Can’t This Gang Shoot Straight?

The Securities and Exchange Commission used to be one of the most respected federal agencies in Washington. Some would argue that this is a low barrier to overcome, but nevertheless, the SEC was for many years considered a well run agency that, by and large, did what it was supposed to, and helped to give the United States the best and most transparent capital markets in the world. Alas, things have changed and now it seems that the SEC is the agency that can’t seem to get it right.

The most recent stumbles have come over the fact that the SEC Chairwoman, Mary Shapiro, who was given a mandate by President Obama to strengthen enforcement, failed to disclose to her fellow commissioners a conflict of interest involving the agency’s former top lawyer, David Becker. According to the SEC Inspector General’s report, it seems that Mr. Becker stood to have a financial interest in the settlement of the Bernie Madoff fraud case, and although he disclosed the potential conflict, Ms. Shapiro stayed silent on it, even allowing her fellow commissioners to vote on how to divide up the Madoff assets without telling them how their top lawyer might potentially benefit from the decision.

Not only that, but the Inspector General’s report also brings to light the fact that the SEC decided not to have Mr. Becker testify before Congress for fear that his conflict of interest would come to light. And this is from the agency that is charged with “full and fair disclosure” for investors.

This is bad enough, but it come after a series of other blunders over recent years that make you wonder if the agency has lost its way. Most notably, this is the agency, charged with protecting investors, that actively ignored the pleas of Harry Markopolos to investigate the returns being generated by Bernie Madoff, which turned out to be the biggest ponzi scheme in history.

More recently, and somewhat more mundanely, proxy access, a pet SEC project that would allow shareholders the ability to nominate directors using a company’s own proxy materials, was struck down by the Federal Appeals Court for the District of Columbia. According to the appeals court, the SEC had “inconsistently and opportunistically framed the costs and benefits of the rule; failed adequately to quantify the certain costs or to explain why those costs could not be quantified; neglected to support its predictive judgments; contradicted itself; and failed to respond to substantial problems raised by commenters.” Further, the court said there is “good reason to believe that institutional investors with special interests” – such as unions and pension funds -- would use the proxy access rules to advance their own issues and chided the SEC for “ducking serious evaluation of the costs that could be imposed” by shareholders representing special interests. It certainly doesn’t sound as if the Court of Appeals thought the SEC was taking a fair and balanced approach towards rule making in this instance.

And finally, how about the $557 million lease the SEC entered into without competitive bidding, which the agency can’t afford and doesn’t need because the underlying assumptions for the space were incorrect. Never mind that Commissioner Shapiro approved the lease in a 10 minute unscheduled meeting and later said that “The agency made a terrible mistake here,” and “I view myself as being ultimately responsible.” In most corporations if you were responsible for a $557 million mistake, you’d be fired, or maybe the SEC would investigate you…

Crisis Communication

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 like to repeat it: 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 and Scott Winters of the Houston NIRI chapter, the Conference once again took an interesting departure from the usual lineup of talking heads you normally get at these conferences. The first morning saw everyone engaged in a case study examining a crisis communication situation. The case required everyone to participate, as each table of eight assumed the role of the investor relations/corporate communications professional. They soon found themselves barraged with information in the form of management meetings, memorandums, twitter feeds, media inquiries and videos of the plant explosion in question. In the middle of trying to parse through the data, they found themselves being interviewed by a reporter and asked questions by a sell side analyst. While all of this was going on they found themselves having to recommend media and disclosure strategies to management.

Everyone I talked to said that the exercise was one of the best simulations they had seen on crisis communications. While that’s nice to hear, when I do case studies in my class, I always like to wind up with some key takeaways from the experience, so for the benefit of both the people who were at the conference and those that may wish to learn a little something about crisis communications, so here are the points to remember from the exercise:

1. 1. To quote Dwight Eisenhower, “In preparing for battle I have always found that plans are useless, but planning is indispensable.” In other words, the crisis you wind up with rarely looks like the one you planned for, but the exercise of planning for a crisis causes you to think through the process. This planning process is what helps you to deal with the crisis you do get.

2. 2. There is always somebody important you can’t reach when the crisis breaks. This may seem surprising in this age of interconnectedness, but people go on vacation to remote areas, cell phone coverage tends to break down under the stress of a crisis and there is always someone who is just out of pocket for some random reason or another. Having a clear chain of command as to who acts in the absence of others is important.

3. 3. The need for speed. People have to meet on short notice. Large amounts of data have to be absorbed quickly. Investors want answers right away and if you don’t respond to the press they will come up with their own version of events. There is no time for multiple editing rounds of your press release.

4. 4. You almost never have all the facts you need when you need them. In a crisis information is often garbled, late and sometimes just wrong. This means that the best messages you can send to your audiences are based on simple factual statements.

5. 5. Differing people have different agendas. The corporate counsel may not want to disclose anything at all. Business managers may not want certain facts to come out so that customers, suppliers and creditors don’t get upset. The reporters want to sell newspapers and get good video footage. Analysts care about how the event will affect the company’s stock and what collateral damage there may be to other companies. Good crisis communications has to deal with all of this.

In the end, there is no set formula for how to deal with a crisis, as each situation brings its own unique set of facts. Practice and planning can help however, which is why this year’s NIRI Southwest Conference was so well received.

Before I finish, I have to relate an interesting story from the conference. This year I decided to participate in the golf outing at the conference. I was out on the golf range practicing before the event (I need a lot of practice) when the person on the next practice tee looked at me and asked, “Are you the blogging professor?” I guess there are worse things you can be known as – it even has a sort of ring to it –“The blogging professor.” Maybe I’ll have it put on my business cards.

Building a Good Investor Presentation

The company presentation to analysts is a staple of investor relations, yet it doesn’t get the type of analysis it deserves. I’m not talking here about whether or not your slides are any good or how well your chairman speaks in public. Rather, I’m talking here about the basic structure of how you convey the information about what your company is and how it operates. A good presentation can generate interest in your company, whereas a bad presentation may very well turn off investors. Presentations are further complicated by the fact that at any given conference, a company executive will be speaking to a spectrum of investors, ranging from those that know the company well to those who may never have heard of it before.

There are many ways to create a well thought out overview of company information for investors and I don’t claim to hold a patent on the only way to do things. What follows is my approach, worked out over thirty years of presenting to investors. It is designed to organize the flow of information you need to convey.

First, start with a structure that borrows from a common investor relations framework:

Past Performance + Perception of Future Performance = Stock Price.

In other words, investors analyze the value of a company’s stock by trying to project what it will do in the future, using what it has been able to accomplish in the past as a reality check. From this framework, it becomes clear that when speaking to investors, a company needs to address both where it’s been and where it’s going. While this may seem obvious, I have seen many presentations totally ignore one side or the other of the equation.

In order to impose some logical flow to the requirements of such a formula, it makes sense to break down the presentation into three basic building blocks of information: Who we are, What we’re currently doing and Where we’re going in the future. This format helps to keep the story on track while still retaining enough flexibility to be creative.

Who We Are: This is the foundation of the presentation. It should include basics on the company’s industry, position within the industry, market share, operating locations, history and culture. The art to doing this section correctly is to provide enough basic information so that someone new to the stock has a good grasp of what your business is, while providing sufficient new information to keep those familiar with your story interested. For example, if you are in the oil exploration business, the basic information you give out should not only include the basics of the segment of your industry, but would also include updated information on the number of rigs you might have in operation and new exploration sites.

What We Do: This is the section of the presentation where companies can talk about what makes them unique. Most companies have an overriding operating philosophy which drives them forward; for some, such as Wal-Mart, it is being the low cost operator, while for others, such as Apple, it’s an obsession with design excellence. As important in this section as the “what we do” is the “why we do it”. If you can convey to investors not only what you are good at doing, but also the driving force behind what you do, you begin to put some informational meat on the presentation.

Finally, Where We’re Going: This is probably the most crucial part of the presentation. Critical information areas include giving investors some insight into how your company plans to compete; opportunities for growth and profitability; how you view the future of your industry; and the unique products or service offerings you plan to use to set your company apart going forward. This should be where the good investor presentation distinguishes its company from other possible investments in an investor’s mind. Remember, sophisticated investors are looking at an investment in your company as a claim on the future cash flows of the company, so they have to have a good sense of where those cash flows may be coming from.

Interwoven into all of this, Dave Mossberg, my colleague at Three Part Advisors, would add, “The presentation should give the investor three compelling reasons to own the stock”. Investor relations being a consultative sale, rather than a hard sell, the art here is to make the compelling reasons obvious enough for a reasonably astute investor to grasp without hitting them between the eyes with a two by four. So if, at the end of the presentation, the investor can sum things up by saying something along the lines of: they have a great track record, industry leading technology and are growing rapidly in an industry segment that is poised for expansion, you will have accomplished your presentation objectives.

Golf and Investor Relations

Mark Twain famously called golf “A good walk spoiled”. I was reminded of this because last weekend I returned to playing golf after a ten-year hiatus. In between swings of the golf club (of which there were many), I got to thinking about what investor relations practitioners can learn from the game of golf. So, hard on the heels of a discussion of the infield fly rule and IR (May 25, 2011), here are some of the thoughts that popped into my head about how golf resembles IR.

First, the more people you have, the longer the process takes. A twosome in golf plays more quickly than a foursome. In investor relations, if you are drafting documents, a large group takes much more time writing, editing and revising than a small group. While in a normal quarterly release process, this doesn’t matter too much, except to raise the blood pressure of the investor relations officer that has to try and write clear concise prose after the securities lawyer, the accountants, the general counsel, the CEO and the operations people have had their say, it becomes much more important when faced with a crisis situation when speed is essential. So when you need to get a release or a response out quickly, have a smaller designated group lined up for those exceptional circumstances. To many businessmen, this is counter-intuitive, as they are used to solving issues by throwing more bodies at the problem.

A corollary to this is that you are only as speedy as your slowest player. If you are out on the course and have one player who is constantly searching for their ball, or taking eight or nine practice swings before hitting the ball, everyone has to wait. Similarly, in the editing process, if you have one person who is consistently late in sending in edits, the entire process slows down.

Both golf and investor relations have their own coded clichés designed to blunt the impact of bad news that we can pull out at a moment’s notice. For example, in golf, when you say, “You’re on the beach”, it refers to your having landed in the sand trap; not to taking a quick refreshing break at the seaside. Similarly, in business, the phrase, “He left to spend more time with his family” does not really mean that the person in question wants to become more of a family person; rather it means he was fired and the company does not want to tell you the real reason the executive was let go.

Finally, both golf and investor relations are governed by sets of complicated and arcane rules that can get you into trouble if you’re not careful. It’s important to know the rules and abide by them – in golf, no one wants to play with a cheater, whereas in investor relations, your reputation for honesty and integrity are of paramount importance. Interestingly, in both golf and investor relations, the primary means of enforcement is self policing, although there are notable exceptions. Golf pros are bedeviled by people watching on TV who will call the PGA if they think there has been the slightest rules infraction, and in investor relations the plaintiff’s bar is always willing to second guess disclosure issues if the company’s stock price goes down.

Well, that’s it for now – you don’t want to overdo these analogies. Besides, I need to go practice my swing – it could be that I will play another round before ten years is up.

Small Cap Companies and Efficient Markets

One of my favorite quotes about the capital markets comes from Fischer Black, the financial mastermind who helped invent the Black-Scholes option-pricing model. Black, who had been a Professor at MIT, situated on the Charles River in Cambridge, left the world of academia to work for Goldman Sachs, which sits near the Hudson River in Manhattan. After experiencing finance from both the academic and practitioner viewpoints, Black commented, “Markets look a lot less efficient from the banks of the Hudson than from the banks of the Charles.”

I bring this up because last week I was involved in the East Coast IDEAS Conference in Boston at which most of the presenting companies were small capitalization firms. My background is primarily in large capitalization firms, so the conference was an opportunity to see the other end of the spectrum and learn a few things. The most surprising thing I learned as a result of speaking to company managements was how difficult it is for good small cap companies to get noticed by investors. It seems that finding a good match between underfollowed companies and investors can be a daunting challenge.

Part of this can be ascribed to much less sell side coverage available to small cap stocks. The name of the game with sell side coverage is commission flow, and small cap stocks have a lot less of it than larger cap stocks do. Without the distribution of information available from the sell side sales force, small cap companies are forced to try and bring themselves to the attention of investors through their own efforts. Similarly, investors have a hard time finding the good companies through all of the “ground clutter” on their radar screens. Add to this the fact that many smaller companies do not have full time investor relations officers, relying instead upon their CFOs to speak to investors and you have a combination of factors that can lead to companies just not finding the right investors. The result is that the markets seem a lot less efficient in the small cap space.

In theory, (from the banks of the Charles) the efficient market theory would say that as long as your company information is public, investors will find you and properly value your firm. So filing required reports with the SEC and having a web site should be sufficient. In reality (from the banks of the Hudson) this rarely seems to be the case for small cap stocks. What is required of smaller companies is what I refer to as “retail institutional marketing”. They have got to go out and actively bring themselves to the attention of potential investors because they are competing with so many other small cap companies for attention and investment dollars. And it seems as though those investors are not easy to find.

There is a solution for this, and that is for investor relations firms with knowledge of the capital markets for small cap companies to bring companies and investors together. One way to think of this is that IR consulting firms step into the role of the sell side sales force in terms of their knowledge of what investors may be interested in, introducing their client companies to interested investors. The difference is in the method of payment. The sell side is paid for via commissions from the buy side, whereas IR firms are paid by the company. When done correctly, a good IR firm can add to the efficiency of the markets by helping to match the right investors to the right companies, helping them achieve better liquidity and proper valuations

(Full and fair disclosure: The author consults for Three Part Advisors, an investor relations consulting firm and a sponsor of the East Coast IDEAS Conference.)

The Infield Fly Rule and Disclosure

With the advent of Memorial Day and warm weather (down here in Houston we define warm weather by temperatures being above 90 degrees, where they will stay until late September), my thoughts have turned to baseball and what we in the investor relations profession can learn from it. After all, baseball is a deceptively simple game consisting of throwing a ball, hitting it with a stick and then catching the ball. This compares to investor relations, which on the surface is also deceptively simple, as it’s really just about talking to people about your company and how it’s doing.

In both instances however, what starts out to be simple, rapidly get complex as the result of rules. For example, in baseball, consider the infield fly rule. The infield fly rule is designed to eliminate a situation where a base runner might be damned if he does and damned if he doesn’t. That is, the purpose of the infield fly rule is to prevent the defensive team from turning a double play by intentionally dropping or not catching a fly ball hit to the infield. The rules of baseball define an infield fly as the following:

An INFIELD FLY is a fair fly ball (not including a line drive nor an attempted bunt) which can be caught by an infielder with ordinary effort, when first and second, or first, second and third bases are occupied, before two are out. The pitcher, catcher and any outfielder who stations himself in the infield on the play shall be considered infielders for the purpose of this rule. 
When it seems apparent that a batted ball will be an Infield Fly, the umpire shall immediately declare ”Infield Fly” for the benefit of the runners. If the ball is near the baselines, the umpire shall declare “Infield Fly, if Fair.” The ball is alive and runners may advance at the risk of the ball being caught, or retouch and advance after the ball is touched, the same as on any fly ball.

There are several interesting aspects to the rule, such as it requires the judgment of the umpire that the ball can be caught with ordinary effort, an outfielder can be an infielder for purposes of the rule, and it has exceptions for line drives and attempted bunts. And, in true regulatory fashion, this is just the definition. You have to go to another rule to discover the effect of the rule, which is that the batter is out. This is a rule that only a lawyer can love.

Next consider the rules and regulations surrounding disclosure of material non-public information. The rule here appears to be a little less complex than the infield fly rule (although technically speaking, it’s not a rule at all as it came out of court decisions), and goes as follows:

“Information is material if there is a substantial likelihood that a reasonable shareholder would consider it important in making an investment decision.” And “There must be a substantial likelihood that the disclosure of an omitted fact would have been viewed by the reasonable investor as having significantly altered the “total” mix of information made available.” (TSC Industries, Inc. v. Northway and Basic v. Levinson.)

There are several striking similarities between the disclosure of material information and the infield fly rule. First, the judgment of the umpire, or in this case the arbiter of fact such as a judge, jury or your securities law lawyer, is called for to figure out what is important and what a reasonable shareholder would think. Next, if you think about the cases handed down about people who have been caught using insider tips, you know that outsiders can be considered insiders. Also, just as with the infield fly rule, there are clear exceptions to the application of the rule. Just as base runners cannot be forced to leave their base in the case of an infield fly, companies can’t be forced to disclose if the disclosure would interfere with sensitive negotiations (for example, in the event of merger negotiations) or if the issue isn’t ripe (due to facts still being discovered). Finally, just as with the infield fly rule, you have to go to a different rule, in this case Rule 10 b-5, to learn that failure to disclose a material fact is unlawful. Coincidence? You decide. It’s enough to make me think that Casey Stengel would have made a great securities law lawyer.

So the next time you’re confronted with a disclosure issue, think of the infield fly rule and take comfort in the fact that very few people truly understand the way these things work, and even fewer can make the right calls under the pressure of the moment.

Expert Networks Following the Rajaratnam Verdict

There was a front page article in today’s New York times as part of the coverage of the guilty verdicts against Raj Rajaratnam, that was titled, “Next Up: A Crackdown on Expert Networks”. The gist of the article is that federal prosecutors were now going to focus their insider trading crackdown on the use of expert networks. In fact, there have already been a number of indictments and guilty pleas resulting from the government’s investigation.

Expert networks, in a classic example of the law of unintended consequences, sprang into being following the enactment of Regulation Fair Disclosure. The theory was Reg. FD was forcing companies to stick to a plain vanilla disclosure script, telling everybody at the same time, whereas investors would pay to get something more than plain vanilla before everyone else. It proved to be a good theory, as on Wall Street, time and information are money, and expert networks could help investors with both. If an investor needed to get up to speed on a new industry, a new drug or a new technology, paying an expert for an hour or two of their time could be much more efficient than spending a week researching the topic. And presumably the investor could get the information free of corporate spin with some insights into the topic that corporate management might be unwilling to discuss.

Alas, like all good ideas, abuses soon appeared. Some expert networks solicited people to act as experts on the companies they worked for, with the implied marketing pitch to investors that they would be able to get an insider’s perspective. And lo and behold, some of the experts actually gave out material, non-public information about their companies. Many of these “experts” were in technical fields, such as medicine or technology, and it would be easy to say that they might not be expected to know technical SEC regulations. However, when someone is paying a person large sums of money to tell them about things that are not generally known about their company, it’s fair to say that person knows he’s doing something wrong. At the very least they are violating their duty of confidentiality to their employer, at the worst, they are violating the federal securities laws.

So now that people are beginning to be sentenced, what does it mean for expert networks?First, they’re not going away. The desire of Wall Street for fast information that may give them an investment edge will insure that the expert networks will continue to be around. Costs will go up as more compliance is layered into the process, both by investors and the networks, but the demand for the product will not go away. Second, companies will strengthen their disclosure policies to prohibit employees from acting as experts. As I write this I am sure there are securities lawyers all over the country drafting memos advising their clients to update their disclosure policies to prohibit all employees from participating in expert networks. Third, maybe, perhaps, we hope, the bad actors will be forced out of the business.

I hate to sound like a cynic about the last point, but when you’ve hung around the industry as long as I have and witnessed Michael Milken, Dennis Levine, Martin Siegel, Ivan Boesky, R. Foster Winans (The “Heard on the Street” columnist from the Wall Street Journal), James McDermott (the former CEO of Keefe, Bruyette & Woods who gave tips to his adult movie star mistress) and Martha Stewart, you get just a bit jaded about the ability of regulations and compliance programs to overcome the lure of making a quick buck.