The concept of corporate governance implies consistent and effective laws, methods, and metrics for governing our nation's public companies. The sad fact is that there is no such thing. It's a myth. Here's why:
People talk about the fiduciary responsibility of boards of directors. What that means, in plain speak, is that boards are supposed to:
1) Hire and fire the CEO and appoint other corporate officers
2) Compensate the CEO and other corporate officers
3) Oversee corporate strategy
4) Represent shareholders in the transparent and effective governance of the company
As an ex-officer of several public companies and as a consultant, I've been involved with lots of boards, executive staffs, investment banks, VCs, corporate attorneys, and the like. At least in my experience, boards don't operate the way they're supposed to.
Let's take the last point first. Shareholders are offered a slate of directors and a handful of issues to rubberstamp. That means they have two choices: accept or reject.
Now, let me ask you this. If your spouse or doctor says, "Here's my recommendation, take it or leave it," what do you do? That's right, you take it. Is it the best thing for you? Who the heck knows? You had a gun to your head so you nodded up and down. ... Read more
Corporate fraud didn't start with Enron, Tyco, and WorldCom and it didn't end with them, either. Fraud is rampant in the technology industry. What most employees, investors, and consumers don't realize is how much it costs them.
Excuse me for stating the obvious, but you'd be surprised how many people think there's some magic pile of dough somewhere that pays for companies to comply with investigations, contest charges, and remedy issues. In fact, the costs are born primarily by the corporation. That means it comes right out of shareholders' and employees' pockets. Consumers also pay, albeit indirectly.
And yes, we're talking about costs that materially impact earnings, balance sheets, and cash flow. We're talking about internal and outside lawyers, accountants, consultants, crisis PR, D&O (directors and officers) insurance, Sarbanes-Oxley compliance, exit packages, and even recruiting costs to replace executives.
Of course, the biggest cost is in terms of loss of market capitalization. ... Read more
In case you've been in a sensory deprivation tank for the past few days and missed the news, Henry T. Nicholas III, founder and former chief executive officer of chipmaker Broadcom, was indicted on securities fraud, conspiracy, and federal narcotics charges on Thursday.
Henry T. Nicholas III
One of the indictments was related to options backdating, the cause of a $2.2 billion charge Broadcom took last year. But it was the sex and drug-related indictment that captured the media's attention.
If you read the indictment (PDF), you'll understand why one report said, "You can't make this kind of stuff up," .
Rarely does a billionaire and technology industry legend self-destruct in such dramatic and flamboyant style. But there's more to this human tragedy than meets the eye, and it almost surely extends beyond Nicholas. ... Read more
(Credit:
Steve Tobak)
Here's the first installment of Train Wreck's first recurring post: Dysfunctional Executive Watch. It'll show up whenever there's enough material. Enjoy the lunacy, and let us know if you've got something to report.
You've got fraud
On Monday, the Securities and Exchange Commission filed civil charges against eight former executives of AOL Time Warner for fraudulently inflating online advertising revenue by more than $1 billion. Four of the executives agreed to pay millions in fines and return ill-gotten gains. Charges against the other four, including former CFO John Michael Kelly, are still pending.
The company had previously agreed to fork over $500 million to settle civil and criminal charges brought by the SEC and the Justice Department. ... Read more
Eliot Spitzer, Governor of N.Y.
(Credit: N.Y. State)Five years ago, then N.Y. Attorney General Eliot Spitzer was involved in an investigation into conflicts of interest between research and investment banking at ten of the nation's top investment firms during the Internet bubble.
The landmark $1.4 billion settlement helped put Mr. Spitzer on a fast track to the governor's mansion, but that's not the whole story. ... Read more
Before I began writing this post, I googled "the ends justify the means" and got 204,000 results. The volume of philosophical discourse that's gone into analyzing the implications of the phrase is staggering.
Frankly, I think it's all a bunch of pseudo-academic crap. It's never acceptable to breach moral, ethical, or legal boundaries to achieve some perceived greater good. But I didn't always think that way. ... Read more
Did you know that the president has a Corporate Fraud Task Force? That's right, he does. It's led by the deputy attorney general, whoever that is.
Anyway, this task force has apparently been very busy. Over a five-year period since its inception, the task force claims 1,236 corporate fraud convictions, including 214 CEOs and presidents, 53 CFOs, 23 corporate counsels, and 129 vice presidents.
That's a lot of fraud. Who knew there were so many dysfunctional executives in this great nation? The dark side of greed and capitalism must be pretty attractive, huh?
I also wonder what these executives' boards of directors were doing while all this fraud was going on? Aren't they supposed to be looking out for shareholders? Isn't that what corporate governance is all about?
Anyway, members of the task force have successfully brought a laundry list of fraud and other charges against executives of Adelphia, Cendant, Comverse, Computer Associates, Dynegy, Enron, Enterasys, Homestore, Imclone, Impath, Monster, Network Associates, Prudential Securities, Qwest, Refco, and WorldCom.
The Justice Department has also recovered $1 billion in ill-gotten gains and distributed the funds to victims of corporate fraud. Want to know how much money shareholders actually lost in all those fraud cases? Me too, but I'm confident the number has two or three more zeros than what was recovered.
According to a Department of Justice fact sheet, President Bush created the task force in July of 2002 "to restore public and investor confidence in America's corporations following a wave of major corporate scandals." Did it work? Has your confidence in America's corporations been restored? Not mine.
You know what I think? I think it's great that the government is cracking down on white-collar crime. Sure, it's sad that so many officers of public companies have such flexible views on ethics and morality. But you know, if that's the way it's got to be, then I say lock 'em up...without the severance package.
While that might be rewarding, I have to admit it doesn't help investors. If, like me, your confidence in America's corporations has not been restored, there's only one thing you can do about it. Don't let your investment and retirement strategy depend on a branch of the government to cover your butt.
The only way to truly mitigate the potential risk of corporate fraud is to diversify your portfolio, plain and simple. If you don't, you're asking for trouble. I hate to say this, but with these kinds of fraud conviction stats, anyone with 5 percent or 10 percent of their assets in one company's stock really doesn't deserve to keep it.
Just when you think you've seen it all and covered this stuff to death, another (alleged) greedy sociopath comes along with even more creative ways of defrauding investors.
David Brooks, former CEO of body-armor manufacturer DHB Industries, has been indicted by the feds on a laundry list of charges that include conspiracy, securities fraud, insider trading, tax evasion, and obstruction of justice.
The company's former COO, Sandra Hatfield, and CFO, Dawn Schlegel, were also indicted on similar charges.
Brooks and his cronies allegedly (it's always allegedly) used false accounting entries to inflate profit margins, filed misleading SEC reports, pumped up the company's stock ten-fold, and cashed out to the tune of $200 million.
The scandal also includes millions in unreported bonus payments and Brooks' use of company funds for all the usual personal excesses: luxury cars, vacations, jewelry, lavish parties, and to fund other family-owned businesses. But there are excesses I've never seen before: cosmetic surgery and the purchase of an armored vehicle for the family's use.
I've got to ask, what exactly does a family need an armored vehicle for? ... Read more
This blog's supposed to be about corporate dysfunctionality, but somehow we've gotten sidetracked. We've never really looked at the big picture. The big picture is this: a reasonably significant percentage of executives and their boards are dysfunctional.
What do I mean by that? I mean they shouldn't be doing some of the things they're doing, and those things can get them in big trouble with a variety of law enforcement agencies. Why do they do it? Who knows.
As for you good folks--investors and employees--well, I don't want to be an alarmist, but if you knew what really goes on out there, the countless ways you can get screwed, well, let's just say you'd need a good dose of Ambien to get any sleep.
The good news is you can protect yourself; we'll get to that in a minute.
Until then, here are the most common ways that dysfunctional executives and directors can mess up. I've included a few well-known examples, but the scary part is that, for every big-name scandal, hundreds fly under the radar screen.
The seven deadly sins of corporate dysfunctionality
Creative accounting
Most of the biggest scandals of our time have included some form of creative accounting: shell companies, offshore accounts, creative expensing, or just your run of the mill accounting fraud. That's what did in Enron, WorldCom, Adelphia and a host of others.
Conflicts of interest
One of the biggest scams in history was the conflict of interest between investment banks and their research analysts leading up to the dot.com bust. The top ten investment banks coughed up $1.4 billion to get the SEC, the N.Y. attorney general and a host of others off their back. A few analysts were banned, but amazingly, nobody went to jail.
Insider trading
If you really think this is just the domain of Martha Stewart and ImClone ex-CEO Sam Waksal, then I've got some nice used cars from New Orleans to sell you. I'd be willing to bet that at least half the executives who say they've never traded on inside information would be lying. The other half have so much money they don't need to.
Dysfunctional families
I don't care if it's IBM in the old days, Motorola all too recently, Adelphia, Wang Laboratories, or Atmel. If you're considering a company with any family relations on the executive management team or the board, forget it. And if a family actually controls the stock's voting rights, as was the case with Adelphia, soon enough you'll read about it in the newspaper.
Rubber-stamping boards
Behind every dysfunctional executive and company is a board that fits nicely into the CEO's back pocket and rubber-stamps everything put in front of them. Tyco was a great example, but there are probably hundreds, if not thousands of boards that are blindly loyal to their company's CEO.
Generic SEC filings
10Ks have to be the biggest waste of paper since An Inconvenient Truth was published. The risk factors are generic and watered down while the business sections do more to hide than highlight competitive challenges. The lawyers and Sarbanes-Oxley consultants are in charge. That's really scary.
Ludicrous compensation
How many CEOs and other officers have been sacked as a result of stock option backdating scandals? Must be 30 or more in the technology space alone. Besides the sometimes ludicrous equity and monetary compensation, CEOs can sometimes make even more money by quitting or getting fired. Sure, some deserve their pay, but many don't, and there's everything in between.
Well, that's the seven, and I'm not even talking about the rare psychopath that can take down an entire sector. Take Bernie Ebbers of WorldCom. How smart do you have to be to ask a simple question: in what universe does it make sense for a guy who was a motel owner, a milkman, and a gym teacher to somehow be competent at running one of the world's largest telecom companies? Just thinking about it makes me feel delusional.
With all these ways to get hosed, what's an investor to do? Simple, diversify. If you have more than five or ten percent of your net worth in any one stock, you're asking for trouble. As for employees, you need to manage your own career. Don't expect anybody or any company to do it for you. Trust and protect yourself and you'll do fine.
The only person you can be sure isn't dysfunctional is yourself. If you're not sure if you're dysfunctional, take this quiz and find out.
As reported, Dell recently concluded a year-long internal investigation into its accounting practices. As a result, the company will restate its financials for four fiscal years (2003 through 2006) plus the first quarter of fiscal 2007. The good news is that the cumulative decrease in net income will be between $50 and $150 million - peanuts compared with Dell's reported profit of $12 billion during the restatement period.
The bad news, however, is contained in a rather heavily wordsmithed paragraph of Dell's press release:
"The investigation identified evidence that certain adjustments appear to have been motivated by the objective of attaining financial targets. According to the investigation, these activities typically occurred at the close of a quarter. The investigation found evidence that, in that timeframe, account balances were reviewed, sometimes at the request or with the knowledge of senior executives, with the goal of seeking adjustments so that quarterly performance objectives could be met."
It appears that certain senior executives had a chronic case of end of quarter madness, a relatively common disease among executives of publicly traded companies.
Confirming what was evident from Dell's announcement, CFO Don Carty said in a conference call with investors, "We did find evidence of fraud." But neither Carty nor Michael Dell - who reclaimed the CEO role in January - would divulge the identities of the senior executives referenced in the company's release. ... Read more
