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Monday, August 21, 2006

The WSJ: The New White Collar Crime Column

I think I've figured it out. Since June 21, 2006, the Wall Street Journal has published a bizarre series of columns which basically claimed that the practice of backdating option grants for highly compensated executives is not only harmless but a sign of corporate boards actively looking out for shareholders by actively managing incentive compensation. At first, the editorials might have been explained by hallucinogenic compounds being added to Holman Jenkins' water cooler since the first three columns were all penned by him. The August 21, 2006 edition seems to indicate the WSJ editorial staff is on to something even bigger...

A recurring op-ed column on white collar crime…

…written by actual or alleged white collar criminals!


The 8/21 edition has an op-ed piece written by Maurice (Hank) Greenberg on the "culture" of over-regulation in American business and the stifling affects it is having on major US corporations and the economy.

I'll give you a minute to really read that last sentence and savor the irony like a fine Bordeaux.

Greenberg headed AIG for 38 years and resigned in 2005 after Eliot Spitzer uncovered a pattern of transactions undertaken by AIG that appeared to inflate revenue using sham transactions with General Re, deliberately mis-categorized losses to improve evaluations of its insurance exposure, or otherwise improve the appearance of the quality of earnings of the firm. (#1).

IN HIS DEFENSE, no criminal charges were filed in the end by Spitzer and Greenberg has been convicted of no criminal offense, and the civil lawsuit of Greenberg by Spitzer has not been resolved. (#2) HOWEVER,

* AIG itself has admitted to many of the practices alleged by Spitzer's complaint
* AIG has restated its results for the periods involved in the incidences alleged by Spitzer's complaint
* AIG itself is cooperating by providing evidence to Spitzer
* Berkshire Hathaway's legal counsel actually spotted suspicious payments between AIG and BRK's General Re subsidiary and provided the information to Spitzer's office, granted as part of a deal on an unrelated legal investigation (#3)

In his column, Greenberg cites the fact that only 1 of the 25 largest IPOs of the year 2005 involved a US company. Horrible, isn't it? The dearth of IPOs might be related to the desire of companies to avoid public accounting standards due to SOX, true. However, could it also be due to a normal boom / bust cycle in IPOs? A cycle that inevitably results when investment bankers can't make an easy profit pumping and dumping overpriced shares of unproven, unprofitable new companies because individual investors have already lost their shirts on fine IPO stocks like VA Linux, WebVan, CommerceOne, Ariba or any of the other must-have stocks of 1999?

Of course, the dearth of IPOs might also be due to a complete collapse of confidence on the part of individual investors (suckers, as they're referred to on Sand Hill Road and the mahogany suites of Wall Street) in the transparency of financial data presented by banks and auditors of ANY company, much less those trying to sell IPO shares. The continual stream of stories of abuses at the top at the expense of individual stockholders isn't likely to improve Main Street's willingness to trust Wall Street any time soon.

Greenberg's column was entitled Regulation, Yes. Strangulation, No. In it, he suggests a review of reporting requirements under Sarbanes-Oxley is warranted in a world where American companies must compete globally for capital to grow. I've commented previously (#4) that whatever flaws might exist with SOX, we'll never know its true value because you'll never hear about the multi-billion dollar fraud averted because stricter SOX reporting within the company stopped it from beginning or mushrooming. SOX may yet turn out to be the cheapest form of macroeconomic mal-practice insurance America could ever buy. I just wish we would impose the same accounting transparency on the government's books.

In the mean time, I can't wait for the next column in the series. Maybe a getting started primer on selecting the perfect nude ice sculpture for a $2 million dollar birthday party by Dennis Kozlowski? Or a refresher course in debits and credits by Bernie Ebbers?


(#1) http://www.marketwatch.com/News/Story/Story.aspx?guid=%7BB3D95392-C93A-42DB-A893-5E6835FAE3A6%7D&siteId=mktw

(#2) http://www.businessweek.com/magazine/content/05_24/b3937038_mz011.htm

(#3) http://www.badfaithinsurance.org/reference/General/0188a.htm

(#4) http://watchingtheherd.blogspot.com/2006/05/is-sarbanes-oxley-really-problem.html

Thursday, August 17, 2006

The WSJ: Three Strikes on Options

I've commented previously

The WSJ: Wrong, Wrong, Wrong
The WSJ: Still Wrong on Options

on the sheer lunacy of prior op-ed columns written by Holman Jenkins of the Wall Street Journal regarding options backdating and executive compensation. Since Mr. Jenkins last settled in for a pitch, the following events have taken place:

August 11, 2006 -- Juniper Networks announces that investigations into its accounting of options treatments indicate that none of its financial results prior to 1/1/2003 should be relied upon and that it will likely face de-listing by NASDAQ. (#1)

August 16, 2006 -- Geoff Tate, who already resigned as CEO of troubled Rambus, resigned from the board as well after the firm announced a week prior it would not be able to release its quarterly results on time, potentially leading to it being de-listed by NASDAQ. (#2)

August 17, 2006 -- Dell Computer announces an SEC probe into its revenue recognition practices the same day it announces a 51 percent drop in earnings for the same quarter last year. (#3)

Despite a torrent of reader feedback to the WSJ on his prior columns and despite more announcements of options related investigations and related financial chicanery since, Mr. Jenkins decided to step into the batter's box once again and take a swing at the options backdating issue in his August 16, 2006 column.

Let's see how he did.

POINT: The most recent indictments of officers at Brocade and Converse don't prove the CEOs were out to inflate their pay, only that document fraud and improper accounting were involved in an otherwise legitimate corporate goal. This is a restatement of a point from his prior columns that compensation committees primarily focus on trying to find the optimal incentive dollar amount to drive the desired executive behavior, then use the variables at their disposal (options quantity, grant date, grant price and vesting periods) combined with an estimate of future stock price to create that incentive.

COUNTERPOINT: WRONG. Jenkins basically believes that if these CEOs were intending to profit exorbitantly from the abuse of options pricing, the vast majority of their compensation would have been derived from the artificially cooked grant prices on these options. From his column,

Look at the Converse complaint: Of the $138 million in option profits collected by Kobi Alexander, a mere $6.4 million was the result of backdating.

Wow. A "mere" $6.4 million. I stand corrected.

If the owner of a home isn't smart enough to watch his house, a thief will come and go as he pleases using the front door, the back door, the garage door, or the sliding patio door on the basement walkout. In reality, these executives (and MANY executives) are equal opportunity thieves. They will take unwarranted compensation in the form of inflated salaries, artificially priced options, country club memberships, low-interest loans to their personal account and family members, you name it. Fudging the paperwork on the grant dates and prices just makes all the numbers add up in Excel to avoid or delay a tip-off that prompts someone to start asking questions.

POINT: A bird in the hand beats two in the bush. Jenkins argues that employees psychologically prefer options which seem to have some immediate value (e.g. options granted today at $4.00/share with the company stock trading at $5.00) rather than par-priced options (options granted today at $5.00/share). His example cites the fact that an employee will prefer 1000 options at $4.00 over 2000 shares priced at $5.00 even though the employee would come out ahead if the stock only goes up $1.00 to $6.00 since the employee is "ahead" the entire time until the stock reaches $6.00/share. He argues that compensation committees understand this and simply want to utilize that psychological factor when granting options to promote performance that grows the firm.

COUNTERPOINT: WRONG. Jenkins grossly overestimates the patience and long-term approach of the executives who profited most from these backdated options. I doubt if most of these CEOs really cared about the company stock price more than 2-3 years out (typically at the point where the first chunk of a grant begins vesting). They are in it for CASH in the SHORT TERM, PERIOD. Many stories have been written recently about the growing unease of the CEO that wears the crown, as boards grow more impatient during company slumps and sack executives with increasing regularity. There is a growing contingent of "mercenary executives" (management gypsies?) who profit handsomely by moving from one company to another for a 2-4 year stint, negotiating a nice exit package on the way in, sucking down a nice $200-$400k salary and enjoying a few perks and taking a few meetings at the 19th hole at Pebble Beach. If the company manages to tread water or improve a bit, that first chunk of backdated options starts paying off around year 3 or 4. If things go south, there's that exit package with a few lovely parting gifts and a year's salary to tide them over while they wait for a buddy to bring them in at another victim, I mean firm.

POINT: A flawed accounting rule encourages firms to issue options at par rather than below par. Jenkins' theory is that the compensation committees of all of these fine, upstanding companies sat down and carefully decided the optimal amount of likely dollar compensation they wanted to pay these executives based upon current stock price and expected future price to encourage the desired behavior, THEN AND ONLY THEN attempted to set a grant price to yield that amount THEN rigged the paperwork and grant date to make them par grants due to this accounting rule. In other words, that last little trick with the pen and the calendar was just a teensy little illegal step in the otherwise perfectly legitimate exercise of making compensation decisions.

COUNTERPOINT: You're kidding, right? Jenkins argues that executives wouldn't bother spending the time going back to backdate the options of every employee just to boost their own pay by reducing expenses hitting the bottom line. This thinking completely overlooks two facts. First, I doubt that any of these dozens of cases actually involved HR going back and altering paperwork of grants that had been already issued and disseminated to employees. That would have exposed the practice to too many people outside the compensation and audit committees. Instead, the paperwork was first distributed WELL AFTER the supposed grant date so no "guessing" of the low-point or rework was involved. Second, executives absolutely DO have an incentive to systematically distort earnings on the plus side by avoiding below-par options because another abused portion of their immediate compensation (their BONUS) is based upon quarterly results. Rigging the grant prices of options to appear as par-priced options takes advantage of the flawed accounting rule to help this quarter's earnings and their bonus pay. Getting to pick the date with the lowest price to set the "par price" provides the artificial (and undeserved) bump in the options' value 3 or 4 years out when the first chunk of the options begin vesting.

Though options backdating itself has not been mentioned as part of Dell Computer's SEC woes, the "par-priced options" accounting treatment that avoids an expense hit becomes important when looking at Dell's financial performance over the years. There are several excellent recent commentaries about how an analysis of Dell's stock buybacks over the past few years to recover shares paid to employees for options effectively inflated their income by deferring what are essentially employee salary expenses to future quarters. If the same dollars spent on stock buybacks were deducted from earnings in prior quarters as salary expense, Dell's numbers would look FAR less profitable and would have merited smaller bonus compensation for executives.

In the final paragraph of his piece, Jenkins says this:

And embroiled are not just a few bad apples (pun alert) but Apple, Pixar, Microsoft, Juniper Networks and, if Professor Lie is to be believed, 29.2% of all listed companies. In such circumstances, "the CEO is a crook" is an explanation that quickly loses its power.

We live in a world where obscenely overpaid executives are supposed to be capable of managing a multi-national business and make decisions with complicated accounting and tax implications yet need help figuring out how to minimize the taxes on their own ill-gotten booty. Did you know many executives get free tax advice included as part of their compensation package? Why would you hire an executive to manage a billion dollar company who can't handle the tax implications of $5 million in personal income?

In this world, I have no trouble believing 29.2% of America's executives aren't smart enough to recognize a fraud as obvious as options backdating. However, "the CEO is an idiot" is not a valid legal defense.

Holman, step away from the plate. You're out.


#1) http://news.com.com/2100-1014_3-6104579.html

#2) http://news.zdnet.co.uk/hardware/chips/0,39020354,39281026,00.htm

#3) http://today.reuters.com/news/articlenews.aspx?type=businessNews&storyID=2006-08-17T201840Z_01_WEN4203_RTRUKOC_0_US-DELL-EARNS.xml

Sunday, August 13, 2006

Talking With The Enemy

If nothing else, the 60 Minutes show aired tonight (2006/08/13) with Mike Wallace's interview of Iranian President Mahmoud Ahmadinejad should raise at least one key question with all Americans.

For enemies with whom we've previously denied relations or contact, who would benefit more from establishing contact, us or our foe, and why?

There are at least a few possible answers that come to mind.

The Foe Benefits via Elevated World Stature -- I think this is the default assumption of most people in our government (of both parties). By talking to someone like Arafat, Ahmadinejad, Quadaffi, Kim Jong-il, etc., we immediately grant world stage status to someone we fundamentally view as a tin-pot dictator or sectarian / religion nutjob. This complicates our goals by possibly encouraging 3rd party players to view the foe as more substantial and potentially weigh in on their side rather than staying out of the fray or siding with us. I'm not so sure this argument holds much weight when you consider some of the people we HAVE engaged who have murdered or oppressed millions.

The Foe Benefits By Tempting Us Into "Diplomacy" While They Continue to Pursue Their Goals -- This might be the backup response to many people in America who feel diplomacy moves too slow to address urgent economic or military threats posed by these countries.

America Benefits By Learning More About the Psychology of our Foe -- Think about what an astute observer can glean from a few days of discussion with an opponent. In a "kumbaya" sense, one could learn more about the true motivations of the foe and possibly find areas of common agreement that could be used to develop a better sense of cautious trust or ways to defuse unproductive tension. In a pure Machiavellian sense, one could get a little insight into their thought process, emotional hot buttons, or logical weak points that could be very useful in determining our strategy. More importantly, no meeting of heads of state takes place without DOZENS of lower-level staffers having DOZENS of meetings beforehand, giving us even greater insight into the people feeding information to the top and how that might be manipulated or used to our advantage.

The Enemy Benefits By Learning More about Our Psychology -- if it is possible for us to learn something damaging to the foe by direct talks, it works in the other direction as well.

In the case of the 60 Minutes interview, I'm not sure which case might apply. Ahmadinejad proved he understands US media and politics by appearing to appear reasonable as he criticizes Bush for his belligerence and claims Iran is not interested in a bomb, knowing full well the initial American reaction will likely be to rally around the President. In reality, that is exactly what he wants us to do. Ahmadinejad ran as what passes for a moderate in Iran and only after taking power and finding how difficult it was to control the Revolutionary segment of his party and the mullahs, found it easier to keep the masses distracted from local problems by returning to the "US as bogeyman" theme knowing we'd return the favor and justify his tactic.

Lurking beneath the feigned "reasonableness", he still came across like the religious nutjob he is and demonstrated the combination of that zealotry and his intelligence is something we cannot ignore or eliminate through isolation or ignoring them willfully.

Part of me wonders if we couldn't use negotiations with Iran to weaken their government. How convinced would the global jihadists within their government be of their revolutionary purity after seeing their government deal directly with the "Great Satan?" It's time we start using some reverse psychology on them.

Fed to Try New Tactic: Clarity


WASHINGTON - Former Federal Reserve Chairman Alan Greenspan left the door slightly ajar. His successor, Ben Bernanke, wants to open it a bit more. If investors, businesses and consumers have a better grasp of what the Fed is thinking about interest rates and the economy, they may be inclined to respond the way the central bank wants them to. And that can help the Fed do its job_ keeping the economy and inflation on an even keel.


The Fed wants to be more open in communicating with millions of Americans. Millions who can't even explain why stocks and bonds usually go in opposite directions, much less the more subtle theories of the impact of monetary policy on economic expansion or the pros and cons of deficit spending on the fiscal side. Millions who cannot recognize the disconnect between the unprecedented economic stimuli that have been applied to this economy (record low interest rates AND record government deficit spending) and the anemic growth in jobs and GDP.

The Fed can't succeed in stabilizing economic performance through information because the structure of our entire economy has been altered by corporate and government policies gambling on the ignorance of the masses about the long term consequences of deficit spending by governments and concentration of economic power under fewer and larger corporations. In short, their policies have been driven by the assumption that central bankers and large corporations know better than the rest of us. NOW they want to open our eyes to the financial precipice to which they have led us?

Yea, THIS will end well...

Saturday, August 12, 2006

The Truth in War-Mongering Act

Here are some excerpts from a August 12, 2006 AP story on depleted uranium (DU):



The Department of Defense says depleted uranium is powerful and safe, and not that worrisome.

An estimated 286 tons of DU munitions were fired by the U.S. in Iraq and Kuwait in 1991. An estimated 130 tons were shot toppling Saddam Hussein.

Fifteen years after it was first used in battle, there is only one U.S. government study monitoring veterans exposed to depleted uranium.

Number of soldiers in the survey: 32. Number of soldiers in both Iraq wars: more than 900,000.


Here we go again.

1) use of depleted Uranium munitions in war against an enemy whose equipment doesn't merit the penetrating power of DU
2) lack of knowledge about treating the medical impacts of exposure
3) veterans getting the runaround from the Veterans Administration and our government who are doing nothing to improve treatments for those exposed or rethink and eliminate our use of DU.

This is really absurd and obscene when you think about it. Despite having technology that can deliver bombs with near pinpoint accuracy, we insist on going that extra mile and coating the warhead with a little magic juju that contaminates everything in the blast zone with something guaranteed to harm the health of anyone, friend or foe, who ever crosses the site for the next XX years.

Keep in mind that the current $306 billion dollar price tag for the war in Iraq doesn't include the health care costs for the next 70 years for these veterans. I see no proposal from the Bush Administration to recognize these post-war problems and commit funding to address them. Maybe someone will propose some new legislation to cover these expenses. Maybe we should call it the Truth in War-Mongering Act.

Thursday, August 10, 2006

Was the Big One Foiled?

ABC News aired a special version of Primetime tonight (8/10/2006) covering the story of the 10-plane bombing plot. The subtitle of the show alone, "Was the Big One Foiled?", says a great deal about how little we've learned from fighting terrorism.

NO. "The big one" was not foiled. The phrase "the big one" implies there is one pinnacle of destruction to which the terrorists aspire (there isn't) and that the bombing of a jet or multiple jets out of the sky is that pinnacle (it absolutely isn't).

My most vivid memories of the morning of September 11, 2001 are:

1) Thinking back at my failure of imagination when a friend / coworker walked into my office and said "you gotta see the news, a plane just crashed into the World Trade Center" -- upon hearing the word "plane," my initial reaction was "hmmm, must have been a dark rainy morning in NYC, I guess a Cessna had equipment trouble, got lost and crashed into the building" -- my imagination was incapable at the time of imagining someone purposely flying jets directly into skyscrapers.

2) Sitting in the reception area of my company watching television shots of BOTH towers burning and noticing 20 people around me literally in shock and tears.

3) Suddenly realizing about an hour after the attack that in some sad sense, America STILL got off "easy", in the sick sense that if the terrorists had aimed for sheer economic and ecological damage rather than symbolism, they would have taken out chemical plants or nuclear power plants, potentially killing TENS OF THOUSANDS immediately or over time.

The most important lessons we still need to learn about terrorism are:

1) Islamic terrorism has grown well beyond its Middle East roots. The British attacks last year and the 10-plane plot all involved native born citizens, not newly immigrated foreignors. America's second biggest terrorist attack (The Murrah Building in Oklahoma City) was made in the USA with no help from Osama bin Laden.

2) We are fixating on air travel as the preferred delivery mechanism of terror at our peril. I'd love to think that all terrorists have agreed to spend 95% of their time and effort blowing up planes so we can focus virtually all of our efforts on airline security. That would be perfect. In reality, terrorists will eventually focus on other targets with weaker protection. Some of those targets could be far more deadly than jetliners exploding over the Atlantic.

3) Because we cannot protect every potential target, a strategy focused solely on stopping attacks is guaranteed to fail. Focus must also be applied to eliminating the economic and political conditions that breed terrorists. By no means will a "pax economus / democratus" of worldwide prosperity and democracy stop every nutjob from acting on private conversations with Muhammed, Jesus, or (fill in your favorite deity...) but we need to break the cycle of failed policies that are producing so many ready-made, brainwashed recruits for the nutjobs to use as pawns.

4) This would-be British attack was foiled PRIMARILY because of inside information from an informant within the cell. That was followed by lots of traditional international intelligence work and local police work. There is no evidence Britain's troops stationed in Iraq provided any help in chasing down these bad guys. There's no evidence that information gathered by torturing detainees in Guantanamo Bay broke the ring wide open after the initial tip from the insider. There will never be any evidence that the presence of 130,000 American troops in Iraq chased any bad guys out of the woodwork in Baghdad, Basra, Mosul, Kirkuk or any other place we've lost 2500+ lives occupying.

5) Though the British enjoyed some degree of cooperation from Pakistan's ISA in nabbing some of the cell members, the cooperation may not have been complete. ABC's story tonight indicated the ISA had the ringleaders of this cell under surveillance but the process of triggering the beginning of the arrests somehow tipped off the key leaders, allowing them to avoid capture. Do some searching on the web about our efforts to capture bin Laden in Afghanistan in 2001 and the assistance provided by Pakistan (our ally) and see if a pattern emerges. ABC's coverage tonight also indicated some of the cell members traveled to Pakistan for advanced training in bomb making. Pakistan. Our "ally" in the war on terror.

I'm very happy the British uncovered this plot. I'm hopeful uncovering these 25 plotters will expose more of the web of contacts providing funds, designs and materials for future attacks. If the British case against these suspects holds up, I hope they get the maximum penalty.

Terrorism won't ever be eliminated. However, we have another example of how large-scale, systemic terrorism can be combated by using information, insight and imagination. None of those have been used much to date in America's "war on terror."

Tuesday, August 01, 2006

Newly Translated From the Latin

After watching the August 1, 2006 NewsHour interview with Condoleeza Rice on the mideast debacle, I think I've stumbled across a new rule for interpreting and parsing political dialogue:

When the speaker uses more than two Latin words consecutively, they don't have a clue.

It doesn't matter what the topic of discussion is, any time you hear a string of more than two Latin words together on a talking head show, you should immediately verify your hip waders are within easy reach.

Of course, the most popular phrase for all political discussions is quid pro quo, which loosely translated into English means "your ethical lapse negates my ethical lapse, therefore we should both win re-election." This phrase is frequently used in close proximity to words and phrases such as "cigar", "golf trips", "interest-free loan", "IPO shares", "executive jets", "book deal" and "indictment."

Another phrase most Americans have heard but don't fully understand is e pluribus unum, which most believe means "out of many, one." Recent research into the etymology of the phrase has in fact determined the phrase means "out of many taxpayers, one bloated bureacracy", which is not only a more accurate translation, but seemingly a better description of our direction.

Condoleeze Rice seems to be determined to singlehandedly add another one to the list of Bartlett's Familiar Obfuscations, status quo ante, which translates into English as "wistful nostalgia for the state of beneficial corruption we had before this current mess." I think she's used this in every public appearance she's had for the past month.

At the rate this administration is going, there will be plenty of prima facie evidence for nos populus to consider when voting these people out of office.

Res ipsa loquitur.