WSJ 10/20/03
The mutual-fund scandal is spreading, as it becomes clear that players throughout the $7 trillion industry could face scrutiny for improper practices that are turning out to be surprisingly common.
On Thursday, Massachusetts securities regulators signaled that they are investigating whether employees at three big mutual-fund companies -- Fidelity Investments, Morgan Stanley and Franklin Resources Inc. -- helped brokers get around prohibitions on short-term trading in their funds. The same day, state prosecutors in New York who have spearheaded a growing criminal investigation of the fund business, notched their first conviction of a mutual-fund executive: a former senior official with Fred Alger Management Inc., who pleaded guilty to obstructing the probe.
New York Attorney General Eliot Spitzer, having earlier forced changes in the way analysts at brokerage firms operate, now says he intends to use the mutual-fund investigation to clean up another part of the financial world that has favored large clients at the expense of smaller ones, including millions of workers and retirees. The Securities and Exchange Commission, scrambling to keep up with him, as it did during the investigation of Wall Street analysts, is now filing civil suits of its own and is considering possible new rules aimed at preventing misbehavior in mutual-fund trading.
Industry heads have begun to roll. Top mutual-fund executives at Bank of America Corp. and Bank One Corp. have lost their jobs because of allegations of questionable rapid trading at those firms. Alliance Capital Management Holdings LP suspended a veteran portfolio manager who ran one of the country's largest technology-stock funds.
The widening debacle -- which could shake investor confidence and lead to significant changes in mutual-fund rules -- is rooted in a paradox that has dogged the industry since its birth nearly 80 years ago. The central attraction of mutual funds is that they offer the opportunity to buy shares in a single investment that reflects the composite value of dozens, or even hundreds, of individual securities.
The chance for rapid speculative profits arises from the common mutual-fund practice of assigning a value to fund shares only once a day, usually at 4 p.m. Eastern time. But the value of the securities those fund shares represent changes continuously. That means that fund-share prices often are out-of-sync with the underlying assets -- a discrepancy that big, sophisticated investors can exploit. Technological advances and the globalization of markets have opened many more such opportunities.
The big investors' quick profits from these games ultimately come out of the pockets of longer-term shareholders. Regulators and class-action lawyers are expected to try to recover these shareholder losses in legal actions that could cost fund companies hundreds of millions of dollars.
The mutual-fund industry has wrestled with the pricing paradox for generations. In the 1930s, many mutual funds effectively had two prices: one that was public and another, more-up-to-date one that was made known to certain big investors hours before it was published. Those in the know could make quick profits because they knew where fund prices were headed. The Investment Company Act of 1940 eliminated this blatant unfairness by requiring funds to stick to a single public price, among other rules that created the modern mutual-fund industry.
In 1968, the SEC tried to fine-tune pricing rules because it found long-term shareholders were still being harmed by the quick-hit tactics of some large traders. Today, if you buy fund shares after 4 p.m., you pay the price set the following day.
But over the past six weeks, the investigations by Mr. Spitzer and others have brought to light that there is still plenty of room to game mutual-fund prices. Even more shocking and potentially damaging are the allegations that some fund employees have gone out of their way to help big investors unfairly lock in quick, short-term profits. In exchange, fund executives allegedly have asked short-term traders to make separate, longer-term investments on which the fund companies earned healthy management fees.
"This seems to be the most egregious violation of the public trust of any of the events of recent years," says Arthur Levitt, a former SEC chairman. "Investors may realize they can't trust the bond market or they can't trust a stock broker or analysts, but mutual funds have been havens of security and integrity."
One major question as the probes expand is how many of the 95 million mutual-fund customers will be so shaken that they redeem their shares. After a wave of scandals ranging from accounting fraud at major corporations to stock-hyping by major-brokerage analysts, some investors appear to be reacting to the burgeoning mutual-fund imbroglio. Four firms whose employees were said by Mr. Spitzer to have allowed improper short-term trading -- Bank of America, Bank One, Janus Capital Group Inc. and Strong Capital Management Inc. -- saw investor withdrawals in September totaling $7.9 billion, or 1.85% of their total assets, according to fund analyst Lipper Inc. Stock funds overall enjoyed net inflows of $19.5 billion last month, Lipper estimates. The firms have said that they are cooperating with the New York State investigation.
In the civil case in which those firms were mentioned, Mr. Spitzer alleged that Edward J. Stern, a managing principal of Canary Capital Partners LLC, a hedge fund, had arranged with the mutual-fund companies to trade their shares after the 4 p.m. deadline. Mr. Stern and Canary agreed to pay a total of $40 million to settle the complaint without admitting or denying wrongdoing. State and federal investigators say that a number of hedge funds -- lightly regulated investment pools that cater to wealthy clients and use a variety of money-making strategies -- frequently engage in improper mutual-fund trading.
Two types of short-term fund trading have emerged from current investigations: late trading and market timing.
Late trading of the sort allegedly done by Canary is flat-out illegal according to Mr. Spitzer's office and other regulators. A late trader takes advantage of buying at the 4 p.m. price when events indicate that price is already obsolete. For example, if by 6 p.m., it appears that stock markets around the world are rising, a trader can purchase shares of a stock mutual fund at today's 4 p.m. price confident that those shares can be sold on the following day at a higher price. Ordinary investors not able to engage in late trading would have to wait to act on the rising markets until the next day.
Mr. Spitzer has alleged that Canary had a late-trading agreement with Theodore Sihpol III, a Bank of America broker. Canary allegedly could place orders during the day to buy and sell shares in Bank of America mutual funds, but the orders wouldn't be officially submitted to the funds until after 4 p.m. According to a criminal indictment of Mr. Sihpol, the broker would receive a phone call after 4 p.m. from Canary employees, telling him which of the trade orders the hedge fund actually wanted put through. Mr. Sihpol, who has been charged with grand larceny and securities fraud, would pass along only those orders -- which carried a pre-4 p.m. time stamp, making them appear legitimate, according to the indictment. Mr. Sihpol, who has been fired by Bank of America, has pleaded not guilty.
Market timing, the other form of short-term trading, isn't illegal. But most mutual-fund companies have written policies, by which they are legally bound, that say they at least try to discourage the practice.
To understand how market timing works, consider the following example of a mutual fund that invests in overseas stocks: U.S. stocks rally during the afternoon on a day when overseas markets, now closed, were flat or down. That means when the international stock fund prices its shares at 4 p.m., just like every other mutual fund, the value of its overseas holdings will be hours old and won't reflect the rally in the U.S. markets. Based on the assumption that the prices of those overseas holdings will catch up with the U.S. market, a market timer buys the shares before 4 p.m., planning to turn around and sell for a quick gain the next day.
Most mutual funds say they try to deter market timing by refusing to accept orders from these frequent-trading investors or charging them extra fees. Traders, for instance, who seek to redeem their investment within 90 days will be assessed a fee of 2% to 3% of the transaction. Fund companies that have permitted such trading -- and especially those that have encouraged it -- could face allegations of failing to protect the interests of all of their shareholders.
James Connelly Jr., a former executive with the Alger Management mutual-fund firm, allegedly permitted large investors, including a Texas hedge fund, to move quickly in and out of Alger funds. Alger generally prohibited other investors from market-timing trades. Apart from pleading guilty to the state obstruction-of-justice charge, Mr. Connelly has paid a $400,000 civil penalty to settle SEC allegations that by allowing some investors to time their trades in this manner, he violated his fiduciary duty to protect other investors. Mr. Connelly neither admitted nor denied the SEC allegations. Alger said it is cooperating with state and federal investigators.
Late trading and market timing hurt longer-term, less-active shareholders, according to the SEC, Mr. Spitzer and others. That's because a mutual fund is a finite pool of assets. If one investor is permitted to cash out a quick profit based on a fleeting discrepancy between the fund's official price and shifting securities prices, the cash has to come from somewhere. Normally, the fund would pay out of its cash holdings or sell securities to generate the money. Either way, the payout diminishes the overall pool, and other shareholders are hurt.
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In addition to this "dilution" effect, as it's known in the industry, rapid short-term trading can raise a fund's transaction costs: the expenses of actually buying and selling securities in response to a hedge fund moving in and out of the mutual fund. Since transaction costs generally are shared by all of a fund's investors, the higher expenses become another penalty imposed on long-term shareholders.
For the speedy traders, on the other hand, short-term shuffles can be quite lucrative. Mr. Stern's hedge fund, Canary Capital, generated returns of 28.5% in 2001, a year when the Dow Jones Industrial Average lost 7.1%.
Jason Greene, an associate finance professor at Georgia State University's Robinson College of Business, co-authored an April 2000 study that found that over a five-year period that ended in 1999, a market-timing strategy designed to take advantage of price discrepancies in international stock funds returned an average of 34.2% annually, nearly three times the returns an investor would have earned by buying and holding the same funds. Mr. Green and his co-author, Charles Hodges, an associate professor of finance at the University of West Georgia, successfully put the strategy to work in their own retirement accounts.
Mutual funds are willing to accommodate market-timers and late traders because of the other business these generally large investors generate. In a number of cases, Mr. Spitzer has alleged, fund companies have agreed to allow short-term trading of specific funds in exchange for longer-term investments the traders placed in other funds.
At Janus Funds, e-mails made public by the New York attorney general suggest that sales executives at one point earlier this year debated whether to violate the funds' prospectus rules before deciding to assist with timing trades. "We won't actively seek timers," one e-mail said, but when market-timing business could mean "increased profitability to the firm," Janus would "make exceptions." Janus has said that it is investigating to what extent executives permitted market-timing trades.
Some of the alleged wrongdoing went beyond the clever timing of trades. At Bank of America, some employees helped Canary make investment bets against the stocks owned by the firm's mutual funds, according to Mr. Spitzer. By facilitating this "shorting" of stocks, Bank of America was potentially helping to drive down the value of investments of its own long-term shareholders.
Since the first mutual fund, the Massachusetts Investors Trust, opened its doors in March 1924, most mutual funds have calculated their share price once a day based on the close of market trading. In the days long before computers, many funds publicly announced their price the following morning at 10 a.m. However, some mutual-fund insiders, along with big investors who had been tipped off, knew prices the previous evening and could trade on the information.
The Investment Company Act of 1940 did away with that particular abuse by requiring one official price. But by the bull market of the late 1960s, another weakness had become evident. At that time, most funds calculated their share price and then allowed investors to buy and sell shares at that price for the next 24 hours.
This "backward pricing" meant that share prices were usually out-of-date. Big investors, who because of their size could buy funds without paying the large up-front sales charges common at the time, would acquire large amounts of mutual-fund shares during a rallying market and sell quickly after the fund's shares were repriced and reflected the market's gains. This practice, just like the market timing of today, diluted the profits of long-term investors.
In 1968, the SEC mandated that mutual funds reverse their policies to today's "forward pricing," under which investors get the next day's price if they place orders to buy or sell shares after 4 p.m.
The opportunities for more investors to market-time funds grew during the 1990s, as markets boomed and more funds were offered. Greater electronic access to market data world-wide also created more ways for sophisticated investors to profit from short-term fund trading.
Some fund companies have fought back. Vanguard Group, for example, imposed penalties and restrictions on short-term traders, even going so far as to bar investors from making trades in some of its index funds between 2:30 p.m. and 4 p.m. That is when most market timers place their bets.
SEC Chairman William Donaldson this month said the commission would consider adopting a rule that would require all fund-share orders to be in the hands of fund companies by 4 p.m. That move would also make it more difficult to conduct short-term trading in the midafternoon.
THE NEW YORK Stock Exchange's elite specialists are knocking heads with the Big Board over a new set of trading parameters that could result in tens of millions of dollars in regulatory fines, a dispute that crystallizes the age-old question of whether human traders and technology can efficiently interact.
Last week, the five specialist firms at the heart of a probe into trading practices on the floor of the New York Stock Exchange were told they willface disciplinary action for improper trading, including trading ahead of clients for their firms' gain, that could have cost investors more than $100 million. The specialists could face substantial fines on top of any reimbursement to customers, according to Big Board officials.
This was far different than the message the exchange delivered to specialists just a few weeks before. Two firms, Van Der Moolen Specialists USA and LaBranche & Co., have said that the customer-loss figures they were given by NYSE regulators in late September were substantially lower than the ones they now face, and officials at the specialist firms wonder how the alleged investor losses shot up so high -- to $35 million from $10 million in Van Der Moolen's case -- in so short a time.
The disconnect is symbolic of a growing divide between the 211-year-old exchange and the powerful specialist firms, who oversee trillions of dollars in investor trading each year on its floor. Long the backbone of the Big Board's "open outcry" trading model, the specialists have traditionally seen eye-to-eye with the institution that provides not just a roof over their heads, but their reason for being. The controversy unleashed last week marks a rarely seen standoff between the codependent entities.
At the heart of the NYSE's reversal -- and behind the jump in apparent losses -- was a directive from the Securities and Exchange Commission during the summer in which exchange investigators were told to change the time period for which they were examining specialist trades from trades that took longer than 60 seconds to execute to trades that took more than 10 seconds to execute, according to people familiar with the matter. This, according to people familiar with the matter, would better help regulators zero in on possible trading violations where a specialist ignores an investor's order and trades for the specialist firm's own account.
Robert Murphy, who until recently was the head of LaBranche's specialist unit and a director of the NYSE, said that scrutinizing trades that take longer than 10 seconds is "not a bad concept." However, the specialists lack the technology to process many trades in less than 10 seconds.
"When you have five parties to a trade, it may be a stretch to get it done in under 10 seconds," he says. "But with the right technology, it can be done."
Specialists are referees who oversee the buying and selling of investors' stock on the floor, using their firm's capital to make trades happen when not enough investors exist to do so. In the current probe, specialists are accused of interpositioning their firms' orders between customer orders that could have interacted with one another unfettered by a middleman, and costing investors as a result. The SEC's time-parameter guidelines were intended to catch another violation known as "trading ahead," these people say, in which a specialist ignores an initial investor order and trades for the specialist firm's account instead.
Specialists say that many trades are completed in less than 10 seconds. But one of the key attributes of a specialist, they argue, is his or her ability to search the crowd of brokers on the floor and find the best price for an investor, particularly on large-sized trades -- a process that can take longer. Because of this, specialists fear that with the new 10-second time parameters, such trades will automatically find themselves under a regulator's microscope and potentially subject the specialist firms to fines and disciplinary action. While specialists say they are willing to attempt to trade faster, they believe the floor's order-book technology is inadequate to the task, given that simply reporting a completed trade can take several seconds and more than a dozen keystrokes on a computer.
The NYSE declined to comment for this article.
The decision to broaden the specialist probe to look at "trading ahead" began in July at the behest of the SEC, according to people familiar with the matter. Up to then, the probe had focused on a related violation of whether floor traders had made trades for their firms' accounts at times when they should have hung back and let public investors meet, without the traders' intervention. Such behavior is known as a violation of the specialist's "negative obligation."
Over the summer, examiners from the SEC's office of compliance inspections and examinations arrived in New York City to interview specialists at a number of firms as part of a broader examination into the trading practices on the Big Board's floor.
This report, which was presented to the NYSE last week, is extremely critical of many aspects of the Big Board's model, finding fault in its trading practices, self-regulation, oversight and disciplinary actions, according to a person familiar with the matter.
During its interviews, according to people familiar with the matter, examiners were told by specialists that most trades handled on the designated order turnaround system, which electronically ferries investor buy and sell orders to and from the specialist's post on the floor, are completed within just three or four seconds. Armed with that information, the SEC had a number of conversations with NYSE surveillance officials, telling them to narrow surveillance parameters to trades that took longer than 10 seconds, a move the SEC hopes will catch trading-ahead violations, these people say.
The NYSE, ill equipped to deal with the request, had to develop separate software to handle it, according to a person familiar with the matter. For instance, initially it took exchange investigators five-and-a-half hours to assess just one day's trading activity, according to this person. Now it can be done much more quickly and the exchange announced Thursday that it is installing software at the point of sale to deter this conduct and to beef up the exchange's market-surveillance efforts.
Specialists are furious with the new results and claim that the alleged customer-loss numbers shared with them by NYSE regulators last week were inflated by a proliferation of "false positives," or trading behavior that may seem inappropriate at first glance, but on further study will turn out to be legitimate market-making activity. Representatives of the five firms, which include Van Der Moolen, a unit of Van Der Moolen Holding NV; LaBranche; the Spear, Leeds & Kellogg specialist unit of Goldman Sachs Group Inc.; the Fleet Specialist unit of FleetBoston Financial Corp.; and Bear Wagner Specialists LLC, which is minority-owned by Bear Stearns Cos., declined to comment. In conversations late last week, officials at the firms said that their top priority right now is to lay hands on the stock-trading information the exchange used to make their newest regulatory determinations and check investigators' work for accuracy.
In the meantime, the mood has grown increasingly tense between the firms and the exchange. Tempers flared on Friday at a meeting at the Big Board between executives from the five big specialist firms and NYSE co-chief operating officers Catherine Kinney and Robert Britz, as specialists demanded to see the data that has caused regulators to increase the potential losses to customers.
Meanwhile, well-known class action law firm Milberg Weiss Bershad Hynes & Lerach has filed a suit in U.S. federal court in the Southern District of New York against the five specialist firms on behalf of all persons or entities who purchased or sold shares of stocks of NYSE and American Stock Exchange listed companies between Oct. 17, 1998, and Oct. 15, 2003.
"Defendants, in contravention of `negative obligation' rules, stepped `in front' of trades and failed to disclose that orders were not being filled at the best prices, but were being manipulated for defendants' benefit," the law firm said in a press release. Representatives from the firms either declined to comment, or didn't return calls for comment.
New York -- FRANK QUATTRONE'S legal team is signaling that the former Silicon Valley financier may prefer to face a new trial on the obstruction-of-justice charges against him rather than risk a verdict from the deadlocked jury now sitting, some legal experts say.
John Keker, Mr. Quattrone's lawyer, said Friday he might move for a mistrial after Judge Richard Owen told him and government lawyers that the jurors were in "substantial disagreement" and had disclosed their current vote to the judge, against his instructions to them. Although it wasn't clear whether Mr. Keker would actually move for a mistrial, some legal experts said a mistrial based on those grounds alone was unlikely.
Mr. Keker also said he opposed the federal judge's stated intention to read the jury a so-called Allen charge in court today that could break the deadlock by urging the jurors to reassess their views. Mr. Keker said reading such a charge, named after a case in 1896, might be premature after only two days of deliberations, according to a court transcript of the backstage colloquy.
After Judge Owen disclosed the jury's quandary in open court at 4:30 p.m. Friday, Mr. Quattrone nodded his head, and later blew a kiss to some of his relatives as they hugged and kissed happily in the first two rows.
Mr. Quattrone went on trial three weeks ago on criminal charges of obstruction and witness tampering for forwarding a colleague's e-mail on Dec. 5, 2000, urging employees of his technology-sector investment-banking unit at Credit Suisse First Boston to "clean up" their files. He did so shortly after learning that a federal grand jury was probing the allocation of initial public offerings at CSFB, a unit of Credit Suisse Group.
The jury, which got the case Wednesday afternoon, on Friday heard portions of Mr. Quattrone's testimony about his role in IPO allocations. Initially in questioning by his own attorney, he minimized his responsibility for such allocations. Then, under tough cross-examination by the government, he was confronted with two dozen or more e-mails detailing instances in which he sought to influence or review allocations of the hot stocks, in some cases to curry favor with investment-banking clients.
Failure to resolve the current deadlock would be "a big victory" for the defense, said Michael J. Proctor, a Los Angeles criminal defense attorney who worked for Mr. Keker's firm from 1990 to 1996. A new trial would give the Quattrone legal team a chance to improve the star banker's performance under cross-examination on the IPO allocation issue, he said. "The bad cross can be dealt with if there's a new trial," he said. "I've got to believe the defense would like to have done that all over again."
Mr. Proctor and other legal experts believe that Mr. Keker could defuse the issue in a new trial by presenting and explaining some of the damaging e-mails about allocations on direct examination of Mr. Quattrone. Assuming the defense had access to those e-mails, Mr. Proctor said, "it was a significant mistake for the defense not to have defused the situation in the first instance by having Quattrone testify more carefully about his limited role in the IPO process and by perhaps even showing the e-mails to the jury before the government did." In a new trial, the prosecution wouldn't have the same element of surprise in raising those e-mails, other lawyers noted.
A new trial could also give the defense a different judge, which could also improve Mr. Quattrone's chances because Judge Owen is considered generally sympathetic to prosecutors.
According to a court transcript, Mr. Keker wrangled with the judge during a 50-minute session in a room just off the courtroom late Friday over whether he could see the full contents of the jury's note, which included their votes on the three charges. Without disclosing their votes, the judge read lawyers for prosecution and defense the brief narrative portion, which said: "Two jurors, one on each side, feel they cannot be persuaded to change their views. It is not clear what would be likely to change the current vote distribution. We are having difficulty thinking of evidence which would change our assessment of whether there is reasonable doubt."
"We would like to see the note," Mr. Keker said.
Judge Owen replied: ". . . you have got all the information you need, which is there is a substantial disagreement." The judge said, "I'm not going to, I don't want to give you the numbers."
"The jury can't communicate with you without us knowing about those communications," Mr. Keker said.
"I know, but the jury has unhappily dishonored its obligation to the court," Judge Owen said.
Mr. Keker told the judge "it may be appropriate for us to move for a mistrial now because the jury has obviously failed to follow the court's instruction in an important matter."
An Allen charge typically is given to jurors after they have declared they are unable to decide on a verdict. Such charges generally urge jurors to reach agreement, partly because of the time and effort required to try the case before a different panel. Assuming the hold-out doesn't favor conviction, "usually the defense doesn't like Allen charges because a hung jury is generally a victory for the defense," said Matthew Fishbein, a former federal prosecutor now a defense attorney at Debevoise & Plimpton.
If Mr. Quattrone were convicted of just one of the three charges, it could be considered a victory for the government, because they were based on a single e-mail and only circumstantial evidence of intent. Mr. Quattrone would still face as much as two years in prison, and Judge Owen could consider acquitted conduct because sentencing goes by a "preponderance" of evidence, not the tougher "beyond-a-reasonable-doubt" standard for conviction.
ASIAN MAKERS of the electronic gadgets and toys destined to be wrapped up and tucked under American Christmas trees say holiday demand in the U.S. is markedly firmer than it was last year.
With manufacturing of holiday goods now at its peak, makers of everything from semiconductors to finished cellphones, digital cameras and DVD recorders are reporting strong sales to U.S. brand-marketers, distributors and retailers. After two disappointing Christmas seasons in a row, manufacturers' hopes this year are running high, fueled in large part by a strong back-to-school season. Some executives say they believe the long-awaited tech recovery is in sight.
Several new products -- or existing products with fresh features and newly cheap price tags -- are likely to be hot gifts this year, Asian executives say. Digital videodisc players will be available for well under $100, and some Chinese and Taiwanese-made DVD recorders could be selling for as little $300 when the holiday season is in full swing. Digital still cameras with resolutions of up to three megapixels could be available for as little as $150.
Sony Corp. and Matsushita Electric Industrial Co., Japan's two consumer-electronics giants, say DVD recorders seem poised for a boom, as prices drop and more models hit the market. Matsushita is betting heavily on its Panasonic-brand DVD recorders. It plans to sell six models in the U.S. this season, compared with two last year. The company expects October-to-December sales of DVD recorders to be triple those in the year-earlier period.
U.S. orders for cellphones with built-in cameras, DVD-writing drives for PCs, and flat-screen TVs are especially strong, says Wookyung Kim, an investor-relations manager at South Korea's LG Electronics Co. LG is forecasting double-digit growth in its electronics exports for the holiday period, helping the company through a slump in its domestic market.
Sunplus Technology Co., a chip designer in Taiwan, says sales of chips used in educational toys, such as the PowerTouch Learning System sold under Mattel Inc.'s Fisher-Price brand, also have been strong. With its traditional Christmas-order season almost finished, Sunplus says it has seen no sign of the gloom that descended on holiday sales in seasons past. "Overall, consumers have stronger demand this year than in the past two years, especially on . . . digital cameras and video players," says Wayne Shen, a Sunplus spokesman.
Sales by Asian suppliers in October offer no guarantee that U.S. shoppers will buy the merchandise headed for stores in December. Indeed, some economists would argue that retailers and manufacturers are setting their Christmas sights too high, as U.S. consumers continue to struggle with heavy debt and a lackluster job market. Still, up and down the supply chain, Asian companies are optimistic about signs of economic vigor in the U.S.
South Korea's Samsung Electronics Co., the world's biggest maker of computer memory chips and the No. 3 maker of cellphones, said it expects the steady improvement it has been experiencing in most products this year to continue during the holidays. Last week, Samsung reported better-than-expected third-quarter results and raised its full-year sales forecast for cellphones to 55 million units from 52.5 million. It also said it expects average holiday selling prices for cellphones to rise -- a rare feat in the electronics industry.
In Taiwan, whose companies manufacture most of the world's notebook computers and flat-screen displays, 119 of the 146 technology companies tracked by J.P. Morgan reported a rise in September revenue compared with a year ago. Nearly a third announced record-high monthly sales. Among those was Taiwan Semiconductor Manufacturing Co., a maker of cellphone chips for Texas Instruments Inc. and graphics chips used in Microsoft Corp.'s Xbox game machine. Taiwan Semiconductor is on track this year to far exceed its revenue for 2000, the last year before the global tech bubble burst.
"Overall [information technology] spending has started to recover. You can see in the industry lots of component supplies are getting tight," says Alex Liou, controller at BenQ Corp., a Taiwan maker of flat-screen monitors and DVD machines for its own brand as well as for Dell Inc. and Philips Electronics NV. BenQ saw third-quarter revenue jump more than 30% over last year and expects fourth-quarter revenue to grow about 40%.
"At least as of now, it seems like we're having the best second half since 2000," says Bhavin Shah, head of Asian technology research at J.P. Morgan. "The third quarter was clearly better than normal, and in the fourth quarter there's a very good chance of a repeat."
DIGITAL VIDEODISC recorders are poised to become the coming holiday season's electronics hit.
New models are rolling out and manufacturers are cranking out the first big advertising campaigns for the technological successor to videocassette recorders. But the real driver may be price.
Right now, the cheapest DVD recorders are about $400. But when the first Christmas specials appear in November, market watchers expect the lowest-price, stand-alone machines that connect to a television set to cost about $300, down from retail prices of $800 last year and $1,700 just two years ago. At that level, DVD recorders could begin to mimic the stunning takeoff of DVD players two years ago, positioning the recorders to replace VCRs and their bulky tapes as the favored method for storing the latest episode of "CSI: Miami" or archiving the tape of Aunt Sally's retirement party.
"We're starting to see the signs of exponential growth," says Reid Sullivan, vice president, entertainment group, at Panasonic Consumer Electronics, a unit of Matsushita Electric Industrial Co. of Japan. To fuel that growth, Panasonic just launched a roughly $10 million television-and-print ad campaign for recordable DVDs that will run through December.
Market watcher IDC says world-wide shipments of stand-alone DVD recorders should reach 45.8 million units in 2007, up from 780,000 last year. "The industry is definitely putting a big push into it," says Susan Kevorkian, an IDC analyst.
Unlike DVD players, which only play prerecorded discs, DVD recorders can store TV shows, home movies shot on camcorders, digital still images and a family's stock of prerecorded videotapes on the small discs. Owners of VHS tapes can convert their movie collection to DVD format by plugging a VCR into the DVD recorder. However, copying of copyrighted DVDs such as recent movies is precluded by anticopying features.
Retailers see the recorders as a way to move consumers from cheap DVD players -- some now sell for as little as $40 -- into higher-priced, higher-profit electronics. "People can finally get rid of their VCR when they have this device," says Paul Broussard, a buyer at Circuit City Stores Inc. The Richmond, Va., chain recently beefed up its DVD-recorder offerings in anticipation of robust Christmas sales.
Contributing to the price declines is the emergence of new and low-cost suppliers. This holiday season, consumers will be able to choose from among 12 brands of DVD recorders compared with just four last year, says Sean Wargo, director of industry analysis at the Consumer Electronics Association.
Low-cost suppliers such as APEX Digital Inc. and BenQ Corp. are keeping the pressure on pricing. APEX helped break the $100 barrier for DVD players, making those machines last year's hottest-selling consumer electronics product. BenQ, a Far East component maker, also is entering the market, using others' designs. Holland's Philips Electronics NV and Cirrus Logic Inc. of Austin, Texas, late last year began selling complete "chip sets" -- the basic electronics of the recorders -- and requisite software so that other companies can design and make DVD recorders with less effort.
Mid- and higher-price DVD recorders from Sony Corp., Philips and Panasonic provide connections for flash-memory cards, PC cards and camcorders. For instance, the Philips DVDR75, priced at about $480, comes with an iLink connection to accept video from camcorders. The EMR-E60S from Panasonic costs about $525 and has built-in Secure Digital and PC-card slots to accept still images from digital cameras.
Some of the higher-priced DVD recorders allow viewers to watch certain portions of a TV broadcast even while it is being recorded. Such "time shifting" lets viewers arrive midway into a show and watch it from the start. Until now, such features have been available only on recorders such as TiVo and ReplayTV, which use computer disks to store programs.
Some makes of DVD recorders also include a computer disk, allowing selected portions to be "burned" onto CD-like, silvery discs. While prices are heading down, higher-priced models are emerging as well. Sony's RDRGX7, selling for about $800, includes precision cinema "progressive" technology that prevents motion blur. The company also recently introduced a high-definition DVD recorder, which costs more than $3,000 and is available only in Japan.
Replacing the millions of VCRs tucked beneath TVs will take time, of course. With VCRs running around $75 a apiece, the consumer-electronics industry still expects to sell nearly nine million VCRs this year, compared with less than one million DVD recorders.