Why Cheney Should've Held On to Halliburton

The Securities and Exchange Commission, spurred by a New York Times report, is investigating the accounting practices of Halliburton (HAL - commentary - Cramer's Take) in the period when Vice President Dick Cheney served as chief executive officer. In 1998 the oil-services company changed the way it accounted for cost overruns on construction jobs, booking some of them as current revenue, even though clients could dispute and not pay the charges. The shift, which involved tens of millions of dollars, came when the company badly needed to post impressive numbers.

Cheney may pay a political price, but he won't pay a financial one as a result of the accounting games the company played under his watch. He uncontroversially dumped all of his Halliburton stock and options in the late summer of 2000. As such, Cheney is benefiting from an unexpected effect of the ethics regime governing the stockholdings of executives-turned-high-government-officials.

A 'Clean' Slate?

The lag time between CEO departures or retirements and the emergence of accounting questions is one of the most frustrating aspects of the current wave of scandals. It's a given that accounting games always come home to roost, because you can't hide inflated subscriber numbers (Adelphia), debt (Enron) or the misallocation of costs (WorldCom) forever. The bad news is that by the time the information comes clean, the executives who signed off on the shady numbers have already cashed in and are frequently long gone. (In Cheney's case, it took four years for the numbers at issue to come to the SEC's attention.) In fact, it has become a commonplace for newly installed CEOs to take various charges and adjustments to earnings in their first quarter at the helm, to clean up any mess left by their predecessors and start with a clean slate.

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Of course, it makes sense for CEOs to sell all their shares once they leave a company. After all, they no longer have any role in its operations. Even if Cheney had held onto his stock after leaving, he would've been forced to sell in early 2001.

Title 18 of the U.S. Code forbids executive branch employees from "participating personally and substantially" in any decision that might affect a stock they or relatives may own. So upon entering office, those with significant stakes and potential conflicts are expected to sell. This is an entirely rational expectation. (As important, it allows divesting executives to burnish their images as latter-day dollar-a-year men. When Robert Rubin joined the Clinton administration in 1993, for example, he gave up his highly lucrative partnership in Goldman Sachs (GS - commentary - Cramer's Take).)

Cheney liquidated his Halliburton holdings shortly before he was picked as Bush's running mate. Between Aug. 21 and Aug. 28, 2000, Cheney exercised 660,000 options at between $21 and $29.562 and sold them at prices between $52.28 and $53.93, for proceeds of about $35 million. The likely profit: About $20 million. On Aug. 24 he sold 39,200 shares back to the company for $54 apiece, raising another $2 million-plus to cover the taxes on profits generated by the larger options exercise. Cheney agreed to forfeit long-term options.

A Tell on Cheney's Competence

Ordinarily, a CEO blowing out his position like that would raise suspicions about a company's health. But Cheney's sale was seen as purely a political necessity, and Halliburton stock actually rose in the weeks after Cheney left. But it has been dropping ever since.

Halliburton's decline accelerated last year when it became apparent that the company may have exposure to asbestos liability. The company acquired this potential liability as a result of Cheney's signature move as CEO: the 1998 acquisition of Dresser Industries. The accounting investigation has added fuel to the fire.

The stock now stands at $14, below where it was when Cheney took over in 1995, and that is perhaps the best verdict on his competence as a CEO. In short, the decisions that Cheney made, the mergers he engineered and the financial strategies he endorsed created no value for long-term investors. Had he lost the election, Cheney would surely be feeling his shareholders' pain. All of those options that he exercised in the $20s back in 2000 would've plunged underwater late last year.

Thomas White, the secretary of the Army who formerly ran Enron's energy service division, which has been accused of improperly inflating its earnings, could have been similarly fortunate. (Like all good senior executives today, White denies having any knowledge of the methods by which his unit turned profits upon which his exorbitant compensation was based.) Upon taking office in May 2001, White owned between $25 million and $50 million of Enron stock and another $25 million to $50 million in Enron stock options. White reluctantly liquidated most of his holdings throughout 2001, meaning he preserved at least some value as Enron skidded toward zero.

Upon assuming office in 2001, Treasury Secretary Paul O'Neill, the longtime CEO of Alcoa (AA - commentary - Cramer's Take), similarly resisted selling his Alcoa stake, estimated to be worth $100 million. But he ultimately gave in and dumped his shares. Another smart move: Alcoa is off more than 30% from its peak in May 2001.

O'Neill and Cheney are the lucky ones: Some CEOs-turned-government-officials sell their stock before it climbs, and lose out on vast sums of money. (Rubin's stake in Goldman Sachs, for example, appreciated by at least a factor of four during his tenure in the Clinton administration.)

A Potential Solution

The Cheney case raises the question of how we can remedy the apparent injustice of CEOs using government service as an excuse or occasion to dump stock and avoid the consequences of the decisions they made.

Why not allow -- or even force -- former CEOs to keep their stock?

Sen. John McCain has proposed legislation that would bar CEOs from selling stock during their tenure. That would surely mitigate against the sort of short-term earnings-juicing strategies that have become so prevalent. But encouraging -- or even requiring -- CEOs to hold onto their stock after they leave -- even if they leave to serve in government -- would provide an even stronger disincentive against massaging the numbers.

Now, the prospect of high government officials directly owning significant stakes in publicly held companies would send the ethics cops at Common Cause into high dudgeon. And it could create a situation where Cabinet members see their wealth grow while they're in office.

But selling stock doesn't solve the ethics problems of CEOs in government; it merely removes the appearance of a conflict. Dumping his Halliburton shares didn't make Cheney any less sympathetic to the concerns of oil companies when it came to formulating a national energy policy. O'Neill is not likely to be less concerned about the fate of the largest domestic aluminum company because he no longer owns shares in it. The fact that Rubin disassociated himself from Goldman didn't make him any less solicitous of the needs and prerogatives of Wall Street firms. In a sense, in fact, it freed him to be Wall Street's voice and advocate in the inner councils of the Clinton administration.

Forcing high-ranking executives who enter public life to hold onto their stock and options for the duration of their public service might have two beneficial effects. First, it might discourage favoritism. People could track the shares' performance and correlate it with policy shifts. Such holdings would surely make officials hypersensitive to charges that the policies they enact would be unfairly partial to their own economic interests.

Second, it would create a kind of accountability for this small class of executives. They would have to live with the long-term consequences of their corporate work, and would be unable to realize the full value of their holdings until there is no question that the numbers they reported were accurate. And in cases where those numbers turn out to be fishy, it would also give investors the satisfaction of seeing the former CEOs watch, helplessly, as their fortunes dwindle along with theirs.

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Daniel Gross is the author of Bull Run: Wall Street, the Democrats, and the New Politics of Personal Finance. At the time of publication, Gross had no positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. He welcomes your feedback.

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