10 Forecasts
from January/February 2002
These days nobody wants to go out on the proverbial limb with New Year predictions—at least nobody you’d listen to. But that doesn’t mean you can’t set targets, make a wish list, sound a warning bell, or say what you’re almost positive will happen. Here’s a sampling of prognostications, from people who know their business.
SEC’s Pitt: Bullish on Defanging Reg FD
- Harvey Pitt
Harvey Pitt, the new head of the Securities and Exchange Commission, is known to be friendly to corporations and has long advocated an overhaul of the securities laws. But don’t expect him to start with the hoary ones that he says “reflect a time, and a state of technology, light-years away from what we now confront daily.” Instead, his first goal may be to take some of the teeth out of Regulation Fair Disclosure, which requires companies to share significant information with the general public rather than with selected groups, such as analysts.
What else will he push for? Nasdaq’s transition to a for-profit exchange.
Any big battles shaping up? Pitt and some institutional investors like the idea of a centralized electronic order system that would give the SEC oversight over electronic trading. This puts him up against discount brokers and Federal Reserve chairman Alan Greenspan. Among their objections: the belief that such a system would limit competition.
As a Washington, D.C., partner in the New York City law firm Fried Frank Harris Shriver & Jacobson, Pitt, who’s 56, has had clients that include all of the Big Five accounting firms, Wall Street giants Bear Stearns, Merrill Lynch, and Morgan Stanley, the New York Stock Exchange—and Ivan Boesky, convicted inside trader and poster boy for ’80s greed. So closely associated is Pitt with big corporations that he went out of his way during his Senate hearings to reassure the committee that he wouldn’t abandon the investor protections put in place by his predecessor, Arthur Levitt. Democrats took some solace in Pitt’s stint as SEC general counsel during the 1970s, and he won unanimous approval. He’s said to be a consensus-builder, whereas Levitt was more of a hard charger.
Consensus-builder or not, Pitt may be in for disappointment. “There’s a private joke among SEC chairmen,” says Joel Seligman, dean of the Washington University Law School, “that whatever you start out wanting to accomplish is all but guaranteed to wind up on the back burner.” That’s already happened, in fact. Pitt had hoped to slip into his new job with minimum fuss and attention. September 11 and the havoc it caused in world financial markets pushed him into the spotlight.
by Joshua Green
D&O in an Unsafe World
- Carolyn Rosenberg
Should directors be thinking any differently about their exposure to risk since September 11? You bet, says attorney Carolyn Rosenberg, who was one of the superstars in our recent Special Issue, “America’s Best Corporate Lawyers.” A summary of her counsel:
“If your corporation is on the brink of bankruptcy, you should make sure you’re insured for a worst-case scenario,” Rosenberg says. Some directors’ and officers’ insurance policies include a “priority of payment” provision, which means that if the company files for protection under Chapter 11, the insurers will pay losses stemming from fiduciary-liability claims before everything else. Directors who don’t have this coverage should get it now.
Another safeguard you should add to your D&O liability policy is a “waiver of automatic stay.” This makes it more difficult for a company in Chapter 11, or its creditors, to come between a director and any D&O payments. Suppose a director is sued. He or she will want to turn to the D&O policy to pay defense costs and any judgment or settlement, rather than having the policy proceeds frozen while the company, the creditors, and others fight over who the money should go to.
Directors should also make sure that the insurance companies they’re using are financially stable. Some may be in difficult straits because of claims related to the World Trade Center disaster.
Other areas of potential liability for directors might arise from the SEC’s new rules concerning audit committees. Outside directors who serve on these committees may want additional D&O coverage, which some insurance companies already offer.
by Sasha Issenberg
What FASB Wants
- Edmund Jenkins
Can you imagine a more incongruously mundane task than figuring out how public corporations, which were due to close their books just 19 days after September 11, should account for their terrorist-related losses? As the private-sector organization responsible for setting the rules of financial reporting known as generally accepted accounting principles, or GAAP, the Financial Accounting Standards Board had to do just that. It concluded, amid considerable controversy, that the losses businesses had sustained should be treated as ordinary rather than extraordinary items in their financial statements.
In a conversation with Julie Connelly, FASB’s 66-year-old chairman, Edmund Jenkins, explained that decision and the implications for directors of several other financial-reporting issues.
On FASB’s terrorism ruling:
There’s no question that the attacks were extraordinary in the dictionary sense of the word. But not all of the business activities that were impacted could be considered extraordinary. For some industries, business activity had been declining before September 11. You had to ask to what extent the adverse impact was due to economic events that were already in place.
We concluded that investors could judge the total impact of the terrorist attack more clearly if companies considered all their losses as an ordinary part of continuing operations, rather than as extraordinary. They can, however, break out “unusual” expenses in the earnings statement, even though all losses will be included in income from continuing operations. We also encourage companies to talk at length about the nature of their losses in footnotes.
On dealing with pro forma earnings numbers:
In my judgment, pro forma numbers should always be presented in conjunction with the reported earnings, so an investor can understand the difference between the GAAP determination and the pro forma figures. But sometimes the income statement may contain items that really are one-time events and distort communication with investors. Board members, particularly audit-committee members, should understand why pro forma earnings or performance metrics like EBITDA [earnings before interest, taxes, depreciation, and amortization] and core earnings are the best predictors of the company’s future. They also need to be sure that the measurement is applied consistently from one period to the next.
A lot of these pro forma numbers appear in press releases and earnings announcements, and FASB has no jurisdiction over those. However, we have been considering a project to see if there’s a way to improve the organization and structure of the traditional financial statements, so that they will provide better information and call attention to earnings that are repeatable as opposed to those that aren’t.
On expensing employee stock options:
What board members need to focus on is that the number that would appear in financial statements as an option expense would likely be much lower than what gets reported in the press now. Financial statements would record the value of the option, not the difference between the exercise price and the market value of the stock, which is what the press uses.
There are option-pricing formulas that determine value and take risk into account. Such a formula, particularly in a period of rising stock prices, would result in a much lower total-compensation figure than what appears in the press. And I think corporate executives and boards would be much better off. Compensation would be more realistic and understandable.
But the expense would still be more than nothing. It would not be zero. And I haven’t found many in the business community that would support FASB’s undertaking a project in this area.
Gorillas, Lawyers, and Other Proxy Threats
- Pat McGurn
Topic A for this year’s proxy season? Succession planning, says Patrick McGurn, director of corporate-governance programs at Institutional Shareholder Services, a Maryland proxy-voting company. “Succession is really hot right now, even more so than last year,” he says, “because of all the disaster stories about boards taking a year to find a replacement and getting the old CEO to come back in.” (For more on this, see “Retired CEOs Make a Comeback,” page 10.)
McGurn also warns directors that corner-office performance “will be the 800-pound gorilla this year. There will be more pressure for CEOs to put their pay in line with performance and to share the pain when companies are downsizing, shutting plants, and laying people off.” Shareholders will be pushing for boardroom evaluations—“The downturn in the economy will reveal poor management and structures that boards don’t have in place,” says McGurn—and a more open process for nominating new directors.
Outside auditors will come under fire, too. “If there’s a huge differential between what companies are paying for traditional audit fees and such non-audit expenses as consulting and tax help, the directors have to do a better job of explaining that to shareholders,” McGurn says. Otherwise, more shareholders will vote against boards’ choice of auditing firms and against directors nominated to audit committees.
Expect more alternative slates to push for boardroom seats. “Directors before were more likely to see snow on their Hawaiian vacations than to see a proxy fight at their companies,” says McGurn. “These days they should know that they’ll have to face at least one.”
And class-action suits? “Litigation isn’t the next wave,” McGurn says, “it’s the wave hitting the beach.” More serious still, institutional investors are getting actively involved by claiming lead-plaintiff status. That gives them the right to choose the law firm that handles a case—and to decide when to settle and for how much.
by Jessica Fourneret
Dowries, Goofs, and Euro M&A
- Espen Eckbo
Expect more mergers and acquisitions between European and U.S. companies in 2002—sometimes for much the same reasons impoverished English peers married the wealthy daughters of American robber barons a century ago. European CEOs and directors want to match the far larger compensation packages earned by their American counterparts, and a merger with a U.S. company is one way to do it. In exchange, the Americans get an entree into Europe.
So says Espen Eckbo, 49, the director of the Center for Corporate Governance at Dartmouth College. Eckbo, who blames Europe’s unions and its egalitarian culture for the disparity in pay, isn’t opposed to such marriages. He says the extra money will help merged companies find the top talent that they need to stay competitive.
Merger-minded U.S. corporations must stay clear of the European Commission’s monopoly laws, which wrecked the GE-Honeywell deal last summer. Directors should ask themselves, “Is this a politically visible transaction?” says Eckbo. “If so, there are back channels through which one can signal one’s intentions prior to opening the whole can of worms. Co-opting people up front is part of the European style.” (He should know; he’s from Norway.) GE, in contrast, presented its wedding as a done deal, riling regulators.
Transatlantic mergers can be further complicated by European accounting, which in many cases is still less open than America’s. But Eckbo sees a move toward an international accounting standard in Europe, and says the Securities and Exchange Commission is beginning to accept it. In the meantime, he suggests that Americans frustrated by Europe’s bookkeeping ask for numbers that meet “international standards. It’s better not to call it a U.S. standard,” he says. That would be another cultural goof.
by Joshua Green
What One Director Will Ask at His Next Board Meeting
- John Gutfreund
John Gutfreund, 71, senior managing director of C.E. Unterberg, Tobin Inc. and former chairman of Salomon Brothers, serves on the boards of a number of companies, including LCA-Vision Inc., Nutrition 21 Inc., and Universal Bond Fund. He spoke with Ann Reilly Dowd. Excerpts:
On how September 11 will change the role of directors:
I would guess that the immediate impact of the tragedy depends on, one, a company’s business profile and how international is it; two, what restrictions will the U.S. government place on it; and three, what excess risks will there be on its international operations in terms of sourcing and distribution. But all directors should be pushing their corporation to enunciate its priorities and define where it’s headed. At my next board meetings, here are the kinds of questions I’ll be asking management: In the wake of September 11, what’s your corporate exposure? What’s your present strategy? Are you eliminating any strategies you’ve had?
On other challenges facing board members:
The relationship between auditing and compensation committees is interesting, because the way people are looking at their earnings now is all over the lot. It’s not just after-tax earnings but EBITDA, cash flow—whatever measure is best for management is what’s been used for the last few years, not what’s best for the company and its shareholders. Directors are going to have to be ever more aware of their responsibility to the nonmanagement shareholders. This has been coming over time, but I think the extraordinary technological revolution, mirrored by outlandish stock prices, has led to compensation and auditing problems that people are going to look back on and say, “My gosh, how did I ever let that happen?”
On particular challenges facing comp-committee members:
You have a number of serious issues. Are you overcompensating underperforming executives? Are you compensating on a yearly merit basis? Are you retaining whom you should be retaining, in terms of key employees and the ties that bind them? Also, the compensation committee will have to be sensitive to the extreme situation that may prevail in a downtown New York City company, versus a company in Iowa. The strains and pains might be much greater here, certainly on an interim basis—hopefully an interim basis.
On the growing risks of debt:
It’s very important to understand that you can raise money whether the stock market is at 10,000 or 2000. The difference is the price you pay for it. Corporations have been spoiled by ready access to very cheap money. They’re not going to pay more. They are going to sell debt instead, and that’s what they’re doing. Of course, it’s not smart, because you get overburdened with too much debt and you can’t carry it, and eventually you go into a very difficult situation, if not bankruptcy. Some companies are already there.
On New York City’s future:
The city is the capital of the world in terms of finance, and many companies will still need some key people in headquarters-type offices here. But certainly support personnel should not be here. If you’re earning $30,000 to $75,000 a year, it’s a hell for apartments, schools, general living conditions. And I don’t see how that is going to change in the near future.
Help For the Curious ---- and the Delinquent
- David Weild
By early 2002, you’ll have the awesome technological resources of Nasdaq at your fingertips. “It will be a one-stop shop for CEOs and board members,” promises David Weild, head of the association’s corporate client-services group. “You’ll just call an 800 number, or access a private Nasdaq site from your desktop, and get answers to all kinds of questions.”
Among those questions: Who’s been buying my stock? Who’s been investing in my competitors? Which brokerages are handling these trades? How did my competitors do in the current quarter? Besides all that, the source will provide updated information on any new regulations from the Securities and Exchange Commission, the New York Stock Exchange, and other entities. “The idea,” says Weild, “is to customize the service for you so you won’t have to dig around for what you want to know.”
As a Christmas present to the less fortunate, Nasdaq may extend the suspension of its delisting rule. After the September 11 attacks, the association gave companies an extra 90 days on top of the 90 they already had to get back into compliance with such listing requirements as minimal stock prices. Weild says that Nasdaq will make new rules for delisting before the end of 2001, perhaps keeping the 90-day standard for companies that trade on the national market but giving those on the small capitalization market a little more time to rehabilitate themselves.
by Ann Reilly Dowd
Eyes East
- Wilbur Ross
Wilbur Ross, formerly the executive managing director of the investment banking firm Rothschild Inc., made his reputation (and fortune) by buying assets and distressed debt from such troubled companies as Texaco and Trans World Airlines. When domestic opportunities dried up, Ross, who’s now 62 and head of his own investment firm in New York City, turned to Japan and Korea, looking for similar opportunities there. Directors of U.S. corporations should be doing the same thing, he said in an interview with Sarah Max. Highlights:
Q: Why Japan? Why direct investment? And why now?
A: First of all, Japan is the second-largest economy in the world. It’s the right place to be. Second, foreign companies have found it very hard to penetrate the marketplace there, because distribution systems are very complex and there are a lot of hidden barriers to foreign imports. So owning something there is a better way to get in. Third, the productivity improvements we’ve had in the U.S. are just beginning in Japan. Japan is miles and miles behind in using information technology. At most banks in Japan the ATMs are only open when the bank is open, and department stores are just starting to use bar-coding.
Q: What makes you think Japan will try to catch up?
A: The Japanese market is now at a 17-year low, and I think the Japanese people are ready for the kind of harsh love that Prime Minister Koizumi is talking about. We’re madly in love with what Koizumi is doing. Whereas previous governments only paid lip service to ending unproductive companies, Koizumi is really pushing this. He also understands that the government needs to create social safety nets, like unemployment benefits, so that companies can lay off workers. Until recently there was no incentive for substituting capital for labor, because you couldn’t lay people off.
Q: Is there opportunity for many industries?
A: Yes, but it’s biggest in financial services. Japanese people claim one-third of all savings in the whole world. Japan has sold three banks to private equity groups, including Kansai Sawayaka Bank, which we bought last year for about $300 million. So far, no big U.S. bank has tried to buy a Japanese bank.
Q: What other countries have caught your eye?
A: Korea. The structure of the economy and legal system is remarkably similar to Japan’s, but it’s farther along in the recovery process than Japan because its economy didn’t get as sick as Japan’s. Also, its president, Kim Dae Jung, has been a real agent for change. [Ross and American International Group Inc. are in the process of investing $860 million in three Hyundai financial companies.]
Q: What about China?
A: When you operate in distressed space, you need legal systems that function very well. In China, you basically don’t have laws. It’s a place we’d love to go into—if and when it gets a legal system that permits it.
Still Doomy After All These Years
- Henry Kaufman
The go-go ’80s made little dent in the pessimistic outlook of Henry Kaufman,then chief economist of Salomon Brothers. His colleagues nicknamed him Dr. Doom, and the crash of ’87 seemed to validate his downbeat approach to market analysis. The big bull market of the ’90s tested his views, but now, of course, he looks right again—and he sees little reason to cheer up. Here’s some of what Kaufman, 74, told writer Rob Norton:
Projecting economic and financial events a year or two out is virtually impossible. There are too many uncertain variables that can’t be quantified. For one thing, we don’t know what the magnitude of defense expenditures will be. Secondly, the uncertainty created by the terrorist attacks will to a certain extent remain in force, and might even be enhanced if there were other attacks on the U.S. There’s no way of forecasting that.
Certain aspects have changed, however, some of which are notable. We have moved into an environment in which the role of government is being enlarged. Until recently, many of the businesses and institutions in the private sector wanted to get the government out of the business of business. Now a whole series of private-sector constituents want the government to return.
The political debate about the sanctity of the federal budget surplus is over for the time being. The budget for the fiscal year that started on October 1 will probably be in deficit. The discussion about preserving the sanctity and viability of the Social Security program is also over. It’s readily understandable that in emergencies—in wartime—the role of the government and the level of government expenditures are going to increase, but we have to be very careful here that there isn’t a complete and irreversible mood change.
The globalization of business and financial markets will be at a standstill, at least for a time. The industrialized world in its entirety is in a sort of recession, and political uncertainty diminishes the willingness to take risks.
There will be further, massive business and financial consolidations. There is a substantial squeeze on corporate profits and a significant deterioration in credit quality in the private sector. These trends will worsen. Thus mergers and consolidations will take place not on the favorable terms of the last couple of years, but on distress terms.
Another dimension of uncertainty is the value of the U.S. dollar in the currency markets. At best, the dollar will move now in relationship with the military successes of the U.S., and not with its immediate economic successes. If there are other terrorist attacks on the U.S. and no terrorist attacks anywhere else, this will diminish the role of the dollar as a safe haven.
Sister Nudge's New Target
- Patricia Daly
With General Electric just maybe vanquished, shareholder-activist and Dominican nun Patricia Daly has trained her sights on ExxonMobil. Using the leverage of some $100 billion that various religious communities and institutions hold in major corporations, Daly, 45, pressures companies to clean up their act—and the environment. She harried GE for years to force it to remove toxic materials from the Hudson River. “She’s not a nun, she’s a nudge,” said one GE executive. (For more, see www.boardmember.com/issues/1999_3/.) The U.S. Environmental Protection Agency has ruled that GE must clean up its mess, but hasn’t delivered a detailed order. GE says it will appeal the decision.
Daly’s beef with ExxonMobil: global warming and the company’s insistence that the Kyoto treaty isn’t the way to prevent it. Instead, CEO Lee Raymond calls for voluntary measures and another round of scientific studies. The Bush administration supports this view.
“Word games and disinformation,” charges Daly, who at this year’s annual meeting urged the board: “Directors, I believe we would be a better company if you gave some incentives to Mr. Raymond and the top executives of this company to give us a good environmental and social record.”
What’s more, she argues, ExxonMobil will run into financial grief when other countries—including those in the European Union, which account for as much as 27% of the corporation’s sales and support the Kyoto approach—look elsewhere for renewable energy sources. She says that BP/Amoco and Shell take a more enlightened stance on the controversy.
