Monday, March 29, 2010

Bells Are Ringing

If you ever get the chance to participate in a bell ringing ceremony for the New York Stock Exchange, grab it. It’s a lot of fun. Recently, the Jones Graduate School of Business at Rice University held a panel discussion on the Future of the Capital Markets. One of the panelists was Duncan Niederauer, the CEO of NYSE Euronext, and as part of the program, the Jones School was honored by being allowed to remotely ring the closing bell on the New York Stock Exchange for the close of trading on March 29, 2010.

For those interested in the actual mechanics, the bell actually starts to ring 15 seconds before the close of trading and trading stops when the gavel comes down. The interval between the start of the bell ringing and the gavel coming down is to allow traders to complete their trades. Given that we are talking about professional traders and New Yorkers to boot, it’s never a problem completing trades in that last 15 seconds.

When you ring the bell at the New York stock Exchange, the only one who has a challenging role is the CEO, who has to simultaneously depress a button and remember to bring down the gavel 15 seconds later. This is the corporate equivalent of walking and chewing gum at the same time. As most CEOs are used to having someone else perform such complex tasks, it can sometimes be a challenge. Everyone else on the podium simply has to clap and look engaged.

Doing it remotely is a lot more fun. You get these cute little commemorative cowbells and you get to ring them and shout like mad for 15 seconds. Everything else gets taken care of back in New York. At Rice last Thursday, it seemed as if the entire school was in attendance. We rang our bells and shouted like mad and it was great. And yes, I’m in that picture somewhere.

Wednesday, March 10, 2010

Know Thine Enemy

As a matter of self-defense, one should always try to understand their enemies. For those of us that are in the business of dealing with the equity markets, this would include trying to understand class action securities lawyers. These are the people who bring lawsuits against companies alleging fraud and seeking to recover the lost value of stock for shareholders following some event that has caused the stock price to go down, while simultaneously collecting large fees for their firms. If you want some insight into the mindset of these plaintiff’s lawyers, I suggest you get a copy of the book, “Circle of Greed” by Patrick Dillon and Carl M. Cannon.

The book tells the story of the rise and fall of Bill Lerach and his firm, Milberg Weiss Bershad Hynes & Lerach. In its day, the firm was perhaps the most feared and reviled securities class action law firm around, bringing cases against a veritable who’s who of corporate America, from Fortune 500 companies to Silicon Valley high tech pioneers. One of the key insights of the book is that the mindset of a plaintiff’s lawyer is to immediately assume fraud on the part of a corporation when something unusual happens and the stock price goes down. It doesn’t matter that the process of running a complex corporation in a highly competitive environment is fraught with difficulties that mean that things don’t always go as planned and that the markets are unforgiving in such a case. In the minds of lawyers like Bill Lerach, if a stock has been going up and suddenly declines, the company has clearly been hiding something and defrauding shareholders. If this was compounded by management making optimistic comments and selling stock, the company was clearly guilty and large settlements could be extracted. My own personal experience confirms this: Many years ago I was on a continuing legal education panel with a lawyer from the firm of Milberg Weiss and he told me that the best research tool for new lawsuits he had was that day’s edition of The Wall Street Journal. He would read it every day and look for stocks that had taken a large decline in the previous day’s trading and assume that company was ripe for a lawsuit.

After reading the book, I want to add securities class action lawsuits to the old saying that legislation and sausages are things you don’t want to watch being made. In the old days, before the Private Securities Litigation Reform Act of 1995, securities class action lawsuits were little more than a legalized form of corporate extortion. A company’s stock price would go down, a lawsuit would be filed and, faced with the prospect of producing boxcars full of documents, tying up management’s time and attention with depositions and trial strategy, and a hostile jury willing to vote for the small shareholder against big corporations, most companies made the economically rational decision to settle. All you needed to do was file a lawsuit and you had a gun pointed at the head of the company. The 1995 Act has changed things a bit in that plaintiffs have to actually allege specific acts of fraudulent behavior before they can get certified by the court to lead the class action suit. But importantly, it hasn’t changed their mindsets – they still believe corporations are guilty – they just have to work harder to prove it.

“Circle of Greed” tells a compelling story, the Greek drama of how one person rose to the peak of his chosen profession, but was ultimately undone by his own seeds of fraud sown early in his career. While Lerach was publicly taking a high moral tone, claiming to recover money for the little shareholder, he and his firm were engaged in an ongoing scheme to pay illegal kickbacks, covered up by perjury, to people who agreed to act as named plaintiffs in their cases. Having a ready stable of plaintiffs meant that Milberg Weiss could get to the courthouse first and capture the lion’s share of the attorney’s fees. In the end, disbarment, jail time and significant fines were the fruit reaped by their actions.

While engrossing, the book is not perfect. It’s probably about 100 pages too long, with so much detail that you start to think the authors are trying to prove how thorough they were. It’s really not necessary to tell the reader where every one of the many lawyers in the book went to law school. More disturbing to me is the fact that the authors can’t seem to make up their minds about who the bad actors are. At one point they seem to point at the plaintiff’s bar, at others they seem to think almost all of corporate America is corrupt and the securities law plaintiffs are serving a useful enforcement purpose. At the end of the book I came away with the feeling that the authors believe the whole system is corrupt, but their sympathies lie much more with people like Lerach than corporate America.

(Author’s note: I received a free copy of this book from the publisher. No promises were made about reviewing the book in return, but after reading the book I thought readers of this blog might be interested.)

Tuesday, March 2, 2010

Sales, Marketing, Relationships and Investor Relations

There is an old saying that goes, “When the only tool you have is a hammer, everything looks like a nail”. So those of us who went to Kellogg Graduate School of Management are often accused of seeing everything as a marketing problem, because that’s what Kellogg is best known for. But in getting ready for this year’s investor relations class at Rice, I pulled out Philip Kotler’s “Marketing Management” and was quite surprised by how many of the principles of marketing apply to investor relations, so maybe there is some truth in the old saying.

For example: Boiled down to its essence, investor relations is consultative selling. You want the right type of customers (investors) to buy a piece of your company (stock) and to have a good ownership experience (own the stock for a long period of time). The purchase and sale decisions regarding your product (stock) are, for institutional investors, done in a complex, multiparty transaction involving sell side analysts, salesmen, buy side analysts, portfolio managers and traders, with information about your company being judged against a competing universe of offerings.

Marketing fundamentals tell us that any time you have complexity in the way a purchase decision is made with lots of competing choices, the process takes a longer period of time to analyze the pertinent data and come to a decision. Rivel Research has stated in one of their studies on the buy side that it can take 3 – 5 “touches” with management before a purchase decision is made. I have personally known investors who took 4 – 5 years of following a company before they made a significant investment decision. Yes, there have also been occasions where investors make a purchase after a single visit, but usually there has been significant research done before the visit.

Marketing also tells us that complex purchase decisions require more upfront effort by all parties involved. This is why it is important to realize that investor relations is a relationship business. It is much harder to sell a product if you do not have rapport with the customer. On the IR side of the fence, this means treating analysts fairly and consistently, helping them understand your company and industry, chasing down the details that help fill in the picture for the customer and eliminating some of the informational uncertainties that go with buying stocks.

Often managements have an “us or them” mentality when it comes to investors. You are either in the boat pulling on the oars and helping the stock price go up, or you are out in the water circling the boat awaiting an opportunity. It doesn’t have to be that way. As a partner at Goldman Sachs once said to me, “There are good companies and there are good stocks – they’re not always the same.” Stock prices fluctuate, and not always because the firm’s underlying intrinsic value has changed. This is where relationships come in. Patient, long-term investors may follow you for a long time before they find the right entry point. If you have built a relationship with them, they may be more likely to pull the trigger when the opportunity presents itself. Similarly, in times of market turmoil, investors are much more likely to stick with your company if they know you, believe that you are telling a straight story, respect your work and have been treated fairly by you in the past.

Of course, if you are completely owned by index funds, quants, quick buck hedge funds and day traders all this goes right out the window…