The Proxy, Social Engineering and Corporate America

August 22, 2009

A recent article in Pension and Investments regarding CalSTRS backing of new proxy access requirements by the SEC raised a couple of issues for me. The number one issue I saw was that there was no mention of S&P 500 index company, APOLLO GROUP (APOL). If a state fund like CalSTRS is going to back proxy access reform for director nominations I would think that companies that CalSTRS invests money in would at least have to offer shareholders voting-rights in their publicly traded shares; APOLLO GROUP doesn’t. As such, they don’t give shareholders access to a proxy whatsoever. Is this issue part of proxy reform? If so, I haven’t seen it. In fact, in Googling APOLLO GROUP and CalSTRS I find no news story where CalSTRS flags APOLLO GROUP as a proxy or shareholder Frankenstein. They replaced Worldcom in the S&P 500 in May 2002.

The second issue has to do with CalSTRS calls for greater diversity in corporate boardrooms. I’m very curious as to how CalSTRS equates greater diversity with improved long-term sustainable shareholder-value and how they intend to qualify and quantify how improved corporate performance is directly attributable to social diversity. I’m not saying that a correlation doesn’t exist; I’m asking how do they intend to track this and inform their investors and retirees.

What tools are they going to use in the process? How will they work with their investment managers to ensure their objectives are being met? How will they oversee this goal? From what I have read on the web, tying corporate performance to diversity goals is an imperfect alchemy at best and nailing Jello to a wall at worst.

If they’re calling for it, do they have an obligation to report on it to their constituents on a regular basis? Curious.

Self-Serving Compensation Practices Designed For Gaming

By Robert L. McMahon

NY Times business columnist Gretchen Morgenson has done investing America another great service! Her “Fair Game” column this week, July 26th, uncovers a compensation scheme so sweet, the executives benefiting from it are probably taking daily insulin shots.

Here Gretchen has uncovered, and remember, this is in a post Sarbanes-Oxley America, a company that is adding to its cash-earnings an amortized dollar amount of what it has expensed to acquire additional assets to grow its business. Likewise, they are also adding back to its cash-earnings what it expenses in stock awards to its executives. Would you like to go back and read that again? I thought so.

Alliance Data Systems (ADS) has created an alternate reality that gooses its earnings and makes it easier to hit earnings targets that then make it much more beneficial and lucrative for their C-suite executives to profit from their targeted stock awards via an accounting alchemy that can turn costs into earnings.

This only proves to me the futility of legislating regulatory fixes on American business that dances around aggressive, unseemly, and shareholder unfriendly accounting practices. It also demonstrates to me just how disinterested professional investment managers are by this type of behavior. If the institutional investor community are OK with this, then they’re essentially saying that it’s OK to lie to them as well. They’re the agency shareholders for America and by accepting this type of compensation practice they’re enabling management to undermine the financial health of the company within which they’re investing other people’s money.

According to the Times piece the firm awarded an additional 710,303 stock units the first quarter of 2009. If certain, as yet, unspecified “cash-earnings” growth targets are met for this year, a third of these stock units will vest by early 2010. In addition to that caveat, if the target is met in 2009, the balance of the stock units will vest by February 2012. Well guess what? On July 24th The Wall Street Journal reported a stock buyback by ADS worth $225 million dollars – roughly 4.5 million shares. By reducing shares outstanding they’ll be able to further inflate their “cash-earnings” more easily! So much for how well Sarbanes-Oxley protects the investor from sleazy accounting practices.

For the benefit of you the investor – the American handing your 401(K), kid’s college fund, or company pension plan to an institution – here are the top five institutional investment and mutual fund companies holding ADS on your behalf for your benefit. If you want, let them know that you don’t like being lied to.

Top 5 Institutional Holdings:
Franklin Mutual - 4.5 million shares
Wellington Management - 4.4 million shares
Fidelity Management - 4.2 million shares
Putnam - 3.7 million shares
ValueAct Capital Partners - 3.7 million shares

Top 5 Mutual Funds
Fidelity Small Cap - 2.4 million shares
Mutual Shares Fund - 2.1 million shares
Putnam Voyager - 1.3 million shares
Waddell Reed - 1.1 million shares
Mutual Beacon Trust - 1.1 million shares

Source: Wall Street Journal, Company Research, 26 July 2009

Proxy Access Is After the Fact

Please know that I'm a big believer in easier proxy access. Some people may think that I'm dead-set against it.

However, "proxy access" is not a silver bullet solution; it's a solution after you, the shareholder owner and investor, have been shot by a poorly governed company. Proxy access is "reactive" and is not "pro-active".

The wording of the Schumer bill does not put teeth where it needs to be and that is on the side of the professional investment and pension fund managers to be better engaged in researching, assessing, monitoring, and analyzing the corporate governance profiles of the companies they are buying and selling for OUR benefit - i.e. retirement, college-funds, trust fund, etc... And disclosing how they are incorporating these assessments in their compliance program(s).

Investors look upon professional investment and pension managers as folks who should be completely informed about a company's risks and if you're not looking at governance as a risk, well, what good are you? Where's the value in launching a proxy fight after the $60 or $80 stock that was one of your "Top 10 Holdings" craters to $3 a share?

As I have previously said, if you're not managing the risk, the risk is going to certainly manage you.

“Proxy Access” – Holy Grail or Trojan Horse

By Robert L. McMahon

Is “proxy access” really the Holy Grail solution to better corporate governance or simply a well masked Trojan Horse to advance social and environmental policies without accountability? Small wonder the discussion centers on the proxy, huh? If there has ever been a topic that makes citizen-investors’ eyes glaze-over and roll-back in their heads it’s having a corporate governance discussion about “proxy-access”. Yes, I know I’m hitting this subject extremely hard, but if anybody wants to know why John Q. Public, and those in the media, cannot seem to follow the ball when having a discussion about why “Corporate Governance” is so important, it’s because all discussions revert to heated and conflated perspectives about the proxy.

Would proxy access have prevented Merrill Lynch from turning itself into a mortgage bank these last six or seven years? Prevented AIG from issuing uncollateralized credit default swaps? Improved our automotive industry; or stopped Citibank from becoming a “financial supermarket”? The answer is no. Discussions about the proxy access, at this point, are equivalent to discussing place-settings as the Titanic is sinking; it’s all form without substance. And although I know and appreciate that having access to the proxy is extraordinarily important, agenda driven special interests are blowing so much smoke we’re unable to see the 800 pound gorilla playing with Grandma’s crystal – the pension and investment managers who actually invest OUR money in the companies that turn into governance disasters.

The bottom-line is that John Q. Public would much rather our professional investment and pension fund managers get more aggressive in seeing the next Enron or AIG on the horizon and not after it has already been slipped into their retirement fund, mutual fund or 401(k); proxy, schmoxie at that point, right? But is that how new legislation being discussed in Washington, and touted by the Council for Institutional Investors (http://www.cii.org/), is framing the discussion? No, of course it isn't.

Senator Charles Schumer is leading a charge in congress to introduce new legislation on May 19th called the “Shareholder Bill of Rights Act of 2009”. The three (3) major sections of this legislation are the following:

· Section 2: Shareholder Vote on Executive Compensation

· Section 3: Shareholder Input in Board Elections

· Section 4: Corporate Governance Standards

Just who, may I ask, are the vast majority of shareholders in America today? They are the large institutional pension and investment management firms of all stripes – public pensions, union pensions, brokerage firms, mutual funds, insurance companies, asset managers, trusts, banks, hedge funds, you name it. Just where to do these “agency” owners fit in the discussion of corporate governance? John Bogle, the founder of The Vanguard Group of mutual funds, has laid much of the blame for what has transpired in corporate governance failures at the feet of these “agency” shareholders that invest vast amounts of OUR money in the companies – “issuers” in governance parlance – that have failed. Let’s ask three (3) questions:

· Did the failures in corporate governance occur because the “issuers” were stiffing access to a proxy and the agency owners couldn’t effect change?

· Were the agency-owners more focused on their own parochial agendas for change and regarded other governance issues as unworthy of their consideration?

· Or were the agency owners not even considering “corporate governance” as a metric to be examined in the investment selection process?

If you’re thinking that delivering a solution for just one of these questions will be a silver bullet, you’re wrong. As I have previously written on my Blog, what we really need are investment and pension managers who act like genuine owners; not just advocates for change or traders.

Actually John Q. Public knows that the problems facing us are more driven by the failures of our pension and investment managers than by simple “proxy access” or beating up on the issuers themselves. If one company is poorly governed and implodes it should come as no great shock to anybody and shouldn’t create systemic risk to the global economy. But since 2000 we have witnessed a near systemic breakdown in all sorts of industries and companies, investors aren’t just chagrined by the corporate disasters, but their confidence has been radically shaken in their investment professionals. The pension and investment management industries are flooded with degreed, chartered and certified investment “experts” who have managed to measure every aspect of a company’s finances and managed to miss how to qualify and quantify corporate governance quality.

Where, in Senator Schumer’s “Shareholder Act”, are the accountabilities and responsibilities imposed on these agency-owners to be more engaged in researching, assessing, monitoring, managing, limiting and disclosing governance risk in the investment selection and oversight process? Why are we going to make this a one way street where large institutional and “political” investment managers and pension funds get to succeed in imposing an agenda on a company, but then exempt themselves from having any responsibility that may cause this company to fail; meaning if you pressured for change to improve overall financial performance due to poor corporate governance, you’re going to need to assess how your changes are improving both performance and governance; otherwise what’s the point? How does the legislation address that Senator?

Likewise, I didn’t see anything in the bill that addresses companies who are either public now or wish to go public later, where they have to offer voting-rights, that dual class stock structures, special class stock, stock with superior voting rights and so forth will be prohibited. There is no mention of imposing new or remediated rules on index companies when they place a company in an index - that will wind up being widely held – that they have to adhere to a particular governance profile. The company that replaced Worldcom in the S&P 500 index in 2002 is Apollo Group, a company that doesn’t offer voting-rights on the Class A, publicly traded shares, doesn’t offer access to a proxy at all, and is controlled by insiders and founders.

Nothing in Senator Schumer’s bill addresses the lack of focus on long-term sustainable investment performance on behalf of the investors. In fact, and I’m going to be pretty bold here, I see it as nothing more than a means for politically favored state and union pension funds to press agendas in social and environmental policies on corporations without any accountability as to whether or not their advocated changes bring about long-term sustainable investment performance and value.

Is it Stranger than Fiction? You be the Judge

By Robert L. McMahon

The last year has been, if nothing else, a watershed moment in our country’s financial history as the US government has stepped forward to prevent a worldwide financial calamity where bank accounts, investment accounts, and homes and livelihoods are all lost forever. But what does the systemic failures of the banking, mortgage, derivatives and housing markets have to do with “rescuing” the American auto-industry?

Since the early 1980’s this industry has been walking on thin ice and has been sustained through witless and craven congressional interference, witless and spineless corporate management, and witless and ignorant union demands that have bled the goose dry. And now the US tax-payer is supposed to come in and save what the foolish, cowardly and ignorant couldn't? This is business?

This situation got me thinking – “I’ve heard this before.” It was a long time ago, but not in a galaxy far away. It was a book I read the summer of 1979 and I have read it six times since; maybe I’ll read it again this year. Let’s see who’s first to send me the name of the book and the author. Here’s the passage that today’s financial crisis and the US auto-industry prompted:

“We voted for that plan at a big meeting, with all of us present, six thousand of us, everybody that worked in the factory. The Starnes heirs made long speeches about it, and it wasn’t too clear, but nobody asked any questions. None of us knew just how the plan would work, but every one of us thought that the next fellow knew it. And if anybody had doubts, he felt guilty and kept his mouth shut – because they made it sound like anyone who’d oppose the plan was a child-killer at heart and less than a human being. They told us that this plan would achieve a noble ideal. Well, how were we to know otherwise? Hadn’t we heard it all our lives – from out parents and schoolmasters and our ministers, and in every newspaper we ever read and every movie and every public speech? Hadn’t we always been told that this was righteous and just? Well, maybe there’s some excuse for what we did at that meeting. Still, we voted for the plan – and what we got, we had it coming to us. You know, ma’am, we are marked men, in a way, those of us who lived through the four years of that plan in the Twentieth Century (Motor) factory. What is it that hell is supposed to be? Evil – plain, naked, smirking evil, isn’t it? Well, that’s what we saw and helped to make – and I think we’re damned, every one of us, and maybe we’ll never be forgiven….Do you know how it worked, that plan, and what it did to people?

Try pouring water into a tank where there’s a pipe at the bottom draining it out faster than you pour it, and each bucket you pour makes that pipe an inch wider, and the harder you work, the more is demanded of you, and you stand slinging buckets forty hours a week, then forty-eight, then fifty-six – for your neighbor’s supper – for his wife’s operation – for his kid’s measles – for his mother’s wheelchair – for his uncle’s shirt – for his nephew’s schooling – for the baby next door – for the baby to be born – for anyone anywhere around you -- it’s theirs to receive, from diapers to dentures – and yours to work, from sunup to sundown, month after month, year after year, with nothing in sight for you but their pleasure, for the whole of your life, without rest, without hope, without end …From each according to his ability, to each according to his need…..”

Okay, be the first to go on record with the author's name and book title!

When laws are brushed aside by governments and investor rights get trampled people need to hear it and understand it. Companies, corporations that are publicly traded and borrow money from investors (i.e. the public) are the first line beneficiaries in a bankruptcy; that’s corporate and investment law. If the government begins trashing investor rights in a bankruptcy to benefit union workers at the expense of bond-holders our financial system, and government, is no better than Venezuela’s. Adios amigos.

In Memorium: William Seidman, God bless....

Prayers and condolences to the family and friends of one our country's great financial minds, William Seidman.

Bernie Madoff and Me

It's been almost a year and half since Bernard L. Madoff Investment Securities, LLC (BMIS) and I parted company. It was no great loss for me except that I was unemployed, but the tragedy and irony of what has transpired since really caught me by surprise; and for the long-time employees of BMIS I left behind it must've been downright traumatic. Why has Eleanor Squillari, Bernie's secretary of 25 years, come forward now? I believe she's doing it as a form of "post-traumatic stress " therapy. Yes, she probably is writing a book, but that only helps her make sense of what her life has been caught up in by this crime.

For my part I've been trying to reconcile my role at the firm, Business Analyst and Project Manager, with the technology I saw there and, what I call, the dysfunction of managing it. From the outset few people were told what my role was to be and why the head of technology, the late Liz Weintraub, hired me. And although she passed away shortly after I joined the firm, the two people she recommended to replace her, never had a full picture as to my role. They viewed me as an outsider to their "unique" world. And unique it was.

Although the trading technology I saw was sophisticated, it was also somewhat dated by 2007 standards. BMIS used Stratus Technology - super computers - for their trading engine and had the software developed and supported for this in-house; a quintessential Rolls-Royce when a Smart Car is required. Yes, this was the model for robust and sophisticated trading 20 or more years ago, but with today's off-the-shelf, plug-n-play technology you simply don't require the added expense of "owning" the IT to the extent Madoff did. Expanding into additional asset-classes for example required "reprogramming", table structure expansion, directory changes, and other issues I had not contended with since the 1980's.

And this is not an indictment of the people managing the Stratus Systems. These people were doing Homeric work, but seemed more and more pushed to the wall to hold the systems together as newer requirements were pushed down to them from Madoff Trading. I was always wondering and trying to inquire as to "Why". How come these legacy systems weren't "sunset" and newer technologies implemented so Madoff could grow his business faster? Not only was Madoff competing with other B/D institutions, but in a real way they were also competing with technology providers. If you're ABC broker-dealer "employing technology" and not "building technology", you're better positioned to begin trading a new asset class or instrument a whole lot quicker; you're just buying what you need off the shelf and implementing it.

In hindsight it becomes very apparent. Madoff couldn't upgrade to other technology platforms because he would have to invite other IT technologists in to assist with the upgrade. This would entail an assessment of not only the Stratus Trading Engine, but a system Madoff kept on the 17th floor - an IBM A/S 400. In today's world, trading engines and reporting systems can reside together - makes things easier given today's data-base and data-modeling technologies. But in Bernie's World, these were separated; and to Bernie, for good reason. The A/S 400 was Bernie's printing press for statement generation and he couldn't risk the information being stored on that system being seen by other, more knowledgeable, technologists. If the A/S 400 had "statement records" on it, but no individual trading data, questions would have been raised and the charade found out.

In retrospect I met some very, very smart people at Madoff. Several IT developers there deserve to be product, program and division managers within the financial services and trading industries; these people were wonderful to work with and should not be held to some foolish myopia about "having worked at Madoff" - Bulls--t!

Most recently though I was reminded, in very stark terms, of just how insidious and evil this whole affair actually is. I was interviewed for a BBC production regarding my experiences with Madoff and only just realized yesterday, 5/11, that my British interviewer was the son of a man who killed himself as a result of losing his retirement funds to Madoff. His father was a professional British Soldier, an Officer, a Gentleman. Words cannot express what needs to be.