July 27, 2006
SEC Rules on Executive Compensation
The SEC finalized its new rules on the disclosure of executive compensation and they are a welcome addition to SEC regulation. The SEC did a good job here and we all owe them congratulations and thanks.
Of interest is why it took so long and SEC Chairman Cox's comment that "no issue in the history of the SEC has generated such interest." My experience with corporate legislation is that executive compensation is incendiary stuff. Corporate executives are fixated on the disclosure of their pay and will fight it tooth and nail, even blocking legislation that contains other provisions that are helpful to their companies if pay disclosure is part of the package. This is why, for example, the Delaware Supreme Court could not stand up to executives who threatened to move their companies to another state of incorporation if the court in the Disney case decided to police executive compensation.
Unfortunately, corporate executives will see this new required honesty as another reason to "go dark" or to stay private and not do an IPO, or do an IPO in London rather than the United States. Section 404 costs (from SOX) are troubling to executives in publicly traded companies but the disclosure of their true compensation may, unfortunately, be a more powerful incentive (even though it is not a good business reason as opposed to a personal reason) to stay or go private.
July 26, 2006
Phillip Goldstein has responded to my last post with an argument that the SEC is operating generally outside the scope of the authorizing legislation, the Investment Company Act of 1940. I am generally sympathetic to such claims and believe, like Goldstein, that the SEC has pushed some of its regulations past its Congressional mandates (I have written about this in the regulation of our trading markets under the amendments to the 34 Act). We are dealing here, however, with another act, the Investment Advisers Act of 1940, an act with different goals and policies. The Adviser's Act has both a broader reach and a lighter regulations than the Company Act. A manager can be required to register as an adviser and not advise a mutual fund, for example. At issue is whether, under the Adviser's Act, the SEC rules were unauthorized. Here is where the argument gets strained. Look, I do not like the SEC hedge fund rules either, never have, but the question of SEC authority does not depend on whether the rules represent bad policy.
Investment Banks and Private Equity
In an article by Landon Thomas Jr. in today's New York Times ("Goldman Finds Investing for Itself Rewarding"), Mr. Thomas discussed the conflicts faced by investment banks that also act as private equity investors. As a private equity investor an investment bank can compete with some clients for deals, other private equity investors that the banks service, and be on the other side of deals with other clients, blue-chip companies that the banks service. The bank must "walk a thin line", not upsetting other clients of its investment banking services (underwriting and consulting). The news story misses the big issue. Clients of an investment bank can take care of themselves, either waiving conflicts or not; they are fully capable of protecting their own interests.
There is an interest group that cannot protect its own interests easily, however, and that is affected by a bank's multiple roles -- public shareholders. When an investment bank that advises a publicly traded company sides with the company's executives against the public shareholders, as Merrill is doing in the HCA deal, then there is an affected party in the conflict that cannot protect itself -- the public shareholders.
July 25, 2006
"Emergency Rules" for Hedge Funds
SEC Chairman Christopher Cox has recommended his staff implement "emergency" provisions in response to the D.C. Circuit Court's decision invalidating the SEC new hedge fund registration requirements. He has instructed his staff to re-institute a "look-through" rule under another section of the Investment Adviser's Act, Section 206(4), a general anti-fraud rule. This does not re-establish a registration system for hedge funds however. Hedge funds, once the Court decision becomes effective in August, can voluntarily choose to register with the SEC but no longer will be required to do so. Cox has also asked the staff to raise the minimum wealth requirement for an individual to invest in hedge funds that charge a performance fee (most do) to $1.5 million (it is now $1 million). With heavy irony, Cox noted that the SEC now had to protect hedge funds that had relied on exemptions to past regulations contained in the now invalidated rules. These funds could be in violation of the old rules of the Investment Adviser's Act when the Court suspends the new rules in August.
Hasty regulations and now a hasty retreat are roiling the industry. The Treasury Undersecretary Randal Quarles, also testifying before Congress, had it right -- "it [is] premature to say we need regulation until we complete our review..."
HCA Buyout: A smelly deal
Three private equity firms and the senior executives of HCA have offered to buy the company for over $31 million, the largest buyout in history. This is a classic "management buyout", or MBO, in which the senior executives of the company participate on the buy side, purchasing the firm from its public shareholders. MBOs are rift with potential conflicts of interest and this one is a classic. Since 2001 the senior executives of HCA (the Chairman/CEO and the founder/Director) had as their advisor, Merrill Lynch, now one of the buyout firms. As executives of a publicly traded company the executives and their advisor had a fiduciary duty to the company to maximize its value for its public shareholders. Now they are buyers and maximizing value for themselves. These MBOs have an inherent off-color odor.
It will be a tricky dance for the lawyers to fumigate the smell. The company will create a committee of independent directors who will negotiate the price, ostensibly free of interference from the executives and the one time advisor. The committee, with new advisors and lawyers, will take competing bids, which will likely be non-existent due to HCA's size, and will bargain for a slight increase in price (to show that they are tough). The buyout group will have held back a few dollars a share in its announced price to account for the need to concede a bit to the committee. The buyout group will reform the company and resell it to the public (a "round trip") at a substantial profit. HCA has already done a round trip once.
The question in such deals is always the same. Why did the executives not do for the public company what they now propose to do for the company when they are the owners? Are the executive taking personally a corporate opportunity that they discovered as fiduciaries? [And in this case are their advisers also taking advantage of their inside information.] Have the executives of a publicly traded company "dogged it" to set up the buyout opportunity? Of course, we will hear heated denials (with great umbrage) all around to these questions.
Some of the potential answers are troubling. First, a publicly traded company is so heavily regulated that it cannot move in response to business opportunities. Our regulations are too heavy handed. Second, the executives of a public company have such large agency costs (personal incentive problems) that the elimination of the costs will bring large gains. The only answer that may be positive, a change in investor profile is necessary to accomplish a change in firm structure (the private firms are willing to take higher risks than are public shareholders), is empirically questionable (why the round trip, selling the company back to the public if public shareholders are unwilling to accept and price the new risks??).
July 24, 2006
ABA Committee on Executive Signing Statements
When the President is confronted with a law from Congress that he thinks is, in part, unconstitutional (it impedes executive prerogatives, for example) but he respects those parts of the law that are constitutional, what should he do? 1) Veto the entire law (he has no line item veto)? 2) Sign the law, enforce the entire law and bring an lawsuit in federal court to have the unconstitutional parts stricken? 3) Sign the law, enforce only the parts he believes are unconstitutional and not those that he believes are unconstitutional? The ABA wants him to do 1) and not 3), even though Presidents have done 3) for ages. What galls the ABA is that the President does 3) and announces it when he signs the bill -- he is transparent. He is signaling to Congress and others that those who object to his position can take the case to the Supreme Court. [They are correct here however that the Supreme Court should recognize Congress's complaint as a "case and controversy".]
The ABA Committee has decided this transparency is a threat to the constitution. Better to sign the law and then issue an internal memo to Justice not to enforce it?? If 3) is a constitutional option, and it is, then an open signing statement is the best way to announce the administration's intentions. The Committee (look at its membership) is anti-Bush. When Clinton did this in the backroom it was fine but when Bush does it out in the open, it is "a strategic weapon." Please.
Open Skies Agreement
United States statutes forbid foreign ownership of more than 49 percent of the stock of a domestic airline and of more than 25 percent of the "controlling stock" (voting control). Moreover, the statute forbids foreign owners from "any semblance of control" activity in an airline. The Bush administration, while not lifting the stock ownership limits, wants to lift the operational control limits over commercial activities. The administration hopes to attach more foreign investment into domestic airlines, which are struggling, and to use the concession to get concessions on United States investments in other industries in other countries. Congress is refusing to go along and has sent clear signals, in riders to bills, that it will not support the administration's position.
Congress and the Executive are following recent tradition in which Congress is protectionist and the Executive is facilitating international trade and investment.