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One of the ongoing controversies of the accounting world is the appropriateness of “success fees” (also called contingent fees) and referral commissions fees paid only upon the successful conclusion of a project, merger or public offering of stocks or bonds, or upon a referral.

It is an issue particularly relevant to investment bankers and investors. In years past, many CPA firms shied away from contingent fees, fearful that success-related paydays would undermine the credibility of accountants. For example, if an accountant who is called upon to study the books of a company targeted for acquisition only gets a bonus if the acquisition goes through, there might be an incentive to make the target seem more attractive than it really is.

“When accountants take contingent fees, it opens up a Pandora’s box,” said Larry Hurwitz, president of Lawrence Financial Corp. in Brentwood, a boutique investment banker. “Will their numbers or recommendations be untainted?”

Los Angeles has been at the epicenter of the contingent fee controversy, with many local firms or branches embracing the pay-dirt-equals-payday philosophy in the early ’90s.

Until recently, these practices have fallen into a gray area in state and federal law. Some accountancies went ahead and charged these fees as the debate over them raged among industry bodies and regulatory agencies.

But several states including California have been passing bills that codify the types of fees that accountants can legally charge. This year, the California Legislature passed a bill that allows accountants to accept referral or finder’s fees for recommending a lender to a buyer starting in 1999 (some local accounting firms have already been charging these fees).

“The new law is creating a stir,” said Thomas Schulte, managing partner with Roth Bookstein & Zaslow LLP in West Los Angeles. “Many say this is an area we ethically should not get into. Our clients expect referrals based upon true needs, not related fees.”

And Hurwitz points out that lenders and investors might like to be assured that accountants aren’t putting a rosy cast on financials just to make a referral successful.

Still, Hurwitz, known for his talent in raising money when it is hard to find, figures the change in contingent fee law and regulations will be a good one.

“Now, an accountant will have an incentive to refer a client to me. Before, he probably just told (clients) to get a bank loan, and banks never lend. Now they may make a fee if I can raise the money.”

Shulte said every accounting firm in Los Angeles has a stack “40 to 50” deep of letters from lenders, consultants and others who want to form partnerships to get referrals.

Convertibles

Convertible bonds had a good October, which managed to put the investment category back into the black for calendar 1998.

Convertible bonds are corporate IOUs that can be exchanged for stock, given certain conditions. Some investors like them for providing much of the appreciation potential of stock, but in the case of a downturn they provide the protection of bonds, as they pay interest.

But most convertibles have been issued by mid-cap companies, which as a group have not kept pace with the all-powerful S & P; 500 index, investment-wise. Thus the exchange value of the bonds has lagged. In the current bull market, large-cap issues have been tough to beat.

But in October, spurred by the rally in small- and medium-cap stocks, convertible bonds returned 2.73 percent to investors, based upon a 2.34 percent increase in convertible bond values and a 0.39 percent interest return, according to Froley Revy Investment Co. Inc., a Westwood-based money manager with about $2 billion under management. For the year, convertible bonds have yielded 2.20 percent, in both principal and interest returns, according Froley Revy.

Junk yet?

Junk bonds were crushed in the summer financial freak-out, as investors took flight to quality, usually U.S. Treasury bills and notes. But now, high-yield non-investment grade bonds are making a comeback, as investors sense the international financial crisis is passing. In addition, the Federal Reserve moved last week to lower interest rates.

“The (junk) market is coming back, there are increasing values and liquidity. It’s much improved from August, September and October,” said Ken Malamed, president and chief investment officer at Century City-based Financial Management Advisors Inc., which has more than $1 billion under management, most of it in junk bonds.

Malamed said today’s market offers the best values ever even better than the junk fire sales that followed the demise of brokerage Drexel Burnham Lambert Inc. in the early 1990s.

“Back in 1991, we were facing a recession, the Gulf War, and a forced liquidation (sale) of junk bonds by the S & L; industry,” recalled Malamed. “Drexel was gone, and you had only 10 market makers which traded junk. And only about 200 issues.”

Nevertheless, back then, junk bonds offered yields only about 550 basis points (5.5 percent) above Treasuries, said Malamed. But today, junk is offering yields about 650 basis points above Treasuries. “And there is no recession, there are about 40 to 50 market makers in junk, there are about 2,000 issues, and we do not have rising inflation or interest rates,” Malamed said.

In other words, today’s junk market is much more liquid and mature. Malamed calls this a “historic” buying opportunity for junk bonds. “It just doesn’t get any better than this,” he said, referring to double-digit returns to be had in a low-inflation environment.

Coastal split?

There’s a great deal of bloodletting going on right now at New York’s big investment-banking houses, but the layoffs aren’t happening here.

“In New York there are some bankers looking for work, but out here, we aren’t seeing it. I don’t think the Los Angeles market has had that kind of downturn,” said Lorne Greenberg, founder of West Coast Capital LLC, echoing the sentiments of many others.

The short story? Major New York wire houses such as Morgan Stanley Dean Witter and PaineWebber are cutting overhead built up during one of the plushest environments ever, the 1990s. Smaller regional shops, like those in Los Angeles, are keeping the troops on board, and many are hiring. And even the big boys in Los Angeles are talking growth, not retrenchment.

“We are looking for good people, and we are seeking to increase the number of professionals here (in Los Angeles),” said Jay Flaherty, managing director with Merrill Lynch, head of the firm’s large Los Angeles investment banking operation in Westwood. The parts of the firm that were cut were back in New York and London, said Flaherty.

Contributing Reporter Benjamin Mark Cole writes about the local investment community for the Los Angeles Business Journal. He can be reached at sevencontinents@mindspring.com.

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