Tales of Financial Greed and Bad Behavior

Stock Market Video

Don’t Do This! World-Class Mistakes

A Cause A Day Keeps Reality Away

In Case You Missed It

In this week’s Stock Market Video, Mike Cintolo discusses how the market’s intermediate-term trend remains down, and thus, he’s playing things relatively defensively–holding some cash, not doing much buying, but also not selling much at this point either. He also points out numerous tight set-ups he’s watching, many in non-growth sectors. Stocks mentioned include Michael Kors (KORS), Silver Wheaton (SLW), Catamaran (CTRX), Ensco (ESV) and the Financial (XLF) and Emerging Markets (EEM) exchange traded funds.

It’s always fun (and instructive) to read stories about people who are noble and good and successful; Investors Business Daily always features at least one in its front section. These people give us good models to follow and give us hope that we, too, can overcome stiff odds and triumph at what we do. But I have to admit that I’m also drawn to stories about people who screw up royally. These stories allow me to feel superior—or at least lucky—and invite speculation about the answer to the age-old question “What was he thinking?!?”

Don’t Do This! World-Class Mistakes

In light of recent market fluctuations, I thought I’d share a few tales of greed, bad behavior and just plain mistakes that have popped up in the financial press over the years. I’m leaving out plenty of stories of pyramid schemes and outright fraud, preferring ones without hardened criminals at their heart. Think of them as “Shark Week” or “Storm Stories” for investors.

  • Kent Ahrens was a securities trader for First Capital Strategists, a firm that had been around since 1980, but only registered with the SEC as a registered investment advisor in 1988. Ahrens, for reasons known only to himself, decided to make some unauthorized trades on behalf of First Capital’s Common Fund, a fund that consolidated holdings for a group of college endowments. After losing $137.6 million for the Common Fund, Ahrens pleaded guilty to one count of fraud, paid a fine, and agreed to be permanently barred from ever handling anyone else’s money. Not a bad idea.
  • In 1995, Barings Bank—a venerable institution that had financed the Louisiana Purchase and the Erie Canal and was Queen Elizabeth’s personal bank — was declared bankrupt and was bought by the Dutch bank ING for one British pound.  This ancient institution, founded in 1762, was wiped out by the unauthorized trading activities of one 28-year-old man named Nick Leeson. Leeson was a young star at Barings, in charge of the bank’s Singapore securities office. His real job was to execute trades for other departments and clients of Barings, and to make tiny arbitrage profits by exploiting differences in Nikkei futures trading on different exchanges. With no supervision, Leeson soon moved into the immensely risky business of trading futures on the Nikkei 225 stock index and Japanese government bonds. After some initial bad luck, he kept raising his bets, hoping to cover his losses.  He managed to conceal those losses until they reached about $1.4 billion (!), at which point Barings didn’t have enough money left to meet a margin call and was declared bankrupt. Leeson had a number of years in a Singapore prison to think about where he’d strayed from the straight path.

Of course it doesn’t take criminal behavior to bring about disaster; in the computer age there have been lots of honest mistakes, instances of what computer geeks call “fat fingering” the trading keyboard, that have had dire results.

  • In 2005, a lowly computer operator at Japanese securities giant Mizuho Securities made a little mistake. He was supposed to sell one share of stock from the company’s holdings in J-Com, a manpower recruitment firm, for 610,000 yen.  Instead, in one of those “oops!” moments that happen to all of us, he sold 610,000 shares of J-Com for one yen apiece. That was, unfortunately, about 40 times more J-Com stock than Mizuho owned at the time. The firm tried to cancel the order within two minutes, but the Tokyo Stock Exchange blocked the attempt.  The cost to Mizuho of having to buy enough stock to cover the sale is said to have completely wiped out the company’s profit for three months. It also resulted in the resignation of the Chairman of the Tokyo Stock Exchange when it was decided that the Exchange’s trading system was partly to blame, tagging it with half of the loss.(It’s a nice footnote to the J-Com story that an unemployed freelance trader who bought a ton of the mispriced stock wound up with a profit of about two billion yen (about $18 million) after the dust settled. Even financial disasters can sometimes rain gold down on those who least expect it.)
  • Just one month later, on the first trading day of 2006, an employee at the investment bank Nikko Citigroup was trying to buy two shares of Nippon Paper for his private portfolio. (Some Japanese equities are very expensive, and Nippon was trading at about 510,000 yen a share)  He followed all of his employer’s rules and put the order through Nikko’s own trading department…with one small error. You guessed it: his order was put through for 2,000 shares. The compliance department apparently failed to notice that the order (worth about $10 million) was more than 74 times what the employee had in his account. This one took months to iron out, but there were no high-level resignations.
  • And finally, just to show that these things just keep happening, on August 1, 2012, a software glitch at Knight Capital caused the company’s computers to buy billions of dollars worth of 148 different stocks. By the time the company unwound the unwanted positions, its losses were up to $460 million and the company was on the verge of bankruptcy. The outcome of this particular trading disaster is still in doubt.

If these tales of financial disaster are helping you to put the current market rumblings in perspective, you can find lots more on the Web. Just Google Joseph Jett and Kidder Peabody, Toshihide Iguchi and Daiwa Bank, and Robert Citron and Orange County, California. You’ll find links to many more.

If you’re in the mood for even bigger financial disaster stories involving speculation and gullibility, you might check out the Tulip Bulb Mania (crashed in 1637), the South Sea Bubble (crashed in 1720), the Mississippi Bubble (crashed in 1721), the Florida Real Estate Bubble (crashed in the late 1920s), the Nikkei Bubble (crashed in 1989), or the Tech Bubble (crashed in 2000), or the Housing Bubble (crashed in 2008), with the latter two providing the downside shocks that have made the past 11 years such a perilous time for equity investors.

All of these stories teach the same lesson, but it seems to be one that every new generation of investors has to learn first hand. That is: if it seems too good to be true, it probably is. Or, to put it another way: crashes always occur; but they occur only when a majority of investors believe that a crash is impossible and that it’s really different this time.

Here’s this week’s Contrary Opinion Button. Remember, you can always view all of the buttons by clicking here.

Admittedly, every one of us has our own personal reality, and knowing true reality is something for philosophers. Nevertheless, if we are open-minded, we can understand enough of other people’s realities to come closer to understanding the collective reality that governs the stock market, which is good. Contrarily, if we are too wrapped up in causes, we are liable to be blinded to the reality of others and commit grave investment errors. (Note: this is the only quote attributed to Jim Fraser, co-host of the Contrary Opinion Forum in Vermont for many years, and I’ve been unable to determine where he originally published it.)

In case you didn’t get a chance to read all the issues of Cabot Wealth Advisory this week and want to catch up on any investing and stock tips you might have missed, there are links below to each issue.

Cabot Wealth Advisory10/29/12 — The Best Investing System

Tim Lutts takes on the task of identifying the best investing system, comparing the pros and cons of four: small-cap, growth stocks, value stocks and exchange-traded funds (ETFs).

Cabot Wealth Advisory 10/30/12 — 20 Tips to Become a Better Investor 

Mike Cintolo keeps this list saved on his computer; whenever he’s in a rut, he reads through these tips to make sure he’s not violating some core principles. Stock discussed: Silver Wheaton (SLW). 

Cabot Wealth Advisory 11/1/12 – 3 Revolutionary Investment Ideas 

Tim Lutts writes that businesses with revolutionary factors are where he finds some of his greatest investments. Interestingly, his three ideas are related to automobiles. Stock discussed: Polaris Industries (PII).

Have a great weekend,

Paul Goodwin


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