Business Law Prof Blog

Student Loans

Educators have long been concerned over the heavy loan debt carried by students once they leave school.  Their primary concern is that the loans constrain the work choices the students have once they graduate.  In other words, students cannot take "public interest" jobs and must, horrors, go to work in private industry to pay back their loans.  Like most redistributive arguments from the left, the argument assumes the existence of the loans.  That assumption is now in question.  One of the largest student loan agencies, the Penn. Higher Educating Assistance Agency, is suspending student loans, even if backed by the federal guarantees.  The collapse of the securitization market makes it impossible to cash flow the business.  In the past the loans were packages and resold and the new money was used for new loans.  Now the loans cannot be resold at reasonable rates and there is little new cash for new loans. 

So now students may not have to worry about repaying loans; they may not be any.  Students that do not have the cash to go to school must work before school in, I daresay, private industry, to raise cash to go to school.  Public service jobs will not support future tuition just as they did not support past tuition. 

Educational institutions could attempt to take up the slack by turning into loan companies, a task for which they are not designed and will not do well, but the amount available will be slight compared to the amounts that were available in the private market.  Government could step in the loans and we would have another huge, very expensive government system to fund and monitor all in a time when government budgets are stretched to the breaking point.  Higher taxes anyone?. 

Another hard lesson for the left--be careful what you complain about you may lose it.

Ohio's Economy

The debate last night in Cleveland Ohio between Barack Obama and Hillary Clinton featured a discussion about the Ohio economy.  Apparently both candidates blame NAFTA and other free trade agreements for the decline in manufacturing jobs in Ohio.  Both candidates featured, therefore, promised to "re-negotiate NAFTA" in the debate in an effort to win votes in Ohio.  Yes the Ohio economy is struggling:  Unemployment last measured in December was at 6%, a full percentage point higher than the national average;  mortgage defaults in the fourth quarter of 2007 were at a 1.44% rate, compared to a national average of .87%; over the last eight years, real median income has dropped from over the national average to $2,300 below the national average (a drop of around 10%); and over the last eight years Ohio has lost over 275,000 manufacturing jobs (a drop of about 25%).  But some other facts are notable:  1) Nafta took effect in 1994 and from 1994 to 2000 there was income and job growth in Ohio. Nafta is not the cause of the recent drop, which dates from 2000.  2) Nafta did not greatly reduce tariffs on Mexican goods, they were already low.  The inevitable conclusion is that trade with China (and India and other emerging Eastern Europe economies), which grew dramatically after 2000 (China's admission into the WTO dates from 2001) is a more likely cause.  Indeed, the stump speeches of both candidates now routinely attack China.  Any long-term solution for Ohio, however, has to involve investment incentives that induce private companies to locate or grow here.  This takes time and careful planning.  However, the other routine parts of the candidates stump speeches -- Attacking corporate profits or the pay of corporate executives or the decrying the pay and benefits of workers is not consistent with a plea for corporations to locate or grow businesses here.  Ohio needs to invest in infrastructure (roads, power sources, and cleanup of abandoned factories) and to invest in education and incentives for local talent to stay in the state; the state and the federal government need to reduce corporate taxes and dividend taxes (to eliminate once and for all any double tax on earnings); and the state needs to give up protectionist support (in its many forms) of industries that are not competitive.  We need to drop our takeover protections, for example.  We could also follow Indiana's example and privatize some of our government functions (Indiana sold its northern toll road to Australians who overpaid a whopping $6 B and used the money to attract three new Japanese car manufacturing plants).       

Sweet Irony

A piece in the New York Times by Andrew Ross Sorkin today castigates CEOs for not doing more M&A deals in the current, volatile stock market.  Sorkin notes that many deals fail and that those that are successful are often at the beginning of a "deal" cycle.  Deals that are done in "follow the leader" markets are most likely to not be successful. His conclusion?  CEOs should do more deals now, when the market is unsettled and M&A volume is down.  This from the paper that in the past has routinely lambasted deal makers.  While I am on this tack one should note that after the paper's many attacks on the dangers of hedge funds last year it is the main line investment banks and brokerage houses (and often their internal hedge funds) that have disgraced themselves in the sub-prime loan mess.  The main line banks have inadequate risk controls on a process that separated incentives from long term quality; the private hedge funds have, as a group, done somewhat better.      

Potter v Bailey: The Wrong Debate

Several opinion writers, Floyd Norris is the latest, have noted the application of the movie "Its a Wonderful Life" to the sub-prime mess.  Bailey, the idealist, versus Potter, the cold hearted investor, in evaluating the plight of sub-prime borrowers who cannot face their mortgage payments in ARM resets.   Should we show compassion or be tough?  "We can't [foreclose]. These families have children." [Bailey]  "They're not my children" [Potter]  So Congress and the Fed are ready to pass laws that look silly on their face:  1) Banks cannot loan money to those who cannot pay it back.  2) Banks must verify income figures from those presented by borrowers (stopping "liars loans") 3) Banks must check the objectivity of appraisals on property that is collateral to loans.  They might as well pass a law that states 4) Banks should be profitable.  The laws restate bank's obvious business incentives and perversely given borrowers the incentive to try and hook wink banks so they can sue under the new statutes.  The most rational borrower under the new rules is now one that goes to a bank purposely ignorant, hoping a bank will make a mistake, so the borrower can get something for nothing.  The fallout, no more sub-prime loans to anyone anywhere anytime, will hurt people with poor credit ratings the most, the sub-prime borrower. 

The core of the problem in internal bank controls (whether as investor in SIVs or as originator/underwriter of SIVs) and banks are suffering huge losses because of it. We do not need legislation to correct this; banks will correct it themselves.  The market has its own penalties -- CEO are getting fired, financial stock is swooning, new owners (China and Abu Dhabi) are buying stakes in our banks, investors will not longer buy any securities backed by mortgage loans -- the correction is already in place.  We do not need new legislation.  Prosecutions should sue those it can find who lied to people and plaintiff attorneys should be class actions against banks that did not disclose problems with internal control fast enough.  The system is working the way it is.

This is another classic case of government overcorrection, fueled by bleeding-heart columnists.   

Income Inequality

The new CBO report on IRS data from 2005 shows that the richest 5% had the largest percentage gain in income from 2000 levels.  It also shows that all levels gained to some degree.  What we are unhappy about is the percentage gain was not spread out more evenly.  First, we should be delighted that all levels gained. We take this for granted.  It may be that it is more likely than not that all levels gain if the top gains rather than the reverse.  Second, the top levels pain a higher percentage of total tax.  The richest 1% pay 39% of all income taxes (a gain of 2% since 2000); the richest 5% pay 60% of all income tax (a gain of 4% since 2000); the richest 10% paid 70% of all income taxes.  It is hard to imagine a more progressive tax system than we have already.

The Home Foreclosure Mess

The top three states in home foreclosures are California, Florida and Ohio.  In California and Florida there was a spike in real estate values that attracted speculators, many of whom were flippers.  The speculators who took risks and lost do not deserve much sympathy.  In Ohio, however, the housing market did not show substantial price spikes.  The situation is very different.  Those losing their homes were cause by rising unemployment rates in their income sectors and by the false hope (lured by low teaser initial rates) that many in the lower income sectors could afford homes that were beyond their means.  Should government money bail them out? Should the government force "renegotiation of rates" (should SIV trustees be prohibited from foreclosing)? The argument is more complicated.  One has to balance long-term injury to the home lending market (caused by disabling execution on loan; loans with be more expensive in the future and less available to lower income earners) with short-term relief for those who are facing the lose of their homes.  The moral questions are much tougher.  Since the government, if empowered will probably make a mess of things, I would let the market clear on its own.   

Ohio Court Stops Foreclosures by SIVs

A federal judge in Ohio, Judge Boyko in Cleveland, asked a straightforward question of Deutsche Bank National Trust Company, a trustee for securitization pools of mortgage backed securities.  The bank was attempting to foreclose on 14 homes in Ohio. "Prove that you own the loan and the mortgage."  he asked.  The Bank could not.  The legal papers had not kept up with the multiple assignments that created the securitization pools.  This is a new and serious wrinkle for the already hammered SIVs who have pooled subprime mortgages and sold securities in the pools to others.  The default rates on the mortgages are up and the value of the securities is, corresponding, down, causing major banks, who had purchased the securities to take massive write-downs.  Now the potential defaults will be augmented by the possibility that the SIVs cannot  execute on the homes.  Loans that were worth 40% to 60% of their face value (due to the underlying collateral, the home) are suddenly worth nothing, nadda, zero.  The write downs will get bigger unless the lawyers can figure out how to find the appropriate legal documents that demonstrate ownership. 

GM 3rd Quarter Loss

General Motors reported a third quarter loss of $39 billion dollars. GM attributed the loss to a $38.6 billion non-cash charge largely related to the write-off of accumulated deferred tax credits. The loss is the second largest quarterly corporate deficit in the history of the United States. According to Standard and Poor’s, the largest quarterly deficit belongs to AOL, who wrote down $45.5 billion following its troubled merger with Time Warner in 2002.   The reported loss is larger than GM's total market capitilization.  Those who admire unions might ask themselves whether any unionized industry in the United States is doing well at the moment. A serious question for management is whether the shareholders would be better off if the company were liquidated and the cash reserves just distributed to shareholders in a liquidation dividend.

Credit Suisse Case on the IPO Market

The Supreme Court held In Credit Suisse Securities v Billing, consistent with its past history, that securities laws cede jurisdiction over market structure of the securities markets to the SEC, pre-empting the federal antitrust laws.  The ruling was not a surprise.  I agree with the holding but not he SEC use of its power; the SEC has favored antifraud enforcement over competitive concerns and, in my view, overly micro-structured the securities markets to limit otherwise healthy competition.  Justice Stevens concurring opinion reminds me that judges, when they step out from making jurisdictional decisions and decide to comment on market forces, are often, well, just out of their league.  Justice Stevens pronouncement that underwriting syndicates cannot fix prices and the suggestion that they can is "frivolous" is a laugher.  The market for underwriting has very few players (there are five or six large investment banks) and underwriting fees for stock are an amazingly stable 7% across time, across types of companies, across size of offerings.  To say that the few underwriters, participating in each others offerings, have informally or formally colluded to fix a 7% rate is not frivolous; it is plausible, even probable.  Then there is the "underpricing problem."  Watch the Blackstone IPO on its first day.  Why do American IPOs average, 15% or more underpricing on the first day?  There are competing theories, some are market based and some are not (they are based on the market power of investment banks).  Stevens is way out of his league in his pronouncements in his concurrence and he was sanctimonious in tone when he wrote them.  Why make such statements without an adequate record or investigation?  Put on the robe and some judges get instant smarts.       

The SEC and Global Uniformity

I am consistently buffaloed by the SEC's strategy on global integration of our legal standards.  We are told by the SEC that the Sarbanes Oxley Act of 2002 will put American markets ahead of other markets, give us a competitive advantage, because our markets will have more integrity due to stronger rules against fraud. Then, in the next breath, we are told that we will accept international accounting rules rather than use our own so we can integrate with the global disclosure standards.  Should not, using the SEC's logic on SOX, our rules be better or stronger??  Accounting rules are at the core of the disclosure system; if we brag about having the best regulatory system to differential ourselves from other world markets should not our accounting rules be unique and better.  Pick a strategy or explain why SOX (on accounting rules, by the way) is different than FASBs (v IFRA). 

"The [Public] Corporation Will Disappear"

Holman W. Jenkins, Jr., of the Wall Street Journal quote Nobel laureate Myron Scholes in the Weekend edition that "the [public] corporation will disappear."  His point:  the move from public markets in favor of private equity markets is caused by risk management contracts (derivatives) competing with equity.  He also notes the impact of regulation has affecting the trend.  His point only makes sense if one does not "look through" investors.  A public corporation has over 500 shareholders (300 on the way out).  We are calling corporations private is they have less than 300 shareholders even if each of those shareholders is itself a pool of multiple investors.  If we "looked through" the funds and counted individual investors, the 300 shareholder limit would be shaky for many newly converted "private companies."  In other words, his argument does not rest on risk management as much as it rests on a legal rule that does not permit "look through" judgments.  [ Recall the ill fated hedge funds rules which do use "look throughs"]  It suggests to me that an old, old standard, the 300 shareholder rule should be reconsidered and SEC regulation (for IPOs and for periodic reporting requirements, including Section 404 of SOX ) should scaled with the total capitalization of the firm.  This is the primary request of the Small Business Advisory Committee that reported to the SEC last year.  The SEC rejected the request out of hand; it should look at the scaling regulation question again. 

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

Judge Kaplan and the KPMG case

The Wall Street Journal editorial page today called the KPMG tax fraud case in New York a "fiasco" and suggested that the Justice Department "reconsider" the case at its "senior levels."  The behavior of the Justice Department attorneys has been less than exemplary but there is another problem here.  We are watching a Judge over control a complex case.  And there is no normal relief for this until an appeal.  Kaplan has written a scathing opinion in June over the government's use of the Thompson Memo.  Judge's should rarely write "scathing" opinions; this should be reserved for a once in a decade case.  A Judge has the awsome power to decide the fate of the people before her; she rarely needs angry words -- a decision is enough. The Judge does not like the policy of the memo (I do not either) but wrote a nutty legal analysis about its unconstitutionality.  The Judge continues to "exchange barbs" with prosecutors.  Judges should not "exchange barbs" with anyone (again, perhaps, with a one in a decade exception).  Now the Judge has delayed trial, trial Judges should normally do the opposite and facilitate and push for a speedy trial on the merits, except in very unusual circumstances.  This case is not that unusual .  A Texas judge has ruled on the merits that the KPMG tax shelters are legal; a speedy trial may even benefit the defendants here.

I suspect that the Wall Street Journal may get its way and the Justice Department will drop the case.  The Judge's decisions and conduct will not get reviewed.  Indeed, it may be vindicated.  Pity.

Federal district court judges are an admirable bunch, but a few, a very few, are not.  They sit alone in important cases and can, with self-righteous sanctimony, lose patience and focus.  I have been there and seen it.  I have not been in this courtroom to watch this case and therefore cannot say.  From long distance ... 

Kerkorian and GM

The push by Kerkorian to join GM with Nissan and Renault is the subject of much speculation on whether it will work and whether the GM board will buy it.  Kerkorian's motives have also been dissected.  See Paul Ingrassia, Kerkorian Motors, WST today (Kerkorian wants new managers and likes Ghosn of Nissan).  Many are missing the boat.  GM's problem is an operating deficient caused by overpaying its workers, masking by a stash of cash.  The company must wait for the cash to run out, sucked away by operating losses, before it can restructure in bankruptcy.  An alternative is a merger.  The GM shareholders, Kerkorian included, can use the merger to take cash out of the company and the new owners can restructure.  It is a brilliant use of a well known acquisitions strategy. The GM board should go along. 

Not for Profit Troubles

Not for Profit Corporations (or nonprofit corporations) have been repeatedly in the news recently for scams.  Some are overpaying their CEOs (NYSE), some are making political contributions (churches), some are not doing what they promised in exchange for their status (hospitals that do not treat the indigent), and some are in illegal tying arrangements with for profit business (home down payment charities).  Without oversight by private owners, we must rely on the IRS and state attorney generals for regulation of not for profits.  Charities are not high on their list of concerns.  Abuse is the inevitable consequence. 

Mr. Ellison... Where's our money??

Posted by Jason R. Job

That's what Harvard is saying to Oracle Corp. founder, Larry Ellison.  According to Sarah Duxbury at the San Francisco Business Times, Mr. Ellison has failed to pay any of the $115 million pledge to Harvard to create The Ellison Institute for World Health. (See link here).  According to the article, Ellison's pledge would have been the largest single give in Harvard's history.

Additionally, Ellison still owes the $100 million that he was ordered to pay to charity as a part of a settlement which he proposed back in September and was approved in November.  (See Prof. Oesterle's discussion of the settlement in his related post Ellison Settlement Questions).

Having worked a bit with the Ohio State Foundation when I was in school, I am sure that many parties are working long and hard to obtain Mr. Ellison's pledge.  However, more importantly, this story will become a PR nightmare for both Oracle Corp. and Mr. Ellison.

Wal-Mart

Wal-Mart is the world’s biggest company by sales.  Its sales for fiscal year 2005 were over $312.4 billion.  Wal-Mart now has over 3,800 stores nationwide. In America there are more Wal-Mart employees (1.3 million) than high school teachers.   

The company’s competitive advantage is its sheer efficiency – it is a superbly run organization that sells products for less than anybody else can. 

Why is such a successful company, an employer of millions, so controversial?

    Several communities have voted to keep Wal-Mart stores out on the grounds that the stores destroy local shopkeepers.  Others claim that Wal-Mart pays parsimonious wages. The State of Maryland has passed legislation, aimed at specifically at Wal-Mart, that requires large, non-unionized retailers to spend a minimum amount on health-care benefits.  Banks are fighting Wal-Mart’s request to offer its own, inexpensive personal credit card.

The rhetoric gets heated. In the language of the street, Wal-Mart is a “modern day plantation” paying “slave wages.”

The “Wal-Mart effect” is the subject of three new books and a documentary film.  Two of the books and the film are harshly critical.  The title of the book by Anthony Bianco, The Bully of Bentonville: How the High Cost of Wal-Mart’s Everyday Low Prices is Hurting American, sets the tone of the criticism.  There is a high social cost to Wal-Mart’s low prices.   

Behind the charges, data is scarce.  Here is what we know to date.  A typical Wal-Mart store employs 150 to 350 people; the bigger “superstores”, which also sell groceries, employ 400 to 500.  The arrival of a store in a typical county destroys 180 to 270 retail jobs over what it employs.  A Wal-Mart associate does the job of 1.5 to 1.75 people at any rival. 

Yet a Wal-Mart attracts new retailers that take advantage of the increased customer traffic and the new retailers create new jobs.  The retailers set up across the street and put out “workers needed” signs.  Estimates of the average new job creation around a single new Wal-Mart store exceed the number of jobs destroyed by the store by close to 100.  In other words, there is a net gain in jobs, not a net loss.

Do Wal-Mart’s pay “slave wages”? A new study by David Neusmark and co-authors (Public Policy Institute of California) estimates that a Wal-Mart store reduces per worker retail wages by only about 1 percent. 

On the positive side, what Wal-Mart saves in efficiency, lower payrolls, it passes on to consumers in prices.  A Wal-Mart store in the area slashes one’s shopping bills, even if a shopper never shops there. 

Emek Basker, an economist, estimates that the price of goods such as toothpaste, shampoo, aspirin and laundry detergent fall by 7 to 13 percent in the five years after Wal-Mart’s arrival in a city.  The Economist, the world’s best news magazine, reports that superstores return 25 cents back for every dollar spent on groceries, a average savings of $450 a year for a family.  The numbers on other merchandise, clothing, are larger still. 

The numbers will not silence the critics.  They know consumers save at Wal-Mart and the total employment and wage numbers will not satisfy. 

Wal-Mart is a lightning rod for a diverse body of social critics.  Some are suspicious of the deeply religious, white Protestant culture of the company’s leadership.  Others dislike capitalism, the profit motive, and the regimen of financial efficiency.  Yet others fear size or the “not from around here” nature of the business.  There is an odd “do they really care about us” uneasiness about a business designed to give costumers’ exactly what they want at the lowest price.

Wal-Mart’s success has inevitably attracted social critics of American culture and economic system.  Wal-Mart is best, the most successful, at prospering in this system and therefore the most obvious target.  Wal-Mart will find no relief from such critics – until a better retailer comes along.

Ballot Initiatives: Using The Wedge Issue

Those who put ballot initiative procedures into state constitutions thought that they were a counterpoint to political parties.  When politicians ignored the wishes of the people, the people, using ballot initiatives, could enact their views into law.

But politicians are a resourceful group and they have figured out how to use ballot initiatives to advance their political party’s fortunes.  They have discovered the “wedge” ballot proposal. 

Here is how it works.  A political party needs to energize its political base for an election so its core voters will show up at the polls.  If they show up they will vote for the party’s candidates.  To whip up excitement among these loyal but undependable voters the party puts a carefully selected initiative on the ballot.  The initiative is on a hot button issue that the party’s core voters care very deeply about.   The core voters will show up just to vote on the initiative and stay long enough in the voting booth to also vote for the party’s candidates for office.

Republicans used initiatives on gay marriage in the 2004 President race to turn out conservative voters.  Some pundits claimed that the Ohio initiative on gay marriage gave President Bush the extra 60,000 votes he needed to claim the Electoral College votes of Ohio, the pivotal state in the election.  In this year’s Congressional elections, the gay marriage initiative is on another six state ballots.  Republicans are also using initiatives on tax and spending limits to turn out their base conservative constituency in several other states.

The Democrats, although late to the tactic, have responded with ballot initiatives of their own.  In the 2004 Senatorial race in Colorado, the Democrats took back a seat held by the Republicans with the help of a ballot initiative promoting renewable energy sources.  In six states this year, Democrats have successfully placed initiatives on the ballot that raise the minimum-wage.  In Missouri this year, a Democrat for the Senate is hoping for help from a ballot initiative permitting private funding of embryonic stem-cell research.

Academic research has found that ballot initiatives are effective in midterm elections.  The authors of the studies have found that ballot initiatives can increase voter turnout by as much as eight percentage points.  The studies of presidential campaign are mixed however; some find no effect on voter turnout in some states while others find a small effect.

But, as I noted above, politicians are a resourceful group, and they are already developing counter measures.  The most obvious counter-measure is to match ballot initiative with ballot initiative.  Both parties struggle to get offsetting ballot initiatives on the same ballot. 

The more subtle counter-measure is to moot an opponent’s ballot initiative with legislation.  In Michigan and Arkansas, for example, Republicans in the state legislature passed minimum wage increases to keep the Democrat’s initiative on minimum wages off the ballot.  Around elections then we can expect to see state legislatures flip-flop on legislation.  A state legislature controlled by one party that has blocked legislation promoted by the other will, on the eve of the election, pass the other party’s bills.

This counter-measure, of course, will further encourage a minority party to have several ballot initiatives in advance of any election.

Whether all these is good or bad is hard to say.  One thing is for certain, however, political parties will be a very vigorous proponent of ballot initiatives in all future elections.                

GM's Way Out??

GM is bleeding cash, $10 billion last year for Pete's sake, and still cannot declare bankruptcy (Chapter 11) to do the radical restructuring necessary to survive as an ongoing company.  Takeovers, the 80s method of workouts outside of Chapter 11, are blocked by state legislation and state courts.  Proxy contests take too long, are too expensive, and have only a very small chance of success.  What to do?   New accounting proposals, not yet in place, would require companies to report their pension deficits.  With the GMAC sale, the new accounting rules would leave GM with a negative shareholders' equity of $43 million (instead of the positive $14.6 billion under existing rules).  Eureka!  Declare a change to the proposed rules, declare bankruptcy, enter Chapter 11, form the creditors committees and fix the company.

NYSE & Archipelago Merger Gets SEC Approval

Yesterday, the SEC approved the merger between the NYSE and Archipelago Holdings, Inc.  The deal is supposed to close on March 7, 2006 and the combined company, NYSE Group Inc., will trade under the symbol NYX.

Our Coverage:

NYSE Merger with Archipelago Holdings (May 3, 2005)

NYSE/Archipelago Deal (November 5, 2005) by Bill Sjostrom

NYSE Spin on Shareholder Primacy (November 8, 2005)

NYSE Settles (Nov. 16, 2005)

Media Coverage:

Washington Post

Bloomberg.com

FoxNews.com

Associated Press via Yahoo!

Additional Coverage:

Publically Owned Stock Exchanges: An Unexpected Consequence -- A User Backlash

Cramer's Darling GOOG Misses

Posted by Jason R. Job

One of Prof. Oesterle's "favorite" stocks when I was a student at Ohio State was Google.  Every day in class, he would come in and discuss why he believed that Google was overvalued.  (Check out some of his discussions of GOOG: Oct. 21, 2005; Aug. 18, 2005 (Google at One); July 22, 2005).

Today, after the closing bell, Google (NASDAQ: GOOG) reported net earnings per share of $1.22 per diluted share while street estimates were $1.51 a share.  After GOOG reported earnings, its shares were halted.  Then, once the shares reopened for trading, GOOG was trading down $70 to $361 per share or 17%.

Additionally, it will be interesting what Jim Cramer has to say tonight on Mad Money when his "fan favorite" is trading down nearly 150 points from his prediction!! (Cramer expected shares of GOOG to hit $500).  BOOYAH!

Truth on the Market Blog

We would like to congratulate former contributing editor to the Business Law Prof Blog, Prof. William Sjostrom and his fellow bloggers  for creating another business based blog, Truth on the Market(TM).  In its introductory post, Prof. Sjostrom describes Truth on the Market as follows:

We have launched this blog to provide the metaphysical subjective truth on abstract, concrete and invisible markets throughout the civilized world (whatever that means). More specifically, as indicated by our current tagline (we know it’s unoriginal; we hope to come up with something better soon) our blog will provide academic commentary on law, business, economics and more. The “more” will include observations on law school, blogging, being a law prof, smoking bans, payola, legal valuation, football, processed cheese, and calorie counts, among other things.

Buyer's Remorse?? Boston Scientific Raises Bid for Guidant to $80 a Share

Posted by Jason R. Job

This morning, Boston Scientific (NYSE: BSX) announced that it has raised its former $73 a share bid for Guidant (NYSE: GDT) to $80 a share in hopes to purchase the company. (Reuters story.)  According to the terms of the deal, GDT shareholders would receive $42 in cash and $38 in BSX common stock.  Additionally, BSX has increased the bottom of the price collar and if the deal does not close before March 31, 2006, it has offered to increase its bid by $0.0132 per day between April 1, 2006 and the closing day.  Further, BSX has added Abbott into the mix.  Abbott has agreed to purchase BSX's intervention and endovascular businesses, while agreeing to share rights to Guidant's drug-eluting stent program and has agreed to purchase $1.4 billion in BSX's common stock contingent on the closing of the BSX-GDT acquisition.

As Professor Oesterle has stated many times prior and I completely agree with, there will be some buyer's remorse when GDT finally does sell itself.  Johnson & Johnson began this bidding war at $76 and then dropped its price to the mid 60's before BSX stepped in.  Since then, I have not noticed any "big news" out of GDT, which would make them more profitable.  Basically, this has just become a bidding war between two companies who believe they will be getting the great company to increase potential synergies for their shareholders.  However, the big winner in this whole game will be the shareholders of Guidant who have seen their potential buyout jump from $68 to something around $80 a share.

Update:

Reuters is reporting that GDT is now seeking a $77 per share offer from JNJ in order to preserve their agreement.  As GDT's board meets today to determine whether BSX's $80 bid is superior, JNJ does have 5 days to counter-offer or walk away from the deal and accept the $625 million break-up fee.

Kerkorian's Tracinda Sells 12M Shares of GM

Posted by Jason R. Job

Late yesterday, when General Motors (NYSE: GM) closed trading at a 23-year low, Tracinda, the investment vehicle for Kirk Kerkorian, filed with the SEC that it has sold 12 million shares of General Motors, reducing its stake to 44 million shares.  The SEC filing can be found here.  According to the filing, the following describes the purpose of the sale:

On December 15, 2005, and December 19, 2005, Tracinda sold 5,000,000 shares and 7,000,000 shares, respectively, of General Motors common stock in private transactions. Tracinda sold these shares

because it is eligible for substantial federal and California corporate income tax savings if it incurs a capital loss prior to the end of its current fiscal year, January 31, 2006. The capital loss will offset certain capital gains realized by Tracinda in an unrelated transaction. The Filing Persons may determine, based on market and general economic conditions, the business affairs and financial condition of General Motors, the market price of its shares and other factors deemed relevant by the Filing Persons, to acquire or dispose of additional shares. In this regard, the Filing Persons may consider acquiring additional shares when they are able to do so without jeopardizing the tax benefits realized as a result of the sales described herein.

Kerkorian's Tracinda sold the shares of general motors for $251 million.  A far cry from the $372 million he would have paid for those shares from his $31 per share May 2005 tender offer.

Even though Kerkorian's reason for selling the stock, I feel is somewhat legit.  I do question whether his true motivation is to lessen his stake in a company that is having some major problems, allowing him to sleep better.

Today, GM shares have traded as low as $19.30, but currently are trading for $20.15.

SEC Committee to Discuss SOX 404 Exemption

Posted by Bill Sjostrom

The SEC Advisory Committee on Smaller Public Companies is meeting tomorrow at 9am EST.  According to this article, the committee, among other things, will be discussing a proposed small company exemption from oft-maligned Sarbanes-Oxley Section 404.  Click here for the meeting agenda, including a link for the live audio webcast of the meeting.

Large Investors Not Done With Wendy's

Posted by Jason R. Job

Today, Billionaire Investor Nelson Peltz told Wendy's International (NYSE: WEN) that he believes that the shares are undervalued.  In a Schedule 13D filed by Peltz's investment vehicle Trian Fund Management, Peltz notes that the purpose of his approximate 5.5% stake in Wendy's is as follows:

"The Filing Persons acquired the Shares and Options because they believe that the Shares are currently undervalued in the market place and represent an attractive investment opportunity. In early December 2005, a representative of the Filing Persons attempted to contact John T. Schuessler, the Chairman of the Board and Chief Executive Officer of the Issuer, several times. After leaving several messages for Mr. Schuessler, the representative of the Filing Persons was contacted by Mr. John Barker, Senior Vice President, Investor Relations and Financial Communications of the Issuer. The representative of the Filing Persons told Mr. Barker that “we come in peace” and that the Filing Persons had established a significant stake in the Issuer, just below the Schedule 13D 5% filing threshold. The representative of the Filing Persons requested a meeting with Mr. Schuessler, at a convenient time and location, to discuss the Filing Persons’ value creation plan, which includes (i) the immediate commencement of a 100% tax-free spinoff of Tim Hortons, (ii) the sale of the Issuer’s ancillary brands, (iii) the reevaluation of certain components of the Issuer’s previously announced strategic initiatives and (iv) a significant reduction in costs at the Issuer’s Wendy’s Old Fashioned Hamburgers business. The representative of the Filing Persons advised Mr. Barker that if the Filing Persons’ value creation plan was discussed and agreed to, the Filing Persons would possibly maintain their ownership level below 5% (and not file a Schedule 13D) since the intention of the Filing Persons was not to wage a battle in the press. On December 6, 2005, Mr. Barker informed the representative of the Filing Persons that Mr. Schuessler was currently too busy “managing the brand” to meet with representatives of the Filing Persons. A paper prepared by the Filing Persons that sets forth “A Recipe for Successful Value Creation” at the Issuer is attached hereto as Exhibit 3, and incorporated herein by reference.

The Filing Persons do not have any present plan or proposal that would relate to or result in any of the matters set forth in subparagraphs (a) – (j) of Item 4 of Schedule 13D except as set forth herein or such as would occur upon completion of any of the actions discussed above. The Filing Persons intend to review their investment in the Issuer on a continuing basis. Depending on various factors including, without limitation, the Issuer’s financial position and strategic direction, the Issuer’s response to the actions suggested by the Filing Persons, price levels of the Shares, conditions in the securities market and general economic and industry conditions, the Filing Persons may in the future take such actions with respect to their investment in the Issuer as they deem appropriate including, but not limited to, purchasing additional Issuer Securities or selling some or all of their Issuer Securities, communicating with the Issuer or other investors or conducting a proxy solicitation with respect to a minority of the Board of Directors of the Issuer at the Issuer’s next annual meeting, at which one-third of the Board of Directors of the Issuer may be elected. The Filing Persons have no intention, either alone or in concert with another person, to acquire or exercise control of the Issuer." 

The full version of the Schedule 13D filing can be found here.  A Reuters article can be found here.

This is the second time this year that a large shareholder has went after Wendy's stating that its shares are undervalued.  As described in the post An Example of The New Strategy of Hedge Funds: Wendy's, Pershing Square Capital Management pushed Wendy's to spin off a portion of its Tim Hortons business.  Pershing Square has also purchased a large stake in McDonalds, which is described in the post Will Ronald McDonald Put on His Smiley Face for the Hedge Funds.

In morning trading, Wendy's is up $1.50 to $52.87 or approximately 3%.

Monday M&A Activity

For those of you looking for M&A activity, Paramount Pictures has agreed to purchase Dreamworks SKG for $1.6B.  (AP report can be found here).  According to the terms of the deal, Paramount Pictures, a division of Viacom Inc., will purchase Dreamworks SKG for $775M in cash and assume $825M in debt.  Additionally, Paramount Pictures will have the distribution rights to the lucrative Dreamworks Animation SKG Inc., which includes the rights to distribute the "Shrek" franchise.

There are also a couple of rumors hitting the street this morning.

Reuters is reporting that a group of three private equity firms (Bain Capital, The Carlyle Group, and Thomas H. Lee Partners) will announce a deal to purchase Dunkin' Brands for about $2.4B.  (Reuters article can be found here).  Dunkin' Brands, which includes Dunkin' Donuts, Togo's sandwich stores, and Baskin Robbins ice cream, is being sold by French beverage company Pernod Ricard.  Earlier this year, Pernod Ricard along with Fortune Brands purchased British rival Allied Domecq for $14.2B, which previously owned Dunkin' Brands.

The Wall Street Journal online edition reported Sunday that ConocoPhillips (NYSE: COP) is in advanced talks to purchase Burlington Resources (NYSE: BR) for more than $30B.  (Reuters report can be found here).  With the price of natural gas rising, Burlington Resources' natural gas assets are seen to be the major reason for this potential deal.

Botched Trade Costs Tokyo Brokerage Approximately $225M

Posted by Jason R. Job

Hans Gremiel, a writer for the AP, wrote an article about how the Japanese government has rebuked the Tokyo Stock Exchange and Mizuho Securities Co. over a typographical mistake cost Mizuho Securities over 27 billion yen, which equates to approximately $225 million.  (Article can be found here).

Basically, a trader for Mizuho Securities wanted to sell one (1) share of J-Com Co. on Thursday morning at 610,000 yen.  However, the trader incorrectly typed the trade in to sell 610,000 shares at 1 yen.  J-Com Co., a job recruiting firm, was debuting on the Tokyo Exchange with approximately 15,000 shares being offered.  Nevertheless, the Tokyo Exchange processed the sale of J-Com, even though the sale was approximately 41 times the number of outstanding shares.

According to the article, this sale cost Mizuho Securities at least 27 billion yen, but since it occurred through human error, that amount could easily increase.  Additionally, Mizuho Financial Group, the parent of Mizuho Securities and Japan's second largest bank, stated that they would fully back the losses from the erroneous trades of J-com, which could wipe out Mizuho Securities' first quarter profit of 28 billion yen, or $233 million.

I wonder if this trader was invited back for another day of trading?  Nevertheless, shouldn't the exchange caught this wacky trade?

Going Private: Dave and Buster's

Posted by Jason R. Job

One of my favorite restaurants and places to hang out when I was a law student at the Moritz College of Law at The Ohio State University was Dave and Buster's.  There was nothing like a cold brew, some good food, and a quick 18 holes of Golden Tee to take my mind off of the labors of law school.  So today, I was reading the financial news and noticed that Dave and Buster's (NYSE: DAB) has agreed to be taken private by Wellspring Capital for $18.05 a share.  (Press Release can be found here in .pdf or here in HTML).

What I found most interesting was Chief Executive Officer, Buster Corley's comment regarding Wellspring's proposal to purchase Dave and Busters.  Corley stated, "We believe that this proposal to buy the company offers all of us as shareholders a unique opportunity to realize value at a time when the company has been challenged to perform up to expectations."  For once, an honest CEO, who has decided that maybe it is time to cash in his chips and maximize shareholder value.

Recently, the stock was trading up $2.33 to $17.54 a share.

Citigroup Wins Case Versus Disgruntled Investor

Today, a Citigroup spokesman stated that a National Association of Securities Dealers panel rejected a $900 million claim brought by Donald Sturm.  Mr. Sturm, a wealthy Colorado investor, argued that he held onto nearly 21 million WorldCom shares based upon Citigroup analyst Jack Grubman's recommendation.

Citigroup's argument was that Mr. Sturm was a knowledgeable investor and should take responsibility for his decision to hold his shares of WorldCom.  Mr. Sturm attempted to argue a direct link to Mr. Grubman's research and to prove that his research was flawed.

Since arbitration hearings are private and the panel did not disclose the reasons for its ruling, we are left to speculate why it sided with Citigroup.

Reuters article can be found here.

Hedge Fund Settlement Deal Announced

According to the SEC, Millennium Partners LP agreed to pay $180 million in fines and restitution to settle charges brought against it by the New York Attorney General’s office and the SEC for its fraudulent trading activity.  Millennium made over $100 million in ill-gotten revenues by “flying under the radar.”  The limited partnership set up a series of shell companies, accounts, and P.O. boxes in an effort to throw off the SEC monitoring of its market-timing transactions. 

"Millennium developed multiple schemes that cost mutual fund investors tens of millions of dollars," Spitzer said. "As a result of our investigation, those frauds have been halted, and restitution will be made to investors who were harmed."

For more, click here.

SEC General Counsel Roundtable

Tomorrow at noon eastern SEC Chairman Cox is hosting the General Counsel Roundtable at SEC Headquarters in DC.  It will be webcast live at www.sec.gov.  Panelists include the SEC's general counsel, a PCAOB broad member, and former SEC chairman Harvey Pitt.  Click here for a complete list of panelists and other details.

Silver Lining in Sarbanes-Oxley?

Posted by Bill Sjostrom

This Business Week article asserts that some companies have found a silver lining in SOX.  In particular, Section 404 “is enabling businesses to cut costs and boost productivity.”  Section 404 requires a public company to include in its annual report various disclosure about internal control over financial reporting, including an attestation from the company's auditor regarding the controls.  The increased auditor work triggered by Section 404 is viewed as one of the most expensive items of SOX compliance.  It makes me wonder whether the article was commissioned by the Big Four accounting firms.  The article mentions later that “94% of top executives at the 217 public companies it polled said the costs of compliance far outstrip any gains.”  Why then is Business Week writing about the 6% or less minority?

I’ve always found it ironic that public accounting firms were at the center of the Enron, WorldCom and other debacles that triggered the enactment of SOX, yet have benefited the most from it.  Audit fees for big companies rose by 55% last year.  Sure SOX reduces the types of non-audit services that an auditor can perform for a client, but it creates huge opportunities for getting business from non-audit clients that otherwise would have gone to the clients’ auditors.  At the same time, it probably means higher fees for these services as synergies from having the same firm perform audit and non-audit services are lost.

Shareholders Persuade Knight Ridder

Posted by Jason R. Job

As we discussed in a post entitled Largest Shareholder Pressuring Knight Ridder, two large shareholders of Knight Ridder (NYSE: KRI) urged the Knight Ridder board to pursue the competitive sale of the company.

Today, Knight Ridder, one of the largest newspaper companies in the US, announced in a press release that it was exploring strategic alternatives to enhance shareholder value. (Click here for the press release).  According to the press release, Knight Ridder has begun working with Goldman Sachs in this process.  However, Knight Ridder was cautious about a potential sale stating:

"In making this announcement, the company stated that there can be no assurance that the exploration of strategic alternatives will result in any transaction.  The company does not intend to disclose developments with respect to the exploration of strategic alternatives unless and until its Board of Directors has approved a specific transaction."

In addition to the announcement of exploring strategic alternatives, the Board also amended the company's by-laws to provide that shareholders may submit proposals for consideration and/or nominations for directors to be elected at Knight Ridder's 2006 Annual Meeting of Shareholders.

It appears that the shareholders are winning with Knight Ridder, unlike the shareholders at McDonald's. (For more discussion about McDonald's check out my post entitled: Pershing Square to McDonald's: Spin Off Restaurants).  Knight Ridder has responded to Private Capital Management LP, who threatened to nominate its own slate of directors if Knight Ridder did not pursue a sale of the company, by allowing PCM to nominate potential directors and propose potential suitors for the business.

I do not personally own any shares of Knight Ridder; however, I do personally own shares of McDonald's.  Also, I am not recommending either stock for purchase or sale.

Red Zone LLC Puts Pressure on Six Flags

Posted by Jason R. Job

On November 8, 2005, Dan Snyder's, Red Zone LLC sent a letter to shareholders of Six Flags Inc. (NYSE: PKS) to convince shareholders to vote their shares to oust three non-independent directors from the board of Six Flags.  Specifically, Red Zone hopes to oust Kieran Burke, the Chairman and CEO, James Dannhauser, the CFO, and Stanley Shuman, who the letter to shareholders states is "an investment banker who has a serious conflict in his dual role as board member and managing director of one of the company's financial advisors."  (A copy of Red Zone's Letter to Shareholders can be found here).

For those of you, who are not up to date, basically, back in August, Red Zone initiated a tender offer to purchase 34.9% of the outstanding shares of Six Flags at $6.50 a share in order to unlock potential shareholder value.  After Red Zone initiated the tender offer, Six Flags' Board instructed shareholders not to tender their shares because the Board was looking for potential buyers for the company.
 

During Six Flags' conference call on Tuesday, Burke responded to Red Zone's tender offer and urged shareholders to allow Six Flags to complete the process of selling the company.  In the conference call, Burke said, "I am confident that we will have an attractive transaction to recommend to shareholders by the end of December." 

In response, Red Zone's letter to shareholders noted:

"It has been two and a half months since the company began its "prompt and orderly" sales process and now management is saying that although some unknown number of "initial bids" have been received it will be at least another month before "final bids" are received and two more months before a decision is made on a possible sale. This timeline conveniently coincides with the deadline for shareholders to respond to our consent solicitation and effectively pushes any hope for a conclusion to the sale process into early 2006 when we believe Burke and Dannhauser could stand to gain an additional $10 million under their golden parachutes. Don't be misled by management's vague statements about its over-extended sales process. As the largest stockholder of Six Flags, we are skeptical that management's process will result in an attractive offer for your shares. In our view, the true purpose of the sales process is to stall and delay your vote on the performance of this board and management by creating high hopes among shareholders for as long as possible."

It certainly appears that Six Flags' Board is buying their time to cash in on the additional $10M in compensation.  And, Red Zone has received some public backing from other shareholders.  Last week, Diaco Investments LP, which owns about 9.8 percent of Six Flags stock, threw its support behind Red Zone, saying that it opposed a sale of the company. 

On Wednesday of this week, Tigris Management issued a press release stating that it would vote its shares in favor of Red Zone's solicitation because:

Not voting for Red Zone means voting to retain the current management team of Six Flags. This is the same team that posted six straight years of operating losses, culminating with an equity-linked share offering that effectively diluted shareholders by a third; current management has been unable to stem the 90% decline in Six Flags' shares, to $3.49, until Daniel Snyder started buying the shares last year.

Tigris Management also noted it believed that Red Zone's track record would allow it to unlock potential shareholder value.  Also, Tigris noted that it believed "that Six Flags shares can trade at $17.50 if the company is managed as effectively as comparable theme park operator Cedar Fair, L.P."  Finally, Tigris believed "based on Red Zone's history of value creation, values in excess of $33 per share can be achieved."  Shares of Six Flags currently trade at $7.32.

In response to Tigris' statement, Six Flags issued an additional press release, on Wednesday, which can be found here.  In its press release, Six Flags noted that Tigris did not disclose any of its Six Flags shareholders nor is there any public information regarding Tigris' activities or assets.  In response, Tigris amended its statement stating that Tigris' Managing Partner, "Murat Azizoglu, Ph.D., in a personal investment account. There are 4,000 shares in this account, which Dr. Azizoglu acquired on September 7, 2005, at a cost of $7.05 per share, as a potential long-term investment."  It is also worth noting that Bill Gates has an 11.5% stake in Six Flags and last year said that he was dissatisfied with the current Board's performance.

Today, Six Flags sent a letter to shareholders, again urging shareholders to wait until the Board can complete the sale of Six Flags.  A copy of the letter can be found here.  Six Flags' Board reminds its shareholders that Red Zone is attempting to gain control of Six Flags without paying full value for the company.  Six Flags desires that its shareholders wait until the potential sale process of Six Flags is completed, and if they have signed the "white card" in favor of Red Zone's plan to vote out the non-independent directors, then the shareholders can fill out a new "blue card" to revoke the votes in favor of Red Zone.

The activity between Red Zone and Six Flags shows the hostility that can occur when a large shareholder or shareholders come in and attempt to throw out the old board of directors to make changes in a company.  Unfortunately, for the targeted board of directors of Six Flags, the voting requirements allow shareholders to remove them from the Board.  Ultimately, as long as Red Zone LLC and other shareholders provide enough votes to oust the targeted members of the Board, then that is what will happen.  However, Six Flags' Board will attempt to find a potential purchaser and perform a merger which will not allow its common shareholders to vote.  Thus, allowing it to sell the company without funds like Red Zone to stop the merger.

Anyways, it will be interesting to see what happens, but either way, it is a great example of how private equity can influence public companies.

Related Earlier Posts:
Redskins Owner Ups His Bet on Six Flags
Six Flags Response: We're For Sale

In full disclosure, I do not own any shares of Six Flags, Inc.  Also, my comments are not intended to be a recommendation to buy or sell shares of Six Flags.

Proposed Executive Compensation Legislation

Posted by Bill Sjostrom

In a press conference this afternoon, Congressman Frank will announce “The Protection Against Executive Compensation Abuse Act." The act will "address the problem of runaway executive compensation by requiring greater disclosure of executive compensation to shareholders."  Click here for the press release.

It will be interesting to see the details of this legislation and whether it goes anywhere.  The press release implies the legislation is built on the old adage that “sunshine is the best disinfectant.”  Sunshine has worked in this area—it forced Dick Grasso to resign  and cost Jack Welch access to corporate apartments, jets and Red Sox tickets.  As this post speculates, it also got Robert Iger an expanded “for cause” provision in his employment agreement.  Executive comp, however, already receives a ton of sunshine.  The SEC requires extensive periodic disclosure concerning it, including the filing of many of the underlying documents.  All these documents are publicly available at sec.gov.  For example, the retirement agreement that caused the flap for Welch in 2001 was filed with the SEC in 1996, and here’s a