Whistle While You Work

If you look at the history of financial regulation in the United States, one of the things you notice is that almost all regulation of financial activity at the federal level comes as a result of some form of financial scandal or abuse. This goes all the way back to the Securities Act of 1933, which resulted from the stock market shenanigans brought to light by the Pecora hearings following the stock market crash of 1929. In more modern times, this trend has continued with the enactment of the Sarbanes-Oxley Act of 2002 in the wake of Enron, Tyco, and others, and the Dodd Frank Financial Reform Act of 2010 that was spawned by the housing and mortgage crisis.

These laws are usually enacted quickly, as legislators are anxious to demonstrate that they are doing something, but the resulting legislation lingers on for many years. Companies are left to deal with and adjust to murky legislative language and often burdensome regulations resulting from laws that are designed to prevent the last crisis. Often these laws have unintended consequences, such as the effect of Sarbanes-Oxley on the number of companies choosing to file their IPOs in the United States.

Now we have at least one provision tucked away in the Dodd-Frank law which may come back and bite public companies. I am referring here to the whistleblower provision in the financial reform act. Under this provision of the new law, if a whistleblower provides independent information of fraud to the SEC that results in a successful enforcement action that recovers at least $1 million in sanctions, the whistleblower is entitled to recover at least 10% and up to 30% of the recovered funds.

There are a couple of interesting twists to this legislation. The first is that the independent information regarding the fraud can come from independent analysis of public information. Thus, an outside analyst without any inside knowledge of the company’s books and records can blow the whistle on a company if their analysis shows that the company must be acting fraudulently. This was precisely what happened in the Madoff scandal, when Harry Markopolos went to the SEC with an analysis that showed the returns shown by Madoff were impossible to achieve. It doesn’t take a great leap of imagination to foresee a new subgroup of analysts devoted to looking for financial fraud with the thought of collecting a reward from the SEC.

It also doesn’t take a great deal of imagination to think that the plaintiff’s bar would be very interested in the new whistle blower rules. Now, instead of trolling through Form 4 filings to look for Section 16(b) short swing profits violations by insiders, aggressive attorneys can cultivate relationships with short sellers in the hopes of joining together to find companies engaged in fraudulent activities. Given that short sellers are almost always convinced that companies are defrauding the public and plaintiff’s lawyers never pass up an opportunity to turn a new legal provision into a revenue stream, this is a match made in heaven.

If nothing else, people involved in the disclosure of company information pursuant to the securities laws needs to take a close look at the whistleblower provisions of the Dodd Frank law. Under the current SEC proposed regulations, whistleblowers do not even have to first go through company channels before blowing the whistle. So the company needs to get their disclosures right on the first try, because if they don’t, there may not be a chance to remedy things before the SEC is notified. And the possibility of $100,000 or more in reward money can make it very tempting for whistleblowers to accuse first and verify later.

Social Media and Investor Relations Redux

Readers of this blog will know that I am somewhat of a skeptic when it comes to the use of social media in investor relations (and yes, I recognize the irony of that statement when written in a blog). It’s not that I think there is no use for twitter, linkedin and the other social media services, it just that they strike me as being over-hyped compared to the nitty gritty job of getting the basic message right. But I am here to report that even I can be convinced of the ways that social media can be helpful.

Earlier this week I was privileged to give a speech to the NIRI Houston chapter on my favorite topic, the intersection of academic disciplines and real world investor relations. Before the speech I was introduced to Catherine Crofton of Q4 Web Systems. It turns out that Q4 Web systems had agreed to sponsor the luncheon and Catherine was going to introduce me. As we chatted about investor relations issues before lunch, Catherine told me about a success story of one of their clients in using social media. It turns out their client, TVI Pacific Inc., launched a campaign to use social media in their investor relations program that, coupled with a good story, helped to raise the firm’s visibility with investors, resulting in improved trading volumes and stock price performance. Q4 Web Systems has written about the program on their blog, which can be found at

http://www.q4blog.com/2010/01/11/tvi-pacific-shares-roi-of-using-social-media-for-ir/.

As I thought through this example, it occurred to me that the company in question, TVI Pacific, was a micro cap company, and one of the big issues facing small cap companies is simply one of visibility. If you are a Fortune 500 company, visibility is not an issue; many sell side analysts cover you, you have a large established base of institutional shareholders and the media is focused on you. However, if you are a small cap company, just getting on the radar screen of many investors presents a problem: the sell side may not cover you at all, very few institutions may own you and you are thinly traded. In short, the markets are a whole lot less efficient when it comes to small caps, mostly it seems because the information does not get in front of the right investors.

There is actually some interesting academic research on this topic. The title of the paper is “Investor Relations, Firm Visibility and Investor Following” and was written by Brian Bushee of Wharton and Gregory Miller of the Harvard Business School. The paper finds that investor relations efforts to improve a small cap firm’s visibility result in better trading volumes and increases in institutional ownership and better valuations.

The interesting thing about the TVI Pacific case is that they used social media in the form of postings on Twitter, Facebook, Fliker, YouTube and Slideshare and links on their website. Slideshare is a new one on me, but it turns out there is a site that allows you to post and share your slide presentations. (For those of us who have had to sit through endless boring powerpoint presentations during meetings, this may seem a bit masochistic, but it seems to be a popular site. Who’d of thunk?)

So if you are a small cap stock in need of visibility, social media may be an additional set of tools an IR officer can use at very low cost, assuming you can get the company’s general counsel to sign off on the use of them.

And it also seems as though a certain cranky IR observer may have to wind up eating his words.

Yowzer! Step Right Up and Hear the Professor!

I’m happy to report that I will be speaking on February 15^th at the Houston NIRI chapter on the topic of “IR Insights from Academia: Does Any of That Fancy Theory Apply in a Real World Context?” This will be the second time I’ve given this talk, having successfully addressed the Dallas NIRI chapter last November (at least they said it was successful). For those interested in attending, details can be found on the NIRI Houston web site, http://www.niri-houston.org/Luncheon--1.html?ModKey=mk$clsc&LayoutID=7&EventID=95

I find the topic fascinating because it gives me a chance to talk about the intersection of theory and practice. Since leaving the corporate practice of IR and developing my investor relations class at Rice University, I’ve had the opportunity to step back from the day-to-day pressures of IR and really think about what it is IR practitioners do and how all of that fits into things that are taught in business school.

When you think about the discipline of investor relations, it incorporates aspects of marketing, communications, finance, law and the capital markets. Further, the audiences it affects go far beyond just investors to encompass employees, customers, suppliers, creditors, bond holders and governmental entities to name a few. When you throw into the mix that there are some schools of academic theory that hold that active investing and investor relations activities add no value, there’s quite a bit that can be discussed.

Just by way of a teaser for some of the topics I cover in the talk, here’s some of the theory versus real world that I cover:

Finance – most valuation models are constructed using discounted cash flow techniques and how they work has a significant impact on your company’s stock price. Beyond the modeling technique however, there lies a significant takeaway to think about.

Marketing – a lot of investor relations literature talks about targeting investors, but that is only one-third of the three crucial steps to marketing.

Communications – there is a lot of really bad IR communications out there, much of it in the form of PowerPoint slides. I look at examples from some of the biggest corporations in the U. S. (This section is the most fun.)

Law – lawyers are taught to think in a particular way, and regulatory lawyers have a unique take on that. As someone who practiced law for ten years, I attempt to bridge the communications gap between lawyers and IR practitioners.

If you are in the Houston area, I hope you can join me. If you are not in the Houston area, but are interested in having me come to a local NIRI chapter, please give me a call. I’m somewhat of an evangelist on bringing more academic rigor to investor relations, so there is no charge for the talk other than travel expenses.

When is a CEO’s Illness Material?

There was an article in yesterday’s Wall Street Journal entitled “Investors Want Right to Know” which uses the recent announcement of Steve Job’s latest medical leave of absence to advance the argument that Boards of Directors need to disclose more about the health of their chief executive officer. I’ve written about Steve Job’s illness and the lack of disclosure surrounding it on a number of occasions before (see “The Weighty Issue at Apple”, Jan. 6, 2009 and “Maybe Things Were Not So Simple and Straightforward” Jan. 15, 2009) and I stick by what I wrote then. In short, this is a sensitive area where the privacy of an individual bumps up against the disclosure of material events.

Surprisingly, in light of the numerous other items executives must disclose, there is no SEC rule requiring that a company disclose or discuss the health of its CEO. On the other hand, there is no right to privacy under the federal disclosure laws and regulations, either. So what it boils down to, as it does in so many investor relations situations, is the materiality of the issue. If the fact that your CEO has a life threatening disease would be enough to create “a substantial likelihood that a reasonable shareholder would consider it important in making an investment decision” then you had better disclose it.

There are probably two lines of inquiry a Board needs to think about in considering disclosure; the corporate side and the health side of the issue. Factors to consider on the corporate side in making such a disclosure would include:

• How irreplaceable is the CEO perceived to be? People such as Sam Walton of Wal-Mart and Steve Jobs of Apple score highly on this test. Less visible CEOs might not be considered as important to the future of the company, particularly if there is a well publicized succession plan in place and the CEO is nearing retirement age.
• How much is the company paying the CEO compared to everyone else on the proxy compensation list? One of the most visible measures of how much the Board of Directors thinks the CEO is worth is how much they are paying him compared to the other important executives. If he’s making several multiples of the compensation of the next person on the list, then the logical assumption is that the Board views him as almost irreplaceable.
• Does the company have a risk factor in their 10-K report that talks about how unique and important their CEO is to their future? Obviously it’s difficult to argue that a life threatening illness to the CEO is not material if your risk factors say he’s very important to your future. (Apple in fact did this, but it sure doesn’t look good.)
• What is the fact situation surrounding the CEO? Does he portray himself as the sole identity of the firm or does he showcase other executives in public appearances, relations to investors, suppliers and customers?

On the health side of the equation, not to put too fine a point on it, we can all agree that the death of a CEO would be material. So the question Boards must wrestle with is how incapacitating, short of death, must an illness be before a Board has an obligation to disclose. Some commentators have been calling for more regulation by the SEC in these cases, but I think that is likely to be difficult, as hard and fast rules when dealing with health issues can prove a very slippery slope.

All of this sounds good in theory and it would work, except for one thing: Boards usually choose not to disclose a CEO’s illness. I can understand this from a couple of perspectives: the need for privacy in a very stressful situation and the Board’s sense of loyalty to the CEO. Further, when you go through the type of analysis I’ve outlined above, you can often find reasons not to disclose. So investors need to understand, and I think most do, that disclosure in these situations will be slower and more guarded than in a typical corporate situation.

As for the situation at Apple, I have very little sympathy for those who are now crying for more disclosure. If, after all the publicity surrounding Steve Job’s illness during the previous two episodes, an investor hasn’t gotten comfortable with an Apple after Steve Jobs, then they have been asleep at the switch.

Maybe We Have Things Backwards

I’ve been reading an interesting book lately. Normally I stay away from business books, particularly ones that sound like they want to solve business problems with touchy-feely quick fixes. But in this case I listened to the author get interviewed on the Harvard Business Review podcast and I was hooked. The title of the book is “The Happiness Advantage” by Shawn Achor and its basic premise is that we have things backwards when it comes to success and happiness.

If you are like me, you probably grew up thinking that if I can just be successful, then I’ll be happy. What this type of thinking leads to is a continual round of striving, only to discover that the goalposts keep getting moved. For example, you start out thinking, if I study hard and get good grades, I’ll get into a good school and then I’ll be happy. So you get into a good school and instead of being happy, you discover that now you have to study even harder so you can get the job or graduate school admission that will make you happy. Then when you land the job you think will make you happy, you discover that you need to really buckle down and start your career so that you can achieve true happiness when you get the big promotion. And so it goes, and we never really feel as if we’re happy, because there’s always more out there that we need to achieve in order to think we’re happy.

Mr. Achor turns things around and, based upon research, shows that happy people are more successful. Further, he demonstrates that you can learn to do a lot of small things in your everyday life that will increase your ability to feel positive about things, basically making happiness a habit. I’m still reading the book, so I can’t speak to everything Mr. Achor claims can be achieved, but the way I think about it is, if some of these things make you feel better about life and increase the probability of your success, why not give it a try?

In the field of investor relations, one way to look at it in this context involves the flow of information: many times IR officers are placed in a situation where analysts want more information than our companies want to provide. For example analysts may want to follow the inflation rate in your product category and your company only releases that information in its earnings release. There are two potential ways to handle the situation. One is to simply say the information is not available intraquarter (as Oddball, played by Donald Southerland in the classic movie Kelly’s Heroes says, “Negative waves, Moriarty”). Or you can choose to be helpful by pointing them to a government inflation index that closely tracks your own internal inflation that will help the analysts without divulging your number. I guarantee that the analyst will think more highly of you and your firm if you choose the latter course.

When all is said and done, a large part of investor relations is based on relationships that you build with investors over time. If those interactions that you have with investors are positive in nature, the investors are more likely to have a good impression of your firm and its prospects. And that’s a big part of the battle.

Focus on the Fundamentals

I spend a fair amount of time listening to business experts on the Harvard Ideacast and Knowledge@Wharton podcasts. I choose to listen to the podcasts as opposed to read the scholarly articles they are based upon for two reasons: First I find that authors are much more likely to speak in plain English than they are to write it. Second, I spend a fair amount of time cycling to stay fit and listening to podcasts beats hearing my playlist of oldies for the 2,000^th time (and I can hear traffic over the sound of the spoken voice whereas Bruce Springsteen tends to drown out the sound of approaching cars).

One thing I’ve noticed about business experts, whether their field is human resources, finance or management, is that they are all convinced that the insights they bring and the field they are working in are the most important and critical applications for the modern corporation. Almost every expert comes across as being convinced that if company managements would only sit up and take notice of the expert’s crucial insights, companies could solve all of their ills and rake in the profits.

And so it is with investor relations experts as well. Over the past several years as I have observed and commented upon the field of investor relations, I have seen a parade of experts inform us how our lives were going to be radically changed by the latest topic du jour, and that we had better get on the train because it was leaving the station and those that were not on board were doomed to extinction.

Let’s start with XBRL. I first wrote about this topic in January 2009, so almost two years have gone by since I confessed that I didn’t understand the revolution. Guess what? I still don’t understand what all the fuss was about. XBRL sure hasn’t changed my life, and I look at company filings and websites all the time. It may have changed the lives of some programmers that had to map all that data, but to me it just seems like another government mandate that has had little to no impact in the real world.

And how about social media? Has it totally changed your IR program yet, the way all the experts claimed it would? I think the only change social media has made to IR is to give rise to an entire set of new experts that will get you prepared for the revolution they say is coming.

The point here is not that these issues don’t have an impact – they do, albeit a minor one in the scheme of things. These relatively new technologies will grow in importance over time, just as the use of the web and email have, although each new technology brings about its own dangers (see my June 10, 2009 post “Email is Not Your Friend”). The point I am trying to make is that IR practitioners should not let the latest fad overshadow the fundamentals of what we do. And what we do is to ensure that investors have sufficient information to make reasoned investment decisions about our company’s stock. This is accomplished by making sure the information our companies disclose is clear and understandable and presents a complete picture so that investors can make an informed investment decision. Clear and understandable generally comes in two parts: how we plan to make money in the future, back-tested against what the company has accomplished in the past.

The medium of how information gets delivered, whether it is in the form of paper, telephone, fax, email, text messages or social media, is just a tool – the important part is the information itself. So as we move into a new year, let’s focus on the important stuff and make sure that we make sure the basics are covered before we start chasing the stuff at the margin.

Proxy Advisory Services Regulation: What’s Good For the Goose…

As a commentator, one of the best things you can find to write about is when you come across someone being totally disingenuous; it’s almost as good as when companies do something really stupid (for which see “How Not to Run a Conference Call” December, 2007 and “What Was He Thinking, Whole Foods Version”, August 2007).

Which brings me to this week’s subject, the possibility of the Securities and Exchange Commission imposing regulations upon proxy advisory firms. Proxy advisory firms have grown in size and influence over the last twenty years. Their positions on corporate governance, compensation and proposed mergers and acquisitions have become important to both investors and corporations, creating in effect, de facto standards. Yet the manner in which the proxy advisory firms reach their recommendations and ratings, the formulas they use when looking at compensation and equity plans, and the process by which they make recommendations regarding merger and acquisition activity are considerably less than transparent. Further, the amount of research available to support their positions on corporate governance is less than overwhelming and far from conclusive. Finally, some firms, such as ISS, have actively worked both sides of the street, advising institutions how to vote and selling their consulting services to corporations to tell them how to structure things in order to get approval and high ratings from ISS.

So when the Securities and Exchange Commission asked for comments on the proxy process earlier this year it is not surprising that a number of comments came back suggesting that proxy advisory firms be subject to some regulation from the SEC, namely that proxy advisory firms should be subject to proxy rules and regulated as investment advisers, including mandated disclosure of specific conflicts of interest, transparency on how they develop their ratings and recommendations, and that they adopt procedures ensuring the accuracy of their reports and voting recommendations.

It seems as though the proxy advisory firms, which like more regulation for corporations, are not so happy when the shoe is on the other foot. Here’s Nell Minow, Chair of The Corporate Library and former general counsel and CEO of ISS in a comment letter to the SEC: “I would like to object in the strongest possible terms to the possible regulation of proxy advisory services.” Later in her comment letter, she goes on to explain how market forces will keep the proxy advisory services honest.

In other words, if we just let competition work without government getting in the way, everything should be fine. Of course this is exactly what they say doesn’t work for corporations when they want more regulation on say on pay, proxy access, compensation disclosure and a whole host of other corporate governance issues.

It does seem to make sense that these firms, which have a great deal of influence in how investment firms vote should at least be required to disclose the methodology by which they come to their ratings and recommendations, disclose any potential conflicts of interest (or better yet, be prohibited from conflicts of interest) and show they have stringent procedures in place to prevent inaccurate reports and recommendations.

After all, if increased disclosure and regulation is good for the goose (corporations), then it is certainly also good for the gander (proxy advisory firms).