December 7, 2007
Executive Pay Consulting Conflicts
It took a formal series of hearings before a House committee, the House Committee on Oversight and Government Reform, to gather data on what most already knew to be true: Executive pay consultants are often giving advice on appropriate levels of executive pay when also acting under severe conflicts of interest. The consultants often also provide often services to the same corporation. Such a conflict for auditors was explicitly outlawed by SOX in 2002. At issue is why did this not come up in the several court cases that handled complaints on executive pay. Where are our courts on this?
United Health Ex-CEO Settles Backdating Charges
In a settlement of record proportions the ex-CEO of United Health, McGuire, has agreed to surrender 9.2 million compensatory stock options, a retirement plan, and an executive savings account. He allegedly acquired the options in a program that used back dating to maximize option value on grant dates. The total estimated value -- about $420 million. He also agreed to pay $7 million as a civil penalty to the SEC and will be barred from serving as an officer of a publicly trading company for 10 years. He had already voluntarily given back $200 million of options when he was fired. The total value lost -- $627 million. Yet, do not cry for Mr. McGuire; he retains 24 million in compensatory stock options in United Health valued at roughly $800 million. The former United Health general counsel has also settled, agreeing to repay $20 million in option gains and to surrender another $3 million in unexercised options. Where was the board of directors?? The entire board at the time of the option grants (from 1999 to 2006) should be fired. Their best excuse, they did not know, is not acceptable. The board approved these staggering payments and should have taken the time to make sure they were justified in their details. What a colossal abandonment of oversight.
December 6, 2007
The Subprime Bailout Plan: Anti-Trust Violation?
I am uncomfortable with the subprime bailout plan for reasons different that those made prominent in the press. First, it is not an assault on contract rights. One party to a contract, the loan servicer, can always offer new terms to the other, the loan debtor, in the hopes of working out a default. Furthermore, the workout cannot be a threat to investors in SIVs who hold the mortgage loan; the investors may get better returns with a workout than a default. Second, the subprime rate forgiveness agreement is not a government bailout. There is no government money involved, other than perhaps the FHA part of the plan -- which is another matter altogether-- and yet to be worked out (it has to be put into legislation). Third, it is not government fiat; participation in the plan is voluntary. But, my problem, the plan is a concerted agreement among competitors, sanctioned by the government. Without government involvement it would be an anti-trust violation. Individual loan servicers should work on their own rate deals and compete with other loan servicers on how well they do. The government should not fix the rates and then protected the fixed rates from anti-trust price fixing challenges by its involvement (state action is exempt). The plan is, flat out, an anti-trust violation.
Sovereign Wealth Funds
The investment of Abu Dhabi in Citigroup raises anew concerns about sovereign wealth fund investments in United States companies. I believe our regulation on these investments if badly flawed. The CFIUS system is front-ended loaded. That is, it attempts to stop the initial investment. It has no remedy for investments that have been made and are then misused. The effect is that we over-prohibit or over-condition the initial investment, discouraging investment in this country that we sorely need. The conditions for Abu Dhabi were heavy handed (they cannot vote their stock and cannot seek directorships). I am also uncomfortable about the involvement of Congress and its protectionist sentiment in the approval process. On the other hand, we under regulate investments that are misused once in place. We need to be tolerant of sovereign wealth fund investments as long as they act like investors and when they do not, impose corrective conditions. Designing triggers for corrective regulations after an investment is in place is tricky and itself can be overdone, also discouraging legitimate investment however. If China, for example, invests in United States companies and begins to use the investments for foreign policy purposes, we ought to be able, on good provable grounds, to sterilize any stock owned or cap sales of stock. or bonds owned.
The Subprime Plan
Blogs are abuzz with speculation about whether SIVS affected by the Paulson subprime loan plan revealed today have violated their fiduciary duty to their investors. The SIVs have voluntarily agreed to freeze teaser interest rates for five years for qualifying debtors on mortgage loans. It appears that the SIVs have favored the debtors over their investors and in so doing have violated their fiduciary duty to their investors. The plaintiff's lawyers are bound to be disappointed here. First, it depends on what type of entity the SIVs are and in which jurisdiction, if they are corporations, are they incorporated. Those SIVs incorporated in states with "constituency statutes" will not support a suit. Second, and more important, if the deal helps investors by producing more returns on the altered loans they can hardly complain. The SIVs (and their service companies) can argue that the SIV will collect more money not less if the majority losses from loan defaults (30 to 60 of the value of the loan) are replaced with minor losses from rate foregiveness. The stock market today pushed up the prices of firms that hold subprime debt, indicating that the market at least views the investors to be better off with the plan, not worse off. This litigation, at present, is will not be the gold mine hoped for by plaintiff lawyers.
Goldman Sachs Plays Both Sides
The activities of Goldman Sachs in collecting fees by creating and funding SIVS the purchase subprime loans (as an underwriter of the SIV securities) and in profiting as an investor by shorting the subprime loan market are raising eyebrows from Wall Street to Washington. The size of the short position does not support an argument for a pure hedging position. At issue is whether Goldman, and other banks that may have done the same thing, mislead investors as an underwriter by pushing secuirties that another part of the bank thought were going to decline in value. Many are carefully re-reading those underwriting prospectuses. For private litigants, this is a 33 Act Section 11 liability claim -- easier to prove than Rule 10b-5 liability (which also may be alleged). The SEC may have an even easier time with Section 17.
December 3, 2007
Goldman Sachs: Playing Both Sides?
There is scuttlebutt in the markets that Goldman Sachs, while creating the SIV vehicles based by mortgage loans that issued the CDOs that had caused such massive write downs, was, at the same time shorting the sub prime market. It took fees for creating the SIVs and investment gains on the short positions. If true, this should attract the attention of the class action plaintiff lawyers.