January 12, 2007
Westar Energy Convictions Reversed
The criminal convictions of Wittig and Lake, convicted of looting Wester Energy of Topeka, were reversed by the tenth circuit. The opinion joins the list of other several circuit court opinions that have reversed convictions in major trials over financial scandals that were disclosed in 2002. Here is the pattern. Prosecutors discover widespread financial fraud can be very technical -- so they pick what they see as a clean, focused instance of abuse. At trial, the prosecutors cannot resist attempting to throw in all the bad conduct, most of it irrelevant to the specific charge, and they find that the charge they have chosen, in the heat of the moment, is itself a very technical claim. In the Witting and Lake case they chose to feature the executives personal use of company aircraft. The prosecutors came to realize late, apparently, that there is an SEC rule on the issue and the defendants may not have violated the rule. It makes sense to choose a specific part of the fraud to try but -- prosecutors must choose, as the saying goes, wisel and then stick to the strategy, try the case narrowly to match the claim
Caremark Takeover Case
The newly filed case against the directors of Caremark RX on the pending merger with CVS will ask the Delaware courts to face a very difficult problem -- when does the post deal compensation position of the insiders on the board create a disabling conflict of interest? The case also presents another challenge to common deal protection covenants -- the "no-shop" and "last-look" provisions.
Holman W. Jenkins, Jr. on Apple
Holman W. Jenkins, Jr. of the Wall Street Journal has written much and often on the options back-dating scandal. In short, he thinks the scandal is a excessively large media flap over the enforcement of an otherwise technical and now obsolete accounting rule. He has a point -- the options in issue should have been expensed on the income statement rather than disclosed in the footnotes to the balance sheet (because they were in the money and not at the money options)-- seems to be a minor lie (like a lie about one's age). But is it?? No. There are many things he overlooks. First, the lie may also have tax consequences. A percentage (small, I admit) of the options were in "tax qualified" plans that should not have been so characterized. Moreover, many of those who lied about grant dates also found it convenient to lie about exercise dates and exercise dates of all options, qualified or not, affect tax returns of both the company and the individual grantee. Second, it is disingenuous at best for high-tech companies, who fought like cats and dogs (and still do) over the new options expensing rule to now say that the failure to expense under the old rule, when they should have, is no big deal. The income statement figures matter to these folks in high tech industries. They were lying on something they cared mightily about, the bottom line on their income statements. It is easy to see why. High-tech companies have always worried about common valuation multiples (the p/e ratio of their stock for example), usually often their income statements -- more expenses, higher multiples. So, even if not in the minds of financial economists, in the minds of the executives of high tech companies, investors were affected because they could give investors lower multiples and make the stock look more attractive. The high tech companies have also worried about stock dilution. Jenkins makes the point that the companies who illegal back dated options could have given similar compensation value in "at the money" options legally, no sweat. Sure but the number of options required would have skyrocketed -- it takes many, many "at the money" options to equal the value of one solidly "in the money option." The options would be substantially more dilutive of the ownership (voting) rights existing shareholders. The companies, when options are exercised, usually try to buy back stock to offset the dilution, which means the companies have to buy back considerably more stock when executives exercise their options and this has nettlesome legal and public relations problems. Finally, Jenkins ignores that back-dating options is at is core a falsification of official records. This is a bad habit to get into. More importantly, there is always a sacrifice. Steve Jobs will not lose his job, or his stock derived from his illegal grants, but a young lawyer, newly hired out of law school by Apple, who did Job's (or someone's) bidding by creating the false documents will lose her job (she already has), and her reputation and perhaps even her ability to practice law. The back-dating procedure and its cover up requires scapegoats. The misuse of this young lawyer (who should have known better I agree) really, really fries me. Where is Al Gore's compassion on this???
Young Lawyer Ends Up Holding the Bag in Apple Back Dating Scandal
Executive stock option backdating requires false documents. At minimum, someone prepares a false resolution of the board of directors (a final grant of the options) and a false certification of the resolution (by a corporate secretary) and inserts the resolution into the official board minutes. Second, someone prepares a false disclosure document for filing with the SEC. The two documents are usually executions of otherwise carefully prepared form documents. It takes a lawyer who understand the need for the documents to execute the documents. Falsification will also necessarily involve those who direct the lawyer to falsify the paper and may also involve others who participate in certifying or signing the false papers with knowledge of their falseness. A young lawyer at Apple, right out of law school, admits to creating the false paper. No-one, however, will admit to asking her to do it nor to knowing that what she did was "wrong." She is left holding the bag.
At young lawyers in corporate practice should heed the simple advice of NEVER, EVER BACKDATE A DOCUMENT. Refuse to do it; if it costs you your job so be it. Otherwise it could cost you your career.
January 8, 2007
Private Equity and CEO Pay
The main charge against excessive CEO pay is the claim that CEO's are taking advantage of diffusely located shareholders in publicly-traded companies. A potential answer is the stunning data on the pay of CEOs in privately held companies. Private equity firms are offering similar pay packages for CEOs in privately held portfolio companies. The shareholders in such firms have no control problems; they are in firm control. There are two possible answers: First, the public firm pay packages have artificially set the market price for the private firms; and/or second, the problem is not shareholder confiscation but rather an issue of how a given among of compensation is dividend among employees (CEO on down to line workers). In other words, the CEO no longer divides the bounty with the rest of the employees of the company.