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Strategies & Market Trends : Gorilla and King Portfolio Candidates -- Ignore unavailable to you. Want to Upgrade?

To: chaz who wrote (51993)	7/11/2002 5:43:43 AM
From: chaz	Read Replies (1) \| Respond to of 54805

Mike... I've just realized that I misread the story. It's a criminal investigation by the Justice Department, not an SEC investigation. Chaz

To: chaz who wrote (51993)	7/11/2002 10:44:49 AM
From: Mike Buckley	Respond to of 54805

Chaz, How would someone looking at SEC filings discover something like ..."capacity swaps," whereby Qwest bought telephonic capacity on another company's system and booked it as a capital expense, which is only recorded slowly over several years, while selling the same amount of capacity to the other firm, and booking that immediately as revenue. Great question! I'm going to provide my answer and I hope others provide theirs. In the best-case scenario, that information will be in the 10K. Part of it might be in the section describing recognition of revenue. The other part of it might be addressed in the notes to the financial statements. However, let's assume that the practice has been fraudulent or that the reporting of it has been fraudulent and that the information is simply not in the SEC filing. Despite that, the SEC filings can be immensely helpful in improving the odds of staying away from companies that might be fraudulent. I'll mention examples (though I couldn't possibly think of all of them) that demonstrate my point. In every SEC filing I believe you'll find a discussion of the management team and their background. As an example, at one time there was a Siebel Systems CFO who had been with a company prior to arriving at Siebel. That prior company had serious legal issues that made investors wonder if Tom Siebel had made a good pick. If that was a serious enough concern for you, you might have wanted to avoid investing in Siebel Systems on that basis alone. I believe looking at the numbers very closely also provide great indications about the management team. As an example, let's assume for the moment that you think it's unwise to grow a company primarily by leveraging debt. Assume looking up WorldCom's SEC filings reveals extraordinary debt ($30 billion) and relatively little cash ($2 billion). Above and beyond the philosophy of how to prudently use debt, it also might be a good indication that management simply doesn't share your core values and might be up to doing all sorts of things you would object to, including fraudulent activities. The section of the 10K that delves into the details of the stock options would reveal a lot about management's philosophies as would tracking the average annual rate of increase of the number of shares outstanding. If the company isn't growing free cash flow, that's an indication that growing free cash flow is not a high priority of its management team. (An online friend told me that Enron's free cash flow was negative in most years.) There are many, many bits of information in each 10K that when added together paint a pretty good picture of the management team and whether or not it has the core values you look for. There's no question that we can't entirely protect ourselves from fraud. And I doubt that I'll ever find a management team I can entirely trust. (I haven't yet.) But we can certainly put the odds in our favor by doing our due diligence. Unless we've pored through the SEC filings, we haven't done our long-term, fundamental due diligence. By the way, I don't pretend that I've done all the due diligence I could do. The recent news of business practices reminds me that I probably should hit the 10Ks really hard in case I've overlooked something or didn't place appropriate emphasis on something. Hope this helps. --Mike Buckley