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One of the more interesting stories of the past year has been the rise and fall of a bulletin-board traded stock called Optionable. The firm was started in 2000 to be a trading and brokerage service provider for financial institutions, hedge funds and commodity (energy) traders with the company's revenue generated from fees earned by energy derivative transaction fees. One look at the financial statements from the 1st quarter of 2007 shows the high growth that the company "was reporting" to shareholders. In comparing revenues y/o/y for the 1st quarter revenues grew by more than 300% to $9 million while net income based on these statements showed growth of nearly 4 times to $3.1 million or 0.06 per share. In addition, in January 2007, the New York Mercantile Exchange (NYMEX) agreed to acquire a 19% stake in Optionable with an option to increase the position to 40% of the company. It was widely believed that Optionable acquired the position in order to gain access to Optionable's derivative trading platform. During this period, the stock climbed from $0.50 in September 2006 to as high as $8 per share in February 2007 after the NYMEX deal was announced as people became enamored with the supposedly strong growth prospects of the company. But if you look at the stock price today it has fallen to just 14 cents.

So what happened? First in April, the Bank of Montreal, Optionable's largest single customer (30%+), announced that they had lost more than $300 million in natural gas trades which went the wrong way on them and they blamed Optionable for mispricing some of these securities. The next straw to fall for the company was the NYMEX deciding that they would launch their own electronic trading platform which would compete with Optionable thus spoiling many investors' hopes of NYMEX acquiring Optionable or actively using their platform. Following these announcements, it was made public that a forensic auditing firm had found that Optionable was mispricing natural gas options. Finally, NYMEX decided to cut all ties with the firm which has resulted in a significant loss of business for the company. In addition, it was found out the CEO Kevin Cassidy, who later resigned, had served a prison sentence for credit card fraud and income tax evasion (these prison sentences were never disclosed in any financial reports from the company).

So what could we learn from this story? First, a company may show fast growth on its financial statements, but it is not guaranteed that this will continue in the future and if taken at face value can be disguised by revenue acceleration or other accounting methods. Second, don't think that just because a major firm makes a major investment in your stock does not mean that all is well with your organization and it is important to not only do your homework when you buy the stock but to continue to constantly analyze and review the financials. Third, be aware of arm's length transactions and how they could affect your stock's value and finally fourth be sure to fully understand the management team that is running the company in which you are investing.

In the end, this stock is now trading for just 14 cents on the Bulletin Board and is another story of poor corporate management to go along with some of the more famous stories in the early part of the decade.

Source: Lessons From the Optionable Debacle