SEC Chief Can't Win for Losing

It must be tough to be the head of the SEC, when you know that you'll always be under a microscope - and gun. Business moaned and complained about Sarbanes-Oxley, how regulation would be the death of business on this continent. (Notice how profits are doing pretty well, thank you very much?) Now Christopher Cox is getting pummelled over not having a higher profile during the Bear Stearns financial crisis. Of course, it was the Fed that had to pull the bank out, and Congress that has to deal with how to better regulate the industry (and maybe, who knows?, go back to some of those old deposit requirements that seemed to work so well). I think the problem is that people want someone to blame - anyone. Businesspeople are just regular folk, when you get past the bespoke suits and expense accounts, and they get scared when the entire framework of their world quakes. But I'm not sure there is a happy or short answer. Regulation may work for a while, but will eventually fail as people forget why it was put there in the first place, or someone locates gaps that let them do as they wish. And when things go wrong, we can only blame ourselves. Perhaps a bit less yearning for something from nothing might go a much longer way to sanity.

AOL Time-Warner Merger A Crock From Day One?

Bloomberg has an interesting story: the SEC is suing some former AOL execs for allegedly overstating Internet advertising revenue by more than $1 billion between 2000 and 2002:

In mid-2000, before AOL completed its $124 billion takeover of Time Warner, the Internet service provider began overstating revenue by paying more for goods and services in exchange for customers' ad purchases, the SEC said. The company agreed to pay $300 million in 2005 to settle a related regulatory probe.

Interestingly, the whistleblower, called as a witness in a number of cases, is also being pursued by the SEC. Now that seems plain silly. You'd think that the SEC would want to encourage people to come forward, and it sounds as though someone needed to at the company. Now what are people going to do in other companies? Help hide anything because they don't want to be held accountable?

JP Morgan to Sweeten Bear Honeypot

It sounds as though JP Morgan may have to up its offer for Bear to $10 a share, and the entire situation is creating an interesting dilemma. ON one hand, the Fed is looking to ensure that commerce continues. It's not that Bear Stearns itself is so important to the economy so much as its position as a middleman in so many transactions. The problem is that if Bear had gone into bankruptcy, then the court would have had no choice under the law but to freeze all transactions in which it took part, no matter what it was actually doing. That could be a big enough hiccough to derail enough commerce that suddenly everything would come tumbling down.

So the Fed wanted to keep this from happening, and I can understand that. But Bear Stearns is a publicly-traded company, and the public that trades the company was pretty upset about the price being only $2 a share when it had gone for as much as $30 on Friday - and that was a loss of two-thirds of its value. According to a New York Times story, shareholders were ready to head to court.

On one hand, I don't have a lot of sympathy for the shareholders. They wanted the high return and were happy to overlook the questionable nature of the business that the bank was doing. Hey, it's capitalism, and there's risk. Why is it that so often so many people who have money to invest suddenly want welfare for the rich? But the intriguing issue is which governmental (quasi or not) agency has precedence when it comes to the conflict of interests? Can the Fed encourage a fire sale, or does the SEC have to come in on the side of investors, who want as much money per share as they can get?

The new offer must be approved by the Fed, which had initially balked at the new price.

If the Fed balks, does the deal come apart? This seems like a deal that is so important to the economy that the Fed is effectively powerless to say no, which means it has little leverage in a negotiation.

A new deal could raise even more questions about the Fed’s involvement in the negotiations. As part of the original deal, the Fed guaranteed to take on $30 billion of Bear’s most toxic assets. The central bank had also directed JPMorgan to pay no more than $2 a share for Bear to assure that it would not appear that the Bear shareholders were being rescued, people involved in the negotiations said Sunday night.

Might not the SEC say, "Sorry, folks, but the directors can't legally agree to such a deal?" I don't know that different branches of business regulation have ever clashed in such a way.

Wikileaks Reports JP Morgan Document on 10B5-1 Trading Plans: Claims Inider Trading

Wikileaks is reporting sudden discovery of the 10B5-1 trading plan:

A confidential memo obtained by Wikileaks shows that not only has the U.S. Securities and Exchange Commission created an insider trading loophole big enough to drive a truck through, but that Wall Street is taking full advantage of it, establishing 'how-to' programs and even client service divisions to help well-heeled clients circumvent insider trading regulations.

However, life just isn't that simple. There are several ways of structuring these plans, and there has been some evidence that these plans may be getting better results than you might mathematically think.

But the story isn't new, and the SEC is hardly ignoring potential abuse. Also, if someone uses the particular approach mentioned in this leaked document, they will probably lose the legal protection that 10B5-1 plans offer. Also, an executive wishing to game the system has much more effective and invisible methods of doing so. I covered the topic last December in Corporate Secretary.

SEC Slaps Wrists Over SOX Violation

According to the Associated Press, the Securities and Exchange Commission "charged 69 accounting firms and partners on Thursday with violating a landmark 2002 antifraud law by auditing public companies without registering with the board that supervises the accounting industry."

According to Sarbanes-Oxley, accounting firms and accountants that audit public companies must register with the Public Company Accounting Oversight Board (PCAOB), part of the SEC that provides oversight to the accounting industry:

Without being registered and subject to inspections by the board, the 69 accounting firms and partners around the country together issued audit reports for 53 public companies from November 2003 to October 2005, the S.E.C. said.

Of these, 28 firms and 22 partners were censured by the SEC but didn't have to pay any fines. There are still cases pending.

My question is why have such regulations when you're not going to strictly enforce them when it comes to the very businesses that are supposed to provide the reviews that help investors know if things are on the up and up? Are they claiming that they can provide adequate audits if they can't even get things together enough to register as the law says they should? If slapping wrists is all that happens, then my bet is on yet more problems with public companies going forward. Why not, when there don't seem to be serious consequencies?

Dell Not Well After Knell

A death knell usually means the end of something. Sometimes it happens after a long illness. In the case of Dell, the bell tolls for for conditional listing, for having to restate four years of accounting records, for being unable to predictably deliver products on time. It's the end of Dell as everything thought they knew it.

I'm generally suspicious when praise of anyone or anything gets too loud and continues for too long. It was perhaps three or four years ago that there were some obvious signs that Dell was traveling down a dark path. They were insanely profitable compared to other PC vendors, and while Wall Street rejoiced, investors should have been scratching their heads. As the saying goes, when a deal seems too good to be true, it probably is. Given the thin margins and massive supplies of products, pricing dropping faster than a stone through a clear sky, how could they have been managing profits that were triple those of companies like HP?

One part of the answer came from electronic component analysts who said that they were squeezing suppliers tight enough to suck out virtually every penny of savings the vendors could get from economies of scale. "We're making you efficient," said Dell, according to these analysts. "Get your profits from your other clients." Those other companies - sometimes even competitors of Dell - naturally took offense that they should be underwriting that company's earnings. So a growing number of suppliers began to walk away.

No problem for Dell: suppliers were a dime a dozen. But management forgot that there's more cost in a supply chain than the incremental expense of parts that you buy. There's reliability and service. Bottom feeders eventually get down into the muck, and if things go badly, their low-priced friends don't have enough capital to pull things back up into cleaner waters. Then there was the other strategy: reduce customer service, outsource technical help, anger customers, leave them on their own to solve their problems. All of these actions happened to lower Dell's costs - and another way of putting that is the company wanted to take even more money out of customers' pockets, only without being obvious about it.

And now we see that Dell had yet another strategy: stretch the truth. (It's something most of us grew up calling a lie.) Here's how the Reuter's put it:

Dell Inc. said on Thursday it would restate four years of financial results, reducing net income for the period by as much as $150 million, after a lengthy audit found that top executives sought accounting adjustments to reach quarterly performance goals.

It wasn't enough to keep trimming corners and tick off customers. To keep the stock price up, managers were prepared to play with the numbers to get the results they wanted.

It was perhaps in 2003 or 2004 that I began telling some people I knew that I expected to see front page stories, titled, "Whatever Happened to Dell?", in BusinessWeek within five years. Maybe I was a year or two optimistic. As the Reuters story further stated:

Dell, based in Round Rock, Texas, said it did not expect the restatements to have a "material" impact on its current balance sheet or on cash flows during the restatement period, which covered fiscal 2003, 2004, 2005, 2006 and the first fiscal quarter of 2007.

Not material? Of course management is going to say it's not material. Once you use the M-word, you're really SEC fodder, because the CEO and CFO are now personally responsible for having signed off on misleading financial reports. Right now the analysts are saying that the adjustments look "minor." I'm with Larry Dignan on SeekingAlpha that these reactions are annoying and, to my mind, at least, misleading:

While the restatements were small, Citigroup analyst Richard Gardner notes that Dell would have missed estimates during its first fiscal quarter of 2003, second quarter of 2003 and fourth quarter of 2005 without the accounting hijinx. That’s hardly meaningless.

What company misses multiple quarters and then sees analysts say, "Oh, that's OK, it's the thought that counts?" And that doesn't address the really big problems in supply chain and in customer service and, ultimately, customer retention. What is Dell doing? Saying everything is fine and looking for a new advertising agency. Obviously the company needs a new story. Let me suggest a lead:

After evaluating how we've treated business partners, customers, and investors, we've decided that we have to completely change the way we do business and act with respect toward the people and organizations that hold our future in their hands.

It may not be catchy, but it might actually work.

The Real Problem of Compliance

I was recently speaking at a meeting with some fairly large public companies. The topic was a relatively new SEC requirement: plain English explanations of executive compensation. After I spoke, there was a lull and it seemed that no one had any questions. And then, just as the organizers were about to move ahead onto something else, one question came, then another, and another, and another.

Actually, I'm not sure that question is the right word. The tenor was more of a statement ... really, a complaint about the prospect of having to spend even more money for compliance. It wasn't the plain English disclosures so much as all the recent waves of compliance issues. The displeasure really came in several parts: the seeming arbitrariness of many of the regulations, the sense that business is starting to exist for the sake of regulation and not the other way around, the attempt of the SEC to push its requirements into other countries, and the cost of it all.

I could understand the displeasure - I've heard much of this from upper level management before - but this spilled forth in a rush of bitter anger that was palpable. Someone did eventually say, "Let's be fair; he's not with the SEC," which did get a laugh, but it was like putting a spark to gunpowder.

What really surprised me, although in retrospect it shouldn't have, is that so many businesspeople from such a range of companies were acting completely emotionally. Their focus was on themselves, understandably, but in a way that did not allow any improvement of the condition. For example, they were literally saying, "The regulations are killing us!" I asked, "Were your revenues higher this year than last? Did you make higher profits this year than last?" The answers were yes and yes. So I replied, "Then it's not killing you." Oh, no, they said, the compliance issues are killing us.

Again, hearing this isn't new, but I found that as I applied some logic to the situation, they wouldn't change their focus. They wanted to remain in pain, which is a pretty common, if perverse, reaction. But complaining only about how something is unfair is useless. Either it is out of your control, in which case you can't do anything about it and should focus on what you can do to minimize the impact, or it is in your control, in which case you should stop complaining because you're doing it yourself.

But many executives apparently are doing neither. They continue to complain and don't make the effort to find a better way to deal with things. For example, I pointed out that Sarbanes-Oxley business controls documentation gets you maybe 90 percent of the way to real business process reengineering, where you can eliminate a lot of waste and work in a more rational fashion. Their reaction? "It sounds good, but I'd like to see you make it happen here." Yet I can imagine the reaction of any of these people if a subordinate took the complaining approach when being told that there was only X amount of time for a given project.

If compliance is that much of a burden, use the courts and lobbying to see if you can get changes. But in the meanwhile, the real problem, as usual, is ourselves. Instead of feeling crushed, find how you can make the weight lighter at least, or see if you can make multiple times more profit from the expense, by actually using the information you get to improve business.

US Agencies Rethinking Financial Reporting

According to the Financial Times (sorry, no free link), both the Securities and Exchange Commission and the Treasury Department are planning studies of a complete financial oversight overhaul:

The rules-based regulatory structure, built up since the 1930s, has been criticised by representatives of the financial services executives, who have called for a more flexible regulatory philosophy akin to one in the UK.

For those that done realize, the US and Europe have taken different directions toward financial controls. In our own land of individualists and rule-breakers, the approach has been an ironic reliance on rules and checklists. If you were able to mark off all the boxes, you'd be safe. The difficulty is that you have to go through all the checklists, even if they didn't really apply to your circumstances, which meant increased compliance costs.

Europe has employed a more principle-driven approach of stating what needs to happen and allowing corporations to find their own ways. It's become popular to invoke this model, particularly among many who think that it will mean an end to "needless" regulation. Personally, I think that many hope a new approach would largely free their companies from regulation, period.

While both models have their strengths and weakness, I'm not sure that the European approach will deliver American companies what they think they want. After all, it's generally easier to satisfy the letter of the law than its spirit. But if you must satisfy principles rather than checklists, aren't you essentially looking at the spirit instead of the letter? Directors and managers won't necessarily be able to say "We followed the checklist" when investors claim a violation of the principles, or spirit. I've found in life that almost every time something seems to be the solution to a problem, it almost inevitably makes things worse. Let's hope that American companies don't rue getting what they asked for.

SEC Bailout for Small Business? Or Big?

Companies have been putting heavy pressure on the SEC for a number of years now, trying to get the agency to lessen the reporting requirements of Sarbanes-Oxley. And it came out with an expected change yesterday. Although the actual text isn't up on the SEC, it essentially says that companies can now focus on the areas where fraud would be most likely to occur, using a risk management approach. Many journalists and spinners tout the new guidance as great for small business. And that it may be, but if you read the SEC's news release (the full guidance text isn't yet up on the web site), the mention of size is:

The Securities and Exchange Commission today unanimously approved interpretive guidance to help public companies strengthen their internal control over financial reporting while reducing unnecessary costs, particularly at smaller companies. The new guidance will enhance compliance under Section 404 of the Sarbanes-Oxley Act of 2002 by focusing company management on the internal controls that best protect against the risk of a material financial misstatement.

There isn't anything there suggesting that only small cap companies will feel the effects. Given the track record of large corporations in the past, I'm guessing that much of the actual reform that was starting to take place will now recede into the horizon, as managers and directors quickly use the chance to lessen the "overwhelming burden" of which they've been complaining. Interestingly enough, during this difficult time for them, profits hit record highs, as have stock prices. So, if the difficulties haven't shown up in financial performance, are they, perhaps, far less than the griping would suggest?