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Who Can You Trust?

By: Investor Solutions

By: Investor Solutions, Inc.

After all the scandals at Enron, WorldCom, Global Crossing, Adelphia Communications, and Tyco International (to name a few), where can you safely invest your money? The March 15th (2005) conviction of Bernie Ebbers, the former CEO of WorldCom, on nine counts of fraud, conspiracy, and filing false documents is sure to be the first of many to follow this year as the government “shakes down” on white-collar crime. Later this year, it’s expected that many of the Enron top executives will go to trial on similar charges that crumbled the energy giant back in late 2001. One of Enron’s ex-CEO’s Jeffrey Skilling is facing 36 charges alone ranging from insider trading to various types of securities fraud.

Still, the collapse of these companies left thousands of employees’ jobless and doubting the integrity of upper management positions. And let’s not forget that many of them had large chunks of company stock in their 401(k) plans completely wiped out. While keeping company employees completely in the dark on the real financial status of the corporation, many of the top executives unloaded their stock before the bottom fell out. At Enron, how could this have happened to a company that once stood as number 7 on the Fortune 500 list? Here are seven pointers that you can use to protect yourself:

Don’t keep all Your Eggs in One Basket

Don’t limit your market exposure to just a few different stocks. If you own five different stocks with an even weighting in a $1,000,000 portfolio and one of those companies goes belly up- your portfolio is now worth $800,000! Why take the additional risk, invest in a similar type mutual fund composed of 200 to 250 different companies to minimize your risk of failure of a single firm.

Large Executive Sell-Offs

It might be a red flag when top ranking executives start to sell-off large blocks of company stock or exercise options that they own. In 20 separate transactions, from Jan 2001 to Nov 2001, Kenneth Lay (ex-CEO Enron) sold over $70 million of Enron stock back to the company at prices he knew did not accurately reflect Enron-s true financial condition. After learning of Enron’s plan to hide $500 million in losses on the books, he started to dump the company stock.[1]

Mergers & Acquisitions

It’s ironic that most large mergers are reviewed by the Department of Justice and the Federal Trade Commission prior to consummation, because this is an area that put WorldCom in a world of hurt. Mergers & Acquisitions are usually associated with strong financial & economical growth for companies. However, in the case of WorldCom which did nearly 70 deals in the span of five years, should this have raised some questions or stricter review of the accounting by the regulators? If a company’s M&A is off the charts at figures too good to be true, then they probably are.

Close Ties between Management and the Board

If you’re going to invest large sums of money in one particular stock, it might be worth your while to review the background of the board of directors. If the board has strong ties to the company (i.e. former long-time employees, significant amounts of stock, use of company perks, etc&); it might be a warning sign that the management and the board have too close of a relationship. Not a good sign for an investor, since you’ll want your board to pose tough questions to company management and probe into various accounting and debt issues.

Stocks with Erratic returns

As an investor, we all drool at the opportunity to purchase the next Microsoft and watch our stock price double in a short amount of time. Unfortunately, many companies that double their stock price in a year or two are unable to sustain that same level in the years that follow. In many cases, these huge stock price increases are due to an increase in market share that was initiated by a merger or acquisition of which was supported by undertaking more corporate debt. When companies have large debt to equity ratios as compared to their peers or you notice sharp downgrades in quality rating of their debt instruments, there might be financial troubles brewing within the company.

High Exposure to Government Policy

Energy and Telecom companies spend an enormous amount of their liveliness lobbying regulators and elected officials. When the government ordered the breakup of AT&T in 1984, WorldCom stepped up and benefited from rules that enabled them to compete. However, just like governments can give- they can take away. When the rules change, these companies can find themselves on the losing end of the game. Be cautious of companies that rely too much on government policies, since political policy can shift just as quickly out of favor as it did to benefit the company.

Employee Stock Ownership

Be a smart investor; utilize the diversified investment options available to you in your 401(k) plan if you have them. If company stock is one of your options, it’s fine to invest a small portion of your savings in the company stock, but don’t put yourself in a position to loose your entire account if one stock goes belly-up. If company stock is your only option within the plan, then you may want to lower your contribution percentage and open an IRA on the outside to give yourself better risk protection.

Although many companies have high integrity and outstanding leaders at their executive positions, there are always a few bad apples that ruin the fun for everyone. You can’t let these few stop you from investing for your future wealth, but you can be a smarter investor and apply the risk reduction techniques that you’ve learned. Your retirement plans are designed to be long-term wealth accumulation tools that enable you to build substantial retirement savings. These accounts should not be invested in speculation stocks or single company stock. Take advantage of the world markets, they offer international diversification and risk reduction.

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[1] U.S. Securities & Exchange Commission, SEC Charges Kenneth Lay, Enron-s Former Chairman and CEO, with Fraud & Insider Trading, Release # 2004-94