Category Archives: Meetings - Page 2

Ernst & Young: Enron Redux?

Posted by on March 15, 2010 No comments

What have we learned from the collapse of Lehman Brothers Holdings?

The report issued by a bankruptcy court examiner into the collapse of Lehman Brothers was released last week, sending shock waves through the business world. Aide from many details about high-risk business deals undertaken by the company, what has been most revealing to me is the blame laid on Ernst & Young, Lehman’s outside auditors. One would think that post-Enron, where the once venerable Arthur Anderson was extinguished in the blink of an eye, the remaining Big Four would be a bit more rigorous about their audit engagements. Apparently not.

What came out of the Enron disaster was the Sarbanes Oxley Act (SOX), which among other things imposed increased responsibilities on companies and their auditors to conduct and verify their internal controls. In addition, Congress and the SEC severely limited outside accountants from engaging in non-audit work with the firms they were auditing.

Say hello to the “rule of unintended consequences.”

An interesting thing happened in 2001. That was the year that auditors were prohibited from doing other consulting work for their corporate audit clients. In the case of Lehman Brothers and Ernst & Young, that event seemed to have just the opposite effect in that the auditor’s fees skyrocketed. From 1999 to 2007, the last year auditor fee data was reported to Lehman’s shareholders, Ernst & Young’s fees increased 7 fold from $5.3 million to more than $31 million. While some of the increased revenues can be attributed to the additional work created by Sarbanes Oxley compliance, it remains interesting from a shareholder perspective that the numbers accelerated in such rapid fashion.

The following chart reveals the dramatic climb in E&Y’s fees for the 9-year period. It suggests that, in terms of fees collected from it’s client, the risk of “not biting the hand that feeds you” increased dramatically.

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What we see is that, in the case of Lehman Brothers and Ernst & Young, the auditor was able to recoup their non-audit fees in spades. While the apparent conflict of interest that was eliminated by SOX was eliminated, the motivation to rigorously assess the financial dealings of Lehman Brothers may have taken a back seat to the revenues generated from the long-term engagement with Lehman Brothers.

I have no doubt that Ernst & Young officials would rigorously argue that no such conflicts existed. However, when “credible evidence” suggests that “accounting gimmicks” were not uncovered by Ernst & Young to shareholders, investors can only wonder.

So what have we learned here?

Despite SOX reforms, there are still risks to investors from shoddy audit oversight. Auditors are still subject to enormous pressure from unscrupulous clients who try to hide risk from their investors. Long-term engagements by companies of their outside auditors pose real risk to investors.

KB Homes: Where is the Compensation Committee?

Posted by on March 10, 2010 No comments

As noted on Wednesday, ProxyAnalyst recommends a vote against the Compensation Committee members of the board of directors at KB Homes. The Los Angeles-based homebuilder has continued to grant substantial stock awards, retirement benefits and bonuses to its CEO Jeffrey Mezger while the company has underperformed over the last five years.

In 2009, Mr. Mezger was awarded a base salary of $1M. However, after awards of stock options, stock grants, incentive awards and a slew of other compensation benefits, his salary rose to more than $9M.  While his total pay has fluctuated over the last five years, it has in no way tracked the overall performance of the company for that period.

The following graph reflects the company’s stock price performance for the period. It is not a pretty sight with the company losing almost 70% of its share value during that period.

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What I find most troubling is the manner in which the Compensation Committee failed to adequately address shareholder concerns while shoveling executive pay out the door. The compensation problem at KB Homes hasn’t gone unnoticed by at least some shareholders.

Last year, the company was targeted with a proposal calling for an advisory vote on future compensation packages doled out by the board. The proposal received a majority of the motes cast on the issue. However, the company rejected implementing the proposal saying:

Although a majority of votes cast were in favor, the proposal failed to achieve the affirmative vote of the majority of shares of our common stock present and represented at the 2009 annual stockholders meeting, the applicable standard under our by-laws. Based on this outcome and given the significant legislative and regulatory momentum underway at the time of the 2009 meeting and through to the present time to establish a mandatory advisory vote for all U.S. public companies, your Board continues to believe that it is in the best interests of all stockholders to evaluate adopting an advisory vote mechanism when definitive rules are established.

So what the company said here is interesting for two reasons.

First, it points out a glaring flaw in the proxy voting system in which a company – in this case KB Homes – can count votes present or broker non-votes in calculating the total votes counted.

Let’s put this in the context of a presidential election. You and I vote for our candidate (he is running against the incumbent). Our guy receives a narrow majority (say 35 million) of the votes cast in the election out of a total of 60 million votes cast. However100 million voters were eligible to cast their votes. But 40 million of them stayed home. The incumbent says, “100 million voters are eligible to vote and if they didn’t, we will assume they voted for us, the incumbents.” So the incumbent counts an additional 40 million votes in his favor and walks away with the election.

Doesn’t sound fair but that is what KB Homes executives did in 2009 on the say-on-pay shareholder proposal.

Second, the company argues that because legislation is pending in Washington that might be a game changer on executive pay practices, it somehow shouldn’t have to pay attention to the wishes of a majority of its voting shareholders. What was that legislation anyway? While Congress has been debating financial reform for some time, nothing has materialized and the SEC has not taken any grand steps to obligate companies to obtain shareholder approval of pay awards. There is no real risk of legislative reform and I suspect that company executives knew that but obfuscation rather than reality seems to be the order of the day in that statement.

That brings us back to the situation at hand. The four directors, Stephen F. Bollenbach, Timothy W. Finchem, Michael G. McCaffery and Luis G. Nogales have not served the best interests of KB Homes shareholders in granting these pay packages to the company’s executives. Mr. Nogales is over-boarded (he serves on three other boards), Mr. Bollenbach is overpaid to the point that his independence is called into question and the Committee as a whole has not publicly demonstrated any sort of public leadership that could clarify its decision to pay executives outsized pay packages at shareholder expense.

An Ancient Fable for Post-Modern Times

Posted by on February 17, 2010 No comments

This little tale was taken from a longer article of fables written by Daniel Greenberg in Mondays Washington Post.

The Alligator and the Mouse

The mouse king needed a ride to the other side of the river, so he called on a large alligator for help.

“Can you take me to the other side of the river?” the king asked. “I will pay you $20 billion from my coffers.”

“That’s a lot of money, even if it is in mouse dollars,” said the alligator. “I’ll take your offer.”

So they set out on the river, which was very shallow, allowing the alligator to crawl more than halfway across. Then they hit a deep spot and started to sink.

“Help!” cried the king. “I can’t swim.”

“Neither can I,” said the alligator.

“But you’re an alligator,” said the king. “Surely all alligators can swim.”

The alligator explained that he had once been able to swim. But the river was so shallow and so rich with fish to eat that he had grown plump and lost the skill.

“What do we do now?” cried the king.

At this point the subjects of the king who were watching from the river bank recognized what was happening. Many began paddling furiously to the sinking alligator. They used their little mouse legs to prop him up and propel him to the other side. Most did not survive the task.

When he was safe on the other side, the mouse king asked, “Why did you accept my offer if you couldn’t swim?”

The alligator said, “I will be honest. I did it for the money. I figured we would somehow make it to the other side. And sure enough, we did make it. You see, I was right.”

“But what about all of my subjects who drowned in the river?” asked the mouse king.

The alligator shrugged. “Hey, risk is a part of every transaction,” he said.

With that, they went to dinner at the restaurant on the other side of the river and shared a very nice bottle of wine. And forgot about the whole thing.

Barclays Bonuses Deferred: The Shell Game Continues

Posted by on February 16, 2010 No comments

The financial press reported on Saturday that Barclays’ top executives are giving up their bonuses for 2009 amid pressure for governments and irate investors over the gross excesses. As noted in the Financial Times, U.K. unions noted that:

“The bonuses being paid out are still big enough to incentivise excessive risk-taking and still contribute to wider inequality, which many increasingly recognise as a profound economic and social problem for the UK,” said Brendan Barber, general secretary of the Trades Union Congress.

FT.com

It also remains unclear what the total compensation packages look like for the top executives at the bank. Somehow, it seems unlikely that John Varley and Bob Diamond, the top executives at Barclays will need to find side jobs to make up for the bonuses.

Citizens United and the Pharma Industry

Posted by on February 15, 2010 No comments

Yesterday, PhARMA, the Pharmaceutical Research and Manufacturers of America announced that its president, Billy Tauzin, is stepping down from his post. Mr. Tauzin, a former congressman from Louisiana, is noted as a shrewd player on Capitol Hill with close ties with Democrats. But the pharmaceutical trade group is apparently looking to get back to its conservative roots, shifting its vast financial resources towards the republicans in the coming months.

What this means for investors and other stakeholders is unclear but based on past practice, the prospect of this industry weighing in heavily on issues and causes dear to its collective heart is likely.

The pharmaceutical industry is notorious for spending massive sums on television advertising both to tout its products and to weigh in on political causes. One needs only watch prime time television to learn about Lipitor, Plavix, Nexium and a raft of new diseases and syndromes that can be treated with a pill. Thinking back to the Medicare drug benefit debate during the Bush years or the Clinton health care debate in the early 1990s and the industry’s well-financed voice can be remembered.

Now that the Supreme Court has unleashed issue advertising, we can expect to see an acceleration of political spending by an industry trade group that has spent tens of millions of dollars each year in the political sphere. Its impact on shareholders is two fold.

First, as pharmaceutical companies become more emboldened in their ability to spend and influence political races and public policy, the reputational risk from spending will increase. Excessive political spending to influence election outcomes does not have a direct bearing on business operations.

Second, the institutionalized corruption created by the industry’s oversized spending will have unintended consequences both for the individual pharmaceutical companies as well as on business as a whole.

Will the pharmaceutical industry take the lead in excessive political spending?

Only time will tell.