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All things aside, one must be impressed by the careful design and implementation of what is a seemingly simple and apparently legal investment gambit by Cornerstone Progressive Return Fund (NYSEMKT:CFP), ostensibly having the effect of transferring wealth from unsophisticated new investors to that of existing shareholders and insiders.

Plan B: Making Money for Shareholders: It would seem, on the face of it, that CFP may not have been primarily operated for the purpose of making money on behalf of its shareholders—although, I’m sure they would have been happy if they did.

This conclusion is supported by two observations: 1) the fact that the fund in the aggregate, since its inception, has not made a dime on its investments—in fact it’s lost money on behalf of its shareholders (see chart below); 2) Most Boards wouldn’t have tolerated such miserable investment performance and probably would have moved to replace the investment management team.
Plan A: By all outward appearances, CFP may have been primarily designed to facilitate the sale of shares by its major shareholder(s) who acquired a 98.8% ownership (9.2 million shares) in CFP post its 2007 IPO. The scheme (in the British sense of the word) was to facilitate an attractive price at which the existing and major selling shareholders would profitably sell their shares.

The chart below illustrates the aggressive liquidation of the major shareholders position in the past seven months.
Propping Up Share Price? One method to prop-up the stock price greater than underlying value (NAV) is to distribute significant periodic return-of-capital distributions. The underlying premise would be to attract income-oriented investors not able to distinguish the “import” of distributions based on return-of-capital (ROC) and those based on successful investment results; thereby, creating the impression to an unsophisticated investor that CFP was a success investment fund.

Hiding the Pea: As a consequence, yield-hungry investors, not fully appreciating the source of the distribution, bid-up the stock price well beyond its investment value. This has been evidenced by CFP’s stock selling at a significant premium to its NAV. This is in contrast to its investment peers selling at a discount. This, along with the possibility of a few well-paced trades, may have afforded the existing selling shareholders an attractive exit platform.

However, what new investors are receiving are distributions from the fund’s original capital—or, what’s left of it (see chart above). To add insult to injury, a new investor is paying both a premium and a management fee for that privilege.

So, Why is this OK? In my humble opinion, the key to why this is apparently legitimate is that there is full and careful disclosure on the part of CFP that the distributions are a return-of-capital (with accompanying and related language of its impact on investors) both on its press releases and on its website—Oh, wait a second….., that’s right, CFP doesn’t have a website. Sorry investors.

The other important key component of this scheme (again, think British) was “caveat emptor”. Retail investors didn’t understand the nature of the distributions; they were just chasing yield.

Pretty Spiffy: So, CFP was covered legally on both sides of the transaction: 1) It fulfilled its disclosure requirements in a broadcast fashion; 2) it was protected from investors’ recourse for loss on investment by the common law rule of “Let the buyer beware”.

Point-of-Purchase Standards: Now, I would find all of this less objectionable if such a warning regarding CFP came at the point-of-purchase—like on a pack of cigarettes with a warning label that effectively says:

“Warning: This stuff will kill you and likely increase my health care premiums.

A CFP Warning Label: In the age of “street name” holdings of investments, there is no longer the opportunity to receive a stock certificate where one can affix an appropriate warning label.

In lieu of this opportunity for a warning, any broker who sells its clients shares of CFP (in the case of an on-line broker—a pop-up screen) should be required to provide the following disclosure:

“Warning: An investment is CFP may be hazardous to your financial health for the following reasons: it has failed to make any money investing its funds since inception; its distributions have been substantially a return-of-capital which may have the affect of inflating the share price beyond its investment merits; it’s major shareholder has been aggressively selling or distributing 5.7 million shares of its approximately 9.2 million share original holdings in the past 7 months and is likely to continue this established distribution pattern; the chairman and the original, major shareholder are related through marriage; and it has recently slashed its current distribution in half.”

If based upon this warning the client decides to buy the stock, Congratulations! They are eligible for the Eqcome 2010 Investor Stupidity Award.[1]

Parting Observation: Is what CFP, its management and major shareholders doing illegal? People who are familiar with the situation who have a legal background indicate probably not.

Is it unethical? I’ll leave that “call” up to reader.

Would I want to be their investment partner? Absolutely not. CFP’s major shareholder(s) appeared to have lost money on this investment gambit. It’s just unfortunate such losses have been mitigated at the expense of unsophisticated investors.

Caveats: This article does not advance a case of wrong-doing on the part of CFP, its management, major shareholders or its agents. In fact the article states in the affirmative the legitimacy of the collective actions. The article also implies investor stupidity is a personal affliction and not a crime.

However, legitimacy and being a profitable investment are two separate Issues. The article is intended to address the latter—particularly with regards to new investors purchasing shares of CFP. Other articles supporting the position of avoidance of CFP shares are linked below in a footnote.[2]

For defenders of CFP, please argue the facts by presenting rebuttal points and marshaling data to support your position. If you can’t, don’t bother commenting because you’re wasting everyone’s time. Haranguing will be subject to demerits. Thank you.

[1] here (.pdf)

[2] here (.pdf)

Disclosure: No financial interest, long or short in CFP, CLM or CRF