as access to capital tightens.

EWJ – iShares Japan While a sweeping victory for the Democratic Party of Japan has ended over 50 years of rule by the LDP bringing some hope to voters; the new leadership  appears, if anything, to have a less developed recovery plan than their predecessors. We view Japan as something of a Ponzi Economy -with a population maintaining very high savings rate whose nest eggs allow the government to borrow at ultra low interest levels in order to execute stimulus programs designed to encourage people to save less. This cycle of internal public debt accumulation (now hovering at close to 200% of GDP) is anchored to a vicious demographic curve that leaves the Japanese economy in the long-term position of a man treading water with a bowling ball in his hands.

SHY – iShares 1-3 Year Treasury Bonds  If you pull up a three year chart of 2-Year Treasuries you'll see the massive macro Trend of interest rates starting to move in the opposite direction. We call this chart the "Queen Mary" and its new-found positive slope means that America's cost of capital will start to go up, implying that access to capital will tighten. Yields are going to continue to make higher-highs and higher lows until consensus gets realistic.


THE MACAU METRO MONITOR

CONSTRUCTION OF MACAU’S LIGHT-RAIL SYSTEM SET TO START NEXT SUMMER macaunews.com.mo

Construction of Macau’s Light Rapid Transit project is to begin in June 2010, according to Lei Chan Tong, director of the Transport Infrastructure Office.  The first phase will focus on the completion of two main routes, costing an estimated MOP4.2 billion to build.  The "skytrain" system will connect the Macau Peninsula with Taipa over a 20 km-long track, complete with 23 stations. 

 

GAMBLER SEEKS TO BLOCK WYNN CASE scmp.com

Henry Mong Hengli’s attorney’s requested that a high court judge deny a motion by Wynn Resorts Macau seeking a summary judgment over HK$30 million in unpaid gambling debts.  One of the arguments being advanced is that the credit agreement between Mong and the operator was never approved by the local gaming regulator.  Wynn has argued that the Macau laws in question apply to credit agreements between casinos and VIP junket agents and were not focused on direct loans to players.  Wynn also points out its view that having casinos acquire advance approval from the bureau each time credit is issued to players would be impractical.

The implications of this landmark case are crucial to Macau’s gaming market, given the reliance on credit-driven casino play. 


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Ball Underwater: SP500 Levels, Refreshed...

At around this time last week, we were staring at the associated market impact of the US Dollar being that Ball Underwater that was released to the upside. As the Buck broke-out, equities broke down (taking the SP500 down for a -3.5% correction in 4-days).

 

Today, we’re seeing quite the opposite. As global risk managers sell that Dollar back down to new YTD lows (down -0.93% to $77.30), the REFLATION trade is back! (Energy, XLE, and Basic Materials, XLB, are the 2 best performing sectors in our 9 S&P Sector study, trading +3% and 1.4% on the day, respectively).

 

Gold is trading > $1000/oz. Oil is trading straight back up above its immediate term TRADE line at $71.12/barrel. Copper is making new YTD highs.

 

Dollar down = Ball Underwater. As simple as this inverse correlation sounds is as simple as simple does.  

 

After doing a lot of covering/buying on Wednesday of last week, I have been doing a lot of nothing for the last few days. Why? Well, A) I get the fundamental short case against the US Dollar (its once again broken across all 3 of our investment durations) and B) I’m happy watching one of the 24 stocks and/or ETFs we are long in the virtual portfolio find this last gasp of air.

 

Where does the air run out of the REFLATION trade? I’m sticking with the high-side of what we called our Range Rover line (updated 5 weeks ago at 1041 on the SPX).

 

My newly established lines of immediate term support for the SP500 are 1015 and 1008 (dotted green lines in the chart below). Intermediate term TREND support is now 952.

KM

 

Keith R. McCullough
Chief Executive Officer

 

Ball Underwater: SP500 Levels, Refreshed...  - a1

 


Slouching Towards Wall Street… Notes for the Week Ending Friday, September 4, 2009

Read It And Weep

 

We have just read the report from the Office of the Inspector General of the SEC, Case No. OIG-509, “Investigation of the Failure of the SEC to Uncover Bernard Madoff’s Ponzi Scheme”.

 

After reading this sorry document – the 22 page Executive Summary of a 450-pager to be delivered in the coming weeks – we can say with all sincerity that we truly hope there was massive fraud and criminal deception at multiple levels within the Commission.  We have been dealing with regulators for the better part of three decades, and we have seen some humdingers.  But even we are not so cynical as to believe the SEC is as incompetent as the Inspector General’s report makes them out to be.

 

Even a saint would come away with a ruffled feather and a diminished opinion of human nature after reading this report.  An unmistakable whiff of fraud, meddling and deliberate cover-up emanates from nearly every paragraph of this horrifying document.

 

This Executive Summary is required reading for everyone who works in the finance industry – as well as for everyone who invests, anyone who cares about how our government works, anyone who either believes in, or doesn’t believe in the capitalist system, and anyone whose life stands to be affected by the foibles of human nature.  The voters of this nation should have it emblazoned on the insides of their eyelids in laser-hot day-glo letters.  The government has failed its citizenry.  The SEC is surely to blame, but they are not to be blamed alone.

 

The morning after this document came to light, former SEC Chair Harvey Pitt found himself under the bright lights of the Bloomberg TV studio, defending with sad and weary mien the embattled Commission, and praising Chairman Schapiro for the job she is doing in upgrading the Commission’s staff and strengthening its mandate.

 

But then, Pitt would have to defend the Commission, wouldn’t he?  As would just about everyone involved with this sorry enterprise.

 

The OIG report finds that, as early as 1992, the SEC came into possession of information that, if followed up on in even  rudimentary fashion, would have brought Madoff’s scheme to light, and the game would have been over then and there.

 

Meanwhile, the Summary contains references too numerous to mention of moments where a dismally under-qualified staff of examiners actually came up with something so blatantly out of order that even they suspected it was wrong – and where senior SEC staffers overseeing the examination either failed to follow up, or specifically instructed the junior examiners to abandon a line of inquiry.

 

In one apparent case of routine regulatory numbskullery, a team of examiners was sent to Madoff’s offices because allegations had surfaced of improper dealings in the firm’s advisory business.  Once there, the team set about looking for evidence of front running.  When it was pointed out that this was not the reason investigators had been sent in, the SEC staffer in charge responded that, he knew that front-running was not the charge at issue, but that his team’s expertise was in analyzing front running, so they were performing a front running investigation.

 

(“What are you doing on your hands and knees?”

“I lost a contact lens.”

“Where?  Here on the floor?”

“No. Over there in the corner.”

“So why aren’t you looking over there in the corner?”

“There’s more light here.”)

 

The OIG’s Summary recounts six separate complaints brought to the SEC’s attention regarding Madoff’s business.  Two of them were from Madoff investors – which meant that even under the Commission’s own inane internal unwritten guidelines, they had to follow them up.  A third was actually submitted three times, each more detailed than the previous.

 

Regulators receive a lot of “tips”, many of which are so vague as to be useless – or clearly motivated by personal hostility.  One of the unwritten rules of regulatory investigations is that they can not follow up on everything, so a sort of regulatory triage takes place, in which first priority is given to allegations from insiders – partners of a money manager, C-level executives of a public company, supervisors, senior bankers or head traders in brokerage firms.  Red flag status is also accorded to tips received from immediate family – spouses are best – especially when the family member in question is part of the business enterprise.

 

As to other tips, unfortunately we see clearly how even the most detailed presentations were tossed aside.  We have read Markopolous’ report to the SEC.  It reads like a doctoral thesis.  For a senior SEC supervisor to toss it aside requires a significant level of willful negligence.  We hear the staffer in question had a personal animosity to Mr. Markopolous, and so she did not pass his report on to others who might take a closer look at Madoff’s business.  She no doubt taught Mr. Markopolous a lesson he won’t soon forget!

 

On top of the complaints, SEC examiners in an unrelated routine examination of another hedge fund came across internal emails describing with great specificity the fund’s own due diligence on Madoff, describing in detail why Madoff’s returns were not credible.  The fund’s internal emails identified red flags, including “(1) incredible and highly unusual fills for equity trades; (2) misrepresentation of his options trading; (3) secrecy; (4) auditor; (5) unusually consistent and non-volatile returns over several years; and (6) fee structure.”  The OIG report goes on to describe another internal email which “provided a step-by-step analysis of why Madoff must be misrepresenting his options trading.”

 

This email was neither the first, nor by any means the only report to come to the SEC’s attention raising serious suspicions as to whether Madoff was trading at all.  Many of these were based on a simple analysis that compared options volume reported by Madoff to his customers, with volume actually traded on the options exchanges on the days in question.  The presence of repeated, consistent vast discrepancies should have occasioned someone at the SEC to merely duplicate the exercise – we have heard arguments about SEC examiners being junior, not well enough trained to catch out a Madoff, but how much training does one require to pull a month’s worth of Madoff customer account statements and place a call to the CBOE to see whether the numbers match?

 

How about two substantial articles in well-regarded publications – Barrons’ and MAR Hedge – raising serious questions about Madoff’s operation?  The OIG report says Lori Richards – then head of Enforcement – “reviewed the Barron’s article in May 2001 and sent a copy to an Associate Director in OCIE shortly thereafter, with a note on the top stating that Arvedlund [author of the Barron’s article] is ‘very good’ and that ‘This is a great exam for us!’”

 

Not only did OCIE not open an investigation, the OIG report says “there is no record of anyone else in OCIE reviewing the Barron’s article until several years later.”  In other words: Lori Richards was the only person in her entire chain of command who actually read the newspapers – presumably this was part of the skills set that qualified her to head the Enforcement Division.  In keeping with her aggressive move to upgrade the Commission, we understand Chairman Schapiro intends to designate multiple Barron’s readers, to avoid a gap in coverage now that Richards is leaving.

 

The fact that never, at any time in any of the examinations or investigations launched by the SEC into Madoff’s business, did any SEC examiner call any third party to verify anything – not trading volume, not customer positions, not customer assets, not trades, executions, orders – nothing, means not merely that the SEC fell down on the job. 

 

The failure, in the course of an investigation, to independently verify any aspect of Madoff’s business is not an “oversight” or a “failure” on the part of the SEC staff.  It is not even a colossal and tragic blunder.  It is criminal negligence, pure and simple. 

 

We have sat through many a routine firm examination – NASD, SEC, exchanges, state regulators, we’ve dealt with them all.  Among the very first documents requested by an examiner is the trades blotter.  And one of the first steps an examination team does in a firm-wide review is to verify trading with the clearing firm or prime broker.  There are two simple reasons for doing this.  The first reason is to verify that the firm is keeping accurate records – or honest ones.  Since every firm knows its examiners will request the blotters, and that the blotters will be compared with the clearing firm’s records, there is high incentive to maintain accurate blotters.

 

The second reason examiners always verify a firm’s blotters with an independent source is – imagine what would happen to a regulator who failed to obtain third-party verification, and then it turned out to be a fraud?

 

Can you imagine such a thing?  Neither could Harvey Pitt.

 

Poor Harvey, sitting there ruefully wagging his head over the demise of what he characterized as a good – nay, a “great” agency.  Since part of Madoff’s scamming took place during Pitt’s tenure as SEC chair, he would naturally have to defend the staff and their actions.  This he did by speaking of how “dedicated” and “principled” so many of them are.  To be sure, Pitt also said – and it was his position historically, we recall – that the Commission was “over-lawyered”, with too many attorneys, and not enough market practitioners.

 

This gives us yet another opportunity to lay into one of our favorite flogging ponies – and to note that, while we continue to beat it, this horse is still far from dead.  We have raised numerous times the notion of bringing a high-visibility team of Wall Street professionals to the SEC.  The process whereby young talent goes from law school to the SEC, and thence to Wall Street, is exactly backwards and has resulted in, for one thing, Bernie Madoff.

 

We will briefly repeat our strong recommendation that the SEC bring in a team of industry compliance professionals and hand the examination and investigation process over to them.  In the few cases we are aware of where this has been tried, the professionals in question found themselves smack up against a brick wall of bureaucratic nit picking and internecine feuding over resources and authority occasioned by the Kafkaesque hierarchy of job grades and examination schedules.  While this is traditionally exactly the way to run a government bureaucracy, this is no way to regulate the world’s most important financial marketplace.

 

We are greatly encouraged by the Commission’s volte face under Chairman Schapiro.  In her Statement on the Release of the Executive Summary of the Inspector General’s Report, Schapiro mentioned that the SEC has already filed twice as many restraining orders related to Ponzi schemes as were filed in the comparable period a year ago.  Underlying all our criticizing, we have a fundamental respect for Mary Schapiro and the job she has done throughout her career. 

 

Where John Thain harmonized technologies to make the NYSE much more powerful, Mary Schapiro was stuck, in her tenure as NASD Chair, with having to harmonize personalities in her efforts to merge the NASD and NYSE cultures.  It is a testament to her perseverance and patience that she accomplished this thankless task.  Having spent two decades supervising these folks, we would sooner boil and eat our own scrotum than have to get a stadium full of financial professionals to work with one another.

 

That being said, any increase in enforcement, investigations and surveillance is an invidious comparison, when put alongside the Cox SEC.  Same store comps are going to be great when measuring against a property that was shuttered last year.  We know the Commission will be far more effective under Chairman Schapiro than under her predecessor.  The question is whether Chairman Schapiro will have the political will to make some nasty decisions – and, in the process, enemies – and whether Congress and the President will back her up.  Otherwise the accomplishments of her first year as SEC Chair will be recorded with an asterisk, and the hoped-for Change We Can Believe In will be reduced to Chump Change.

 

We are waiting with fearful anticipation for the full report, which we shall force ourselves to read cover to cover.  Make no mistake: while our experience dealing with regulators has frequently left us with a sense of the pathetic, we nonetheless feel an acute sting of embarrassment for an industry that has come to this sorry state, and profound personal chagrin at being a part of this, however remote from the squalid epicenter.  The shame of Bernie Madoff and his thieving associates – surely, no one believes he did this all himself – is a shame that permeates the financial industry.  The shame of those willing to benefit from Madoff’s “garden variety” fraud, who considered it “business as usual”, is a moral tragedy that tears at the very fabric of our society.  The opprobrium we heap upon the bunglers at the SEC is a shame in which we are mired too.  Truly, this brush has tarred us all.

 



Insaaaaane!!!

 

Now it can be told.  Speaking unabashedly from the front page of the Forward (4 September, “Crazy Eddie’s Cousin, A Former Fraudster, Speaks Out On Syrian ‘Subculture Of Crime’”), Sam Antar – cousin of “Crazy Eddie” Eddie Antar – told it like it is regarding the scandal that hit over the summer.  The arrest of several dozen New Jersey politicians, together with five prominent Rabbis (and a Moslem – let’s not forget the Moslem!) sparked outrage and “I told you so” from nearly every quarter.  Speaking on condition of publicity, Sam Antar spilled what beans he held regarding corruption in certain circles within the community where he grew up, and with whom he still has close ties.

 

Antar, who served as CFO of Crazy Eddie’s, was indicted along with his cousin, an uncle and other officers of the company.  In a journalistic passage that cleverly parodies the cadences of penitential prayer, the Forward article describes Antar’s “almost gleeful” willingness to discuss his past misdeeds.  “He lied.  He committed fraud.  He skimmed money.  He misled investigators.”

 

Antar’s version of the story is, his cousin and the other family members were going to blame the whole fraud on him – so he blamed it on them.  He turned state’s evidence, and got off with a suspended sentence, while his cousin and uncle went to prison.

 

Antar, who continued to live in the Syrian Jewish community after the scandal, believes he was largely left alone because, even though he turned on other members of the community, they were his own family.  In this community noted for being close-knit, blood is thicker than Arak.

 

The mainstream financial press, meanwhile, has run stories about the Madoff trustee gearing up to go after charities and claw back monies they withdrew from their Madoff accounts in the years before the scandal broke.

 

Call us cynical – please! – but we are convinced that all the biggest charities that invested with Madoff knew he was doing something highly immoral – or outright illegal.  The problem was, they were betting on the wrong crime.

 

Bernie started his career by taking advantage of a weakness in the system.  The weakness was called Spreads, and by rebating firms for their order flow, Bernie ended up pocketing most of the spread, while filling the customers on their respective sides of the market.  The seller got the bid price, the buyer paid the offer – Bernie paid a penny to each side, and kept ten and a-half cents.  God’s in His heaven, all’s right with the world.

 

The fine line separating commerce and crime is a fascinating topic, and Madoff’s tale may yet prove a laboratory for the analysis.  Where does an entrepreneur who exploits a weakness in the market slip over into being a criminal?  At what point does taking advantage of a market inefficiency become immoral – and finally, illegal?  And at what point does society intervene and place boundaries to this behavior?

 

Financial professionals who invested serious money with Madoff did so partly on the strength of his position in the marketplace – the unassailability of the man with whom many of them had traded in earlier times, who bestrode the financial world like a colossus – one foot planted in the shadowy world of third-market trading where he could manipulate the hell out of every trade that came his way; the other crushing the windpipe of the regulators in his capacity as Chairman of NASDAQ and senior advisor to the SEC.

 

Then there were senior foundation officers at the charities that gave Bernie millions – tens or even hundreds of millions.  These were intelligent, dedicated and hard-working professionals, generally people who understood the working of the markets.  While they did not go to the length – quite simple, really – of third party verification of the Madoff Magic there were many who assiduously teased apart the monthly statements sent to them by Madoff & Co, and who kept coming to the conclusion that he was front running and skimming pennies off customer trades – in effect picking off his own customers, as well as pocketing the spread. 

 

They figured out that Bernie was committing a low-level fraud on a massive scale, taking undisclosed bits and pieces, then doling them out to this investors.  To keep the performance steady, they thought he was doling out the profit in lean months, then holding back more for himself when he had good ones.

 

Imagine their surprise when they discovered that – yes – Bernie was breaking the law and stealing money; but – no – he wasn’t breaking that law, and he wasn’t giving them the money.  Bernie broke an altogether different law, and he kept all the money for himself.

 

Aside from questioning just how “due” the due diligence was of these firms that were responsible for billions of dollars of foundation money, does it not seem reasonable that they should be clawed back on money they withdrew – especially if they believed they were receiving the proceeds of illicit activity?

 

As the rabbis in Sam Antar’s community can tell you, among the primary reasons God destroyed the world with the Flood in the time of Noah was the prevalence of a kind of theft we today call “victimless crime.”  It is the equivalent of skimming the third and fourth decimal places of interest-bearing bank balances; the equivalent of entering fictitious orders to manipulate the price of stock in the marketplace.  The equivalent of pocketing the spread, when no one on either side of the trade expected to share in it anyway.

 

These crimes are victimless, because no one gets hurt.  Actually, no one knows they have been hurt.  And isn’t that the same thing?

 

But someone does get rich.  How can it be that one person is becoming monumentally wealthy at the expense of others, yet the others appear to not be losing anything?

 

If you can figure that out, you are way too smart to work at the SEC. 

 

 

Moshe Silver

Chief Compliance Officer

 


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