Thursday, December 17, 2009

XBRL – Part Three, or, Son of the Return of XBRL

Back in January and February of this year, I wrote a couple of pieces about how I didn’t really get what all the whoopla surrounding XBRL was about. Those pieces generated a fair amount of comments and I even wound up talking to the folks at the SEC about XBRL. Not to put too fine a point on it, at the time I stated that I just couldn’t understand how XBRL was going to revolutionize the use of data by investors.

While I was doing research the other day on the SEC’s EDGAR database of filings, I noticed that reports are now beginning to be tagged as having “Interactive Data”. So I thought that I owed it to myself to go back and see how this XBRL stuff works in practice. Maybe the scales would fall from my eyes and I would see the error of my ways. Maybe I would be able to see how the data flowed seamlessly, enabling us to quickly reach investment decisions that were lost to us before. And maybe pigs would fly.

What I found when I went to the interactive data was that you could click on a heading such as Income Statement, and the P&L would come right up. I found the data had two properties: first, the headings were tagged. So for example, if you click on Revenues, you find that it’s US GAAP, the data type is monetary, the balance type is a credit and the period is the duration of the quarter. In other words, what you learn in Accounting 101. Secondly, you can grab the data and paste it into another document fairly easily. Also of note was the fact that the financials and notes are available as an Excel download, although everything I downloaded had a file name of “Financial_Report.xls”, so if you don’t rename the file right away, it becomes one of many with the same name.

After I had played with the data for a while, I sat back and thought about the cost /benefit analysis for what we’ve gone through with XBRL. On the benefit side we’ve gained a bit of functionality. I, for one, will welcome the ability to grab data off a downloaded spreadsheet rather than re-keying it when I want to do some analysis. But I don’t see a lot beyond that. The tagging of the data seems to merely tell me what I knew before. Further, professional investors have had the data in comparable and downloadable form for years. Systems such as Bloomberg and Telemet Orion (and I assume Reuters, although I have no experience with that system) already perform this function and a lot of other analytics as well. So my conclusion is that only relatively small investors are being helped. Against this we have to weigh the thousands of dollars spent and numerous man-hours invested by every company converting to XBRL.

To me this seems like another example of something that sounds good in theory, but the practical advantages just don’t seem to live up to the hype. In other words, it’s a governmental agency imposing a standard where the costs outweigh the benefits. The irony of it all is that the ultimate cost for all of this will be born by investors, because the cost of adopting to the new systems is a corporate expense, which lowers earnings, which will result in lower share prices.

Friday, December 4, 2009

A Discounted Cash Flow View of Investor Relations

Every now and again, it’s helpful to stop and think about the frameworks in which investor relations operates. From a finance viewpoint, traditional academic finance approaches the valuation of a company along the following lines: “the value of a company is based upon investors’ estimates of the sum of its future cash flows, discounted back to their present value”. (Investors will often use earnings per share and dividends per share as proxies for cash flows.) The confidence that investors have in those estimates is based largely upon: 1. A company’s past performance as a measure of its ability to continue to perform, and 2. The investors’ view of the economy and the markets as expressed by the discount rate they assign to the cash flows. In other words, what drives the equation are estimates about the future, using the past record of the company as a reality check.

When you think about it this way, several interesting things about investor relations pop up. First, the equation is predicated on what will happen in the future, yet most of investor relations is spent explaining what occurred in the past, i.e. last quarter. So it’s important that proactive investor relations officers spend much of their time discussing what the firm is doing to insure future revenues and where the markets for their products are headed. If investor relations can’t, or won’t, explain how the firm intends to grow revenues, earnings and cash flows into the future, they shouldn’t expect investors to make that leap of faith for them. Companies that have to sell products or services will almost always have better forward-looking market data than investors. Judiciously sharing that data with investors will help them make better estimates. And by removing some uncertainties, it can help lower the discount rate assigned to the cash flows, which results in a higher present value.

Secondly, management matters. How can investors be expected to place large bets on your company’s future performance through the ownership of stock, if they haven’t met and assessed management’s ability to continue to perform? Yet many investor relations departments view their roles as gatekeepers, only allowing access to management at limited times to favored investors. If you want to achieve fair valuation over the long haul, investors need to speak periodically with management. Investor relations departments can function to save management a lot of time by making sure investors understand the company before seeing management and by covering what I would characterize as “routine maintenance” questions, but eventually, investors need to hear directly from the management team to see if they have a grasp on strategy, details, customers and markets.

Third, consistent profitability over the life of the investment will be more valuable than big profits in the out years of the investment, because they will be discounted less and will help compound earnings projections in later years. Consistency will also help investors assign lower discount rates to future cash flows, as they are much more comfortable projecting based on visible trends than they are if your earnings are all over the map.

So why then does everyone make such a fuss about the most recent results, and why do the short-term results seem to have such an outsized influence on the stock price? The answer, quite simply, is “Because that’s the way the math works”. (When my kids were struggling with math in grammar school I used to tell them that all of life was a math problem – this is a perfect example.) If, based on recent results, an analyst reduces their estimate for the first year of a five year model, not only does the reduction count for more because it is almost entirely undiscounted, but it will reduce estimates in future years, as the models are constructed to build and compound on previous years. Further, if the model is taking dividends into account by estimating them as a percentage of earnings, it will reduce all subsequent dividends as well. Conversely, changes made to estimates in the later years of a model have a much smaller effect on estimated present value and the price investors will pay for a company’s stock.

To put all of this in perspective, smart investors are betting on your future success, and that’s where the bulk of investor relations communication should be. But don’t neglect to adequately explain current earnings because if you don’t, and estimates are too low in the early years of investors’ earnings models, the perceived value of your firm will wind up being too low.

In other words, the ability to adequately explain current and past performance creates the foundation necessary for investors to understand a company, but helping them understand the basis for future profitability is the structure they need for estimating a fair value for your stock.

Wednesday, November 18, 2009

Looking Forward by Looking Back

The upcoming holiday season of Thanksgiving, Christmas and New Year’s is always cause to sit back and reflect on what has transpired over the course of the past year and what it portends for next year. I freely admit that my crystal ball is as fuzzy as the next person’s but we’ve had such an interesting year I can’t resist the temptation to extrapolate past events into future predictions in two areas, regulation/legislation and, the use of social media in investor relations.

Investor relations in the U.S. during 2009 was heavily impacted by the advent of a new administration in Washington, an administration that comes from a different political viewpoint than the previous administration, one that favors more regulation rather than less. The new Chairman at the Securities and Exchange Commission, under pressure to prove that the SEC was still relevant, made it very clear during the year that increased regulation of the securities markets and more vigorous enforcement of existing regulations were top priorities at the Commission. Thus during the year we had a flurry of regulatory actions that touch upon investor relations issues, including Reg. SHO, designed to cut down on “naked” short selling, approval of NYSE rules eliminating broker discretionary votes in director elections, proposals regarding the use of “dark pools” and updating the rules surrounding notice and access for proxy materials.

On the enforcement side, we had the first ever enforcement action under Reg. G, relating to abuse of Non-GAAP numbers, the first Reg. FD enforcement action since the SEC lost the Siebel II case in Federal court, and a series of high profile insider trading indictments.

And guess what? For next year I predict … more of the same. In large part, the continued regulatory onslaught will be driven by Congress. For months now, financial markets reform has been on the agenda of our august legislative body, but the bills being considered by the House and Senate are quite a bit different as they relate to how corporations deal with investors. The Senate version includes requirements for annual, non-binding say-on-pay voting, mandated proxy access, and elimination of staggered boards, among other things. My prediction is that most of these requirements will be negotiated out of the Senate version as the business community begins to focus on these items, but that won’t be the end of the process. The SEC, being a political animal, will pick up the ball and then attempt to do by regulation what Congress failed to do by legislation. Look for some of the aforesaid issues to pop up on the SEC agenda next year. It will continue the trend towards the federalization of state corporate law that has been ongoing over the past fifty years. On the enforcement side, the Commission will continue to try and bring actions so that they appear to be doing their job. After dropping the ball on Bernie Madoff, they’re desperate to prove there is a new sheriff in town.

On the more practical side of actually communicating with investors, the hot topic during the year gone by was the use of social media. Particularly during the last half of the year there have been a spate of commentators, myself included, discussing the issue. Generally, the arguments break down upon the following lines: For social media – “This is the dawn of a new era where everyone can communicate with everyone else without anyone getting in the way, and isn’t that great? And anyone who doesn’t get it is a troglodyte.” Those against social media – “You’re right – I don’t get it. This stuff tends to be a bunch of unfiltered junk and a huge waste of time.”

The truth, of course, is somewhere in the middle and I think that over the course of the next year we will continue to see modest use of social media by investor relations departments. Dell has shown that blogs can be done in a thoughtful manner and Southwest Airlines has successfully used Twitter to get the word out quickly during a crisis communications situation. But most corporations are conservative in nature, and have general counsels that lie awake at night worrying about securities litigation, so things will happen very slowly. In fact, by the time corporate legal departments get comfortable with, and figure out how to let investor relations people use Twitter safely, it will be old technology and social media will have moved on to something else.

Thursday, November 12, 2009

Insider Trading Hurts Us All

There seems to be an epidemic of insider trading cases these days. First we started with the Galleon indictment alleging that Galleon profited from receipt of material nonpublic information from a variety of sources, including an investor relations firm working for Google, corporate executives at IBM and Intel, and a partner at the McKinsey consulting firm. This has been followed by criminal charges being brought against an additional fourteen people including hedge fund managers, a trader, a broker and a M&A lawyer, with five of them already agreeing to guilty pleas.

All of this raises some interesting questions ranging from, “Where have prosecutors been for the past several years?” to “What have compliance officers been doing at these firms?” but what I want to focus on is the bigger picture, insider trading itself. As you would expect, a number of commentators have expressed opinions about insider trading, and some people have gone so far as to suggest that the penalties for insider trading should be abolished because it’s common and impossible to police. Even beyond that, a number of noted academics have argued that insider trading is good for the markets because it makes the market more efficient.

Let’s start with the basics; the case law and the statutes surrounding he use of material non-public information are, with a few exceptions, pretty clear. To greatly oversimplify: If you are in possession of such information and you received it as a result of a duty to the corporation, or from someone who has such a duty, or if you have misappropriated the information in violation of a fiduciary duty, you can’t buy or sell that security.

The insider trading laws in the U.S. really get to the issue of fairness in our securities markets and go all the way back to the Pecora Commission hearings following the stock market crash of 1929. The result of those hearings was that the public was outraged that bankers and stock market insiders could manipulate company information for personal gain. The Securities Act of 1933 and the Securities Exchange Act of 1934 were a direct result of those hearings and the U.S. emerged with the most transparent market system in the world. The prohibition on dealing in insider information has served our markets well over the years.

In sum and substance, you cannot allow people to benefit from information simply because of their position, nor can you allow them to leak that information to a select few. To do so would mean that the markets were a rigged game, and people’s faith in the markets would take a severe blow.

Because of the large sums of money at stake over inside information that traders can benefit from, there will always be a few people willing to test the system, from Dennis Levine and Ivan Boesky in the 1980’s to the Roomy Khans of today. But let’s be clear – these are not close calls. Everything I have read about the current series of cases involves people who knew they were going beyond normal everyday information gathering and into the realm of the illegal. The use of disposable cell phones to avoid detection and payment to sources of information are not things one normally sees in the normal information gathering process of analysts.

This is not a victimless crime – activities that bring disrepute on the fairness of the markets impact all of us because people will be less willing to commit capital to unfair markets. I have absolutely no sympathy for this type of crime and hope that prosecutors continue to bring cases where appropriate. Fortunately, I think we will continue to see these cases, as good prosecutors can make their bones on them – after all, look at what it did for Rudy Giuliani.

Tuesday, November 3, 2009

Reg. FD and the Law of Unintended Consequences

It used to be in the good old days (some would say bad old days) stock analysts saw a goodly percentage of their job as talking to and cultivating relationships with management. The classic example of this is the analyst I refer to as the “Information Vampire” who would talk to management until they felt they had sucked every last drop of information from them. The thought process was that by building a relationship, the analyst would pick up enough tidbits of information to give them an advantage over the average investor, and because management liked them, they might let the analyst know something important before everyone else, either in a one on one meeting or by being the first phone call they made when news is breaking. On such things careers were built on Wall Street.

Then along came Regulation Fair Disclosure, in which the SEC mandated that if a company is going to say something important, it has to tell everyone at the same time. It doesn’t matter if you are best buddies with the analyst who has followed you through thick or thin or if a portfolio manager had been a loyal shareholder for many years. The reasoning was that the securities markets need to appear to be a level playing field for all concerned, regardless of whether you are a professional money manager with $50 trillion in assets or you are a retail investor looking to buy 100 shares of stock. (This is very much the same type of governmental thinking that gave us the Robinson-Patman Act prohibiting price discrimination between customers, but that’s a subject for another day.) The SEC then proceeded to announce a series of enforcement actions to drive home the point that you can’t just go off and blab to institutional investors. They never actually won a court case on the subject, but they made their point and companies toed the Reg. FD line.

This, of course, did not stop Wall Street’s desire for an information edge. We are, after all, talking about an industry with serious amounts of money at stake. It just meant that the quest for information went elsewhere. Hence today, courtesy of Reg. FD, we have at least two new types of information hunters on the scene.

The first of these is the “Channel Checker”. This is a person who specializes in cultivating a network of industry sources, be they lower level employees of the company, suppliers, customers and competitors. They usually don’t talk to the company very much, if at all. This type of analyst has always been around, but since the advent of Reg. FD have increased in number as they try to supply investors with they type of information edge they can no longer get from the company.

The second type of information provider that has gained more prominence since Reg. FD has been the expert network systems. These are organizations that have created data bases of people with expert knowledge on particular subjects. Then, when an investor needs to get up to speed quickly on a subject, whether it’s current inflationary trends in the footware industry in China or the likelihood of a drug getting through the FDA approval process, there is someone out there, that for a fee, will expound on the subject. (Disclosure: On occasions, I have been retained by expert networks to discuss things about which I have knowledge.)

Companies, of course, don’t like either one of these developments, as they can’t control the information being disclosed or put any spin on the story. In and of themselves, the channel checkers and expert networks are not a bad thing, they are just different sources of information. It’s just that the SEC shouldn’t kid themselves into thinking that Reg. FD has made the information the same for everybody. It just means that professional investors have to redirect their efforts as to how they get it and how they pay for it.

Thursday, October 22, 2009

Loose Lips Sink Ships – What Investor Relations Officers Can Learn from the Galleon Fiasco

By now there shouldn’t be a single investor relations officer who is not familiar with the recent news that the Galleon Group hedge fund has been charged with insider trading. The case is a great example of the lengths some less than scrupulous investors will go in order to obtain information that might give them an edge on the market. Among the allegations in the government’s criminal complaint are that inside information was obtained by Galleon personnel from executives at IBM and Intel, from a McKinsey partner and from Market Street Partners, an investor relations firm.

At this point, every self respecting investor relations officer should be revisiting their corporate disclosure policy and scheduling refresher sessions with their executives on the dos and don’ts of making public statements and discussing internal information. I don’t doubt that every one of the firms named as having leaked the information had a policy in place discussing conversations with securities analysts and confidentiality of information. But periodically, people need to be reminded of it. Put succinctly, periodically they need to have the bejesus scared out of them. I’ve always found that the prospect of public humiliation, the ruin of one’s career, large monetary penalties and the possibility of jail time will focus the mind amazingly.

What investor relations officers do appears deceptively simple – they just talk to people. So naturally, executives, who have been successful in many other things within their organization, think that they can do this as well as any staff geek stuck away in an office who has never had to run a division or make real money. And thus begins a slippery slope that unscrupulous analysts are happy to exploit. Once an analyst has established a relationship with an executive, more and more information begins to slip out, inadvertently or not, until the damage is done. This is at least partly because executives do not deal with analysts every day and are probably not familiar with what the company is and is not saying publicly. Further, although they may get briefed once a year on what constitutes material information, it’s not a central part of their workday and probably not something they are likely to remember.

The short answer for companies is that unless you are a designated company spokesperson, you should not be talking to investors or analysts unless you are under supervision of someone from the IR department. You should hammer this point home with your executives. The risks in doing anything else are just too great. Remind them of this by showing them some of the people involved in the Galleon scandal doing a perp walk in front of the cameras.

In saying this I am not advocating less information being made public. I am an advocate of more and better disclosure for investors. However, that disclosure should come from people who know how to deal with the Street and the myriad of ways they will try to escalate the amount of information being given.

So the next time you have an analyst day, or a field trip to a facility, tell your executives to leave their business cards in the office. After all, you don’t want your ship springing leaks.

Tuesday, October 13, 2009

Wal-Mart and Same Store Sales: The Fallacy of Less is More

There was an opinion piece recently in the daily email reporting of IR Alert by Carol Schumacher, the Vice President, Investor Relations of Wal-Mart. In the piece, Ms. Schumacher details how Wal-Mart’s practices for reporting sales store sales have evolved over time. I read the article with some interest as I have owned Wal-Mart stock for many years and have longed believed that they were one of the premier retailers in the world. I wish I could say the same about the way they report same store sales today.

In the early days of the company, when sales were regularly outpacing everyone on the planet, Wal-Mart reported weekly comparable store sales every Saturday. This to me is ideal. It shows you have great reporting systems, a desire to keep investors informed, and by the time the company reported the quarter, one item of uncertainty, the sales number in your more mature stores, has been eliminated and the market has incorporated it into their estimates.

Alas, it could not last, particularly as Wal-Mart’s sales began to slow, and a few years back the company moved to a more common monthly reporting system. At the same time, they instituted a program to provide guidance on their view of the upcoming month’s sales. My guess (and that’s all it is) is that the issuance of guidance was a bit of a sop to the Street to ease the fact that analysts were going to get less frequent hard information and more company estimates.

This year, Wal-Mart has stopped reporting same store sales on a monthly basis and will report them only in conjunction with their quarterly earnings. Again, to sweeten the pill, they shifted to providing guidance on comparable sales figures for their U.S. and Sam’s Club stores for the upcoming quarter.

The reasons given in the article for all these changes seem to fall into three basic categories: 1. This is the way everybody else does it, 2. By giving out only quarterly numbers, they decrease volatility in the stock, and 3. Wal-Mart is focusing on more long-term metrics, which will help focus investors more on the long term.

Because I don’t agree with the direction Wal-Mart is headed in, let me try and address these issues in the order listed. First, Wal-Mart didn’t get to be the biggest retailer in the world by doing things the same way that everyone else does. The company has famously broken the mold on many retail practices and prospered. Further, this isn’t the way everybody else does it. It is only the way other companies whose sales have slowed down do it. If Wal-Mart were posting numbers that regularly showed them to be well ahead of the competition, as they were in the 1970’s and early 80’s, my guess is that they would be continuing to give out weekly comp store sales numbers. By changing the way they report, what Wal-Mart is really doing is sending a message that they think future sales will look less robust than they have been in the past.

Second, to understand the volatility issue, look at what Wal-Mart did: they consistently scaled back on providing hard data in a timely fashion, going from weekly to monthly to quarterly comp store sales numbers, while substituting guidance or estimates. Of course you are going to get guidance wrong from time to time. These are after all, estimates about future events. And when guidance varies from actual numbers, trading volatility will follow. The answer is not to decrease the flow and timing of hard information; the answer is to decrease the amount of estimates.

Third, and finally, let us turn to the issue of getting investors to focus on long-term metrics. Companies need to remember that the stock market has a split personality: over the short run it is a popularity contest, trading on the number du jour; over the long haul it is a discounting machine, using past information to discount estimates of future cash flows. It takes both short-term and long-term investors to make a market, and when you are a bellwether stock such as Wal-Mart, you will get both in droves. Investor relations officers all want the long-term buy and hold investor, but short-term investors help increase a stock’s liquidity and when a stock trades more liquidly, volatility goes down, not up.

I know that Mies van der Rohe famously said, “Less is more”, but he was speaking about architecture, not same store sales. When thinking about same store sales, I tend to follow the maxim of classically trained economists, which is: “More is always better”.

Tuesday, October 6, 2009

How to Read 10K Reports Revisited - Cracking the Code

A portfolio manager friend of mine told the following joke to the students in my investor relations class last April: Question: If you are a public company, how do you hide something from analysts? Answer: You put it in the 10-K report. There is a lot of truth to this. Reports on Form 10-K are dense, laid out in a fashion to follow a government bureaucrat’s idea of how to display information and written mostly by lawyers and accountants. This is a deadly combination.

Because of this, companies can sprinkle little tidbits of information throughout the filing and comply with disclosure requirements without really telling you much unless you learn how to read the code. (I just read the latest Dan Brown thriller, so it may influence my writing here.) To me cracking the code means opening up two or three years worth of filings on your computer, seeing what’s changed and applying some simple math. I’ve written about this before (see my blog posts dated September 10, 2008 and March 5, 2009) but I like to revisit it periodically to show how disclosure is not necessarily the same as telling you what’s really going on.

This time I decided to look at Sysco Corporation’s 10-Ks for the past three years. I chose Sysco because having worked there, I know the company well, but it’s been long enough ago so that I did not have a hand in writing any of the 10-Ks in question. Further, Sysco, which has been faced with a shift in their industry – consumers who, in the face of economic duress, are dining out at restaurants less often – seems to be managing the downturn about as well as you could expect. Because Sysco has been coping with deteriorating sales trends by reducing their expenses, I thought that if I focused on headcount, some interesting things might pop out that perhaps should have merited more discussion in the filing. I was not disappointed.

To begin, I called up three years of 10-K filings and did a word search on “employees”. It turns out that Sysco had 47,000 full time employees last year, compared to 50,000 in 2008 and 50,900 in 2007. This means that the decline in employees is 6% this year compared to last year and 7.7% over a two-year period. Interestingly, nowhere in this year’s filing does the company talk about the trend except to mention “reduced headcount” without telling what it previously was. For that you have to go back to the previous filings. This is fairly typical of what you see companies do: give you the fact, but neither explain it or put it in the context of quantity or time. They’ve complied with the technical disclosure requirement, but haven’t really explained what’s going on.

While I was going through this exercise, I also noticed that they were engaged in a similar exercise in disclosing the number of sales related personnel. This year Sysco states that they have 13,000 sales, marketing and support staff. You have to go to the previous years’ filings to find out that this compares to 14,000 a year ago and 14,400 two years ago. So the decline in sales oriented personnel was 7.1% last year and 9.7% over a two-year period. This outpaces the decline in overall headcount and the decline in overall sales, and raises some interesting questions about sales going forward, but nowhere in the filing does Sysco address this topic. For example: Does this mean that Sysco thinks they had too many sales people before? Is this decline in sales personnel an indication of Sysco’s thinking that sales are likely to remain depressed going forward? Have they reorganized their sales force along different lines? With 9,000 more customers than in 2007 (391,000 then versus 400,000 in 2009) and 9.7% fewer sales personnel, what’s happening to customer service levels? Unfortunately, you will search in vain for answers to these questions in the 10-K.

And in this, Sysco is not alone. Companies focus on checking the regulatory boxes when they write their 10-Ks. In spite of the SEC’s efforts to the contrary, these are mostly documents that look back at the previous period’s results. What investors need is something that helps them gauge the future prospects of the company by pointing out trends and important correlations. And for that, companies leave them on their own. And then they whine that investors are undervaluing them because they don’t understand how rosy their future prospects look. As Pogo once said, “We have met the enemy and he is us.”

Wednesday, September 30, 2009

It’s Not Easy Being Green

Last Spring, prior to his graduation from high school, my son went on a senior trip to Disney World. When he returned, he presented each family member with a small souvenir gift. (Given that he is a teen-aged boy, this in itself is a small miracle, but sometimes all those lectures about common courtesy and thoughtfulness bear fruit in the most unexpected ways.) I bring this up because the gift he gave me was a small book about one of my favorite characters, the muppet, Kermit the frog. The book was titled “It’s Not Easy Being Green”. Over the years, Kermit has been right about a lot of things, and the expression “It’s not easy being green” is equally true when it comes to the way corporations portray their positions towards the environment.

Corporations are in a tough spot on this one. Corporations exist in order to maximize profits for shareholders. To the extent they divert corporate resources to fund social or environmental causes unrelated to their business, it represents a transfer of wealth from shareholders to a different constituency. Further, it is a transfer of wealth over which shareholders have little or no say. This is troublesome because corporations do not exist to redistribute wealth. We all know that governments exist to redistribute wealth.

This does not mean that corporations should not be concerned with the environment or the social context in which they operate. Rather, it means that corporations should be paying careful attention to those issues where they can have an impact and where the cost of ignoring them will have a detrimental effect on the company’s future prospects, image or share price. Spending money to make a difference in environmental and social issues that are part of how they operate is an acceptable corporate expenditure. Spending money to fund the chairman’s pet charity to save the Tibetan yak is usually not, unless you are in the business of mountain expeditions.

How does all of this fit into investor relations? In my twenty-five years of talking to investors, it has been rare that major institutional investors raise these types of issues. Institutional investors focus on your company’s future prospects, back-tested against your current performance. Unless your company’s future prospects are being impacted by environmental or social issues, they don’t care. There are a few “socially responsible’ investment firms, but I’ve never really seen them have much more than a gadfly effect.

So does this mean corporations should just ignore the issue? You probably can, but I would hope not. Your company is probably doing things that you can point to as responsible corporate citizenship. Most companies are constantly testing ways to save money by eliminating waste and inefficiencies. The best of these ideas often result in both costs savings and benefits for the environment. Here’s an example from the book The Wal-Mart Effect, by Charles Fishman: in the 1990s, Wal-Mart came to the conclusion that there was no need for deodorants to come in a separate box. The cardboard box added cost, took up shelf space and required trees to be cut down to make the cardboard. Yet the box didn’t add anything to the customer experience and surrounded what was already a perfectly good container. So Wal-Mart worked with manufacturers to get rid of the boxes. As a result, the product cost less to produce, some of which was passed along to consumers and the environment benefited because the demand to cut down trees for cardboard was reduced. (One can only hope that they are working on the same thing with respect to blister packs.)

Good companies undertake these types of projects all the time. A good investor relations practice is to make a list of all the projects your company does to eliminate waste and inefficiencies or to make the work environment safer. The next time you’re questioned about your company’s commitment to the environment, pull out your list and discuss it along with the comment “Look, we can’t be all things to all people – our resources, just like everyone else’s are limited. But we do choose to try and change things for the better where we can have an impact.” Better yet, be proactive and talk about these things as part of your regular communications.

I am not enough of a Pollyanna to think that this will mollify activist investors with a militant agenda, but you’re not going to make them happy anyway. The objective here is to have a well-reasoned response that shows you are influencing things to benefit your customers and the environment in which you operate. And, like Wal-Mart, you probably shouldn’t expect to receive too much credit for what you do. After all, “It’s not easy being green”.

Wednesday, September 23, 2009

Keep Your Eyes on the Ball

The underlying premise of investor relations is simple: to the extent you can give investors a clear picture of what your company’s future earnings prospects are, the better they will be able to accurately assess the value of your firm and its stock price. This derives from the financial principle that the value of a firm is equal to the sum of its future cash flows, discounted back to a present value. Your past earnings history, even yesterday’s quarterly release, is germane only to the extent that it illuminates and gives confidence to estimates of future cash flows.

I bring this up because lately it seems to me that there are more distractions than ever to the discipline of investor relations. To start, it is the silly season in Washington and regulatory initiatives are in full swing. Every day seems to bring more news about SEC initiatives, whether it’s on flash trading or creating a new division of Risk, Strategy and Financial Innovation. They seem determined to prove that they can cure past ills by more regulations. Further, the industry association, NIRI, seems to be singularly focused on regulatory issues, which I guess makes sense as they are based in Washington and are creatures of their environment. Added to that we have whole new channels of communication opening up in the amorphous world of social media with twitter, facebook, linkedin and blogs. Then we have technical issues such as XBRL reporting and IFRS accounting to worry about. All of these are things that investor relations officers need to be aware of, have an opinion on and react to if it is their ox that is getting gored, but are not central to what they do.

With all of this going on, it’s very easy to forget the main function of investor relations: creating a clear and concise picture of what your firm’s prospects are and how you intend to get there. I will grant you that investor relations derives from regulation. Without specific regulatory guidelines most companies would be loath to tell investors anything, regardless of what the financial theory says. But the jumbled mess that we refer to as securities law regulation is a means to an end, not an end unto itself. Let the lawyers worry about the latest SEC staff interpretations; let the accountants worry about IFRS. What investor relations people should worry about is whether the market understands how what your company is doing leads to profits in the future. This means disclosing not only what happened in the past quarter; it also means helping investors gain insight into your markets, your industry and the trends, both long-term and short- term, that drive your business.

Likewise the social media that we are seeing today is nothing more than additional forms of communication. I’ve been around this business so long that I remember when conference calls were a novelty. Today conference calls are just another tool to get the company’s story to investors efficiently. Done well, they are helpful; done poorly they can be a disaster. Social media will eventually play out in a similar fashion.

So my advice is to let the hype and chatter pass you by. Keep your eyes on the goal of getting investors to understand your business and its prospects. Appropriate valuation in the form of stock price will follow.

Thursday, September 17, 2009

A Dive Into Dark Pools

Earlier this week the luncheon topic for the NIRI Houston chapter was “Dark Pools”. This is a subject that has received much press lately, most of it with ominous overtones to accompany the rather sinister name, so I went with much anticipation, much like you’d go to a scary movie. I have to confess that I knew very little about all of this before I went, and when the luncheon was done, I was more confused than ever. So on the premise that I can’t be the only one who is confused, I decided to do a little more research and, at the expense of stretching a metaphor, try and shed some light on Dark Pools.

First, what are these things? As I understand it, a Dark Pool is an electronic crossing network that allows buyers and sellers of stock to place liquidity (an offer to buy or sell) into a pool anonomously and wait for execution while disclosing little, if any, information. Only when an order is executed is the information on the trade made public. To use a phrase from Bruce Springsteen, these market participants are “Dancing in the Dark”. This is in contrast to normal markets where public order flow allows market participants to judge supply and demand for a stock and adjust accordingly.

Second, are these things inherently good or bad? The ostensible purpose of Dark Pools is to allow holders of large blocks of stock to execute their buy or sell orders without indicating to the markets what they intend to do. Therefore Sellers can sell without driving the price down and buyers can buy without driving the price up. The pricing is done within the Best Bid or Offer context of the National Market System, so price discovery is occurring using normal market systems. This seems like a good thing if you are a large institution looking to move large blocks of stock. Additionally, if you are looking to buy or sell a relatively illiquid stock, dark pools can help you do so with a minimum of price disruption. If you are a company, it would seem that this balances itself out, especially when you consider that institutional investors trade approximately 80% of the stock volume in the U.S.

Third, why the big deal about all of this? Follow the money. The Exchanges – NYSE and NASDAQ, hate these things because they pull significant amounts of orders off the exchanges, which means less order flow and less earnings for them. Traders and specialists hate them because they obscure market information and eliminate trades that they would otherwise execute by putting it all into a machine. This eliminates both the lifeblood of traders – information – and jobs. So much volume has come off the floor of the NYSE that there are significantly fewer traders these days and they have been forced to close trading rooms.

Finally, are there things that should be of concern? If too much volume comes off of the visible Bid/Ask market system, the bids and offers shown on the publicly displayed market quotation system might not accurately reflect true supply and demand. This is why we are seeing rumblings by the SEC to regulate areas of dark pools if too much volume is traded in them. (The nature of regulators is to regulate.) While dark pools are good for large institutional investors moving large blocks of stocks and companies that trade using sophisticated algorithms, it is considerably less clear that they offer any benefit for anyone else.

I think what is happening here is that technology is opening up new channels for trading and moving things away from the old duopoly of the NYSE – NASDAQ. As they are the ones with the most to lose, they are also the ones that will yell loudest. At the end of it all, the lesson is that not all investors are equally suited to all markets. With the emergence of several new ways to trade stocks we are moving away from a “two markets fits all” approach to customized execution based upon the needs of the investor. Many permutations on order execution are bound to follow. The exchanges better figure out how they fit into all of this or they will be left behind.

Tuesday, September 8, 2009

More On Social Media and Investor Relations

My goodness gracious, but social media seems to bring out divergent opinions among investor relations professionals. My post last week elicited more responses, both in the form of comments on this blog and in emails, than anything I’ve written over the past two years. Interestingly, the opinions voiced were pretty evenly split; half of the people were proponents of the use of social media in investor relations and half didn’t see the point. Even more interestingly, the half that supported the use of social media were generally those that posted a comment on the blog, while the half that admitted that they, like me, didn’t get it, sent me a one-on-one email.

I thought it might be useful to distill down some of the things I’ve learned over the past week as I have dipped my toe into the waters of social media. In no particular order, here are some of the things I’ve found:

1. Sign up for things and people will start finding you.

In doing research on this topic, I set up accounts on facebook and twitter and worked on updating my linkedin profile. One thing I discovered is that all of a sudden, people started to ask to be my friend on facebook. I don’t know how they knew I was out there, but they found me. The same thing, to a lesser degree, happens on linkedin, but there I can at least see how it happens, as the site shows you how people are linked.

2. You may already be on Twitter.

After I signed up for twitter, I discovered that you can sign up to follow a link called IRbloggers. Lo and behold, when I went there, my latest blog post was listed with a link back to the blog site. Who knew? A close analysis of some of the statistics from my blog shows that for the last month, twitter is actually the fourth most frequent means by which people get to my blog. This is a recent phenomenon, as the same analysis over the past year shows twitter well down the rankings as a referral site.

3. Twitter can get your message out fast.

Perhaps the most common reason cited for the use of twitter is its ability to let people know quickly that more information is available elsewhere, with a link back to the full information set.

4. Twitter can let you know what’s going on in the virtual universe.

Assuming you subscribe to the right feeds, or follow the right people, twitter can give you fast insight into what people are thinking in the webosphere.

5. You can waste a lot of time on this stuff.

Following all the links and feeds takes time, which for most of us is a precious commodity. Robin Tooms, of Savage Design and a social media maven, during Q & A at her Social Media Boot Camp at this year’s NIRI Southwest Conference estimated that she spends an hour to an hour and one-half per day on social media. Personally, I don’t have that kind of extra time in my day and if I did have the extra time, I would want to be somewhere other than in front of my computer.

6. A lot of the stuff is irrelevant or garbage.

Even on a twitter follow site as targeted as IRbloggers, 90% – 95% of what comes across has no relevance to me. Do I really need another distraction in my day wading through the dross to find one or two relevant pieces of information?

7. The digital tsunami is descending on us and we might as well learn how and when to swim.

Where all this comes out no one really knows. The proper etiquette has yet to be figured out. There are certain to be fits and starts into how it comes out in the end, with plenty of unintended consequences along the way. Just because you can be connected 24/7 doesn’t mean that you should be. I’m always amazed when I see analysts who have flown thousands of miles to attend a meeting with management ignore the person in front of them, assume the “Blackberry crouch” and start dealing with emails and other items on the web. Not only is this incredibly rude, but it also makes you less effective for both tasks that you are undertaking. Maybe they’re trying to find the extra hour or two to deal with all the additional information they are being deluged with. In a counter reaction to this type of behavior, this year, for the first time, at the Jones Graduate School of Business, we have to include a statement in our course syllabus banning the use of laptops and cell phones during class because the preponderance of students were not using their laptops for note taking.

I could write more, but I have to go now and update my facebook wall…

Tuesday, September 1, 2009

Investor Relations and Social Media

Every generation has a point in the development of technology where they hit the wall. For my grandparents’ generation it was color TVs. My grandparents could never seem to be able to tune in their color TVs so that people looked normal – they always had a reddish or green tinge to their skins. For my parents’ generation, the people who were able to survive the Great Depression and World War II, cell phones have stopped them cold. Today’s seniors just don’t seem to be able to grasp what all those cool features on the phone are for – and why would you want a camera on your phone anyway? While I don’t claim to speak for my entire generation, for me, my technological Waterloo has been social media.

I don’t think of myself as a Luddite. After all, I write a blog, my business has a web site, I have an iPhone and I work on a computer most days. I’ve even learned how to send text messages on my phone, as it is the fastest way to get a response from my three college age children. But I confess that twitter and facebook have me stymied. I just don’t get it. Twitter because I’m incapable of saying anything in 140 characters or less and facebook because why would you want to put all that information out there in the public domain? And because I don’t get the social application of these services, I certainly don’t understand their application to investor relations.

First, let’s start with our friends at the Securities and Exchange Commission. The SEC has been very clear that all of the rules that apply to disclosure of information in other contexts also apply to social media. So I guess that means that if you inadvertently twitter a piece of material, non-public information, you must issue a press release as soon as possible thereafter. Of course, if you’ve taken the time to type out the information, I would question how “inadvertent” the disclosure was, which means that the press release should have been issued either before or simultaneously with the twitter. And how do you write a “Safe Harbor” disclaimer in less than 140 characters? These are the sorts of things that will drive your securities law lawyer to distraction, so they are quite possibly inclined to say that you would be better off not twittering about investor relations topics in the first place.

Secondly, who has the time? We all live days that are filled with lots of information flow, meetings, phone calls and other demands on our time. Do you really need another distraction, particularly one as unfiltered as social media tends to be? In a business context? I remember in the early days of email having a colleague extol the virtues of email because it bypassed all the filtering layers of a corporation, allowing anyone to communicate directly with you. These days I look at the constant stream of email that flows through my computer and sincerely wish for better filtering devices. And I don’t even work in a corporation, with its constant stream of emails from Human Resources, Security, IT, meeting and calendar reminders and notices of the annual golf outing, charity events and other odds and ends.

Finally, let’s not forget the primary mission of investor relations, which is relating to investors – making sure they understand your company and its prospects so that they can accurately value the company and its stock. Call me old fashioned, but I believe that this means that you actually have to talk to investors, listen to their questions and give them thoughtful responses. For that, the best, most efficient piece of technology that you have was invented in 1876. It’s called the telephone.

I suppose that over time social media will create a niche for itself in business, but for the present, to me, it seems over-hyped. I believe that truly sophisticated technology simplifies you life rather than adding more complications. And I don’t see how social media makes your life simpler.

Monday, August 24, 2009

More on Activist Investor Situations

As I wrote last week, the highlight of the NIRI Southwest Regional Conference this year was a case study on how activist investors swoop in on a company that is experiencing operational and governance problems. That is not to say that the case study was the only thing we learned from. Damien Park, who runs a firm devoted to helping companies who find themselves in these types of situations called Hedge Fund Solutions, opened the conference with some interesting facts about activist investors. Here are some of his observations, mingled with my views on the situation.

Activist investors will have studied your company for an extended period of time – often a year or longer. This means that they are not acting on impulse but rather have thought through exactly what they want to do. The company, in the meantime, is often caught unawares, much like a deer in the headlights of an onrushing truck.

To this I would add that companies compound the time crunch by the committee structure to how they react in these situations. The CEO, COO and CFO get together and discuss the problem. Then they bring in their advisors – the general counsel, the investor relations officer, the corporate communications people and others and have another meeting. Then the Board of Directors schedules a meeting. All of this takes up that precious commodity, time.

As Damien pointed out, while the company is doing this, the activist has issued a press release and probably started giving interviews to the press. He probably is also saying that the company has not responded to his overtures. He may have already started to talk with other investors about how he thinks things can be improved at the target company. “Me too” hedge funds have started to buy up the company’s stock in anticipation of making a quick buck. Everything is designed to ratchet up the pressure on the company and the Board of Directors to force them to accede to the activist’s demands quickly.

The company, after an internal meeting or two (or three, or four) will come to the realization that they do not have the expertise in-house to deal on even terms with the activist and will start casting around for experts they can hire. This is one of the critical junctures of the process. Choose wisely and you may emerge unscathed; choose poorly and you may have a couple of directors on your board from the activist firm. Companies, especially the smaller capitalization companies that tend to be the focus of many of these types of attacks, generally don’t know the right people to call.

From what I can see, there are a limited number of firms that specialize in these types of situations and if you are a company under the gun, you want one of them. You don’t want your local outside counsel. You don’t want your normal public relations firm. This is like brain surgery – you want firms that have done this many times before and know exactly what the options are and are capable of acting quickly. Yes, they will probably be from New York and cost a lot of money, but now is not the time to be cheap.

One way to help prepare your company is to start to get to know the right firms before things go downhill. At a minimum you should have in your rolodex/contact list the following types of firms that work on activist shareholder defense situations: a law firm that specializes in this area, a proxy solicitation firm, a firm that is expert in the defense against activist investors, a public relations firm that has experience in proxy contests and shareholder activism and investment bankers that have M & A experience. There are a limited number of firms that have extensive experience in this area, so talking to all of them, selecting the ones that fit your company and you are comfortable with and maintaining a dialog is not that time intensive. And more crucially, when the time come that you need this type of advice, you will know the right people to call and save precious time.

Think of it as the Boy Scout defense: “Be prepared”.

Monday, August 17, 2009

IR and Activist Investors

Last week I had the pleasure of attending the National Investor Relations Institute (NIRI) Southwest Regional Conference in San Antonio. I’m on record as having said this before, but I think it bears repeating: I believe that the Southwest Regional Conference is a better learning experience for investor relations professionals than the National Conference. I say this because the Southwest Regional Conference is shorter – a day and one-half as opposed to two and one-half days and thus more focused and, with a smaller number of people in attendance, you actually feel as if you have a chance to get around and talk to everybody.

This year, under the leadership of Lee Ahlstrom, President of the Houston NIRI chapter, the Conference took an interesting departure from the usual lineup of speakers. The first morning saw everyone engaged in a case study examining the actions of an activist investor confronting a company with operational and governance issues. The case required everyone to participate, assuming the role of members of the Board of Directors, while members of management, the activist investor, and an institutional investor presented their side of the situation. The case drove home the incredibly fast pace of events in these types of situations, as members of the Board found themselves with large amounts of data, conflicting agendas and not much time to make a decision.

As someone who uses case studies to teach investor relations, I was very interested to see how things would turn out. After all, the audience was mostly corporate IR practitioners, who would normally be expected to side with management. I had worked on the case with Lee and a number of other professionals in the field and thought that the case was even-handed, presenting issues on both sides of the situation, but with case studies you never know quite how the participants will react. To my surprise, the overwhelming number of participants voted in favor of negotiating with the activist shareholder, recognizing the difficult realities of activist investor situations.

I would be the first to admit that a single case study result does not a trend make. But Directors face enormous pressure to do something in these situations beyond the Nancy Reagan defense (“Just say no”). Add to that the additional pressure Board members face when you consider Director’s liability and potential lawsuits, and you start to understand the leverage activist investors have.

As investor relations professionals we are often the early warning system for these troubles. If you are consistently getting questions about underperforming units or assets, you should let your management know. Hedge funds often talk to one another about investment ideas and when the same question keeps popping up it can serve as a warning sign. Similarly, if your corporate governance scores are low or your compensation practices out of line with your peers, you should be tactfully suggesting that the Board address these issues. Better that the Board act on its own than be forced to by an activist investor.

Finally, set up a program to talk to your major institutional investors to discuss items other than the latest quarterly results. Solicit input on governance issues, compensation and equity plans, with senior management present. You can do this either as a separate call or ask that you spend 5 – 10 minutes on the topics during your next non-deal roadshow. Those are the institutional votes you will need next time there is a potential proxy fight and you would be well served to have a history of listening to your investors on these issues rather than waiting until you are under the gun.

Tuesday, August 11, 2009

Corporate Communications and Ethics

What do you do when you no longer believe in the position or information your employer wants you to tell the public? If you hang around the business of disseminating information for companies long enough, this is an issue you may very well face.

Such was the position Wendell Potter, former Vice President of Corporate Communications at CIGNA, the health care insurer, found himself in a while back. His experience in seeing the human side of lack of health care coverage ran smack into his company’s opposition to health care reform and its practices of canceling health care coverage in order to write only the most profitable policies. Potter underwent a change of heart and wound up leaving his executive position at CIGNA in order to work for the opposite side of the argument. You can discover more about his actions and see his interview with Bill Moyers at

The interview set me to thinking about the right way to handle such situations, either in an investor relations context or a broader communications context. What are the ethics of the situation? Does your duty lie to your employer or your sense of what’s right? When do you reach the point of walking away? What about your family that relies on you for support? You can’t predict how or in what circumstances these situations will confront you. Not all of us have a moment such as St. Paul on the road to Damascus, but if you have thought through some of the things you may face beforehand it helps clarify the issues when it becomes your turn in the penalty box.

First, there are the simple cases. At the egregious end of the scale, if your employer tells you to communicate something that is wrong or clearly misleading, and it’s material, you are obligated to say no. For public companies, disseminating false or misleading material information is a violation of federal securities laws and no employer can make you break the law. If your choice is between going to jail or being unemployed, better to be free and poor than employed but awaiting sentencing.

At the other end of the scale, there are the things your company does which you may not personally like but which you have to defend. Corporations are profit-maximizing entities that sometimes close divisions or plants at great human cost. You may not like the particular actions in question, but they are for the long-term health of the corporation and its shareholders, so you swallow hard and stick to the company talking points. Welcome to the real world. As long as you can get up in the morning and look yourself in the mirror, you should be OK.

But what if things fall somewhere in the middle or you can no longer look yourself in the mirror? You become convinced your company is wrong, or headed down the wrong strategic path? They are not doing anything illegal, but they are doing things you don’t agree with. At what point do you get off the bandwagon? Are there things you can do to prevent what looks to be inevitable or are the only options quit or keep your mouth shut? I wish I had the answers for those questions, but they are often very dependant on the exact situation a person finds themselves in, and each of us must find our own ethics path, often without much help from anyone else. There are however, a couple of books that might be helpful to the process. Joseph L. Badaracco, Jr. a Professor of Business Ethics at Harvard Business School, has written two books, Defining Moments, When Managers Must Choose Between Right and Right and Leading Quietly, An Unorthodox Guide to Doing the Right Thing. These books suggest strategies for de-escalating situations where ethical conflict may arise. In addition, Professor Badaracco recognizes in Leading Quietly that sometimes the small things we do in the name of self-preservation are OK. All of us have mixed motives in the business world, including the desire to stay employed. Sometimes it may be necessary to pick your battles, saving your moral stands for the important issues.

I haven’t presumed to provide many answers here. When faced with these situations, each of us must do what we believe to be right. The press celebrates those like Wendell Potter who take a clear moral stand. Certainly there is justification for this, as they have clearly sacrificed much to make their stand. But as Professor Badaracco points out in his books, there are often things we can do to dial down the potential conflict before it comes to an all or nothing stand. These may not be perfect solutions, but it’s not a perfect world.

Monday, July 13, 2009

Getting Useful IR Data for Free

Occasionally, while doing research on the web for something I’m working on, I will run across something that I didn’t know about, pause, and think, “Huh, I wonder if I’m the only one who hasn’t known about this until now?” Such was the case recently when I was engaged in research about the change in ownership of a company.

There is a web site, that I have found to be very useful in tracking change in investor ownership. The improbable name comes from (I think) the fact that they attempt to follow the investments of some of the largest hedge funds, the whales, and derive some measure of wisdom from what they are doing. The site is set up to help investors track the holdings of hedge funds, but it is also very useful for tracking the change in investor ownership of companies as well. The site has compiled data from SEC filings about investor ownership in companies and put it into reasonably useful form.

As most investor relations officers in the U.S. know, the Investment Advisors Act of 1940 requires that all investment advisors with assets under management of over $100 million file a report of their holdings on a quarterly basis with the SEC. The quarterly reports are known as 13 F filings and are helpful in understanding your company’s shareholder base. There is an entire cottage industry of firms that provide this sort of information to investor relations officers. Generally, this information tends to be expensive and bundled with lots of other services. The advantage of the Whale Wisdom site is that it’s free – and you don’t even have to register to use it. In this day and age of constrained budgets, that’s a big advantage.

There are several useful things you can do on the web site. You can select a company, yours, your competition or some other company, and see who owns them. You can look at ownership changes over time, as the information on filings goes back to September 30, 2007. I find this particularly useful, as when you look at a whole year’s worth of data, trends become much clearer then if you are looking at a single quarter. Are good, solid, long-term holders trimming their positions? Are more hedge funds moving in? Are you losing growth investors and getting value investors in their place? (I’ve seen this with several companies I follow closely as they have hit the wall on organic growth. When you start seeing lots of value investors, you know the P/E ratio will be a long time recovering.) You can even download the information to an Excel spreadsheet if you want to manipulate the data further.

Often times the investors themselves won’t tell you what they’re doing – the larger funds are particularly sensitive to this – so it’s up to you to figure it out. If the type of investor you are getting doesn’t match your story, it’s time to sit down and reconsider reality.

Another nice thing the site does is allow you to type in the name of an investment firm and see their holdings. So if you’ve got a new investor you’ve never heard of before, you can go see what else they own and get a feel for their investment style. You can sort their holdings to see how important you are in their investment universe. You can even see if the firm has any 13D filings, indicating the possibility that they may be a more active (read hostile) type of shareholder.

Due to the schedule of 13F filings – 45 days following the close of each calendar quarter – the information is not up to the minute. You wouldn’t want to rely upon it if you were in the middle of a proxy contest. But if you are interested in looking at longer-term trends in your company’s stock, this site is helpful. And the price is right.

Personal Note: Investor Relations Musings is taking a vacation next week, as I join 8,000 of my closest friends biking across the great state of Iowa in the rolling party known as RAGBRAI. If you are a faithful reader, do not fear, the blog will return in two or three weeks, as soon as I’ve had a chance to recover from my vacation.

Monday, July 6, 2009

A Healthy Debate

There’s an interesting column in today’s New York Times entitled “Unhealthy Fixation on Job’s Illness” by David Carr, whose column, The Media Equation, looks at business events form a media perspective. In the column he basically says that the people clamoring for more disclosure on Steve Job’s health are a bunch of blood sucking voyeurs who won’t be satisfied unless they have real time readouts on all of his vital signs. I’ve written about Apple’s lack of disclosure about Steve Jobs in the past and I’ve even created a case study out of this fact set for my class on investor relations at Rice University, so at the risk of being classified as a blood sucking voyeur, I thought I would chime in and try to bring some rationality to the subject.

First, I would agree that, under normal circumstances, the health of senior executives is a private matter that does not require disclosure. While they are paid boatloads of money as if they are the only people that count in the organization, the fact of the matter is that they are mostly interchangeable parts, people that can be substituted for without a material change to the company. However, I also believe that there are certain people who are so identified with a company’s performance in the eyes of investors that a serious threat to their health requires telling shareholders. Warren Buffet of Berkshire Hathaway is one. Bill Gates and Sam Walton, when they were CEOs during their companies go-go years, are two other examples. There may be a few others, oftentimes founders of companies, that fall within this classification.

Companies can also exacerbate the situation and put themselves in a position of having to disclose. They often put boilerplate language in their “Risks” section of their SEC filings, as Apple did, saying something along the lines of: “Much of the future success of the Company depends on the continued service and availability of skilled personnel, including its Chief Executive Officer…”. Once such a statement is in the SEC filings, it would seem to me to be hard to argue that a serious illness to the CEO is not material to investors. After all, you’ve just told them that much of your future success will be attributable to your CEO, and basic finance dictates that a firm’s stock price is the discounted value of its future cash flows and capital gains. Further, if your firm celebrates the cult of the CEO; if the CEO is the only one who ever talks to the street; if your CEO either runs a one man show or give that impression to investors, your firm may be putting itself in a similar spot.

The federal securities laws do not mandate that a company disclose the health of the CEO or any other senior executive. On the other hand, they also do not grant a right of privacy on the issue of health. It all comes down to what would be considered material in the eyes of investors. In the case of Steve Jobs, the media reaction and the stock price movement relating to announcements about his health tell us that investors consider this information material. It may not seem fair, but these things are always viewed in hindsight.

Finally, even if the initial judgment is that disclosure isn’t necessary, you still don’t have the right to mislead, and this is where Apple may be most vulnerable. Once you choose to say something, you have to be truthful and not omit anything which, under the circumstances, might otherwise make the statement misleading. And Apple has had a whole series of statements that appear to be less than completely truthful when it comes to Mr. Jobs’ health.

So, what are the lessons here for corporate practitioners? If you want to plan so that this isn’t even an issue should your CEO get sick there are several things that you can do. First, take a team approach to meeting with investors. Let the Street see that the COO and CFO are also very capable individuals who know the business and can step in quickly should the CEO get ill. This applies to both in-person meetings and quarterly earnings conference calls. Next, get your lawyers to revise the risk section of your 10 – K and 10 – Q filings and remove language about how valuable your senior executives are and what a calamity it would be if you should lose them. Lawyers like to think of these sections as insurance policies against securities law class action lawsuits, but unless you want to disclose health issues, the language may be doing more harm than good. Finally, if you do decide to say something, make sure the disclosure is accurate and complete. Remember, the Securities and Exchange Commission and your mother strongly agree on one thing: It’s wrong to tell a lie.

Monday, June 29, 2009

A Libretto for the Upcoming Legislative Changes

There is an old saying that goes “No man’s life, liberty or property are safe while the legislature is in session”. Recently we’ve been treated to a great example of this as the Obama administration introduced its proposals to overhaul the regulation of the financial industry and is revisiting a version of national mandates on health care. This being a blog on investor relations, I will focus on the process of changing the regulations in the financial industry, as eventually those of us involved in the equity markets will be impacted by such changes. Most aspects of the regulatory apparatus that oversees the financial industry, from the Securities and Exchange Commission, the Commodities Futures Trading Commission, the Federal Reserve, the Federal Deposit Insurance Corporation the Comptroller of the Currency and various and sundry other regulators have come under scrutiny. Nobody really knows how all of this will play out yet, but it makes great theatre, so I thought I would give everyone a guide to the proceedings.

Act One, Scene One: Capitalists will seek an investment edge that will allow them to reap profits. Once they find one that is legal, the early movers will become very rich. They will be followed by many more capitalists who, seeing the profits to be made, will expand the pool of money available for the investment in question. As more money chases a finite number of investments, standards will be lowered. See for example, the funding of start-ups in the dot .com boom, the prices paid for private equity deals in early 2008 and the sub-prime housing lending bubble. Eventually, when prices get crazy enough, the whole bubble collapses under its own weight. Investors lose tons of money. Everybody blames someone else for the collapse. There are outraged calls for Congress to act.

Act One, Scene Two: Enter the politicians and the bureaucrats. Sensing an opportunity to score easy points with the public, politicians begin to make proposals to protect investors, consumers or anyone else that can vote. After all, people vote, corporations don’t. The legislation that is proposed is designed to fix the immediate problem on hand and to demonstrate that Congress can act. Press conferences are held, laying out bold new initiatives to protect investors and consumers. Hearings are held, wherein the scapegoat du juor gets publicly flayed. While the politicians are preparing to act, the bureaucrats swing into action. This is where bureaucratic empires can be won or lost. Witness the recent struggles between the SEC and the CFTC. While it might make sense for one agency to regulate both securities and the derivatives that trade off them, neither the SEC nor the CFTC was going to submit to the other. Influence is wielded to protect regulatory turf and deals are cut.

Act One, Scene Three: Congress drafts legislation. In fact, they draft multiple versions of legislation. Nothing makes a Congressman or Senator feel better than to cosponsor legislation that will help them demonstrate to the folks back home that they are helping stamp out the evils of the flawed financial system that allows poor hapless consumers and investors to be sucked dry by rich bankers and hedge fund managers. Nobody pays any attention to the additional regulatory costs being layered onto the system. After all, corporations will pay that, and corporations don’t vote.

Act Two, Scene One: As the legislative process heats up, the fabled lobbying system swings into action. Lobbyists work on three basic premises: 1.) Time is their friend. The longer legislation can be delayed, the better the chance provisions can be inserted into it that benefit their organization. 2.) Every corporation resides in a home district or state of some Congressman or Senator and those corporations control jobs and investment spending in somebody’s home town, and those people do vote. 3.) While corporations don’t vote, their trade organizations control lots of money. And money is the mother’s milk of politics.

Act Two, Scene Two: Legislation finally gets passed. The President holds a bill signing ceremony and smiling legislators gather around him. The system works, sort of. The bill that gets enacted is usually far too long, with conflicting provisions and a very unclear legislative history. It will inevitably prove to have unintended consequences that will later require further legislative or regulatory fixes. Lawyers representing constituencies whose oxen are getting gored by the legislation are preparing to file lawsuits challenging the law even as the President is signing the bill.

Act Two, Scene Three: Capitalists begin combing through the legislation seeking an investment edge that will allow them to reap profits…