Good Honest Dollar $$

According to an article in The Australian a couple of weeks ago, executives of Goldman Sachs told managers earlier this month to ensure that reaction inside the bank was subdued regarding the announcement on July 15 of a settlement concerning the firm’s highly publicised dispute with the Securities Exchange Commission (SEC).

Cheering or other forms of celebration, they feared, would damage the firm’s reputation beyond what had already occurred since the announcement of the SEC action last April.

(The settlement, under which the bank agreed to a penalty of $US550millon, represented the largest fine ever imposed on a Wall Street firm to-date.)

Good thing too. The settlement has removed a great deal of uncertainly for Goldman. But it was not a cause for celebration, especially given the prospect of further legal action – not to mention the damage which the bank’s reputation has suffered as a result of these events.

About the settlement
Announced on July 15, the settlement relates to charges against the firm brought about by the Securities Exchange Commission (SEC) in April for defrauding investors by misstating and omitting key information about ABACUS 2007-AC1 (ABACUS), a financial product it sold to two institutional investors as the American housing market was faltering in 2007.

Under the terms of the settlement, Goldman has admitted that marketing materials relating to the transaction in question contained incomplete information. The bank has accepted a fine of $550 million and has also agreed to undertake appropriate remedial action with regard to practices in its offering of mortgage securities.
 

Worries not over
To be sure, from Goldman’s point of view, the settlement does remove a great deal of uncertainty. Better yet, they actually got a fairly good deal: the amount paid is well below worst case scenario predictions (some analysts were tipping $1billion or more – refer article) and no departures at senior levels were required. Things could have been worse.

Still, their problems are a long way from over. For one thing, there are obvious concerns about the settlement serving as encouragement for further legal action from investors who lost out on other Goldman products. Already, Australia’s Basis Capital is asking for $US1billion in damages plus recoupment of initial capital relating to the sale of Tiberwolf securities in 2007 (refer article).  Royal Bank of Scotland (RBS), too (whose subsidiary ABN Amro lost $841 million through the provision of credit insurance on the ABACUS transaction), is widely rumored to be considering its options.

And let’s not forget the ongoing criminal investigation into the bank and its employees by US federal prosecutors either.

Credibility damage
Moreover, the settlement does serve as a blow to Goldman’s credibility.

Granted, the settlement did not constitute an admission of guilt. Nevertheless the fact that Goldman were willing to settle for that amount of money does suggest that they had a case to answer. And given how quickly they caved in, the firm’s initial response (where they dismissed the complaint as being ‘unfounded in law and fact’) does now look a little nonsensical.

For Goldman, this matters. Ranked eighth in Fortune’s 50 Most Admired Companies (refer Goldman Media Awards site), the firm’s standout reputation amongst its peers, along with the prestige associated with its name, has long been a crucial source of competitive advantage.

Hold the Celebrations
Throughout its history, Goldman has had many achievements to celebrate.

In the past six months alone, these include awards such as Euromoney’s Best Global Investment Bank (Jul 2010) and Investment Dealer’s Digest’s Bank of the Year (Jan 2010) as well as inclusion in Business Week’s 20 Best Companies for Leadership (Feb 2010) – and these are just to name a few.

These awards are a credit to Goldman (as are the stellar returns the firm delivers to shareholders so consistently). Celebrations relating to achievements like this are more than justified.

Not so for the ‘award’ from the SEC of Wall Street’s largest ever financial penalty. No matter how much of a relief the settlement might have been, its announcement was no cause for celebration. Any cheering would rightfully have caused further damage to the bank’s reputation.

Goldman was right to be relieved. It was also right not to open the champagne.

That should only happen at times worthy of celebration.

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In my mind, there are at least two key messages which we can derive from Ikea’s recent decision to halt its expansion within Russia:
 
(a) that despite recent efforts, Russia has not done enough to tackle the problem of corruption; and
(b) that corruption has a real impact upon business decisions and upon the lives of ordinary citizens.

 
Ikea’s decision
Ikea announced on June 23 it’s intention to halt further expansion in Russia, citing the difficulties in terms of business operations caused by practices relating to corruption within the current administrative environment (refer article).

According to the announcement, the Swedish home furnishings retailer intends to continue to operate its stores in existence within the country and also to complete work associated with stores already under construction. Beyond that however, the company intends to suspend all future investment.

No doubt the decision was primarily driven by business-case considerations rather than any desire to make a stand based on moral grounds.

Nevertheless, the company’s decision is worthy of public applause. The problem of corruption at administrative levels in Russia will only be dealt with when companies take a stand. Hopefully, the sheer embarrassment from announcements like these will help to further stimulate existing efforts on the part of the government to eliminate these types of filthy practices.

 
Where the bribes apparently occur
The problems to which the company refers relate not so much to the government itself but more to the practices at the administrative level, such as when dealing with authorities relating to fire, health and safety, electricity, tax, customs and other related authorities.

‘Diligent’ officials in these areas have been known to particularly effective at discovering ‘problems’ with company operations. Such ‘problems,’ which would otherwise take a considerable time period and involve a significant level of administrative effort on the part of the company concerned in order to be resolved, are, from my understanding, typically considered to have been ‘rectified,’ after the authorities concerned receive some form of payment.

In Ikea’s case, these problems have been known to occur most frequently immediately prior to the opening of new stores, when the company is most vulnerable to any form of delay.

Examples described in the article referred to above include: (a)authorities declining to connect electricity days before the opening of one store in Moscow; (b)the halting of the opening ceremony at another Moscow store due to the parking lot being ‘too close’ to a natural gas pipeline; and (c)an outlet in Nizhny Nogorod being closed for its opening holiday season on the basis of ‘fire code violations’.

 
What the company’s decision says
As stated above, the company’s decision makes two clear statements about the problem of corruption within the Russian administrative environment.

 
• Dirty practices still exist despite cleanup efforts.

According to the article, the national government in Moscow has made considerable efforts in order to create the perception that corruption related problems are being dealt with, such as prohibiting surprise inspections by health and fire authorities and requiring the income and assets of their spouses as well as their own (spouses, apparently, are a common conduit for bribery related activity).

Whilst these types of measures no doubt represent a step in the right direction, Ikea’s decision clearly highlights the fact that not a great deal has changed in practice. Significant levels of corruption within the administrative environment, it would appear, still represent the reality which confronts firms who operate within Russia.

 
• Corruption affects ordinary citizens, not just individual target companies.

The halting of the company’s expansion in Russia means that job creation opportunities for ordinary citizens have gone begging.

So too have opportunities for consumers in some areas to experience the benefits in terms of convenience and price competitiveness typically associated with having a local Ikea store operating within their area.

I cannot help but wonder how many other foreign companies have either avoided operating in the country altogether or limited the scope of operations there partly out of concern about the prevalence of corruption related practices.  I also cannot help but wonder how many opportunities for consumers, small businesses and workers have been lost as a result.

Bottom line – corruption affects real people in real communities, not just the immediate target companies.

For far too long, it seems that a few tycoons and wealthy families in Hong Kong have run companies under their control as they please, with scant regard for issues relating to corporate governance.

For far too long, it seems that Hong Kong authorities have been ever unable or unwilling to stand up for the rights of minority shareholders.

But things can change, and hopefully, a court ruling last month (refer article) represents a promising sign that authorities are becoming less tolerant of corporate governance abuses.

 
The case and the judgment
The case in question concerned a proposal for the privatization of PCCW, the telecommunications firm which commands a dominant position within the Hong Kong market.

The proposal would have seen Richard Li, son of renowned tycoon Li Ka-Shing, along with China Telecom, PCCW’s second largest shareholder, acquire the 52.4% of the firm which they do not already own.

One problem – Hong Kong law requires the approval of the majority of non-buying shareholders before these types of buyouts can proceed, and given that many small shareholders had expressed venomous opposition to the deal, it was not likely that this requirement would have been met.

Mr. Li’s solution – Gift a whole load of his own shares, in small parcels of worth about $1,000 each, to agents at an insurance brokerage firm that he once controlled.

The recipients would then have become stockholders and would thus have been entitled to vote on the proposal – votes which would then have had a significant influence on the outcome. Presumably, given their past relationship with Mr. Li, along with the nature of the gift, they would feel bound by a sense of obligation to vote in favor of the proposal.

As a result, the prospect of a scenario occurring whereby the privatization went ahead even where it was not widely supported amongst non-purchasing shareholders would certainly not have been out of the question. Had this have occurred, then the objective of a law designed to protect the interests of ordinary shareholders would have effectively been circumvented by virtue of actions which essentially represented a form of manipulation of the voting process.

On April 06, a judge ruled that Mr. Li was within his rights to split up his shareholding in the manner described above, even if this was solely for the purpose of pushing through a deal.

Fortunately, however, common sense prevailed and a later decision in the appeals court reversed the earlier decision. As a result, the transaction has now been abandoned.

 
A fair and just decision ..
The decision reflected a simple dose of basic common sense.

Laws which provide for minority shareholders to have their say on critical matters exist for a reason, and to allow controlling or influential shareholders to manipulate the voting process simply by donating shares to their buddies would represent a clear violation of the basic fundamental principles of fairness and corporate democracy.

Not only that, but if these types of practices are allowed, it would not be difficult to imagine scenarios occurring whereby large shareholders are able to manipulate processes relating to corporate governance and push through arrangements which are not in the interests of minority shareholders – such as transfers of company assets to parties related to large shareholders at prices which do not represent fair market value.

Indeed this may well have been the case with the PCCW proposal – apparently, many long term shareholders demonstrated venomous opposition to the deal, and one of the judges labeled Mr. Li’s offer “pathetic” and “outrageous.”

 
.. and a victory for corporate governance?
More broadly, the decision just might be a sign that Hong Kong authorities are getting serious about corporate governance and the protection of minority shareholder rights.

If this is indeed the case, then it represents a change which is both more than welcome and long overdue.

For far too long it seems that Hong Kong has been a place where wealthy tycoons rode roughshod over the rights of small shareholders, and indeed, many commentators had apparently expected this trial to be a mere formality which would be over in a single day.

Fortunately, they were mistaken, as may be any tycoons who still believe that abuses of minority shareholder rights will be tolerated by the courts.

Today, I have four points which I would like to discuss in relation to the debacle in relation to performance bonuses at AIG:

 
(1) Let’s do away with this talk about bosses committing suicide.

Rhetoric or not, to use the term so loosely is completely irresponsible.

For one thing, this form of talk is completely disrespectful to those whose lives have been affected by suicide.

But even more importantly, it is difficult to judge the emotional state some of the bosses at the center of the scandal. Granted, I find it difficult to imagine that any of them would literally base a tragic decision to end there own lives based solely upon the rhetoric of a senator. Nevertheless, it is not difficult to imagine that there would be at least one or two who are in a somewhat vulnerable state, and talk of suicide, under these circumstances, should not be brandished around so lightly.

 
(2) Those responsible should resign and make a fresh start.

I am not talking here about people like Edward Liddy, the current chief executive, who has only been at the helm a couple of months and appears to be serious about dealing with the problems.

Instead, I am referring to members of the senior management team who presided over the trading division whilst the bank racked up so many losses. From the bank’s point of view, regaining the trust of both the global investment community and the American public represents a crucial part of its rebuilding process, and it is difficult to see how this can happen with some of those responsible for the crisis still at the helm.

But resignations should not be viewed entirely from a negative perspective. On the contrary, upheaval provides the opportunity for a fresh start not only for the bank, but also for the individuals concerned themselves.

There is no denying that serious mistakes were made. Nevertheless, I have no doubt that the individuals concerned still have a great deal to offer, and a fresh start, with the opportunity to apply their talents and experience in a capacity where their reputations are not so tainted, may be exactly what these individuals need to provide them with the opportunity to make this happen.

 
(3) The bonuses should be repaid.

The payment of bonuses of more than one million American dollars each to seventy-three employees was completely inappropriate at a time when the American taxpayer is having to shoulder the burden of this kind of bailout.

I am not in a position to make informed comment with respect to the legal issues involved in any attempt to recoup the payments, but from an ethical perspective, these payments should never have been made.

They should now be repaid, and Mr. Liddey’s call for all staff who received bonus payments of more than $100,000 to give back at least half of these is more than fair under the circumstances.

To be sure, a degree of reluctance on behalf of some rank and file employees to return payments to which they were contractually entitled is somewhat understandable, particularly for those who performed their individual responsibilities in a diligent fashion.

Nevertheless, large bonus payments are appropriate only in cases where exceptional performance is achieved by both the individuals concerned and the team as a whole.

Clearly, this has not happened, and employees of AIG should accept that the bonuses of such a magnitude were not appropriate under these circumstances.

 
(4) Focus on the bigger picture.

Public anger about bonus payments, whilst justified, must not be allowed to detract from the much bigger picture of rebuilding America’s broken financial system in any way.

The financial system is the backbone of American commerce and industry, and the re-building task is for too important for governments and regulators to become distracted by squabbles about bonus payments.

In this regard, the suggestion that bonus payment money be recouped by deducting it from the next tranche of aid money is especially counter-productive. Given that the staff concerned would still get to keep their bonuses, all this would appear to achieve would be the deprival of some of the funds which the bank needs to keep itself afloat and start the rebuilding process, an affect which is counter to the reason that AIG is receiving funds in the first place.

In short, the bonus payments were completely inappropriate, and public anger over them is more than understandable.

But this cannot be allowed to detract from the much bigger picture of rebuilding the American financial system – the fortunes of too many businesses and households are at stake for this to be allowed to happen.

The contrary surrounding the adequacy of disclosure from Apple Inc, with respect to the health issues surrounding its co-founder, Steve Jobs, has raised interesting issues about the extent to which corporate boards should go in terms of the disclosure with respect to any personal health issues which are experienced by senior executives.

Broadly speaking, I feel that health issues are the private concern of the individual executives concerned and that corporate board should refrain from public discussion of such matters unless such concerns have a direct impact upon the employment of the executive concerned.

 
The Steve Jobs Drama
The drama surrounding the health of Jobs unfolded as follows:

 
• In June 2008, Jobs appeared noticeably thinner at a public event. This sparked off public rumors about his health, particularly after he had battled with pancreatic cancer in 2004.

Despite increasing pressure, the board refused to comment on this matter due to privacy concerns.

 
• On January 05, Jobs made his first public comment on the issue, stating that his doctors believed they had found the cause – a hormone imbalance.

Jobs indicated that the treatment would be simple and straightforward, and that he would remain in his position throughout the recovery process.

 
• On January 14, Jobs issued further disclosure, indicating that his health issues were more serious than at first thought, and that for this reason, as well as the distraction arising out of public curiosity surrounding his health, he had decided to take a medical leave of absence.

 
• The company’s disclosure with respect to the above matter is currently the subject of an SEC Enquiry, to determine whether or not investors were provided with misleading information.

(Jobs is extremely well respected, and of course, I, like many others, sincerely hope for the sake of himself and his family that he is able to make a full recovery)

 
Two criticisms – one potentially valid
Broadly speaking, criticism of the company’s disclosure falls into two broad categories; (a) that the initial disclosure on Jan 05 was misleading; and (b) the general secrecy of the board regarding Jobs’ health overall.

With respect to the first point, investors may well have a valid complaint.

Directors have a responsibility to ensure that all public disclosures are accurate and are not misleading in any way. Accordingly, investors do have a right to ask questions about why the key messages contained in the two disclosures – just nine days apart – were so different.

It will be difficult to make informed comment on this until the completion of the enquiry, and it is genuinely possible that a clearer picture emerged during the time between the two disclosures about the nature of the illness.

Nevertheless, if the initial disclosure on January 05 does prove to be inaccurate, then this will represent a breach of ethical duty from the board with respect to their responsibilities relating to the accuracy of public disclosure.

 
When private health is private business
However, I cannot agree with broader criticisms about general non-disclosure with regards to Mr. Jobs’ health.

Apple is under fire for its continued refusal to reveal anything about his health during the months from the time when he began to noticeably appear thinner and the time of the first disclosure on January 05.

But there were two good reasons for the company’s silence with respect to this matter during that time:

 
• There was nothing definitive to report.

Based on Jobs’ statements, it appears to be clear that neither he, nor his doctors understood the cause behind the loss of weight. Until such time as this was properly determined, neither Jobs nor the board would have had any idea what impact, if any, his health issues would have upon his work in the long term.

 
• It was his private business.

The only time companies should make any form of public disclosure about the health issues of senior executives is when it becomes clear that the issue concerned has an impact upon the ability of the executive concerned to perform his or her duties going forward.

Beyond that, such issues are a private matter for the individual concerned, and any public disclosure or discussion on such matters from the company would represent an invasion of privacy and would be completely inappropriate.

In the case of Jobs, the company was correct in its refusal to discuss his health until it became clear that it would have an impact upon his position at the company.

Prior to that, his personal health issues were his concern and his concern only.