Throw the rascals out!
Angry that a company you own is being run into the ground? Or that the company's executives are lining their own pockets at shareholders' expense? Or that the company's management is just too cozy with relatives, consultants and accountants?
Then vote the directors -- the people who are supposed to make sure the company is managed for the benefit of its shareholders -- out of office. The proxies that companies are currently sending out as part of this spring's annual meeting season offer investors just that chance.
The current crisis in the markets has been called many names. It's an accounting crisis, some analysts say. Certainly, evidence exists that hundreds of companies massaged their numbers. It's a credit crisis, others state, noting the number of companies that hid billions in debt in an effort to keep balance sheets looking good. And still others observe that it's a profit crisis, as companies disclose the tricks they used to make it look as though earnings were growing faster than they were.
But to me, the underlying theme that stretches from
PNC Financial Services Group
is a crisis in corporate governance. At company after company, the board of directors has failed in its basic duties of representing shareholders and riding herd on management.
Simple Rules, Complex Violations
What are boards supposed to do? The board's powers and duties are spelled out in every company's corporate charter, and you can usually find a reasonable summary of the job in the annual statement that comes along with the proxy ballot. For example, the
Johnson & Johnson
board's audit committee is supposed to make sure that management maintains an adequate system of internal controls so that financial reports can be prepared in accordance with generally accepted accounting principles. This committee also is supposed to supervise the work of the independent auditor.
The board, working through its compensation committee, reviews the company's compensation policies and reviews decisions by the management compensation committee that determine how much, and how, management is paid. The compensation committee also administers the stock option plans at Johnson & Johnson.
And finally, a corporate governance committee is responsible for ensuring that the board and the CEO are doing their jobs within the guidelines laid down by the company.
Investors can find similar descriptions at most U.S. companies. (I've picked Johnson & Johnson as an example for no other reason than that the company does an especially good job in its proxy statement of laying out the duties of the board and reporting on the policies and decisions of the important committees.)
Sounds good on paper, doesn't it? But the current crisis makes it very clear that many companies didn't give their own rules much more than lip service.
Hall of Shame Nominations
How bad were the lapses in corporate governance? Well, here are, in alphabetical order, eight companies that make my personal hall of shame.
The company guaranteed loans of $2.3 billion to the Rigas family, which founded and still owns much of this cable TV company. The loan, the company's chief financial officer told Wall Street on March 26, is secured by assets that normally would be able to secure no more than $700 million, according to Merrill Lynch. Oh, and by the way, the chief financial officer added, the debt wasn't included on Adelphia's balance sheet, even though the company was liable for its repayment. The CFO's name? Timothy Rigas, son of CEO John Rigas.
It's no secret that Cisco has been one of the most acquisitive technology companies over the last decade. But many investors don't know that high-ranking Cisco executives owned stakes in many of the acquired companies through their investments in two major California venture capital firms, Kleiner Perkins Caufield & Byers and Sequoia Capital.
CEO John Chambers, for example, held a stake in five private companies that Cisco acquired. And eight other Cisco executives owned pieces of 12 companies that Cisco bought. Company policy at Cisco allows such outside venture investments, so nobody violated any company rules (Chambers even recused himself from voting on a 1999 $7 billion acquisition and has donated the shares he acquired in such deals to charity). But that's my point -- company rules ought to rule out conflicts of interest like this, especially when shareholders are questioning the bookkeeping on Cisco's acquisitions strategy in general.
Didn't anybody on the audit committee at Elan see that the company was too deeply connected with its auditor KPMG? Donal Geaney, Elan's CEO, is a former KPMG partner. So is Chief Financial Officer Shane Cooke. Hard to see KPMG getting tough with its former partners. The company has been "aggressive" about taking research and development joint ventures off its balance sheet and has used accounting that inflated revenue by investing in tiny biotech firms that would then use Elan's capital investment to pay for research conducted by Elan. Elan would then book that payment as revenue, thus round-tripping its own capital.
What's the logic in giving top company managers the opportunity to invest in side deals? In 2001, El Paso gave 16 top executives, including CEO William Wise, the chance to buy into El Paso Global Networks, the company's telecommunications network. Not only did the company loan the executives 80% of the cash, it then bought back all the outstanding stock and stock options of Global Networks at a premium, according to a company proxy filing. Shareholders took the risk, it seems, and the CEO and others got a distracting side bet that put them potentially at odds with shareholder interest. Better to just pay the extra money in cash or add more options in the parent company stock, I'd say.
Exactly why did Enron's accounting spiral so far out of control? You can find one answer in the makeup of the company' audit committee, which mixed passivity and conflict of interest. For example, member John Mendelson heads up the M.D. Anderson Cancer Center at the University of Texas -- the recipient of $1.6 million from Enron since 1985. Hong Kong billionaire Ronnie Chan missed more than 25% of meetings in 2000. Lord John Wakeham, who joined the board in 1994, earned $72,000 a year as a consultant to Enron.
Before he joined Global Crossing as executive vice president for finance, Joseph Perrone was in charge of auditing Global Crossing's books for Arthur Andersen. His new job at Global Crossing? Overseeing the way Global Crossing booked revenue from its swaps of network capacity with other telecommunications firms. Those accounting methods are now under investigation by the
Securities and Exchange Commission
and the FBI.
Perrone's name also figures in two deals that Global Crossing signed with Withit.com, a company run by Joseph Perrone Jr. It's not clear how much scrutiny the accounting issues of that deal with Within.com got from Global Crossing's board. But with a majority of the board composed of either company insiders or lawyers and bankers who did business with Global Crossing, the situation was ripe for abuse.
I know the reasoning: Loaning money to top executives to help them buy company stock aligns shareholder and manager interests. But the practice also gives such executives an opportunity to avoid exactly the kind of insider-trading disclosure that shareholders are entitled to have. Over the last three years, Dennis Kozlowski, CEO of Tyco International, used $88 million in loans from the company to buy shares in Tyco. During the company's 2001 fiscal year, Kozlowski returned $70 million of that stock to the company.
Because the transaction wasn't a sale on the open market, but rather a swap to repay debt, it didn't have to be disclosed to investors until 45 days after the close of the company's fiscal year. A traditional sale, on the other hand, must be reported to the SEC by the 10th day of the following month. Technically, Kozlowski was correct in saying that he rarely, if ever, sold his Tyco shares during 2001. But the company's board of directors was shirking its job when it let him exploit that technicality.
When is a loan to a CEO simply too big? When it becomes a distraction for investors. WorldCom's $340 million loan to CEO Bernie Ebbers certainly fits that category. The loan is secured only by Ebbers' shares in WorldCom. (He can't sell them without company permission.) But the sheer size of the loan has become an issue in the stock market and has depressed the stock's price. Investors fear that Ebbers will have to dump shares to meet a margin call on the next dip in the stock, or that WorldCom will wind up having to eat the loan altogether.
The board didn't have to put the company in this jam. $200 million of Ebbers' loan was originally owed to
Bank of America
; WorldCom stepped in to cover that sum, and to extend additional credit. (I can't help but think that Ebbers is occasionally distracted from the job of pulling WorldCom out of the current telecommunications slump by worries over his own highly leveraged bet.)
How to Fight the System
Now, getting rid of a director isn't easy, and winning a vote against the recommended auditor is even harder. (For non-U.S. companies such as Tyco International, the situation can be especially daunting.) If you've got a serious gripe with a company's board, you'll have to do some organizing.
Use stock chat boards to contact other disgruntled investors. Read the proxy statement carefully to see if a group of shareholders or a large institutional investor has already filed for a vote on governance issues. A call to some of the big institutional owners should tell you if anyone is planning an organized challenge at the company's annual meeting. And think of going to the annual meeting itself. The question-and-answer period can be a good time for getting your issues heard.
Don't worry if you lose the actual vote. In the long run, letting management and directors know that shareholders are watching can be just as important as winning the actual count.
Jim Jubak appears Wednesdays on CNBC's "Business Center" at 6 p.m. EST. At the time of publication, he owned or controlled shares in the following equities mentioned in this column: Apache, Citigroup, E*Trade Group and Intel.