John P Gavin CFA's blog

A new data point we received from the SEC reaffirms risk of an undisclosed SEC probe for Jefferies Group (JEF).  This has not gone away despite a cleverly worded press release put out by Jefferies the last time we raised this issue in November that temporarily succeeded in taking the pressure off the company to explain itself to investors. The video walks you through how they did it.

The following is from an update we originally published for subscribers on 12-Jan-2012 --

Jefferies Group Inc. (JEF- $14.62 Mkt. Cap.- $2.9 B) New SEC Data Point Re-affirms Risk of Involvement in an Undisclosed SEC Investigation. In a letter dated 28-Sep-11, the SEC confirmed that this company was somehow involved in an active and ongoing investigation that appeared undisclosed at the time. In a letter dated 11-Jan-12, we received new information from the SEC suggesting, again, this company was involved in unspecified SEC investigative activity. We continue to find no disclosure of the same as of this date.

There is a strong case to be made that Qualcomm has a material accounting risk that remains largely undiscounted despite the company having first disclosed elements of it over a year ago in November 2010. This could put investors at risk for a negative surprise in 2012.

According to Qualcomm filings, whistleblower allegations made to its audit committee in December 2009 triggered a formal SEC investigation in September 2010. The SEC investigation appears active-and-ongoing as of QCOM’s most recent disclosures. Amazingly, not one person has bothered to ask a single question about this exposure in any of the conference calls that took place since the matter was first disclosed.

In the balance of this note, I explain why Qualcomm’s accounting exposure should be viewed as a material risk. I also review the 6 most common disclosure tactics that we see public companies use, typically with the effect of minimizing bad news or throwing investors off the scent. To date, Qualcomm has used 5 of them, making the risk impossible to assess and discount, even for seasoned investment professionals.

The bottom line is this. Qualcomm is a public company that has disclosed a material risk factor investors cannot analyze. To our view, that means management trust has been compromised as they could give investors what’s needed to analyze this exposure, but chose not to. Investors will have to decide on their own if that is the kind of risk that lets them sleep at night.

In an 8-K filed this morning, Diamond Foods (DMND) disclosed that it received a formal order of investigation from the SEC. To our view, this is not a good development for DMND, as it appears to be an escalation of the situation.

An SEC investigation moving from informal to formal allows the SEC to issue subpoenas. In general, this is only done when some entity in the mix is failing to voluntarily provide SEC investigators with the information, records, or testimony deemed necessary to conducting their investigation.

With this in mind, we have 3 questions DMND investors need answered.

Applied Industrial Technologies Inc. (AIT) appears poised to improve its governance efforts by potentially separating the current position of Chairman & CEO into two positions.  This is a result of the incumbent departing in October. The splitting of the positions hasn't happened yet.

So far, a new CEO was appointed and the board announced its plan to reevaluate its leadership structure.  While the DI Guy applauds this development, investors could still be stuck with a Chairman & CEO if the AIT board fails to follow through by separating the roles.

In our experience of having prepared in-depth risk profiles on over 1,500 public companies, cases like what could happen at AIT are uncommon, if not rare.  All too often we see the opposite; that is, the Chairman retires, the CEO assumes both roles, leaving shareholders on the losing end of that governance shift.

We hope the board of AIT does not squander this rare opportunity to improve its overall corporate governance by separating the roles and duties of Chairman from those of CEO.  Now is the time for those with an interest in the company to let their wishes be known.

The following is excerpted from today's DI Report on AIT:  "In Apr-11, David Pugh (Chairman & CEO since Jan-00) announced his intent to retire by the Oct-11 annual meeting. Neil Schrimsher was appointed CEO in Oct-11. Pugh also stepped down from the board. Following Pugh’s departure as Chairman, AIT disclosed that the board intends to reevaluate its leadership structure."

Perhaps it's the nature of the beast, but there's typically a lot of happy talk on Wall Street anytime deals are announced, as was the case with AT&T's T-Mobile deal. Maybe that explains why investors appear surprised this deal is now bogged down in regulatory problems.  They shouldn't be. 

The company disclosed back in August that the Justice Department had filed a complaint against AT&T alleging that the proposed acquisition of T-Mobile would substantially lessen competition and likely raise prices.  This is what we call a risk that hides in plain sight.  These are the risks frequently blown-off by investors, often to their chagrin later.  But this stuff matters. 

We took that August disclosure to be of sufficient concern that it contributed to our changing the risk rating on AT&T from Medium Risk - Positive Bias to Medium Risk - Negative Bias on 27-Sep-2011. Our rationale on this is simple: 

• Management will always know more than you. 
• Management also hates saying anything bad. 
• When management does disclose something bad, as happened here, a safe default is to assume it's material.
• Material events that cannot be analyzed, or are glossed over with happy talk, are risks that can come back to bite you later.

For more on this take a look at the nice write-up by John Dvorak at Marketwatch.

Like they say, talk is cheap.  Happy talk even cheaper.  But when it comes to investing in public companies, what management and their lawyers deem necessary to put in writing carries the day for the prudent investor.