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Investor's Eye: Godrej Consumer Products, Hindustan Unilever, Shree Cement, Marico, Insurance

 
Investor's Eye
[April 30, 2013] 
Summary of Contents
 

 

STOCK UPDATE

Godrej Consumer Products
Recommendation: Hold
Price target: Under review
Current market price: Rs836

Q4FY2013 results-First cut analysis

Result highlights 

  • Godrej Consumer Products Ltd (GCPL's) overall consolidated operating performance was a mixed bagged in Q4FY2013. Though the company was able to post a strong revenue growth, the operating profit growth was below par as the during the quarter. The benign raw material prices aided the consolidated gross profit margin (GPM) to improve by above 150 basis points year on year (YoY). However, there was a substantial drop in the EBIDTA margins of the key international geographies (including Indonesia, Africa and Latin America), which led to the consolidated operating margin (OPM) declining by 263 basis points YoY to 16.3% (key disappointer).

  • GCPL's (consolidated) revenues grew by 29.7% YoY to Rs1,715.5 crore, which is largely in line with our expectation of Rs1,676.6 crore in Q4FY2013. The strong growth was largely driven by a strong organic growth of close to 20% YoY.

  • GCPL's stand-alone (domestic; 54% of the consolidated revenues) business registered a strong revenue growth of 18% YoY to Rs925.4 crore. The strong growth can be attributed to the strong performance of the core segments including soap, household insecticide and hair colour. The revenues of the soap segment grew by 17% with the volume growth standing at 4% YoY (higher against the industry growth of 1%). The performance of the hair colour segment was the highlight of the quarter with the segment registering a revenue growth of 27% YoY, which is 2x the industry growth. The domestic household insecticide segment maintained the strong growth momentum with its revenues growing by 26% YoY (2.1x the category growth).

  • On the other hand, all the international businesses registered a strong revenue growth of 48.4% YoY to Rs770.0 crore driven by a mix of organic and inorganic growth initiatives. Megasari (GCPL's Indonesian business; contributes half of the international business revenues) maintained it's above 30% YoY revenue growth momentum on account of the continuous marketing investments and new product launches. GCPL's African and Latin American businesses grew by 39.1% YoY to Rs178.0 crore and 72.0% YoY to Rs141.0 crore respectively during the quarter.

  • Despite a 342-basis-point year-on-year (Y-o-Y) improvement in the GPM of the stand-alone business, its OPM was down by ~100 basis points to 19.7%, which is largely on account of a 120-basis-point Y-o-Y increase in the advertisement spends as percentage of sales and ~500-basis-point increase in the other expenses as percentage to sales during the quarter. Also, the international business registered a 431-basis-point decline in the EBIDTA margin, with the Indonesian business witnessing ~200-basis-point drop in the EBIDTA margin (due to an increase in the wage hike), the Latin American business witnessing ~430-basis-point drop in the EBIDTA margin (largely on account of the tougher regulatory norms on imports and a higher inflationary environment in the Argentinean and the African businesses EBIDTA margins declined by above 1,200 basis points (on account of a four-week closure of the Kenyan business due to election and continuous higher marketing investment behind brands).

  • Overall, the consolidated OPM of GCPL was down by 263 basis points YoY to 16.3% (lower than our expectation of 17.8%). Hence, the operating profit grew by just 11.6% YoY to Rs279.1 crore. 

  • However, the lower incidence of tax and higher other income led to a 30.6% Y-o-Y growth in the adjusted profit after tax (PAT; before minority interest) to Rs232.9 crore (ahead of our expectation of Rs206.3 crore).

  • During the quarter, there was a one-time exceptional gain of Rs129 crore (after tax exceptional gain of Rs103.1 crore) for the divestment of non-core food business of Megasari. Hence, the reported PAT grew by 73.4% YoY to Rs334.1 crore in Q4FY2013.

  • The continuous pressure on the OPM has surprised negatively, especially since the softening of the commodity prices has aided the strong improvement in GPM. We will try to gain more clarity on the sustainable margin picture from the management and then review our earning estimates for FY2014 and FY2015. At the current market price, the stock trades at 30.9x and 24.8x its FY2014E and FY2015E earnings respectively. In view of the limited upside from the current level, we have downgraded our rating on the stock from Buy to Hold.

 

Hindustan Unilever
Recommendation: Hold
Price target: Rs600
Current market price: Rs583

Voluntary open offer pushes valuation into expensive zone

Key points

Unilever announces offer to increase its stake to 75% in HUL
Unilever PLC (Unilever) has made a voluntary open offer to acquire 48.7 crore shares of Hindustan Unilever Ltd (HUL; or 22.5% of the equity capital) at a price of Rs600 per share (20.5% higher than the April 29, 2013 closing price). With this, Unilever's (the promoter group) stake in HUL will go up to 75% from 52.48% currently. At the open offer price of Rs600, HUL is valued at 36.1x its FY2014E and 32.6 x its FY2015E earnings. The potential value of the transaction at the open offer price is approximately Rs29,220 crore.

Unilever's offer reflects its confidence on Indian operations
Unilever has always maintained that the emerging markets (including India) are one of its key growth drivers in the long run. This open offer thus gives a big vote of confidence in the Indian consumer story. HUL has a portfolio of strong brands straddling the pyramid in the domestic market. The company has maintained its thrust on achieving a steady growth through innovation in the portfolio considering the consumer preferences and needs. It has enhanced its focus on improving the gross profit margin (GPM) in the coming years through strategically buying the key inputs and improving the revenue mix (giving emphasis on premiumisation strategy). 

View: Open offer pushes valuation into expensive zone; opportunity to take home some profits
HUL's stock price had a decent run up yesterday on account of posting a better than expected fourth quarter results. The voluntary open offer announcement acted as an additional trigger for the stock to shoot up by almost 18% in today's trading session (April 30, 2013). At the current market price, the stock is trading at 35.0x its FY2014E earnings per share (EPS) of Rs16.6 and 31.8x its FY2015E EPS of Rs18.4, which is substantially ahead of its historical average valuation multiple of around 26x. Hence, though the long-term growth story is intact for HUL (the company with one of the stable cash flows and steady dividend payout), but we see limited scope for an upside in the near term and that provides an opportunity to take some profits off the table. The long-term investors can continue to Hold the stock.

 

 

Shree Cement
Recommendation: Hold
Price target: Rs4,660
Current market price: Rs4,490

Q4 operating performance beats expectations

Result highlights 

  • Operating performance exceeds expectation on lower P&F cost and effective tax rate: In Q3FY2013 Shree Cement posted an operating profit of Rs420 crore (up 12.6% year on year [YoY]), which is ahead of our as well as the Street's estimate on account of a lower than expected power & fuel (P&F) cost. Further, on account of a minimum alternate tax (MAT) credit to the tune of Rs48.4 crore the overall effective tax rate slipped to just 6% during the quarter which expanded the earnings growth. The adjusted net profit stood at Rs274 crore as compared with Rs117.3 crore in the corresponding quarter of the previous year. 

  • Power business drives overall revenue growth; revenues from cement division remain flat: For the quarter Shree Cement posted revenues of Rs1,471.6 crore, which is higher by 6.9% YoY and in line with our estimate. The overall revenue growth was driven by a sharp jump in the revenues from the sale of merchant power units (around Rs288.7 crore as compared with Rs173 crore in the corresponding quarter of the previous year). On the other hand, the revenues of the cement division largely remained flat YoY at Rs1,182.9 crore as a 6.2% drop in the volume YoY offset the impact of a higher average realisation, which was up 6.1% YoY. However, the average blended cement realisation declined by 2.5% quarter on quarter (QoQ) to Rs3,632 per tonne, which is lower than expected. The robust revenue growth in the power division was driven by an increase in the power volume (72.2 crore units as compared to 43.0 crore units in the corresponding quarter of the previous year) due to the commissioning of the second phase of its 150-MW power plant.

  • Correction in P&F cost coupled with a higher realization YoY results in margin expansion: The operating profit margin (OPM) expanded by 144 basis points YoY to 28.6%. The margin expansion was largely on account of a sharp correction of 53.7% in the P&F cost YoY to Rs404 per tonne and a higher average blended cement realisation, which rose by 6.1% YoY. However, the other cost components like freight cost, raw material cost and other expenses continued to move northward. The EBITDA from the power division improved to Rs0.9 per unit as compared with Rs0.6 per unit in the corresponding quarter of the previous year. Consequently, the operating profit increased by 12.6% YoY to Rs420 crore. On a per tonne basis, the EBDITA per tonne of cement increased by 9% YoY to Rs1,088.

  • Drop in the depreciation and lower effective tax rate further expand earnings growth: During the quarter under review, the depreciation charge declined by 46.1% YoY to Rs126.5 crore. Further, there was a MAT credit to the tune of Rs48.4 crore on account of which the overall effective tax rate corrected to 6% as compared with our estimate of 18%. Hence, the adjusted profit after tax (PAT) growth further expanded to Rs274.1 crore as compared with Rs117.3 crore YoY. 

  • Cement capacity to enhance to 15.5mtpa by June 2014: The company is in the process of adding another 2mtpa grinding capacity in Bihar which will increase its overall cement capacity from 13.5mtpa to 15.5mtpa by December 2013. Further, the company is also adding 4mtpa of clinker capacity through units IX and X at its current location in Ras, Rajasthan. The two capacities are expected to be complete by June 2013 and June 2014 respectively.

  • Upgrading earnings estimate for FY2013; fine-tuning estimates for FY2014 and FY2015: We are upgrading our earnings estimates for FY2013 mainly to factor in the lower than expected P&F cost and effective tax rate. The revised earnings per share (EPS) estimate for FY2013 now works out to Rs259 whereas for FY2014 and FY2015 we have just fine-tuned our earnings estimates. 

  • Maintain Hold with price target of Rs4,660: We believe the performance of the company will improve at the operating level due to cost saving on the P&F front and a healthy growth in the revenues of the power business. However, on account of limited upside from the current level and the key concerns in terms of pressure on the cement realisation and higher freight cost due to partial deregulation of diesel price, we maintain our Hold recommendation on the stock with the existing price target of Rs4,660 (we have valued the cement business at enterprise value /tonne of $130 and the power business at a price/book value of 1.25x). At the current market price, the stock trades at an enterprise value/EBIDTA of 7.6x on FY2014E and 6x FY2015 earnings estimate. 

Marico
Recommendation: Hold
Price target: Rs232
Current market price: Rs
225

Price target revised to Rs232

Result highlights 

  • Q4FY2013-subdued performance: The third quarter of FY2013 was yet another quarter of subdued performance by Marico, with the revenue growth standing in the high single digits and the adjusted profit after tax (PAT) declining by almost 15% for the quarter. An improvement of more than 350 basis points in the consolidated gross profit margin (GPM) was the only breather for the quarter. The domestic business continued to support the overall business performance with a 12% year-on-year (Y-o-Y) revenue growth while the revenues of the international business declined by 1% year on year (YoY) in Q4FY2013. The revenues from Kaya grew by 15% YoY during the quarter. The volume growth of the core domestic brands (including Parachute and Saffola) continued to remain subdued with the growth remaining in the mid-single digits.

  • Consolidated results snapshot: Marico's net sales grew by 9.4% YoY to Rs998.6 crore in Q4FY2013, which is lower than our expectation of Rs1,055.4 crore. The revenue growth was pre-dominantly driven by a volume growth of 8% YoY. The benign key input prices (such as copra) and a change in the revenue mix led to a 363-basis-point Y-o-Y improvement in the GPM to 55.8%.Though the advertisement spends as a percentage of sales remained flat, the other expenses as a percentage of sales increased sharply by ~300 basis points during the quarter. An increase in the legal and professional fees along with a higher hedging cost led to a 100-basis-point additional increase in the other expenses as a percentage of sales during the quarter. This resulted in the operating profit margin (OPM) remaining flat at 12.0% YoY. Hence, the operating profit grew by 6.8% YoY to Rs120.3 crore in Q4FY2013. The higher incidence of tax led to ~16% Y-o-Y decline in the adjusted PAT (before minority interest) to Rs59.9crore in Q4FY2013. The tax rate stood significantly higher at ~36% largely on account of a higher contribution from the domestic business and reduced profit in the international business.

  • Revision in earnings estimates: We have revised downwards our earnings estimates for FY2014E and FY2015E by 9% and 8% respectively to factor in lower than earlier expected revenue growth in the international business and an increase in effective tax rate (24% for FY2014 and 25% for FY2015). Also, we believe it will take sometime for core brands such as Parachute and Saffola to witness a strong revival in the volume growth. 

  • Outlook and valuation: We believe Marico's business fundamentals are intact and the demerger of the Kaya business into a separate entity would help the company to enhance its focus on improving the growth prospects of its domestic and international fast moving consumer goods (FMCG) business in the long run. Though the near-term outlook is bleak, we expect the company to achieve an earnings growth of around 20% over the next two to three years on account of its diversified product portfolio and focus on driving growth by launching new products. At the current market price, the stock trades at 32.1x its FY2014E earnings per share (EPS) of Rs7.0 and 26.2x its FY2015E EPS of Rs8.6. In line with downward revision of our earning estimates, we have revised downwards our price target to Rs232. We maintain our Hold recommendation on the stock.


SECTOR UPDATE

Insurance

APE declines by 15.2% in FY2013

Key points

  • The growth in the annual premium equivalent (APE) of the life insurance industry declined for the ninth consecutive month during March 2013 as it declined by 14.0% year on year (YoY). The slowdown was mainly contributed by the Life Insurance Corporation of India (LIC), which showed a decline of 18.3% YoY in the APE. On the other hand, the private players reported a decline of 7.7% YoY in March 2013, with Tata AIA Life Insurance Company (down 35.6% YoY), ICICI Prudential Life Insurance (ICICI Prudential; down 18.0% YoY) and Max Life Insurance (Max Life; down 8.1% YoY) posting the steepest decline in the APE. On the other hand, players like MetLife Insurance Company (MetLife; up 76.9% YoY), Kotak Life Insurance (Kotak Life; up 15.9% YoY) and Birla Sun Life (up 12.6% YoY) posted an increase in their APEs on a year-on-year (Y-o-Y) basis.

  • In FY2013, the private players fared relatively better as their APEs declined by mere 3.8% YoY as compared with a 21.3% Y-o-Y decline by the LIC and a 15.2% Y-o-Y decline by the industry. The growth in the APE of the private players was mainly led by players like SBI Life Insurance Company (SBI Life; up 9.7% YoY), Kotak Life (up 9.3% YoY) Bajaj Allianz (up 7.4% YoY) and HDFC Life Insurance (HDFC Life; up 5.2% YoY).

  • On a month-on-month (M-o-M) basis, the APE for the industry increased dramatically with LIC growing more than the industry and the private players. On an M-o-M basis, all the 22 players posted an increase in their APEs. Companies like Birla Sun Life, Aviva Life and MetLife posted the highest increase in their APEs on an M-o-M basis.

  • The market share of the private players in FY2013 improved by ~470 basis points to 39.6% (LIC, 60.4%) compared with 34.9% in FY2012. During the period under review, companies like SBI Life, HDFC Life, Bajaj Allianz, Kotak Life and ICICI Prudential turned out to be the major gainers as their market share improved by approximately 155, 120, 95, 40 and 20 basis points respectively.

  • Compared to an expectation of a 15-20% growth at the beginning of the FY2013, the APEs for the industry declined by ~15% and 3.8% for the private players. Going ahead, the transition towards the newer regulations (proposed for traditional products) will continue to impact the premium growth. However, the private players expect about 10-12 % growth in their APEs during FY2014 led by the launch of new products and a scale-up of distribution capabilities.


Click here to read report: Investor's Eye

 

 

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The Sharekhan Research Team
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[aaykarbhavan] Wall Street Journal



Pick Your Battles

Think a rival is taking anonymous swipes at you online? Follow these steps.

By DENNIS NISHI
Lots of grumpy customers take potshots at companies in forums, review sites and social networks. But what happens when a rival makes anonymous digs at you?

Experts say these situations don't come up often, but when they do, they need to be handled with an especially light touch. Rivals may be trying to draw you into a nasty public fight that could alienate your customers. Their advice: Avoid those kinds of showdowns, and don't try to be sneaky by posting anonymous comments of your own. Both approaches are likely to backfire.
Here's the smart way to handle the situation.
Be alert for signs a rival is hounding you.
In most cases, they'll simply cut and paste the same messages across multiple online venues. If they don't do that, they might use similar phrases from site to site, as well as the same links or photos. On forums, they might show up as a collusive gang of brand-new posters, without a track record on the site.
Take your suspicions to site administrators.
Creating a fake identity for deceptive purposes—sockpuppeting—is against the terms of service at most forums and review sites, and most administrators will be willing to work with you. If the overseers can trace the posts back to a rival's Internet-protocol address, you can ask them to remove the posts, shut down fake member accounts or even—in extreme cases—block the IP address.
Once the posts are gone, follow up on forums to dispel any lingering suspicions.
You might provide company experts, for instance, who can clear up false claims. This is a vital step, since many forum messages will keep coming up in Google GOOG +0.73% searches, especially when specific terms are mentioned. If you respond after the fact, you can get the truth on record.
If any of the attacks gain traction with concerned customers, supply a response in a Q&A on your website or social-network page.
But don't call attention to the false claims by referring to them directly. For instance, if a rival wrote falsely that your products are made in China, just make a point of saying that your goods are made in the U.S.
Whenever you counter claims, keep your tone helpful and neutral.
Don't be as nasty as the company that slammed you. Discussion sites can be very close-knit places with peculiar social dynamics. If you come in and sour the tone—particularly if you seem to have an agenda—users will get turned off.
Start early.
Before you run into trouble, establish a presence on forums and maintain goodwill there by answering questions without trying to give users a hard sell. If you build loyalty, users will be suspicious of random attacks on you and stick up for the company.
Mr. Nishi is a writer in Los Angeles. He can be reached at reports@wsj.com.
A version of this article appeared April 29, 2013, on page R5 in the U.S. edition of The Wall Street Journal, with the headline: Pick Your Battles.

How Entrepreneurs Come Up With Great Ideas

There is no magic formula. But that doesn't mean there's no formula at all.

Vote
At the heart of any successful business is a great idea. Some seem so simple we wonder why nobody thought of them before. Others are so revolutionary we wonder how anybody could've thought of them at all.

Related Video

Engineering grads of 2013 earn far higher salaries on average than the typical new college graduate. Lauren Weber reports. Photo: Getty Images.
But those great ideas don't come on command. And that leaves lots of would-be entrepreneurs asking the same question: How did everybody else get inspiration to strike—and how can we work the same magic?
To find out, we turned to the experts—the startup mentors who discuss launching businesses at our Accelerators blog, as well as other investors, advisers and professors who have seen and heard countless success stories, and entrepreneurs who have written success stories of their own. They saw inspiration coming from all sorts of sources—everyday puzzles, driving passions and the subconscious mind.
Here's what they had to say.
Look at What's Bugging You
Ideas for startups often begin with a problem that needs to be solved. And they don't usually come while you're sitting around sipping coffee and contemplating life. They tend to reveal themselves while you're hard at work on something else.
For instance, one company of mine, earFeeder, came about because I wanted news on music I loved and found it hard to get. So I created a service that checks your computer for the music you have stored there, then feeds you news from the Internet about those bands, along with ticket deals and other things.
David Cohen
Founder and CEO, TechStars
***
You're Never Too Old
Mark Zuckerberg with Facebook, Paul Allen and Bill Gates with Microsoft, Steve Wozniak and Steve Jobs with Apple AAPL +3.20% —those success stories lead some people to think that coming up with big ideas is a young person's game. But the tech entrepreneurs who rose to early fame and fortune are just the outliers. The typical entrepreneur is a middle-aged professional who learns about a market need and starts a company with his own savings.
Research that my team completed in 2009 determined that the average age of a successful entrepreneur in high-growth industries such as computers, health care and aerospace is 40. Twice as many successful entrepreneurs are aged over 50 as under 25, and twice as many over 60 as under 20.
Vivek Wadhwa
Vice president of academics and innovation, Singularity University
***
Be Present in Life
Start your brainstorming with problems that you are personally invested in. Building a business is hard as hell and takes the kind of relentless dedication that comes from personal passion.
Clockwise from the top left: Xerox; Associated Press; Bloomberg News; Chipotle Mexican Grill
The next big question is "How?" Great ideas and innovations come from executing on your idea in a different way than everybody else is attacking it, if they're attacking it at all. A great way to do this is to look outside of your industry to see how others are solving problems. Approaches that they think are routine might be out of the ordinary for you—and inspire great ideas.
Also, most businesspeople tend to ignore our creative side until we really need it. Making sure that your life has a balance of the arts is a great way to stay engaged creatively.
This last tip will seem insanely obvious. However, in the world we live in, it's easier said than done: Simply be present in life.
I'm sure you can relate to how overconnected we all are. Something as simple as having a cup of coffee becomes a juggling act of replying to emails and managing schedules. It's easy to miss a potential piece to your innovation puzzle when it's right under your nose if you aren't there.
Angela Benton
Founder and CEO, NewME Accelerator
***
Ideas Are Abundant; Drive Isn't
Perhaps the greatest factor that determines whether or not an entrepreneur will be successful isn't the business idea itself, but rather the entrepreneur's willingness to try (and keep trying) to turn the idea into reality. Great ideas are abundant, but it's what we decide to do with them that counts.
Samer Kurdi
Chairman of the global board, Entrepreneurs' Organization
***
Let Your Subconscious Do the Work
When the mind is occupied with a monotonous task, it can stimulate the subconscious into a eureka moment. That's what happened to me. The business model for my company, ClearFit, which provides an easy way for companies to find employees and predict job fit, hatched in the back of my mind while I was driving 80 miles an hour, not thinking about work at all.
The subconscious mind runs in the background, silently affecting the outcome of many thoughts. So, take a break and smell the flowers, because while you're out doing that, your mind may very well solve the problem that you are trying to solve or spark a solution to a problem you hadn't considered before.
Ben Baldwin
Co-founder and CEO, ClearFit
***
Attack Practical Problems
Make a note whenever you encounter a service or a customer experience that frustrates you, or wish you had a product that met your needs that you can't find anywhere. Then ask yourself, is this a problem I could solve? And how much time and money would it take to test my idea?
That last point is crucial. As my sage Stanford professor Andy Rachleff encouraged me, "Make sure you can fail fast and cheaply." In business school, I had a couple of big ideas. One was improving domestic airline service—which would have cost millions and taken years. I decided to pursue another opportunity that was a lot cheaper and would show results faster—a clothing line called Bonobos.
In the end, it took me just nine months and $15,000 of startup funds to get a little traction and market feedback.
Brian Spaly
Founder and CEO, Trunk Club
***
Head Into the Weird Places
For entrepreneurs to stretch their brains, they should seek out the unusual.
Watch and listen to weird stuff. I enjoy watching obscure documentaries and listening to unusual podcasts. It's thrilling to find cool ideas lurking just a few clicks away.
Walk in weird places. I take walks in hidden suburban neighborhoods, department stores, community colleges. When you're walking with no purpose but walking, you see things in fresh ways, because you have the luxury of being in the present.
Talk to weird people. Striking up conversations with people who are different from you can be powerful. I still remember random conversations with strangers from decades ago, and how they shaped me.
Victor W. Hwang
Co-founder, CEO and managing director, T2 Venture Capital
***
Search for a Better Way
As one goes about their daily life, it is useful if they routinely ask themselves, "Isn't there a better way?" You would be surprised at how frequently the answer is, "Yes." Other sources of inspiration for me are existing products. One should never feel that just because there is a product out there similar to yours that you can't execute it and market it better.
Liz Lange
Fashion designer
***
Think Big
There are several factors an entrepreneur should consider when choosing a business idea or opportunity.
Go big or go home: There are opportunities to make money by building businesses that marginally improve on existing products or services, but the real thrill sets in when the decision is made to go after an enormous idea that seems slightly crazy.
Make the world a better place: The best kind of entrepreneur pursues a business that simplifies or improves the lives of many people. He or she repeatedly asks "what if" when thinking about how the world works and how the status quo could be dramatically improved.
Fail fast: As overall startup costs decline and markets move much more quickly, it has become easier to test ideas without devastating consequences of failure.
Pivot quickly: Many of the most successful companies exist in a form that is entirely different from how they were first envisioned. A successful entrepreneur will realize when a company is moving in the wrong direction or is missing a much larger opportunity.
Kevin Colleran
Venture partner, General Catalyst Partners
***
Taking It to Market
It is important to look at an idea in two ways: first, to consider the initial inspiration for the business, and second, the often very different concept that ends up being executed to create the new company. We typically think of these ideas as the thing that sets these great entrepreneurs on the path of success. However, an idea is only that until you do something with it. Great entrepreneurs also discover the strategies to deliver the new innovative solution to the market.
Ellen Rudnick
Clinical professor of entrepreneurship and executive director of the Michael P. Polsky Center for Entrepreneurship and Innovation at the University of Chicago Booth School of Business
***
Listen to People Who Know
Entrepreneurs come up with great ideas in a number of ways. Here are some of the best.
Get customer feedback: Listen to customers and create products and services that give them more of what they like and/or remove what they dislike.
Listen to front-line employees: The workers who manufacture the widgets, interact with customers and so on see what takes too long to accomplish, what is too expensive, what causes problems. Talk to those workers, or even do those jobs yourself.
Reverse assumptions: Many great entrepreneurs come up with ideas by reversing assumptions. For example, the old assumption was that a bank needed to have tellers and branch locations. The ATM concept asked: How can we offer banking services without having a branch location and tellers?
Dave Lavinsky
Co-founder and president, Growthink Inc.
***
Get Inspired by History
You often hear about the pursuit of the new new thing. But I believe entrepreneurs have a lot to gain by looking into history for inspiration.
In the mid-'90s, some beer enthusiasts and experts called us heretics for brewing beers with ingredients outside of the "traditional" water, yeast, hops and barley. So, I started researching ancient brewing cultures and learned that long ago, brewers in every corner of the world made beer with whatever was beautiful and natural and grew beneath the ground they lived on.
We now make a whole series of Ancient Ales inspired by historic and molecular evidence found in tombs and dig sites.
Sam Calagione
Founder and president, Dogfish Head Craft Brewery Inc.
***
Be Prepared to Shift Gears
Entrepreneurs need to understand two things. For one thing, their first (or second or third) idea is often not the real opportunity. In fact, it might stink. They have to be on the lookout for why it stinks and be willing to shift course.
But they also need to understand that even if their idea has problems, there's often a good opportunity buried within it. They need to talk to people and continue tweaking and transforming it. In the process, they encounter setbacks, rethink their approach, try again and redefine what they're doing.
For all that, the idea may fail—it's happened to many successful entrepreneurs. But they weren't deterred by failure. They kept at it and were better positioned to recognize and shape the next idea into something truly great.
Donna Kelley
Associate professor of entrepreneurship and Frederic C. Hamilton chair of free enterprise, Babson College
***
You Can't Rush the Brain
I don't know where great ideas come from. I am not sure anyone does. I am not even sure how I come up with my ideas. The brain does its thing, and out pops an idea.
While you are waiting for the brain to get its act together, do what you can do. Do the doable. Meet with people, schmooze, have a laugh or two. Build mock-ups and prototypes. At the very least, collect other people's problems. That's always a guaranteed doable.
The deep idea here is that action has a creative aspect distinct from thinking. And thinking need not come first. Mostly it doesn't.
Saras D. Sarasvathy
Isidore Horween research associate professor of business administration, University of Virginia's Darden School of Business
***
What Not to Do
One thing that isn't a rich vein of entrepreneurship gold: reading a market forecast from a big-name consulting firm and deciding to create a product to serve that need.
Guy Kawasaki
Author and former chief evangelist of Apple
Please send your comments or questions to reports@wsj.com.

Ready !!!!!!!!! Indian Government want more and more taxes.....

Are You Ready for the New Investment Tax?



It's time to grapple with the new 3.8% tax on investment income.
The ordeal of 2012 taxes is barely over. But it isn't too early to understand and cushion the blow of the investment-income levy, which Congress passed in 2010 to help fund the health-care overhaul.

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The tax, which took effect Jan. 1, applies to the "net investment income" of married joint filers who have more than $250,000 of income (or $200,000 for singles). Only investment income—such as dividends, interest and capital gains—above the thresholds is taxed. The rate is a flat 3.8% in addition to other taxes owed.
"Affluent investors who ignore this tax will be in for a total shock next April 15," says David Lifson, a certified public accountant specializing in tax at Crowe Horwath in New York. Such income is typically not subject to withholding, and people won't be factoring it into their estimated taxes. Lower-bracket taxpayers who receive a windfall large enough to owe the tax will also be in for a surprise.
The new levy is one of several tax increases taking effect this year, including higher top rates on income and capital gains, limits on deductions, and an extra 0.9% payroll tax. But the 3.8% tax will cost many Americans even more.
The reason: an odd interaction between the regular income tax and the alternative minimum tax, or AMT, a separate levy that rescinds the value of some tax benefits. This year, many affluent taxpayers will have higher income because of new limits on exemptions and deductions. But this higher income will also help lower their alternative minimum tax.
As a result, many people paying AMT won't owe much more in 2013—unless they have investment income subject to the 3.8% tax.
"This brand-new tax is independent of most other provisions in the code," says David Kautter, a CPA at the Kogod Tax Center at American University. He gives an example, using figures from President Barack Obama and his wife Michelle's 2012 tax returns and a calculator from the nonpartisan Tax Policy Center in Washington.
Last year, the Obamas had gross income of about $662,000 and owed federal income tax of about $108,000. Under 2013 law, Mr. and Mrs. Obama would lose more than $25,000 of their deductions and exemptions, but their AMT would also fall by about 40%.
The upshot: They would owe about the same income tax as they did in 2012.
However, less than 2% of the Obamas' 2012 income was from investments. If half of their income had been from dividends, interest and capital gains, then the Obamas' 2013 income-tax bill would rise by at least $11,000 because of the 3.8% tax, says Mr. Kautter.
Given the tax code's many quirks, individual results will vary. To find out how the new tax will affect you, check out the Tax Policy Center's free online tool at calculator.taxpolicycenter.org. Users can plug in numbers from 2012 returns—or any numbers—and get a side-by-side comparison of taxes for 2012 and 2013, detailing which elements will change.
Congress and the Internal Revenue Service have designed the 3.8% tax to cast a wide net. (See box on this page.) But there are exceptions, plus strategies for minimizing the hit. Here are steps to consider.
Minimize your adjusted gross income. The trigger for the 3.8% tax is $250,000 of adjusted gross income for joint filers ($200,000 for singles). Only net investment income above that is taxed.
Adjusted gross income, or AGI, is the number at the bottom of the front page of Form 1040. It includes certain adjustments to income but not itemized deductions, such as charitable donations, mortgage interest and state taxes.
So if a couple has $245,000 of AGI, they wouldn't owe the tax, even if all of it is investment income. But if they have $255,000, they would owe 3.8% of $5,000.
What reduces AGI? Among other items: deductible contributions to tax-favored retirement plans such as 401(k)s, individual retirement accounts or pensions; a charitable contribution of IRA assets by taxpayers 70½ or older; moving expenses; deferred compensation; and capital losses up to $3,000 deducted against ordinary income.
Rearrange your assets. The new tax is even more reason to move income-generating investments such as high-yield bonds or high-turnover mutual funds into tax-sheltered accounts such as IRAs, says Eric Lewis, a principal at Bedrock Capital Management, a financial-planning firm in Los Altos, Calif.
This advice also applies to real-estate investment trusts, he says, because they generate "nonqualified" dividends taxed at ordinary rates. For taxable accounts, he favors tax-free municipal bonds, which aren't subject to the new tax.
Time income if possible. Say a single investor with $150,000 of AGI wants to sell stock with $100,000 in long-term gains. If he sells it all at once, he will owe $1,900 due to the new tax. But if he sells half his stake on Dec. 31 and the other half on Jan. 1, there's no tax.
Lower earners who can foresee a windfall will often benefit from planning, notes Mr. Lewis. If a couple routinely has $125,000 of income but expects a $300,000 gain from a one-time asset sale, they would owe $2,850 in the new tax. "Good planning can probably avoid it," he says.
Options include an installment sale that spreads payments over a number of years or a "like-kind" exchange, a tactic in which an investor swaps assets instead of selling them, says Kogod's Mr. Kautter.
Harvest losses. The new tax applies to "net" investment income, so investors can reduce their capital gains by subtracting capital losses. One of the tax code's great benefits is that losses on one asset can offset gains from another—and excess losses can be carried over for use in the future.
Don't fret about your house—in most cases. The new tax applies to gains on the sale of a principal residence, but it probably won't matter for most people. That's because sellers can reduce their gain by the purchase price of the house, plus capital improvements, plus $500,000 per couple (or $250,000 for singles). Only gains above that amount are subject to the tax, assuming the sellers exceed the income thresholds.
Say a couple bought a house for $300,000 in 1990 and paid $100,000 for an addition in 1998. This year they sell it for $850,000. The gain in the house would be $450,000, which would be fully covered by the $500,000 exclusion.
Know how retirement income helps—and hurts. Taxable payments from pension plans, regular IRAs and Social Security aren't subject to the 3.8% tax. But such income raises AGI in a way that can expose other investment income to the tax.
For example, a couple with $290,000 of taxable income from IRAs and Social Security wouldn't owe any 3.8% tax—but that situation is unusual. If $100,000 of their income came instead from dividends, interest and capital gains, then $40,000 would be subject to the 3.8% tax, because they have that much investment income above $250,000.
For this reason, the "best" income is a qualified Roth IRA payout. The payout doesn't raise income and isn't taxable. An added bonus: It doesn't help raise Medicare premiums or tax on Social Security payments.
Consider Roth IRA conversions. Full income taxes are due on the conversion of regular IRA assets to Roth accounts, but such shifts can make sense for taxpayers who expect their income to rise above the $250,000 or $200,000 thresholds later in retirement.
"If income is lower now because people are waiting until 70 to take Social Security and IRA withdrawals, we consider Roth conversions," says Mr. Lewis.
Understand what's exempt. Tax-free municipal-bond interest isn't subject to the 3.8% tax. The income from taxable Build America Bonds is subject to it, however, as would be capital gains from trading munis.
Life-insurance proceeds, gifts and inheritances are also not subject to the tax, nor are appreciated assets donated to charity.
Another exception: income from real-estate activities earned by "qualified professionals." Such people must spend a minimum of 750 hours actively managing real estate (not just arranging financing), and that must equal more than half their working hours, says Stewart Karlinsky, a CPA and professor emeritus at San Jose State University in California.
Owners of Subchapter S firms might also escape the tax if they are actively involved in the business. There are various tests of active involvement, but the most common is working at least 500 hours a year. "This is a good reason to have family members work in a family-owned business," says Mr. Karlinsky.
Finally, active partners don't owe the 3.8% tax on their share of a partnership's business income, unless it's from trading financial instruments or commodities, says Monte Jackel, a tax expert in Silver Spring, Md.
Check in with your hedge fund. Tax strategist Robert Gordon of Twenty-First Securities in New York suggests that hedge-fund investors ask managers about possible changes that could pose problems.
The 3.8% tax is prompting some managers to consider taking their own incentive pay as a fee rather than as "carried interest" subject to the 3.8% tax. While this could help the managers, it could put investors at a disadvantage by giving them large amounts of nondeductible investment expenses, says Mr. Gordon.
Hedge funds with "trader" tax status could face a worse problem: Current rules don't allow the funds to offset gains with losses before paying the 3.8% tax. "A trader fund could actually have a loss, and investors would still owe the new tax," he says.
Go offshore. The 3.8% tax gives wealthy taxpayers yet another reason to invest legally through offshore funds in the Cayman Islands and elsewhere, says David Miller, an attorney at Cadwalader, Wickersham & Taft in New York.
Using a "blocker" corporation allows investors to delay the payment of the 3.8% tax by letting income build up in the offshore fund. This strategy can also reduce tax when paid, because the tax would be owed on net rather than gross income.
Know what's different for trusts. The 3.8% tax applies at a much lower threshold for trusts—$11,950 of income instead of $250,000 or $200,000. But that's only for investment income retained in the trust. If the income is paid out to beneficiaries, their own tax rates apply.
Hold investments until death. As with the capital-gains tax, the new levy doesn't apply to assets held at death.
Such assets are marked up to their current value and become part of an estate. The current federal estate-tax exemption is a generous $5.25 million per individual this year (and indexed for inflation), so holding highly appreciated assets until death could be a smart move.
For example, say an elderly woman owns a beach property now worth $1 million that was valued at $50,000 when she inherited it in the mid-1970s. If it's sold while she's alive, she would owe as much as $36,100 due to the 3.8% tax, plus capital-gains tax. If she still owns the property at death, however, neither tax will apply.
A version of this article appeared April 27, 2013, on page B7 in the U.S. edition of The Wall Street Journal, with the headline: Are You Ready for the New Investment Tax?

  • Apr 26, 2013Life and Style

    The Criminal Mind

    Advances in genetics and neuroscience are revolutionizing our understanding of violent behavior—as well as ideas about how to prevent and punish crime.

    Advances in genetics and neuroscience are revolutionizing our understanding of violent behavior—as well as ideas about how to prevent and punish crime, writes Adrian Raine.
    Donta Page's brain scan, left, shows the reduced functioning of the ventral prefrontal cortex—the area of the brain that helps regulate emotions and control impulses—compared to a normal brain, right.
    Adrian Raine
    The scientific study of crime got its start on a cold, gray November morning in 1871, on the east coast of Italy. Cesare Lombroso, a psychiatrist and prison doctor at an asylum for the criminally insane, was performing a routine autopsy on an infamous Calabrian brigand named Giuseppe Villella. Lombroso found an unusual indentation at the base of Villella's skull. From this singular observation, he would go on to become the founding father of modern criminology.
    Lombroso's controversial theory had two key points: that crime originated in large measure from deformities of the brain and that criminals were an evolutionary throwback to more primitive species. Criminals, he believed, could be identified on the basis of physical characteristics, such as a large jaw and a sloping forehead. Based on his measurements of such traits, Lombroso created an evolutionary hierarchy, with Northern Italians and Jews at the top and Southern Italians (like Villella), along with Bolivians and Peruvians, at the bottom.
    These beliefs, based partly on pseudoscientific phrenological theories about the shape and size of the human head, flourished throughout Europe in the late 19th and early 20th centuries. Lombroso was Jewish and a celebrated intellectual in his day, but the theory he spawned turned out to be socially and scientifically disastrous, not least by encouraging early-20th-century ideas about which human beings were and were not fit to reproduce—or to live at all.
    The racial side of Lombroso's theory fell into justifiable disrepute after the horrors of World War II, but his emphasis on physiology and brain traits has proved to be prescient. Modern-day scientists have now developed a far more compelling argument for the genetic and neurological components of criminal behavior. They have uncovered, quite literally, the anatomy of violence, at a time when many of us are preoccupied by the persistence of violent outrages in our midst.
    The field of neurocriminology—using neuroscience to understand and prevent crime—is revolutionizing our understanding of what drives "bad" behavior. More than 100 studies of twins and adopted children have confirmed that about half of the variance in aggressive and antisocial behavior can be attributed to genetics. Other research has begun to pinpoint which specific genes promote such behavior.
    Brain-imaging techniques are identifying physical deformations and functional abnormalities that predispose some individuals to violence. In one recent study, brain scans correctly predicted which inmates in a New Mexico prison were most likely to commit another crime after release. Nor is the story exclusively genetic: A poor environment can change the early brain and make for antisocial behavior later in life.
    Most people are still deeply uncomfortable with the implications of neurocriminology. Conservatives worry that acknowledging biological risk factors for violence will result in a society that takes a soft approach to crime, holding no one accountable for his or her actions. Liberals abhor the potential use of biology to stigmatize ostensibly innocent individuals. Both sides fear any seeming effort to erode the idea of human agency and free will.
    It is growing harder and harder, however, to avoid the mounting evidence. With each passing year, neurocriminology is winning new adherents, researchers and practitioners who understand its potential to transform our approach to both crime prevention and criminal justice.
    The genetic basis of criminal behavior is now well established. Numerous studies have found that identical twins, who have all of their genes in common, are much more similar to each other in terms of crime and aggression than are fraternal twins, who share only 50% of their genes.
    In a landmark 1984 study, my colleague Sarnoff Mednick found that children in Denmark who had been adopted from parents with a criminal record were more likely to become criminals in adulthood than were other adopted kids. The more offenses the biological parents had, the more likely it was that their offspring would be convicted of a crime. For biological parents who had no offenses, 13% of their sons had been convicted; for biological parents with three or more offenses, 25% of their sons had been convicted.
    As for environmental factors that affect the young brain, lead is neurotoxic and particularly damages the prefrontal region, which regulates behavior. Measured lead levels in our bodies tend to peak at 21 months—an age when toddlers are apt to put their fingers into their mouths. Children generally pick up lead in soil that has been contaminated by air pollution and dumping.
    Rising lead levels in the U.S. from 1950 through the 1970s neatly track increases in violence 20 years later, from the '70s through the '90s. (Violence peaks when individuals are in their late teens and early 20s.) As lead in the environment fell in the '70s and '80s—thanks in large part to the regulation of gasoline—violence fell correspondingly. No other single factor can account for both the inexplicable rise in violence in the U.S. until 1993 and the precipitous drop since then.
    Lead isn't the only culprit. Other factors linked to higher aggression and violence in adulthood include smoking and drinking by the mother before birth, complications during birth and poor nutrition early in life.
    Genetics and environment may work together to encourage violent behavior. One pioneering study in 2002 by Avshalom Caspi and Terrie Moffitt of Duke University genotyped over 1,000 individuals in a community in New Zealand and assessed their levels of antisocial behavior in adulthood. They found that a genotype conferring low levels of the enzyme monoamine oxidase A (MAOA), when combined with early child abuse, predisposed the individual to later antisocial behavior. Low MAOA has been linked to reduced volume in the amygdala—the emotional center of the brain—while physical child abuse can damage the frontal part of the brain, resulting in a double hit.
    Brain-imaging studies have also documented impairments in offenders. Murderers, for instance, tend to have poorer functioning in the prefrontal cortex—the "guardian angel" that keeps the brakes on impulsive, disinhibited behavior and volatile emotions.
    Of course, not everyone with a particular brain profile is a murderer—and not every offender fits the same mold. Those who plan their homicides, like serial killers, tend to have prefrontal functioning. That makes sense, since they must be able to regulate their behavior carefully in order to escape detection for a long time.
    So what explains coldblooded psychopathic behavior? About 1% of us are psychopaths—fearless antisocials who lack a conscience. In 2009, Yaling Yang, Robert Schug and I conducted structural brain scans on 27 psychopaths whom we had found in temporary-employment agencies in Los Angeles. All got high scores on the Psychopathy Checklist, the "gold standard" in the field, which assesses traits like lack of remorse, callousness and grandiosity. We found that, compared with 32 normal people in a control group, psychopaths had an 18% smaller amygdala, which is critical for emotions like fear and is part of the neural circuitry underlying moral decision-making. In subsequent research, Andrea Glenn and I found this same brain region to be significantly less active in psychopathic individuals when they contemplate moral issues. Psychopaths know at a cognitive level what is right and what is wrong, but they don't it.
    What are the practical implications of all this evidence for the physical, genetic and environmental roots of violent behavior? What changes should be made in the criminal-justice system?
    Let's start with two related questions: If early biological and genetic factors beyond the individual's control make some people more likely to become violent offenders than others, are these individuals fully blameworthy? And if they are not, how should they be punished?
    Take the case of Donta Page, who in 1999 robbed a young woman in Denver named Peyton Tuthill, then raped her, slit her throat and killed her by plunging a kitchen knife into her chest. Mr. Page was found guilty of first-degree murder and was a prime candidate for the death penalty.
    Working as an expert witness for Mr. Page's defense counsel, I brought him to a lab to assess his brain functioning. Scans revealed a distinct lack of activation in the ventral prefrontal cortex—the brain region that helps to regulate our emotions and control our impulses.
    In testifying, I argued for a deep-rooted biosocial explanation for Mr. Page's violence. As his files documented, as a child he suffered from poor nutrition, severe parental neglect, sustained physical and sexual abuse, early head injuries, learning disabilities, poor cognitive functioning and lead exposure. He also had a family history of mental illness. By the age of 18, Mr. Page had been referred for psychological treatment 19 times, but he had never once received treatment. A three-judge panel ultimately decided not to have him executed, accepting our argument that a mix of biological and social factors mitigated Mr. Page's responsibility.
    Mr. Page escaped the death penalty partly on the basis of brain pathology—a welcome result for those who believe that risk factors should partially exculpate socially disadvantaged offenders. But the neurocriminologist's sword is double-edged. Neurocriminology also might have told us that Mr. Page should never have been on the street in the first place. At the time he committed the murder, he had been out of prison for only four months. Sentenced to 20 years for robbery, he was released after serving just four years.
    What if I had been asked to assess him just before he was released? I would have said exactly what I said in court when defending him. All the biosocial boxes were checked: He was at heightened risk for committing violence for reasons beyond his control. It wasn't exactly destiny, but he was much more likely to be impulsively violent than not.
    This brings us to the second major change that may be wrought by neurocriminology: incorporating scientific evidence into decisions about which soon-to-be-released offenders are at the greatest risk for reoffending. Such risk assessment is currently based on factors like age, prior arrests and marital status. If we were to add biological and genetic information to the equation—along with recent statistical advances in forecasting—predictions about reoffending would become significantly more accurate.
    In a 2013 study, Kent Kiehl of the University of New Mexico, looking at a population of 96 male offenders in the state's prison system, found that in the four years after their release, those with low activity in the anterior cingulate cortex—a brain area involved in regulating behavior—were twice as likely to commit another offense as those who had high activity in this region. Research soon to be published by Dustin Pardini of the University of Pittsburgh shows that men with a smaller amygdala are three times more likely to commit violence three years later.
    Of course, if we can assess criminals for their propensity to reoffend, we can in theory assess any individual in society for his or her criminal propensity—making it possible to get ahead of the problem by stopping crime before it starts. Ultimately, we should try to reach a point where it is possible to deal with repeated acts of violence as a clinical disorder.
    Randomized, controlled trials have clearly documented the efficacy of a host of medications—including stimulants, antipsychotics, antidepressants and mood stabilizers—in treating aggression in children and adolescents. Parents are understandably reluctant to have their children medicated for bad behavior, but when all else fails, treating children to stabilize their uncontrollable aggressive acts and to make them more amenable to psychological interventions is an attractive option.
    Treatment doesn't have to be invasive. Randomized, controlled trials in England and the Netherlands have shown that a simple fix—omega-3 supplements in the diets of young offenders—reduces serious offending by about 35%. Studies have also found that early environmental enrichment—including better nutrition, physical exercise and cognitive stimulation—enhances later brain functioning in children and reduces adult crime.
    Over the course of modern history, increasing scientific knowledge has given us deeper insights into epilepsy, psychosis and substance abuse, and has promoted a more humane perspective. Just as mental disorders were once viewed as a product of evil forces, the "evil" you see in violent offenders today may someday be reformulated as a symptom of a physiological disorder.
    There is no question that neurocriminology puts us on difficult terrain, and some wish it didn't exist at all. How do we know that the bad old days of eugenics are truly over? Isn't research on the anatomy of violence a step toward a world where our fundamental human rights are lost?
    We can avoid such dire outcomes. A more profound understanding of the early biological causes of violence can help us take a more empathetic, understanding and merciful approach toward both the victims of violence and the prisoners themselves. It would be a step forward in a process that should express the highest values of our civilization.
    –Dr. Raine is the Richard Perry University Professor of Criminology, Psychiatry and Psychology at the University of Pennsylvania and author of "The Anatomy of Violence: The Biological Roots of Crime," to be published on April 30 by Pantheon, a division of Random House.
  • Apr 26, 2013Law Blog

    Lawyer Admonished for Ignoring Client for Three Years





    While the line between diligent and dilatory isn't always clear, it's safe to say ignoring a client for three years falls into the latter category.
  • Apr 26, 2013US

    States Take a Shot at Looser Alcohol Rules

    New Hampshire, Texas Consider Easing Late-Night or Sunday Limits, but Similar Pushes Have Failed Elsewhere This Year





    New Hampshire and Texas consider easing late-night or Sunday limits, but similar pushes have failed elsewhere this year.

Brokerage Ills Stir Auditor Scrutiny

By JEAN EAGLESHAM and MICHAEL RAPOPORT
U.S. regulators are tightening their scrutiny of accountants in an effort to crack down on firms bungling "red flags" that signal fraud and imperil customer money.
The increased attention is occurring largely at the Commodity Futures Trading Commission, where investigators and top officials were rattled by the collapses of Peregrine Financial Group Inc. and MF Global Holdings Ltd. MFGLQ +27.27% At both firms, rules that are supposed to protect customer funds were allegedly broken without being detected by accountants.
The CFTC hasn't accused the auditors for MF Global and Peregrine of wrongdoing. But their inability to spot problems is spurring the agency to examine more closely under its existing rules if accountants are properly policing the financial controls at thousands of U.S. futures and swaps firms.
Getty Images
The demise of MF Global has raised wider fears about accounting.
"Accountants haven't been our prime focus," said Bart Chilton, one of the CFTC's five commissioners. Now, though, the agency has "increased our efforts," though it isn't clear how far enforcement officials will go to crack down on allegedly shoddy accounting.
Earlier this month, the CFTC filed its first-ever disputed civil lawsuit in federal court against an accounting firm for alleged audit failures. Tunney & Associates and owner Michael Tunney of Orland Park, Ill., did five audits of Linn Group Inc. even though the accountants lacked "any experience" with futures firms "or any entity that holds customer segregated accounts."
Mr. Tunney allegedly outsourced most of the job to a friend, whom he paid 70% of the $18,000 audit fee for doing the work, according to the CFTC. Mr. Tunney did the 2011 audit on his own after his friend died, the regulator said.
Investigators allege the audits failed to adequately test Linn Group's accounting system, internal controls and procedures for safeguarding assets. The CFTC claims the audits failed to detect improper mingling of Linn Group's own money with a trading account for customers.
In a separate enforcement action, Linn Group agreed earlier this month to pay $400,000 to settle accusations by the agency that it failed to properly handle, monitor and report customer money. Linn Group fired Tunney & Associates before reaching the settlement.
Robert J. Trizna, a lawyer representing Linn Group, said "no customer funds were lost or at risk, and no improper compensation was received" by the firm related to the alleged rule breaches. A lawyer for Mr. Tunney declined to comment.
Linn, which is based in Chicago, has about $80 million in segregated customer money, according to the latest CFTC data. While that amount is relatively small in the context of the $1.8 billion total in customer money that went missing when MF Global and Peregrine sank, futures-industry lawyers say the CFTC is trying to send a message. "It's clear that the stakes have been raised for everyone," said Stacie Hartman, a partner at law firm Schiff Hardin LLP.
The Securities and Exchange Commission got more power with the Dodd-Frank financial-overhaul law in 2010 to go after auditors for allegedly aiding or abetting securities fraud through reckless behavior. Auditors previously were liable for aiding and abetting fraud only if they knew about it.
Dodd-Frank gave the SEC a "much lower legal bar" with accountants, said Richard M. Rosenfeld, a partner at law firm Mayer Brown LLP.
In July, an administrative hearing is set to start on the first crisis-related case against accountants. Two KPMG LLP employees were accused by the SEC of doing too little to scrutinize bad-loan reserves at TierOne Bank. The SEC claims the Nebraska bank hid millions of dollars in loan losses from investors during the credit crisis.
A KPMG spokesman said the auditors contest the allegations and "look forward to presenting the facts in support of the work that was performed under the circumstances at TierOne."
George Canellos, co-director of the SEC's enforcement division, said the agency has long been vigilant of public companies and their accountants. "Our record shows we will use all of our legal authority wherever appropriate—including our new powers under Dodd-Frank," he added in an email.
—Aaron Lucchetti and Jacob Bunge contributed to this article.
Write to Jean Eaglesham at jean.eaglesham@wsj.com and Michael Rapoport at Michael.Rapoport@dowjones.com
A version of this article appeared April 30, 2013, on page C1 in the U.S. edition of The Wall Street Journal, with the headline: Brokerage Ills Stir Auditor Scrutiny.


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