2. The neuroscience of happiness.

3. First impressions of the Facebook IPO filing.

4. Chuck Akre on the search for compounding machines.

5. Cigarettes, alcohol or checking email: which is hardest to resist?

6. The downside of investing safely.

And the best sentence I read this week, from here:

“On Monday night, Blake Griffin dunked so hard on Kendrick Perkins that the Mayan apocalypse was called off.”

“There are only three ways a company can grow. First, earn more business from your current customers. Second, attract customers from your competitors. Or third, buy another company. If you can’t do the first, what makes you think you can earn more business from your competitors’ customers or from customers you buy through acquisition?”

Read the whole article here.

2. Why must a captain never leave a sinking ship?

3. Apple’s Massive Numbers and Some Context.

4. The End of Mutual Funds is Coming.

5. Sorry, Einhorn. It was textbook insider trading. And, um, soccer is football.

6. The Random Financial Advice Generator.

Insider trading is “rampant and routine and this criminal behaviour was known, encouraged and exploited by authority figures in several investment funds.”

So sayeth the US attorney for Manhattan. More on the FBI’s Operation Perfect Hedge can be found here in this FT article. And this one.

I have an investor who is concerned this particular era on Wall Street has become just like the 90′s in professional baseball. He believes both major league ball back then and the current scene on Wall Street resemble social experiments that began with the question, “What sort of behavior would you be willing to engage in if we threw tens of millions of dollars at you?”

In baseball, the answer seemed to be, “I will repeatedly inject myself in the butt with copious amounts of steroids.”

On Wall Street, the answer seems to be stuff like this.

Hard not to agree with him.

2. Yes, let’s be honest about private equity.

3. Are you Google’s customer, or its product?

4. Instant classic: a parody of our nation’s finances.

5. The more ya know, the less ya understand.

6. Belgian beer uber alles.

7. The best letter to a lawyer, ever.

New puppy at home, too. Been a blast – although I had quite the battle with my two young daughters when it came to choosing a name for him. After exhausting all other options, I was able to eventually, for a small sum, buy the naming rights to him. It was a desperate move – but I was outnumbered and out of options. There was just no way I could let him be named “Rainbow Princess.”

So, here’s Murphy. Don’t let the picture fool you, though. He may look like a black lab, but turns out he’s really a fur-coated flip-flop destruction machine.

In any case, I will get my next investor letter out in another week or so (you can sign up here), and back to the blog after that.

In the meantime, a belated happy holidays to all.

1 – Bill Miller, former media darling and Morningstar Mutual Fund Manager of the Decade, is calling it quits.

2 – This is a screenshot from the Bloomberg website this morning. I drew the red boxes.

Which is it, people?

Even editors get flummoxed, apparently.

Stay calm out there.

Not sure what term makes me cringe more…”political intelligence” or “honest graft.”

Why would someone coming out of military service have a harder time finding a job? Think about the demographics of a young soldier. Most are men, and unemployment is worse now for men: 9.5 percent in October vs. 8.5 percent for women. Younger vets are coming right out of high school; the job market punishes those with less education. Many vets come from and return to rural and rust-belt areas that are struggling. And the cut-throat competition for jobs has been hardest on those out of work the longest; fair or not, eight years in the Army is viewed by some employers as eight years without private-sector skills and experience.

I think there are at least three points worth making here.

1 – For young people, the military is the single best “jobs program” this country ever developed.

2 – You can’t train integrity. Or as Warren Buffett once said:

“…in looking for people to hire, you look for three qualities: integrity, intelligence, and energy. And if they don’t have the first, the other two will kill you.”

3 – Once upon a time a few brave civilians took on some risk by hiring this particular veteran – thanks to a considerable amount of behind-the-scenes help from my own veteran buddies. I’d like to think it was, as much as I hate this phrase, “win-win.” Those jobs changed my life immensely, and I helped make those companies better, too.

And for anyone currently in the service who might be reading this, here are a few of my own observations about getting out and going to work in the private sector a dozen years ago.

A – Most of corporate America won’t get you. At least, not at first. That point in the quote above about veterans not being hired because they’re viewed as not having any relevant experience is dead-on. The thing is, though, is that while that may be true, after a few weeks at a new job, it also becomes completely irrelevant. And that is because…

B – There is a critical shortage of people in the business world who are, quite simply, unable to get things done. You will be amazed.

C – Concepts like accountability, honor and integrity are completely absent from many workplace cultures. You can’t swing a dead cat in the financial services industry, for instance, without hitting someone who believes those concepts are outdated, quaint, or cliched. Do not go to work for one of those people. Ever. No matter what.

D – When they ask you in the interview, your strengths are your work ethic, your belief that systems not people are the stars, your experience working on high-performing teams, and your ability to self-motivate. Your weaknesses are that you don’t know how to dress and you like your hair short. That hair thing is an easy fix, but lordy, please take that label off the sleeve of your suit jacket. And just know that they’re probably going to initially assume you’re an uncreative, rigid drone who loves tobacco, swearing and blowing things up. That’s their problem.

It’s probably too late to ask that we replace the parades with job fairs this year. But if you run or manage a business, and find yourself in the position of being able to bring on a new hire the next year or two, here’s to hoping you think hard about including veterans in your search, too. I’m biased, but I think veterans are easily the most undervalued assets in the world of human capital. And these guys have certainly earned it.

Happy Veterans Day.

The idea that “lowest average cost wins” when it comes to investing is one of the most under-appreciated elements of portfolio management. And my own averaging down in Tarpon has been a very significant contributor to our returns. So I believe this is an important subject for all investors to grasp.

My theory is also that using FOLIOfn to average down is also a big advantage for portfolio managers. To understand why, you’ve got to know a little about the following four concepts:

1 – Averaging down. I define this as buying more new shares of a stock when it is trading below the average price you paid for your existing shares – while keeping the total weight of that holding constant in your portfolio. So, you’re buying new cheaper shares and selling older more expensive shares. This is synonymous with lowering the average price you paid for that stock.

2 – Tax lots. Think of a tax lot as a price tag that is wrapped around a bundle of a company’s shares that you bought at one particular time. I’ll try to explain this with an example.

Let’s say on every Tuesday of the past July, you bought 10 shares of Google. At the end of the month you owned 40 shares.

Now you want to sell 10 shares out of those 40. At most brokerage firms and mutual funds, you have no say in which ten shares you sell. That’s a bummer, because you could save a lot of money in taxes if you could select the shares you wished to sell in a way that, if your shares had gone up in value, would minimize your capital gain. And had you the option, if your shares had gone down in value, you could create a bigger tax loss (which is good, because it offsets other gains at tax time) by selling those shares that you’d paid the most for.

Again, at most brokers, you have zero control over which ten shares you sold. Fortunately, though, on FOLIOfn, you can sell shares in a tax-savvy way via tax lots.

So in the example above, you have four taxes lots – one for each bundle of Google shares you bought on Tuesdays. When it comes time to sell one of the bundles, FOLIOfn allows you to easily pick the best one to part with by comparing the price tag on each bundle to the current market price. And that can save you a ton of money when it comes to taxes.

3 – Fractional shares. FOLIOfn also allows you to buy fractions of a share. It may sound odd, but say you only have $400 to invest. At most brokers, you couldn’t even buy a single share of Google if it was trading at $535 each. At FOLIOfn, though, you could buy 0.748 shares of Google with your $400 – no problem at all.

4 – Percentage weightings. I manage the Tarpon Folio according to percentage weights. So, for instance, if I wanted to initiate a new position in Google in Tarpon, I’d tweak the core portfolio settings to, say, reflect a (6.0% weighting by dollar amount) in Google. FOLIOfn’s system then interprets that weight into the exact number of shares (and fractions of shares) to buy in each investor account to bring their accounts up to a 6.0% weighting in Google, too. So, it’s a simple concept that plays into things subtly more here in a minute.

Now, here’s an example of why it pays to average down:

On Monday I buy a single share of stock in Pork & Beans Co. for $10.00.

On Tuesday, a customer opens a can that contains neither pork nor beans, but something that can only be described as sinister. Panic ensues. Shares drop.

On Wednesday, I decide to average down, and buy another single share for $5.00.

Now I own two shares, and my average cost is $7.50 ($10 plus $5 all divided by 2). My total position size is $15.00 (the $10.00 share plus the $5.00 share).

On Thursday, I remember that I only want to have $10.00 total invested in this company’s shares, because for risk control reasons I don’t want it to be any bigger than a 10% position in my $100 total portfolio. There’s really no telling what else has been going on in that factory, it being majority-owned by Goldman Sachs and all.

So, to restate – I have $15.00 of my money invested in Pork & Beans Co., which also represents a 15% position in my total portfolio. But I want to get my ownership of that company down to a 10% position in my portfolio, and that means I’ve gotta sell $5.00 worth of shares.

If to do that I just sold the same single $5.00 share I’d bought on Wednesday, then, well, that would be dumb. Not only would I have paid money (for no reason) in commissions to buy and sell that share, but the other share I continued to own would still have a cost basis of $10.00. So after all that I’d still be eating a loss on paper and would not be any closer to clawing my way back whenever the panic subsided and the shares rose in value.

FOLIOfn, however, effectively lets me sell $5.00 worth of shares by selling half of the $10.00 share I bought on Monday – a move which maximizes my loss on that sale, which is good come tax-time. It also lowers my average cost basis, too, because afterwards I would own the 1.0 share bought at $5.00 and the remaining 0.5 shares I’d bought at $10.00. And that means I would have my ideal 10% position in Pork & Beans at an average cost basis of $6.67 ($10 total position divided by 1.5 total shares).

So, long story short, because I averaged down, my cost basis went from $10.00 to $6.67 on that 10% position in my portfolio.

A month later, a private equity firm comes along and buys out Pork & Beans for $17.00 a share. If I had not averaged down and just kept that original $10-per-share cost basis on the books, I would make $7 in profit, or a 70% return. Not too bad at all.

But because I averaged down to $6.67, though, I made $10.33 in profit, or a 155% return. Now we’re talking. Plus, Goldman was secretly short Pork & Beans stock, so that feels even better.

I greatly simplified a few things above, and completely glossed over wash sale rules, but my point is that the kind of performance differential that averaging down can create is, to me, well worth the trouble – and particularly when we don’t have to pay commissions on any trades at FOLIOfn, period. And again, those aren’t just better numbers for the sake of being able to talk about better numbers. That’s a real increase in actual profit for investors in my Spoke Fund®.

That said, please note that if you aren’t really confident in your own valuation of a company, you
probably shouldn’t attempt to average down. All of the above is meaningless if the stock price doesn’t eventually head back up. If the price instead keeps going down as you average down, you will wind up both broke and insane. The above also implies you’re willing to let your winners run, as they say. To average down and capture a price drop, only to then rebalance your position (i.e. sell some shares off) once its price climbs back up, means it might not be worth the trouble, either.

But if you can stay rational when prices drop for temporary reasons, and you’re a long-term buy and hold investor, averaging down can be very smart for your portfolio.

Update: To clarify, the 1/2 share I’m selling was a $10 share. I am taking a loss there, and I did not net that loss out against the improved gain percentage above. Call it mental accounting…I view that loss as something that can be spread over the entire portfolio come tax time. So, all things being equal, it will likely be a shield of sorts for other capital gains in the portfolio. And I am completely ignoring wash sale rules on purpose in the example above, but a good future post would probably tie it all together here.

As a reminder, none of this should be considered investment advice, or anything even close. It’s almost entirely opinion and, in parts below, is pure speculation. But those are the kinds of questions I’ve been getting lately. I’ll return to more objective, quantitative answers in the next post in this series.

And despite a crazy few weeks, I still believe Clearwire’s spectrum, under a set of pessimistic assumptions, is still worth around $6 a share. Implicit in that estimate is that the company finds the short-term funding to be able to ultimately realize that intrinsic value. And while that spectrum value is of less importance to both debt and equity investors right now then the company’s need to find funding, I believe that emphasis will likely change dramatically before the end of the year. Just my opinion, mind you.

On with the Q&A.

Q. Who is going to fund Clearwire?

A. I have no more insight into the answer to that question than any other investor out there.

The reasons I invested in Clearwire prior to knowing the answer to that question, however, were (1) I’ll get a much better price and a bigger margin of safety now then later, (2) I believe the actual probability of the raise happening is significantly higher than what the market appears to be pricing in, and (3) I have faith that somewhere in the parallel universe than can be the telco industry, someone with much bigger brains than mine did the same calculations of Clearwire’s spectrum value as I did – and because that gap between true spectrum value and its current implied pricing in the market is so large, and the TDD technology so potentially disruptive, those brains are going to get off the couch and do something with Clearwire. And, frankly, I also trust that in the negotiations that ensue, John Stanton will defend his own equity interests as strongly as I would defend my own.

So, I like my position in the capital structure as a common equity holder – though I concede Clearwire’s debt could quite be attractive here as well – because I simply don’t believe that my position as a "subordinate" equity holder is going to be relevant for long. I want to be a partner in this business – forever, hopefully – and not a lender to it, and there’s no way to do that without eating some risk. So be it.

That said, it’s also important to be realistic about the hurdles Clearwire could encounter as it seeks additional funding from a strategic partner. Specifically, investors should acknowledge that a funding partner (or partners) might not want to play second fiddle to the first-lien holders (i.e. those debt holders who essentially have first dibs on the spectrum in the event of bankruptcy). That’s a valid issue that folks like the credit analysts at Moody’s have brought up recently. I would argue, however, that the mere act of putting enough "junior capital" into Clearwire will also make the "junior" part of that phrase immaterial, as the company is on a path to self-funding its own operations in the near future. In other words, that equity stake may not be secured, but the ultimate reward for whatever group that funds Clearwire should more than make up for that risk, too, in terms of total return across its investment.

As I explained in my original article, at current prices, the market is pricing in a capital raise of well over than a billion dollars through just a very dilutive equity sale by Clearwire. I believe the actual probability of that happening is very low – less than 10%, I would say – based on a number of factors including public comments the CFO has made as well as the availability of vendor financing. I would guess the financing will be done in stages – and there will unequivocally be some dilution, but my point is that it won’t be nearly as mush as the market seems to believe.

So when shorts assert that Clearwire tried to raise money last year, and apparently couldn’t, or they tried to sell spectrum, but couldn’t, and/or otherwise appear to have no funding options last year, and then try to pass those observations off as being relevant today, I would remind them that: (a) the company only very recently formalized (and pegged the cost of) a switch to LTE Advanced, (b) the entire management team and board has recently been overhauled, and (c) the competitive dynamics throughout the industry have changed quite a bit from a year ago given the T-Mobile acquisition, another year’s worth of network congestion, a shift in emphasis at CLWR to a wholesale business model, and the emergence of Dish’s interest in the space. These things should take a little time.

Whether you’re long or short Clearwire, I’d also suggest you be sure you know the difference between the FDD and TDD flavors of LTE, specifically as they apply to both coverage- and capacity-based models. And not because it will mean you could get a 2 point bounce in the stock in the second Thursday after the full moon, but because it means the actual probability of Clearwire finding strategic funding/getting another wholesale customer/raising capital through vendor financing is considerably higher than most people who don’t understand the difference appear to believe. The technology matters here, period.

Lastly, with regards to specific partners for Clearwire – standby for rank speculation – I am personally intrigued by the potential for the company to do something with Dish. Again, I have no particular insight into either of these companies on this issue, and the odds are that my interest ultimately ends up being little more than wishful thinking, but I would encourage both longs and shorts to read this week’s Bloomberg article on Charlie Ergen’s plans at Dish and ask if there is a better fit out there than Clearwire. And while you’re at it, check out this article, in which Dish’s CEO mentions the possibility of buying or partnering with Sprint or Clearwire.

So, speculate away, I suppose. The point is that Clearwire has other options than Sprint.

Q. Who do you think is shorting Clearwire, and why?

A. This, or some derivation of it, seems to be the second most popular question I’ve gotten. I have had a decent amount of back and forth with some CLWR shorts based on my previous articles, which is valuable in terms of trying to poke further wholes in my own long thesis. Haven’t found any yet – though funding remains the big topic, obviously. That aside, I don’t particularly care who might be shorting the company, although I can certainly understand how frustrating it can be to see something that’s already ridiculously cheap get even cheaper.

Clearwire has been an excellent short if for no other reason than it’s a complicated story with ugly losses to date, a relatively limited float, and an enthusiastic but impatient retail shareholder base – and that makes its daily price subject to all manner of fear, uncertainty and/or doubt sown by the more nefarious shorts. And yeah, that happens – rules be damned, unfortunately. Those rumors show up in all kinds of places, from Yahoo message boards to crazy WiMax iPhone 5 rumors to mysterious, debunked calls to Bloomberg reporters. It’s ridiculous, but it’s also just part of the market these days.

I would characterize Clearwire shorts as follows:

1 – Those simply hedging the 2015 notes sold last fall. These would be hedge funds largely agnostic about most daily events at Clearwire simply covering their bases.

2 – Those seeing an attractive short-term trade. For instance, by selling puts on Sprint (or just going long), buying Clearwire’s 2015 senior secured debt and then shorting Clearwire’s common stock, you can create the cash that pays for the purchase of the 2015 notes, exploit the angst between the two companies, and have plenty of breathing room if there is a debt to equity conversion at Cleawrie. This trade looks good on paper, I suppose, but it (a) implies that conversion and/or major equity dilution, (b) assumes Sprint is better positioned than Clearwire, and (c) I would guess this trade is getting pretty crowded at this point. But those notes are certainly attractive right now.

3 – Those who believe the company will fail – or be massively diluted. These would be shorts who are skeptical of the company’s future based just on its historical financials and past mis-steps – and/or who believe Sprint is actually trying to bankrupt a company it owns most of. I simply disagree that this will be Clearwire’s fate, as per my previous articles. Time will tell who is right. To their credit, the shorts in this group seem to admit they don’t know the technologies here…and to me, that’s kind of the whole point – it is key to the company getting funding. More on this below.

4 – The amateur shorts. If internet message boards are any indication, this group is large.  It includes quantitative and momentum shorts as well.  Ten years ago, shorts were to be respected, but nowadays, any idiot can short anything, and many do. See this post for a whole ‘nuther rant about restoring the uptick rule and reigning in high frequency trading.

It is also important to realize that the shorts – particularly the ones that own Clearwire debt – have large financial incentives to see the company fail. It’s nothing personal, mind you, it’s just math. Should the company go bankrupt, then shorts never have to cover, and debt holders could acquire that valuable spectrum for pennies on the dollar. Fortunately, a decline in stock price alone can’t make a company go bankrupt, and Clearwire’s actual financials have never been better – though we still have a way to go, and they admittedly are taking a back seat to the company’s current funding quest. So the traders will likely have their way with shares until the current fundraising uncertainty is cleared up.

All that said, in my opinion, Clearwire is currently a dangerous short. If Clearwire raises money, signs a new wholesale customer and/or sells excess spectrum, theshort case in 2 through 4 above evaporates instantly. And we know they are currently working hard on the first two efforts there, while the third would be on the table for the right price. Same holds true to a lesser degree if Sprint clarifies on next week’s conference call that it will contract with Clearwire for WiMax beyond 2012. Lot of risk there, too.

So I can’t quite grasp the bravado on the short side here. Clearwire has one significant challenge right now – finding funding – but shorting based on the presumption that they won’t be able to do that seems awfully risky.

Q. Have you considered that Sprint is trying to force Clearwire into bankruptcy?

A. This is a common perception floating around out there – ever since the Pardus Capital letter this past May and the Sprint analyst day disaster of a few weeks ago. Fortunately – and this will disappoint the conspiracy theorists – it is also doesn’t hold any water. Never mind my own beliefs about why this is silly – here is the Chairman of Sprint’s board two weeks ago when asked about Sprint’s partnership with Clearwire:

“No question we want them to do well; it’s in our interest that they do well. Nothing good happens in a restructuring and there’s nothing good in the outcome of that.”

Sprint will also be paying Clearwire a minumum of $1 billion dollars between now and the end of next year as a wholesaler. That is not the act of one company trying to drive another into receivership. That, incidentally, is also why I am not losing sleep over the impact of new iPhone sales at Sprint on Clearwire’s wholesale subscriber trends. By the time we’ll have that billion dollars in hand, we won’t have to guess and can react accordingly then.

Q. What do you say about the fact that Clearwire’s spectrum is of poor quality?

A. In short – hogwash. Let’s step back for radio frequency (RF) engineering 101.

It’s important to understand that the advantages/disadvantages of any given band of spectrum are not absolute – Clearwire’s included.

Of the many trade-offs an RF engineering team has to make when covering an area with a wireless network, the dominant one is the balancing act between the capex budget, cell size and signal strength. It’s really just physics…higher frequency radio frequency waves can carry more traffic, but they peter out quicker and can’t penetrate structures as well.

Lower frequencies, like those owned by AT&T, Verizon, Sprint and T-Mobile travel farther and fade less over time – so they are "stronger" in the sense they’ll travel through walls. Up to now, in telecom, because all those guys were racing to cover the country with signal in order to get and keep as many subscribers as possible, those lower frequencies were an advantage, because the capex costs were lower (specifically, they had to deploy less towers at $150K each to cover the same area then someone at a higher frequency would have to). So in the historical sense, that spectrum has been judged of higher quality – for that capex reason, really.

But if the whole country is already covered with RF waves, and there is more stuff traveling over them, then coverage is irrelevant, and it’s all about making sure your dense areas can handle all the additional stuff. And higher frequencies are better suited to that.

If you’re an RF engineer designing a new network, you’re basically looking at a map, trying to figure out (among other things) where you should stick the pins, or cell phone towers. Around each pin, you draw a circle with a radius of a certain length. That radius depends (among other things) on the frequency you’re working with.

Lower frequencies travel farther, so your circles are bigger. But you’ll have a lot of empty space in the gaps between where the circles come into contact. No coverage in there. And if you overlap the circles too much to reduce that empty space, you can get interference problems – or you’re wasting money covering an area with redundant signals and gear.

But a wide range of frequency in that area is yours to use in your design. You’ve just got to play with all the variables long enough until it all comes together.

So let’s call that entire frequency range in a given area "A to F." You can best cover that whole area if you (a) minimize the gaps and the overlaps in circles and (b) alter the specific frequencies going in and out of any cell sites sitting right next to each other, to avoid interference problems. So, the first cell site will use frequency A, the next one uses B, etc, until you get to a location far enough away from the first one that you can use frequency A again without interfering with anything other A’s around. RF engineers call this "frequency re-use."

In a capacity-based model – one that means you’ve got to get really deep, tight circles – those large radius cells of the traditional lower frequency operators are in that sense less efficient because you don’t always know how closely you can snug the circles together without causing interference problems. Those signals lose strength gradually and inconsistently. So, frequency re-use can be poor.

You can have much more confidence in the spacing of smaller radius circles (like Clearwire) – and better re-use – because it’s much clearer where the signal is going to drop off. And if, say, four of those little circles cover the same general area as one big circle from above, then after enough of them, they’re going to fill in those previous gaps between big circles, too. The problem is you need more towers to do that, which jacks up your cost greatly. Only Clearwire has already built them out – thus the lack of cash flow to date.

Anyway, that’s greatly simplified. For one, the RF guys use hexagons to cover areas, not circles, but never mind. The point is that advantages in a coverage-based approach to designing a network can be disadvantages in a capacity-based model, and vice versa. Clearwire’s higher frequencies give it an advantage in the capacity-based approach – in no small way because its already put up all its towers and has better frequency re-use. It’s just inherently more efficient. For that kind of use.

A dozen years ago, the propagation problem through walls for higher frequency signals was an issue. That will not be anywhere near the same kind of problem for Clearwire under a wholesale model, though, because (1) smartphones contain chips that also can pass traffic over the WiFi that already exists inside many buildings in urban places – and didn’t a dozen years ago – and (2) as long as another carriers’ lower frequency signal can get inside the building, then the initial lift on getting that traffic from a phone to back outside the building is much more the responsibility of that carrier, and Clearwire picks up the slack, so to speak. In a wholesale model, with everyone on LTE.

So that propagation through walls issue for Clearwire is more of a problem in their retail network – but as they’ve announced, they’re no longer trying to compete there. They’re basically going to milk that retail business to fund the wholesale side. So whatever complaints you’ve seen online from retail customers are no doubt valid…but at some point, they’ll be irrelevant, too.

Also – on the differences between TDD and FDD.  The term "disruptive" is easily the most abused adjective in all of tech, but here’s why it might actually apply to Clearwire’s TDD LTE.

Actually, first you should know that the difference in efficiencies between the two technologies can be defined by a number of things – ranging from chipsets to duplexers to power consumption.

What I think is most relevant, though, is that (a) mobile data traffic is very asymmetric…meaning much more stuff is downloaded than uploaded; (b) asymmetric data is difficult/inefficient for FDD systems to handle, because they were originally built for voice, where traffic up and down is roughly the same; and (c) that asymmetry is inconsequential in a TDD system like Clearwire’s because you can so easily change the up/down ratio.

So here’s my lousy metaphor:

TDD (like Clearwire will have) is sort of like a single two-lane road with a clairvoyant yellow line painted down the middle that moves to either side to let more cars go by.

FDD (what all other 4G operators will have) is more like having two one-way roads that are running parallel to each other, with traffic going opposite ways, and a big wall separating the roads from each other.

All things being equal, you can move the same number of cars both ways, but one is going to be a helluva lot more efficient.

The size of Clearwire’s spectrum means all things are most definitely not equal, though…specifically, that spectrum represents a much bigger road with many more lanes. So more cars can use it. And combined with those crazy lines of TDD, it is a very tough combo to beat. Bigger roads, better traffic management.

All that said, if there is an undesirable part of CLWR’s spectrum, it isn’t due to the frequency or technology, but ownership. Specifically, a relatively high percentage of that CLWR spectrum is leased versus owned outright, and based on industry history, the company’s leased spectrum could be valued less than the owned spectrum by the two big dogs in the industry.

To be clear, that is irrelevant to me at these prices, and implicit in my thesis is that the pending spectrum scarcity problem will either outweigh the historical acquisition preferences of AT&T or Verizon, or – perhaps more important – the company’s willingness to opportunistically sell spectrum to anyone, including private equity firms, means the valuation should reflect the perspective of a much broader range of firms than just AT&T and Verizon.

But there is no denying that AT&T and Verizon have shown a historical preference for license ownership in their acquisitions. I just believe the pool of potential buyers and/or ways to monetize the CLWR spectrum asset is much bigger than those two firms, which is why I did my valuations the ways I did. Plus, AT&T also just paid a big premium for the QCOM bands for which nobody even makes gear yet, so they might not be as stingy here as I am presuming, either, in a theoretical buyout. Too hard to say.

Anyway, that’s a minor but legitimate knock on the spectrum – and for some folks it understandably adds even more uncertainty to things. But it’s overblown to me. Again, I think things are cheap enough down here that even if you thought it necessary to attempt to capture that owned/leased issue in a valuation sense, it would still be immaterial in a pragmatic sense for a potential buyer like DISH, or anyone else, really. So, it’s a negative, but it always has been, and the most likely outcome related to it would seem to be that AT&T or Verizon would attempt to claim a lower price on that portion of leased spectrum in the event of a buyout.

I can live with that.

Q. What do you think about the threat from LightSquared?

A. I don’t want this to sound too harsh, but I have yet to talk to anyone I would consider a reputable source in the industry that believes LightSquared will be a credible operating company. That said, it’s possible I haven’t asked around enough – and I am no doubt biased against them, both as a potential competitor to Clearwire and because they appear to be trying to exert political pressure to get what they want, which annoys me to no end.

These guys knowingly acquired slices of spectrum that were absolutely going to interfere with GPS, then bought political favors in the hopes that they could simply shrug their shoulders when it came to solving the very real GPS interference problems that they created. Things just don’t get much more corporatist.  Where are the hipsters in Zuccotti Park on this?

It’s a crapshoot on whether or not L2 gets FCC clearance, but that is hurdle one of many dozen, really, on the path to building a viable company. One of the other immediate challenges for L2 is, well, raising $3 billion – and some portion of that is likely going right out the door to Inmarsat for debt and lease payments they’ll owe.

So, as an investor, you can either write a $3 billion check to L2, see a chunk of that forked over to another company straight away, and then hope to see an undefinable eventual return on that money in about five years…or you can write a $1 billion check to Clearwire, which is guaranteed to bring in at least a billion dollars from Sprint next year, possibly see a cash on cash return within 18 months, and own a piece of the most attractive remaining independent asset in all of telecom on the eve of the Great Spectrum Crunch.

No brainer. And it seems logical to presume that both companies are probably talking to at least some of the same investors.

That said, L2 does have a point in that the GPS manufacturing industry has been sloppy to date about bleedover in their receivers…but those guys also no doubt felt entitled to bleed over given the nature of those high precision uses, and the fact that all RF anywhere near it was supposed to be low-power. I would guess that’s probably why the FCC has let it slide all these years.

Regardless, there is a lot of spin on both sides of the debate, and we still do not yet know how L2 will address any potential latency problems, as per my original article.

But assuming the FCC okayed L2 using Javan’s mysterious filters, and the GPS industry somehow agreed to eat that $400m retrofit cost, interference is unequivocally still going to be a problem in the L-band for high precision receivers. It’s just that L2 says it’s no longer going to be their problem.

And that brings me to this:

It’s hard to see the FCC endorsing the position that no one is responsible for that interference, as approval of L2 would imply.

And I would also doubt that unfunded mandates foist on everyone operating a high precision receiver in an election year will get much traction, politically.

Regardless, I thought Sprint said it best at their analyst day; the capacity that L2 represents still won’t be enough in the long-run. They believe they’re going to need new spectrum in about four years, regardless. And after all the horsetrading L2 is doing now, the usable spectrum they have will be much reduced if they do get through the FCC, at least for the foreseeable future. Specifically, they’ll have a 10Mhz by 10Mhz carrier – or what Verizon has right now for their LTE network. It’s not a small slice by any means, but my point is they’ll all still have the same problem at year five or so – needing more spectrum.

So if L2 makes it through the FCC, that might delay the time frame over which Clearwire can monetize its spectrum, but TDD over bigger swaths still gives them the easy nod in the long-run – again, assuming, as everything does these days – that they can find the funding to get there.

The other interesting angle to all this is that if L2 can’t get FCC clearance by the end of the year, then Sprint can cancel its agreement and move on to other things. So, it’s going to be interesting one way or the other.

There are also those who do not necessarily believe it is a zero sum game between L2 and CLWR, either, depending on how everything shakes out…though you can probably guess my preference for how all this might end.

So take all of that for whatever it’s worth.

Disclosure: Long CLWR. None of the above should be taken as investment advice. Ever.

Here, however, is an excellent graphic, originally from this blogger, that shows one of the under-reported aspects of both the Occupy Wall Street crowd and the Tea Partiers.

What I believe both groups are concerned with at a very high level is really corporatism – not capitalism.

The angst of both groups seems to stem from independent observations that we are headed into a world of corporatism, where large companies give financial support to politicians who then lend legal support for those same companies to fend off competitors and provide regulatory barriers to entry.

“The government of an exclusive company of merchants is, perhaps, the worst of all governments for any country whatsoever,” wrote Adam Smith in 1776’s The Wealth of Nations. And he was the first true free market thinker, mind you.

I think we all realize what the cozy relationship between pols and corporations means when it comes time to vote. Something like 94% of all federal elections in this country are won by the candidate that has raised the most money. But what about the impacts going the other way? How does that relationship impact corporations, as opposed to voting booths?

Hard to say, but I’ll take a guess. I think it’s likely linked to a long-term decline in corporate R&D. More specifically, once companies learn that they can realize higher or more sustainable profits by hiring lobbyists instead of engineers, that’s all the incentive they’ll need to go with the lobbyists. It’s the cold, rational choice – in the short-term, mind you. And in a world where the average stock is held for just 22 seconds, it’s a mistake to underestimate how short-term many management teams can be in their thinking. I’d also estimate that buying a politician’s favor has a much better ROI than designing, manufacturing and launching a brand new product into the jungle that is the open market. See Solyndra, for instance. Or LightSquared. Or the S.E.C., even.

At some point, however, after enough of those engineers have been replaced by lobbyists, and as small businesses that refuse to play by those same rules continue to struggle, innovation is going to stagnate. And I think that’s a huge risk here.

I would submit that R&D is an investment that many public corporations have grown to believe is an unnecessary expense, due at least in part to corporatism. That among other things means we are growing less innovative in the areas that fundamentally impact our economy the most. We as a country seem to have already lost I don’t know how many years of progress in math and science as some of this country’s brightest young minds went to work for hedge funds. And our venture capitalists continue to fund a mind-numbing number of companies that don’t appear to solve any truly meaningful problems.

Now I have no idea, for instance, how to really fix our dependency on foreign oil, but I do know that no politician in this country is going to take the draconian steps that would be required to solve that problem through just policies and regulations. So the good news, Silicon Valley, is that we have some big problems that only technology can solve. And when it comes to anti-corporatism, you are our Obi-Wan.

So please, no more Farmvilles. It’s time to put away childish things.

Income inequality is something that all responsible governments have always wrestled with. And I would argue that it was the desire of politicians to start narrowing the gap between haves and have-nots 15 years ago that helped sow the seeds for the Great Recession to begin with. That and just plain old greed, I mean.

But what’s different now is that both sides of the political spectrum are claiming the usual tools aren’t working. I think they’ve realized that rational solutions are too often compromised by corporatism. And they’re rightfully torqued.

If you asked anyone in the Tea Party or OWS to list the causes of the Great Recession, I’d bet few if any of them would mention a synthetic CDO. But they all recognize a failure of character when they see it. And I think that speaks to something that both Wall Street and D.C. will never be able to fully overcome again.

So I’m hopeful that some long-term good comes out of both the Tea Party and Occupy Wall Street. The division between them seems to be that one side doesn’t trust Big Business but does trust Washington, and the other side doesn’t trust Washington but does trust Big Business. Once both groups learn to not trust either Washington or Big Business, they will find common cause. And who knows where that movement could go…but here’s to hoping it ends with some former start-up engineers running D.C. some day.

P.S. Here is my favorite sign from Occupy Wall Street.

Hat tip Swimmer.

First, though, know that I bought more shares in Clearwire on Friday. I viewed the drop last week as an opportunity. I also have no interest long or short in Sprint. All of that may represent biases of some sort in my thoughts below.

Second – the noise this week will probably get temporarily louder. Last week’s drop in price will continue to embolden the aggressive/opportunistic shorts, and the current investor base of Clearwire is, shall we say, a bit twitchy. That combo can be volatile. So, if the past few months are any indication, you should expect more rumors to pop up, whether about bankruptcy, delisting, debt for equity swaps, WiMax iPhone 5′s, or whatever else. My advice is to ignore them. The probability of any of them happening anytime soon is too low to take seriously.

That said, the company continues to face an important near-term challenge – the need to find additional funding. Again, Clearwire says it has enough cash to last through June of 2012, and though I am confident the company can raise capital through several different avenues, there are simply no guarantees. After Friday, it is clear Sprint will not be one of those sources of near-term capital, but as I mentioned previously, Clearwire has other (better) options, too.

If I had to summarize my thoughts about last Friday, I’d say three things:

(1) Clearwire’s spectrum is as valuable today as it was the night before Sprint’s conference call. Right now, based on asset value, Clearwire is the cheapest company I have ever seen.

(2) Welcome to the world of momentum shorts and high frequency trading. And there was no doubt a lot of selling on Friday by speculators disappointed that Sprint did not announce a Clearwire buyout or capital injection. But if you can’t distinguish between price and value, Clearwire is going to drive you insane.

(3) There really was no new news on Friday from Sprint about Clearwire for anyone who’d been paying close attention the last few months.

As Clearwire’s CEO pointed out later that day, Sprint remains completely dependent on Clearwire – through the end of 2012 at least. And nothing in my original thesis was contingent on anything other then the terms of the company’s existing relationship with Sprint, which will continue as expected.

Q. What the hell happened on Friday?

A. I’m paraphrasing there. That same question was asked a handful of different ways – including, “Do you think Hesse is angling for a better price on a take-under of Clearwire?” and, “Do you think Sprint is trying to push Clearwire into bankruptcy to buy that spectrum cheaply?”

First, a little context. From Sprint’s perspective, I think it’s safe to say they feel like they created a monster in Clearwire. Sprint gave them spectrum, helped arrange for strategic equity, and sent them wholesale traffic. In the end, Clearwire not only refused to pay Sprint to host their network like Lightsquared did, but somewhere along the way Clearwire realized they held all the cards in terms of launching a wholesale business – and that would directly compete with Sprint’s own network hosting plans.

In short, on Friday, Sprint failed or refused to answer several key questions about Clearwire for uncertain reasons that made the management team appear unprepared, arrogant or evasive. Regardless, the day further underscored that Clearwire’s largest equity owner (and currently sole wholesale customer) would not be providing any new capital, and that the relationship between the management teams was strained. Here are some other summaries from folks who were in attendance at the analyst meeting (one here and another article here).

So there was some superficial sandbagging of Clearwire by Sprint on Friday based on some combo of legitimate gripes and plain old jealousy, but I don’t think it was done because Hesse is angling for a better deal or a take-under. I think he is simply stuck for the time being, frankly, and is biding time while the other sources of uncertainty for Sprint out there become clearer…i.e. T-Mobile, L2 getting through the FCC, CLWR’s raise, etc…while hoping that a better path forward emerges for Sprint afterwards.

In the meantime, Sprint has to move ahead with LTE plans to compete with Verizon and AT&T, and the iPhone is a must for them as well. So while I’m not sure what that all means for the value of Sprint, I do know none of it impacts the value of Clearwire’s spectrum. And let’s not forget that Sprint will be paying $1 billion to Clearwire for wholesale services between now and the end of next year. This is not the act of one company trying to force another into bankruptcy.

So, to greatly simplify, there is still uncertainty about how exactly the value of Clearwire’s spectrum will get unlocked, but in my opinion, the gap between market and intrinsic value is so large and the timeline long enough that Clearwire should soon be able to find some strategic equity…and then sign other wholesale customers, line up some vendor financing and, along the way, further contrast its own fate with that of Sprint.

That won’t happen overnight, obviously, but it was going to take a little time before last Friday, anyway. And if there was an irony in all the chaos of that day, it was that Sprint appears to now have a harder road ahead of it then Clearwire.

Disclaimer: Long CLWR. The above in no way constitutes investment advice. It is for educational and informational purposes only. Nothing contained here should be construed by anyone as an invitation or solicitation to buy or sell any security. It does not contain personalized legal, tax, investment, or financial advice.

Courage comes in many different forms – and to be clear, when it comes to investing, courage ranks near the bottom of the list when it comes to defining that term in an absolute sense. As I write from the comfort of my air-conditioned office on a tropical island, I am very aware that there are a number of heavily armed 22 year olds standing watch on my behalf in parts of the world I hope to never visit. So let’s be sure to keep this in perspective.

Nonetheless, the market over the last few weeks has required some courage from the long-term investor. And I once again find myself reminding my own investors that if they can summon that courage, I will do my best to make sure they are adequately rewarded for doing so.

Fear and panic is everywhere out there right now. But it is overblown. I have all of my own money still in the market because (a) valuations are very compelling and (b) the most likely scenario looking ahead is (still) that the U.S. economy will muddle through, Greece will get its latest bailout tranche, and American businesses will continue to slowly drag the rest of us out of this mess. There won’t be a “Lehman event” in Europe, if for no other reason than because everyone expects there will be a Lehman event in Europe.

In the meantime, there are excellent opportunities out there – if you can summon a little steel. Not a lot, mind you. Just a little. And if prices go down more, we will buy more of them.

That all sounds cliched and foolish, I suppose, to traders and armchair economists, but so be it. You can have the next three months. I’ll take the next three years.

This is not 2008. Bonds – not stocks – are forming the next big bubble. 10-year Treasury TIPS bonds paid a negative return not too long ago. Think about that: a guaranteed 10-year negative return. The dividend yield alone on the S&P 500 is more than 2%. U.S. companies are squeezing record profits through productivity gains. And though the U.S. economy staggers and stumbles, nearly half of sales by the largest U.S. companies are from overseas – some of which are, believe it or not, doing okay these days.

It is always a difficult time to invest. Always. Over time, however, valuations will matter. They always do.

And as Ben Graham also wrote, “Price fluctuations have only one significant meaning for the true investor. They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal.”

Stay in the game. This, too, shall pass.

My first job in this industry was as an analyst for a small independent research shop just outside Washington, D.C. It was a technical shop that specialized in just one thing: tracking the buys and sells of corporate insiders. The legal, open-market kind, mind you. The theory the founder subscribed to – and that numerous studies confirmed – is that investors could outperform the market by buying the shares of those companies whose executives were also buying shares, ostensibly because those insiders had better insight into the company than investors.

That small little firm made a ton of money by selling expensive annual subscriptions to its research service to just a few dozen institutional investors, most notably some well-known hedge funds and a handful of even more popular mutual fund companies. The founder had developed a proprietary database that tracked every insider buy and sell of the previous 20 years or so, with deep search functionality, share price data and graphing capabilities.

That was not easy to build, considering that when the firm started, they had to pay someone to literally sit in the offices of the SEC to photocopy the physical Form 4s that came in through the mail and were dumped onto a desk every day. But by the time I’d gotten there, thanks to the mother of all insider databases, with just a few MS DOS commands (don’t ask, kids), you could quickly sort out the wheat from the chafe in terms of insider transactions.

If you’ve ever seen The Matrix, I was “Tank” at that job. I sat alone, surrounded by screens of otherwise indecipherable data that poured into via specialized feeds all day long – from 8 in the morning to 10pm, Monday through Friday, and eight to noon on Saturdays. It. Just. Kept. Coming. Long hours spent running queries were occasionally punctuated by moments of pure panic when a significant buy actually happened. Or when Laurence Fishburne called looking for a phone booth.

There are a number of research firms (and now automated services) that parse insider trading data, trying to derive insight on everything from buy/sell ratios to monthly insider volumes. They were all, to us, just bunk. That’s because, statistically speaking, we could prove that the vast majority of insider selling was meaningless. It was noise. There was little correlation between the vast majority of selling in a company’s shares and subsequent stock performance.

Here’s something that most people don’t realize about insider buying, though:

Most insider buying is also meaningless.

The truth is that most insiders are mediocre investors. While a select few are very, very good, many more are awful. And good returns were most often indistinguishable from luck. So while you might think insiders would have an informational advantage, as a group they often seemed to suffer from the same blind spots and/or delusions of grandeur as armchair investors.

Occasionally, an insider would try to game things, simply because they were aware that some schmuck like me was watching those Matrix screens. If he moved the needle enough with a big enough open market purchase, they knew some bleary-eyed analyst would instantly be sent scrambling to, say, get a report up and out to Druckenmiller’s guys before they heard about it first and called in hollering. So, to amend Peter Lynch’s oft-repeated quote about insider buying:

“Insiders might sell their shares for any number of reasons, but they buy them for only one two: they think the price will rise, or because they think they can impress the hedgies.”

Anyway, the reason our little shop did so well was because we were able to tell quicker than everyone else which insider buying was analytically significant. And here’s a hint – out of the thousands of Form 4s that are filed every month with the SEC, only one or two of them mean anything.

All of that was a long-winded way to say this:

There is a relatively small number of corporate insiders that have actually demonstrated real skill at investing in the common stock of their own companies. If you ignored all the meaningless insider buying – and just about everything else, actually – and did nothing more as an investor but buy shares in a company right after one of these guys did, then you would do very, very well.

One of those guys was John Stanton.

Stanton, the current chairman of Clearwire, was nothing short of a legend back then in that little niche of equity research. Without sounding too breathless, Stanton’s track record of insider buys at both VoiceStream and Western Wireless – companies that he personally ran – was phenomenal. To put it simply, at both companies he bought millions of dollars worth of shares at very low prices, then sold both companies for billions of dollars near their peaks.

Here’s his official Clearwire bio:

John Stanton, Executive Chairman of the Board of Directors, has held numerous leadership positions during his career in the wireless industry. He currently serves as chairman of the board of Trilogy Partnerships including Trilogy International Partners, which operates wireless systems in Haiti, Dominican Republic, Bolivia and New Zealand. Stanton served as chairman and CEO of Western Wireless Corporation from 1992 until its acquisition by ALLTEL Corporation in 2005. From 1994 to 2003, Stanton served as chairman and CEO of VoiceStream Wireless Corporation, which was sold to Deutsche Telecom and became T-Mobile USA.

I no longer have access to industrial-strength databases when it comes to Form 4 analysis, but I don’t really need it, either, to give you a glimpse of Stanton’s abilities. Here is a spreadsheet detailing all of Stanton’s insider buying back until 1998, sliced a couple of different ways.

If I were to summarize the highlights, though, it would look like this:

As CEO of Western Wireless, Stanton bought 4.4 million shares on the open market over a seven year period, at an average price of $7.71 per share. He sold the company for $40 per share. So he earned a 420% return on those shares.

As CEO of VoiceStream, Stanton bought (and acquired options) for 2.9 million shares at an average cost of $6.39. He later sold that company for about $122 per share, racking up returns of (you better sit down now) over 1,800%.

Now that VoiceStream data is a bit muddled. Prior to 1998, you cannot easily differentiate between an open market buy versus an option grant on the SEC site. Plus, VoiceStream was bought out by Deutsche Telekom in a cash/stock deal that ended up being structured several different ways, so his shares might have sold for something slightly different, depending on which option he took.

Regardless, even if these estimates of Stanton’s returns in VoiceStream were off by 1,500 percentage points, he’s still in the insider buying Hall of Fame.

To tie this all back into Clearwire, my point is this: I believe that Stanton’s recent insider buying of $5 million worth of Clearwire shares in August is significant, as it has much in common with those previous two home-runs above. Stanton apparently sees a lot of value in Clearwire at recent share prices.

Of course, the fact that a man you’ve never met has bought shares in a particular company is certainly no reason to invest in that company in and of itself. And to clarify, I started buying shares in Clearwire before Stanton’s most significant recent buying there – so his buying was confirmation, rather than a signal.

But I do think it all brings up a very valid question, which is, “What exactly does John Stanton see in Clearwire?”

I think I figured it out. My analysis of Clearwire was published this morning on the Seeking Alpha website. You can read my thoughts in full right here:

“A Value Investor’s Case for Clearwire.”

It gets a little wonky, but please check it out when you get a chance, and let me know if you have any questions.

Otherwise, here’s to pulling for some of that ole Stanton magic, eh?

Disclaimer: Long CLWR. The above in no way constitutes investment advice. It is for educational and informational purposes only. Nothing contained here or on the Seeking Alpha site should be construed by anyone as an invitation or solicitation to buy or sell any security. It does not contain personalized legal, tax, investment, or financial advice.

“Going Rogue: Share Traders More Reckless Than Psychopaths, Study Shows.”

Read the entire article here.

Apparently traders are giving psychopaths a bad name…

It’s time to shut the SEC down and start over.

We should need no further justification then those recent allegations that SEC staffers have been intentionally destroying documents related to initial investigations. Or that the SEC completely missed Bernie Madoff and his $65 billion scheme – despite repeated warnings from this guy. Or maybe our justification to start over should just be that the SEC blessed the rating agency models before the credit crisis. Or perhaps because when markets were collapsing, S.E.C. staffers apparently sat around and watched porn.

Take your pick, I suppose. Regardless of the reason, the need to overhaul the SEC is a bigger issue than politics or ideology. It has nothing to do with free markets or red tape.

I’m all for free markets, but as I’ve said before, don’t confuse them with what goes on on Wall Street. I happen to think it’s ridiculous that I can’t build a shed in my own backyard without getting permission from someone in the local government planning office. But it’s a big mistake to think that the same annoying hassles that we all put up with every day are magnified even more for Wall Street firms. It’s just the opposite. The rules have been written to enable them, really – and in no small way by the SEC.

Wall Street and the NBA

My analogy about regulation on the Street goes something like this:

Wall Street for the past decade has been like the NBA – you’ve got a ton of very motivated, ultra-competitive people banging heads with each other, night after night. And there are literally hundreds of millions of dollars at stake.

Unlike the NBA, though, on Wall Street, it has been expected that the players will call their own fouls – and they won’t get paid unless they win.

I’m of the opinion that you need a referee to have at least some clearly defined boundaries, both in the NBA and on Wall Street, or else things eventually just stop working. And as much as the players in the NBA complain about the refs, I don’t know any who have suggested banning refs and rules outright. I’d bet most of the players also realize the refs help keep their competitors in check, too. The stakes are so high that they need the referees, or else it’s a race to the bottom as soon as the clock starts.

And to make a key distinction here: I think the thing that’s been missing on the Street for too long is just plain old accountability, and that is, by definition, hard to regulate. But we absolutely need to try, because as per the years leading up to the credit crisis, the first effect of not having any real rules is that common sense goes right out the window. The second effect is a weakening in the enforcement of whatever major rules are on the books. And that’s bad for all of us, because as bigger rules get violated, many small dumb ones pop up in their place.

I also don’t believe that Wall Street is so corrupt that it needs more rules – it’s just that no one is wise enough to know how to act without them.

Not to get too grandiose about this, but it’s only after you establish and compel compliance with certain rules that anything resembling freedom is even possible – whether we’re talking about free markets or letting your toddler walk around the kitchen. Good Big Rules don’t have to “restrain” markets anymore than banning double-dribbling slowed down Michael Jordan. But I agree there is a real risk in having too many Bad Little Rules, so all this needs to be done intelligently.

Whose Job Should This Be?

I would submit that the markets work better with a solid referee. And there are certain things a referee needs to be able to do for the players to take him seriously.

I believe it should go without saying to anyone alive in 2008 that the “self-policing” approach to regulation just does not work on Wall Street. And while I’m normally all for doing things smarter/leaner/better, it is also undeniable that when it comes to enforcing laws, the government has a monopoly on the ability to incarcerate. That would seem to mean that this particular role in the markets has to be filled, alas, by government – for the same reasons that you want the cops in your town to be real policemen, not pastry chefs trying to make a few extra bucks at night.

There are also economies of scale to be had in keeping enforcement a role of the government – namely, that investors are too numerous and scattered to either get informed or enforce their own rights without paying through the wazoo. They need an organization to not only represent them, but which is proud of defending them. And finally, a central policing authority solves what would otherwise be a nasty coordination problem. We need someone to standardize and enforce accounting rules among public companies, for instance.

In the case of securities law enforcement, then, I would submit that the best institution to play this role is, like it or not, government. But let’s not confuse that with being expensive, wasteful and bureaucratic. This is the new SEC we’re talking about.

So, in addition to Bill Cohen’s ideas, here are ten ways I would rebuild the SEC:

1. Arm them.

Seriously. As a former Coast Guard officer, I will tell you unequivocally there is nothing as effective as compelling compliance with rules than calmly knocking on someone’s workplace door, stepping inside, and then, after politely exchanging greetings, chambering a round in a shotgun.

Brother, your heart probably skipped a beat just reading that sentence, no? See what I mean?

Relax. I’m not a gun nut, and I was a thoroughly undistinguished boarding officer. My point, though, is that Teddy Roosevelt had it right about that big stick thing. When it comes to visiting the workplace of someone in an industry that you regulate – whether that workplace is a pilothouse or a trading desk – the difference between showing up with a briefcase compared to a Beretta is unmistakable.

You could be stopping by that workplace just to pick up pink princess cupcakes. Doesn’t matter. Once someone recognizes you are a law enforcement agent carrying a weapon, and that you are interested in talking to them – even for the most benign reason – there is no confusion about your relationship. In the law enforcement community it’s called “officer presence,” and among other things, it makes it immediately clear you are not interested in “soliciting feedback.” You’re not there hoping to land a job at that same firm next year. And there certainly is no confusion about being “partners in industry.”

Think I’m nuts? Perhaps. But, quick, answer this – do you think the agents in the FBI who investigate financial crimes pack heat? Should there be a difference between those guys and agents at the SEC? I don’t think so. SEC agents should also be able to conduct surveillance, monitor court-approved wiretaps, review all records, and go undercover. Period.

At the new SEC, agents could not only indict, but they could cuff, Miranda and full-on roundhouse kick the bad guys. Because I’d bet a pretty good way to deter the next Bernie Madoff is to have a dozen YouTube clips of the last Bernie Madoff getting repeatedly pile-driven right into his polar bear skin rug by a former Alabama linebacker – right before agent Chuck Norris shows up and goes Rocky-in-the-meat-locker on him.

How will this not become the next great reality show?

In any case – the only difference in my mind between FBI agents and the new SEC agents would be that only a select few SEC agents would actually get bullets. So, you know, the lawyers and accountants would have to carry guns, but they’d have no ammo.

I’m not a complete idiot, people.

Otherwise, game on. The point is:

Enforcement, enforcement, enforcement.

The SEC is run by lawyers. It should be run by cops.

Plus, cops are far cheaper.

2. No betting against your clients.

I can live with the fact that all financial advisors are not held to a fiduciary standard. Among other things, that helps my firm find clients. But if you’re not going to be a fiduciary, can we agree that at the very least, you should not sell a lousy product to a client – and then immediately turn around and bet against that same product?

Seems like a no-brainer, and once we’ve got a slew of whoop-arse cops at the new SEC, the cost to enforce this rule is next to nothing.

This, by the way, would be known as the Vampire Squid rule. Thank you, Goldman.

Update: Glory be! It appears this rule might actually become law in the asset-backed securities market. Stay tuned.

3. Truly independent leadership.

SEC commissioners should be politically and financially independent. Barring that, commissioners should be appointed based exclusively on merit. This “five political appointees” thing is absolute horse kaka.

I’d actually like to see the SEC be moved under the Department of Justice, too, just to have some semblance of independence from politics, although I concede that it may be naive to think there is any less politics at DoJ. Nonetheless, my point is this: how many lobbyists do you think just stroll on into FBI headquarters every day?

Exactly.

I’d also say SEC employees should be forced to take an oath to protect the small investor, except I have little confidence that politically appointed commissioners would really honor it, anyway. But as Cohen suggests, the SEC cannot be a revolving door to Wall Street – and I think that having politicos running the agency helps create that door.

What sort of career path is there for an SEC staffer, exactly? No matter how hard you work and how committed to the cause you might be, you’ll never be able to reach for the brass ring at the top of your organization. No, my little striver – those chairs are reserved only for people who can bring politicians dumpsters full of money.

No wonder morale is in the dumps at the SEC. Starts at the top.

4. Incentivize them.

The agency’s budget should be as insulated as possible from politics. It could be funded, among other means, for multiple years at a time, or by, say, the cash from SEC victories in court. And in that case, like investment bankers, agent’s earnings could be a percentage of those winnings. Also, there could be lifetime clawbacks – so agents couldn’t chase dumb cases or over-reach in trial without fear of losing some money, too.

Whatever the mechanism ends up being, the means by which these guys have historically been incentivized has been an abject failure. So, get on that, someone.

5. Use qualified shorts as consultants.

Or at the least, have an enforcement hotline.

Any microcap investor worth his salt could have told you five years ago that Chinese reverse merger companies were going to be a real problem, but the system was not set up to in any way acknowledge reports of it, let alone shut it down. There currently is no real mechanism for market participants to raise a red flag to the regulators on anything suspicious. So if I have a problem with the Fruit Loops I just scoffed down at brekkie, I can look at the back of the box to find out who to call…but if I can prove a company is playing fast and loose with that whole “GAAP compliant financial reports” thing, there is nobody at the SEC whose job it is to take my call seriously. This is crazy.

The process I’d like to see would be something like this: Short sellers (or suspicious longs) can send confidential reports about possible corporate and/or market violations privately to the SEC. The agency has 30 days to respond, again in private. If the SEC settles or successfully prosecutes a case based on that work, the referrer gets compensation of some sort – perhaps a healthy a percentage of that settlement, for instance. If shorts waste the agency’s time, though, they will be billed hourly at an exorbitant rate, subject to clawbacks and/or summarily suspended from the program.

The point is that talented shorts are often the catchers in the rye, but the SEC treats them all as if they’re untrustworthy, vindictive cowboys. They good ones deserve to be heard. And the best could be also tasked with privately investigating other leads the SEC has received.

6. Naked shorting and naked credit default swaps should both be banned from the earth.

No exceptions. That is all I have to say about this.

7. No leveraged ETFs.

One of the biggest hypocrisies in enforcing even basic market rules today is that while only supposedly sophisticated investors can invest in hedge funds, anyone with one eye and a thumb can buy inverse, supra-leveraged ETFs in about two seconds online.

Hedge funds, though often wildly speculative, still have an element of adult supervision. ETFs do not, and given the trillions of dollars involved, it strikes me as stunning that ETFs get a complete free pass here.

If not addressed, this will not end well.

8. Encourage the development of some real tools.

The SEC needs a Y Combinator for financial enforcement start-ups. The agency is trying to fight Star Wars battles with Last of the Mohicans tools. Insider trading, for example, is extremely hard to detect when you’ve got multiple portfolio managers running one pool of money. This is a problem, however, that three 25 year olds in Silicon Valley could probably solve if you incentivized them with enough stock options and FourLoko.

Instead of solving these kinds of problems, though, most of those Valley kids seem to be hunkered down coding video games that slingshot fat cartoon birds into grinning green pigs. And I can’t blame them, frankly. As far as I can tell, there is literally no market supporting the development of any sort of technologies to combat financial fraud on Wall Street. And that’s a shame, cuz the right start-ups could make an absolute killing.

I, for one, would pay top dollar for some reasonably cool-looking glasses that would reveal the true identities of posters on Yahoo! message boards to start.

9. Crack down on high frequency trading.

HFT is legalized frontrunning by hackers. It’s also quickly becoming a commodity service, so while I suspect the market is going to reduce profits for almost all of these guys to zero before too long, the ones that will survive should absolutely be regulated more aggressively. That 70% of trades everyday are done by computers right now is, simply, insanity. The only thing more insane is that the SEC has yet to stop it.

For instance, I’d like to see the SEC make it illegal to hold a stock less than 60 seconds. To deal with quote stuffing, all limit orders should be required to stay open for at least one second. And master order numbers should be confidential.

Done. Problem solved with a law that can be promulgated in full on Twitter.

10. Restore the uptick rule.

This would not only put a damper on amateur shorting, but it would have the side effect, as Doug Kass points out, of neutering HFT.

Again, I am in no way against shorting. At least, I am not against shorting by people who know what they’re doing and are doing it for the right reasons. The problem these days is that any idiot can short anything, and many do. I think the resulting volatility makes people question how fair the markets really are – and they may have a point.

In general, I think it is important to offer some minimum sort of base level protection for small investors from powerful stupid people – those who are long or short. When it comes to the shorts, though, I also think it’s important to protect the markets from what over the last five years has seemed to morph into collusion between prideful skeptics who claim they’re relying on reason to short something…but who really just have outsized financial incentives to constantly spread false rumors. And restoring the uptick rule would address this issue satisfactorily to me.

Other Ideas?

I could go on, but too much more and I’ll start to get cynical. I should point out that we do have the best, most mature markets in the history of the world, and up until relatively recently, they did pretty well without much oversight. The problem is, though, that we cannot afford to repeat our more recent mistakes of regulatory omission – many of which were enabled by a feeble, possibly corrupt regulator that has long been captured by the same institutions it’s supposed to be watching.

So while not everyone will agree with the ideas above, I think we can probably agree that it is time for a new approach, no?

Closer up the shirt looks more like this. The front, anyway. On the back is printed what is perhaps the most coveted piece of timeless investing wisdom in the universe – known only to an elite, good-looking few.

My investors are awesome.

Now you may be saying to yourself, “Wait – Jackson Hole? A few weeks ago? Wasn’t that where they held that meeting with all the masters-of-the-economic-universe?”

To which I’d reply, “You know what’s even crazier? This picture was taken by a distinguished balding gentleman. One of those reserved, academic types. With copious facial hair. And whose last name begins with the letter B.”

Yup. Just blew your mind.

In any case, at least my T-shirts got out of the office this summer.

And drop me an email if you’d one day like an IIM T-shirt of your own.