Business Law Prof Blog

When $7.2 million is not enough: Harvard's Money Manager

  The New York Times reports today that Harvard cannot hire a money manager for its $23 billion endowment.   The offered salary is $7.2 million a year and good money managers are making $250 million a year.  Good gracious.  There is much to be said here.  First, Harvard has and is holding too much money -- it is an educational institutional that is now also a financial institution. This is greater than the GDP of most third world countries. The Harvard money manager makes more than all the academic officials (and over 3500 percent in excess of what Harvard pays a top undergraduate professor).  It is Harvard's version of our problem-- our football coach makes more than any academic offical.  Our education institutions are turning into 60s style conglomerates -- bloated, corrupted and inefficient -- and need hostile takeovers that would force them to focus on their core functions.  Harvard needs to spend more of its money on education or return it, not just continue to grow a huge investment fund.  Harvard could, for example, suspend tuition for all its students for years and still be solvent.  At minimum, I would recommend that doners find other charities -- why donate to a self-perpetuating, bloated investment trust?  Second, how is it that good money managers are worth $250 million a year.  This money is coming out of the pockets of someone.  These outrageous salaries are growing a national pubic relations problem for wall street and main street corporate america.  Ordinary folks (not just the political socialists) are losing trust in our finanical institutions.   At some point this will bear painful political fruit. 

Insider Trading Plans: Rule 10b5-1

   Senior executive managers who want to buy and sell stock in their own companies call their lawyers.  They know that if they hold non-public material information, any transaction completed by them is illegal insider trading.  But what are the boundaries of the rule?  Pushing up to and not over the boundaries can mean significant profits.  Lawyers, put on the spot, chaffed at the risk of giving incorrect advice.  Practices developed to miminize risk.  "Do not buy or sell in the weeks before the filing of a quarterly report but buy or sell within two weeks of its disclosure."

   In 2000 the SEC, responding to pressure from lawyers to provide "safe-harbors" promulgated Rule 10b5-1.  Under the rule executives could be in place a "plan" for buying or selling shares that created a schedule of automatic transactions, enabling the executive to trade even though, at the time of any one trade, the executive had non-public material inside information in her possession.  The rule makes sense -- in theory.

   In practice, the rule has three loop-holes that enable abuse.  First, the SEC has developed a custom of allowing an insider to stop sales under the plan if an executive is sitting on good news.  This is an overly rigid application of the "abstain or disclose" mantra.  A sensible reading of Rule 10b-5 would prohibit the conduct, as a decision not to close a planned sale is still "in connection with the purchase or sale" under the language of the Rule.  The requirement should not be confused with the actual purchase or sale requirement for plaintiff standing under Rule 10b-5, articulated in the Blue Chip Stamps case.  Second,  executives can time the release of postive and negative news to pre-date purchases or sales scheduled in the plan.  This ought to be illegal market manipulation.  And third,  an executive can create such plans with superior information on a companies long-run prospects.   The information may not be definitive enough or private enough to be "non-public" or "material."  This is legal but the SEC should require that the plans themselves be made public.  Currently only the actuals purchases or sales under the plan, disclosed within two days after completition, need be disclosed.   The plans themselves are material information to investors and should be made known to the market.  This would also help with the second problem, reducing the impact on market prices of timed disclosures.

   New studies show that executives make extra-market returns on their plans of over five percent and it is information based.  See Professor Alan Jagolinzer's study.  This should not happen and the rule needs to be tightened up.

News Corporation

  The battle among family members for control of the News Corporation is a reminder of why it is often a bad idea to separate voting control of a corporation from shareholders' economic rights.  Those who control the board of directors start believing that control of the corporation is personal property that can be passed on to children.  Empirical studies show that companies run by the next generation in a family corporation do not, on average, perform as well as other comparable companies.  Setting up a corporation to be controlled by founders with supervoting stock (see Google) while a majority of the economic rights are held by others is an invitation to problems down the road. 

The American Financial Press and the Failed CNOOC Bid for Unocal

     Hong Kong based CNOOC withdrew its takeover bid for California based Unocal Corporation, leaving Chevron as the sole and apparent winning bidder.  CNOOC officials said that their decision was based, among other things, on Congress's efforts to stall the takeover through legislation.  The editorial staffs of many of the more prominent members of the financial press (including the Wall Street Journal), many of whom had been supporting the CNOOC bid, bemoaned the CNOOC decision and lambasted Congress's activities.   The tenor of the editorials was disappointing and, well, irresponsible.

     A debate over whether Chinese state controlled companies should be able to purchase control of United States oil companies is complex and nuanced, involving an analysis of international economic and strategic issues in a fluid situation.  There are considered arguments on both sides to be balanced.  At issue for the United States is how to deal with the market participation of state-owned companies from an emerging international economic power that does not fundamentally repect markets (or private property for that matter).  A state-owned company is subsidized (in this case CNOOC had cheap capital) and competes with companies that are not subsidized (or as subsidized) and the assets of state owned companies are not themselves "on the market" (CNOCC nor its assets can be purchased by United States companies) unless the state decides that it is in the state's interest that they should be.  Reciprocity and fair rules of competition must be negotiated and enforced.  Ignoring the problem is not an option.   

   But this is not the approach of the financial press.  When CNOOC dropped its bid several of the editorials announced the gross unfairness of Congress's decision and the  "rampent protectionism" that had carried the day.  China had a right to be mad, they crowed, and, by necessary implication, had a right to retaliation -- a right to negotiation for deals with our enemies and a right to develop a confrontional responsive strategy.  Congress was not "following the rules of fair play."  Chinese officials will read this drivel and may believe it -- I hope not.  The fanatical support of markets by the financial press and their petulance whenever someone disagrees is counterproductive and potentially  incendiary.

    How should Chinese officials react?  They should recognize that United States authorities will not treat China as equivalent to the United Kingdom when American assets and interests are on the table.  This is not new. American trade rules have long distinguished state-owned from private enterprises (it is easier to subsized state-owned enterprise exports) and have long distinguished states that do not have robust private ownership systems from those that do (it is easier to block imports and foreign investment).  The CNOOC bid represents another evolution of these important distinctions in the modern context of investments from China.  American officials and Chinese officials will have to negotiate arrangements that deal with these differences.

    The finanical press can either throw gasoline on the negotiations or inform them with sensible argument.  In the CNOOC case it has chosen the former route.    

Oversight Systems Survey

  Oversight Systems Inc. has reported the results of its new survey of top business executives on internal controls and risk management. www.oversightsystems.com/survey  Executives are learning to live with Section 404 (of Sarbanes-Oxley) apparently.  The company also reported survey results last year that put a postive glow on Section 404 and the SEC has used the 2004 results to justify its rulings.   

CNOOC Leaves the Field

   CNOOC has decided to withdraw from the competition for control of Unocal Corp., the Califorinia based oil company.  CNOOC stated that the policitical reaction to its initial bid had caused it to withdraw.  Pundits are now speculating on the after effects of the CNOOC decision.  "Will China now be harder on United States companies seeking to invest in China???"  This is difficult to imagine as China now severely limits the return most United States companies earn on their Chinese investments.