If The FBI Probes A Company, Do You Sell?

WASHINGTON - Certain events invite contrarian calls on stocks: a war breaking out, a chief executive being named Time magazine's Person of the Year, and so on. But what about when your favorite stock gets knocked by a government investigation? Buying might not be such a bad idea. Consider the case of ITT Educational Services

In February, ITT Educational Services (nyse: ESI - news - people ) revealed that the FBI and other federal agents, searching at the company's Indianapolis headquarters and at several school locations, had seized information relating to the firm's placement and retention figures, graduation rates, grades, admissions and salaries of graduates.

ITT's share price, at the time not far from a 52-week high of $61, promptly sunk to below $30. The stock--despite subsequent announcements of an SEC investigation, shareholder lawsuits, and other woes--has recovered to a recent $43. But the company, in Value Line's words, remains "under a cloud of suspicion." On Wall Street, 12 of 17 analysts tracked by Thomson First Call rate the stock a "hold" or a "sell."

www.forbes.com...

Do you all agree with this? I sure as hell don't. Just because an investigation is being conducted doesn't necessarily warrant that the stock of the company falls. Yeah, I understand how the "perspective" of the company may decline. However, these investigations are supposed to be discreet and anonymous. So who's fault is it really? The investigating agency, or the company?


Mr. M

Three schools of thought.

One: I'm already rich, and it's a marathon not a sprint.
These people are so loaded and so diversified, they'd probably fire any advisor that actually called to bother them with this news. They ride out everything. Dated a girl like this. She drove me nuts.

"You just lost $150,000!!!"
"That reminds me, I'm out of cat food."

Two: The sky is falling. These stop loss fanatics live in fear and only scan the news to see what to sell. No news is good news. Doesn't matter if they're wrong, because in their mind "better safe than sorry."

Three: Muahahaha. Someone's in trouble? Spread the bad news, and wait for the fall, then buy, buy, buy! Trouble is good news. I know people that only buy Airline stock when one crashes. Sick people. Rich sick people.

Can't tell which you are StarChild. Seems you'd hold. That mean you're rich?

I wish...

I am financially stable, yes. Self-sufficient? No.

As far as this subject is concerned, I question the decline in stock value. Why? Because it isn't right. It is the result of mainly 2 things:

1) Improper procedures conducted on behalf of the investigating agency, in turn resulting in the dissemination of information relating to the on-going investigation.

2) Intentional dissemination conducted on behalf of the company in question, based on stock value expectations in the future.

I feel that #1 is more probable than #2.


Mr. M

Right or not, if the decline is the Fed's fault...there's money to be made there.

Look at M-Clone and the Martha Stewart scandal. It was back up where it was last I checked after the plunge on the investigation.

True. However, this was an inside job, conducted by personnel with direct access to information relating to the company's financial status and activities. Do you really think that applies in this case?


Mr. M

Hmmm, probably not. Looks like the vultures move was between the $30 low and $43. 43% increase. Not too bad. But there's more bad news to follow it seems.

Good question.

In my experience the bank's work a little something like this:

They are aware of a possible SEC investigation before it is released to the public, so they do the following:

Say ABC company is trading on the NYSE at $100 per share, and the trader has $1,000,000.00 of the bank's cash to invest on that day.

Firstly the banker, working on a hunch that the SEC investigation will be released shortly will 'short' the ABC stock to the tune of $1,000,000.00, knowing that the press release will have a negative impact on the stock and it will fall. Shorting is selling stock that you do not own, and is the opposite of going 'long' ie. buying the stock.

He short's ABC at $100.00 per share, and over the next few days ABC shares fall to $50.00 per share. He then buy's 10,000 shares (what he shorted originally: ($1,000,000 divided by $100 = 10,000) at $500,000.00, giving a total gain of $500,000.00 on the trade.

Now, he doesn't stop there. Knowing that the SEC investigation will not adversely affect the stock permanently and that it will regain some of it's loss very quickly he will now buy in the traditional sense. He now has $1,500,000.00 at his disposal, so piles all that back into ABC (going long this time) at $50.00 per share.

The stock regains half of it's loss very quickly and the trader sells at $75.00 per share.

This means, overall, he made $500,000.00 on his first trade (shorting ABC), then he made $750,000 on his second trade (going long in ABC).

His original stake of $1,000,000.00 is now up to $2,250,000.00, and the banker has weathered a volatile stock and market well.

This is textbook trading, but is often not as simple as this. What it shows is that banks can still make plenty of cash whatever the market is doing. The very worst thing for a bank is when the market is stagnant with no big gainers or losers.

B