Author: Doug Cornelius

You can find out more about Doug on the About Doug page

How to Get Caught Insider Trading

Purchase out of the money call options set to expire in two weeks, be an employee of the company acting as an adviser in the merger, not have any activity on that stock before, use an account in your name, exclusively use option when you have barely traded options in the account before, and quickly try to move the money off-shore.

The SEC alleges that Juan Jose Fernandez Garcia and Luis Martin Caro Sanchez had material, non-public information and purchased hundreds of “out-of-the-money” call option contracts for stock in Potash Corp. in the days leading up to the public announcement of BHP Billiton’s bid on August 17.

Juan Garcia is (was?) the head of equity derivatives research at Banco Santander which was advising BHP on its bid. It’s not clear how Luis Sanchez is related to Santander or Garcia. The daring duo made nearly $1.1 million in illegal profits based on $61,000 in option contracts.

How did they get caught?

The warning signs are obvious, but who saw them. Daniel M. Hawke, Market Abuse Unit Chief SEC Enforcement Division, gets his face on the press release. That’s some good publicity for the new structure of the enforcement division.

The complaint mentions the daring duo’s attempt to transmit the funds from that brokerage account back to Spain. It sounds to me like the compliance folks at Interactive Brokers are likely the ones who spotted the red flags and froze the accounts. Otherwise that money would be sitting in Spain and harder for the SEC to grab and demand disgorgement.

Let’s hand a glass of champagne to SEC’s Market Abuse Unit and the compliance department at Interactive Brokers

I agree with Felix Salmon that there is probably a much juicier story behind this incident.

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Social Media as a Risk Factor

It’s official. Social media is a risk factor. At least according to Estee Lauder and lululemon athletica.

Over at Footnoted, Michelle Leder and her team dig through SEC filings digging up the dirt on bad corporate behavior. They were digging through the 10-K for Estee Lauder when Theo Francis came across a new risk factor.

Our inability to anticipate and respond to market trends and changes in consumer preferences could adversely affect our financial results.

Our continued success depends on our ability to anticipate, gauge and react in a timely and cost-effective manner to changes in consumer tastes for skin care, makeup, fragrance and hair care products, their attitudes toward our industry and brands, as well as to where and how consumers shop for those products. We must continually work to develop, produce and market new products, maintain and enhance the recognition of our brands, achieve a favorable mix of products, and refine our approach as to how and where we market and sell our products. While we devote considerable effort and resources to shape, analyze and respond to consumer preferences, we recognize that consumer tastes cannot be predicted with certainty and can change rapidly. The issue is compounded by the increasing use of social and digital media by consumers and the speed by which information and opinions are shared. If we are unable to anticipate and respond to sudden challenges that we may face in the marketplace, trends in the market for our products and changing consumer demands and sentiment, our financial results will suffer.

It’s not exactly: “We could lose millions if the Twitteratti turn on us.”

Public companies disclose risk factors in their SEC filings trying to inform its stockholders and potential purchasers of its stock about potential losses. Failure to disclose a risk could result in a shareholder suit that the company was hiding its risks.

It looks like Estee Lauder is covering itself in case its customers get ugly in social media, start attacking the company, and stop buying its products.

Ever vigilant, Theo Francis poured back through the SEC database to see if any other companies had disclosed social media as a risk factor in its SEC filings. The only other consumer-product company they  found that lists social media as a risk factor in its 10-K was lululemon athletica, a Vancouver-based maker of “yoga-inspired apparel.”

Social media is not a new disclosure in SEC filings, but it was mostly discussed in marketing strategies and business strategies for tech and media companies. For example, Estee Lauder’s competitor Elizabeth Arden talks about the use of social media as part of its marketing strategy, but does not disclose it as a risk factor.

I wonder if we will see other companies start adding social media as a risk factor. Have you seen any other companies list it as a risk factor?

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Can Companies Do Well by Doing Good?

Yesterday’s Wall Street Journal published a story by Aneel Karnani, Professor of Strategy at the University of Michigan’s Stephen M Ross School of Business with a controversial headline: The Case Against Corporate Social Responsibility.

He manages to pull in some corporate governance arguments: “The movement for corporate social responsibility is in direct opposition, in such cases, to the movement for better corporate governance, which demands that managers fulfill their fiduciary duty to act in the shareholders’ interest or be relieved of their responsibilities.” He points out that managers who want to forgo profit to benefit society should expect to lose their jobs. “Managers who sacrifice profit for the common good also are in effect imposing a tax on their shareholders and arbitrarily deciding how that money should be spent.”

Karnani does draw a distinction with private companies, which I find artificial. Most private companies are not owned by a single individual. They likely have given equity interests to many people, just not as many as a public company. Unlike public company shareholders, they have little ability to liquidate their investment if they don’t like the decisions.

That is not to say that companies should be allowed to pursue profits with out regard for social consequences. He just thinks the argument that companies will profit from acting in the public interest.

Obviously, there are some examples where a company has directly increased its profits by acting in a more social responsible manner. I would argue that if you can show a direct increase in profits or revenue, that is not acting more socially responsible. That is acting more fiscally responsible.

Take the case of energy conservation. Many commercial buildings have switched over to more energy efficient lighting. Its more expensive to buy and install. On the other hand, it has lower operating costs. If you put pencil to paper you can calculate the energy savings tied to the investment. Then it’s just a matter of the energy costs being high enough to justify the investment.

Karnani makes an argument for government regulation. Not that the government is perfect, but they are intended to protect the public good. We can see that working with the upcoming ban on incandescent bulbs. (You do know about the phase-out of traditional light bulbs beginning in 2012.)

“In the end, social responsibility is a financial calculation for executives, just like any other aspect of their business. The only sure way to influence corporate decision making is to impose an unacceptable cost—regulatory mandates, taxes, punitive fines, public embarrassment—on socially unacceptable behavior.

Pleas for corporate social responsibility will be truly embraced only by those executives who are smart enough to see that doing the right thing is a byproduct of their pursuit of profit. And that renders such pleas pointless.”

Related articles from MIT Sloan Management Review:

Does It Pay To Be Good?
By Remi Trudel and June Cotte (Winter 2009)
In surveys, customers have long claimed that they’d pay more for ethically produced goods. But is that what happens when they actually buy things? New experiments offer answers.

What Every CEO Needs to Know About Nonmarket Strategy
By David Bach and David Bruce Allen (Spring 2010)
In a global economy, sustained competitive advantage arises from tackling social, political and environmental issues as part of a corporate strategy—not just pursuing business as usual.

Beyond Selfishness
By Henry Mintzberg, Robert Simons and Kunal Basu (Fall 2002)
A syndrome of selfishness, built on a series of half-truths, has taken hold of our corporations and our societies, as well as our minds. This calculus of glorified self-interest and the fabrications upon which it is based must be challenged.

How to Do Well and Do Good
By Rosabeth Moss Kanter (Fall 2010)
The key to achieving both of those goals together? Integrate societal benefits with company strategy.

Using Corporate Social Responsibility to Win the War for Talent
By C.B. Bhattacharya, Sankar Sen and Daniel Korschun (Winter 2008)
Research indicates that there are five steps that can help business leaders increase CSR’s effectiveness as a lever for talent management.

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globe image is by Jackl under the Creative Commons Attribution ShareAlike 3.0 in Wikimedia.

Roger Clemens and Lying to the Feds

Roger Clemens taught us another important lesson in dealing with an investigation. Never lie to the feds.

Mark McGwire essentially proclaimed his guilt when he refused to answer questions about steroid use during his playing career at a congressional hearing. He may have lost in the arena of public opinion, but he will not have to continue in the courtroom arena.

Mr. Clemens said the following, under oath, at a Congressional hearing:

  • “I have not used steroids of human growth hormone.”
  • “I am just making it as perfectly clear as I can, I haven’t done steroids or growth hormone.”
  • “I never used steroids. Never performance-enhancing steroids.”

Instead of having to prove that Roger Clemens illegally took steroids, they just need to prove that he took steroids.

Martha Stewart was never convicted of insider trading. She was convicted of perjury lying to federal investigators. She lied about the circumstances of her trades.They did not have enough evidence to prove insider trading. But they did have enough lies to convict her of perjury.

Roger will now need to worry about trading his Yankees pinstripes for jail stripes. It’s probably going to be tough to get that Baseball Hall of Fame vote while being under federal indictment. Clemens is eligible to be placed on the ballot in 2012. He may need to be more worried about being eligible for parole.

Sources:

Image of Roger Clemens is by Keith Allison

Compliance Bits and Pieces: Ground Zero Mosque Edition

One part of compliance is investigation. Find the facts. Don’t rely on opinion or self-interest statements. With all the hullabaloo about the Ground Zero Mosque I thought I would gather some factual information.

First off. It’s not at Ground Zero.

Just How Far Is the “Ground Zero Mosque” From Ground Zero? by Matt Sledge in the Huffington Post

From 45 Park Place, the former Burlington Coat Factory building that will make way for the Cordoba House, it’s two blocks, around a corner, to get to the WTC site. Park Place doesn’t lie between the construction site and any mass transit stations, so you would need to go out of your way to have it offend you.

Mosques And A City Block (Update) by Scott Greenfield in Simple Justice

If someone was trying to build a Mosque on the Site, there would be one debate. But building a Mosque where the old Burlington Coat Factory used to be isn’t the Site. Not even close. It’s the equivalent of building it ten miles away in Houston. It’s a different neighborhood, climate, time zone. There are a couple of nudie bars, even another tiny Mosque, that far away, not to mention dozens of stores selling cheap junk. It’s not a pretty neighborhood. It’s not what people who don’t know Manhattan think it is. Not even close.

There’s a reason all the elected officials of both stripes in Manhattan think this whole debate is nonsense. They’ve been there and know what they’re talking about. This is being used by politicians to manufacture a debate that doesn’t exist. They are selling a fantasy to people who don’t know any better. This Mosque has absolutely nothing to do with the Site. It doesn’t besmirch anyone’s memory. It might as well be in another country for it’s impact on anything.

The Wikipedia page for Park 51 is full of links to great primary source material and (at least when I read it) mostly avoids opinions on the controversial project.

Park51, originally named Cordoba House and sometimes referred to in the media as the “Ground Zero mosque”, is a planned $100 million, 13-story, glass and steel Islamic community center and mosque. Plans are for the facility to include a 500-seat auditorium, theater, performing arts center, fitness center, swimming pool, basketball court, childcare area, bookstore, culinary school, food court serving halal dishes, and Islamic prayer space for 1,000–2,000 Muslims. It would replace an existing 1850s Italianate building that was damaged in the September 11 attacks, and is located two blocks (about 600 feet, or 180 meters) from the World Trade Center site in Manhattan, New York City.

Muslim Prayers and Renewal Near Ground Zero by Ralph Blumenthal in the New York Times

The location was precisely a key selling point for the group of Muslims who bought the building in July. A presence so close to the World Trade Center, “where a piece of the wreckage fell,” said Imam Feisal Abdul Rauf, the cleric leading the project, “sends the opposite statement to what happened on 9/11.” “We want to push back against the extremists,” added Imam Feisal, 61.

Mosque-erade from The Daily Show with Jon Stewart

The Daily Show With Jon Stewart Mon – Thurs 11p / 10c
Mosque-Erade
www.thedailyshow.com
Daily Show Full Episodes Political Humor Tea Party

SEC versus New Jersey

Fuggedaboutit!

New Jersey became the first state ever charged by the SEC for violations of the federal securities laws. They gave up without a fight and agreed to settle the case, without admitting or denying the SEC’s findings.

This matter involves the sale of over $26 billion in municipal bonds from August 2001 through April 2007. In 79 municipal bond offerings, the State misrepresented and failed to disclose material information regarding its under funding of New Jersey’s two largest pension plans, the Teachers’ Pension and Annuity Fund and the Public Employees’ Retirement System. Among New Jersey’s material misrepresentations and omissions:

  • Failed to disclose and misrepresented information about 2001 legislation that increased retirement benefits for employees and retirees those pension plans.
  • Failed to disclose and misrepresented information about special Benefit Enhancement Funds initially intended to fund the benefits, but then abandoned.
  • Failed to disclose and misrepresented that New jersey would be unable to fund the increased benefits without raising taxes or cutting services.

This case is a clear warning sign for states and cities that are running into retirement funding problems. You need to disclose those problems in the bond offering.

An interesting note is that the State Treasurer signed a 10b-5 certification that the official statement did not contain any material misrepresentations or omissions. The Treasurer was not charged.

The SEC only brings civil charges, so we don’t get to see Robert Khuzami driving up the New Jersey Turnpike trying to slap handcuffs on the state.

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Criminal Provisions under Dodd-Frank

handcuffs

When thinking designing compliance programs, I pay extra attention to the issues that can result in jail time. It’s one thing to pay a fine, it’s a much bigger problem when you take someone’s freedom away.

The Dodd-Frank Wall Street Reform & Consumer Protection Act has added several new federal criminal offenses. The National Association of Criminal Defense Lawyers has compiled the two dozen provisions in a handy guide: Criminal Provisions in HR 4173 (list of the criminal provisions in Dodd-Frank Wall Street Reform & Consumer Protection Act).

Most of these new opportunities to earn a shiny pair of bracelets are related to the new regulatory regime of swaps.

EWWW! The Connections Between Disgust and Morality

What if our moral judgments are simply that a situation makes us feel like throwing up?

Drake Bennett explores some of the new research and thinking in how our moral ideas may have evolved from our more visceral feelings of disgust in Ewwwwwwwww! The surprising moral force of disgust.

The moral emotions model has another radical implication as well. It means morality is not, as the Buddha and St. Augustine said, a way to curb our animal desires: It’s simply an outgrowth of that same animal nature.

The origins of disgust are mysterious. But so are the origins of morality. Both are partly through biological selection and partly as a taught behavior.

The facial expression triggered by disgust is also a social cue: “a visible signal of disgust at both bodily and behavioral transgressions, and an unmistakable warning to the transgressors themselves.”

I think there were lots of “that smells bad” looks last week after the Mark Hurd/H-P brouhaha.

Image of mushroom 6 smells bad! is by Amy.

The Ascent of Money: A Financial History of the World

Niall Ferguson had the unfortunate luck of writing The Ascent of Money just before the unveiling of the 2008’s Great Panic. At the time he finished writing the book in May 2008, only $318 billion of write-downs had been acknowledged.

I was interested in the book because of its focus on the development of our financial institutions. If we want to understand the present and hope to have some insight to the future, then we need to understand the past.

Ferguson starts with the origin of money, “the crystallized relationship between debtor and creditor.” Effectively turning counting into wealth. Once you had money, then you needed banks and clearing houses to aggregate borrowing and lending.

Then the government got involved and introduced government bonds (largely to wage war and pay for the extravagant spending of the monarchies.) This lead to the securitization of streams of payments and highlighted the need for the regulation of securities markets.

Then the sixteenth century brought the rise of the joint stock companies and the market for the trading of these equity interests.

The rise of insurance funds and pension funds in the eighteenth century used the economies of scale and the laws of averages to provide financial protection.

The nineteenth century saw the start of option and future contracts. These eventually morphed into the more sophisticated derivatives seen as a central player the Great Panic.

The last piece was the emphasis on real estate ownership that became a central policy for the twentieth century. This policy, combined with more sophisticated derivatives, became the maelstrom of the 2008’s Great Panic. At the time, the creators and sellers of these products boasted of allocating risk to those “best able to bear it,” when the reality was more that it was being allocated to “those least able to understand it.”

He ends the book with a lengthy afterward called “The Descent of Money.” Those with the pitchforks and torches chasing the bankers will not like where Ferguson ends up. “[F]inancial markets are like the mirror of mankind, revealing every hour of every working day the way we value ourselves and the resources of the world around us. It is not the fault of the mirror if it reflects our blemishes as clearly as our beauty.”

We need to remember that the ascent is not a straight line. It is full of rapid drops, rising bubbles and death-defying falls. “If stock market movements followed the ‘normal distribution’ …, an annual drop of 10% would happen only once every 500 years, whereas on the Dow Jones it has happened about once every five years.”

He spends some time looking at Long Term Capital Management and their collapse in the late 1990s. These quant traders used sophisticated models to identify correlations and uneven pricing. Ferguson focuses on a flaw in their data for their downfall. Their models worked on just five years of data. If they had gone back 11 years, they would have captured the 1987 stock market crash and seen the volatility and unseen correlations.

This fatal flaw sounds much like the flaw in the Gaussian copula function that failed in assessing the risks for mortgage backed securities. They used ten years worth of data in that formula. Unfortunately, the last real estate crash predated that data.

A failure to understand history lead to yet another fatal flaw.

Ferguson does a great job of shedding light on the origins of finance. If you have an interest in finance, then you need to understand the history of finance. The Ascent of Money is worth the time spent reading it.

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Compliance Bits and Pieces: Mark Hurd Special

Mark Hurd

Last Friday, the big news in compliance was the sudden resignation of Mark Hurd as the CEO and Chairman of the Board of Hewlett-Packard. I decided to put together a compilation of other stories I found interesting.

HP and me: Coincidence or not? by Michelle Leder in Footnoted

Of course, footnoted had done its own poking at HP over the years. But one piece that seems particularly prescient right now in light of the shared meals between Hurd and the recently named consultant, Jodie Fisher, is this post from nearly two years ago that talked about some hefty gross-ups for Hurd’s meal. As we noted at the time, we used some back-of-the-envelope math to come up with a total meal bill of $243K. Several days later, HP filed a revised proxy to say that $79,814 tax gross up that was originally reported was actually only $4,117, which we viewed with a healthy serving of skepticism.

(It’s good to see Michelle back after having a baby. Congratulations Michelle!)

Hurd and ethics? Nah, it’s the money by Dennis Howlett in ZDNet’s Irregular Enterprise

The old saying that money talks while BS walks is a good standby but it doesn’t always apply. Sometimes money blinds you. As it seems to have done over some of Hurd’s expenses and the board in bending over to make a messy settlement.

The FCPA – Tone at the Top and in the Middle by Tom Fox in the FCPA Complaince and Ethics Blog

We have previously noted that Hewlett-Packard is under investigation for allegations of paying bribes to obtain commercial sales contracts in Russia. (See here and here) Given the current situation with the former Chairman and Chief Executive and the ongoing bribery investigation by not only German and Russian governmental authorities but also the SEC and Department of Justice for possible FCPA violations, it might be a propitious time for Hewlett-Packard’s top management to implement some or all of Hanson suggestions regarding the communication of Hewlett-Packard’s commitment to FCPA compliance and ethics to its middle management and indeed throughout its organization.

HP, Hurd, Deloitte and Tone at the Top by Francine McKenna in re: The Auditors

What do HP, Boeing and Navistar have in common?  All three companies, over the years, have fought SEC investigations, internal investigations, and shareholder lawsuits. … There’s one more thing these three companies have in common:  Deloitte was their auditor during the worst of these troubles.

The Week in Ethics: Mark Hurd’s Leadership Failure by Gael O’ Brien in The Week in Ethics

Tone at the top only counts when leaders use words that they believe in enough to live.

HP’s letter to employees on Hurd resignation from cnet

On Friday afternoon [Chief Financial Officer Cathie] Lesjak sent a memo to company employees explaining the leadership change and going into some detail about the nature of the claim, and the results of the the HP board of directors’ investigation. CNET has obtained a copy of that e-mail, which we’ve posted below in its entirety.

Here’s The Real Reason HP CEO Mark Hurd Was Fired (As Best We Can Tell…) by Henry Blodgett in Business Insider

Now that everyone has gotten over the shock of HP CEO Mark Hurd getting ejected on an August Friday afternoon–with the timing of the announcement obviously chosen to minimize bad PR–people are looking more closely at the details. And the details leave big questions as to what really happened.

How HP General Counsel Michael Holston Handled CEO’s Sex Harassment Nightmare by Sue Reisinger in Corporate Counsel

For Hewlett-Packard Company general counsel Michael Holston the nightmare began when CEO Mark Hurd handed him a June 29 letter accusing Hurd of sexual harassment. Hurd took the letter to Holston, reportedly within a half hour of receiving it.

Mark Hurd’s Excesses Were in Plain Sight by Eric Jackson in The Street

There are lots of good CEOs who suddenly lose their touch. What alarmed me about Hurd last year was the piggish behavior he and his executive team were exhibiting at the expense of H-P shareholders. What was worse, they were gorging at the trough of lavish compensation and excess perks at the same time that they were hypocritically turning the screws on H-P employees (who remained after a series of layoffs) to accept pay cuts and reduced benefits.

I wrote about the mixed messages from H-P