SEC inquiry into Linn Energy accounting pulverizes shares

Evidence of insider trading activities in LINN. SEC doesn't care. Photo: unattributed

WASHINGTON, July 2, 2013 – We’re a bit late in filing today, but there’s a good reason. Regular readers know that, in spite of recent market developments, we remain fond of both REITs and MLPs, both of which generate great income in the current environment. Recently, we were forced to dump our REITs due to their unintentional entanglement with the Fed’s recent “taper” remarks. MLPs seem to have been going down in sympathy but had begun to recover.

Until this morning, when what almost seemed like an exquisitely timed “hit piece” (in this weekend’s “Barrons”) combined with a massive opening sell order this morning, clobbered long-respected MLP Linn Energy (LINE) driving the stock down roughly fifteen percent and sinking as of this writing (1 p.m. EDT) on very heavy volume.

For months, Linn Energy and LinnCo, (LNCO) both related LLCs, have been hard at work moving to complete an already announced merger arrangement with natural gas developer Barry Petroleum Co. (BRY). Scheduled to be completed in the current quarter, the deal’s conclusion had already been postponed to the third quarter. But now, the SEC has launched a low-level investigation of Linn’s long-known accounting practices, perhaps relative to the proposed merger.

After the aforementioned hit piece on recent developments at LINN in this weekend’s “Barrons”—one of that periodical’s specialties—LINN had been trading OK but weakly on Monday, as indeed it was last week for no apparent reason. But at this morning’s opening bell, a huge sell block hit the market, crushing the stock, which continues to be crushed on extraordinarily heavy volume.

The whole thing is suspicious. Clearly, insiders knew about this story well in advance, given LINN’s market action last week. The one-day wait before today’s smash-fest also seems a little strange as most normal investors, when surprised with what they at least think might be bad news, will dump stock immediately without waiting an extra day. It’s almost as if today’s crushing blow had been planned in advance. Right, we have no proof, but if it looks like a duck…well, you know the rest.

Wall Street analysts, most of whom had been positive on the stock, either switched their recommendations on LINN to outright sell this morning, or, as in the case of Raymond James, revised their current buy recommendations to indicate slightly less enthusiasm.


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“’While we remain confident in Linn’s overall financial health and the soundness of its financial statements, we cannot ignore the uncertainty that the SEC inquiry has brought to the partnership’s near-term outlook,’ Raymond James analysts in Houston said in a Tuesday morning investors note,” the BizJournals periodicals reported this morning. 

“’It is important to point out this is an inquiry,’” continued the Raymond James analysts, “’and not a formal investigation. It is also important to point out that the SEC has reviewed Linn and Linn Co.’s financial statements many times over since the initial, and in our opinion, largely unfounded, questions that arose about the partnership’s hedging practices.’”

In any event, the stock is still being crushed today. Exacerbating LINN’s down-move is the likely fact that most human traders are long-gone for their 4th of July long holiday weekend. So headline-driven HFTs are likely crushing LINN today, aided and abetted by what is apparently a growing cadre of short sellers acting as if in harmony.

Perhaps, instead of investigating LINN’s already-known accounting practices, relatively common with MLPs whose net asset values and payouts are evaluated differently from those of regular C-corporations, the SEC ought to look into what seems very much to any informed outsider would seem like a massive, coordinated hit on LINN’s stock and its investors. Things are made even murkier when you consider that LINN’s all-stock deal for BRY is likely to be materially at risk for at least a lengthy delay due to the SEC inquiry.


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Could LINN actually be guilty of accounting hanky-panky. Yep, it could be, although there’s no evidence we know of, at least at this time, to imagine that they’re another Enron. That said, back in the day when the Maven himself sat at a retail trading desk, he well remembers a wonderful limited partnership that went by the name of Petro-Lewis.

Conservatively structure (apparently) Petro-Lewis had undergone due diligence at all major trading firms, spun off (apparently) reliable income from its ownership of small and mostly stripper oil wells, and proved a favorite among conservative investors who wanted a piece of the post-Jimmy Carter oil action.

Unfortunately, it was eventually discovered that Petro-Lewis was actually something that closely resembled a Ponzi scheme in that it repledged its assets again and again to form even more partnerships from even more wells. It was an absolute disaster for brokers and investors alike, made all the more so because it looked so safe and was endorsed by so many analysts who bought into the story as well.

What the Maven is saying here is that LINN has, at least apparently, had an enviable track records of generating capital gains and high yield for its longtime investors, much more so than either Enron or Petro-Lewis ever did. But that said, after many exhilarating as well as many suicide-inducing experiences with the markets over the years, the Maven’s caution flag is up for LINN. Just because.

One of our portfolios, alas, ventured into a small LINN position last week, one which is now seriously flattened. It’s hard in cases like this to decide whether to hold or fold. Likely, we’ll clear out of part of the position, though hopefully not at today’s bottom. Meanwhile, we’ll hold the rest, which, coincidentally or not, goes ex-dividend shortly—an inducement for the shorts to get out (by buying) in order to avoid owing the dividend as borrowers of the shares. This could give LINN a brief boost, at which point everyone will have to decide whether or not to bail.

It’s a shame, but it happens. You do your best to evaluate and analyze a stock, but you never know when the Feds or the nameless wealthy insiders will decide to jam your holdings and get away with it because of who or what they know.

LINN (and LNCO) are either A. As pure as the driven snow; B. Using accounting methods that could be questioned and or revised on order from the SEC; or C. an evil MLP that should go the way of Enron and Petro-Lewis. The real answer, we suspect, is some flavor of “B,” but you never know these days.

A comment, appearing in Street Insider today (no link available) by Wells Fargo analyst turned neutral on LINN and LNCO, may be the closest thing we have right now to the truth:

“Commenting, analyst Praneeth Satish said, ‘We do not believe the LNCO structure, in and of itself, is under scrutiny. Accordingly, we anticipate LINE to largely return to its growth via acquisition strategy once the informal SEC inquiry and Berry Petroleum (NYSE: BRY) merger are behind the company.  

“’Notwithstanding, we recognize that trading volatility could increase during the informal SEC inquiry. Additionally, we anticipate investors may begin to discount the possibility that the BRY merger does not go through given that the SEC inquiry could take anywhere from one to four months to complete, in our view.’”

Things were modestly happier with many other stocks this morning but severely reversed field this afternoon, although pre-holiday trading is falling in volume, making current results increasingly unreliable predictors of next week’s action. As we finish this article, circa 2:30 p.m., the Dow is now down about 80 points and the rest of the week is likely to be too tough to call, given generally low volume.

U.S. stocks have begun to recover from a slump last month after Federal Reserve Chairman Ben Bernanke said the central bank was considering easing its stimulus measures later this year, if the economy keeps getting better. The central bank is buying $85 billion a month in bonds to keep interest rates low and encourage borrowing.

“We’re in the middle of a transition,” said Chris Wolfe, chief investment officer at Merrill Lynch Private Banking and Investment Group. “You would expect to see, over the balance of this year and going into next year, somewhat stronger macro-economic data that translates directly into stronger corporate revenue growth.”

Earnings season will start the roller coaster moving again earlier next week, so we shall see how well Chris Wolfe’s remarks track, at least short term. Alcoa, the first company in the Dow to report its earnings, will release its second-quarter earnings report after the market closes July 8.

SPECIAL HOLIDAY NOTICE: It’s important to note that trading this week is likely to be extremely light, volume-wise, due to the Independence Day holiday which falls on Thursday this year. The New York Stock Exchange will close at 1 p.m. on Wednesday and reopen on Friday. But even Friday is likely to be a light trading day.

Given the shortened trading week and our own commitments as well, the Maven won’t be publishing columns from tomorrow, Wednesday, July 3 through Sunday, July 7. (We typically don’t run columns over weekends anyway since Wall Street is closed on Saturdays and Sundays throughout the year.)

We plan to resume this column on Monday, July 8. Meanwhile, have a happy and safe holiday weekend.

    —AP contributed to this report

Disclaimer: The author of this column maintains several active trading and investment portfolios and owns residential and investment real estate.

Positions mentioned above describe this author’s own investment decisions and should not be construed as either buy or sell recommendations. The current market is highly treacherous and all investors travel at their own risk, so caution should be exercised at all times.

Illustrations, charts, commentary, and analysis are only the author’s view of current or historical market activity and don’t constitute a recommendation to buy or sell any security or contract. Views, indications, and analysis aren’t necessarily predictive of any future market or government action. Rather they indicate the author’s opinion as to a range of possibilities that may occur going forward.

References to other reporters, analysts, pundits, or commentators are illustrative only and do not necessarily represent an endorsement of such individuals’ points of view. If specific investment vehicles are mentioned in any article under this column heading, the author will always fully disclose any active or contemplated investments in said vehicles.

Read more of Terry’s news and reviews at Curtain Up! in the Entertain Us neighborhood of the Washington Times Communities. For Terry’s investing and political insights, visit his Communities columns, The Prudent Man and Morning Market Maven, in Business.

Follow Terry on Twitter @terryp17

 

 


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Terry Ponick

Now writing on investing, politics, music, movies and theater for the Washington Times Communities, Terry was formerly the longtime music and culture critic for the Washington Times print edition (1994-2009) before moving online with Communities in 2010.  

 

 

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