Business Law Prof Blog

Underwriters Change Tactics Post Global Settlement

In an article from CFO Magazine, Rob Garver discusses new tactics underwriters employ in pitching their services to potential IPO candidates in the post global settlement era.  Whether Spitzer’s settlement will actually help the average Joe investor as he claimed may still be in doubt (click here for previous post), but it has clearly changed the way investment banks market themselves to potential clients. 

Before Spitzer, they would lead with their analyst, and a primary selling point was analyst coverage... Now, investment bankers need to try to differentiate themselves. The problem is that they all do the same thing. If you are sitting there in a pitch meeting and going through five or six different bulge-bracket firms, they can all do the job.

The ability of the bank to distribute the new stock is clearly the best selling point now, which favors the larger banks.  Smaller firms, with less established distribution channels, sell a more focused brand of banking, whether it is categorical expertise or special attention to the companies’ needs earlier in the process.  The Google option, the Dutch auction, has not found many takers, however.  For more info, click here.

Kroger Pursuing Albertsons

Kroger, the No. 1 U.S. grocer, has submitted a bid for Albertsons, the No. 2 U.S. grocer.  Albertsons owns the Albertsons, Acme and Shaws supermarket chains, as well as drugstores Osco Drug and Sav-on Drugs.  "Albertsons put itself up for sale in September after struggling against competition from discounters such as Wal-Mart Stores Inc."  Several teams of private equity firms have also put in bids, and CVS, Rite-Aid and Walgreens have submitted bids for Albertsons' pharmacy unit.  If Kroger's bid prevails, the deal will likely face intense scrutiny by antitrust regulators given the market shares involved.  Article here.

House Passes Cheeseburger Bill

The House recently passed a bill "which provides protection to the food industry from frivolous liability claims that food products are responsible for causing a person's weight gain or obesity."  Companion legislation has been introduced in the Senate.  Article here.

Google Trading at All-Time High

After the market closed yesterday Google announced spectacular third quarter results which greatly exceeded analyst estimates.  Click here for Google's press release and here for a Bloomberg article.  Google's stock hit a high of $338.38 per share in after hours trading, a 12% increase from yesterday's closing price and almost a 400% increase from its IPO price.  The reason the market was taken by surprise is that unlike many public companies, Google does not provide earnings guidance (periodic management comments concerning what they expect for future earnings).  Also, according to Bloomberg, three months ago Google's CEO described the third quarter as a slower period.  Not providing earnings guidance is Google's prerogative and has become much more common following the enactment of Regulation FD, but it contributes to volatility in Google stock.  I'm sure investors don't mind when the stock rockets up, but inevitably Google will one day fall short of estimates, and its stock will rocket down.  [Bill Sjostrom]

Update:  Google opened at $345.00 on Nasdaq this morning.  It's market capitalization temporarily topped $100 billion.  To put the number in context, Exxon currently has the largest market cap at $370 billion follwed by GE at $364 billion and Microsoft at $264 billion.  Click here for a list of the top 20.  Remember when Cisco was number one on this list and your investment portfolio was worth a lot more?  Those were the days.

The Fight for AOL

The Economist has an interesting article about why Microsoft, Google and Yahoo are pursuing AOL despite the atrophy of its dial-up business.

AOL “is big open real estate and you don't want your competitor to get it.” That is because the vaguely defined and fast-changing “web-portal” industry . . .is also showing the early signs of maturity. That would suggest that this industry, like many others, will evolve towards three large generalist players and several small niche firms . . . The big question is which three emerge and in what combination.

Analyzing the online competitors is not easy. Each company is a leader in different areas of the business. Consider internet searching, the most profitable of the provided services. Google is the clear leader of the four companies. MSN is the least successful. AOL is Google’s single largest customer, accounting for 11% of Google’s revenue for the first half of 2005. Yahoo is a strong second, however it is the single most visited site on the net. For more analysis and the potential AOL combinations, click here.

Refco and Private Company vs. Public Company Liability Exposure

The Refco situation provides a good illustration of the huge difference in liability exposure between a private company and a public company. Had the fraud been discovered three months ago, i.e., before Refco went public instead of after, things would have turned out a lot different. Presumably, Refco would have asked Bennett to resign and, if it disclosed the resignation at all, spun it as him “pursuing other opportunities.” It then would have shelved the IPO claiming that “market conditions were not right.” As a private company, Refco would have no obligation to keep the marketplace informed. The financial press may have speculated as to why Bennett suddenly resigned and connected it with the shelved IPO, but if they wrote a story about it at all, they would not know about the fraud absent a leak from Refco, and the story certainly would not be front page news. Pre-scandal, most people probably never heard of Refco. The story simply would not be particularly newsworthy. Bennett would not have gotten arrested unless Refco alerted the authorities, which is unlikely because its business is based on trust and the revelation would have shaken client trust. Ratting out Bennet also would have made it more difficult for Refco to go public down the road.

Thomas H. Lee Partners perhaps would have tried to get a price adjustment on its large investment it made in Refco about a year ago claiming a breach of the stock purchase agreement or a rule 10b-5 violation.  The parties, however, likely would have settled the matter privately. Grant Thorton perhaps would have lost Refco as a client.  Finally, Refco never would have imploded and would have undoubtedly gone public after the internal smoke cleared. 

Since the fraud was discovered post-IPO, things are drastically different. Refco is in bankruptcy; Bennett is likely going to jail; Thomas H. Lee Partners has taken a hit to its reputation and a $275 million loss on its Refco investment; and Refco’s board, Grant Thorton, and the underwriters of the IPO have already been sued or soon will be sued. All this because of a three-month difference in the discovery of the fraud.  [Bill Sjostrom]

Miers as an Investor

To date I’ve refrained from blogging about the Miers nomination given the extensive coverage in the blogosphere and everywhere else. I couldn’t, however, pass up this one. The W$J reports today that although Miers was pulling down $600K annually as managing partner of a big Dallas law firm and "doesn't spend a lot of money on material things", her net worth is a modest $674,295. Her investment portfolio consists of “largely risk-free, low-return investments such as Treasury securities and money-market accounts.” This tells me that she is extremely conservative, at least as an investor. While it does not indicate how she would vote on Roe v. Wade, it does tell me that, in addition to formulating a judicial philosophy, she also needs to bone up on modern portfolio theory, i.e., that a well diversified portfolio consisting of stocks, bonds, commodities, etc. increases expected returns without boosting risk. Or atleast she needs to get some better investment advise. [Bill Sjostrom]

Shareholder Democracy

A lot of bantering has gone on this past year about increasing shareholder democracy, especially with respect to the election of directors (shareholder access to the ballot, majority voting for election of directors). Obviously, this bantering presupposes that shareholder democracy should be increased. What has struck me is that does not seem to be the message coming from the marketplace. There are many publicly traded "totalitarian regimes" out there, i.e., public companies that are controlled by one or a few shareholders. Google is perhaps the best known example. Others include Viacom, Refco, and WebMD. Viacom’s recently announced planned split into two companies provides a good example of shareholder disempowerment.  Although it involves a fundamental change to Viacom, no vote of the public shareholders will be sought or is required to approve it. Since Sumner Redstone controls a majority of voting power, only his consent is necessary.

One may assume that the price of publicly traded shares of controlled companies reflect a lack of control discount. Empirical studies on price differentials of companies with dual classes of stock, however, do not necessarily support this. Obviously, Google’s stock price has faired very well, and WebMD and Refco both recently completed successful IPOs. We know what happened to Refco, but would the stock of Viacom, Google and WebMD be trading even higher if they were not controlled companies? Perhaps, but we don’t know.

This raises a much larger debate among corporate law scholars, in particular, Professor Bebchuk who advocates increased shareholder power and Professor Bainbridge who advocates director primacy.

J&J Seeking Lower Price for Guidant

As Dale blogged earlier  here, the J&J/Guidant deal has run into some snags. Not surprisingly, J&J is attempting to renegotiate a lower price, but Guidant is insisting that the deal be completed as agreed. Click here for more details.  I suspect Guidant's position is that the FDA probe related to its implantable heart device does not trigger a walk-awary right under the merger agreement , i.e., it does not amount to a material adverse change or the like.  My guess is that this is just posturing. [Bill Sjostrom] 

Spitzer's Settlement with Wall Street

This months Institutional Investor has an interesting article by Justic Schack called "Settling for Nothing" about the aftermath of Elliot Spitzer’s $1.5 billion settlement with Wall Street. The article is not freely available on the web, so here’s some highlights: 

Following the bust of the dotcom bubble, and in the wake of massive corporate scandal, ambitious prosecutor Elliot Spitzer attacked Wall Street in the name of the average Joe investor. Almost three years ago, Spitzer announced his grand achievement, a $1.5 billion dollar settlement with twelve of Wall Street’s largest brokerage firms. “‘Our objective throughout the investigation and negotiations has been to protect the small investor and restore integrity to the marketplace. . . We are confident that the rules embodied in this agreement will do so.” Spitzer capitalized on his new found fame and has since taken to the campaign trail, seeking the Governor’s office in the upcoming New York Elections.

With minimal supervision from Attorney General Spitzer, however, the complicated settlement seems to have left the average individual investor behind.

Of the $942.5 million paid by the firms for that purpose, not one cent has yet been paid in restitution. But hundreds of millions have been spent by politicians to plug state budget gaps;

The pact’s acclaimed $55 million federal investor education foundation . . . disbanded . . . without spending a dime on education . . . Now the federal education money is being turned over to the NASD, a self regulatory body owned by the brokerage industry;

 The [twelve] Wall Street firms that . . . must pay $460 million over five years to provide ‘independent’ research to their clients. But it’s impossible for investors to assess the reliability of this research. 

The settlement may have reduced the amount of research available to individual investors . . . giving sophisticated pros a leg up on average Joes.

Likely things would have worked out better if Spitzer had referred the matter to the SEC whose charged with protecting all investors, not just the people of New York, and has the resources to administer a settlement like this.  Alas, that wouldn't have been good for Spitzer's gubernatorial campaign.  [Bill Sjostrom]

Blocking Acquisitions of US Companies by Foreignors

As discussed in an earlier post, the Committee on Foreign Investment in the U.S. (CFIUS) garnered a lot of attention earlier this year in connection with CNOOC’s failed bid for Unocal. Business Week reports here that there are now rumblings on the Hill about giving CFIUS more teeth:

A bill introduced by Senator James M. Inhofe (R-Okla.) would prod the panel to consider a deal's effect on American economic security and the need for energy and other critical resources. Inhofe's bill also contains a controversial proposal to give Congress a veto over foreign mergers.

Both the Bush Administration and business are against the changes. In particular, companies worry about retaliation against their overseas operations.

GM to Shop GMAC

The Wall Street Journal reports this morning that General Motors is exploring the sale of a controlling interest in GMAC, its finance company. A sale could yield from $11 to $15 billion depending on how it is structured. More importantly for GMAC, the sale would reduce its borrowing costs. Currently, GMAC borrows funds based on GM’s credit rating, which was downgraded earlier this year to junk status because of flagging North American sales, high labor costs and soaring pension and healthcare obligations. A separate GMAC would likely receive an investment-grade rating, saving it at least a full percentage point on borrowings.

The WSJ mentions Bank of America, HSBC Holdings and GE Capital as possible buyers. It also mentions a GMAC IPO as a possibility. Click here for a Detroit Free Press article.  I wonder what Kerkorian thinks of the plan.

Refco Agrees to Sell Futures Unit, Files for Bankruptcy

Refco struck a deal to sell its futures-trading business for $768 million to a group led by J.C. Flowers & Co. J.C. Flowers specializes in taking distressed financial companies and either turning them around or selling the pieces to other companies.  Refco said it expects definitive agreements to be reached soon.

Additionally, Refco and a number of its subsidiaries filed for bankruptcy under Chapter 11.  It is anticipated that the bankruptcy filing will slow the sale of assets but will allow for an orderly auction process, more time for due diligence and stem the tide of customer withdrawals. The WSJ reports that clients have removed at least $850 million from Refco's futures-trading business, representing 20% of its assets. Click here for a Reuters article with more details.

Iger’s Disney Employment Contract

In a recent SEC filing, Disney disclosed that the employment contract of Bob Iger, its new CEO, provides that Iger can be terminated for cause if he, among other things, fails “to cooperate … with any investigation or inquiry into his or the Company’s business practices … including … Executive’s refusal to be deposed or to provide testimony at any trial or inquiry.”  According to this Fortune article:

What that means in English is that if Iger stonewalls an investigation (like, say, former AIG CEO Hank Greenberg) or pleads the Fifth, the board can send him packing without his golden parachute. “This clause is quite unusual,” says Stephen Fackler, an attorney at Gibson Dunn & Crutcher who’s crafted hundreds of compensation plans. “Presumably it signals the efforts of the board to establish a different sort of board-CEO relationship in the post-Eisner era.”

Click here for the full-text of Iger's  employment agreement. 

The clause likely was also motivated by the heat the Disney board took with respect to Michael Ovitz's employment agreement.  Ovitz received a parachute payment of $140 million after a 14-month stint at Disney. Shareholders sued the board claiming, among other things, that it should have terminated Ovitz for cause thus avoiding the parachute payment.  As discussed  in an earlier post, the board prevailed in the litigation and settled the suit to avoid an appeal.

Refco's IPO Due Diligence

One of the troubling aspects of Refco’s implosion is that Refco just went through the IPO process.  Outside of an ex post government or internal probe, a company receives no greater scrutiny than from an IPO due diligence investigation.  The investigation is performed in the months leading up to the IPO by the lead underwriters and their attorneys and involves a close examination of all aspects of the company and its business.  The primary purpose of the investigation is to ensure the registration statement is accurate and complete in all material respects.  This obviously was not the end result  with Refco.  And its unlikely that the due diligence team failed to ask the right questions.  SEC regulations require that all transactions between the company and an executive officer in excess of $60,000 be disclosed in the prospectus (See Regulation S-K, Item 404).  Hence, a standard part of the due diligence process is to repeatedly ask about related party transactions so that the required disclosure can be made.  Clearly, the $430 million loan to the CEO should have been disclosed.  Refco illustrates the difficulty of detecting fraud when it is perpetrated by senior management (here, the CEO).  Notwithstanding that Sarbanes-Oxley has outlawed loans to executives, mandated increased internal controls, and ramped up auditing requirements through creation of the Public Company Accounting Oversight Board, nobody involved in Refco’s IPO due diligence detected the fraud.

Additionally, this situation further underscores the absurdity of the AICPA's efforts to greatly limit the role of auditors in the due diligence process, as I discussed in an earlier post.  At the end of the day, as was the case here, for many types of financial fraud the auditor is in the best position to catch it. Hence, auditors should remain an integral part of the due diligence process. 
[Bill Sjostrom]

Refco's Implosion

Less than three months ago Refco Inc., a derivatives brokerage, completed a successful IPO. On the first day of trading, the stock closed at $27.48, representing a 25% pop. A week and a half ago, its stock was at $28.00. Last week, its stock dropped to at $7.90, the NYSE halted trading in it, its bonds traded at 23 cents on the dollar (worse than Delphi bonds), its credit rating was downgraded twice, its banks were considering whether to call their loans, customers were pulling accounts, and Phillip Bennet, its CEO, was arrested. Tough week. So what happened? The marketplace learned that Bennet owed Refco $430 million relating to a scheme going back to the late-90s to bolster Refco’s financial statements. Refco’s business depends on credit, and bolstering its financial statements allowed it to borrow more money at better rates than it otherwise would have been able to. Refco’s credit is obviously garbage now so it has hired Goldman Sachs to figure out where to go from here, which could include a sale of assets or bankruptcy.  Click here for the latest.

The scheme was obviously not disclosed in Refco’s recent IPO prospectus, so plaintiff attorneys are circling. Refco’s largest shareholder, private equity firm Thomas H. Lee Partners, sold about 8 million shares in the IPO but still retains a 38% stake. Bennet owns a 33.8% stake. 

This is a different situation than other scandals (Enron, WorldCom, etc.) because it looks like it was perpetrated not to meet quarterly earnings estimates to keep the stock price propped up but to ensure a steady flow of credit on good terms. Also, the magnitude of the fraud is much smaller—Bennett in fact has already repaid the $430 million. If things had not moved so fast, Refco could probably have weathered the scandal. It may still make it, but it looks doubtful. In this climate, however, the marketplace hears the word fraud and heads for the exits, especially with respect to a business where trust is critical.  Given where Refco’s bonds are trading, it looks as if the market expects more revelations of fraud in the coming weeks, as was the case with Enron and WorldCom.   [Bill Sjostrom]