Investment Advisor Alleges MS Financial Fraud

Bill Parish, of investment management firm Parish & Company, claims Microsoft's stock prices may be artifically inflated, and that MS may actually be losing money instead of generating huge profits. Parish says you haven't heard his claims before because "...Microsoft is a significant advertiser in the major media [and] it has been hard to get exposure there." Slashdot offers no opinion one way or the other on the acccuracy of Mr. Parish's allegations. Please read his report and decide for yourself.

Stock Splits

3) Prohibit Microsoft from buying back its own stock, instituting stock splits or selling put contracts and engaging in other hedging activity for 10 years. These are tricks used to manipulate the stock price and have contributed greatly to building the financial pyramid. It might make sense to outlaw this practice all together.

Both stock buybacks and stock splits have long been considered legitimate tools for a company to use to keep stock value up for shareholders. Now the author wants to outlaw both. When successful stocks don't split, they can become unobtainable to small investors. Witness Berkshire Hathaway - the Class A stocks would require a home mortgage to purchase 1 share. I'm not sure how much of what the author is saying is true and illegal, but his solutions are throwing the baby out with the bathwater. Aramoro

Links to more info

Microsoft Accused of Mis-using Cash Reserves [go.com] "A lawsuit quietly settled late last year alleges that Microsoft's immense cash reserves were used to manipulate its earnings reports, giving the company the appearance of steadily increasing profits and allowing it to consistently exceed Wall Street projections."

SEC Probes Microsoft Accounting [go.com] "Federal authorities are investigating Microsoft Corp.'s, practice of setting aside some of its software revenues and recognizing them later, chief financial officer Greg Maffei said on today."

Commentary regarding FASB trying to get stock options factored into financial statements [go.com] "While these represent true legal and accounting vulnerabilities to Microsoft, the company's future is so strong that the long-term picture remains strong."

Not really...

This guy seems to really hate Microsoft...

But what he basically claims is that in Microsoft accounting (and specifically, in stating the earnings) the overhang of the existing stock options is not being considered. That's true. However, that's true for every company in the US that has issued stock options. This issue has been discussed by FASB (accounting standards setting body) several times and after quite animated debate, the existing situation -- that the companies are not obliged to put the outstanding stock options into their profit-and-loss statement -- was left to stand as it is now.

Basically, the situation is like this. Company X issues a stock option to employee Y at, say, $10/share. Let's say a year passed and the stock of company X is now trading at $100. You *can* say that the company sustained a $90 unrealized loss (I am ignoring the time value of money for simplicity) and that's exactly what Parish is saying. However, in the real world if the option gets cashed in, the company will not go onto the open market, buy a share for $100 and give it to the employee in exchange for $10. The company will just issue more stock.

Of course, this is not a painless procedure. The more stock is issued, the more the value of the existing shares is diluted (or "watered down"). If the company has 100 shares outstanding, each share was worth 1% of the company. If 100 more shares are issued, all shares will now be worth only 0.5% of the company, so the previous share owners clearly become worse off.

And that's exactly why the earning figures released generally show two numbers: one for outstanding shares (those that have been issued and are not treasury stock), and one on a fully diluted basis, which assumes that all stock options are turned into shares. It is quite misleading to say that this is a big scam that nobody knows about. Any investment professional understands what "fully diluted" means and that Microsoft does have a huge number of stock options outstanding. That hasn't stopped them from buying Microsoft shares in huge amounts.

Maybe the guy has a point in that the gullible public should be made more aware of the problem (and I freely concede that this *is* a problem: only not limited to Microsoft, not having such huge importance, and not likely to lead to the financial meltdown of the free world). But financial professionals know the situation quite well. And the measures that he proposes against Microsoft are quite ridiculous.

I suspect that Bill Parish at some point in the past shorted Microsoft stock (or didn't buy it, buying instead something else) and is now very very bitter about it...

Kaa

This is just corporate accounting

This is how the corporate accounting rules work. They don't make any sense. There is a push to make stock option gains come on the company expense reports. It will probably happen. However, until then, Microsoft is following standard accounting rules.

However, as usual, Microsoft is doing a few shady things to exploit the system more than usual. Every tech company has HUGE stock options, the difference is the Microsoft plays more games then the rest.

Stocks are screwy anyway. According to economic theory, a stock's price = present value(future dividends), when in reality, there are no dividends because the tax structure makes capital gains taxed less. As a result, all earnings are returned and reinvested, making the company more valuable. However, because of the lack of dividends, the stock market has these problems.

Placing dividend income at (or below) the capital gains rate would fix the problems. It would force dividends to be paid giving stocks real values. Sure they would be based upon future earnings, but those earnings would start to come on established companies like Microsoft. Also, if cash on hand went to paying dividends, large companies wouldn't have nearly infinite revenue. Basically, profits go to the owners. However, by a shell game, instead of going to the owner, they are used to buy other companies, which increases the share price the amount that the dividend should (in theory).

This encourages the merger mania sweeping this country. A large, wealthy company with huge profits has 3 options:
1) Pay dividends
2) Buy companies
3) Pay dividends with stock buy backs

Dividends are out of the question for tax reasons. Three can cause trouble if it looks like you are paying a dividend (i.e., if Microsoft made %3 percent of it's share price in profits, they buy back 3% of the stock, which means that everyone's stock goes up that value, this continues until their are very few stock holders because the rest sold them back), however, this can cause suspicion as tax fraud. The resulting option is buying companies (or building internal divisions). Either way, a large company is forced to grow beyond it's optimal size, because real profits are out of the question.

Of course, if it grows beyond its means, diminishing returns kick in, growth drops, and the stock collapses... What a way to run an economy.

We need tax AND accounting reform.

Alex

This reads like a paranoid rant

Hmmm. I used to spend quite a lot of time on sci.skeptic, and maintained the FAQ for a while. This gave me a good opportunity to study "fringe" ideas. This article has a lot in common with them:

• It targets a prominant public figure and alleges that he is at the head of a large scale conspiracy.
• Lack of firm evidence to support his position. I tried to read the spreadsheet, but my copy of Excel would not open it. Nothing else in the article gives me any confidence in his position.
• Various out-of-context bits and pieces are made to seem more important than they are. Specifically MS has been accused of manipulating its stock price by reserving money from rich quarters and turning it into profit during poor quarters. But this can only smooth out lumps and bumps, not maintain a long-term growth curve.
• Lots of references are made to people who don't believe the author, along with elaborate justifications for this. No doubt Alan Greenspan is snowed under by letters from crackpot economists and conspiracy nuts. This guy looks just like another one. Ditto the fund managers and newspaper editors. They know what a price support operation looks like, and this isn't it.
• Discussions of how courageous the author is being in revealing this truth.
• Predictions of apocolypse RSN.

I think MS is overvalued, but I very much doubt that the situation is this bad.

Paul.

Re:Slashdot is scared of M$ too

I think Robin included that comment more as a reminder that just because Slashdot posts a link to a story doean't mean that they are endorsing it as the truth. Given all of the zealotry on Slashdot this seems like a very reasonable thing to do. Your *job* (should you choose to accept it:) would be to read the article and form your own opinion.

I'll agree that many stories do include a tounge-in-cheek comment with an anti-MS slant, but I've never taken them as an official Slashdot opinion, more as the posters attempt to be sly.

Anyways... I wonder how many people own MS stock and don't even know it. MS stock has been very popular with mutual fund managers (with good reason) for years.

I'm just cynical enough to believe that big companies, MS included, will try to get away with whatever they can. This sort of thing (if it's true) probably goes on more than we want to believe. The truth is, I'm sad to admit, I just don't have the time or the energy to really care.

Re:This reads like a paranoid rant

Speaking of sci.skeptic, I've been reading SI and the Skeptic for years... and a lot of skeptics forget that every so often one of the "kooks" is correct. They inevitable go through a period where they look like "kooks" at first glance, but I've noticed several common traits which this guy seems to share:

He *doesn't* compare himself to Galileo, an early Einstein, or any other genius "misunderstood in his own time,"

He's speaking in his area of professional interest. He's an analyst taking a hard line on the valuation of stock options, not a taxi driver discussing macroeconomic theory,

His stand is in an area of active debate. If just one major company hoses the books with stock options I think there's little doubt that the FASB will adopt a harder line. He seems to think MS may be that company.

The details *can* be checked. I don't have the MS annual statements handy, or the details of the proposed Expedia spinoff, but he could be easily discredited if he's bending the truth too far

Finally, some non-kooks have looked at his claims and said that they might have merit.

IMHO, he *might* be a kook, but it's at least as likely that he's just someone frustrated at the perceived indifference to something that's obvious to him.

As for the overall presentation, it's targeted towards the general public. If he presents the same document to Greenspan I would be worried, but I have no reason to believe that's the case.