June 23, 2005
Supreme Court Expands Power of Eminent Domain
The United States Supreme Court rendered its decision in the case of Kelo v. New London today, holding that a state political subdivision may use the power of eminent domain to condemn residential real property for the purpose of executing a "program of economic rejuvenation." The opinion essentially allows a political subdivision to claim that an economic development plan serves a "public use," allowing that subdivision to exercise the power of eminent domain over private real property consistent with the Takings Clause of the Fifth Amendment. The slip opinion is available here. The case arises out of an economic development plan involving a Pfizer research development facility, though there is speculation that it could be used by "big box" retailers to obtain real estate in densely populated areas (see article from CNN Money).
For an interesting analysis of whether or not these types of development programs are efficacious, see Wassmer & Anderson, Are Local Economic Development Incentives Effective in an Urban Area? available here.
Who are the Successful Venture Capitalists?
There was a wonderful article on venture capital in the Sunday Business section of the New York times on May 22, 2005 ("So You Want to Be a Venture Capitalist" by Gary Rivlin). In cleaning up I have come across the piece that I had set aside.
Rivlin makes the point that there is a difference between being a successful entreprenuer (and making money) and running a venture capital fund. With examples, he demonstrates that successful entrepreneurs who believe they can use their experience to be venture capitalists (choosing among other start-ups) have had a very rough time -- "the experience proved humbling" and a sure way to lose lots of money. "Some can do and some can't and there's no way of telling until they take the field." Sanford Robertson says. Choosing among portofolio companies and helping them along is proving to be a very different skill from running one yourself. One of the best venture capitalists, Michael Moritz with Sequoia, never ran a company, he was a business journalist for Time magazine.
The problem of conflicted fairness opinions by investment bankers on proposed mergers has its origins in the late 80s case of Smith v. Van Gorkom, by the Delaware Supreme Court. CEOs to justify the price of an acquisition hire an investment bankers to write a fairness letter. The letter tells readers that the price is within a range of fairness. The banker is selected to approval the deal and may even be paid a bonus if the deal closes. The NASD has announced a rule making initiative on fairness opinions and the Secretary of the Commonwealth of Massachusetts launched an investigation of the fairness opinions in the Gillette acquisition. There are reputable independent valuation experts, such as Mercer Capital (http://merceronvalue.com/mt/mt-tb.cgi/28), that will do fairness opinions for a set fee and without ties to any of the parties. A new firm Pirie, Goldsmith & Associates with a stellar management and advisory board offers the service. One wonders why the independent directors on boards of either the buying or the selling firm do not insist on the hiring of one of these independent valuation firms.
June 22, 2005
The United States Circuit Court for the District of Columbia has issued an important ruling on the authority of Securities and Exchange Commission to adopt its new rules regulating the mutual fund industry. (Click here for NY Times Story) The court said the SEC had the power to adopt the new rules, requiring a 75% independent board of directors and and independent chairman, but that the rules were not justified by the investigation of costs and benefits. All claimed a victory. The three commissioners, including the departing Chairman Donaldson, said the case vindicated SEC power to pass the rules; the two dissenting commissioners, the Republican nominees, said the case implied that the rules were ill considered. Since Donaldson is leaving, the court has given his successor, Cox, the opportunity to withdraw or delay the rule -- something he is likely to do.
This will be the first of many cases in which the business community contests some of the SEC's more radical new rules proposals.
Grasso's Salary at the NYSE
Folks are not asking the right question when it comes to Grasso's over the top salary package at the NYSE. No one can defend the amount paid to Grasso; the only issue for the press and for the prosecution is who was responsible for approving the salary. Did Grasso steal the money or was the salary approved by the Board. The more significant issue for the public is how the NYSE could pay such an outrageous salary at all. This is a non-for-profit New York Corporation paying out a huge percentage of its operating budget on an excessive salary. Under competitive conditions the exchange could not get away with it, as competitors that run more efficiently could find ways of making the NYSE suffer for its poor management. The lack of exchange to exchange comptition creates this kind of slush money to be distributed by those exchanges with monopolistic pricing power. It is the monopolistic pricing power of the NYSE that creates the spoils that enable participants to divide obscene amounts of money. Either the government must regulate salary or the government must facilitate more exchange to exchange competition, for otherwise this problem of theft by salary will reappear.
Romano on Sarbanes-Oxley
Professor Roberta Romano, one the the country's finest scholars on business law, has published an article on Sarbanes-Oxley in the latest edition of the Yale Law Review. It is excellent and makes the point that the act is largely a political mistake. She advocates a correction, make the provisions of the act aimed at corporate governance optional.
Now that Roger Blackwell, a chaired professor in marketing at the Fisher College of Business (Ohio State Univ.) has been convicted of insider trading, the University is faced with the decision of what to do with the Blackwell Inn, a beautiful hotel/restaurant located next to the business school and across the street from the football stadium. The Blackwell Inn is named after Mr. Blackwell. (See Article)
I want to put in a plea for keeping the name the same. Blackwell's story, an Ohio farm kid who makes good only to slip at the end of his career, is one worth remembering and very educating for the next generation of business school students. The Inn will always have this tag line, this inside story, and get more publicity not less and the publicity will be have its own education purpose. Keep the name.
June 21, 2005
Blackwell Convicted of Insider Trading
A chaired marketing professor at the Fisher School of Business at the Ohio State University, Roger D. Blackwell, was convicted of insider trading. (See Story) He served on the board of a company that was subject to a takeover and told friends about the event before it was announced. The embarrassment for the school is one for the history books. Blackwell had made a large gift, most of it testimonial, towards the building of a hotel in the business school complex and has his name etched in stone on the building. The hotel is called the "Blackwell." Until yesterday the hotel feature a prominent display case containing the most popular of his 20 or so books. He was a very effective public speaker and, as such, a very popular teacher in the upper class and master's programs. Thousands of students have taken his classes. Indeed, he taught a class last quarter, after his indictment.
In a stunning display of bad taste, the local newspaper, the Columbus Dispatch, ran a second story on the conviction that asserted, and I am not making this up, that he could make more money after his conviction than before if he played the Martha Stewart card -- writing a book on his fall from grace. Someone tell the Dispatch that he is going to prison -- and for a much longer term that Martha served -- unless he can win on appeal.
Adelphia ex-CEO Sentenced
The court sentenced the elder founder of Adelphia Communications, John Rigas, to fifteen years in prison.(See Article) His son Timothy, aged 49, received a twenty year sentence. A second son, Michael, faces a retrial in October.
The convictions are starting to roll in. Last Friday the former CEO and CFO of Tyco International were convicted of looting the company. Bernard Ebbers of WorldCom also awaits sentencing. In 2004 two Rite Aid Corp executives were sentence to ten and eight years in prison. In March of 2004 a former finance executive of Dynergy was sentence to twenty four years in prison. The jury is still out on the former CEI of HealthSouth. More trials and convictions will come.
Convictions for financial frauds take time and yet the public, on the revelation of the scandals demands immediate justice. The effect of the temporary disconnect between public anger and public prosecutions means that lawmakers are pressured to pass legislation in the interim as a demonstration that they are doing something. The legislation, in this case the Sarbanes-Oxley Act of 2002, is never elegant.
June 20, 2005
Fairness Opinions on Mergers
Six months ago Symantec announced that it would acquire Veritas Software. Investors in Symantec recognized the deal was terrible for the company and pounded the stock. Since the deal was a stock swap, the falling price of Symantec meant that the Veritas shareholders lost any price premium on the deal. Yet Symantec was able to hire two investment bankers who issued "fairness opinions" on the price (Lehman Brothers for Symantec and Goldman Sachs for Veritas). Why? The fairness opinions are paid for by the managements seeking to push through the deal (some are even contingent on the deal closing). Managers pay big fees for a rubber stamp from a big name bank. This "fairness opinion" charade needs to stop. The investment bankers should be liable (without indemnification rights) to the deal's shareholders if the opinions prove to be substantially off and the managers should be liable personnally for the fees as a waste of corporate money. Moreover, in all cases, the managers should reveal whether or not any other investment bankers, contacted even informally, refused to give an opinion and the opinions should come with a disclamer ("Paid out of corporate funds by your managers who support the deal.")
The New Enforcement Paradigm: Indicting the Corporation
When I first wrote about the 2003 "Thompson" memo (my article was published in Spring of 2004), many did not understand the memo's significance or even know that it existed. All corporate lawyers do now.
On January 20, 2003, then Deputy Attorney General Larry Thompson wrote a ten page memorandum circulated to Unites State Attorneys that recommended corporate entity level indictments if the corporation did not quickly and effectly cooperate with federal investigators in uncovering finanical fraud. Cooperation is unequivocal: companies must waive attorney/client privilege, turn over evidence on its own employees and not help its employees defend any charges (breaching indemnification agreements). Mr. Thompson urged, among other things, that prosecutors use "deferred-prosecurtion agreements" even if corporations did offer their cooperation. In a deferred prosecution agreement a company agrees not to contest a list of violations and agrees to help prosecutors find those insiders culpable for finanical fraud. An independent monitor reports to prosecutors on whether the company has fully complied and, on a favorable report, the prosecutor sets aside the charges, after a designated period.
The power in the threat is what happened to Arthur Anderson when a company in the financial services industry is indicted on criminal charges--company collapse.
This is a new enforcement paradigm. There are several examples of the new paradigm in action. The deferred prosecution of Computer Associates led to the firing and indictment of the company's CEO, Sanjay Kumar, and head of sales. The threat is so effective that even deferred prosecution is no longer necessary, the companies capitulate and cooperate when prosecutors make a phone call. The KPMG case on tax shelters and the Ahold NV case on inflated revenue figures are examples.
Prosecutors are delighted with the new form of coerced cooperation. Corporate attorney's grumble but counsel firms to comply. This powerful new weapon has obvious benefits but can be misused. Evidence of misuse will come in the form of the frequency of scapegoats -- a conspiracy of prosecutor and firm to conviction of mid-level personnel to pad prosecutors statistics and get higher level executives off the hook. There are some very suspicious examples already in the wind (e.g., Time Warner). Time will tell.