Perhaps most surprising is that Citigroup has effectively unplugged the new economy, see full report, through a merger scheme in which Traveler's Insurance has been able to acquire the nation's largest bank, Citicorp, and then later change its name to Citigroup. While all eyes are on the technology sector, Citigroup has engaged in a variety of financial practices that are directly undermining both the new and broader economy. In addition, Citigroup is also positioned to eliminate Microsoft from its most important growth market.
In the last three years alone, Citigroup has issued more than 2.5 billion new shares to purchase three companies using the pooling loophole, most of the cost of which will never be reflected in the financial statements. Cisco Systems has received considerable attention for its abuse of the pooling loophole due to the number of companies it has acquired, with transactions totaling more than $20 billion. Traveler's Insurance purchase of Citicorp alone involved a transaction valued at more than $70 billion.
Citigroup is also an aggressive issuer of variable annuities and involved in a wide range of egregious financial practices including predatory lending. Banks with abusive business practices such as Citigroup were supposed to be among the biggest losers in the new economy due to the emergence of more cost effective competition. Sadly, many technology companies, most notably Microsoft, have turned their backs on ordinary consumers by not caring about the impact of Citigroup on the new economy. These impacts include the efforts of its subsidiary, Salomon Smith Barney, to stimulate too many mergers which have destabilized telecom in particular.
What makes our economy and free market system great is the integrity of our financial system and without achieving key reforms this integrity will be lost as the scorecard for success is corrupted. Microsoft, Cisco Systems & Citigroup are all standing in the "winner's circle" even though their financial success is an illusion and based upon financial engineering. Stocks are often under or over valued yet this overall situation is not related to valuation or excessive regulation but whether or not we are witnessing watered stock fraud. Meanwhile, many solid companies that should be in the winner's circle, both tech and non-tech, are excluded.
A key part of maintaining the system's integrity is a strong and proactive Securities and Exchange Commission or SEC. Clearly, the most important person in global finance is now Arthur Levitt, Chairman of the Securities and Exchange commission. Alan Greenspan is getting most of the press, and doing a fine job, yet we are being distracted.
Arthur Levitt is an example of an outstanding public servant doing great work. What he needs for success, however, is the media's full support in disclosing this massive watered stock situation to the American public. Only then will he have the political muscle to succeed. A transcript of Levitt's groundbreaking speech regarding market integrity is available in the press archive. For this reason I have made a strong effort to draw more media attention to this remarkable situation and for the last year included watered stock fraud management as a fundamental part of my business as an investment advisor.
It is surprising that no one has stood up and taken a leadership position on this situation. For that reason I have reluctantly stood up myself. Everyone seems to be afraid of speaking out against these three companies, including both US Senators from Oregon, one a Democrat and the second a Republican, both of whom and their top assistants, I have met and asked for a dialogue on this issue.
Question 1: Isn't this just a sales pitch to make yourself look good and gain clients by riding on Microsoft's current troubles with the DOJ?
No. Regarding Microsoft, I actually began publishing my research before the DOJ trial and consider the trial an unfortunate distraction from the real issue, which is the yet to be reported massive watered stock financial fraud as summarized in the Financial Pyramid Summary in the press archive. This claim can be verified by reviewing the date on the press release that appeared on PR Newswire issued on September 28, 1998. Sadly, Microsoft, who is PR Newswire's largest client, told the service to stop issuing my press releases and they complied with Microsoft's request, even though they acknowledged the content was high quality and newsworthy.
Even though I receive a significant amount of interest from potential clients over the Internet, I have an elaborate screening mechanism and to date have not accepted a single such client. In fact, I have lost many clients even though they have received excellent above market returns because these people are uncomfortable with my views with respect to Microsoft and Cisco Systems. That is changing now however as more of Microsoft's practices have been divulged in the mainstream media.
Simply put, this effort represents an enormous personal and financial sacrifice because Microsoft is a highly respected company here in the Pacific Northwest. I have numerous close relationships with Microsoft employees in addition to their various legal, accounting and public relations advisors. The same is true for Citigroup. I have little no interaction with Cisco or its key advisors.
The research materials published on the Internet are primarily there to demonstrate to existing clients and others that I am willing to walk the extra mile and help ensure the integrity of the overall financial system. I have never accepted a penny from any investment company, either directly or indirectly. No 12-B 1 fees, no annuities, no wrap agreements, no joint marketing, etc. All fees come directly from clients and so whether you agree with my analysis or not, you can be supremely confident that it represents an independent perspective.
Question 2: What is "watered stock?"
Parish & Company defines watered stock as a company that meets the following criteria. These criteria quickly eliminate more than 99 percent of all companies from consideration. Only those companies satisfying all of the following parameters are considered watered stocks. The three most watered stocks, and strikingly similar in their overall business practices, are Microsoft, Cisco Systems and Citigroup.
1) Gross revenues exceed $5 billion and reported annual net
income exceeds $500 million.
It is important to note that watered stock fraud can only exist in large and well established companies. Smaller companies that are highly valued are a natural function of the capital formation process and many will indeed grow substantially and through such growth eliminate the dilution from aggressive financial practices used to ignite the business.
2) Gross revenues (in Citigroup's case revenues less interest
expense, insurance claims and bad debts), divided by the total shares outstanding,
including employee stock options, yields a number less than 10.
The objective here is to capture the impact of the excessive use of the pooling method for acquisitions in which shares are printed on the equivalent of a photo copy machine and used to pay for acquisitions with no subsequent accounting for the cost of most of this activity. This activity is captured by relating gross annual revenues to the number of shares outstanding. The biggest abuser here is Citigroup followed by Cisco Systems. Even Microsoft has 25 percent fewer shares outstanding than Cisco Systems. Cisco's annual revenues are approximately $20 billion yet it has 8 billion shares outstanding.
3) The company's total market value must exceed 1 percent of
the Standard and Poors 500 Index and the annual dividend yield must be
less than 2 percent.
This again highlights that watered stock fraud is really only an issue for companies that reach a certain size and influence on the overall market. At their recent peaks Microsoft, Cisco Systems and Citigroup together represented more than 10 percent of the entire S&P 500 Index. Neither Microsoft or Cisco has ever paid a dividend and Citigroup's dividend is less roughly 1 percent which is most unusual for an FDIC insured bank.
Two additional measure applicable to technology companies include the following:
1) The stock option wage expense taken as a tax deduction but not charged to the publicly disclosed earnings statement exceeds taxable income in 2 of 4 quarters in any given year. Employees are now taxed at ordinary income rates for the amount of the tax deduction taken by the company when they exercise options, even if the stock is not sold. In addition, employees also have to pay the exercise price upon exercising the options. They are clearly prepaying their own wages in a massive watered stock based pyramid scheme.
This measure will reveal only those companies that grossly abuse the right to provide stock options to employees and thereby shift their entire corporate federal income tax burden to employees. Neither Microsoft nor Cisco Systems now pay any federal income tax due to the success of this scheme. The scheme is also grossly distorting the underlying reported success of their primary businesses by inflating reported net income and stimulating interest in the stock price. This is because none of this wage expense, for which a tax deduction is provided, is charged to the earnings statement we see.
2) The remaining stock option debt exceeds gross annual revenues.
This measure will show how leveraged the future is by commitments in place regarding unexercised stock options granted and their relation to gross annual revenues. At Microsoft, with almost 800 million options outstanding, that means that a wage debt of $800 million occurrs with every $1 increase in the stock price.
Summary Comment: It is again important to note that only those companies meeting all of the above criteria would be considered watered stocks.
Question 3: What is your background and what makes you qualified to discuss these matters?
Please see the resume in the summary of services section on my home page. My background includes Public Accounting for Arthur Andersen, Chief Financial Officer for a regional financial institution, Senior Analyst for a large bank, Peace Corp Volunteer in Paraguay, South America, Business Planner for Japanese Technology firm, Educator, etc. I am generally known to be an expert on financial services and technology.
During the last 5 years I have also also taught 6 classes on International Finance at leading Universities in Latin America through an exchange program at a local University. The classes are generally one week long, in Spanish and I go as adjunct faculty. They have included courses in Santiago Chile, Lima Peru, Tegucigalpa Honduras, Bogota Columbia and Oaxaca Mexico.
In addition, from its inception until 1998 I was a loyal Microsoft supporter, having converted thousands of people to the Windows platform in a variety of organizations. This required numerous battles with advocates of other platforms including OS 2 and various Unix variants. Having had network administrators reporting to me and being responsible for technology plans and purchasing activity has also helped me understand an inside perspective of how Microsoft is affecting organizations internally.
I also taught computer related classes as adjunct faculty in the Professional Development Center at Portland State University for more than 5 years. These included "Getting the Most from Microsoft Windows," "Organizational Planning Using Excel" and "Effective Presentations Using Powerpoint" Course reviews were generally outstanding and two even resulted in standing ovations when done.
This is important to mention because today most of Microsoft's supporters are not genuine. All they care about is the stock price and they'll turn their backs on Microsoft if the stock does not perform. Perhaps that is part of the problem in that they are simply running scared to sustain the stock price. My support was always genuine.
Having been a Chief Financial Officer for a financial institution, I am also familar with many of the key issues unique to financial service. This has helped me unravel Citigroup's scheme.
Question 4: What caused you to look at this area?
One afternoon while drinking terere, a local tea, in Aregua, Paraguay my friend Enrique, when asked how things were going with the economy, told me that he was no longer receiving his pension checks. Enrique had worked more than 35 years. It struck me as odd that the corruption could reach such a point that the equivalent of our social security system could stop issuing payments altogether. At the same time many articles were being written describing how rapidly global capital was moving, in particular the financial crisis in Asia.
The obvious question became, where was all this capital going and did it include Enrique's pension checks? At that moment while sitting in the midst of an imploding Paraguayan economy I made a decision to study this area and try to answer this question, where did the capital finally end up. In the old days corrupt officials transferred funds to Swiss bank accounts yet these fund were now clearly flowing into the U.S. stock market, in particular Microsoft and Cisco Systems. Local investment was seen as unattractive from a risk/reward perspective.
It seemed odd that Microsoft and Cisco's watered stock fraud could cannibalize the most promising future markets for their products but that is the fundamental nature of pyramid schemes. Enrique is married and with three grown children, all of whom are ideal prospects for both these companies products. At the time, they had one computer which was unusable due to a virus and no practical internet access due to excessive phone fees.
Later while teaching another class in Lima, Peru and having lunch with one of the students and his daughter, a former newspaper publisher whose paper failed in an economic collapse, another curious effect was noticed. His daughter mentioned she was an attorney and working long hours, 7 days a week. When I asked what type of law she practiced she mentioned that she mostly worked with attorneys from Microsoft on copyright issues. It seemed odd that Microsoft would be making such an intense effort in a country ravaged by poverty, political instability and at the time in the midst of the Japanese Embassy hostage crisis. Two of the students in my class, local business people, were hostages for 8 days as the terrorists began with several hundred hostages before releasing all but a small group.
What became clear, once again, was that Microsoft was investing almost nothing in Peru yet trying to extract significant software revenues and thereby quickly cannibalizing a potential future market. Growing poverty from a lack of access to computer tools simply doesn't allow for much long-term economic success and therefore Microsoft's business practices seemed foolish at best. Good businesses make investments in their future markets. At the time Microsoft's only other research and development facility was in England.
In October of 1998 the Long-Term Capital Hedge fund came close to failing and threatening the global financial system, providing another clue. It was so close to failing that the Federal Reserve had to orchestrate a bailout. One of its partners, Myron Scholes, received the Nobel Prize for his Black-Scholes option pricing model. It seemed especially ironic that this hedge fund using exotic math models could leverage more than $1 trillion in fixed income securities and almost collapse the global financial system when its math formulas did not produce the desired result. A good headline might have been Nobel Prize winning economist one year contributes to a collapse of the financial system the next. When asked what kind of business this fund is in, Myron Scholes responded that "they are basically sucking nickels from all over the world." I suppose in plain English that means they were running a financial pyramid scheme. This is a rather odd business when you provide no product or service other than "sucking nickels."
The Black Scholes model used by Microsoft and Cisco to report its stock option debt to shareholders is nothing more than a financial tool used by corrupt executives to gain access to retirement system investment dollars by inflating earnings and fueling interest in their stock prices without participants knowing it. Approximately 7 cents out of every dollar dedicated to stocks in most retirement plans is indeed now going to the purchase of Microsoft and Cisco Systems.
It is interesting to compare Microsoft with Intel. Intel now has substantial facilities in Ireland, Israel, Costa Rica, Malaysia and many other parts of the world. This is smart business and will probably breed a multitude of spin-offs in these countries, thereby stimulating the local economies and producing a broader market for Intel's products. Key to this effort by Intel is to develop the local work force at each site and this often includes transferring employees here to the U.S. for specialized training. Intel's stock should benefit enormously over the long term from this sound and responsible business strategy.
Another impact of this scheme is the complete collapse of quality investment analysis as large mutual fund companies scale down these areas and instead invest in marketing. For this reason these companies, most notably Fidelity Investments, are poorly diversified and over concentrated in both Microsoft and Cisco Systems. I have provided my research to Fidelity several times and although they have closely analyzed it, they have not reported any of it to there shareholders and instead continue to extract what could be considered excessive management fees and build holdings in Cisco Systems and Microsoft. Fidelity Investments is a prominent fund family in many retirement funds. Another example is the Janus family of funds.
Perhaps the most important impact of this scheme is the destabilization of the stock market since many good companies are getting little interest in there stock and executives are now taking some of these companies private. Why bother with being public if a few companies cooking the books and practicing watered stock fraud are going to get all the investment capital? This is a disaster for advisors like myself because many mutual funds' returns end up being driven by the watered stock fraud at Microsoft and Cisco Systems. The pool of quality funds has effectively shrunk.
As an advisor I also help people determine strategies for exercising their employee stock options. Where I always begin is framing the quantity of options outstanding in relation to the underlying business in an effort to the risk of not exercising until a later date. This includes comparing the firms position to others and this is how I discovered that both Microsoft and Cisco Systems had uniquely aggressive programs.
Question 5: Are you afraid of being sued by Microsoft, Cisco Systems or Citigroup?
Maybe that would be a good thing because it would allow me to make my case and call for necessary evidence to defend myself. Such a suit by them would most likely be considered malicious and could clearly backfire and expose either company to a significant counter claim. They also run the risk of igniting a tidal wave of financial fraud lawsuits as the public discovers the nature and impact of their financial practices.
Question 6: Have you spoken with representatives of all three companies?
Yes. In addition, I always send each company, their attorneys, public relations firms and the Securities and Exchange Commission a copy of reports prior to releasing them. You can be certain that all substantive facts are soundly researched and accurate. In addition, all key financial data is taken directly from the SEC filed reports available from the Edgar database. Many forget that these SEC reports are now often more than 350 pages long and very difficult to understand. One could say that I try to summarize them in plain english for the average person.
Question 5: Why hasn't this been more widely covered in the press here in the U.S. when prominent newspapers in Germany and England have reported your findings?
This is somewhat of a mystery. Of course the New York Times did print a front page story on June 13, 2000 yet the Times is one of few publications left with genuine integrity. Some say the scheme is just complicated enough to make it difficult to understand, much less believe. Others say that Microsoft's interlocking partnerships with key media companies, including Reuters, make such disclosure difficult. Although many leading reporters are now asking to be added to my mailing list, they still have not done the story, probably because they can't get it past there editors. Perhaps it is just a little too hard to believe.
My personal feeling is that there are only a few national figures, for example Oprah, with the integrity to help the average person understand why this is so important to address. Even though NBC has close partnerships with Microsoft, including MSNBC Oprah probably has the political power to do such a story if she wanted.
I am also often told that this whole situation seems similar to the tobacco industry story which was very difficult for CBS to report. The truth is that it might be much more difficult to report due to Microsoft's interlocking ownership of many media interests and key partners, such as Paul Allen, who also have numerous media interests. Another difference with the tobacco situation is that we can all choose whether or not to smoke yet our retirement funds may not offer us a choice to avoid this watered stock fraud. At times I wonder how many young person's college education's will be impacted by parents unsuspectingly investing in watered stock. Fidelity will preach thinking long-term and that is good provided they are not posting management fees quarterly on watered stock.
Question 8: Please summarize what you hope to accomplish from publishing this research.
We are blessed with the best economy on the planet and are now the envy of the world. Why should we throw it all away just because a few large companies need to cheat on there financials to sustain a pyramid scheme that benefits fewer people that most realize.
I am a very strong free market advocate and also believe in minimal government intervention with respect to the financial markets. Full disclosure, however, is essential to maintain integrity in these markets. There is almost no cost to such disclosure. For example, if Microsoft and Cisco Systems are going to be taking tax deduction for wages that exceed taxable income and not report a dime of this as a charge to earnings, that's a problem that should be fixed. You want the deduction, fine, just make sure you also charge it to the earnings you report to the public. That might take a total of a two hours for a competent accountant to compute. One might think that this is the very essence of an information based economy. Failure to achieve such disclose could lean us toward a more controlled society and threaten our free market system.
If Cisco Systems wants to spend $6 billion to purchase another company, that is also fine. Let's just make sure that they account for the cost of the acquisition. What they effectively have now is a photo copy machine in the accounting department printing up watered stock on request to pay for such acquisitions, knowing full well that this cost will not be reflected on either the income statement or balance sheet.
This is clearly watered stock fraud as they now have 8 billion shares outstanding, including employee stock options, and annual sales are only $20 billion. If Cisco were valued at twice annual sales that would be $40 billion or about $5 per share, it is currently at $66. For a small company this type of difference should not be a great concern yet with Cisco representing 25 percent of the entire annual federal budget, we need more dialogue here.
Question 9. What is the best way to understand your study?
Read everything in the press release section twice. I wish it
were easier but it is quite a scheme. Most of the pieces are only two pages
anyway. If something is not clear or you disagree please do send
me an email.