TEN TIPS FOR REVIEWING ANNUAL REPORTS- Hartley Bernstein

Annual reports can be a valuable tool for investors, but they also may foster unrealistic expectations. Companies, like politicians, can be masters of spin, and annual reports provide a valuable opportunity to paint a corporate picture in the most appealing strokes. Investors need to look beyond the luster, at the company’s performance and potential. In other words, it is important to separate the facts from the fluff.

Annual reports are intrinsically more appealing than the average prospectus or financial report. Why? They generally have pages of pictures and colorful charts. Shareholders get an instant peek at officers, directors, plants and products – in color no less. But appearance is far less important than substance, particularly where investment dollars are involved. A photogenic management team is no substitute for profitability. From an investor’s point of view, a successful business presents the prettiest picture.

What should shareholders focus on when they are reviewing an Annual Report? We offer a few suggestions:

1. It’s Fair to Compare. How does the company characterize the state of its business and its future plans? Take a look at the previous year’s report. Did the company perform up to last year’s expectations or did it fall short? Did the business meet last year’s projections, and were projects started or completed as previously anticipated? If not, is there a reasonable explanation? If a company did not follow through on previous promises, there is good reason to be uneasy about future projections. An annual report offers the company a good opportunity to present its vision for the future, but having done so, it needs to fulfill those goals.

2. The Bottom Line. In the end, every public company is measured by its financial performance. Focus on the financial statements, although they may be the least colorful and most tedious section of the Annual Report. Have revenues been steady, or increasing? If not, is there a logical explanation, or a troubling one? If shrinking revenues were caused by the overall economic environment, and the company remains sound, shareholders may decide to stay the course. They may be far less comfortable, however, if revenues dwindled because the company lost a major customer, or its principal product became obsolete.

3. Cash is King. In the same vein, the financial statements will tell the shareholder how much money the company has available. Has the corporate bank account grown over the past year? Does the company have access to additional financing or lines of credit? In difficult economic times it is important to determine whether the company has sufficient resources to weather a bad year or two and survive.

4. What’s Happening? Does the company’s business have forward momentum? Has it explored new products, new partnerships or promising acquisitions? Is the company warning that it may fail to meet prior expectations? A warning is not necessarily a signal to panic, but it may be a sign of deeper problems. Why does the company plan to fall short of earlier projections? The company should provide an explanation – which may be as simple as the fact that the economy has slowed and sales are down. Shareholders need to review these facts and determine whether the company, or its industry, is likely to recover in the foreseeable future.

5. Explanation for Compensation. Executive compensation has become one of the hottest topics on Wall Street, and with good reason. When the stock market was soaring in the late 1990s, companies did not hesitate to provide generous compensation packages to their top management. High salaries, astronomical bonuses and piles of stock options were handed out like candy on Halloween. It did not seem to matter whether the company was making or losing money, as long as stock prices remained high, investors did not question the exaggerated amounts being handed to corporate leaders.

Revelations of corporate corruption exposed some of the excessive practices that had been lining the pockets of management. That does not mean, however, that every company has abandoned the practice. Review management compensation with care. Have salaries and bonuses continued to increase while revenues have remained steady or dropped? Do existing long-term compensation agreements seem out of step with the current state of the company’s business and revenues? Has there been any effort to renegotiate those agreements – downward – in view of existing conditions?

6. Stability of Management. The annual report should provide detailed information about the company’s officers and directors. Has the management team remained intact? Determine whether any key employees have departed, and how that is likely to affect business. For example, if the principal investigator has resigned from a bio-tech company, has a suitable replacement been hired? Why did the employee leave and what are his or her successor’s qualifications?

These biographies should offer some insight into each officer and director’s prior experience. Have they been involved in the industry for an extended period of time? If not, what skills and experience have they brought to the company? Be wary of a management team that is comprised principally of promoters or former stock brokers who are looking to build the value of the stock rather than the quality of the business.

7. Taking Stock. Has the company issued stock or options in the past year? If so, what has it received in return? Some companies hand out stock in exchange for services – a warning sign that they lack cash. Are options due to be exercised? If they are, that may mean dilution for existing shareholders.

8. Declaring Independence. Has the company established an Audit Committee? Are there Independent Directors? What are their qualifications? Under the Sarbanes-Oxley Act of 2002 companies that are listed on any U.S. Exchange are required to have an audit committee comprised of “independent” directors. To be independent, a director may not be affiliated with the company (other than as a director) and may not receive any compensation from the company (other than as a director).

9. Subsidiaries and Affiliates. Has the company provided detailed information about subsidiaries and affiliates? This is particularly important if a significant amount of the company’s business is constructed through those affiliated corporations. The Annual Report and accompanying financial statements should offer information about those subsidiaries and affiliates, including their revenues, profits and losses. Does the company use offshore corporations as affiliates? If it does, it should offer a reasonable explanation, particularly in light of recent revelations showing that some businesses – Enron in particular – hid losses offshore.

10. Gloss is not Enough. Annual reports may be printed on slick, expensive paper, and can be filled with appealing pictures of smiling faces, sunsets and corporate offices. Try not to be overly impressed by the packaging. Content remains the key. Thumb through the pictures quickly, and take your time reviewing the state of the business, the condition of its finances, and the qualifications of its management team. In the end it’s what is on the page that counts – not the quality of the paper.

The Annual Report is a useful tool, but investors should seek additional information. Check out research reports issued by reliable analysts, review the company’s public filings, and discuss any questions with a trusted financial advisor. As always, before you invest, investigate.

Reference link http://www.stockpatrol.com/article/key/annualreports

About Hartley Bernstein: Hartley Bernstein is a corporate and securities attorney and civil litigator with a specialty in business transactions and civil litigation.

Hartley Bernstein's Guide to Bankruptcy Lawyers

A bankruptcy lawyer’s job does not start and finish with the filing of bankruptcy papers. It involves much more. In this article, New York based corporate lawyer Hartley Bernstein explains what a bankruptcy lawyer really do.

What is Bankruptcy?

Many people know intuitively what bankruptcy is but law does not have intuition. It needs a concrete definition. The job of a bankruptcy lawyer starts with an explanation of bankruptcy. The lawyer helps the client know what bankruptcy means legally, what other options are available, and if it is a right decision to declare yourself bankrupt when debt settlement may be more beneficial.

What is Your Bankruptcy Type?
Law differentiates between bankruptcies. Broadly speaking, there was two ways to go bankrupt: (a) chapter 7 type bankruptcy and (b) chapter 13 type bankruptcy. Either can be more beneficial to you, depending on your specific situation. It is the job of your lawyer to explain the difference between these types.

In chapter 7 bankruptcy, you agree to your assets being sold. The proceeds from the auction are divided among creditors. The entire process takes a few months and personal assets are usually protected.

In chapter 13 bankruptcy, you agree to make a monthly payment to creditors for between three and five years. The debts are settled at the end of this term. This type is beneficial for those, who can count on a steady income.

 What is the Bankruptcy Process?

It is part of the job of a bankruptcy lawyer to explain to you every phase of the bankruptcy process: (a) It starts with an application. (b) Meetings between creditors and trustees come next, (c) followed by an agreement on the details of bankruptcy.

What Happens after Bankruptcy?
An attorney’s job does not finish after the declaration of bankruptcy. The lawyer can offer advice and recommendations on how to rebuild credit and established a new business.

A bankruptcy lawyers explains you what bankruptcy is, what its types are, what the process is, and guides you on how to rebuild your life after bankruptcy.

About Hartley Bernstein: Hartley Bernstein is a corporate and securities attorney and civil litigator with a specialty in business transactions and civil litigation.

Hartley Bernstein’s Guide to Corporate Law

TV has made corporate law one of the coolest professions in America. Yet, for all the good things it has done for the profession--an unintended (or deliberate?) effect of a lot of exposure has been on children and young students, who are increasingly flocking to the law school to enter the world of corporate law. This is good. But here is a word of caution: in vogue, though, the world of corporate law is, it is not easy. So New York based corporate lawyer Hartley Bernstein has written this blog to introduce corporate law to individuals whose only source of information of the field has been the television.

Corporate lawyer

The job of corporate lawyers is to ensure the commercial transactions happening under their watch are legal. To this end, they have to have a profound knowledge of both the statutory law and the regulations of state and federal agencies. Let’s try to understand this with an example: there are companies A and B. Company A wants to buy five computers a month from company B for the next five years. In this scenario, the job of a corporate lawyer is to draw a contract that is acceptable to both companies while making sure none of the terms and conditions in the contract goes against the tax law, zoning law, property law, and laws on licensing.

Although this sounds simple, the job is hard. It requires a lot of effort and hard work on part of lawyers who often have to burn the midnight oil to make sure nothing goes against the law. What it means for those aspiring to become corporate lawyers such as Hartley Bernstein is that fame and wealth come a lot later. And the road to become a successful law is paved with hard work, diligence, and perseverance.

Hartley Bernstein’s guide to penny stocks

Penny stocks have been around for a long time. But many people still have not gotten used to them. These inexpensive stocks are still categorized as something out-of-the-norm. In this blog, New York-based corporate lawyer Hartley Bernstein explains penny stocks in the layperson’s terms.

What is a penny stock?

Penny stocks are those stocks that can be bought for incredulously low prices. I know what you are thinking - how low is low? This is a good question. A million dollars may be a “low” amount for Bill Gates or Warren Buffet, but for an ordinary American in New York, it is a fortunate. In other words, the definition of what is a penny stock is not fixed but it evolves with markets. A few decades ago, stocks that were traded for less than one dollar were classified as penny stocks. Currently, any stock that you can buy or sell for less than five dollars falls into this category.

Origin

When the term penny stock was coined, these stocks were traded for less than a dollar - pennies. Although today they are traded in dollars, they are still called penny stocks because the investors’ attitude toward them has not changed. They are treated as penny stocks.

What differentiates penny stocks from other investments?

Hartley Bernstein opines that the biggest factor differentiating penny stocks from other stocks is the risk involved. Penny stocks are high risk investments. They are usually traded on Pink Sheets and other places that are more open to manipulation. Penny stocks are usually issued by companies that are either new or hard on cash.

Should I invest in penny stocks?

Hartley Bernstein’s advice is - be careful because the chances of a scam are very high.

Hartley Bernstein’s guide on how to form a corporation

Congratulations that you have decided to form a corporation! What do you plan to do next? Are you confused? Do not worry. This little guide from New York based corporate lawyer Hartley Bernstein will help you. It lists the five essential steps to forming a corporation. This blog is a short overview of the entire, very technical, and very complicated process.

·         Pick up a name

Pick up a name for your business, that is compatible with the corporation rules of your state. Although state rules vary, there are a few that are held across the United States. These rules dictate that the name of your new corporation cannot be the name of an existing corporation or government (federal, state), and there has to be a designer (LLc, incorporated, or corporation).

·         Appointment of directors

Major policy decisions and decision on finance are taken by the people at the helm, directors. The directors have rights to issue stock, decide on salaries, and approve loans. Owners can, or cannot be directors. Some states rule that there should be as many directors as there are owners.

·         Paperwork

After have chosen a name and a team of directors, the next task is to jump into the river of paperwork. It is advisable to hire an established corporate lawyer because the work is complicated and time-consuming. Hartley Bernstein has over 35 years of experience in corporate law.  This is also the time when you can obtain the necessary licenses and permits. A lawyer can be of huge help here.

·         Create bylaws of your corporation

How are the directors and employees going to interact? What rules is your corporation going to follow to settle matters internally? These are called bylaws. An expert attorney can help you create bylaws for your corporation.

·         Hold meetings with directors

It is important that you hold regular meetings with the board of directors. This is very important as at these meetups, you can decide what direction your corporation is going to take.

This is an extremely short guide on how to found a corporation. To learn about the legislation in your state, or to ask more specific questions, talk to New York corporate lawyer,  Hartley Bernstein.

Apollo Publication Corporation - Language Problems

This is the time of year when newspapers and magazines hand out annual awards, citing notable achievements of 2005.  Our award for the most audacious business plan of the year goes to Apollo Publication Corporation – a worthy successor to Toks, Inc.  As readers will recall, Toks tried to peddle a wacky plan to take over dozens of the world's largest corporations – companies like General Electric, General Motors, AT& T and AOL Time Warner.  See One Tok Over The Line.  The SEC stepped in and stopped Toks from selling shares to the public – although it is difficult to believe that even the most unsophisticated investors would have signed on for the Company's absurd multi-trillion dollar concoction. 

Toks wanted to take over the world's largest companies.  Apollo, an Ontario, Canada corporation, has bigger plans.  Apollo wants to unite the world.  The Company's incoherent business plan appears to center on the creation of a single language that will unite every living person on the face of the earth.  Esperanto move over.  Here comes Luobus.  Or, as an administrative judge aptly put it: "Apollo's business plan is not altogether clear, but could be described as a visionary plan to undo the result of the biblical story of the Tower of Babel." 

The Company's program is based on the notion that we all were created by the same God, or should we say Goddess, Luo.  Conveniently, Apollo's Chief Executive Officer and "First Director" (and, so far, its only shareholder) bears the name Lucy Luo.  A direct descendant, perhaps?

The Company's mission, in its own words, is this:

The truth is that the human being has been created unequally. There is no equal to all our mind, our body, our characteristic, our personality, our imagination, our voice, our verbaling (sic), our expression, our energy, our ability, our beauty, etc. How could we deal with all these differences?

Apollo Publication Corporation has her mission to unify the world Language, History and Culture, to form all documents of Law on IOE(The Imperial Of the Earth), to print all Specifications and Standards on IOE, to issue the new and only Notes of Currency and Stamp on IOE, to publish News about founding of IOE, to consolidate Globe School Textbooks, to Web World Wide Customers Online purchasing, schooling, banking and charting, etc.

Welcome you to join our team, to support our school texbook (sic), to do what ever you can help no matter big or small. Let's together to build better world on the Earth.

IOE is not the dream but the reality. Believe the God Luo is with you.

This ambitious plan might have escaped notice if not for the fact that Apollo claims that its "team" of directors and advisors is comprised of an impressive list of current and former world leaders, including George Herbert Walker Bush, George W. Bush, Jimmy Carter, James Baker, Fidel Castro, Jacques Chirac, John Paul Manley. Alan Greenspan, Tony Blair, Joseph Lieberman and Pervez Musharrif.

The SEC found it difficult to believe that Ms. Luo has assembled this powerful team – none of whom appear to have acknowledged any involvement with the Company.  Consequently, the Commission has issued a "stop order" suspending the effectiveness of Apollo's registration statement and thereby preventing the Company from selling shares to the public.  The Registration Statement, which recited the Company's incredible list of "directors," included absolutely none of the required financial information.   Not surprisingly, the SEC found this unacceptable.

The stop order followed a one day administrative hearing conducted on September 26, 2005 - which Ms. Luo did not attend.  The Administrative Judge concluded that the Registration Statement was inadequate in several critical respects.  First, the Court found the Company's list of notable directors to be inherently "incredible," despite Ms. Luo's insistence that Apollo is free to hire anyone, including political figures.  While that may be true, those individuals – including world leaders – should be given an opportunity to say yes to a company's invitation.  There is no indication that any of these individuals agreed to lend their names to Apollo - although Ms. Luo apparently forwarded to the SEC "signature pages" purporting to reflect consents signed by "George H. Bush", "George W. Bush," and "Joseph Lieberman."

Second, the Court found that Apollo's Registration Statement lacked any meaningful financial information, despite the requirement of audited financial reports.  Its only reference to finances consisted of a broad statement to the effect that it "has a solid plan for 5 year working capitals and funds…by IPO and "keeps sufficient unrestricted cash on hand to fund our working capital and planned expenditures." 

The Company claims to enjoy investment banking relationships with Canadian Imperial Bank of Commerce (CIBC) and Goldman Sachs.   The Court found no evidence of such business dealings.

Apollo, which apparently did not respond to the merits of the SEC's claims, instead claimed that all documents in the case, except those submitted by Ms. Luo, were forgeries.  This included the statement of a process server who said that notice of the hearing was served upon Ms. Luo.  Ms. Luo said that the process server incorrectly described her appearance and age, although she did not deny receipt of the process.

No world leaders have rallied to Apollo's defense.

Hartley T. Bernstein is a corporate and securities attorney and civil litigator with a specialty in business transactions and civil litigation.

St. George Metals, Inc. - Heavy Metal News

This time the dragon slew St. George.  In this case the dragon was an administrative law judge who issued an Initial Decision revoking the registration of St. George's securities.

St. George Metals, Inc. (OTCBB: SGGM) is a tiny Pink Sheet company with no discernible business, that captured attention just over one year ago with a puzzling announcement.  On September 2, 2004, CMKM Diamonds, Inc. (Pink Sheets: CMKX) announced that St. George had agreed to pay $10 million and deliver 200 billion restricted shares of St. George common stock in exchange for 5% of CMKM's mineral claims.  The announcement did not indicate where St. George – which ceased operations in October 2002, claiming that it had exhausted its financial resources – would get the funds.

 See Buddy Up! - CMKM Diamonds, Inc.; U.S. Canadian Minerals, Inc.; Juina Mining Corp.; St. George Metals, Inc.; and United Carina Resources Corp

St. George and CMKM have traveled similar paths in recent months.  The Securities and Exchange Commission suspended trading in CMKM shares temporarily in March 2005 and subsequently asked an administrative court to revoke the Company's registration.  On July 12, 2005, an Administrative Judge issued an Initial Decision granting the SEC's request and terminating the registration of CMKM securities.  CMKM has now asked the SEC to review that order and a final decision is pending.

St. George now finds itself sailing a similar boat.  On July 1, 2005, the SEC issued an order temporarily suspending trading of St. George securities for 10 days, until 11:59 pm on July 15, 2005.  The Commission said that the suspension was issued because questions had been raised about the adequacy of publicly available information concerning, among other things, St. George's assets, liabilities, management, stock issuances, purported mining operations and other business activities.  St. George has not filed any required quarterly or annual financial reports since November 2002.  See, SEC Targets St. George Metals, Inc.
On July 1, 2005, the SEC sought an order revoking the registration of St. George's securities.  In granting that application, the Administrative Court noted that St. George has failed to file required annual reports since April 26, 2002 and required quarterly financial reports since November 14, 2002. St. George certainly was aware of this delinquency.  In April 2005, the Company appointed a new president and proclaimed that one of its goals was to become compliant with the SEC's filing requirements.  It failed to do so, despite prompting from the SEC.

The Administrative Court concluded that St. George's failure to file was "egregious and recurrent."  The Company failed to file eleven reports over three years, although it recognized its obligation to do so, and promised to comply.  This has left the public without accurate current information - a situation that prompted the Administrative Court to revoke registration of St. George's shares.

Like CMKM, St. George will have an opportunity to challenge the Initial Decision.

It's Sho-Time - The FAQS About Regulation SHO

Short selling has become a lightening rod for controversy.  What is a short sale?  Put simply, a short sale is the sale of a stock you do not own.  A short seller must be prepared to buy or borrow those shares at some future time to cover that short position.  People sell short because they believe that the price of a stock will drop and they will be able to buy or borrow it at a lower price.  If the price drops the short seller realizes a profit, if it rises, the short seller incurs a loss.

The ability to deliver shares – in other words, to cover the short – is central to short selling.  A naked short sale exists when a short seller does not – or cannot – borrow shares to cover the short position,
Depending upon your perspective, short selling in general, and naked short selling in particular, can be a useful investment tool, an instrument for stock manipulation, or a convenient whipping boy for struggling companies seeking to pass the blame for their own shortcomings.  The truth lies somewhere in that mix.

In order to address some of these concerns, the Securities and Exchange Commission adopted Regulation SHO in January 2005.  Despite the new rules, some observers remain concerned that illegal short sales are depressing markets, while others continue to claim that such practices are being used to damage or destroy companies.  Exactly what aspects of short selling are addressed by Regulation SHO?  The statute itself is somewhat opaque – a challenge for non-lawyers to dissect. 
Thankfully, the SEC has now provided a series of answers to some of the most frequently asked questions in an April 11, 2005 release called – what else? – Key Points About Regulation SHO.  The full text of this release can be found at http://www.sec.gov/spotlight/keyregshoissues.htm.  

The SEC explains the distinctions between lawful and unlawful naked short sales.  Market makers may be entitled to make naked short sales in order to maintain an orderly market.  On the other hand, as might be expected, naked short sales designed to manipulate the market are unlawful – as, of course, is any market manipulation scheme.

The SEC sounds several notes of caution.  The commission reminds investors that short selling may not be the reason for a stock's depressed price.  Other factors may be responsible for loss of value.  Thinly traded speculative stocks that trade on the Pink Sheets are particularly susceptible to plummeting stock prices.  These stocks tend to be thinly traded and closely held.  More often than not, the companies have few assets, negligible assets and limited operating history.  Short sales are the least of their problems.

The SEC also warns investors to be wary of message board posters who speculate about the impact of short sellers.  Issuers, promoters, or shareholders sometimes circulate false rumors and unfounded statements about large naked short positions in chat rooms and on message boards in order to stimulate buying interest.  This is particularly true when it comes to stocks that trade on the OTCBB or Pink Sheets.  These manipulators may encourage investors to buy securities by claiming that there will be an imminent "short squeeze," in which the alleged naked short sellers will be forced to cover open short positions at increasing prices.  Often those claims are false.

We urge readers to review the SEC's comments and answers to Frequently Asked Questions about short sales for a succinct, easy to follow explanation.  Individual investors who have further questions or complaints should contact the SEC's Office of Investor Education and Assistance at 1-800-SEC-0330 or (202) 942-7040 or http://www.sec.gov/complaint.shtml.

Hartley Bernstein

Miami Conference to Target Penny Stock Fraud

Following a clampdown on their illegal activities by local regulators, stock promoters in Vancouver, Canada have turned their sights on lightly-regulated U. S. markets, according David Baines, noted investigative reporter for the Vancouver Sun. As StockPatrol.com has warned, this epidemic of penny stock fraud, criss-crosses the borders of the U.S. and Canada, with Nevada corporations operating from Canadian offices to sell shares to U.S. and international investors.  The result is a regulatory quagmire.

"They have not changed their address, or the nature of their deals, they have simply shifted their trading venue from Canada to the United States," noted Baines. "Because these deals are listed in the United States and mainly target American investors, Canadian regulators tend to give them a lower priority than companies listed on Canadian exchanges. And because the companies are domiciled in Canada and run by Canadian residents, U.S. authorities give them a lower priority than more accessible U.S.-based deals.  The net result is a regulatory gap that enables scurrilous Canadian promoters to continue doing what they did in the old days of the Vancouver Stock Exchange, that is, scam investors."


Mr. Baines, who has an impeccable record of exposing securities crooks over many years, will join with StockPatrol.com's founder, Hartley T. Bernstein to provide details about penny stock fraud techniques at OffshoreAlert's 4th Due Diligence Conference, in Miami Beach, Florida, on November 14 & 15, 2005.


The two men are scheduled panelists on a 90-minute session entitled "Pennies from Hell: Securities Fraud Dissected", along with Andrew Scott, Chief of Police of Boca Raton, which is the securities fraud capital of the United States; Sasha Angus, Director, Enforcement Division, of the British Columbia Securities Commission; and Christopher Byron, an investigative reporter with the New York Post.


"Penny stock fraud is one of the most widespread and destructive forms of financial crime, collectively costing investors billions of dollars each year in North America alone," said David Marchant, publisher of the Conference's organizer, OffshoreAlert newsletter, which specializes in exposing financial crime.


"Our panelists will look at how stocks are manipulated, including the roles played by market-makers, brokers, promoters, and newsletter writers; the use of offshore shell companies to conceal illegal trading, and how to identify red-flags."


Another speaker at the OffshoreAlert Conference is Marcos Jimenez who, as U. S. Attorney for the Southern District of Florida, spearheaded one of the largest-ever financial crime investigations in North America, a joint FBI/RCMP effort known as Operation 'Bermuda Short'.   Mr. Jimenez will talk about the planning and execution of an operation that led to 58 people being indicted for securities fraud and money laundering offenses in 2002, 85% of whom subsequently pleaded guilty or were found guilty by a jury. Operation Bermuda Short netted, among others, Canadian investment banker Mark Valentine, who has been the subject of numerous StockPatrol.com articles.


In another session, Dr. Howard Schilit, author of 'FINANCIAL SHENANIGANS: How to Detect Accounting Gimmicks and Fraud in Financial Reports', will teach attendees how to identify red flags in financial statements, including the use of offshore structures such as special purpose entities, creative accounting techniques, falsely-valued assets and off-balance sheet items – all of which are used to con investors in securities scams.


OffshoreAlert's 4th Due Diligence Conference is being held at The Fontainebleau Resort, in Miami Beach, on November 14 & 15, 2005 and its purpose is to show attendees, particularly those involved in international finance, how to protect themselves against monetary and reputational problems by conducting prudent due diligence on existing and prospective clients and business partners.


It is designed for investors, brokers, attorneys, auditors, professional researchers, senior managers, private investigators, law enforcement agents, banking and securities regulators, and anyone else who wants to minimize their exposure to risk.

Former Tyco Honchos Sentenced By Hartley Bernstein

Courts continue to impose lengthy prison sentences on former corporate hotshots found guilty of looting their companies.  This week, Tyco’s fallen leader, Dennis Kozlowski joined former WorldCom chief, Bernard Ebbers and Adelphia Communications founder, John Rigas, behind bars.  A New York Supreme Court justice sentenced the former Tyco CEO to a lengthy 8 1/3 to 25 year prison term – somewhat less time than prosecutors were seeking, but far from the minimum sentence that the Kozlowski legal team had sought.


Kozlowski is going to jail because a jury found him guilty of orchestrating a massive fraud that siphoned hundreds of millions of dollar from Tyco.  Mark Swartz,  TYCO’s ex-CFO, also received an 8 1/3 to 25 year sentence for his role in the fraud.  The two men, who will not be eligible for parole until they have served almost 7 years in jail, were led from the courtroom in handcuffs to begin serving their terms.


Jurors found Kozlowski and Swartz guilty in June, after a four month trial that devoted considerable attention to the opulent lifestyles enjoyed by the two defendants – courtesy of Tyco funds.  The defendants had been accused of fueling lavish lifestyles - including such items as a $6,000 shower curtain purchased by Kozlowski -  through illegal bonuses and generous loans, to the tune of $150 million.  It was the second trial for both men, who dodged a bullet the first time around when the court declared a mistrial.  They were not so fortunate this time.

In addition to imposing the prison sentences, the court ordered Kozlowski and Schwartz to pay back $134 million to Tyco.  Kozlowski and Schwartz also were ordered to pay criminal fines of $70 million and $35 million, respectively.


Because they were convicted in a New York State court, the defendants will not be spending the coming years have the opportunity to while away their days in a prison camp or minimum security prison, a so-called “Club Fed” – ala Martha Stewart.  Instead, because they received sentences of more than 6 years, the two men are likely to land in a maximum security state prison which houses violent offenders, and rarely plays host to white collar criminals.


Hartley T. Bernstein is a corporate and securities attorney and civil litigator with a specialty in business transactions and civil litigation.  As corporate counsel, Mr. Bernstein has represented both private and public companies in connection with various corporate issues, including governance, mergers/acquisitions, employee compensation agreements and contractual matters.

This One Is In the Genes

Those Wolfson boys are at it again.  This time they have been accused of bilking investors out of $6.6 million.  According to reports in the Salt Lake Tribune, Allen Z. Wolfson, his son David M. Wolfson and Michael S. Newman have been indicted by a federal grand jury on nine counts of wire fraud. 
The three men purportedly established a bogus company called Stem Genetics, which claimed to be conducting stem cell research.  The indictment claims that Stem Genetics did not conduct any stem cell research – and did not employ anyone qualified to do so.  

The defendants reportedly dumped unregistered shares of Stem Genetic stock overseas, at inflated prices – targeting investors in Great Britain, Australia and New Zealand.  Potential investors were told that the Company's shares would soon trade on NASDAQ, at a price of $7 a share, around 20% more than the price they were paying.  Those customers were charged high commission, which were not disclosed.

The charges are reminiscent of those leveled in an earlier case against David Wolfson – also involving the sale of unregistered stock overseas.  In 2004, the Securities and Exchange Commission charged David Wolfson with orchestrating a scheme that involved the sale of shares under Regulation S, which permits oversea sale of unregistered shares to non-U.S. residents.  It seems that Wolfson and his colleagues found struggling U.S. companies that were hungry for cash (and occasionally formed the companies themselves) and then arranged for them to sell stock to a British Virgin Island corporation called Sukomo at a deep discount - 30% of the bid price.  

Since Sukomo was purportedly a non-U.S, citizen, the stock was sold without registration under Regulation S.  There were a few problems with this setup, as the SEC discovered.  First, Sukomo actually was a boiler room operating from Laos and Thailand, and looking for stock to dump on overseas investors. Second and more important as far as Regulation S is concerned, Sukomo may have been a non-U.S. resident but it never was a bona fide purchaser. In reality, Sukomo was simply acting as a broker and the proceeds from its boiler room operation were going back to Wolfson, his colleagues, and to a lesser extent, the issuing companies.  See, Beware The Evil Twins.

The Salt Lake Tribune reports that Allen Wolfson is awaiting sentencing in New York for securities fraud and Newman is serving a prison sentence in Laos for a financial crime.  A spokesperson for the U.S. Attorney's Office in Salt Lake City says that the SEC has recovered about $1.5 million of the funds lost by investors to the Stem Genetics scheme.

The Game Is On

Stock Regent is running a contest. It is offering a $500 cash prize to the individual who buys, and then holds, the most shares of IBC between January 6, 2003 and January 17, 2003.

The contest seems like a transparent attempt to generate volume for IBC – but for whose benefit? Stock Regent admits that it “may receive compensation for the efforts in research, presentation, and dissemination of information on companies featured on our web site and within our newsletter reports.” In a lengthy disclaimer posted on its website, Stock Regent goes on to say that “[a]ll compensation can easily be found on the bottom of the the [sic] page for the companies being profiled.”

There is no compensation information concerning IBC at the bottom of the Stock Regent report on IBC, or anywhere else on the Stock Regent website. In fact, we did not find any compensation information at the end of any of the reports posted on the Stock Regent website. Does that mean Stock Regent has not been compensated for any of its promotional efforts? Is the $500 “prize” merely a whimsical gift from a philanthropic stock promoter? That does not seem likely.

So where is the benefit to Stock Regent? Has the promoter been compensated by IBC or some third party? Does Stock Regent or its owners hold a position in IBC shares that it is attempting to dump during the contest period? In other words, what is the promoter’s undisclosed agenda?

Investors who vie for that $500 prize should be aware that victory may come at a considerable cost. IBC is a start-up company with a questionable future, limited capital and minimal revenues. IBC shares may have the “potential” to double as Stock Regent boasts – but they also may decrease in value and become virtually worthless. The trip down is not all that far for a stock that trades for less than $2 per share.

There also can be no assurance that investors will even be able to recoup the purchase price. Such is the nature of over-the counter stocks. The investor buys the stock based upon an “ask” price – the price at which a market maker is prepared to sell stock to the public. Shares are subsequently sold at the “bid” price – the price at which market makers are prepared to buy stock from the public. Since the bid price is routinely lower than the ask price, a customer who wants to resell his or her shares immediately is likely to suffer a loss. This difference between the bid and ask prices - known as the “spread” - can be substantial.

In recent days, IBC stock has been trading at slightly under $2 per share. At one point on January 8, 2003, for example, the bid price for IBC shares was 1.8 cents, while the ask price was 2.1 cents. That means an investor could purchase 25,000 shares for $525, and sell them immediately for $450.

Investors were in even more trouble if they paid that 2.1 cents ask price, and then held the IBC shares as the Stock Regent contest rules required. By the time the market closed on January 9th, the bid price for IBC shares was 1.5 cents – down about 30% from that initial 2.1 cents purchase price.

The potential risks of an IBC investment are evident. Stock Regent’s agenda is not. Why is Stock Regent prepared to pay $500 to the investor who purchases the greatest number of IBC shares in a two week period? What will Stock Regent gain from creating a demand for IBC shares? Is this an effort to pump up the demand for IBC stock so that Stock Regent or some other undisclosed party can dump shares? Is IBC aware of this promotion? Is the Company complicit in this effort?

In other words, shouldn’t we assume that Stock Regent has a good deal more to gain than $500? Or is this promoter simply motivated by a generous spirit?

Let’s keep our eyes on this prize.

New York Corporate Lawyers: Why you need to hire Bernstein Cherney LLP

It is important that a business chooses the right corporate lawyer in New York that will represent its best interest. Every day crucial decisions need to be made and there is always some risk lurking around the corner. Instead of waiting for the problem to show up, it is important that you use the services of a corporate lawyer that will be available to work on various legal challenges facing your business. The goal is to realize a favorable outcome every time your business needs to make a legal decision--and this is where Bernstein Cherney LLP comes in.

Debra Cherney

Here are a few reasons why you need to contract Bernstein Cherney LLP.

 Experience 

A corporate lawyer needs to be well versed with the state and city’s corporate laws and regulations. When something goes wrong, or a question arises, you want to know that you have someone in your corner that has a sound grasp of the city’s present legal climate. It is important that you get a corporate lawyer who is capable of handling the legal challenges facing your business. During the initial consultations, feel free to ask the lawyer about his/her previous experience. While they may not get into the details of the other clients, it is possible for the lawyer to explain different situations that they have handled in the course of their practice, as well as the outcome of these situations.  

Communication 

 It is important that you and your New York corporate lawyer have an open. It is important that a business chooses the right corporate lawyer in New York that will represent its best interest. Every day crucial decisions need to be made and there is always some risk lurking around the corner. Instead of waiting for the problem to show up, it is important that you use the services of a corporate lawyer that will be available to work on various legal challenges facing your business. The goal is to realize a favorable outcome every time your business needs to make a legal decision--and this is where line of communication at all times. You want to be sure that when you call with a question or concern, you are going to get a response from your lawyer in a timely manner. You want to have the peace of mind that should your business be caught up in a legal situation, there will be a professional ready to come to your aid. If you do not feel appreciated and valued during the initial consultation, or your communication breaks down and you experience difficulty meeting the lawyer, then you know that this might not be the right lawyer to contract for your business.  

Hartley Bernstein

Commitment and the relations  

 Apart from communication, you want an attorney who values you. At Bernstein Cherney LLP, you are not just another client; our lawyers want to know you and the nature of your business. In a sense, we are looking to create a professional working relationship with our clients that will last over a period of time. Thus, when doing engaging our services, feel free to ask all your questions upfront. Do not be afraid to ask how your business’ legal issues will be handled and what you can expect from our lawyers - Hartley Bernstein

Bernstein Cherney LLP

767 Third Avenue
30th Floor, New York
New York 10017
Tel: 212-381-9684
Cell: 917-656-4550 
e-mail: hbernstein@bernsteincherney.com
Fax: 646-304-953
http://www.bernsteincherney.com

Parent Shock: Children Are Not Décor By Hartley Bernstein

OTHERS, like Debra Cherney, 49, and Hartley Bernstein, 56, were more resigned to giving up control. They were possibly even happier than most late parents at the birth of their twins, a boy and a girl named Cole and Brooke, in 2003, having lost their daughter Raine to respiratory failure in 2001. When the twins became mobile, the couple realized that they would need to create a designated play space in their prewar Park Avenue apartment. Still, the room they sacrificed — the formal dining room — was tough.

“I’m pretty sensitive aesthetically, and it does something for me when I look at a pretty room,” Ms. Cherney said. “Looking at what the room used to be was the visual equivalent of listening to Bach or Mozart. Now it’s the visual equivalent of listening to Barney.”

She felt the full impact when she and Mr. Bernstein put their 18th-century mahogany dining table and chair set in storage. “When I bought the table I was envisioning these beautiful, lovely dinners with fine china,” she said. “Once you have kids and once you give up those things, it was like, ‘Who was I kidding?’ I remember thinking this room will look nice again — in about 18 years.”

The issue of safety, too, can pose vexing choices for parents in thrall to design. Even before Kipp Cheng and his partner of 15 years, Mark Jarecke, arrived home with their son, Beckett, last March, they could see that many of the furnishings in their Maplewood, N.J., colonial house, including a set of four Barcelona chairs and a glass-top Noguchi coffee table, were accidents waiting to happen. But they weren’t eager to act.

“We are both small-town guys who lived in the city and tried to establish an aesthetic point of view that was largely modernist and minimalist,” said Mr. Cheng, 40, a playwright and a publicist for the American Association of Advertising Agencies. “But when you become parents, you kind of have to throw that out the window.”

As difficult as the prospect of change was for Mr. Cheng, who recalls the details of nearly all the couple’s furniture purchases, it was even harder for Mr. Jarecke, 37, the creative director of CondéNet, the Web division of Condé Nast.

“We spent years collecting meaningful, quality pieces,” he said. “Getting those kinds of pieces — the handmade silk pendant lamp, the teak Danish sideboard — it’s a huge project. Basically each room was finally done, and then it all got blown apart.”

Among the most troubling matters was the fate of the Barcelona chairs, whose “corners are basically razor blades,” Mr. Cheng said. After much deliberation, they put three in the garage and wrapped the corners of the fourth in foam so it could stay in the living room. “It was just sad,” Mr. Cheng said.

As for the coffee table, they avoided doing anything until Beckett gave them no choice: while learning to walk last summer, he used it as his main training prop. “He’d cruise and trip and hit his face on the table’s edge,” Mr. Cheng recalled.

Mr. Jarecke initially refused to discuss parting with or altering the table in any way, but they eventually compromised and decided to wrap the edge of the top in foam. “As I’m taping it,” Mr. Cheng said, “I’m saying, ‘I’m taping over what makes the difference between this being a Noguchi table and a Kmart table.’ ” Mr. Jarecke was even more distraught. “It transformed this beautiful modernist piece of furniture into a piece you’d find in a ’70s rec room,” he said.

FOR some design-minded parents, certain compromises are too much.

In 2004, Bob Stratton, a design technologist who specializes in home automation, and his wife, Sandra McLean, 50, a food activist and writer, bought a former tool and die factory in Cobble Hill, Brooklyn, and set about turning it into a two-story, 4,000-square-foot loftlike home appropriate for themselves and their son, Vin, and daughter, Fia, then 2 and 5.

“We spent many, many hours designing a place that would be kid-friendly as well as sensitive to our need to live in a well-designed adult environment,” said Mr. Stratton, 48. Construction took a few years, and the family settled in last March.

They built a kitchen and dining area in the center of the first floor, using durable Corian for both the cabinets and a Parsons-style dining table designed by Mr. Stratton. “I wanted the Corian top so there would be no repeat of the famous carving incident,” Mr. Stratton said, referring to the time when Fia, at 4, used a pen to carve her name into a cherry dining table just delivered from France. (“I thought I would die,” Ms. McLean said.)

They put down cork tiles throughout, as protection for glassware and other breakables, including the children themselves, and they set up a 500-square-foot play area in the basement, with a trade-off that some parents would consider draconian: “They can play with a toy in the main living area, but it has to go away when they’re done,” Ms. McLean said. “I’m very concerned with what’s in my visual space. When people come into the house, I very much do not want them being bombarded with toys.”

She also refused to babyproof furniture when the children were younger. She was “never one of those mothers” who put safety corners on coffee tables, she said. “That stuff is just gross, and I don’t feel you have to sacrifice living space to that degree.” And she decided not to install wire railings on the open side of the floating walnut staircase Mr. Stratton designed to connect the first- and second-floor living spaces.

“We couldn’t bear it,” she said. “It was too ugly. So basically what we did was we trained the kids to hold onto the handrail, and it’s worked. No one’s ever fallen off.”

Still, even extreme devotees of design seem to end up relaxing their standards over time. After several expensive pieces from Ligne Roset were delivered to the McLean-Stratton home last June — a brown microsuede one-arm sofa, a low white leather swivel chair, a white shag carpet and an arched chrome floor lamp — Ms. McLean instructed Fia and Vin not to eat on the couch, and told them half-jokingly not to “sit on it, stand near it or even look at it.”

But in the last several months she has grown to appreciate how the children delight in wrestling on the rug and using the swivel chair as an oversize Sit ’n Spin. “You know what?” she said. “They jump all over it, but it’s good furniture, and it actually holds up fine.”

No "Dr. Michel" in the House

Stock scamsters employ a seemingly endless variety of ploys to seduce unsuspecting investors.  Not long ago a group of pump and dumpers were leaving phony messages on telephone answering machines.  People receiving the messages were supposed to believe that the caller had dialed them by accident, intending to leave a stock tip for a friend.  StockPatrol.com warned investors when the scam surfaced in August 2004, and the SEC filed complaints against the wrongdoers in May 2005.  See Sorry Wrong Number and Phony Phone Calls.

But phony phone calls were not the only technique in vogue in 2004.  If telephone messages worked, why not try faxes?  This week the SEC caught up with a group of individuals who devised a scam to mislead investors into believing they had inadvertently received confidential stock tips faxed by a stockbroker to his customer.  The handwritten faxes seemed to embody an urgent message from a financial planner to his client, “Dr. Michel,” urging him to buy shares that were about to triple in price. 
There was, in fact, no broker and no Dr. Michel.  Instead, according to charges filed by the SEC on July 15, 2005, an individual named Joshua Yafa and his company, Global Media Marketing, distributed approximately 153,000 phony faxes in December 2004, urging recipients to buy shares of AVI Global, Inc.  AVI had hired Yafa as a public relations consultant and rewarded him with AVI shares.  According to the SEC, AVI’s stock price soared by 25% the day after the faxes were transmitted and Yafa dumped his shares, reaping more than $300,000 in proceeds.
That, however, was not the end of the story.  The SEC says that Yafa’s misleading fax soon engendered a copycat scam.  According to the Commission’s complaint, an individual named Michael O'Brien Pickens obtained a copy of Yafa's "Dr. Mitchel" fax and replaced AVI with three different microcap companies Pickens had been promoting - Data Evolution Holdings, Inc. (DTEV), Infinium Labs, Inc. (IFLB), and Soleil Film, Inc. (SFLM). The Commission claims that Pickens took Yafa’s scheme to a new level, sending out almost a million of the modified faxes.  He then made more than $300,000 when shares of all three companies increased by as much as 100%.
The Commission also filed fraud charges against Serafin Sierra, a salesman at Vision Lab Telecommunications, Inc., the "fax blasting" company that transmitted all of the "Dr. Mitchel" faxes.  The SEC asserts that it was Sierra who provided Pickens with a copy of the original Yafa fax, thereby facilitating the scheme.

The SEC action may be the least of the problems facing the individuals who orchestrated this scheme.  The United States Attorney's Office for the Southern District of New York has initiated a related criminal proceeding.

Hartley T. Bernstein is a corporate and securities attorney and civil litigator with a specialty in business transactions and civil litigation.  

And When You're Not...

On December 13, 2006, a U.S. District Court in California entered judgment against Dieter Raabe, one of the principal players in a “pump and dump” scheme that used the Internet to entice investors.  Raabe, Raabe, and his cohorts, James E. Franklin and Samuel Wolanyk, were named in an SEC action filed almost four years ago, on January 14, 2002.  

According to the SEC’s complaint, Franklin set up a “financial advice” website, called "Red Hot Stocks," where he touted stocks that he had acquired privately – through private placements or as consulting fees.  Then, after misleading “profiles” about the companies were published on “Red Hot Stocks,” and share prices increased, Franklin dumped his holdings.  The SEC charged that Wolanyk authored and distributed the profiles, while Raabe issued trading instructions for the stocks in a Canadian brokerage account.  The SEC also claimed that Raabe and Franklin engaged in illegal sales of unregistered securities.

In December 2005, a jury enjoined Franklin and Wolanyk from future violations of the securities laws and ordered them to pay $770,000 and $50,000 respectively. 

Now, Raabe has been ordered to pay civil penalties totaling $831,310 and, like his co-defendants, has been enjoined from future securities law violations.

767 Third Avenue
30th Floor, New York
New York 10017
Tel: 212-381-9684
Cell: 917-656-4550 
e-mail: hbernstein@bernsteincherney.com
Fax: 646-304-953
http://www.bernsteincherney.com
 Hartley Bernstein, Debra Cherney

This One Is In the Genes

Those Wolfson boys are at it again.  This time they have been accused of bilking investors out of $6.6 million.  According to reports in the Salt Lake Tribune, Allen Z. Wolfson, his son David M. Wolfson and Michael S. Newman have been indicted by a federal grand jury on nine counts of wire fraud. 
The three men purportedly established a bogus company called Stem Genetics, which claimed to be conducting stem cell research.  The indictment claims that Stem Genetics did not conduct any stem cell research – and did not employ anyone qualified to do so.  The defendants reportedly dumped unregistered shares of Stem Genetic stock overseas, at inflated prices – targeting investors in Great Britain, Australia and New Zealand.

  Potential investors were told that the Company's shares would soon trade on NASDAQ, at a price of $7 a share, around 20% more than the price they were paying.  Those customers were charged high commission, which were not disclosed.

The charges are reminiscent of those leveled in an earlier case against David Wolfson – also involving the sale of unregistered stock overseas.  In 2004, the Securities and Exchange Commission charged David Wolfson with orchestrating a scheme that involved the sale of shares under Regulation S, which permits oversea sale of unregistered shares to non-U.S. residents.  It seems that Wolfson and his colleagues found struggling U.S. companies that were hungry for cash (and occasionally formed the companies themselves) and then arranged for them to sell stock to a British Virgin Island corporation called Sukomo at a deep discount - 30% of the bid price.  

Since Sukomo was purportedly a non-U.S, citizen, the stock was sold without registration under Regulation S.  There were a few problems with this setup, as the SEC discovered.  First, Sukomo actually was a boiler room operating from Laos and Thailand, and looking for stock to dump on overseas investors. Second and more important as far as Regulation S is concerned, Sukomo may have been a non-U.S. resident but it never was a bona fide purchaser. In reality, Sukomo was simply acting as a broker and the proceeds from its boiler room operation were going back to Wolfson, his colleagues, and to a lesser extent, the issuing companies.  See, Beware The Evil Twins.

Hartley T. Bernstein is a corporate and securities attorney and civil litigator with a specialty in business transactions and civil litigation.  As corporate counsel, Mr. Bernstein has represented both private and public companies in connection with various corporate issues, including governance, mergers/acquisitions, employee compensation agreements and contractual matters.  During his career, he has represented companies and broker/dealers with respect to public offerings, private placements of securities, corporate financing transactions and strategic planning.
 
The Salt Lake Tribune reports that Allen Wolfson is awaiting sentencing in New York for securities fraud and Newman is serving a prison sentence in Laos for a financial crime.  A spokesperson for the U.S. Attorney's Office in Salt Lake City says that the SEC has recovered about $1.5 million of the funds lost by investors to the Stem Genetics scheme.

 

IF YOU HAVE QUESTIONS OR COMMENTS FOR STOCKPATROL.COM, CONTACT US AT editor@stockpatrol.com

The Hedge Fund Front - A System Failure in the Making?

The barn door is wide open – and the federal government is concerned.  Last week, a Treasury Department official warned legislators that steps need to be taken to reduce the likelihood that a "systemic risk event" could occur in "the private equity pools of capital industry."

In other words – government-speak aside – if hedge funds tumble the economy could suffer catastrophic consequences.  That should wipe the smiles off of a few faces.  After all, hedge funds have been Wall Street's superstars, rising to unparalleled prominence in the wake of the dot com disaster and helping to fuel an economy that has risen with investor confidence.  Is another bubble about to burst?

The government's cautionary thoughts were offered by Treasury Under Secretary for Domestic Finance, Robert Steel on July 11, 2007, in testimony before the U.S. House of Representatives Committee on Financial Services.  While recognizing the "many benefits" that hedge funds and other private investment vehicles bring to the capital markets, Mr. Steel acknowledged that "the growing size and scope of private pools of capital merit appropriate attention, particularly given possible challenges posed by private pools in areas of investor protection and the potential for systemic risk."

The Secretary's remarks seem timely considering recent tumult at hedge funds, led by the disastrous demise of two Bear Stearns hedge funds that bet on the sub prime mortgage market and lost big.  But while the observations may be opportune, efforts to address "systemic" problems may be far too late to help investors who have, or are about to feel the effects of improvident hedge fund positions. 

As StockPatrol.com recently pointed out, the Bear Stearns fund failures may simply be the opening act.  See, Is The Sky Falling?  Sub prime mortgages may continue to drag fund values downward – but they represent only one of the myriad illiquid investments that hedge funds have found so appealing.  Consider this thought from Under Secretary Steel: 

Innovations in financial products, such as complex derivatives and other structured products are expanding the ways in which market participants, such as hedge funds, can apply leverage. A concentration of market positions and high leverage may lead to market disruptions and illiquidity if traders simultaneously unwind their positions. Consistent with the growing complexity and often illiquid nature of these innovative products is the difficulty in valuing these securities.

Hedge fund managers are typically rewarded based upon fund value, so inflated asset values can trigger higher fees.  Since illiquid assets, by definition, have scant independent market, fund managers have had the luxury of placing high arbitrary values on them, and whistling in the dark while the economy remained strong.  As the investing public is rapidly learning, hedge funds increase their value by borrowing additional money and using their portfolios – including shaky illiquid holdings like sub prime mortgages – as collateral. 

As Under Secretary of Steel advised Congress, hedge funds have proliferated at an astonishing pace, doubling over the past five years, capturing an estimated 50% of current trading volume, and accounting for approximately $1.4 trillion in assets.  The Under Secretary lauded hedge funds as "significant providers of liquidity in our marketplace, making our markets attractive to investors," but with this caveat:  "The scale, complexity and dynamic nature of these business models and their investment strategies emphasize why we believe heightened vigilance is necessary. Managers are now relying more heavily on the use of leverage, transaction volumes are increasing, and the impact of hedge funds on markets continues to grow."

The Under Secretary outlined a goal of "mitigating the potential for systemic risk in financial markets and protecting investors" and, in so doing, hit upon an issue that is likely to resonate in the future.  As StockPatrol.com noted on June 26^th, "with cash flowing freely in recent years, a broad range of investors have jumped into hedge funds and their promise of even greater riches.  Institutional investors, including pension funds and endowments reportedly have increased their investments in hedge funds and other less liquid instruments." 

The government would appear to be painfully aware of that trend.  As Under Secretary Steele noted, "some concerns exist about indirect exposure of less sophisticated investors to hedge funds through their pension fund investments."  Consequently, he pointed out, "investment fiduciaries, such as pension funds managers, have a responsibility to perform due diligence to ensure that their investment decisions on behalf of their beneficiaries and clients are prudent and conform to established sound practices consistent with their responsibilities." 

The federal government, according to this testimony, encourages hedge funds to provide accurate, timely information to investors.  But, in a nod to hedge fund managers, who thus far have avoided many of the rigors of regulation, he stopped short of urging full disclosure.  "[T]his need for transparency and disclosure should not go so far as to materially discourage innovation in the marketplace. There needs to be some balance regarding disclosure. For example, we need to respect sensitive proprietary information, and individual positions should not necessarily be expected to be disclosed."

Is that enough?  Without detailed disclosure, including the nature of positions and the method of valuation, investors will remain in the dark.  The extent of proprietary positions or investor concentration can be a critical element of the due diligence process.  Participants in the Horizon ABS Fund may have been far less sanguine about the liquidity of their money if they had been aware that a single investor accounted for a quarter of the fund's purported $650 million in assets.

The government appears to see the potential pitfalls and problems – and to recognize that regulators have the ability to check abuses under existing anti-fraud statutes.  But those laws often address failure to disclose material information – and hedge funds are subject to few traditional disclosure obligations.  We would appear to be well past the time for studies and  commissions or a protracted process that ignores the urgency of the situation.  Until transparency means investors get a clear, unobstructed view of hedge fund investments, the picture will remain opaque, as will the prospect of that "systemic event" the Under Secretary fears.

Hartley T. Bernstein is a corporate and securities attorney and civil litigator with a specialty in business transactions and civil litigation.

IF YOU HAVE QUESTIONS OR COMMENTS FOR STOCKPATROL.COM, CONTACT US AT editor@stockpatrol.com