As CNBC investigates allegations of improprieties in its million-dollar stock-picking contest, the cable channel may end up disqualifying some of the top 20 finishers for artificially inflating their returns in the competition. Depending on which, if any, of the top performers are ruled out, CNBC could find itself writing a million-dollar check to a day trader who had a run-in with securities regulators and has drawn attention from other finalists for what they consider suspicious trading.
The man is Joe Dondero, who finished fourth in the contest with a total 32% return, and works as a trader at Visionary Trading in New Jersey. According to records from the National Association of Securities Dealers, Dondero was "the subject of multiple NASD inquiry letters." Records from the New Jersey Bureau of Securities show that he was "discharged" from one securities firm for his trading activity.
Dondero declined to comment on his work history or his trading for this story. Reached on the afternoon of June 13 at a local horse-racing track, he said, "I'd be happy to talk after CNBC comes out with something, but until then I have no comment."
Anointing Dondero as the million-dollar winner would make for quite a finale for the American Idol of the stock-picking set. CNBC, part of General Electric, launched the contest in March and attracted 375,000 participants with heavy promotions from popular anchors such as Joe Kernen and Becky Quick. It nearly tripled traffic to the channel's Web site, as CNBC.com profiled the top performers and viewers weighed in with comments on their favorites. (MSNBC.com is a Microsoft-NBC Universal joint venture.)
But as BusinessWeek first reported on June 7, a design flaw in CNBC's own software appears to have allowed certain contestants an unfair advantage in the popular game. The technology reportedly allowed contestants to see which stocks were rising in after-hours trading and then to buy those stocks at the lower, 4 p.m. EST closing price. That led to certain finalists showing a pattern of consistently picking stocks that took off after the closing bell on strong earnings reports.
Such a pattern could now lead to disqualification. On June 8, CNBC put out a statement saying it is investigating improprieties in the contest, and specifically mentioned contestants who were "able to change their trades after the markets closed."
Dondero's trading doesn't match that pattern, which means he could be in line for the grand prize. He cracked the top five in the final round of the contest, largely with picks of relatively small companies that have very thinly traded stocks.
His trades drew criticism from other finalists, nonetheless, with at least three contestants complaining about his choices early in the final round. Because Dondero was picking thinly traded stocks in the CNBC contest, the other finalists worried that he could be manipulating the prices of those stocks in real-world markets. "He only picked stocks that could be manipulated," says Jim Kraber, one of the finalists who says he flagged CNBC. Kraber emphasizes that he has no way of knowing whether Dondero was indeed manipulating stocks.
CNBC took somewhat-belated action to prevent such manipulation. BusinessWeek has learned that on May 18, midway through the final two-week round of CNBC's contest, the cable channel asked each of the 20 finalists to sign a statement that any real-world trades they made were not "for the purpose of, or with an intent to, affect or manipulate the price" of the stocks they were picking in the contest. The penalty for failing to sign was stiff: "If you fail to return the attestation or your attestation is not truthful, you may be disqualified from the contest," wrote CNBC Vice-President of Marketing Tom Clendenin in an e-mail.
A close examination of Dondero's trading in the CNBC contest raises questions about his approach, but offers few definitive answers. The primary concern of other finalists was that Dondero was buying stocks in his CNBC portfolio and then driving up the price by buying the same stocks in the real market the next day. That's easier to do with thinly traded stocks than heavily traded ones. Dondero did pick some thinly traded stocks, but not all of those trades were successful. He also made other kinds of purchases that contributed to his portfolio returns.
In the final round of the CNBC contest, Dondero saw nice gains on picks of BioProgress, a British pharmaceutical company, and Hanarotelecom, a Korean telecom company, which both trade on Nasdaq.
On a typical day, neither stock sees much action in the real world. BioProgress trades an average of 3,100 shares a day on Nasdaq, while Hanarotelecom averages 7,400 trades a day. But both saw huge jumps in volume in the days after Dondero picked them. Hanaro soared from close to 19,000 shares on May 14, to well over 27,000 the next day. Dondero realized a 6.4% gain for his contest portfolio, as the stock rose. The following day, when Dondero chose BioProgress, more than 5,000 shares changed hands, compared with zero shares the previous day. Again, Dondero saw a healthy gain of 4.5%.
But Dondero didn't always make money on his thinly traded stocks. On May 21, he again picked BioProgress, and again volume spiked, this time to 23,000 shares from 1,400 the previous day. But Dondero lost 2.64% on the trade.
Other thinly traded stocks Dondero picked included Velcro, the famous fastener maker, and Macronix International, a Taiwan-based manufacturer of computer memory. Neither were big winners for him in the final round.
Indeed, Dondero's biggest winner during the finals was Fremont General, the subprime mortgage lender whose stock trades an average of 4 million shares a day. Dondero picked the stock on May 22 and after the market closed that day, the company said that it would sell its commercial real estate business for $1.9 billion. The news drove shares up 26.7%, a huge one-day gain in the contest.
Dondero's picks in CNBC's contest could be examined as part of the cable channel's investigation into "unusual trading." Beyond looking at traders who may have benefited from its own software glitch, CNBC says that it has retained an "independent securities expert" to look into allegations of market manipulation. CNBC declined to comment for this story. But it previously said, "Integrity is paramount to CNBC. We are taking all allegations of improprieties very seriously."
If CNBC looks at Dondero's picks, it wouldn't be the first time his trading has been the subject of a probe. The NASD records say that he was the subject of the regulator's inquiry letters because of "wash" trades, among other things. Wash trading is when someone buys and sells the same security simultaneously — or in quick succession — to create the appearance of active trading. It can be done to generate commissions for a broker or for tax purposes.
The New Jersey Bureau of Securities records pertain to Dondero's time at a day-trading firm in Iselin, N.J. called Evolution Financial Technologies. The records say that, "As a result of his trading activity, Mr. Dondero was on heightened supervision and probation which resulted in his changing from a proprietary trader to a customer. This did not involve customers or a loss."
Dondero, who attended the College of New Jersey until 1999, has worked at a series of small financial firms. One of them, Heartland Securities, was sued by the Securities & Exchange Commission for alleged stock manipulation and falsifying records. Heartland closed in 2003 after two executives, Sheldon Maschler and Jeffrey Citron, paid $29.2 million and $22.5 million, respectively, without admitting or denying wrongdoing. (Citron went on to found the Internet phone company, Vonage Holdings.) Dondero was at the firm after the alleged wrongdoing, but before the settlement.
After BusinessWeek asked Dondero for comment on his background and his trading, a reporter said he wanted to make clear that the story would proceed with or without Dondero's cooperation. "You gotta do what you gotta do," he said.