Marginalized!
from Winter 2000
by David Moon
What would you think if you found out that the CEO of your profitable, respected, good-as-blue-chip company had to sell a block of stock to meet a broker’s margin call? Is he spending his high-priced time day trading—or running the company? And just how smart is he in the first place anyway, if he’s losing millions in the market?
Now let’s suppose the CEO spent that borrowed money to buy stock in his own company, the one in which you, too, have shares? Would you feel any different? Are his interests now more or less tightly aligned with other shareholders?
This isn’t a hypothetical question. Indeed, it’s something that shareholders of WorldCom must be pondering. According to a recent SEC filing, on September 28 CEO Bernard Ebbers sold three million shares of company stock, worth approximately $78 million, to help cover a broker’s margin call. Ebbers had borrowed on margin to add to his WorldCom holdings, although the company declined to say exactly when Ebbers did this or how many shares he bought. The company’s proxy, which was filed on May 1, only five months before the margin call, mentioned no margined shares.
Like other shareholders, Ebbers was hurt when the share price fell 50% from its July peak. When the company announced on September 30 that Ebbers had sold those three million shares, the stock price fell another 8%.
An SEC filing by the company identifies these particular shares as ones Ebbers bought on the open market in 1996, at between $10 and $19.25 each. But the filing didn’t specify whether they were the ones bought on margin. His largest purchases occurred much more recently—and he paid much more for them. From 1997 until 1999, the number of WorldCom shares he owned increased by fewer than 3 million, to 17.1 million. But from April 1999 through the end of May 2000, Ebbers increased his stake by 60%, to 27.3 million shares. During that period, the price of WorldCom stock ranged from $36.25 to $64.50. At those prices, Ebbers’ increased holdings required a net investment of somewhere between $370 million and $658 million. In the 75 days immediately preceding Ebbers’ sale to meet the margin call, WorldCom’s stock price declined from $50 to $30, decreasing the value of Ebbers’ entire 27.3 million shares by $546 million. At the time of the margin call, the three million shares Ebbers sold represented 11% of his total WorldCom holdings and options.
No one can accuse Ebbers of not putting his money where his mouth is, along with borrowed money as well. But what did the WorldCom board members know about any of this, and when did they know it? The company declined to comment, as did Ebbers.
There is no evidence or even suggestion that Ebbers’ leveraged position influenced any of his corporate decisions. But all board members should be aware of potential conflicts of interest their top executives might face, particularly if a company is planning a stock-financed acquisition that could decrease the price of its shares and trigger an expensive margin call. If an executive merely owns unleveraged shares of company stock, he’d be relatively unconcerned if the shares are hit by a market bounce; if he faces a pricey margin call, his decision making could be affected.
With this potential conflict in mind, the banking industry monitors the accounts and credit reports of its tellers and executives carefully so as always to seem above reproach. Should any other industry be different?
David Moon is president of Moon Capital Management.
