Winners and Sinners 2007 (And What They Made)
from
September/October 2007
by Randy Myers
“Einstein Failed Math Too” Trophy
Apple Inc.
The legend holds that Einstein flubbed math when he was in grade school, though some recent biographers say it may not be true. Did he or didn’t he? The same can be asked about the Apple board’s explanation of the role played by CEO Steve Jobs in the company’s stock-option-backdating scandal.
“They said Jobs participated in it but didn’t understand the accounting issues,” says Peter Henning, a law professor at Wayne State University and previously an attorney in the division of enforcement at the Securities and Exchange Commission and in the criminal division of the Justice Department. “That came very close to a dog-ate-my-homework excuse.”
The board’s internal investigation was led by three of its highest-profile directors: former vice president Al Gore, Google CEO Eric Schmidt, and former IBM CFO Jerome York, the chair of Apple’s audit and finance committee. Investigators spent 26,500 hours searching more than a million physical and electronic documents and interviewing 40-plus current and former directors, officers, employees, and advisers. Then the special committee concluded that while some Apple options had been backdated to get favorable pricing for key employees, there had been “no misconduct by current management.” This even though the committee said that Jobs “was aware or recommended the selection of some favorable grant dates.”
There may be no major U.S. company, except Berkshire Hathaway, where the sitting CEO is so closely linked to the corporation’s success. The dilemma faced by the board, says Henning, was whether to bend an ethical line to benefit the bottom line. In the high-tech industry, he concludes, that’s apparently an acceptable trade-off. Should it be? You don’t have to be an Einstein to know the answer.
“Most Meaningful Soundtrack” Citation: The Song Is You
Vonage Holdings Corp.
With mocking music that goes “woo-hoo, woo-hoo-hoo,” a TV commercial for Internet phone company Vonage pokes fun at people for spending foolishly. You mean like buying Vonage stock?
Issued at $17 a share when Vonage went public in May 2006, the stock fell to about half that in less than one month, and over the next year plunged to $3 and change. One money manager said watching the fall was like “watching a train wreck.” Shareholder suits have been launched against the company, including a class action alleging improprieties with the IPO. Vonage lost $286 million last year—and, according to the annual report, “may never achieve profitability.”
Trouble, trouble, trouble. But one does not go onto the board of a company like Vonage without some inkling that there may be stormy seas. Inkling: While neither admitting nor denying guilt, Vonage’s controversial founder, chairman, chief strategist, and acting CEO, Jeffrey Citron, paid $22.5 million in 2003 to settle SEC fraud charges that dated back to his time running an online brokerage firm, Datek Online Holdings Corp. (As part of that deal, he’s barred for life from working on Wall Street.) The riskiest decision by the Vonage board was to count on the integrity of the company’s technology. A federal jury ruled in March that Vonage had infringed three Verizon patents and ordered it to pay Verizon $58 million and to stop using Verizon technology. Vonage, which denied infringement, won a stay of the order to stop use, pending an appeal, and has warned that it may not be able to continue operating if it does not prevail.
Vonage did get a potential break on April 30, when the U.S. Supreme Court ruled in another case, KSR v. Teleflex, that courts should not take a “narrow, rigid” view of the factors to be considered when deciding whether a new invention is “obvious” or truly merits patent protection. Legal experts widely agree that the ruling will make it harder for companies to get and defend patents, and attorney Mark Kesslen, head of the intellectual-property practice at Lowenstein Sandler PC in Roseland, New Jersey, says he expects the Vonage-Verizon dispute to be reviewed in light of that decision.
Vonage shareholders had better hope so. Otherwise, they’ll be able to say only one thing when they recall the mocking woo-hoo refrain: “They’re playing our song.”
“Peace in Our Time” Plaque: Building a Bridge to Shareholders
Home Depot
The esteemed philosopher Don Vito Corleone famously said, “Keep your friends close, but your enemies closer.” For as long as there have been publicly held companies, however, corporate boards have had a patented prescription for dealing with dissident shareholders: Fight them. If necessary, beat them back with a stick. Recently the board of Home Depot decided it would rather switch than fight. In February, the directors sidestepped a potential proxy battle with the activist investment firm Relational Investors by inviting Relational executive David Batchelder to join them on the board. In exchange for the seat, Relational dropped its campaign in favor of a special committee to review Home Depot’s strategic direction and to explore alternatives, including a sale of the company.
The olive branch to Relational was one of several shareholder-friendly moves the Home Depot board has made since it appointed vice chairman and executive vice president Frank Blake to replace chairman and CEO Robert Nardelli at the start of this year. Most pertinently, Blake had Home Depot directors attend the 2007 annual meeting (all but one, who had a previous commitment, showed up). He also made sure that questions from investors were addressed. Nardelli was roundly criticized in 2006 for not insisting that directors attend the meeting and for ending it after only 45 minutes without answering any questions from the shareholders in the audience. The company is expected to maintain the new open-door policy.
So speak up, everybody. After all, that’s what, um, friends are for.
“Unfortunate Irony” medal: Playing Their Own Game
Take-Two Interactive Software Inc.
The Sarbanes-Oxley Act of 2002 required directors to increase their scrutiny of the companies they serve. Board members at Take-Two Interactive Software, maker of the Grand Theft Auto video game, apparently did not get the instruction manual. But this year five of them, including CEO Paul Eibeler, were finally unseated as part of a shareholder backlash against irregularities stretching back a decade. Options were a big part of the problem, as Take-Two itself admitted in an SEC filing shortly before the March annual meeting.
The company “did not maintain adequate control and compliance procedures for option grants” and the compensation committee “abdicated its option-granting responsibilities and permitted the company’s prior chief executive officer, Ryan Brant, to control and dominate the granting process,” said the filing, which followed an independent legal review arranged by the board. Between April 1997 and August 2003, the filing elaborated, Brant engaged in a “pattern and practice” of backdating options that benefited himself and certain subordinates.
Did this take the board by surprise? Brant had stepped down as chairman in 2004 during an SEC investigation into the company’s sales accounting, though the board kept him on as a non-executive “publishing director” of subsidiary 2K Games until he resigned in October 2006. In February, facing a criminal charge of falsifying business records in connection with option backdating, Brant agreed to pay $6.2 million to the SEC and $1 million to New York City and New York State to settle the matter.
No wonder shareholders pushed out those directors, along with the whole executive team. By way of a postscript, three of the ousted board members, Robert Flug, Oliver Grace Jr., and Mark Lewis, and two former directors, Todd Emmel and Steven Tisch, have agreed to repay the company their after-tax gains from improperly dated options. The payments range from $10,620 to $244,100. It sure took a long time, a very long time, for this particular Take-Two game to reach the finish line.
“Mick Jagger Angst” Award: Can’t Get No Satisfaction
Emmis Communications
In a voice that had the scratch of sandpaper, the late great comedian Jimmy Durante used to amuse audiences with a routine built upon one silly question: “Did you ever get the feeling that you wanted to go and still have the feeling that you wanted to stay?” That nicely describes the plight of Emmis Communications.
Emmis owns and operates about two dozen radio stations in the United States, and others around the world. It also publishes magazines. Like a lot of its peers in the radio game, it isn’t flourishing. CEO and founder Jeffrey Smulyan conceded in 2006 that Emmis’s core business hadn’t grown in five years. Against this backdrop, you might imagine that directors and shareholders would have been delighted when the company got a buyout offer at $15.25 a share, or a 13.6% premium over where the stock had just been trading.
But that offer in May 2006 came from Smulyan, who owned 17% of Emmis’s stock and, through a special class of shares, controlled about 70% of the votes.
To many other shareholders, it looked as if the CEO was trying to get the rest of the company on the cheap; after all, it had traded as high as $23 in the 12 months prior to his bid. What’s more, Smulyan made it clear that if the board tried to entertain any competing offers, he’d use his majority position to reject them.
The Emmis board formed a special committee of independent directors to consider the deal. A number of institutional shareholders opposed to the offer quickly complained that the committee might not have the moxie to stand up to Smulyan, and it seemed as if the company was headed for litigation. But then the committee did what almost nobody expected: It did not approve the deal, even after Smulyan indicated that he might be willing to bump his offer to $16.80 a share. And about a year ago, the offer was withdrawn.
Yet no ticker tape rained down on the Emmis board. As Mama said, you can’t please all of the people all of the time, and the directors took flak from Arnhold & S. Bleichroeder Advisers LLC, owner of 1.7% of Emmis’s outstanding shares. In a letter to the Emmis board, the investment firm argued that since Smulyan was going to block any other offer, his represented a best-case outcome for shareholders that directors should have endorsed. The letter suggested that because of “Mr. Smulyan’s personal and professional ties to board members,” the directors, “in an extreme overreaction,” rejected the offer to avoid any potential claims that they were acting under a conflict of interest.
The company’s stock was recently trading at about $9 a share. After accounting for a special $4-per-share dividend paid last November, that puts it just a smidgen above where it was when Smulyan made his original bid. Shareholders remain at odds over whether the board did the right thing in rejecting the deal, and Wall Street traders continue to speculate that Smulyan might come back with a new offer. If that happens, and the bid comes to a vote, maybe directors should flip a coin.
Uh-oh. Heads they lose, tails they lose.
