March 25, 2023

High & Low Finance: Going Dark, and Putting Blindfolds on Investors

That is happening more and more often as companies avail themselves of the right to “go dark” because they do not have very many public shareholders. They no longer have to file financial information with the Securities and Exchange Commission, but the securities are still publicly traded.

These days, such investors seem to have few friends. Congress is much more interested in making it easier for companies — or “job creators” in the current jargon — than it is in protecting unfortunate investors. The so-called JOBS Act, enacted last year with widespread bipartisan support, included a provision making it much easier for small banks to go dark, and hundreds have done so.

Going dark, it should be noted, is not the same thing as going private. When that happens, securities are purchased from the public investors. They may not like being forced out, but they are out.

Not so when a company goes dark. The investors are in, but they may or may not be told what is going on. Companies that go dark sometimes make audited financial statements public, and sometimes they do not.

There is no better example of the perils of going dark — as well as proof that “preferred” can be a misnomer when it comes to stock — than the former Equity Inns, an owner of hotels, whose common shares were acquired by Goldman Sachs in 2007.

Although the common shares went away, preferred shares remained — or actually, new issues of preferreds replaced old ones. What has happened since then “smells like insider trading,” says James J. Angel, a finance professor at Georgetown University and an investor in the preferred stock. Goldman says that is nonsense.

While Goldman acquired the common stock, for $23 a share, or $1.9 billion, it did not acquire the $146 million of preferred shares in public hands. Those shares were in par values of $25 and had been sold primarily to individual investors interested in collecting a reasonably safe income stream. One series paid 8.75 percent a year, and the other 9 percent.

Before the takeover, those shares had been trading above par, and Goldman could have called them at par value. Instead, it took the preferred shares into the dark. The company assured the S.E.C. that there were fewer than 300 shareholders of record for each series of preferred, giving the company the right to go dark. The securities continued to trade over the counter in what Wall Street calls the “gray market.”

Goldman soon halted the dividend payments, and the share prices fell to as little as a penny.

How was the company doing? The financial statements were confidential, but Goldman did agree to let preferred shareholders see them — for a fee — as long as they signed confidentiality agreements that would prevent them from sharing the statements with anyone else, including prospective buyers of the shares.

Someone has, however, violated that confidentiality agreement. After I began calling around for this column, a set of financial statements arrived in an envelope with no return address. Assuming they are accurate, they show that over the three years through 2012, the company had net losses of $315 million on revenue of $1.2 billion. But most of those losses came from $251 million in depreciation. Operating cash flow was a positive $174 million. Told of some of the numbers in the statement, a Goldman spokeswoman did not dispute them.

Those numbers, however, are for the entire company. The preferred shares seem to have an interest in only 1 percent of the assets. If Goldman could find a way to put the 1 percent owner in bankruptcy, while keeping the other 99 percent out, it might be able to largely eliminate the preferred.

Even that might not be necessary. Goldman was also the lender in the deal, and perhaps it could restructure the debt in ways that would essentially give the debt holders — Goldman, that is — the ability to get everything, leaving the preferred shareholders with nothing.

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As Worries Ebb, Small Investors Propel the Markets

Millions of people all but abandoned the market after the 2008 financial crisis, but now individual investors are pouring more money than they have in years into stock mutual funds. The flood, prompted by fading economic threats and better news on housing and jobs, has helped propel the broad market to within striking distance of its highest nominal level ever.

“You’ve got a real sea change in investor outlook,” said Andrew Wilkinson, the chief economic strategist at Miller Tabak Associates.

While the rising market may lift the nation’s collective spirits, it will not necessarily restore everyone’s portfolios. In good times and bad, many individual investors tend to buy and sell at precisely the wrong moments. They dump stocks after the market falls and buy stocks after the market rises, the opposite of what investors aim to do.

Some market experts worry that might be happening this time, too. People who got out as stocks plummeted in 2008 and early 2009 have already missed a remarkable rally. The Standard Poor’s 500-stock index has soared 120 percent since March 2009, passing the 1,500 milestone. This year alone, the main indexes are up 5 percent. Now, the investing public seems more afraid of missing out than of misreading Wall Street again.

Americans’ latest stock-market romance is young, and it could easily fade before it becomes something more serious. Some market watchers warn that given the big run-up in prices, the market is already ripe for at least a brief correction.

Still, the optimism that has pervaded the market in recent weeks is a drastic change from recent years. Until recently, many investors had continued to shy away from stocks in the face of a trio of hovering problems — the potential breakdown of the euro zone, fears of a stalling Chinese economy and political brinkmanship in Washington that threatened to drive the economy into a new recession.

One after another, these threats appear to have dissipated. This week Congress found at least a short-term way around the nation’s debt ceiling, sidestepping Republican threats to let the government default when it reached a self-imposed borrowing limit in February or March.

As the fog of crisis has cleared, investors have more clearly focused on the cascade of good economic data pointing to a growing housing market, shrinking unemployment and corporate earnings that were stronger than expected.

“The last few weeks represent the belief that there will be no existential threat to any large global economy in 2013,” said Nicholas Colas, the chief market strategist at BNY ConvergEx group.

Jim Cole, a 52-year-old employee at the Bank of the West in San Francisco, had most of the money in his individual retirement account in cash at the end of 2012 as he awaited a bad outcome to the fiscal negotiations in Washington. Since Congress reached its agreement, he has put almost all of that money to work in stocks.

“I just bought some more stock this morning,” Mr. Cole said Friday. “There doesn’t seem to be this swirl of impending doom hanging over the U.S. economy or the world economy looking out six to 12 months from now.”

The optimism about the economy and corporate profits has helped fuel eight straight positive days for the S. P. 500, the longest such run since 2004. The S. P. 500 finished Friday up 8.14 points, or 0.5 percent, to 1,502.96.

The Dow Jones industrial average rose 70.65 points, or 0.5 percent, to 13,895.98, near its high. The technology-heavy Nasdaq composite index climbed 19.33 points, or 0.6 percent, to 3,149.71, still well below its peak in 2000.

There is no surefire data to use to gauge the behavior of retail investors. Some of those who left stock-focused mutual funds in recent years have put the money instead into specific stocks or exchange-traded funds, which hold baskets of stocks. But analysts agree that most indicators point to rising confidence in the market.

The level of bullishness among small investors has nearly doubled just since mid-November, according to a weekly survey conducted by the American Association of Individual Investors.

In the last three weeks, the market data company Lipper reported that $14.9 billion had gone into all stock-focused mutual funds, the most in any three-week period since 2001. Mutual funds focused specifically on American stocks have collected $6.8 billion since the new year, the most in all but one comparable period since the financial crisis.

Floyd Norris contributed reporting.

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Rule Change Would Allow Some Foreign-Owned Stores in India

The government said it would allow foreign retailers that sell just one brand of products — a group that would include companies like Ikea, Gap, Apple and Starbucks — to open wholly-owned stores in India, up from a maximum of 51 percent ownership now, if they met certain strict conditions. Many foreign chains, most notably Ikea, which buys a lot of furniture and furnishings from India, have not opened stores in the country because they did not want to take on Indian partners.

The decision follows a series of steps Indian officials took in recent weeks to bolster flagging investor confidence and increase foreign capital flows to support its slowing economy and the falling rupee. This month, for instance, policy makers allowed individual investors in other countries to invest directly in the Indian stock market, rather than being required to go through intermediaries like offshore funds.

Last month, many investors, foreign and domestic, said they were deeply disappointed when the government led by the Congress Party quickly reversed a decision to allow 51 percent foreign investment in multibrand retailing — a category that covers companies like Wal-Mart Stores, Tesco and Carrefour. Many had seen the decision to allow foreign retailers as a welcome spurt of free-market initiative by a government that has resisted such change in its seven-year tenure.

But many Indian political leaders, including some members of Congress and its allies, opposed allowing foreign retailers into the country, saying they would decimate small shopkeepers and wholesale traders that employ about 34 million people. Much of that criticism
was aimed at so-called big-box retailers like Wal-Mart Stores, which has a wholesale business in India.

The decision Tuesday to further open up single-brand retailing to competition, which officials had signaled
in early December, suggests that Prime Minister Manmohan Singh and his aides believe there will not be significant political resistance to niche foreign retailers, which will by and large cater to the middle and upper classes of Indian society rather than to the masses.

Still, the approval comes with some strict conditions that might be difficult for some companies to meet. Among them is a requirement that single-brand retailers buy 30 percent of the value of their products from small Indian businesses and artisans that have invested less than $1 million in plants and equipment. If, over time, the suppliers grow and invest more than that sum they will no longer be counted against the 30 percent minimum requirement. Previously, some analysts said that such a purchasing condition would violate World Trade Organization rules, which apply to India.

The new rules also say that investors wishing to own 100 percent of single-brand stores must own the brands that their stores sell, which would preclude franchisers. Another requirement would block companies from rebranding related goods made by others.

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Wealth Matters: Managing Risk in an Investment Portfolio

The debt debate fell into the category of events that could hurt your portfolio, with you having little control over it. The same goes for the drop in stock prices at the end of the week; even if you did everything right with your own finances, your portfolio still could lose value.

Yet there are many risks in people’s investments that they can control. How many investors, for instance, know what is in their portfolios and, more important, how those assets work — or do not work — together? How many people use several financial advisers who do not know what the other managers are doing? These and other common mistakes can expose a portfolio to unintended risks.

“This is a primary issue for individual investors,” said Stephen M. Horan, head of private wealth management at the CFA Institute, an association of investment professionals. “We have a much clearer sense of what return is than what risk is. But losses govern the accumulation of wealth to a dramatic extent.”

Here are three areas of risk that often get overlooked:

SECURITY SELECTION The classic example of unintended risk in a portfolio is the investor who buys six different mutual funds and thinks that equals diversification. What the investor may not realize is that all six funds can own 10 of the same stocks. Instead of diversifying risk, the investor has concentrated it.

Mr. Horan said investors needed to know what their holdings actually were. It is easy. Look up the funds’ Top 10 holdings, available on the fund’s Web site, and the sector concentrations. Then, investors need to have the courage of their convictions. Lynn Ballou, an investment adviser and also an ambassador for the Certified Financial Planner Board of Standards, said investors inadvertently increased their risk by being swayed by people who had little knowledge of their portfolio.

“It’s, ‘I went out to lunch with someone and he said, wink, wink, nod, nod, I’ve heard about this company and I’m going to buy some and you should, too,’ ” Ms. Ballou said. “All that is what I call sexy noise. And 99 times out of 100, it’s just fun lunch talk.”

But should investors act on those tips, they risk a problem that Chris Walters, executive vice president at Citizens Trust , calls “portfolio happens,” the accumulation of investments that are not part of an overarching strategy and do not work together.

At the extreme, he said, was a client who recently bought $1 million of gold bullion without telling anyone. “We said, ‘How are you going to get it home? What are you going to do with it?’ ” Mr. Walters said. But the best advice is to have a personal benchmark, pegged to when you will need the money, like in retirement. Thomas J. Pauloski, national managing director in the wealth management group at AllianceBernstein, said he urged his clients to do that.

“You want to get people away from focusing on the day-to-day jousting,” he said. In doing this, an investor hopes to reduce the risk of buying high and selling low.

MANAGING SECURITIES The market crash of 2008 has instilled a fear of being overly concentrated with any one manager or firm. But spreading out everything among different people is not the solution, either.

“We think about the best fund managers and do a pretty good job at the beginning of finding them,” Ms. Ballou said. “But we don’t stay on top of them. And then, it’s, ‘I just read my famous fund manager retired or got indicted — what do I do now?’ ”

She said more people should think about who is managing their portfolios the way they would think about a garden: after spending time planting beautiful flowers, they don’t let it go without pruning and weeding.

This discipline is not easy, even among the wealthiest. One investor, whose family’s wealth came from an agricultural products company and inheritance, said it was not until the family decided to move to another financial firm that they found out how much unintended risk was in their portfolio.

The investor, who asked not to be name to protect his family’s privacy, said the family had 5 percent of its $50 million of liquid wealth in Microsoft and 7 to 8 percent in Oracle. But since the stocks were held in various accounts, they did not realize how concentrated they were.

“We looked at the stock statements and not what was in the funds,” he said. “Microsoft and Oracle are great companies, but we didn’t have any other significant holdings.”

BNY Mellon Wealth Management performed the risk audit on the portfolio and the family moved their money to that firm. But Timothy E. Sheehan, senior director for business development at the firm, said the risk audits he did for clients were something anyone could do.

“All of this is public information,” he said. “But when you tell them they own 30,000 different equity shares, they say, ‘How did that happen?’ ”

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Fair Game: Inciting a Revolution: The Investor Spring

Mr. O’Donnell, a retired chief executive of the J. Walter Thompson Company, and a man who picks his own stocks, figured that if Twitter, Facebook and other social media could help oppressed citizens in Tunisia and Egypt rally for change, they could help disenfranchised individual investors too. You know, the folks who own shares in publicly traded companies but rarely get a say in how those companies are run.

Mr. O’Donnell found a group of like-minded people at the InvestorVillage Web site. All of them own shares in the Celgene Corporation, a bio-pharmaceutical company based in Summit, N.J., and all of them have been dismayed by what they see as outsize executive pay at the company, whose stock price has returned little over the last five years.

Celgene shares were trading at about $59 on Friday — roughly where they were at the end of 2006. Given that this is a drug stock, there have been many ups and downs over that time, of course. But returns have been slim for shareholders who held on throughout that period.

Mr. O’Donnell has owned Celgene’s shares for almost six years. He hastens to note that this is a well-managed company, with fine operational performance and plenty of promise. Nevertheless, he says: “A lot of frustration has emerged regarding shareholders’ lack of returns relative to management’s pay packages. The stock has been roughly flat, in spite of executional excellence. In the meantime, the C-suite has been richly rewarded.”

While Celgene’s executive pay was relatively stable from 2007 to 2009, last year it ramped up considerably, according to company filings. The top four executives received a total of $24.6 million in 2010, up 30 percent from the amount paid to the four highest-paid executives during the previous year.

The company’s stock price, by comparison, rose a mere 5 percent last year.

MR. O’DONNELL has tapped into an issue that concerns many individual investors but which many feel powerless to change. Yes, individuals get to cast their votes at annual stockholder meetings. But such votes can seem like exercises in futility for investors, because companies need not bow to investors’ wishes.

With last year’s Dodd-Frank legislation and regulatory rules requiring that companies put their pay practices to an advisory vote of shareholders at least once every three years, Mr. O’Donnell thought 2011 could be the moment to rally investors on the issue. An Investor Spring, as it were, just in time for Celgene’s annual meeting on June 15.

Reaching out to fellow holders, Mr. O’Donnell quickly hit pay dirt. David Sobek, an associate professor of political science at Louisiana State University, agreed to develop a Web site,, to attract other dissatisfied Celgene investors.

“I saw this as a collective action problem,” Mr. Sobek says. “How do you get a bunch of people with similar interests organized? Before the Internet, just tracking down fellow shareholders was almost impossible. But we have been able to organize people in a way that we didn’t think would be possible, and that in itself is a victory.”

To keep the group from being hijacked by gadflies, the organizers specifically asked those interested in joining to refrain from “personally directed or emotional attacks” because they would “detract from the possibility that our concerns will be seriously considered by existing directors and/or institutions.”

After several months of outreach, Mr. O’Donnell and Mr. Sobek say that they received commitments from investors holding 2.7 million shares. These investors have promised to vote against Celgene’s pay practices and all directors up for re-election who have sat on the board’s compensation committee.

They also said they would vote to require the company to put its compensation practices to a shareholder vote once a year, rather than once every three years as management recommends. With approximately 461 million shares outstanding, 2.7 million shares voted against management’s proposals and board members will by no means be enough to prevail. Institutional shareholders control roughly 90 percent of Celgene’s shares, and these investors typically vote with management.

Still, voting as a bloc might get the group of disgruntled investors more attention from Celgene’s board and management. Representatives of the group say they want Celgene’s board to re-examine its pay practices and align them more with shareholder returns. One concern: the company’s increased use of restricted stock in the last two years, rather than equity grants that are more closely aligned with a rising share price. Also disturbing to some investors is the fact that Celgene has a poison pill in place, an antitakeover device that shareholders view as entrenching management.

In its filings, Celgene describes the financial measures its board uses to assess its executives’ performance. These measures include growth in earnings per share and revenues — though they are not calculated using generally accepted accounting principles. The company also says it emphasizes long-term growth in shareholder returns.

Asked about the investor group and its rumblings, Brian Gill, a Celgene spokesman, responded that the company’s shares have been a top performer in the sector over the last 10 years. The company’s pay practices, he says, receive good grades from institutional proxy advisory services.

“We all feel the frustration of a company that continues to deliver these industry-leading operational financial results but at the same time exists in an environment where health care reform and austerity issues also impact the valuation,” Mr. Gill says. “We take every investor’s comments and recommendations seriously.”

THE outcome of the investor vote won’t be known until June 15, of course. Many of the investors who have joined to vote their shares expect to attend Celgene’s annual meeting.

“This is a test case to see how far one can go with this,” Mr. O’Donnell says. “It seems like it’s worth a shot. Maybe the individuals in the C-suite will have a greater sense of empathy for the collective individual investor. It will be interesting to see how it pans out.”

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