The Best of The Blunt Bean Counter - Common Investment Errors

This summer I am posting the best of The Blunt Bean Counter blog while I work on my golf game. Today, I am re-posting an August, 2011 blog on common investment errors I have observed over the years.

I am involved in wealth advisory for some of my clients as their wealth quarterback, co-coordinating their investment managers and various professional advisors to ensure they have a comprehensive wealth plan. I sort of chuckled when I reviewed this list, as not much has changed in the last eight years.

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Duplication of investments

Duplication or triplication of investments, which can sometimes be interpreted as diworsification, is where investors own the same or similar mutual funds, ETFs or stocks in multiple places. A simple example is Bell Canada. An investor may own Bell in their own “play portfolio,” they may also own it in a mutual fund, they may own it in a dividend fund and they may own it again indirectly in an index fund. The same will often hold true for all the major Canadian banks. Unless one is diligent, or their advisor is monitoring this duplication or triplication, the investor has actually increased their risk/return trade off by overweighting in one or several stocks.

Laddering

This is simply ensuring that fixed income investments such as GICs and bonds have different maturity dates. For example, you should consider having a bond or GIC mature in 2019, 2020, 2021, 2022, 2023 and so on, out to a date you feel comfortable with. However, many clients have multiple bonds and GICs come due the same year or group of years. The risk of course is that interest rates will spike, creating a favourable environment for reinvesting at a high rate, and you will have no fixed income instruments coming due for reinvestment. Alternatively, rates may drop and you have all your fixed income instruments coming due for reinvestment, locking you in at a low rate of return. With the current low interest rate environment, you may wish to speak to your investment advisor about whether shortening your ladder a year or two makes investment sense for you; however, that ladder should still have maturity dates spread out evenly over the condensed ladder period.

Utilization of capital gains and capital losses

Most advisors and investors are very cognizant of ensuring they sell stocks with unrealized capital losses in years when they have substantial gains. However, many investors get busy with Christmas shopping or business and often miss tax loss selling. Even more irritating is that I still occasionally see clients paying tax on capital gains as their advisors have not reviewed the issue with them and crystallized their capital losses. Always ensure your advisor has reviewed with you your personal realized gain/loss report by early December, and the same holds true for your corporate holdings, except the gain/losses should be reviewed before your corporate year-end.

Taxable vs. non-taxable accounts

There are differing opinions on whether it is best to hold equities and income producing investments in your RRSP or regular trading account. The answer depends on an individual’s situation. The key is to review the tax impact of each account. For example, if you are earning significant interest income in your trading account and paying 53% (when I wrote this article initially, the rate was 46%, quite the jump in rates) income tax each year, should some or all of that income be earned in your RRSP?  Would holding equities in your RRSP be best, or do you have substantial capital losses you can utilize on a personal basis? There is not necessarily a one-size-fits-all answer, but this issue must be examined on a yearly basis with your investment advisor. (In 2017 I wrote a two-part blog series on considerations for tax-efficient investing, which you may wish to review. Here are the links: Part 1 and Part 2.)

Tax shelter junkies

I have written about this several times, but it bears repeating, I have observed several people who are what I consider "tax shelter junkies" and repeatedly buy flow-through shares or other tax shelters, year after year.  I have no issue with these shelters; however, you must ensure the risk allocation for these type investments fits with your asset allocation.

Beneficiary of accounts

This is not really an investment error, but is related to investment accounts. When you have a life change, you should always review who you have designated as beneficiary of your accounts and insurance policies. I have seen several cases of ex-spouses named as the beneficiary of RRSPs and insurance polices.

The content on this blog has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The blog cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information on this blog or for any decision based on it.

Please note the blog posts are time sensitive and subject to changes in legislation.

BDO Canada LLP, a Canadian limited liability partnership, is a member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms. BDO is the brand name for the BDO network and for each of the BDO Member Firms.

The Best of The Blunt Bean Counter - Resverlogix - A Cautionary Tale

This summer I am posting the "best of" The Blunt Bean Counter blog while I work on my golf game. Today, I am re-posting a November, 2010 blog post on my trials and tribulations as a shareholder in Resverlogix, a small Canadian public bio-tech stock. [Note: I have edited the original post to reduce the length and updated the tale at the conclusion of the post].

I selected this post as a "best of" for two reasons:

1. It is still an interesting story and my experience should still prove as a caution for your investing, even almost 4 years after my post was published.

2. This post has a soft spot for me. Back in November, 2010, I was a struggling blogger with maybe 3 readers. When I posted this blog, it was picked up by Seeking Alpha a large U.S. investment research and discussion site as a featured article and by several Canadian finance bloggers as a "blog to read". This publicity started my blog on the way to where it is today (a blog with 13 readers :)

Resverlogix - A Cautionary Tale

This post will recount the saga of my share ownership of  Resverlogix Corp. (“RVX”), a TSX-listed company. This is a cautionary tale in investing and a very interesting story and it should not be construed as investment advice. If I had the inclination, there is enough gossip and innuendo surrounding this stock that I could spin this story into one that could be printed in the National Enquirer; however, it is my intent to be mostly matter of fact and reflect the investment element.

The saga begins in the spring of 1996 when I was made aware of a bio-tech stock out of Calgary called Resverlogix Corp. (“RVX”). The company was working on a drug (RVX-208) to turn on Apolipoprotein A-1 (“ApoA-1”). ApoA-1 is the major protein component of high density lipoprotein (HDL). HDL is known as the “good cholesterol.” In extremely simplistic terms it is hoped that the protein will promote the removal of plaque from the arteries by reverse cholesterol transport (cholesterol is removed from the arteries and delivered to the liver for excretion).

With my eyes wide open to the fact that bio-techs are very risky, I dipped my toe into RVX as the concept denoted above was very novel and extremely exciting. In addition, the CEO Don McCaffrey stated it was the intention of RVX to sell pre-clinical, which in my mind removed substantial bio-tech risk.

In early December 2006, Pfizer announced that its cholesterol drug Torcetrapib failed its clinical tests and Pfizer’s stock plummeted. If I had done more then dip my toes in RVX, I would be writing this blog post from the Turks and Caicos because after Pfizer’s failure, RVX was seen as a possible successor and fueled by rumours of a sale, RVX stock went from $5 to $30 within about ten weeks. Helping fuel the fun was a press release stating that RVX has hired UBS Securities as an investment banker to help with a “strategic alternatives.” Not a bad profit for a ten week time frame.

What follows is the roller coaster ride from hell. The stock drops from $30 to $13 in two months as no deal emerges and by August of 2007 it is at $9.  By the end of the October, 2008 stock market crash, RVX is down to $2.30. I blow most of my gains on the initial huge run by buying back shares as I think the price is a bargain. This story includes my ignorance.

The dramatic stock drop was caused by RVX not receiving any public offers, Big Pharma’s reluctance to make purchases due to numerous drug failures and financing issues.

Anyone who has ever been involved with a small-cap stock, and especially a small-cap bio-tech stock, is aware that financing is a huge issue. RVX engaged in “death spiral financing,” a process where the convertible financing used to fund a small-cap company can be used against the company in the marketplace causing the company’s stock to fall dramatically. It can lead to the company’s ultimate downfall.

While RVX stock stayed low, the science moved along tremendously with positive testing and good results in Phase 1B/2A testing . In October 2009, RVX announced it would move ahead with parallel tests called Assert and Assure. These studies were to be run by renowned researchers  at the Cleveland Clinic. This was considered to be important confirmation that RVX had a potential blockbuster drug.

The primary endpoint of Assert was to determine if RVX-208 would increase ApoA-1 and to examine safety and tolerability. Assure was going to use a process called intravascular ultrasound to detect changes in plaque and examine early lipid effects and plaque on the coronary vessels. Assert moved ahead quickly, dosing patients ahead of schedule in late 2009.

What was extremely interesting to investors was that at the beginning of 2010, even though the stock price of RVX was only $2.40, the science had moved at a rapid pace and  if Assure was successful, a “big if,” investors were hopeful a bidding war for RVX would ensue, with estimates in the range of $30-$60. Of course, if Assure failed, RVX would most likely fall to less then $1.

I personally felt that $2.40 was a ridiculously low price for a drug with potential yearly sales of 10-20 billion dollar and purchased more shares at that point. Score one for my investing intelligence.

The stock floated around the $2-$3 range until March 2010 when the stock took off up to $7.50, mostly propelled by an article by Ellen Gibson of Bloom berg stating “Resverlogix Corp., without a marketed product, may accomplish what Pfizer Inc., the world’s biggest drug maker, couldn’t: Creating a new medicine that fights heart disease by raising so-called good cholesterol.” There was some additional publicity that followed and the stock jumped around in the $5 to $8 range. At this point I sold a portion of my stock and bought call options. The options provided me high leverage but could expire worthless, but most importantly, the options allowed me to remove a significant amount of my cash investment, while retaining potential upside to the stock.

In May 2010 it was announced that the Assure trial would be delayed as RVX was having trouble recruiting patients. The RVX spin was positive saying that since Assert had finished early, the researchers could now use what they learned in Assert to plan Assure; however, many months were wasted. The market did not appreciate the delay in Assure and the stock price fell from $6.80 to $2.80 in late June.

RVX decided to present the Assert data at a Late Breaking Trial Session on November 17th at the American Heart Association (“AHA”) conference. These session slots are supposedly only provided to those companies providing significant trial results, whether good or bad, and there is an embargo on any information being released prior to the presentation. RVX would lose their presentation spot if any information was released.

At RVX’s Annual General Meeting in early September, which I did not attend, the trial’s principal investigator Dr. Stephen Nicholls of the Cleveland Clinic spoke, and while he could not speak about Assert results, those there blogged about his appearance and said that his apparent enthusiasm for RVX 208 bode well for the AHA presentation. After the AGM, the stock rose from the high two's into the mid-fours over the next several weeks as attention was directed towards the November 17th AHA presentation.

Many investors were unaware that Merck would also be presenting results on a HDL drug they were working on known as Anacetrapib, a drug from the same family of inhibitors as Pfizer’s Torcetrapib which, as noted above, had failed miserably. Thus, investors who had heard of Merck’s presentation were not expecting much.

I expected an increase in RVX’s stock price as the AHA approached on anticipation of positive results that would put them one step closer to Assure testing and the small possibility that the Assert results would bring an offer from Big Pharma. Not much happened until the week of November 14th, which is now a week I will never forget and leads to the title of this article.

On Monday, November 16th, in anticipation of the AHA presentation, RVX stock ran from $5.72 to $6.39. On Tuesday, the day before the presentation, the stock ran to a high of $6.98 in the morning and then settled at $6.70 or so until 3:30, at which time, out of nowhere, the stock dropped to $4.50 on significant volume. Needless to say, it was a shocking last half hour of trading and rumours on the stock bullboards ran from a leak of bad results to the shorts pulling a “Bear Raid;” a tactic where shorts try and push the stock down to cover their shorts. This “Bear Raid” theory seemed to make the most sense at the time, since the shorts had a large position with RVX’s presentation scheduled for the next day. A leak did not seem to make sense based on the embargo by the AHA.

Apparently the embargo on the late breaking sessions at the AHA on Wednesday was lifted first thing Wednesday morning. Early Wednesday morning Bloomberg reported that “Resverlogix Corp.’s most advanced experimental medicine, a cholesterol pill called RVX-208, failed to raise levels of a protein thought to help clear plaque from arteries in a study.”

The Bloomberg report was followed by an RVX press release that said the “Assert trial data demonstrated that the three key biomarkers in the reverse cholesterol transport (RCT) process showed dose dependant and consistent improvement.”

Following the RVX release, the Dow Jones reported “A study involving a new type of drug being developed by Resverlogix Corp. showed it failed to meet a goal of boosting levels of a specific protein the drug was designed to raise.”

To put the final nail in the RVX’s coffin for the day, Merck reported its Anacetrapib had tremendous results in increasing HDL and also reducing LDL the bad cholesterol.

The stock opened around $5.30 on Wednesday morning with investors obviously thinking the shorts had caused the prior day’s stock price drop, but after the press releases, the stock quickly dropped to a low of $3.35 by 9:45 am. However, investors were clearly now not sure what to believe; the headlines by Bloomberg and the Dow Jones, or RVX’s press release. The stock rebounded to $4 by the time of RVX’s actual presentation. By all accounts the presentation was very factual emphasizing that RVX did not achieve a statistically significant  % change in ApoA-1. Supposedly, to be statistically significant the p (probability value) would have to be less than 0.05 and RVX’s was 0.06.

Following the presentation, RVX’s stock slid to $2.73. It then slid Thursday to $2.14 before rebounding on the Friday to $2.34 to $2 when this blog was (initially) posted.

All in all, there was mass confusion and huge paper or actual stock losses for RVX shareholders. I probably will now need RVX-208 to combat the heart attack symptoms this experience caused.

You are probably thinking “Why the heck did Mark not sell the day before the AHA?” In retrospect, that would have been prudent, however, I had decided I was going for a home run and would accept a strike out. In the bloody aftermath, more detailed analysis of RVX-208 and Merck’s Anacetrapib were reported. The analysis ranged from optimism for Anacetrapib (MedPage Today, quoted Elliott Antman, MD, professor of medicine at Harvard Medical School (a very well respected researcher according to a doctor friend of mine) as saying "The important thing that we saw here with RVX-208 was the dose response. That means that something is happening with the drug. I think that the dose response trumps P-values.") to comments that the HDL levels were out of line and may never achieve clinical success.

I am not sure there is a moral to this story; this was cathartic to write and like I said, it is a saga, a saga that is still ongoing. I guess, if anything, this is just a cautionary tale about investing in biotech’s and investing in general.

Epilouge

In 2013, RVX came back to life as it undertook its ASSURE  Phase 2b clinical trial that evaluated RVX-208 in high-risk cardiovascular patients with low HDL. The company in early June spun-out RVX Therapeutics Inc.(a unit of RVX containing an epigenetics-based BETi drug discovery platform) to Zenith Epigenetics Corp. so that shareholders of RVX now owned one new common share of RVX and one common share of Zenith. As part of the spin-out, Zenith is entitled to a tiered royalty of 6-12% of revenue derived from RVX-208. Investors liked this transaction as if RVX did well Zenith shareholders would benefit to a lesser degree and they also had a separate platform of drugs. I received Zenith shares and still have them, as they are not publicly trade-able and I look at them as a lottery ticket.

Unfortunately, in June 2013, RVX announced the Assure trial did not meet its primary endpoint and the stock which had risen from the dead to as high as $4, again crashed down to around 23 cents.

In September 2014, the company announced that Post hoc analysis of data from the two Phase 2 clinical trials with RVX-208 showed a reduction in Major Adverse Cardiovascular Events (Mace) in patients with cardiovascular disease and a 77% reduction of  MACE in patients with diabetes mellitus. This news gave the stock new life and together with an April, 2015 announcement of a licensing agreement with an Asian company Shenzhen Hepalink Pharmaceutical Co., Ltd., the stock which seems to have nine lives, has awoken again and rose to a high of $3.14 in April. The stock has now settled back to $1.82 as of Friday as investors now wait in anticipation of a PHASE 3 trial that is scheduled to start in the fall of 2015.

This saga is now coming upon ten years for me as I still have some shares kicking around and the spin-off Zenith shares. Who knows, maybe the Phase 3 trial will finally cause a buy-out of RVX or maybe the stock is on its ninth life and the saga will finally come to a conclusion.

Disclaimer: This post is a cautionary investment tale. It is not meant in any manner, as an endorsement of RVX as a stock purchase. 
 

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.

Who is your Wealth Mangement Quarterback?

In Canada, and specifically Ontario, Chartered Accountants (“CA's”) have independence restrictions and other rules that prevent us from providing specific security advice and from buying and selling securities on behalf of our clients. 

However, in Ontario, we are allowed to earn a fee for providing what I will call quarterbacking advice, where we oversee a client’s team of advisors and ensure a comprehensive team plan is put in place and maintained for each client. As financial quarterback, we try to ensure the client’s investment advisor, lawyer, insurance agent, banker, business consultant and accountant have integrated their advice into one efficient, optimum, co-ordinated plan, taking into account the client’s investment, retirement, income tax and successions needs.

In providing that role within my firm, Cunningham LLP, I have seen clients with investment portfolios and financial plans that fail to consider their needs, miss out on crucial income tax savings and clearly lack a strategic vision. Lost opportunities are created when advisors operate in silos and the situation is made worse when advisors operate at cross purposes, and worse still when they are concerned only with their own fiefdom and fees. In this blog I would like to discuss why you may want to consider nominating one of your advisors as the responsible party for co-ordinating and quarterbacking your other advisors, or if you are up to it, tackling the quarterback job yourself.

There are many professionals who can quarterback your team. The two that seem most appropriate are a fee-for-service financial planner and your accountant. In my biased opinion, I would suggest that in many cases, a client’s accountant may be the best suited and most independent advisor because we often have the broadest vantage point of our client’s wealth and financial picture. But, this is not to say your investment advisor, whether a fee-for-service advisor or not, would not be suitable for the task. Some of the issues and reasons you may wish to put one of your advisors in place as your team’s quarterback are discussed below.

In many cases, I have observed that my client's investment advisors pay little or no attention to my client’s actual business affairs; other than to determine how much cash can be transferred from their corporation's to the investment accounts they hold for that client. So why does this matter? Because the client’s business is most often their largest asset and in many cases is the asset with the most risk. For example, two years ago I had a very successful parts supplier who as the recession began, was told by one of his major customers to halt shipments for a time. His business was in a high risk situation. His advisor had a significant portion of his portfolio in equities and never once considered the risk associated with his business in determining his asset allocation. How about a person who makes their money in real estate; should their advisor have any of their portfolio in real estate stocks? Maybe or maybe not, but the lack of diversification and resulting increased risk of holding real estate stocks in this scenario should be considered, and as I say, it is often totally ignored.  In addition, the income tax consequences of investing are such that the investment advisor should always co-ordinate with an accountant.

My client’s insurance advisors are a mixed group. Many are excellent and ensure they speak to me to understand my client’s needs including business structures, succession planning and income tax issues. However, the reality is many an accountant has shot down an insurance policy in their client’s best interest and some agents try to ensure the accountant is not involved when selling a policy to ensure the sale of the policy.

Lawyers are generally used to working with accountants and these professionals typically work together fairly seamlessly, however, they also typically have minimal interaction with the other advisor groups. In addition, many clients have lawyers they used for a real estate transaction or a will, etc. and they assume the lawyer can handle estate planning, US vacation home planning or similar other transactions not in their wheelhouse. I have seen several messy situations caused by real estate lawyers who decide they are probate planners and cause substantial deemed dispositions of real estate assets for income tax purposes. Again, if the lawyer was working as part of a team, they would have known to contact the accountant or tax lawyer before implementing any transaction.

Your financial world is a complicated place and where you have a team of advisors it is essential to get them all on the same playbook. You will typically be better able to achieve your key objectives in this way while ensuring the efficiency of professional fees.  

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

Common Investment Errors

I am involved in wealth management for some of my clients as their wealth quarterback, co-ordinating their various professional advisors to ensure they have a comprehensive wealth plan. In that capacity, as well as in my day to day capacity, I see several common issues arise in relation to my clients’ investments whether they have professional management or manage their own investments. Here is a short list of some of the issues that I see on a consistent basis.

Duplication of investments

Duplication or triplication of investments, which can sometimes be interpreted as diworsification is where investors own the same or similar mutual funds, ETF’s or stocks in multiple places. A simple example is Bell Canada. An investor may own Bell in their own “play portfolio,” they may also own it in a mutual fund, they may own it in a dividend fund and they may own it again indirectly in an index fund. The same will often hold true for all the major Canadian banks. Unless one is diligent, or their advisor is monitoring this duplication or triplication, the investor has actually increased their risk/return trade off by overweighting in one or several stocks.

Laddering

This is simply ensuring that fixed income investments such as GIC’s and bonds have different maturity dates. For example, you should have a bond or GIC maturing in 2011, 2012, 2013, 2014, 2015 and so on, out to a date you feel comfortable with. However, many clients have multiple bonds and GIC’s come due the same year or group of years. The risk of course is that interest rates will spike creating a favourable environment for reinvesting at a high rate and you will have no fixed income instruments coming due for reinvestment. Alternatively, rates may drop and you have all your fixed income instruments coming due for reinvestment locking you in at a low rate of return. With the current low interest rate environment, you may wish to shorten your ladder, however, that ladder should still have maturity dates spread out evenly over the condensed ladder period.

Utilization of Capital Gains and Capital Losses

Most advisors and investors are very cognizant of ensuring they sell stocks with unrealized capital losses in years when they have substantial gains. However, many investors get busy with Christmas shopping or business and often miss tax loss selling. Even more irritating is that I still occasionally see clients paying tax on capital gains as their advisors have not reviewed the issue with them and crystalized their capital losses.

Taxable vs. Non-Taxable Accounts

There are differing opinions on whether it is best to hold equities and income producing investments in your RRSP or regular trading account. The answer depends on an individual’s situation, however, the key is to review the tax impact of each account. For example, if you are earning significant interest income in your trading account and paying 46% income tax each year, should some or all of that income be earned in your RRSP?  Would holding equities in your RRSP be best, or do you have substantial capital losses you can utilize on a personal basis? There is not necessarily a one-size-fits-all answer, but this issue must be examined on a yearly basis.

Tax Shelter Junkies

I have written about this several times, but it bears repeating, I have observed several people who are what I consider "tax shelter junkies" and continuously buy flow-through shares or other tax shelters, year after year.  I have no issue with these shelters, however, you must ensure the risk allocation for these type investments fits with your asset allocation.

Beneficiary of Accounts

This is not really an investment error, but is related to investment accounts. Where you have a life change, you should always review who you have designated as beneficiary of your accounts and insurance policies. I have seen several cases of ex-spouses named as the beneficiary of RRSP’s and insurance polices.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

Covered Calls

Investors are always looking to reduce their risk in owning a specific stock. One method to reduce that risk is to use a covered call strategy.

Selling covered calls is a strategy in which an investor sells a call option contract while at the same time owning an equivalent number of shares in the underlying stock. It is considered to be one of the safest option strategies in the market.

In simple terms a covered call means you sell a call option to another investor which entitles them to purchase a stock you already own at a specified price. The concept is best illustrated by an example.

You purchase 100 shares of Research and Motion for $58/share and agree to sell it for $60 on the third Friday of the following month.  You receive $4/share for selling this call option. The return calculation is as follows:

Cost of 100 shares at $58/share                        $   5,800

Call premium received – 100 @ $4  ****                     400      - 7% return immediately

If the stock price is above $60 at strike

date, investor receives another $2 ($60-$58)               200      - 3% return

Total return on investment is                                    $600      - 10%

**** The $400 call premium is a capital gain in the year it is received and is not a reduction in the cost base. See my comment to Anonymous in the comment section below for the income tax treatment

If the stock price is below $60 at strike date, the stock will not be called and you will keep the $400 time premium.  However, you have lowered your out of pocket cost of your investment to $5,400 and you still own the stock. Please note that you must hold the stock until the call is exercised or expires.

The downside to using this strategy is that if the stock price rises above $60 you do not participate in any of the upside above $60. Therefore, using a covered call may be more risky for a stock like Research in Motion which can swing dramatically, than for a stock like the Royal Bank, but that would be reflected in the premium you get for selling the call.

In the case of a stock such as Bell Canada that pays dividends, one has to be aware that the  call holders may want to capture the dividend and that has to be factored in.

As often happens in blogging, someone else covers the topic of your blog before you post it. An excellent  detailed step by step summary of the mechanics of writing a covered call are covered in this blog by The Million Dollar Journey.

Please understand that I am in no way recommending a covered call strategy. I am only discussing the concept so you are aware of its existence. The use of a covered call is complex and you should consult with your investment advisor before undertaking such a strategy or if you trade yourself, ensure you grasp the complexities in doing such.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

Reading Financial Statements For Dummies

Today I will discuss some simple tips to utilize when reading financial statements (that clicking sound you just heard are the other readers hitting the escape button when they saw reading and financial statements used in the same sentence). For the two of you still here,"Dummies" is of course used in the popular culture context; however, in the case of reading financial statements, I often feel like one and I am an accountant.
If you are a non-accountant, what should you look for when reviewing a company’s financial statements? I will assume you do not have the background to review such technical items as the accounting policies to determine how revenue is recognized or such; so here are a few simple things non-accountants can look for in the financials:

1. Cash is always king, so always include a review of the statement of cash flows, especially in the case of mature companies. None other then Warren Buffett says "it’s good to compare how much different cash flow is from net income: if the latter is substantially higher than the former, you could have some aggressive accounting to worry about" (see Larry MacDonald's blog Buffet on accounting manipulation for further Buffett comments).

2. For those with a sense of accounting adventure, you can try and calculate the Current Ratio and Debt Ratio:
The current ratio measures liquidity, (a sense of a company's ability to meet its short-term liabilities with liquid assets) and is calculated by dividing Current Assets by Current Liabilities. A ratio of 1:1 implies adequate coverage and the higher above 1:1 the better. If it is relatively low and declining, that is not a good sign.
A company's debt ratio is calculated by dividing Total Liabilities by Total Assets (or alternatively, Total debt divided by Total Assets). This ratio tells you the extent by which a company’s assets have been financed with debt. For example, a debt ratio of 40% indicates that 40% of the company's assets have been financed with borrowed funds. Debt can be good or bad. In times of economic stress or rising interest rates, companies with high debt ratios can experience financial problems. During good times, debt can enhance profitability by financing growth at a lower cost.

3. If you have always wished for a "Coles Notes" summary of the financial statements you are in luck. Effective for all periods ending on or after December 15, 2010 new audit standards in Canada will result in changes to the auditor’s report, which will make it far simpler for investors of any sophistication to determine the key issues in the statements. One major change is the requirement for an “Emphasis of Matter” paragraph in the auditor's report. Companies will now be required to highlight matters that are disclosed in the financial statements that are of such importance, they are fundamental to the users’ understanding of the financial statements. The issues noted in the Emphasis of Matter discussion are disclosed elsewhere in the financial statement notes, but the new paragraph prevents companies from being able to hide these issues in the many pages of notes.

4. The notes to the financial statements are ignored by many novice investors, but the notes often have important nuggets of information. One of the first notes on any set of financials are the accounting policies and accounting estimates notes. For most non accountants, trying to follow and understand the accounting policies and estimates will be futile, however, if these notes disclose a change, try your best to understand the impact of the change on the F/S which should be disclosed in the case of a change in policy. You should also always read the “Subsequent Events” note to determine if anything of a substantial nature has changed for the company that is not reflected in the financial statements. The commitments note will inform you of any required outlays over the next several years and finally the contingency note, which will inform you of potential lawsuits and such. Some of these items may not be disclosed in the Emphasis of Matters note discussed in #3 above.

5. Most public company financial statements reveal how many fully diluted shares are outstanding. I like to see what constitutes that number, so I add together the common shares issued, stock options outstanding and warrants issued. Then I review the terms of the the warrants and options to get a feel for the stock price at which maximum dilution would occur.

6. If you are looking at anything less than a “large cap” company, potential financings must always be considered. I have been sideswiped on several occasions by a private placement or financings at a discount to the current stock price that have deflated a stock on the move. I like to see enough cash on the balance sheet to sustain the business for at least 18-24 months so the company is not hand to mouth each month, although for some small cap stocks, it may be closer to 12 months. For these type companies, the Management Discussion and Analysis will often provide the burn rate for the company. If the burn rate is provided, divide the total of the actual cash on hand, plus short term investments, plus the accounts receivable (a little tricky, but assume A/R is a fairly consistent number) less the accounts payable by the burn rate and you will have a crude idea of how many months of cash the company has available.

The above are just some simple review steps that even non-accountants should be able to undertake to gain a better insight into the companies they have stock ownership in.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

The Kid in the Candy Store: Human Nature, RRSPs, Free Cash and the Holy Grail

Several weeks ago I read a column by Rob Carrick titled “Why TFSAs Trump RRSPs for the young and lower paid.”. The column was premised on a paper by Jamie Golombek of CIBC on why TFSAs beat RRSPs as a better retirement savings for some Canadians. This topic has subsequently been beaten to death, but in this blog I want to concentrate on the exchange I had with Jamie in regard to human nature and its impact on investing.

The Globe and Mail had an online discussion about the above article and I sent in the following comment: “The problem with technically correct solutions is that they ignore human nature. As a Chartered Accountant I can tell you people consider their RRSPs holy and try their best to never withdraw from them. A TFSA or any accessible account is like candy, you stare and stare and then indulge.”

Jamie responded "you may be surprised to learn that that 80% of all RRSP withdrawals are made by individuals under age 60, generally pre-retirement! Not much of a holy grail!" Jamie's paper also reports that recent data shows 1.9 million Canadians withdrew $9.3 billion from their RRSPs in 2008 and taken in conjunction with the 80% withdrawal statistic noted above, suggests RRSP funds are being used well before retirement age to supplement income.

Jamie clearly considered the human nature aspect of investing in his report (see Accessibility of Funds on page 5) and provides statistics to develop or support the thesis of his paper. I have no issue with his statistics or his assertion RRSPs are being used to supplement retirement income by those under the age of 60. I do object however, to his contention that RRSPs are not considered the Holy Grail.

In my practice, I have observed that RRSPs are the Holy Grail for most of my clients. More importantly, RRSPs seem to act like those invisible fences for dogs and form an invisible barrier to prevent my clients from "grabbing" at their RRSPs; although I think Jamie would suggest the barrier may have some holes in it based on his statistics.

I asked Rob Carrick his thoughts on the matter and he responded, "I'm stunned every time I read stats on how many people take money out of their RRSPs, never mind TFSAs. The harder it is to withdraw from a retirement savings vehicle, the better."

On the surface, it is difficult to refute Jamie's assertion without my own statistics. Numbers are numbers. But, if we could dig a little deeper the same numbers may tell a different story. Here is where human nature and its impact on investing come into play. Human nature, like physical nature, takes the path of least resistance. At the end of the day, my professional observation of human nature takes me down the same road as Rob: the greater the barrier, the better - even if some ignore the barrier. Anyway, I will leave this for the psychologists to study and will return to my laboratory, being my office, and provide some personal experiences on human nature and free cash.

RRSPs, The Holy Grail Or Just Full of Holes

In my accounting practice, it has been my experience based on discussions with my clients, that they withdraw RRSPs almost exclusively for financial need only and not for discretionary purposes. I will concede that my client’s incomes are well above the national average and thus they may not be a representative sample. If we could somehow ask each person who withdraws funds from their RRSP in Canada, “why are you doing such and what is the intended use of the funds?", I am convinced that the vast majority would answer we are taking out the funds due to financial need and not for discretionary purchases. Most people take a certain pride and comfort in their RRSP savings. There is a peculiar permanency in investing in an RRSP that is not nearly as tangible in a TFSA or other savings account. Non-RRSP savings accounts seem to represent “leftover money”. RRSPs represent security from old age impoverishment. That is the Holy Grail. Most people cash out RRSP’s only under financial duress. Financial duress is not the same as supplementing income.

So what about those alarmingly counter-intuitive statistics that would suggest we have become an unholy nation desecrating their RRSPs? It is highly probable in my humble opinion, that many Canadians are convinced that they have to contribute to a RRSP by the various advertisements they are bombarded with in January and February each year by financial institutions and at the urging of financial commentators and in fact, many were really not in a position to contribute to their RRSP in the first place, thus dooming their RRSP from inception and inflating the withdrawal statistics.

I See It, I Want It

Now, assuming we are not compelled to withdraw our savings (or perhaps more aptly borrowings), restricted savings accounts are like invisible fences, or the glass in front of the candy counter. Withdrawing cash from an accessible savings account like a TFSA is relatively easy. Especially when we see that cash as “leftover earnings”, or as a well-deserved reward for how much we’ve earned or how hard we’ve worked. If we move away from restricted accounts such as RRSPs, the invisible fence seems to turn off. Now the buying is easy. Self-restraint is hard. Accessible cash quickly winds its way along the path of least resistance and a cash register.

I often observe the sweet lure of accessible cash in the actions of many self-employed individuals and professionals in respect of their quarterly personal income tax installments. Some make significant sums of money, but you would not believe how many don't have the funds to make their quarterly income tax installments. This results in huge income tax liabilities around April 30th and installment interest and penalties for failure to make these required installments. Why don’t they have this cash you ask? In some cases they have not collected their accounts receivable or received allocations from their partnerships, but in many cases, they have spent the free cash that should have been allocated to their income tax installments on discretionary items only because it is was easily accessible and winking at them.

A hot topic that has been widely debated recently is whether it is better for small business owners to eschew salary and RRSPs in favour of leaving the funds in their holding company. Technically leaving the money in the corporation is correct (although I have some reservations with this strategy because you stop RRSP contributions, lose eligibility for CPP income in the future if no salary is taken, and potentially forgo the deductibility of child care expenses if no salary is taken) but in my opinion, the candy (ie: available cash) will prove too tempting for most people and some of those corporate funds will find their way to cover that vacation they wanted in Europe or that new car or boat they have their eye on; whereas if those funds were contributed to a RRSP, the invisible fence effect would come into play. I have observed this first hand with the typical current holding company structure where excess profits from a operating company are moved to the holding company; this new twist would only create more accessible cash to potentially be withdrawn.

Intuitively Rationally Irrational

Although not directly related to free cash, an example of personal behavior superseding fundamental financial common sense is in relation to income tax refunds. Individuals can file a form T1213 to obtain waivers to reduce income tax withholdings in certain circumstances, but almost no one does. Ignoring the administrative issue of obtaining the income tax withholding reduction, which may contribute in part, individuals just love their lump-sum tax refunds (usually as result of their RRSP contributions) and they intuitively know they would not save an amount equal to the same lump-sum income tax refund if they had their income tax withholding reduced on a bi-weekly or semi-monthly basis.

I have only anecdotal evidence to prove people consider their RRSPs the Holy Grail. But really, is it unreasonable to accept that TFSAs or other non registered accounts are merely shelves displaying the cash candy to which our sweet tooth cash cravings will inevitably succumb? The path of least resistance generally ends at the cash register in the candy store. The high road is easier to follow when the candy case is locked. A financial vehicle that people feel is “locked in” will help stymie our natural inclination to self-indulge and spend and will only be accessed under financial duress and not necessarily as a supplement to retirement income. Now that is a Holy Grail indeed.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

Lessons Learned by an Investing Dummy

In life, one makes numerous mistakes; some costly from a personal relationship perspective and some costly from a financial perspective. A friend of mine was recently complaining about a dumb move he made in the stock market and it got me to thinking of some of the less than intelligent moves I have made investing.

For anyone who is a reader of my blog, my Resverlolgix investment is definitely the number one costly mistake. For those who have not read the blog, it is a November 2010 blog called “Resverlogix, A Cautionary Tale” and it is one of my better ones (blogs and investment mistakes) if I do say so myself.

Notwithstanding that disaster, I have also made two errors in regard to playing cute with the bid and ask price on both the sale of a stock and the purchase of a stock. About ten years ago I purchased a stock involved with the debit machines at grocery stores and alike. It was actually a great call on technology which I will discuss further below, but the company was bleeding and I decided to sell. The stock was $2.10 to $2.12 and I was so upset with the stock that I decided I was not going to lose any more money and put my shares up for sale at $2.12. My order did not get filled and the next day the company came out with bad financial news. When everything settled, the stock was worth 40 cents and I had lost another $1.70 per share over two cents.

What do they say about it being okay to make an error once, but if you make the same mistake twice then you’re an idiot? Well, hello. This year I decided to purchase a stock that was trading around $3.90 to $4.10. It was in that trading range for weeks, so I put in a bid for $3.90. I got a partial fill at $3.90, but it hovered around $3.95 to $4.00 for days. Of course, a week later it announced some good news and went to $4.40 and I decided I would not chase it, which is a good rule in general. The only problem is two weeks later they announced a significant licensing agreement and the stock went to $8. At least I had a small fill, but still, I lost out on a $4 gain by trying to buy for ten cents less.

So, lesson number one: once you decide to buy or sell, just do it if the bid and ask is within a reasonable range.

As noted above, I had made a good call on the debit card technology; however, I was too early to the game. Stocks in companies promoting disruptive technologies have unbelievable upside, however, the more disruptive the technology, the longer to market and the more financing problems the company is likely to have.

Thus, lesson number two: stay away from a stock involved in a disruptive technology unless you are willing to put it in the speculative portion of your portfolio and to leave it there for up to ten years, if it survives.

Lesson number three: stick to your guns.

I had a couple of stocks that I held for years during which they barely moved from the initial purchase price. I lost patience and sold and saw both the stocks triple within one year of my selling.

This lesson can also be called the “Ask Mark what he has recently sold and then buy it” lesson.  

The above is pretty tongue-in-cheek, but it is really important to establish personal guidelines in regard to buying, selling and holding stocks and similar investments.

R.I.D.E. Rant

I have a guest rant today on the Toronto R.I.D.E. ("Ride") Program from a friend of mine. The rant hit home with me, as I had the same experience with Ride, except I  was casitigated for chewing gum and was  told that if I dropped the wrapper that contained the plastic piece to blow into the breathalyzer, I would be  fined $100 for littering. Not to give away the ending, but I also blew the same number as my friend. 

Some Sobering Thoughts about the Toronto R.I.D.E. Program

I have always been an advocate of conceding some of my individual rights for the good of society as a whole – including the random testing of potentially drunk drivers.  I thought that if I ever was stopped by such a program, I would gladly participate if such programs can keep drunk drivers off of our roads.

While I still am onside with such a premise, I believe that the ‘decision-tree’ used by the Toronto Ride program is somewhat flawed – based on my first hand experience last night.  Please note that this is not a criticism of any policeman who follows procedure but rather a criticism of the instructions that policemen receive to execute this program.

Last night I was out with my wife and a few friends.  We had a dinner reservation at 7:45pm which was to be followed by a late movie at 9:50pm.  We ordered one bottle of wine for the 5 of us – and I partook in about 1 glass of that bottle – mostly consumed before 8:30pm.  I did not consume anymore alcohol of any kind that night.

After watching the movie, we went to our car, pulled out of the parking lot and then started to head home just after midnight.  I approached an intersection and started to turn right – towards what at first look like police cars attending to an accident – but eventually recognized that it was a Ride testing program – where the police were stopping cars in both directions.   My wife and I briefly thought of pulling a U-turn to avoid the spot check but felt that would be inappropriate as I had no reason to flee (as I was certain I was under the 0.05 blood alcohol limit).

As we approached the spot check, I rolled down my window – and was asked by a policeman if I had had a drink tonight.  I responded that I had one glass of wine about 4 hours earlier with dinner – and had subsequently seen a movie (to provide him some timelines).  I did not have any alcohol on my breath nor was I in any way incoherent nor slurring my speech.  The policeman asked me to pull over and park in the middle of the street.

Process Error #1

If I had answered that I had not had a drink, I would not have been asked to pull over as they had no other reason to interrogate me.  I answered truthfully – and was penalized for doing so.  As my business partner often tells me – desperate people do desperate things – if someone might be concerned about being over the limit, they might have either made the U-turn that I decided not to make to avoid this ‘trap’ (by the way, with no consequence as I observed others doing it afterwards), or answered ‘no’ to the policeman’s question and potentially avoided my current predicament.  My honesty was the key to their decision to pull me over.  This process is flawed by reflecting on the Liar’s Paradox – much akin to reflecting on the merit of someone stating: ‘this sentence is false’.

But I had nothing to hide – so I played by the rules.  Rather than asking me to ‘blow’ right away,  the policeman asked me for my driver’s licence, my insurance certificate and my ownership certificate – and then went away to analyze same.  I thought this was a random spot check for drunk driving – not an assessment of whether all my paperwork was in order – which, by the way, it was.

Process Error #2

If the primary objective of this random trap is to test for elevated blood alcohol levels, why did the pre-test process take in excess of 10 minutes prior to finally being asked to ‘blow’ – as, if my blood alcohol level had been border-line, this could have given me time to sober up.  They could always have done the paperwork afterwards – but the process order seemed odd to me – and contrary to their primary purpose.

I was then asked to walk to the patrol car for a breathalyzer test – ie to ‘blow’.  While walking to his car, I realized that, due to the fact that my car was in one of two ‘stop’ zones in the middle of the street, and that the other spot was similarly occupied, the spot check program was put on temporary hold – as cars were now being waived through without their drivers even being asked the question I was.  This program seemed to entail at least 4 police cars and at least 8 policemen – which was now all on hold as they interrogated me and one other person.

Process Error #3

           This program had effectively ‘trapped’ me – for all the wrong reasons noted above.  But, as a result of trapping me, this very expensive program (ie based on manpower and vehicle power tied up while testing me), was potentially missing out on catching those who were much more likely violators of our drinking and driving laws. 

As I walked to the patrol car – I started to get a bit nervous – as, while I knew that I should easily pass this test based on my extremely limited consumption of alcohol that night, what if my blood system worked differently from others and I was not able to process the alcohol in my blood as quickly as everybody else – or what if the equipment did not work correctly and displayed a false positive. 

After the policeman demonstrated how to properly ‘blow’ into the machine, my heart started to race a bit.   I blew into the machine – and somehow had blown incorrectly and need to do it again – creating more stress and concern by me.  Finally, I was able to ‘blow’ correctly - and recorded a blood alcohol level of 0.00!

Final Thoughts

While I still agree with the concept of the spot check program, the decision-tree process seems deeply flawed and needs rework.  If it is truly random, then stop random cars and test all stopped drivers – rather than relying on a process that itself gets captured within the Liars Paradox- especially if there is no alcohol on the driver’s breath or slurred speech… Finally, if someone is to be tested, it should be done without delay to maximize the effect of alcohol currently in their system.    

This program can work for all of us – but, to be more effective, the process decision-tree needs some work first.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

The Blunt Bean Counter Mentioned in Weekly Blog Roundup

Thanks to Larry MacDonald, author and contributing columnist to the Globe and Mail, for mentioning my blog in his Weekly Roundup of Blogs. Larry’s blog covers various investment topics.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

Capital Loss Strategies

The newspapers are filled with the typical year-end tax planning and investment strategies. It seems the number one strategy in almost all of these articles is to trigger any unrealized capital losses in your portfolio to use them against any capital gains you realized in 2010.

Well, what if you don’t have capital gains or you have capital losses galore from some prior investment mishap? Or, how about the case where you have gains and your spouse has losses, or vice versa? I will examine a couple strategies for 2011 to take advantage of these lonely unutilized losses.

Flow-Through Shares

The first strategy you may wish to consider is the purchase of a Flow-Through Tax Shelter (“Flow-Through”). Please see my September blog entitled Are You a Flow-Through Junkie for a discussion of Flow-Through’s. As noted in the Flow-Through blog, flow-through’s generate a capital gain upon disposition.

So following the $10,000 example in the September blog, you purchase a Flow-Through tax shelter in 2011 for $10,000 which results in income tax savings of approximately $4,600 in filing your 2011 income tax return and leaves you out of pocket $5,400 ($10,000-4,600). It should be noted that the adjusted cost base of your flow-through is now nil.

Typically the Flow-Through funds roll into a mutual fund 24 months following their purchase. If you sell the mutual fund 24 months later for the same $10,000 you purchased the fund for, and apply $10,000 of your unused capital losses, you would end up ahead by $4,600 on the investment ($10,000 cost -$4,600 in tax savings - $10,000 proceeds of sale). You also have downside protection. In the example above, where you utilize your capital losses, the value of the investment could fall to $5,400 and you would still break even.

Of course you and your investment advisor must evaluate the investment risk and consider that commodity prices may drop, or the market for junior resource stocks may deteriorate.

Transferring Capital Losses to a Spouse

Many couples trade independently and even if they trade together, one spouse may have realized capital gains while the other spouse has unrealized capital losses. Because the Income Tax Act does not permit transferring losses directly to a spouse, the typical strategy of selling stocks with unrealized losses to net against realized capital gains is not applicable. However, you are not out of luck.

The Income Tax Act prevents taxpayers from triggering a loss by selling a property to an affiliated person such as a spouse thorough the superficial loss rules. However, using proper tax planning, spouses can utilize the superficial loss rules of the Income Tax Act to allow one spouse to offset their gains against the losses of the other spouse.

Say June bought Glowing Gold Mines for $20,000 and the shares are now worth only $5,000 while her husband Ward is a sharp trader and has numerous gains. In order to transfer June’s capital loss to Ward, she sells her stock on the open market. Ward then immediately buys Glowing Gold Mines on the open market for $5,000. June’s losses are denied under the superficial loss rules because Ward, an affiliated person, has purchased the same security within 30 days of June selling.

But in an ironic twist of income tax fate, June’s loss of $15,000 is denied, but it is added to the cost base of Ward’s shares. His Glowing Gold Mine shares now have a cost base of $20,000 and if he sells them for $5,000 at least 31 days after purchasing them, Ward will have a $15,000 loss to claim against his capital gains even though he only purchased the shares for $5,000.  

Radar Traps

I think we can all agree, police radar traps are a necessary evil in school areas and on neighbourhood streets and certain other areas where speed could result in a fatality. However, it is another story when radar is set up as an apparent money grab in what we perceive to be non-risk areas. Of course, you know where I am going with this.

On the weekend I was driving on the 401 Highway in Toronto which has a posted speed limit of 100, but of course everyone drives between 110 and 120 km per hour. I was driving to an appointment around

Black Creek Drive , an area that I am not very familiar with.

The cut-off to Black Creek appeared to be a continuation of Highway 401. I was not going much faster than the speed of traffic and, in the middle lane, was not aware or even considering that the limit could have dropped. However, to my consternation, as I was flagged down, I learned that the speed limit for this cut-off was 80 km per hour.

The police officer was very fair to me under the circumstances, and I have no issue with him, my issue is the placement of the radar in this area. I told the police officer that having radar in this area is “like shooting fish in a barrel” and he did not disagree. This is one of those “it is what it is” issues, however, that does not mean I cannot publicly vent – one of the benefits of this blog.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs. Please note the blog post is time sensitive and subject to changes in legislation or law.

Resverlogix- A Cautionary Tale

This blog will recount the saga of my share ownership of  Resverlogix Corp. (“RVX”), a TSX-listed company. This is a cautionary tale in investing and a very interesting story and it should not be construed as advice. If I had the inclination, there is enough gossip and innuendo surrounding this stock that I could spin this story into one that could be printed in the National Enquirer; however, it is my intent to be mostly matter of fact and reflect the investment element.

The saga begins in the spring of 2006 when I was made aware of a bio-tech stock out of Calgary called Resverlogix Corp. (“RVX”). The company was working on a drug (RVX-208) to turn on Apolipoprotein A-1 (“ApoA-1”). ApoA-1 is the major protein component of high density lipoprotein (HDL). HDL is known as the “good cholesterol.” In extremely simplistic terms it is hoped that the protein will promote the removal of plaque from the arteries by reverse cholesterol transport (cholesterol is removed from the arteries and delivered to the liver for excretion).

With my eyes wide open to the fact that bio-techs are very risky, I dipped my toe into RVX as the concept denoted above was very novel and extremely exciting. In addition, the CEO Don McCaffrey stated it was the intention of RVX to sell pre-clinical, which in my mind removed substantial bio-tech risk.

In early December 2006, Pfizer announced that its cholesterol drug Torcetrapib failed its clinical tests and Pfizer’s stock plummeted. If I had done more then dip my toes in RVX, I would be writing this blog from the Turks and Caicos because after Pfizer’s failure, RVX was seen as a possible successor and, fueled by rumours of a sale, RVX stock went from $5 to $30 within about ten weeks. Helping fuel the fun was a press release stating that RVX has hired UBS Securities as an investment banker to help with a “strategic alternatives.” Not a bad profit for a ten week timeframe.

What follows is the roller coaster ride from hell. The stock drops from $30 to $13 in two months as no deal emerges and by August of 2007 it is at $9.  By the end of the October 2008 crash RVX is down to $2.30. I blow most of my gains on the initial huge run by buying back shares as I think the price is a bargain. This story includes my ignorance.

The dramatic stock drop is blamed on RVX not receiving any public offers and Big Pharma’s reluctance to make purchases due to numerous drug failures and, probably more significantly, financing issues.

Anyone who has ever been involved with a small-cap stock, and especially a small-cap bio-tech stock, is aware that financing is a huge issue. RVX engaged in “death spiral financing,” a process where the convertible financing used to fund a small-cap company can be used against the company in the marketplace causing the company’s stock to fall dramatically. It can lead to the company’s ultimate downfall.

While RVX stock stayed low, the science moved along tremendously with positive testing and good results in Phase 1B/2A testing . In October 2009, RVX announced it would move ahead with parallel tests called Assert and Assure. These studies were to be run by renowned researchers  at the Cleveland Clinic. This was considered to be important confirmation that RVX had a potential blockbuster drug.

The primary endpoint of Assert was to determine if RVX-208 would increase ApoA-1 and to examine safety and tolerability. Assure was going to use a process called intravascular ultrasound to detect changes in plaque and examine early lipid effects and plaque on the coronary vessels. Assert moved ahead quickly, dosing patients ahead of schedule in late 2009.

What was extremely interesting to investors was that at the beginning of 2010, even though the stock price of RVX was only $2.40, the science had moved at a rapid pace and  if Assure was successful, a “big if,” there would be a bidding war for RVX with estimates in the range of $30-$60. Of course, if Assure failed, RVX would most likely fall to less then $1.

I personally felt that $2.40 was a ridiculously low price for a drug with potential yearly sales of 10-20 billion dollar and purchased more shares at that point. Score one for my investing intelligence.

The stock floated around the $2-$3 range until March 2010 when the stock took off up to $7.50, mostly propelled by an article by Ellen Gibson of Bloomberg stating “Resverlogix Corp., without a marketed product, may accomplish what Pfizer Inc., the world’s biggest drug maker, couldn’t: Creating a new medicine that fights heart disease by raising so-called good cholesterol.” There was some additional publicity that followed and the stock jumped around in the $5 to $8 range. At this point I sold a portion of my stock and bought call options. The options provided me high leverage but could expire worthless, but most importantly, the options allowed me to remove a significant amount of my cash investment, while retaining potential upside to the stock.

In May 2010 it was announced that the Assure trial would be delayed as RVX was having trouble recruiting patients. The RVX spin was positive saying that since Assert had finished early, the researchers could now use what they learned in Assert to plan Assure; however, many months were wasted. The market did not appreciate the delay in Assure and the stock price fell from $6.80 to $2.80 in late June.

RVX decided to present the Assert data at a Late Breaking Trial Session on November 17th at the American Heart Association (“AHA”) conference. These session slots are supposedly only provided to those companies providing significant trial results, whether good or bad, and there is an embargo on any information being released prior to the presentation. RVX would lose their presentation spot if any information was released.

At RVX’s Annual General Meeting in early September, which I did not attend, the trial’s principal investigator Dr. Stephen Nicholls of the Cleveland Clinic spoke, and while he could not speak about Assert results, those there blogged about his appearance and said that his apparent enthusiasm for RVX 208 bode well for the AHA presentation. After the AGM, the stock rose from the high twos into the mid-fours over the next several weeks as attention was directed towards the November 17th AHA presentation.

Many investors were unaware that Merck would also be presenting results on a HDL drug they were working on known as Anacetrapib, a drug from the same family of inhibitors as Pfizer’s Torcetrapib which, as noted above, had failed miserably. Thus, investors who had heard of Merck’s presentation were not expecting much.

A cause of concern for RVX investors from August onwards was that the short position grew from 440,000 at July 31st to 1,770,000 at September 15th and ultimately to 2,160,000 at October 31st. An increase in shorts prior to the most significant trial results in RVX’s history was reason to raise an eyebrow. I figured the increase might have something to do with the people who had financed RVX the last year using shorts as a hedge on their warrants, but I was unsure and sort of wary of this increase.

I expected an increase in RVX’s stock price as the AHA approached on anticipation of positive results that would put them one step closer to Assure testing and the small possibility that the Assert results would bring an offer from Big Pharma. Not much happened until the week of November 14th, which is now a week I will never forget and leads to the title of this article.

On Monday, November 16th, in anticipation of the AHA presentation, RVX stock ran from $5.72 to $6.39. On Tuesday, the day before the presentation, the stock ran to a high of $6.98 in the morning and then settled at $6.70 or so until 3:30, at which time, out of nowhere, the stock dropped to $4.50 on significant volume. Needless to say, it was a shocking last half hour of trading and rumours on the stock bullboards ran from a leak of bad results to the shorts pulling a “Bear Raid;” a tactic where shorts try and push the stock down to cover their shorts. This “Bear Raid” theory seemed to make the most sense at the time, since the shorts had a large position with RVX’s presentation scheduled for the next day. A leak did not seem to make sense based on the embargo by the AHA.

Apparently the embargo on the late breaking sessions at the AHA on Wednesday was lifted first thing Wednesday morning. Early Wednesday morning Bloomberg reported that “Resverlogix Corp.’s most advanced experimental medicine, a cholesterol pill called RVX-208, failed to raise levels of a protein thought to help clear plaque from arteries in a study.”

The Bloomberg report was followed by an RVX press release that said the “Assert trial data demonstrated that the three key biomarkers in the reverse cholesterol transport (RCT) process showed dose dependant and consistent improvement.”

Following the RVX release, the Dow Jones reported “A study involving a new type of drug being developed by Resverlogix Corp. showed it failed to meet a goal of boosting levels of a specific protein the drug was designed to raise.”

To put the final nail in the RVX’s coffin for the day, Merck reported its Anacetrapib had tremendous results in increasing HDL and also reducing LDL the bad cholesterol.

The stock opened around $5.30 on Wednesday morning with investors obviously thinking the shorts had caused the prior day’s stock price drop, but after the press releases, the stock quickly dropped to a low of $3.35 by 9:45 am. However, investors were clearly now not sure what to believe; the headlines by Bloomberg and the Dow Jones, or RVX’s press release. The stock rebounded to $4 by the time of RVX’s actual presentation. By all accounts the presentation was very factual emphasizing that RVX did not achieve a statistically significant  % change in ApoA-1. Supposedly, to be statistically significant the p (probability value) would have to be less than 0.05 and RVX’s was 0.06.

Following the presentation, RVX’s stock slid to $2.73. It then slid Thursday to $2.14 before rebounding on the Friday to $2.34. As of today’s writing, the stock is $2.00.

Notwithstanding the fact I probably will need RVX-208 to combat the heart attack symptoms this experience caused, the story still has more twists and turns.

Some questions arise in relation to the AHA conference itself. Supposedly video clips of presenter interviews were made days before the presentations, and supposedly the slides for Dr. Nicholls’ presentation were available online before the presentation.

The conclusions presented by Dr. Nicholls were buffered somewhat in a post presentation RVX conference call on Wednesday with statements that some of the data RVX noted in their press release was promising and, if the trial had continued, the results may have become statistically significant. More importantly, Nicholls made a couple comments that RVX-208 could still have a “profound effect” on reducing plaque volume. It was clearly a “could” and not a “would,” but a far more positive spin than the media was reporting.

All in all, there was mass confusion and huge paper or actual stock losses for RVX shareholders.

You are probably thinking “Why the heck did Mark not sell the day before the AHA?” In retrospect, that would have been prudent, however, I had decided I was going for a home run and would accept a strike out. In the bloody aftermath, more detailed analysis of RVX-208 and Merck’s Anacetrapib were reported. The analysis ranged from optimism for Anacetrapib to comments that the HDL levels were out of line and may never achieve clinical success.

Meanwhile, RVX created significant problems for itself with its endpoint selection, especially since there was evidence that a longer trial may have given the drug time to   achieve statistical significance. RVX also had an increase in liver enzymes not highlighted in its press release that led to further unanswered questions. The uncertainty around RVX-208 became cloudier as AHA clips and Medical publications said such things as: 

"The discussant for the trial, Eliot Brinton, said “that a drug like RVX-208 that has a modest effect on HDL levels might have a large clinical effect.”"

MedPage Today, quoted Elliott Antman, MD, professor of medicine at Harvard Medical School (a very well respected researcher according to a doctor friend of mine) as saying

"The important thing that we saw here with RVX-208 was the dose response. That means that something is happening with the drug. I think that the dose response trumps P-values."

What is a non scientist to think? At the end of the day, RVX’s stock price was hit so badly that it may cause financing issues in the future. Some may say that although the Bloomberg and Dow Jones writers were accurate in reporting that RVX did not achieve statistical significance, they also went for headlines instead of researching the more hidden or complicated facts. It remains to be seen whether RVX does indeed have a drug that will inspire Big Pharma to either buy or partner with RVX .

I am not sure there is a moral to this story; this was cathartic to write and like I said, it is a saga, a saga that is still ongoing. I guess, if anything, this is just a cautionary tale about investing in biotech’s and investing in general.

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