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The Corporate Reform Weekly
Vol V, #25
June 19, 2006
In This Issue
Executive Pay
1. As stock options backdating probe widens, Sen. Grassley, SEC consider solutions
2. SEC not enforcing “clawback” provisions
Washington Corruption
Corporate Scandal
5. Senate committee grills Fannie Mae executives, Rep. Baker calls for perjury investigation
Shareholder Activism
This Week’s Action Item
Tell the SEC to enforce the “clawback” provision
Executive Pay
With federal prosecutors, the Securities and Exchange Commission, and the IRS investigating cases of alleged illegal stock option backdating at more than 40 companies, more officials in Washington are chiming in on the issue.
One was Senate Finance Chairman Charles Grassley (R-Iowa), who said in a statement that, “It's bothersome to think that after the corporate scandals of recent years, some executives are still looking for ways to cook the books for personal gain.”
Grassley also noted that, “Justice [Department] officials made it clear today in response to my questions that executives can face possible prison time for backdating stock options.” So far, however, no new reforms have been proposed.
Meanwhile, Scott Taub, the acting chief accountant at the Securities Exchange Commission and a member of the PCAOB advisory board suggested that the SEC and/or the PCAOB put in place more specific rules. “We need to write some guidance for auditors on when they need to be suspicious,” he told reporters.
SEC Chairman Christopher Cox indicated that such rules may be forthcoming. “We will issue guidance on the backdating of stock options that will more clearly circumscribe the bounds of acceptable conduct,” he told reporters.
Cox also recently explained the problem of backdating in a speech
"What makes the option work as a powerful motivational tool is, that unlike a bonus, it isn't so much a reward for prior performance as it is an incentive for future performance," Cox said. "That's why the undisclosed backdating of options is such a serious potential problem. By giving the recipient of options an undisclosed paper gain right from the start, it cuts the direct connection to future performance. And in the process, what investors might otherwise view as a shareholder-friendly way to align their interests with those of the company's executives becomes instead a more expensive way for the firm to structure its compensation program."
Put more simply, options benefits executives because when executives cash out on stock options, they get the difference between the current value of the stock and the value of the stock on the day the option was granted. If the stock option grant is backdated to an earlier date when the stock was worth less, the executive will get more money when he or she cashes out.
Though it is unclear how widespread backdating is, several academic studies suggest that the practice may be quite widespread. These studies have found a suspicious correlation between stock grant award dates and stock price lows.
For more, see: “Stock option abuses spread: Lawmaker, audit group express concerns about possible stock option timing abuses at dozens of companies”:
http://money.cnn.com/2006/06/13/news/companies/accounting_options.reut/
“A Crackdown on 'Perfect' Timing: SEC to Clarify Rules on Lucrative -- and Potentially Abusive -- Backdating of Options,” By Kathleen Day, Washington Post:
http://www.washingtonpost.com/wp-dyn/content/article/2006/06/13/AR2006061301770.html
The Sarbanes-Oxley Act was supposed to give companies and shareholders some “clawback” rights in cases where top executives made off like bandits through phony profits that were later wiped out by restatements.
But an Associated Press report says that the “clawback” provision “hasn’t left a scratch.” The report notes that: “the Securities and Exchange Commission hasn't felt compelled, for many reasons, to include the provision -- Section 304 -- in its arsenal of punishments, and the courts have thus far blocked shareholder plaintiffs from recouping bonuses in private lawsuits…But with thousands of companies restating millions of dollars in earnings since the Sarbanes-Oxley act was passed in July 2002 and little effort to reclaim bonuses, activists are fuming with frustration.”
According to the AP, despite 2,000 restatements since the Sarbanes-Oxley Act, there has not been a single SEC-led attempt to require a CEO to pay back ill-gotten gains. Additionally, a recent court ruling found that the law did not give investors a private right of action to pursue shareholder “clawback” suits, which has frustrated shareholder attempts to recover ill-gotten gains.
For more, see: “SEC Not Compelled to Enforce 'Clawback: SEC Not Compelled to Enforce Sarbanes-Oxley Provision on Reclaiming Bonuses From Executives,” Associated Press
Washington Corruption
Federal jurors
are now deciding the fate of David Safavian, the former General Services
Administration chief of staff charged with repeatedly lying to investigators
looking into the influence-peddling activities of his friend Jack Abramoff.
Safavian, who
went to Scotland on a 2002 golf trip sponsored by Abramoff, initially told
investigators that Abramoff had no business before the GSA. As the White
House’s chief procurement officer, Safavian was in charge of the purchasing and
leasing of government property, and Abramoff was allegedly looking to buy some
government properties, one of which he wanted to use for a luxury hotel,
working with his tribal clients on the deal.
Lawyers for both sides rested their cases last week. In closing, federal prosecutor Nathaniel B. Edmonds told jurors that the reason Safavian didn’t cooperate with federal investigators initially was that he wanted to cover up the fact that he was “doing Jack Abramoff’s bidding.” Edmonds said that Safavian maintained a “secret, inappropriate and unethical relationship” with Abramoff and the he offered Abramoff "access, he offered connections, he offered power."
During the
trial, Safavian called Abramoff a "friend and, dare I say, mentor."
Safavian’s lawyer, Barbara Van Gelder, argued that the case against Safavian was weak because Abramoff was not a “contractor” and therefore had no specific business before the GSA. “What did David Safavian do for Jack Abramoff?’ she asked. “Nothing."
For more, see: “Safavian Case Goes to Jurors: Prosecution Says He Kept Relationship With Abramoff Secret,” By Jeffrey H. Birnbaum, Washington Post Staff Writer: http://www.washingtonpost.com/wp-dyn/content/article/2006/06/12/AR2006061201365.html?nav=rss_business
“Prosecutor: Safavian Hid Ties to Abramoff,” By PETE YOST, Associated Press
http://www.forbes.com/home/feeds/ap/2006/06/12/ap2810398.html
Corporate Scandal
Securities and Exchange Commission investigators believe that former NYSE chief executive Richard A. Grasso may have pressed traders to support AIG stocks when the company share price was tumbling, according to a deposition unearthed by the New York Times.
Grasso, who left the NYSE in 2003 after his staggering $188 million compensation package became public, was allegedly trying to keep AIG chairman Maurice “Hank” Greenberg happy by setting up a $17 million fund to buy AIG shares and encouraging floor specialists to prop up share prices. Greenberg, after all, was a member of the NYSE compensation committee from 1996 to 2002.
The SEC deposition is part of a larger investigation into whether the NYSE properly policed floor trading specialists, who are alleged to have conducted trading in a self-dealing manner at the expense of ordinary investors.
New York Attorney General Eliot Spitzer, who is going after Grasso’s compensation as “unreasonable,” under New York State not-for-profit law, will reportedly argue that Grasso was improperly pumping up AIG shares to ensure Greenberg’s support for Grasso’s outrageous compensation.
For more, see: “S.E.C. Asked Grasso if He Buoyed Stock,” By JENNY ANDERSON of the New York Times:
http://www.nytimes.com/2006/06/15/business/15aig.html
5. Senate committee grills Fannie Mae executives, Rep. Baker calls for perjury investigation
The current leadership at mortgage giant Fannie Mae
testified before the Senate Banking Committee last week, offering Senators a
chance to attack the company in light of a recent report the Office of Federal Housing Enterprise
Oversight (OFHEO) that accuses the company of a $10.6 billion accounting fraud
over six years, designed to allow top executives to collect $25 million in
bonuses by meeting earnings targets.
On the hot seat were current CEO Daniel Mudd and current Chairman Stephen Ashley, both of whom were on the board at the time of the scandal but claimed that they were unaware of the fraud that was taking place. During the hearing, Mudd said that he was “shocked and stunned” when he found out about the fraud in September 2004.
“What we're dealing with is an astounding failure of management and board responsibility driven clearly by self interest and greed,” said Sen. Chuck Hagel (R-Neb.) “When we reference this issue in the context of the best we can say is 'it's no Enron,' now that's a hell of a high standard.”
“I really do find it astounding that neither of you knew what was going on," Hagel added.
The Senate has not promoted any new corporate reforms in light of the Fannie Mae scandal.
The OFHEO
report describes a board of directors that was asleep at the wheel while CEO
Franklin Raines and CFO J. Timothy Howard manipulated earnings so that they
could get the maximum payouts. Raines earned $90 million in compensation
between 1998 and 2003. The report said he created an “unethical and arrogant
culture” at the top of company.
Following the report’s release, Fannie Mae agreed to pay $400 million in penalties, but did not admit or deny guilt. Now investigators are looking more closely at documenting the specific roles that current and former and current executives played in the fraud.
In the House, meanwhile, Rep. Richard Baker (R- La.), who oversees the House Financial Services subcommittee, last week asked federal prosecutors to investigate whether Raines committed perjury when he testified before Baker’s committee on October 6, 2004 and denied any knowledge of the fraud.
"[T]hese men . . . had an opportunity to come clean, swearing under oath to tell the truth, which I believe the evidence shows they clearly and arrogantly flouted," Baker said in a statement.
For example, Baker recalled how Raines testified that "There was no decision made to defer any expense from 1998 to 1999. . . . We did not make any deferral." But the OFHEO report found that the company deferred $200 million.
For more, see: “Perjury Probe Sought For Ex-Fannie Officials
By Annys Shin,” Washington Post: http://www.washingtonpost.com/wp-dyn/content/article/2006/06/14/AR2006061401416.html
“Fannie Mae officials grilled at Senate hearing: Lawmakers seek details of $11b accounting woes,” By the Associated Press: http://www.boston.com/business/globe/articles/2006/06/16/fannie_mae_officials_grilled_at_senate_hearing/
Shareholder Activism
The Securities and Exchange Commission should require publicly-traded companies to disclose to investors the financial risks posed by climate change, argue a group of 27 investors representing more than $1 trillion in assets. The group of investors, which includes state treasurers and comptrollers from California, Connecticut, Kentucky, Maine, Maryland, New Jersey, New York, Oregon and Vermont made this demand in a letter sent last week to the SEC.
“Shareholders deserve to know if the companies they own are going down the prudent path – adopting environmental practices that will enable them to thrive in a world of increasing environmental concern and regulation – or whether they are following a path that will damage both our environment and our bottom line,” said California State Treasurer Phil Angelides, a trustee of two of the nation’s largest public pension funds, CalPERS and CalSTRS, which collectively manage about $400 billion in assets.
“This letter sends a clear message that the SEC needs to do more to help investors better understand the climate change-related risks that companies face, whether from direct physical impacts or new regulations," said Mindy S. Lubber, president of Ceres and director of the Investor Network on Climate Risk (INCR), which coordinated the letter.
While some companies have disclosed potential financial
risks from climate change, others have not, saying that such risks are not
“material” and therefore do not need to be reported.
In specific, the group of investors has asked the SEC to:
n “Enforce existing disclosure requirements on material risks that are underreported, such as climate change.”
n “Strengthen current disclosure requirements by providing interpretive guidance on the materiality of risks posed by climate change.”
n “Require companies to include in their proxy statements shareholder proposals asking companies to report on financial risks due to climate change.”
For more, see: “$1 Trillion of Investors Call on SEC to Require Corporate Disclosure on Financial Risks of Climate Change,” CERES press release:
http://www.csrwire.com/PressRelease.php?id=5774
For more on CERES’ efforts to get companies to acknowledge the financial risks of climate change, see: http://www.ceres.org
This Week’s Action Item
Tell the SEC to enforce the “clawback” provision
The Sarbanes-Oxley Act was designed to force executives to pay back ill-gotten gains arising from accounting fraud.
But according to an AP article, there have been 2,000 restatements since the Sarbanes-Oxley Act, but the SEC has yet to make a single attempt to force a CEO to pay back ill-gotten gains.
As This Week’s Action Item, please tell the SEC to stop sitting by idly and start going after CEOs ill-gotten gains and make use of the Sarbanes-Oxley Act’s clawback provisions
Contact SEC Chairman Christopher Cox at chairmanoffice@sec.gov
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Bolstered with
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means of corporate reform.
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