Jackass Investing “Poor-folio” Award issued to CME Group and its CEO Craig Donohue

The credibility of the U.S. futures industry is based on the trust bestowed on it by the clearing house system. The principal behind this is simple:

1) Brokerage firms are required to be member of a “clearing house.”
2) Those brokerage firms, called “clearing firms” are then able to accept customer money. As a requirement of being a clearing member firm this money is held in a specially segregated account (so that a failure of the clearing firm does not result in a loss of the customer segregated funds).
3) The clearing house in turn stands behind all customer transactions. So the customers are not entering into “principal” transactions with each firm, they are entering into transactions with the clearing house. Again, this is to protect each customer from the failure of any individual clearing firm.

In exchange for this protection the clearing house receives a part of every commission paid on every trade by every customer. But the failure of MF Global shows that this protection was always just an illusion and never really existed. Here’s why.

In the case of MF Global customer funds were illegally comingled with corporate funds, putting customer funds at risk. MF Global made a big bet on European sovereign debt and lost. (Of course if that bet were successful Jon Corzine and his minions would have racked up huge bonuses). Because customer funds were included in that bet, those funds were lost as well. It appears that as much as $630 million was comingled, and potentially lost, in this way. So this is where the clearinghouse system should prove its worth. After all, those customers trades were not made with MF Global, they were made with the clearing house.

But apparently that is not so. In a statement on Tuesday, November 1st, CME Group CEO Craig Donohue suggested that CME Group was not responsible for the lost customer money and that the customers themselves would ultimately be responsible for those losses. “Customers have the risk of other customer losses in the customer segregated pool and there’s always the risk as well that customer funds are not properly protected,” he said.

Huh!?

So that’s how the clearing system works. If there are profits to be had, they get distributed among the clearing house and its members. And if there are losses due to the fraudulent activity of one of those clearing members those losses are to be paid by the customers. Well, guess what, there will be no more customers if that’s really how the system works.

For Donohue to make that statement is completely inexcusable and breaks the bond of trust that has existed between the clearing house and its customers for 150 years. Unfortunately it appears that trust only existed if it produced the potential for profits. Donohue’s comment trades honesty, obligation and integrity for expediency, shortsightedness and a breach of trust and in doing so places a limit on the price of that trust. We now know it is not worth $630 million. When customers start to figure out that the protection money they’ve been paying has not protected them, they will find other venues on which to conduct their business. But maybe that’s how the system works.

Once Craig Donohue and CME Group realize that it will ultimately be far more costly for them to abandon their obligation than to save a few bucks today, they may be forced to “do the right thing.” In a world where doing the right thing is defined as doing what produces the most profit, maybe this will get the attention of Craig Donohue. If not, then the protection they have been offering is no better than that provided by your local gangster.

So due to their abandonment of the core principles of trust in the face of fraud at one of the member firms, I present a Jackass Investing “Poor-folio” Award to Craig Donohue and CME Group.

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Halloween Horror! Jackass Investing “Poor-folio” Award to Jon Corzine, as he transforms MF Global from Powerhouse to Poorhouse

MF Global, the brokerage firm headed by ex-Goldman Sachs head honcho and ex-New Jersey Governor, Jon Corzine, filed for chapter 11 bankruptcy protection today. It took Mr. Corzine less than two years to transform MF Global from a futures brokerage powerhouse into a disgraceful poorhouse (read: http://cnnmon.ie/tYDuEi).

The story is both familiar and disturbing, and includes reckless gambling, incompetent credit rating agencies (again!) and unfortunate employees. It started shortly after Mr. Corzine’s appointment as MF Global’s CEO in early 2010 (following his unsuccessful bid for re-election as New Jersey’s Governor). In an interview with Dan Collins of Futures Magazine in December 2010 Mr. Corzine announced,

“I expect that we are on track to move from a broker to a broker/dealer, to an investment bank, and from being a significant participant in futures and options markets and commodities markets to being a full-fledged, quality player in all of the activities that we choose to be involved – including those that historically involve foreign exchange, equities, currencies, advisory and money management over time.” (read: http://bit.ly/sEE7Pk).

Unfortunately, in his attempt at turning Mf Global into a global investment bank on the scale of Goldman Sachs, Mr. Corzine personally steered MF Global into making a $6 billion bet on the sovereign debt of Portugal, Italy, Ireland, Belgium and Spain (every one of the “PIIGS” with the exception of Greece). The old adage, “bulls and bears make money, but pigs get slaughtered,” played out here precisely on cue. A slaughter is what occurred. But I would venture to guess that it affected Mr. Corzine’s reputation more than his pocketbook. I doubt he’s personally in the poorhouse as a result of his reckless gambling. The same can’t be said for many of the hardworking employees of MF Global, who had accumulated stock and stock options acquired through years of hard work (I personally know many of them).

But Mr. Corzine was not alone in bringing down MF Global and destroying the wealth of its investors. The credit rating agencies were also active participants. Less than three months ago Mr. Corzine orchestrated a $325 million bond offering for MF Global that received an investment-grade rating from the ‘big three’ agencies; Moody’s Investors Service, Standard & Poor’s, and Fitch’s. And while Moody’s and Fitch’s did downgrade the debt last week, Standard & Poor’s maintained its investment grade rating until after today’s bankruptcy filing. At least S&P understands the meaning of default! (Do people really pay for this ‘advice’?). For my view on the uselessness of credit ratings agencies and other ‘experts,’ read this complimentary link to my chapter “Myth #13: It’s Best to Follow Expert Advice“.

Taking unnecessary risks is the definition of “Jackass Investing.” The result of Jackass Investing is to turn a “portfolio” into a “Poor-folio.” Because of the precision with which Mr. Corzine followed the script of Jackass Investing that I lay out in my book, I am awarding him this Jackass Investing “Poor-folio” Award. Once again, I’d also award one to each of the credit ratings agencies if I hadn’t already done so. But it’s certainly impressive at how consistently incompetent they continue to be.

UPDATE 11/4/2011
Since I wrote the initial part of this post above, the situation at MF Global has gone from bad to worse. With the disclosure that customer segregated funds were misused, executives of the firm are now likely facing civil, and potentially criminal, charges. In my 30 years of trading I have never seen such a misuse of customer funds, which indicates panic among its top executives, as well as such a bungled process for transferring customer funds. A “Poor-folio” award is too good for these people.

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Rewarding Failure: Jackass Investing “Poor-folio” award for Hewlett-Packard

Small business owners understand the need for hard work, integrity and perseverance. If they don’t, they don’t survive, let alone thrive. When I started my investment firm, Brandywine Asset Management, 30 years ago, there were no guarantees. I spent the vast majority of my waking hours researching trading strategies and the legal issues surrounding setting up and marketing a commodity fund, preparing marketing materials, establishing brokerage relationships… the list was almost endless. Fortunately, so was my energy at that time. But one ingredient that wasn’t endless was my bank account. When, after the first year, the business wasn’t yet paying the bills, I borrowed the money off my credit cards (Why and how I got the cards in the first place is another story). Fortunately credit card companies considered me a good credit risk and continued to extend credit as long as I paid their monthly bills on time. In time, with more than 100k owed to the card companies it became clear that I only had one way out, I had to make the business succeed. That was the only way to pay back the debt. (I know, another alternative would have been to renege on my commitment to the card companies, but I never considered that to be an option. I got myself into the situation. It wasn’t the card companies’ responsibility to get me out. It was mine alone).

Fortunately, with continued perseverance, I was able to grow the business and repay my debts. Brandywine thrived and became a highly successful managed futures trading firms. But believe me, I struggled to reach that outcome. I had many opportunities to fail along the way. Over the years I’ve come to recognize that millions of other small business owners can relate to this story. My story is their story.

But that’s not the story in “corporate” America. Unfortunately, corporate America rewards failure. How else can you explain the obscene severance packages doled out to failed executives by huge companies such as Home Depot, KB Homes, Merrill Lynch and most recently, Hewlett-Packard. Many of these companies’ CEOs damaged their companies financially or reputationally (or in the case of Merrill Lynch, actually took their companies to the brink of collapse), and then got paid tens of millions of dollars to go away. In the case of HP, Leo Apotheker mismanaged the company for just eleven months before the Board of Directors (incompetent boards is a topic for another post) showed him the door. But heh, while you’re on your way out, here’s $30 million as a reward for your failure. Huh!?

Apotheker was just the last in a string of HP executives who were rewarded for being fired (er, “resigned”). Just last year then-CEO Mark Hurd left after being accused of a variety of violations of HP’s Standards of Business Conduct, including “misuse of company assets” that was related to his “close personal relationship” with an HP contractor. An investigation uncovered that the contractor was paid yet there was a question about whether her services were actually provided (this behavior is illegal in all states except Nevada). Oops! And how did all this get past the HP Board of Directors the whole time? Oh right, Mr. Hurd was Chairman of the Board. Despite the damage his behavior caused HP, Mr. Hurd was paid $12 million to leave and was also entitled to an additional $53 million that he negotiated away in exchange for being able to take a leadership role at Larry Ellison’s Oracle.

Prior to Mr. Hurd there was Carly Fiorina, who received over $40 million in severance and stock grants for “resigning” in 2005. Look, I generally liked these CEOs (at least Hurd and Fiorina). They were dynamic and assertive. They should have been paid well. But they should have been paid well for the quality of their work and the value they brought to their shareholders, not for the quantity of the messes they left behind.

As a result…

Because of its continued legacy of rewarding failure in both the executive suite and boardroom, I am awarding HP the most recent Jackass Investing “Poor-folio” award.

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Another Jackass Investing “Poor-folio Award”

This award goes to Moody’s, Standard & Poor’s and Fitch Ratings, the three credit rating agencies whose incompetence contributed to one of the greatest destructions of wealth and confidence in the global financial system ever, and helped precipitate the financial crisis of 2008.

The greed and incompetence of the credit ratings agencies is now well-known.  I first described this and their conflict-of-interest addled ratings process in Myth #13: “It’s Best to Follow Expert Advice” of my book Jackass Investing: Don’t do it. Profit from it. You can read the full text of that chapter here: Myth #13. (The chapter also weaves in interesting references to stock market gurus, financial analysts, ways that rats outsmart humans, and the Apollo moon landings.)

But now it becomes apparent that the greed and incompetence of the ratings agencies were built on a foundation of corruption. The disturbing case of corruption was reported in a 78-page “comment” made by William J. Harrington, an 11-year employee and Senior Vice President of Moody’s, one of the big three ratings agencies. The story was reported by Henry Blodgett here: http://www.businessinsider.com/moodys-analyst-conflicts-corruption-and-greed-2011-8. (And Blodgett certainly knows corruption and conflicts-of-interest. He was sanctioned for putting public buy ratings on stocks that his employer was underwriting, when he personally believed them to be “dogs.”)

Harrington wrote that – surprise – Moody’s often gave out ratings that its clients wanted, against the private conclusions of its analysts; and that Moody’s product managers, those who were responsible for growing business and keeping clients happy, also voted on ratings decisions. You can read Harrington’s comments in their entirety here: http://www.sec.gov/comments/s7-18-11/s71811-33.pdf.

It would have been justification enough to issue this award on the basis of greed and incompetence alone, the charge of corruption makes Moody’s more worthy yet.

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New Jackass Investing “Poor-folio Award”

A Jackass Investing “Poor-folio Award” goes to…

European Securities and Markets Authority

Last Thursday, August 11th, four European countries banned or restricted short-selling in stocks. The bans were imposed in reaction to the sizable stock market losses recently suffered across global markets. This is a political move, not a logical financial one, and history shows it will be counter-productive.

In my book Jackass Investing: Don’t do it. Profit from it., I discuss the attempts that have been made by governments over the centuries to manipulate markets by banning the short-selling of stocks. They do not work. The most recent widespread ban of short-selling – that imposed during the financial crisis in 2008 – resulted in losses in the banned stocks that exceeded the losses on stocks for which short-selling remained permissible. The chapter in which this is covered, “Myth #10: Short Selling is Destabilizing and Risky,” can be read here in its entirety: Myth #10.

The reason short-selling bans are counter-productive is simple: free markets hate inconsistency. Knee-jerk rule changes wreak havoc on investor confidence. What greater statement is there to show a lack of confidence in the markets than to restrict people from selling stocks! Kenneth S. Rogoff, a professor of economics at Harvard states the issue clearly, “The short-sale ban really smacks of desperation.”

Because of their panic in the face of adversity, their lack of confidence in free markets and their signal of desperation to financial market participants, I’m awarding this Jackass Investing “Poor-folio Award” to the “European Securities and Markets Association.” Congratulations!

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The Jackass Investing Poor-folio Awards are given out to those who sink below the crowd by taking actions that contribute to the creation of “Poor-folios.” For more information about Jackass Investing and how to avoid a Poor-folio and create “Free Lunch” portfolios that earn greater returns with less risk, go to www.JackassInvesting.com.

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Ryan Dunn & Jackass Investing

Friday, June 24, 2011:

Life is full of risks. Some are avoidable. Some are unexpected. And some are self-inflicted.

I am saddened by the death of Jackass movie and TV star Ryan Dunn. I didn’t know Ryan, although he was a local guy and the Jackass crew once shot a scene on my property. That came about because Bam Margera, one of Ryan’s co-stars, literally lived ‘around the corner’ from my office, which is in a renovated 17th century grist mill. One day, unannounced (and uninvited), they appeared with cameras and crew on our front field. I guess they found the setting irresistible.  But as far as I remember, we never met.

Ryan left life as he lived it. He died early Monday morning in a fiery car crash behind the wheel of his Porsche. Unfortunately, his death, and that of his passenger and good friend Zachary Hartwell, was both avoidable and self-inflicted. He lost control and launched his car over a guardrail at a speed well in excess of 100mph. He did this while driving his friend home at 2:30 in the morning, after leaving a bar with a blood alcohol level that was more than twice the legal limit.

I’ve read numerous blog posts, articles and comments about the crash that are mean-spirited or self-righteous. Sure, Dunn essentially killed himself and he killed a friend with him. We were fortunate that he did not kill any others who crossed his path. But by all accounts, Ryan was a great guy. He had many friends and, despite his Jackass reputation, treated people with respect. My heartfelt condolences go out to the families and many friends of both Ryan and Zachary.

It would be hypocritical for me to demean Ryan Dunn for his actions. I too have engaged in similarly risky behavior. I like fast cars and have raced them – both on and (recklessly) off the track. I did my own stunts, and not under controlled conditions. It was only through good fortune or the grace of God that I or an innocent person, who intersected with me at the wrong time or place, didn’t meet a similar end. But that doesn’t mean I can’t exploit both Ryan’s and my risky behavior for a positive cause, as I’ll explain.

Our similar misconduct and the scene the Jackass crew shot on my field are not the only connections I have with Ryan Dunn. He was in part the inspiration for the title of my just-published book, Jackass Investing: Don’t do it. Profit from it.” The book is all about risk – Avoiding risk. That’s why I say “Don’t do it.” To me, the definition of jackass investing is the act of taking unnecessary risks. Ryan Dunn got paid to take unnecessary risks – but that behavior also ended his life. In investing your money, you don’t get paid for taking unnecessary risks. Someone else takes your money from you.

But making people money is a far cry from saving lives. Or so I thought. Ryan Dunn and Zachary Hartwell, who was newly married, began their final night on Father’s Day. I am the father of three great boys, and what I’ve come to recognize is that the same philosophy I teach to investors is the basis for what I preach to my boys. Avoid unnecessary risks and take control of your own lives. Ryan’s and Zachary’s deaths cemented the realization that making and saving people money is only my job. My full-time occupation is being a father and shaping and saving the lives of Mitchell, Matthew and Charley.

With every opportunity, and Ryan and Zachary provided me a very public opportunity, I stress to my boys that they are in control of their lives, that whenever possible they should avoid placing their lives in the hands of others, and that they should avoid taking unnecessary risks. In summary – that they should avoid jackass behavior. I am grateful that my boys were not old enough to have been out on the road that night and that no one else’s son or daughter was in the way of Ryan’s car when he lost control. But my boys’ ages will not spare me for long. And that’s why Ryan Dunn, in his death, handed me a gift. He was able to teach my boys in a dramatic and very public fashion, the consequences of taking unnecessary risks. This week a very dark cloud enshrouds the lives of the families and friends of Ryan Dunn and Zachary Hartwell. But I am grateful to them for the silver lining they provided in the form of the unintended positive impact they’ve had on my boys.

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New Book Review

Although the book won’t be published until later this month, I just got this great review for Jackass Investing:

“In the Introduction to Jackass Investing, Mike Dever states “This book should not be controversial, but it will be. That is because investing, which should be a rational pursuit, is not.” I agree with Mike. This book will be controversial. Not because what he presents is wrong. In fact, his book is thoroughly researched and logical to an extreme. It will be controversial simply because so many people have a vested interest in preserving conventional financial wisdom, and this book clearly refutes much of what is conventionally preached.

If I were to use one term to describe Jackass Investing, it would be “ground-breaking.” That is because Jackass Investing goes well beyond being a simple investment book. In it Mike Dever presents an entirely new system of thought. He introduces “return drivers” and explains how to use them to create trading strategies, which are the core components necessary to construct a truly diversified portfolio. He makes his case by systematically describing 20 common (and costly) investment myths, explaining why each is a myth, and not a fact. The author then shows you how to profit from them, precisely because others believe them to be true. The book clearly illustrates the author’s depth of knowledge and 30-plus years of investment experience. But although the concepts he presents are serious and well-supported, Jackass Investing is far from being a dull academic textbook. It’s a highly entertaining read, as he introduces his concepts with the help of entertaining anecdotes and comparisons to popular culture.

For example, In Myth #3 – You Can’t Time the Market,” Mike first recounts the Seinfeld TV episode titled “The Opposite,” where George Costanza comes to the realization that “every decision I’ve ever made, in my entire life, has been wrong. My life is the opposite of everything I want it to be.” Mike then shows how that relates to market timing, in that the market-timing instinct of the average person compels them to do the exact opposite of what they should do. And he shows the statistics to support this. But Mike doesn’t just provide entertaining anecdotes and statistical support. In the “Action Section” for the book, Mike shows readers a specific strategy they can use to profit by doing the “Opposite” of what the masses do.

The “Action Section” on the www.JackassInvesting.com web site is an exceptional bonus provided to readers of the book. All by itself, it is worth multiples of the price of the book. It is where Mike Dever puts into practice the concepts presented in Jackass Investing. There are more than a dozen specific actions presented that can be combined into a “Free Lunch” portfolio. A Free Lunch portfolio is one that produces both greater returns, with less risk, than those espoused by conventional financial wisdom. Each of these Actions could itself be the subject of a book. They are well-researched and immediately available to be employed by the reader. And their pedigree is impressive, often being based on actual trading strategies that have been used by Mike in his trading at the firm he founded, Brandywine Asset Management, or other professional investors for more than a decade.

There aren’t too many books that are able to both introduce ground-breaking concepts, yet also provide specific strategies to use to exploit those concepts. Jackass Investing is one book that does both. It’s a testament to Mike’s writing ability that he is able to combine both into such an entertaining read. Don’t be a Jackass. Read this book.” Robert “Bucky” Isaacson

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