The Single Greatest Analyst / Investigator / Short-Seller the World has Ever Known

While I wish I were referring to myself, I refer to Andrew Left of Citron Research (see my other articles referencing him). Once again today his bold assertions of fraud were vindicated when a court ruled that Conversion Solutions Holding Company & Rufus Harris did bad things. The SEC’s press release on the matter is hilarious. Here is an excerpt:

On the basis of the evidence presented at the hearing, the Court found that Conversion never had any business-related revenue, and that its only source of funds was an ongoing offering of convertible notes and/or stock that began before the time period charged in the Complaint. The Court also found that Conversion had not paid any money for any of the purported assets carried on its books, which consisted of various series of bonds, uncollected interest due on the purported bonds, and a document called the UCC-1 Note. The Court found that the UCC-1 Note is not a standard piece of commercial paper, but an eight-page document signed by an individual named David Hawkins, which purports to be an “Affidavit of Obligation” in favor of Mad Dog Builders, Inc. and Mr. Hawkins, and which contains references to purported legal concepts including the “individual energy protection maxim,” the “social cooperation protection maxim,” and the “Hebrew/Jewish Commercial Code.”

This leaves me to say but one thing: Evidently Rufus Harris was not quite as cool as THE Rufus from Bill & Ted’s Excellent Adventure:

Left’s articles on Conversion Solutions
Original report on Fronthaul Group (July 26, 2006)
Update on Conversion / Fronthaul (August 2, 2006)
Final report on Conversion (August 9, 2006)

I should also point out that as always, the penalty exacted upon Rufus Harris is utterly inadequate to deter future penny stock hucksters. Again according to the SEC press release: “The Court did not find a basis for disgorgement of any ill-gotten gains by Harris or Conversion.”

Disclosure: I have no connection to anyone mentioned above. I am not Andrew Left. I am not Rufus Harris. I cannot play the guitar. I have yet to meet a securities regulator who is neither stupid nor evil.

Let’s Hear it for Financial Armageddon

Some people thought I was crazy with my prediction back at the beginning of this year that we would see a crisis that would look like financial armageddon. But if you take a look at that article, my predictions (while not great) do capture the essence of what has happened. While I was wrong in predicting the demise of all the bond insurers and not the broker/dealers, I did make a couple good predictions:

June: Several regional banks based in California are paralyzed by bank runs. They declare bankruptcy. The FDIC estimates that the bailout of their depositors will cost $30 billion.

…

September: A large insurer reveals write downs due to mortgage-backed security losses equal to its book value. Its stock drops 90% in one day, leading the S&P 500 down 8%.

It is pretty eerie that my prediction of an insurer’s troubles corresponds closely to what has happened to AIG [[aig]]. These are scary times, but the worst is not over. Expect more bank troubles, including the failure of Wamu [[wm]] and maybe National City [[ncc]].

Bert & Ernie sing “Ante Up” by M.O.P.

Disclosure: I have no position in any company mentioned. I do have a friend who works at AIG. I have bank accounts and a mortgage at National City.

Why I Paid Timothy Sykes $2,000

I previously wrote about Timothy Sykes and his attempts to teach stock trading to the masses. That post is now my most commented-upon post on this blog and one of the most frequently viewed. Since writing that post I have changed my views on Timothy Sykes.

First, I have concluded that at least at the present time Sykes’ trading system works quite well. This does not mean that it will necessarily continue to work, and anyone using his system should not put blind faith in it. That being said, the basic premise of short-selling hyped-up stocks should continue to be successful far in the future, although the details of how best to do that will certainly change. I believe in Sykes’ system enough to trade a decent amount of money with it, and so far I have made quite a bit of money trading his system. You can see some of my successful trades on Covestor (on which I am currently ranked 13th).

I have become so convinced of the benefits of Sykes system that I bought his DVD, subscribed to a year of his TimAlerts service (whereby he sends his followers alerts every time he makes a trade, and I even recently bought the first Lifetime TimAlerts subscription (for which I paid him $2,000). I even signed up to be an affiliate to sell his products.

Normally a trading system will either produce a good probability of a profit (i.e., a high percentage of trades will be profitable) or a good ratio of average profit to average loss. Sykes’ system generates both a high percentage of profitable trades and profitable trades that make far more money than unprofitable trades lose. In this sense it is the Holy Grail of trading. The system’s major limitation is that it generates very few trading opportunities where more than a few thousand dollars can be easily deployed, although there are occasional trading opportunities where hundreds of thousands of dollars can be easily used. Also, there are relatively few trading opportunities. This limits the amount of money that can be made with this system to maybe a couple hundred thousand dollars a year at best. However, this limitation of the system also minimizes the chances that hedge funds will exploit the same inefficiencies that the trading system exploits and thus render the system ineffective.

The other problem with a trading system that produces few trading signals is that it is hard to keep from over-trading. The hardest thing to do is sit and wait, as evidenced by Sykes’ own history of impulsive, forced trades. While he was still able to reap huge profits, others may be less disciplined. I have already seen evidence of followers of Sykes’ TimAlerts service trading way too much (and Sykes himself has criticized his followers for this numerous times). I think it likely that some of them will trade away all their profits by forcing trades when the risk/reward ratio is poor.

My Original Criticisms Still Stand

In my original article on Timothy Sykes, I laid out three criticisms of his plan to teach trading to the masses. These criticisms still stand, although these criticisms point out the limits of an otherwise powerful system, rather than revealing the ineffectiveness of the system as I argued in my original article. Anyone considering following Sykes should consider the following:

1. While Sykes’ system will degrade gracefully (meaning that if it stops working it will gradually generate smaller profits, not change quickly from generating profits to generating large losses), I have already noticed cases where he and his followers’ actions have changed the chart patterns his analysis relies upon. He has enough TimAlerts subscribers that they can easily move the market in certain illiquid stocks. This makes using his system more dangerous than if he did not have so many followers.

2. Trading takes time. For many of Tim’s followers, with tiny $5,000 accounts, the amount of time they spend trading the system (especially if they do not follow his advice and ignore non-ideal trades) can be disproportionate to their gains. While I am a full-time trader (I utilize a few strategies, not just Sykes’ strategy), many of his followers have other, full-time jobs. Those people would be wise to concentrate only on the most ideal trades, lest they ruin their careers in a vain attempt to get rich trading.

3. Most people do not have the emotional restraint to be successful traders, no matter how simple and effective the trading system they use. This is my most important criticism. As even Timothy Sykes points out, over 95% of stock traders lose money. Those who cannot handle the emotional demands of trading will likely lose money even if they try to trade a system as simple and profitable as Timothy Sykes’ trading system.

As an illustration of my third point, I bring you the following example.

Nothing is Foolproof: The Case of Ross

As a subscriber to Sykes’ TimAlerts I get to see the comments made by other subscribers; they often share their trades and thus I can get a feel for how Tim’s followers are doing. The problem with any kind of stock trading, no matter how good the system, is that it requires a human to trade it. Human emotions seem almost designed to prevent successful stock trading.

I present here the case of “Ross”, a subscriber to Sykes’ TimAlerts service. Ross should serve as an example that an an emotional, undisciplined person can lose money trading a good trading system. I should point out that while he subscribes to Sykes’ alert service, Ross has not bought Sykes’ DVD. He also appears to be the exception among TimAlerts subscribers — most who post their trades appear to make money.

Sykes bought 4C Controls (OTC: FOUR) at $2.85 on August 18th. At 12:20pm Ross posted [subscribers-only link] “I am in with 300 @ 3.00”.  Sykes sold the stock around 12:55pm after it failed to go up as he had predicted. Ross posted that he was holding FOUR, saying “It looks like it is trying to work it’s way back up.” Sykes responded, saying “ross, in time, u’ll learn to cut lsoses quickly and not risk disasters.”

At 2:02pm, Ross wrote, “FOUR looks like it is going the right direction now.” Sykes castigated him, writing, “haha ross, looks like u got lucky, bad lesson.” Ross continued to hold FOUR overnight; the next morning he wrote, “Well I learned the hard way and lost more then half my money on FOUR this morning. I got in @ 3. and just sold for 1.35 That hurt. All my other trades I have done have tanked on me as well. Pretty much lost most of my money. Looks like I am out of the game for a while.”

While trading FOUR lost Sykes money too, Ross also managed to mess up easily profitable trades by letting his emotions get in the way. He said, “I messed up on USS and ZYXI and EVSO as well. I also made some other trades a friend suggested as well and they went the wrong way.” This was despite Tim having profitably traded those stocks. I myself had a profit margin of over 20% on USS.

Conclusion

If you want to try trading stocks, try following Tim Sykes’ system (I suggest just reading his website and analyzing his trades for a few months, although you can go ahead and directly buy his DVD or TimAlerts trade alerts service if you are rash); it is the best stock-trading system I have seen, as evidenced by Sykes’ top rating on Covestor and his multi-year performance record. However, most stock traders will lose money because they let their emotions rule them; using a profitable system will not prevent them from losing money. Recognize your limits and do not try to trade if you do not have the requisite emotional control. Don’t be like Ross.

Request for help – Looking for a direct market access broker

As my regular readers are aware, I have sold short a number of penny stocks over the last year. However, that strategy has not worked recently due to my broker, Interactive Brokers, forcing me to close out short positions without notice due to an inability to continue to borrow shares. I am therefore searching for a new and better broker. If you happen to know of any brokers that are good at getting long-term borrows on hard-to-borrow OTC BB and Nasdaq stocks (it would also be great to be able to get pre-borrows) and that would be willing to deal with a sophisticated individual investor, please contact me or leave a comment below. If you know what kind of account / trading minimums I would need for them to give me the time of day, please let me know.

I am currently looking into Genesis Securities as well as RBC Professional Trader. If you have experience with either of these, please let me know by leaving a comment here or sending me an email.

Thank you for your help.

Noble Roman’s Sued by Franchisees

I am quoted in another excellent article by Cory Schouten of the Indianapolis Business Journal. Ten former and current franchisees have sued Noble Roman’s for misleading them when it sold them their franchises.

Here is what I was quoted as saying:

But plenty of the blame for franchise problems rests with the Mobleys, according to Michael Goode, a St. Louis stock trader and financial blogger who writes GoodeValue.com.

The company owns only a few stores, giving it little opportunity to prove the model works and to test new products or strategies, Goode said. The Mobleys also tried a nationwide expansion despite lacking national marketing and having limited brand recognition.

But the biggest red flag for Goode was the barrage of area developer agreements that boosted revenue and profit.

“They engaged in business in such a way to get lots of near-term earnings at the expense of future earnings,” said Goode, who previously bet against Noble Roman’s by selling the stock short but no longer has a position.

Further Information

I argued that Noble Roman’s expansion strategy was doomed to failure back on December 2, 2007 when the stock was priced at $2.48. I later criticized management for blaming franchisees for their failures. More recently, I mocked the company’s effort to hire an investment bank to sell itself, calling the company overvalued at $1.50 per share. The stock currently trades at $1.00. Most recently, I reported on the company’s 54% decrease in earnings.

Disclosure: No position in NROM, long or short. I have a disclosure policy.

Perf Go Green Holdings: Another Pumped Up Penny Stocks Falls to Earth

Perf Go Green Holdings (OTC BB: PGOG) is a standard pumped-up penny stock, although it has former NY governor Pataki as a director to lend it “credibility” (although anyone who know’s Pataki’s record knows that he has no credibility at all). The New York Post had a good article about the company. Carol Remond had a great article on Perf Go last week (only available on DJ Newswires, a pay service), in which she brought up some interesting history about the company’s CEO:

“Then, there is the issue of company Chairman and Chief Executive Anthony Tracy’s involvement with an extortion attempt a few years back. According to a court docket available to online subscribers, Tracy pleaded guilty to one count of extortion in state court in Pinellas County, Fla., in August 2002. Joseph Cartolano, a lawyer who represented Tracy, said he is “pretty sure” that his client pleaded no contest instead of guilty, neither admitting nor denying guilt. The judge in the case sentenced Tracy to three years probation and withheld adjudication of guilt – which means that as long as he didn’t violate the conditions of his probation, he wasn’t convicted of a crime.”
…
“According to information available online, Tracy and George Cappelli in November 2001 threatened a Palm Harbor businessman named James McGuire to get back $30,000 he owed to another individual. Michael Holbrook, a detective who investigated the case, said Tracy took McGuire’s watch and said he would keep it until the debt was paid. The detective said that about the same time as Cappelli was arrested, an attorney from Miami called the Pinellas Sheriff Department looking to return the watch without naming his client. Tracy was later identify through information contained in one of Cappelli’s notebooks. Tracy’s lawyer Cartolano said he (Cartolano) called “the owner of the watch to return it.” Cartolano, who explained the affair as “an argument between two guys”, said Tracy was given the watch as a collateral and then returned it.”

The fall of pumped penny stock Perf Go Green is yet another testament to why people should never speculate in penny stocks.

Disclosure: No position in any stock mentioned. I inadvertantly published this article two days previously, violating my disclosure policy (as I had just closed a short position in the stock a day earlier). I regret the error.

Change to disclosure policy

I have changed my disclosure waiting period to 48 hours from seven days. That means that I can now write about stocks up to 48 hours before and after I trade them. I will disclose if I plan to trade a stock I hold immediately after that period.

My previous policy prevented me from writing about certain timely news as my trading always comes before my blogging.

Disclosures and Disclaimers

Are your deposits insured? How to avoid losing money in the coming bank Armageddon

I am not one to use the term Armageddon lightly. But when major banks like National City (NCC) and Washington Mutual (WM) are trading under 30% of book and Wachovia (WB) is trading at under 50% of book value, what othe term is appropriate? The market is pricing in a fair probability of a number of very large banks being bought out at firesale prices (like just happened to PFB) or being taken over by the FDIC and then being dismantled.

That being said, while the coming two years will be a very bad time to own bank stocks or bonds or to have uninsured deposits at banks (over the $100,000 FDIC limit), the economy will not completely collapse (though we should have a decent recession) and the world will move on.

The main thing to do is make sure that you and any friends and relatives never have more than $100,000 at any bank. If you wish to keep more, you may want to visit the FDIC website to see if your type of account is protected for more money (some are). You can search for your bank here and find out if it is insured by the FDIC and you can view financial information on your bank, even if it is private. For example, try searcing for “Home State Bank NA” in zip code 60014* (see random note at bottom of post). Then click on “Last Financial Information”, and on the next page click on “generate report”. This brings you to the bank’s balance sheet. If you click on the link towards the bottom for “past due and nonaccrual assets”, you will be taken to the good stuff. You can see that past-due loans have more than doubled over the last year. Unsurprisingly, much of the increase ($2.5m) was from “construction and land development loans”. It also pays to note that this big increase in past-due loans was solely in the 30 to 89 days late category. A more agressive bank might still be accruing interest on those loans. However, this is a conservative community bank and as you can see towards the bottom of the page, all loans that are more than 30 days late are non-accrual. (An interesting discussion of regulatory vs. tax requirements for deciding which loans are non-accruing can be found here.)

If you go back to the main balance sheet page and click on “net loans and leases” you can find the breakdown of loans. This is a good place to find out how risky your bank’s loan portfolio is. Unfortunately for Home State Bank, 20% of their loans are construction and land development loans. This bank is based in the far northwest exurbs of Chicago, so I think it likely that the bank will take a huge hit here. If you click on “1-4 family residential” you can see the breakdown of these loans. Luckily, most of these are first mortgages. Overall, Home State Bank looks okay. What about your bank?

If you have accounts as a credit union, visit NCUA to see details on insurance of your deposits. You can find your credit union and then request that a financial report be emailed to you. As an example I uploaded the report on my credit union. You can download the Excel Spreadsheet here. When analyzing credit unions, be aware that they will generally have more real estate exposure than similar commercial banks. Important things to examine are delinquent loans as a percent of assets (sheet 2, line 21 in the spreadsheet), asset mix including the amount of REO (sheet 4). If you are afraid of a bank run sparked by articles similar to this, take a look at the amount of uninsured deposits (sheet 5, lines 46-50). Delinquent loan info is always interesting (sheet7). For most of the data in the spreadsheet, an average of peer group credit unions is provided as well, making comparison easy. Overall, I think West Community looks quite safe.

What should you do if your bank doesn’t look safe (such as National City, where I have multiple accounts)? First thing that you should do is make sure your deposits are insured. Then make sure that you have enough cash in safer banks so that you can last awhile if you temporarily lose access to your money. Up until now the FDIC has been very good at getting depositors quick access to their insured deposits at a failed bank, but if things get really bad and big banks go down the FDIC could become backed up and take weeks or months to grant depositors access to their money. It pays to be prepared for such a scenario, even if it is unlikely.

*This bank, by the way, provided me with my first mortgage. Easiest mortgage I ever got — my father and I ran into Steve Slack, the bank president, while dining at the local country club, and I mentioned that I was buying a house in St. Louie. Slack gave me his card and told me to give him a call when I get close to finding a house. There are benefits to relationship banking–my extended family has banked there for three generations and uses the bank for a family company.

Disclosure: I am short several regional and local banks.