[Ed. note: Here is the next exciting installment from Jim Skelton, the Blind Squirrel, who is sharing his experiences as a financial advisor with us. As with all of our contributors, the opinions he expresses are his own, and we haven’t reviewed, approved or screened his ideas. His previous articles can be seen here.] 

Greetings once again to all citizens of the Gumshoe Nation, far and wide. You may recall that a couple weeks back I wrote Part One – Paradise Gained – of this story of my involvement as a financial advisor (FA) with a young man that had big dreams of becoming a successful investment manager. If you missed that you can go here to get yourself up to speed. Now, let’s get on with the story.

When we last left Kurt, he was riding pretty high on the successes he had achieved in his model portfolio. The dozen or so picks he had made were all doing fine – well, maybe not all, but most were – and the super-sized return he got from Telephonos de Mexico had really propelled his average annual return calculations for the portfolio into the stratosphere. But TFONY was now behind us and Kurt was seeking the next big winner. And in addition, he had decided to put the portfolio on margin so he could leverage his returns using that method. Margin trading can be fine when all things work. But it will be a real bear if they don’t.

Kurt was unconcerned about the possibilities of anything going wrong it seemed. As 1987 progressed, the market kept its general uptrend intact, a trend that had held sway since mid-1984. And as you know, a rising tide lifts all boats. In those circumstances, a lot of people get fooled into thinking the gains they are getting are a direct result of their own stock picking prowess and not just that of the market trend. Kurt’s boat was no exception, and it was hard to tell if that was due to his powers of equity analysis or just a friendly market environment. Whatever the real reason, he was growing the account.

Then in early spring of that year he called me, quite excited. He had been researching and following a new company that was totally on fire. A new concept that was taking the nation by storm with revenues and profits anticipated to soar. And the stock price was zooming up along with all the news and hype. Kurt wanted in. Now, before the price got any further out of reach, as he was certain it was bound to do.

The company that had caught his attention was a revolutionary concept company that really was sweeping the nation by storm. It traded under the symbol HSN. Yep, Home Shopping Network, the precursor to what we know of today as purchasing on the Internet. Except, of course, there was no Internet back then, no real private ownership of personal computers as of yet.  Michael Dell and Bill Gates were still kids tinkering with an idea that was in its infancy. But HSN didn’t need any of that. It ran programming all day and night long on secondary TV channels offering people anywhere the opportunity to buy all manner of gizmos and gee-gaws if they had a phone with which to call an order in. And brother, the calls were flooding in! Especially from more rural areas where people didn’t have much access to the brick and mortar stores where they could easily shop. The primary driver of this movement came from stay-at-home housewives who were starved for the ability to shop for and buy the things they wanted or needed – or at least they felt they wanted or needed. The marketers for the programming were genius in creating a sense of urgency to buy. Buy most anything. Especially pretty and sparkly things. Women became transfixed with this new opportunity and sat and watched all day and night long to be sure they didn’t miss out on something they might see a neighbor wearing or using the very next week. It was a stampede to call and buy. And this soaring enthusiasm drove the idea that this company simply had discovered a true gold mine. But never mind that the stock price was trading without any yet reported earnings and that it was near impossible to do any sort of actual financial analysis. Everything was based on perception and belief in the future. And Kurt perceived much greater things to come.

Problem was, he had used most of the margin money he could access. I was a little worried about the possibility of a margin call if we hit a rough patch in the market. Kurt had indicated that he didn’t really have any additional fresh funds as of yet to deposit if that happened, so we’d be forced to liquidate positions in that event to cover the requirements. But he was not worried. If HSN kept the run-up intact he figured the margin debt could be covered, at least in part, by the profits sure to come from that source. And, if necessary, he could always close out a position or two of his lesser performing holdings to cover. Or perhaps even find some new money to bring in. With those options at his disposal he just didn’t see the real risk.

At the time of his call HSN was trading at an all-time high around $52.00 p/s. He directed me to buy 500 shares at market. This took his margin debt to within about 5% of max available, a razor thin margin for error. I made the buy as he instructed.

Over the next three or four days the price continued its drive upward. When it hit about $63.00, I felt I had to call him and discuss. Such a quick gain, a gain of such size, and in a stock where we had no real idea what the value actually could be, well, I felt I ought at least point that out to him. And frankly, I thought that quick gain should be taken and used to give us more breathing room re the margin debt. And even though we were still operating under his original instructions to me that I was not there to give advice, just service, I called anyway. I told him of the progress (he already knew that) but I once again pointed out that these sort of fast-movers could turn on a dime and wipe out all profits in a heartbeat. I recommended selling the position for reason stated above. He hesitated, uncertain, but in the end agreed it was a smart thing to do. Whether or not it would prove to be the right thing only time would tell. I sold the 500 shares around $63.00 that afternoon. Nice little profit – and you can’t go broke taking a profit last time I checked.

I bet you know what is going to happen next, don’t you? You know – seemingly happens every time something like this takes place. Yes indeed, the very next day HSN opened UP about $2.00 from the previous close. It wasn’t long before my phone rang and there was Kurt. The first words out of his mouth were the exact same ones every one of us has used more times that we can count. He blurted out “I KNEW it, I just KNEW it!” He went on to say more such things about how he ought have held, that the stock was headed to at least $100 before year-end, etc., etc., etc. But he wasn’t angry with me. Kurt was a good guy, a reasonable investor. He knew that at the end of any discussion the decisions were his to make, and he took responsibility for that. God bless him – if only everyone had that point of view.

Kurt wanted back in, right then. He gave me an order to sell a couple other positions he was holding to raise additional funds, then use the proceeds from the previous sale of HSN to buy as many shares as he could. After some quick back-of-the-napkin figuring, we found he could shoehorn 1500 shares into the account at current prices. That would make HSN the single largest holding in the account, something near 20% or so as best I recall. A real overweight by any measure. So, on his instruction, I made the buy and vowed to myself to keep my big mouth shut going forward as he had asked me to do from the get-go. This was his baby, and he was in the driver’s seat. I was just along for the ride. Or so I thought.

As seems so often the case, Kurt’s buyback that day proved to be within $1.00 of what became the all-time high for the stock. The frenzy had broken and the selling began. Reality took hold. As it broke below $55.00, Kurt called and bought more. A couple weeks later, with the price in the $40’s, he did that again, selling off more of his core holdings to finance the buy. He was still firmly convinced this was mere profit-taking and as soon as that wave passed the stock would resume its ascent. He didn’t want to be left out of this terrific buying opportunity.

When the stock broke below $35.00, I called him. I knew he wouldn’t want to hear what I had to say, but I felt it must be said. This thing was a train wreck and he was refusing to accept reality. I wanted him to close out that position at whatever price we could get, eliminate the margin debt, and start over. Based on my calculations at the time, Kurt would come out with just a few thousand dollars more than his original deposit. We could began again. Better that than continue this madness. So I rang him up and told him exactly how I felt. He listened. He reminded me that the last time I had recommended he sell, the price jumped up the very next day. I couldn’t argue that – it was true. But I was too late in the effort anyway. By now Kurt had retreated to that final-defense emotional castle that all too many investors find themselves in when things go wrong and, to correct that, they have to admit to some errors in judgement. He simply said that the stock “had” to recover. Had to, you see. I asked why he thought it “had to” come back as he put it. No good answer, just that it must. Kurt was in full-blown denial and, like the Captain of the Titanic, was determined to ride it out to the end.

All of the aforementioned took place from the start of 1987 and ran through late summer. HSN stock stabilized somewhat and Kurt was sure the worst was past. A recovery would get underway soon he thought, and having bought in all the way down, he had positioned the portfolio for terrific gains as HSN rose to and surpassed the old highs. I prayed such would be the case, but some research reports that were coming out made a solid case for why this wasn’t a $100.00 stock, but one more like a $10.00 stock at best. I passed this information on as requested but it had no effect. He was in it to win it come hell or high water.

Then, one day soon thereafter, a miracle occurred. I opened the account one morning and there, to my great surprise, was a wire transfer in for another $100,000.00! Most of the margin debt was eliminated. It was a new day. I immediately called Kurt to see what had happened. He told me that he had secured a loan from an investor to shore up the account for now, in exchange for some sort of convoluted agreement to profit-share in the master account when it returned to its past days of out-sized gains. I really didn’t understand all he was telling me about how this was supposed to work, who that mystery investor was, etc. But I didn’t have to understand. It was done and Kurt was back on top of the world. All we had do now was wait for a return to normalcy and things would be as he always said they would. He even told me, good-natured, that I needed some chill pills so I could stop worrying so much. Secretly, I was by then wishing I had some of those mythical remedies, but I didn’t. So I kept worrying.

Oh yes – this, too. Instead of just letting this fresh cash satisfy the margin debt, he decided to do something a little different. Since this raised the amount he could access on margin again, he used $50,000 to buy more HSN at a price in the low $30’s! Just when he had the relief he needed, he used half of that to add to the problem rather than solve it. I couldn’t believe what I was hearing when he gave me that order. But he did, so I did as instructed and required. It’s a very serious violation for a broker to ignore a legitimate order an investor places. I liked my job and wanted to keep it.

When that settled, I took the past six month’s statements on the account and had a sit-down with my office manager. I felt it prudent to have him in the loop as to what had been going on just in case the world collapsed and I needed somebody in my corner that had knowledge of what I had done and why. I hadn’t done anything at all wrong in the dealings with Kurt, but wanted someone else to be up to speed on the sequence of events and outcomes in the small chance I would find that helpful. We reviewed the account activity, where things stood at the moment, and I recall his final words clearly. He said (I paraphrase), “Look, Jim, he is an adult in full charge of what is happening. He knows exactly where he stands. He makes the decisions and all trades have been clearly marked as unsolicited. He gets his confirms and statements. We’re his broker, not his Mommy.” I felt a sense of relief knowing he had my back, just in case. To back it all up, the manager sent Kurt a polite letter informing him that we had discussed the account and inviting Kurt to call and speak with him (the manager) anytime he wished.

I’m going to skip additional detail from that day forward right up to that awful, disasterous day of October 19, 1987. Black Monday. The Great Crash of ’87. Dow dropped 508 points to 1739, a decline of 29%. In one single day. You think the DJIA dropping 350 points in a day in today’s market is newsworthy? Trust me, in historical perspective, it’s hardly worth mention. Not since the Crash of 1929 had anything even remotely like this been experienced. Bedlam reigned supreme. Mr. Market had finally gone berserk, slaying anything and everything that got in his way. It was useless to try and get a quote. Nobody could say what anything was trading for at any moment. Quotron screens (our old quote system) just flashed and sputtered at random, and nothing you saw on them could be relied upon. Wire operators had stacks of orders waiting input (all was done manually at that time) as brokers screamed in the halls for fills. We were finding the answer to the age old question of “What’s the worst that could happen?” Now we knew, and the answer was unbelievably ugly. You just had to be in the fray to really understand what we went through that day and for the next few trading days as well. I’ll have a complete column someday on just those five days in October to try and give you a sense of what went on from the brokers’ standpoint and the investors that were being slaughtered.

But back now to Kurt. By now it was the following Wednesday and I hadn’t heard from him. And what with all the fires I was trying to get under control, working 16/18 hour days, he wasn’t my only concern. Many other people needed and deserved counsel and advice. At times like that, a little “hand holding,” if sincere, goes a long way to calming the waters. Besides, I had looked at the smoking shell hole that once was his account and found that, with the decline in price across the board, he was now underwater entirely. He owed more than the remaining value of the positions. And a margin call was being issued to recover the money. There really wasn’t anything left to say.

About Thursday I got a “cc” of a letter from Merrill Corporate to Kurt telling him that he had 24 hours to deposit funds to cover the margin debt or his account would be liquidated to cover it for him. Problem was, the account value was short of the debt by some $21,000 or so. The following Friday Kurt finally called. I thought at first I was hearing some 90-year-old man on his deathbed. The voice was frail, weak, sad beyond description. He had gotten the letter and had no way to cover the debt. I pulled up the account and found that the liquidation had already taken place anyway. Our run was done. Paradise Lost. He talked with me a little more, asking if there was anything I could do. Of course, there wasn’t. We hung up shortly after that with me wondering about what would happen regarding the $21,000 shortfall. I didn’t have the stomach at that moment to even bring that up. I knew Merrill would take care of it for me. And they did.

About two weeks later I got what was to be the next-to-final call from Kurt I was to ever get. If anything, he sounded weaker and more defeated than before. I could actually hear the tears in his quavering voice, and the absolute desperation and depression he was feeling. He had gotten the letter from Merrill regarding the shortfall and demanding immediate payment. Failing that, they would began legal proceedings to recover the losses. And that was when I got the full story, the entire truth, of the account and Kurt from his own mouth.

Kurt just opened up and the story poured out. That initial $100,000 deposit that he implied he had accumulated from some trading he had done? Not so. That was the inheritance he had gotten from his Grandfather a few months previous. It was now all gone. And that wire transfer to cover the margin debt from some unnamed investor? The “investor” turned out to be his own father who, upon hearing of Kurt’s situation, cashed in all his retirement savings and gave it to his son with assurances it would be repaid. Now Dad was broke as well, a lifetime of savings wiped away in a flash, and Kurt with no way of repayment. And as for his “experience” in the markets, there really wasn’t any at all before he opened the account with me. And as for those contacts he was prospecting for opening managed accounts with him as the manager, not a single one ever signed up. The only thing he really ever had was that beautiful business card and a boatload of confidence that this was an easy way to riches. So it turned out that Kurt, nice guy that he was notwithstanding, had not only lost his future in the attempt, but had also dragged his mother and father along with him – and that was what was truly crushing his spirit, indeed his will to live. After all this came out he did one final thing. The most heart-wrenching thing anyone up to that time had asked of me. With a voice filled with what I thought to be sincere intent, he implied that if Merrill kept after him for that remaining $21,000 he just could not take it. The reality of what he had done now sat on his soul like a huge cold stone and he could see no way out. The implication of that was left hanging in the air like a very bad smell that won’t go away. I was convinced that this was a young man was on the verge of suicide. I had to try to do something, what I didn’t know. I realized that this was a call that should have been answered by some suicide hot line, not a regular guy like me with absolutely no training in how to deal with people in this state of mind. I told him to hang in for a week or so and I’d do what I could about the debt, but not to expect miracles. It was a just and legal debt and I had never heard of anything other than monetary satisfaction that made it go away. When we hung up I seriously wondered if I’d ever hear of Kurt again.

Having no other thoughts about what I could do to help, I took the demand letter to the manager and we discussed it. Thank God I had made that earlier visit with him about Kurt and the account. He was up to speed on who and what I was talking about. After I ran it all by him, explaining as best I could what I felt was a likely outcome for Kurt if this demand of payment continued, I left it in his hands. I had done all I could. And I had a cold chill running up my spine in anticipation of what might come next.

In early November I got cc’d on another letter from Merrill corporate to Kurt regarding the debt. To my absolute amazement, Merrill had decided to stop the collection process and forgive the remaining balance. They most certainly weren’t going to refund any part of the losses, but they were willing to let this go. I made my way quickly into the managers office, letter in hand, and showed it to him. And gave my profuse thanks for his help. I don’t know what buttons he pushed or who he spoke with, but he pulled Kurt’s chestnuts out of this final fire to be sure.

It was perhaps a month later that I got my final call from Kurt. He had gotten the letter of forgiveness. He was so very grateful for this kindness. And he was in a better mental state. His voice was stronger, his attitude a little recovered from those last desperate days when we last spoke. Kurt had meanwhile been able to secure employment as a concierge at one of the 5-Star Monaco Hotels and Casinos. As part of the comp package, they gave him a small efficiency apartment on site and two meals a day. That is no small thing, living rent-free in those surroundings and eating out of a 4-star kitchen even if your table is in the kitchen itself. Plus a paycheck each week. A new start at life, and far better than having to take some menial job in the Tuscan sun all day. In appreciation for what he thought I had gotten done for him, he invited me and my wife to come for a visit anytime we wanted and he’d see to getting us comped for a room and such. I would have loved to take him up on that one day but never did. Even with the room covered, a trip to Monaco is going to be very expensive no matter what- air fare, meals, casino slush fund, car rental, etc. But the offer was sincere and appreciated. We talked awhile more about life and the future we both hoped to find and rang off. I never spoke to Kurt again. I hope his future got brighter as these many years have now passed.

So endth the tale of Paradise Found – Paradise Lost. Hope you learned something from the telling. Here are a couple takeaways you may notice:

1) Confidence in one’s abilities is necessary for success. Overconfidence, however, can destroy. As Clint Eastwood once said in one of his “Dirty Harry” movies, “A man’s got to know his limitations.” Come to know yours and live within them. I always try to recognize my own and live (and invest) accordingly.

2) Don’t let one big investment success lead you to thinking that it will be repeatable. Or that it happened due to your own superior intellect. It might. But it probably won’t. Letting that big hit convince you that this stuff is easy is a sure and certain road to oblivion. Mr. Market is always watching for people like that. He’s ready to teach a lesson they will never forget. Just ask Kurt.

3) If you trade on margin, do so sparingly and carefully. If and when things go south, even though temporary in duration, it can destroy a portfolio entirely. Be absolutely certain you can sustain the loss and not be destroyed in the process. And for the love of God, never, ever let yourself get underwater.

4) Always, always, tell your FA the truth of your personal financial situation. I can’t emphasize this too much. In fact, I will someday write an entire column on how an investor should approach dealing with a full service broker if they desire, and what to share with them. The questions they ask during the initial interview (the profiling session) may seem intrusive but there is a good reason for asking. And if they aren’t asked, you need to seek another advisor – my opinion. Don’t try to impress him/her with inflated figures of net worth, or of experience, or of risk tolerance, or of goals. If your FA is operating and advising under a false set of information about you, the odds of them giving you the advice you need is greatly diminished. You only hurt yourself and gain nothing in return.

Until next time, all the best to all of you. And stay tuned for the next chapter of the Blind Squirrel Diaries. I’ve got some suggestions for organizing your holdings that just might make your evaluations of performance more effective and helpful. See ya in February!

Jim Skelton
The Blind Squirrel

“Even a blind squirrel finds an acorn every now and then”