Corporate Vigilance Equally Prudent for Private Investors
Wall Street West
by Benjamin Mark Cole
Shareholders of companies large and small aren’t the only ones griping about corporate governance and starting to flex their muscles.
As Louis “Skip” Miller of Christensen Miller Fink Jacobs Glaser Weil & Shapiro can attest, the accountability of management to shareholders is the same: there are fiduciary responsibilities that cannot be breached.
Miller represents a group of disgruntled shareholders (mostly venture capitalists) in privately held Pasadena business incubator Idealab.
In court papers, Miller has alleged much self-dealing among Idealab executives, including founder Bill Gross. Idealab and Gross have publicly dismissed the shareholders suit and complaints as baseless, and have hired lawyer Michael Hennigan at Irell & Manella for defense.
Miller advises private equity investors to be careful. Investors may wish to determine who sits on an audit subcommittee of a private company’s board, and make sure the audit subcommittee represents shareholders, not management. Control of the board is another important consideration.
Without control, private investors have little recourse except to civil courts if they suspect they are being had. They cannot go to the Securities and Exchange Commission, or stock exchanges, and complain of rule violations. And nearly all business litigators consider complicated cases an unpredictable adventure at best.
Concluded Miller, “For private investors, proper corporate governance, board membership, and corporate bylaws are even a bigger issue than for public investors.”
In the late 1970s, it was an article of faith that oil prices would hit $100 a barrel. In the late 1980s, it was that Japan would dominate world commerce. In the 1990s, that the Web would redefine life.
More recently, the mantra is that China will be the world’s manufacturing platform, given its giant population, low wages and huge investments in infrastructure.
“Well, maybe,” said R.M. “Dick” Torre, deal maker with Irvine and Los Angeles-based Global Vantage Securities Ltd., who travels extensively in China and often arranges cross-border transactions.
China’s banking system, for starters, is riddled with cronyism. Money has been lent on projects of dubious economic value, largely at the behest of those with political connections. Another funny thing: “Power usage has been dropping in China in the last year,” Torre said. “That’s tough to reconcile with increased manufacturing.”
Economic figures released by official China are a joke, lamented Torre. “They come out with their figures seven days after a quarter, and they never revise them.” In the United States, economic growth figures come out weeks after a quarter, and are revised for several quarters thereafter.
All the same, the advantages of China, and its 10 cents-an-hour labor, are formidable. “If I were anyone in Latin America, I would be worried, and that includes Mexico,” said Torre. “In the long run, anyone fighting a low-wage war against China will lose.”
Sometimes it pays to be a little on the pokey side. Consider the Los Angeles County Retirement Association, the $28 billion pension fund for county employees. For years, investment experts have badgered public pension plans to put 100 percent of their portfolios into equities, which historically have outperformed bonds. (This is a bigger institutional adjustment than many may know; only a generation ago, many public pensions shunned any risk, preferring only AAA-rated bonds, or federal IOUs.)
But LACERA’s nine-member investment board is not known for blitzkrieg investment maneuvers. And while inching towards greater exposure to equities in the past 15 years, it still has more than a quarter of its portfolio in bonds.
With the stock market tanking for three years straight and bonds appreciating and throwing off yields besides suddenly retro looks good.
“Hey, 8 percent returns look great, if you compare them to losing 20 percent on the S & P;,” said Ken Shaffer, LACERA’s chief investment officer. “It’s the old lesson: Diversification is good.”
Shaffer wondered if a “crab” market one that goes mostly sideways is in the offing. “Maybe it won’t be a bull or a bear for several years,” he said.
Public vs. Private
The CEOs and CFOs of public companies have inked documents asserting their financial numbers are kosher. But the real story starts in third quarter reporting, said Tom Hopkins, partner with the 75-year-old Los Angeles-based law firm Sheppard Mullin Richter & Hampton.
That’s when many public companies will have to certify that their audit committees have either a CFO with public company experience, or a CPA on the board’s three-member audit subcommittee. That individual should be independent not a company officer, consultant, or someone otherwise too closely linked to the company.
This raises a problem, said Hopkins. “The liabilities and time costs of being on a public company board have increased,” he said. “But you can’t raise compensation too much, or it will make it look like the independent board members are not independent.”
Embedded in the Sarbanes-Oxley Act are provisions for 10- and 20-year prison terms for inaccurate financial reporting. And while the likelihood of an independent director doing hard time is remote, it is still not the sort of prospect that encourages participation.
Already, many companies with “orphan” stocks trading on the cheap are considering going private, said Hopkins. Sarbanes-Oxley rules might tip the scales for them.
“It is going to be very difficult to find qualified people to sit on boards, especially the audit committees,” he predicted. “It has always been onerous (due to expensive compliance and reporting procedures) to be a public company, but now it is a lot more so.”
Don’t Invest, Drink
Peter Eichler, chairman of Santa Monica-based Aletheia Research & Management Co., is a guy who likes to put his money down hard on his latest ideas on Wall Street.
“Starbucks?” he asks. ” I would short it.” They are on every corner in America already, and have a mysterious way of blending two-year sales figures at same-store locations, which seems to result in sales growth, said Eichler, scion of the Eichler name attached to the old Bateman Eichler Hill Richard brokerage.
“Think about it: Are Starbucks stores more crowded than a couple of years ago? With a Peet’s coffee and whatever opening up everywhere too?”
Contributing columnist Benjamin Mark Cole can be reached at firstname.lastname@example.org.