Skip to main content

Dana Galante on the value of auditing firms

Currently rereading Jack Schwager's Stock Market Wizards and I came across a very illuminating excerpt from an interview with short-seller, Dana Galante.

Had you read Galante's interview back in 2000, especially her comments on the value of auditing firms and the discretion banks and fund managers had in valuing illiquid investments, you might not have been surprised by subsequent events in our capital markets (read: Enron, Arthur Andersen, The Financial Crisis of 2007-2009, and so on).

Here's an excerpt from Schwager's chat with Galante in which she explains how a former boss was hiding trading losses from investors by marking up the value of illiquid private company investments in the fund's portfolio:

"JS: It almost sounds as if he was gambling with the portfolio.

DG: It sure appeared to be gambling. Looking back, it seemed that he tried to hide these losses by marking up the prices on privately held stock in his portfolio. He had complete discretion on pricing these positions.

How was he able to value these positions wherever he wanted to?

Because they were privately held companies; there was no publicly traded stock.

Is it legal to price privately held stocks with such broad discretion?

Yes. In respect to private companies, the general partner is given that discretion in the hedge fund disclosure document. The auditors also bought off on these numbers every year. He would tell them what he thought these companies were worth and why, and they would accept his valuations. They were these twenty-two-year-old auditors just out of college, and he was the hedge fund manager making $20 million a year; they weren't about to question him.

Another hedge fund manager I interviewed who also does a lot of short selling said that the value of audits on a scale of 0 to 100 was zero. Do you agree?

Yes.

Even if it's a leading accounting firm?

Oh yeah."

Now this type of exchange may not come as a surprise to readers in 2011, but I can assure you that plenty of people were shocked and caught unaware by these realities back in 2001-2003 and once again during the recent financial crisis.

So I guess the moral of the story is, do your own thinking and don't rely on the word of prestigious auditing firms and conflicted ratings agencies. Always do your own homework and try to understand how "business as usual" at the supposed safeguard firms can lead to disastrous results for those caught unaware.

Popular posts from this blog

Jesse Livermore: How to Trade in Stocks (1940 Ed. E-book)

If you've been around markets for any length of time, you've probably heard of 20th century supertrader, Jesse Livermore . Today we're highlighting his rare 1940 work, How to Trade in Stocks (ebook, pdf). But first, a brief overview of Livermore's life and trading career (bio from Jesse Livermore's Wikipedia entry). "During his lifetime, Livermore gained and lost several multi-million dollar fortunes. Most notably, he was worth $3 million and $100 million after the 1907 and 1929 market crashes, respectively. He subsequently lost both fortunes. Apart from his success as a securities speculator, Livermore left traders a working philosophy for trading securities that emphasizes increasing the size of one's position as it goes in the right direction and cutting losses quickly. Ironically, Livermore sometimes did not follow his rules strictly. He claimed that lack of adherence to his own rules was the main reason for his losses after making his 1907 and

New! Finance Trends now at FinanceTrendsLetter.com

Update for our readers: Finance Trends has a new URL!  Please bookmark our new web address at Financetrendsletter.com Readers sticking with RSS updates should point your feed readers to our new Finance Trends feedburner .   Thank you to all of our loyal readers who have been with us since the early days. Exciting stuff to come in the weeks ahead! As a quick reminder, you can subscribe to our free email list to receive the Finance Trends Newsletter . You'll receive email updates about once every 4-8 weeks (about 2-3 times per quarter).  Stay up to date with our real-time insights and updates on Twitter .

Moneyball: How the Red Sox Win Championships

Welcome, readers . T o get the first look at brand new posts (like the following piece) and to receive our exclusive email list updates, please subscribe to the Finance Trends Newsletter .   The Boston Red Sox won their fourth World Series title of t he 21st century this we ek. Having won their first Se ries in 86 years back in 200 4, the last decade-plus has marked a very strong return to form for one of baseball's oldest big league clubs. So how did they do it? Quick background: in late 2002, team own er and hedge fund manager, John W. Henry (with his partners ) bought the Boston Red Sox and its historic Fenway Park for a reported sum of $ 695 million. Henry and Co. quickly set out to find their ideal General Manager (GM) to help turn around their newly acquired, ailing ship. This brings us to one of my fav orite scenes from the 2011 film , Moneyball , in which John W. Henry (played by Ar liss Howard) attempts to woo Oakland A's GM Billy Beane (Brad Pi