April 21, 2006
The Thompson Memo
The NYT reports that federal judges are uncomfortable with the Thompson Memo. Larry Thompson, then the deputy attorney general, authored a memorandum of guidelines on when to indict a company (as opposed to its officers) for criminal fraud. The guidelines considered company "cooperation" a mitigating factor and defined cooperation to include not providing attorney's fees or other support to indicted company officers. Officers who had negotiated attorney fees coverage in their employment agreements found companies refusing to advance cash to cover attorney fees to cover the expenses of trial. Companies will find, of course, that they will have to rely more on insurance companies and less on self-payment systems to avoid the full effect of the Thompson Memo. Payments by an insurance company are not controlled by the company (which has paid the premiums) and cannot be attributed by a federal prosecutor to any failure of "cooperation."
Section 404 of Sarbanes-Oxley
The advisory panel of the Securities and Exchange Commission making recommendations on Sarbanes-Oxley modifications held its ground yesterday. The panel had issued a "draft" report several months ago that had recommended that small public companies be relieved from the burdens of Section 404. Small companies (market cap of under $128) should be exempt and small to medium companies (market cap of $128 to $787) should partially exempt. The initial report attracted a flurry of critics, including a past SEC chair, Arthur Levitt. The critics noted that small companies are more likely to engage in financial fraud than large companies. The advisory panel issued its final reported and held its ground: "The benefits ... are really not worth the costs." The SEC will not decide whether or not to implement the panel's recommendations. I doubt they will. The SEC does not want to appear soft on fraud and does not want to be the subject of political opportunism ("we need to take control over the SEC to get tough on rich criminals") by Democrats seeking advantages in the upcoming elections for the House and Senate.
The auditors, the primary recipients of the higher costs of Section 404, have released a report claiming that Section 404 fees have decreased this year. Small company costs are an average of $860,000 (down 31%) and large company costs are an average of $4.77 million (down 44%). I am suspicious of the data; it depends on a separation of Section 404 costs from other audit costs. Total audit costs did not drop as much. The firms had an incentive to classify costs that could be either Section 404 costs or general audit costs as general costs to make the data a bit rosier.
April 19, 2006
Lee Raymond's Pay Package
Supporters of Mr. Raymond's pay package point to the total returns of Exxon over the past decade -- 223% (or $16 billion). Raymond's claim to only 4 percent of $16 billion looks ($400 million), well, even modest when hedge fund managers take 20 percent of the gains they create in an investment portfolio. This of course begs the question of whether he is easily replaceable or unique in the creation of the returns. If replaceable, a competitive market in human resources would price his value accordingly. When a jockey rides a winner in the Kentucky derby, how much is the horse and how much is the jockey. Supporters of Raymond simply assume that its mostly the jockey. I do not doubt that most CEOs are very capable, but we have no sense of how many other folks are also capable and could do a similar job given a similar opportunity and similar circumstances. I suggest that human nature (and bias) will cause CEOs and those close to CEOs of successful companies to overrate their importance when looking backwards. It is sobering to note, for example, the classic old study that found that stock prices go up on average on the death of a CEO. [Here in Columbus the stock price of two companies that had CEOs resign yesterday went up significantly.] Indeed, the beauty of the American system is that normal folks, with some diligence, get good opportunities and the system can survive normal mistakes. We do not need extraordinary Presidents or CEOs for us to prosper; capable folks will do.
New York Times and Its Shareholders
After reading column after column by New York Times writers Morgenson and Nocera on excessive compensation and wondering why the same columnists are silent on new shareholder voting enhancement proposals we learn that The New York Times Company itself has a dual class stock structure. At the annual meeting yesterday, a single dissenting shareholder, Morgan Stanley Investment Management, withheld its votes for directors. Morgan holds more than 5% of the Class A shares; the Class B shares, held by the Sulzberger family have significantly more voting power per share. Class A shareholders elect 4 of 13 directors; Class B shareholders elect 9 of the 13 members.The result was that around 30% of the Class A shareholders present and voting, withheld their votes. Morgan wants to consolidate the two classes of shares to force the board to improve management and share performance. Morgan noted that the paper's profits were steadily falling at a rate that was worse that the industry average (which is also suffering). Since January 2004 the company's shares have fallen 47 percent (industry - negative 35 percent) and yet management total compensation and increased substantially over the same period. Will the NYT columnists now rail against NYT management compensation?? Don't hold your breath. The dual class stock structure of the NYT and the WSJ protects both papers from takeovers and from shareholder pressure. Both papers are run by wealthy families who, it seems, will sacrifice company profits to kept a particular journalistic philosophy intact. Experience has shown us that in a fast changing industry, overwhelmed by technological change, this strategy inevitability proves to be a disaster (good companies ride old successes and existing trade names until the horse dies).