Washington revs up enforcement

“Wall Street’s Top Cop: SEC Tries to Rebuild Its Reputation,” an interesting piece on page 1 of The Wall Street Journal today, traces the enforcement actions of the Securities and Exchange Commission since the financial crisis reached meltdown five years ago.

The agency is still smarting from suggestions that too little was done to punish Wall Street fat cats for the supposed malfeasance behind the financial crisis, the article says. Actually the SEC brought civil charges against 138 companies and individuals related to the crisis, and garnered $2.7 billion in fines, forfeited gains and other penalties, the Journal says, enumerating them in a timeline graphic.

But the gummy bear image persists in Washington, the story says, so leaders at the SEC feel they’ve got something to prove. For example …

In April, former federal prosecutor Mary Jo White started work as SEC chairman with a simple enforcement motto:

“You have to be tough.”

As crisis-era cases run their course, the SEC will redeploy resources to new enforcement actions, the paper reports.

© 2013 Johnson Strategic Communications Inc.

Steady as she goes, IROs

A quote of the day for investor relations professionals, from National Investor Relations Institute President and CEO Jeff Morgan in his “IR Weekly” email and blog post under the heading “Market Mayhem”:

Market volatility reached new extremes last week as we experienced global market moves of positive to negative 5% from one day to the next. Most believe it is very unlikely these market moves were driven by fundamental analysis of companies, but instead by panic, margin calls and computerized trading. For IROs, these are the most challenging market conditions as they lack logic and rational explanation. Time and other actions outside our influence and control will bring markets back into check, as we continue to tell our story to investors.

I agree, although market mayhem may be more rational than we can see at the moment. However much we dislike “panic,” if the market performs horribly going forward, fear will seem logical in retrospect. Time will tell whether investors should “Hang on and weather the storm” or “Batten down the hatches and go to cash.”

Certainly for IR professionals, whose individual companies may be doing fine even as the market goes crazy, it’s sound advice to hold the wheel … steady as she goes.

© 2011 Johnson Strategic Communications Inc.

Still too big to fail

Tom Hoenig, president of the Federal Reserve Bank of Kansas City and a skeptic on loose monetary policy and the state of the world’s biggest banks, is convinced the United States still hasn’t heeded the lessons of the last financial crisis.

During an otherwise happy gathering in our hometown, the “CFO of the Year” awards event organized by the Kansas City Business Journal, Hoenig climbed on his soapbox to warn of the prospect of another crisis in the future. The trouble is, he said, the same too-big-to-fail banks that starred in the 2008 meltdown and the recent HBO dramatization of Andrew Ross Sorkin’s book Too Big to Fail are still, well, too big to fail – even moreso.

The financial reform law enacted in 2010 to guard against the next crisis doesn’t solve the issue of systemic risk, Hoenig said. And the world’s central banks continue to be “held hostage” by issues raised in 2008, he said. Exhibit A is the way everyone is worrying that debt problems of one smallish country could reverberate through big banks worldwide – roiling capital markets and threatening a new crisis.

“Dodd-Frank does three things, and it leaves one thing undone – and that is the most significant thing,” Hoenig said. What the financial reform law does:

• Enhances supervision. “We’ve enhanced supervision after every crisis,” and it hasn’t prevented the next cycle of financial collapses, Hoenig noted.
• Raises capital standards. But commercial banks used to hold capital around 15% of assets, and now some bankers feel 8% is too onerous a requirement, he said.
• Mandates a new resolution process. But the next time a giant bank teeters on the brink, the bailout impulse will be as strong as ever, Hoenig said.

What Dodd-Frank leaves undone is addressing “too big to fail,” Hoenig said. The U.S. banking system is more concentrated than ever, and that fact haunts the financial markets, he said.

Hoenig offered a “TBTF” history lesson: In 1913, when the Federal Reserve was created, the five largest U.S. financial institutions managed assets totaling 2½% of the country’s GDP. In the Great Depression, the government created a safety net for banks – FDIC insurance and the like – and barred bank holding companies from speculative activities through the Glass-Steagall Act of 1933.

And it worked, Hoenig said. Banks lent money and cushioned their balance sheets against downturns. Investment banks, kept separate from the safety net, took on leverage and invested in riskier assets for greater returns. The economy grew. Markets did well. While the banks expanded, by 1980 the five biggest still held assets equal to only 14% of GDP. One failure wouldn’t have crashed the system.

That changed after the 1999 repeal of Glass-Steagall freed banks to enter other financial services, growing bigger and bigger – and taking on more and more risk. Despite the turmoil of 2007 to 2010, Hoenig said, the banks kept getting bigger.

“Even today, after the crisis, the five largest financial institutions control 20% more assets than before the crisis,” Hoenig said. With the mergers caused by the financial crisis, concentration in U.S. banking has grown to around 60% of GDP.

As one who has lived through weekend “too big to fail” negotiating sessions, Hoenig said, when another giant teeters on the brink the story will be the same. Given the threat that a huge bank failure could lead to collapse in the real economy, he said, “on Sunday evening, before the Asian markets open, you will in fact bail it out.”

Before that next crisis arrives, Hoenig suggested, big U.S. banks should be broken into more manageable pieces – especially, separating commercial banking with its publicly provided safety net from those riskier investment activities in the capital markets. Hoenig laid out more specifics in a speech last month in Philadelphia.

I agree. Let’s dismantle too-big-to-fail before it fails us, again.

© 2011 Johnson Strategic Communications Inc.

Gridlock? Not the end of the world

Of the talking heads on the airwaves and op-ed pages, George Will is one of my favorites – for his insights and the way he offers opinions calmly, without shouting. I appreciate two things Will said on Sunday about the US midterm elections.

Regarding GOP gains in Congress possibly causing gridlock in Washington, which many pundits greatly fear, the conservative Will said on ABC’s “This Week”:

Gridlock is not an American problem – it’s an American achievement. The framers of our Constitution didn’t want an efficient government, they wanted a safe government. To which end, they filled it with slowing and blocking mechanisms: three branches of government, two houses of the legislative branch, a veto, veto override, supermajorities, judicial review. … When we have gridlock, the system is working. [Video here, Will about 5:30]

Asked about calls for more civility in politics, Will likewise gave a contrarian view:

Nothing wrong with that, until you begin to equate civility with the absence of partisanship, as though there’s something wrong with partisanship. We have two parties for a reason. We have different political sensibilities. People tend to cluster – we call them parties. And we have arguments – and that’s called politics. [Video here, Will at about 3:00]

For business issues like taxes and regulation, the new climate in Washington could be contentious. Partisan. Even polarized. The next two years could seem awful to those who wanted the Obama administration’s agenda to fly through. Some analysts like those in this AP story also worry about gridlock hurting the economy.

I think I’m with Will on this one. After all, businesses do not usually get more robust when the government is in activist mode. A unified Capitol Hill can mean businesses have to send more money to Washington, or must try to figure out more 2,000-page laws. So gridlock may be OK, if we can tune out the shouting.

That’s my two cents’ worth. What’s your opinion?

© 2010 Johnson Strategic Communications Inc.

Funny thing about …

October. This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August, and February.

– Mark Twain, American humorist, 1894

At a NIRI meeting last night in Kansas City, I commiserated with a friend over dinner about the state of the economy. It’s like a patient drifting in and out of consciousness in the recovery room – we don’t know whether the surgery was a success until the patient wakes up, smiles and moves a bit. Meanwhile, the job market is lousy. Consumers are cautious. The Fed frets. Companies worry. Waves of regulation and additional costs are looming. And the Nov. 2 election? Bah.

This morning brought a new month and fresh outlook. Hey, let’s have some fun in October – look beyond the macro anxieties – and do some good in investor relations this fall. And the market will do what it will do.

© 2010 Johnson Strategic Communications Inc.

Governance is still about people

Effective corporate governance springs not so much from lists of rules as from the human element of relationships between boards of directors and top managers, according to a veteran director of companies such as Ford Motor and Estée Lauder.

Irv Hockaday, former president and CEO of Hallmark Cards (and Kansas City Southern before that), spoke today at the Association for Corporate Growth in Kansas City. Besides Ford and Estée Lauder, Hockaday is on Crown Media Holdings’ board and is a former director of Dow Jones (before its 2007 sale), Sprint Nextel and Aquila (before its 2008 sale). He’s seen plenty of corporate ups and downs.

While acknowledging the benefits of diversity and other ideals for boards, Hockaday said people who try to codify good governance will fall short:

The corporate nannies, those who tell us how boards should govern companies, have all sorts of rules of the road and advice that appears to me to be gratuitous. … There is a lot to board dynamics and corporate governance that cannot be put down in a rulebook.

Governance at Ford, for example, includes things some people don’t like – family involvement in management and the board, plus disproportionate voting rights for the family’s stock. But Hockaday describes a strong relationship between Ford’s independent directors, the family represented by Bill Ford, and CEO Alan Mullally.

While General Motors and Chrysler succumbed to recession and filed Chapter 11 in 2009, Hockaday credits the human side at Ford – and actions by the board and management – for sustaining Ford as the only one of the Big Three not to file.

None of this is to say that the watchdogs are wrong about best practices for accountability and transparency. But truth is, governance is still about people making good decisions for their businesses – not just minding the nannies.

© 2010 Johnson Strategic Communications Inc.

Sell side: regionals on the rise

Institutional investors are relying a bit more for equity research on mid-sized firms, regional brokers and industry-sector specialists as the bulge-bracket investment banks continue to reel from the effects of the financial crisis, Greenwich Associates reports in its 2010 U.S. Equity Analysts Study. Investor relations people reaching out to analysts might consider the changing sell side mix in targeting sell side firms.

In its survey of 1,007 buy side professionals, Greenwich tabulated “research votes” based on the sources of equity research used, weighted by commission dollars paid out by the institutional investors. So this is more than a popularity contest – it’s a look at who the buy side is paying for equity research.

To be sure, large investment banks still speak with the loudest voice, winning 64.1% of the buy side “research votes” in early 2010. But that’s down from 73.1% in 2008. Regional and more specialized i-banks gained share, from 23.9% two years ago to 32.4%. Independent research firms also gained, from 2.7% to 3.4%, but they remain a drop in the overall research bucket.

Integrity Research Associates notes that the financial crisis has contributed to an exodus of analysts from Wall Street, as some research stars have left troubled big brokerage houses to join regional or boutique firms or set up their own shops.

Greenwich says the bulge-bracket firms saw a pronounced drop in their share of research dollars in 2008, when giants like Lehman Brothers and Bear Stearns disappeared. But the shift continues into 2010.

What shape Wall Street research will take in the future is an open question, but the big i-banks may regain share of voice (and commissions) as the financial crisis continues to ease. “I think the worst is over from the bulge-bracket perspective,” Greenwich MD Jay Bennett tells Pensions & Investments.

IROs tend to seek out analyst coverage where they can get it. Large cap companies or hot stocks almost fight an excess of sell side interest, while small cap IROs work hard to cultivate regional brokers, industry boutiques and independent researchers.

But watching the changing landscape of the sell side – and particularly the shifts in institutional investors’ use of that research – may help IROs allocate their time.

© 2010 Johnson Strategic Communications Inc.

Selling a pig in a poke

For starters, “a pig in a poke” is an ancient expression referring to a scam in the Middle Ages. The trickster would go to the market with a bag tied at the top – inside was an active, wriggling animal that the seller promoted as a small pig. The hapless farmer who bought this bag would later discover what it contained – not a valuable pig to provide future meat, but a cat, comparatively worthless in a world with too many cats already. You could buy a pig in a poke, or sell one. Later, someone inevitably would let the cat out of the bag and the truth would be known.

And so we come to Bank of America‘s merger with Merrill Lynch, announced at the worst point of the financial crisis in September 2008 and closed on Jan. 1, 2009. The deal is back in the news today, and the conflict is over what BofA disclosed about what was inside that bag back in the fourth quarter of 2008.

A federal judge in New York today said he would approve a settlement between BofA and the SEC over lack of adequate disclosure in the bank’s merger with Merrill – but the judge called the consent order “half-baked justice at best.”

The slap was directed mostly at the SEC for not punishing BofA more harshly, but US District Judge Jed S. Rakoff also had a few choice comments on the company’s disclosure around the deal. I gather from news reports that Rakoff can be a little cranky – but in reacting angrily against “too big to fail” banks and the government that bailed them out, he is echoing the feelings of Main Street America.

As an investor relations counselor rather than a lawyer, I find the lessons on disclosure – and IR decision making when “selling” a deal – more interesting than the fine legal points of who’s right or wrong between the SEC and BofA.

In his opinion today, Judge Rakoff said the bank failed to make adequate disclosures following the September 2008 merger announcement, running through the proxy statement leading up to Dec. 5, 2008, approval by BofA shareholders, and right on through the Jan. 1, 2009, closing.

Rakoff cited two basic decisions not to disclose:

• The choice not to disclose in the proxy statement on the merger than BofA was allowing Merrill to pay $5.8 billion in bonuses to execs and top employees “at a time when Merrill was suffering huge losses.”
• The failure to tell shareholders, before either the vote or the closing, about “the Bank’s ever-increasing knowledge that Merrill was suffering historically great losses during the fourth quarter of 2008 (ultimately amounting to a net loss of $15.3 billion, the largest quarterly loss in the firm’s history).”

By not disclosing these flaws, some folks – obviously including the judge – think BofA sold its own shareholders a pig in a poke. Judge Rakoff’s take on it:

Despite the Bank’s somewhat coy refusal to concede the materiality of these nondisclosures, it seems obvious that a prudent Bank shareholder, if informed of the aforementioned facts, would have thought twice about approving the merger or might have sought its renegotiation.

What is far from obvious, however, is why these nondisclosures occurred. The S.E.C. and the Bank have consistently taken the position that it was, at worst, the product of negligence on the part of the Bank, its relevant executives, and its lawyers (inside and outside), who made the decisions (such as they were) to non-disclose on a piecemeal basis in which inadequate data coupled with rather narrow parsing of the disclosure issues combined to obscure the combined impact of the information being withheld.

The consent order includes several “remedial actions” – including requirements that BofA get SEC approval for its choice of independent auditors, disclosure lawyers and compensation consultants for the next three years. Judge Rakoff describes these as mild corrections for a BofA attitude in need of adjustment:

Given that the apparent working assumption of the Bank’s decision-makers and lawyers involved in the underlying events at issue here was not to disclose information if a rationale could be found for not doing so, the proposed remedial steps should help foster a healthier attitude of “when in doubt, disclose.”

On the money side of today’s ruling, Rakoff wrote that the $150 million BofA will pay the SEC is “paltry” but added the settlement is better than a “vacuous” proposal of $33 million he rejected last August. The judge reluctantly approved the 150 mil.

“While better than nothing, this is half-baked justice at best,” the judge wrote. In the spirit of giving partial compensation to the “victims,” Rakoff ordered that the $150 million be distributed to “legacy” shareholders of BofA, not officers and directors and not former Merrill shareholders who got BofA shares.

While not judging what took place behind closed doors leading up to the BofA-Merrill merger, I do think IR people can take two lessons to heart: Don’t sell a pig in a poke and, following Rakoff’s advice, When in doubt, disclose.

© 2010 Johnson Strategic Communications Inc.

Warren Buffett reads annual reports

This weekend’s Wall Street Journal has a readable piece on what Warren Buffett didn’t invest in during the financial and economic crisis (“In Year of Living Dangerously, Buffett Looked ‘Into the Abyss'”) … Bear Stearns, Lehman Brothers, AIG, Wachovia, Freddie Mac and others.

Besides making the point that deciding not to invest can be as important to a portfolio manager as pulling the trigger to buy, the story contains this nugget of side interest to those of us who labor in investor relations:

That night, in his offices in Omaha, Neb., Mr. Buffett pored over Lehman’s annual financial report. On the cover, he jotted down the numbers of pages where he found troubling information. When he was done, the cover was dotted with numbers. He didn’t bite. Six months later, Lehman filed for bankruptcy protection.

So Buffett reads annual reports. Oh, I know, he’s a seventy-something sage, and many of us get most of our information online or on our phones. But Buffett is an investor with influence over market-moving sums of money. And apparently he digs into financial reports, marks them up and then makes his decisions.

Not that a nice annual report would have saved Lehman or AIG. But in the normal course of investing, quality of disclosure and clarity of explanation do matter.

The rising value of trust

As the pace of change accelerates – economically, culturally, personally – people are being overwhelmed with too much information to fully process, authors Tom Hayes and Michael Malone opine in a Wall Street Journal commentary on August 10, 2009. And that overload, they say, places a premium on the value of trusted sources:

Without the luxury of time, trust will be the new currency of our times, whether in news sources, economic systems, political figures, even spiritual leaders. As change accelerates, it will remain one true constant.

We should add investment information to the spheres of life where we’re in need of trust. In a time when credibility in the markets has been bruised, we might ponder the question, How can investor relations professionals enhance the quality of disclosure and news flow to create and sustain trust in our companies?