How concerned are investors about governance?
I don’t know whether the investment community has realized the full ramifications of compliance-related issues. Evidence increasingly suggests there is a direct correlation between improved corporate performance and governance, compliance and transparency. This relationship is affecting companies’ ability to promote themselves.
A phenomenon has arisen out of Sarbanes-Oxley that I call the compliance premium. For example, when a fully compliant company looks to acquire another company, it must make an evaluation of the state of compliance at that firm. It is not possible to maximize the price if the acquiring company has to spend a significant sum bringing the target firm into compliance. A good company could damage its position – and reputation – if it doesn’t do the correct due diligence.
Sophisticated corporations and analysts realize this and factor it into calculations when establishing a price for the target and the new entity as a whole. Eventually people will get smarter and realize that the cost of non-compliance can sap your ability to get a fair price.
What questions should investors be asking companies when evaluating compliance and internal control?
They must go beyond the standard, ‘Do you have a clean 404 opinion?’ The existence of a clean 404 opinion is important but on its own is not enough to determine that a company does not have potential internal control problems.
It’s important to look beyond the process. You have to look at how the company identifies its significant controls, whether any of those controls have exhibited material weakness and, most importantly, how the company has responded. Investors should be cautious about companies that simply look to show a clean opinion and do nothing further.
Are companies doing a good job communicating compliance issues to investors?
Most companies do a terrible job at communicating compliance issues, largely because they get bad advice from their law firms. Take the classic example: ‘Today we received subpoenas from the SEC and the Department of Justice and we are cooperating fully with inquiries.’ This statement is absolutely worthless – of course it would be cooperating; it has to!
This doesn’t tell you anything. When you see a company that makes that kind of statement you should sell the stock short.
So what’s the right way?
Companies should say something like: ‘We have received notification of investigation. It is early in the process and we are looking into the issues the government is concerned about. There is no indication anything is wrong but if something is wrong, it is completely inconsistent with our corporate policy. As a result we are conducting an internal inquiry into the circumstances that led to concerns being raised and we will report the conclusions to the public and the government.’
Companies never say that because they don’t know how to communicate. IROs should be far more proactive in such situations. They should focus on what the shareholders, the public, the government and the media want and need to hear – which is: ‘We don’t think this problem occurred but if it did we will stomp it out immediately because it is not acceptable.’
They should sit down with large investors and explain how the situation was identified and what is being done. Investors would be less likely to panic and the share price may stay more stable. But IROs may get accused of selective disclosure if they conduct such a meeting behind closed doors.
Is SEC chairman Christopher Cox more business-friendly or investor-friendly?
Those qualities aren’t mutually exclusive. Cox is concerned about investor protection, and in many cases what is good for investors will also turn out to be good for business. If anybody is qualified to achieve both outcomes, it is clearly Chris Cox.
Will the system change to let companies identify their beneficial shareholders?
There is an appropriate degree of concern about protecting the privacy and confidentiality of investors but there is a push coming from some companies to have more transparency on this front. They want to know who their beneficial owners are so they can track what their views are.
The way to do that is to make it conducive for beneficial owners to identify themselves to corporate management so a real dialogue can ensue. But it’s unlikely there will be any change to the current situation, which says that unless you own more than 5 percent of the company you do not need to disclose who you are.
How seriously has Refco’s alleged securities fraud damaged investor confidence?
Investor confidence is an amorphous concept: it is whatever the media say it is. It is also closely tied to the market, so if the market is strong, confidence is high.
The important thing is to realize you can’t solve the problems of the marketplace by trying to do everything with regulation and legislation. A lot of what is required [to improve trust] has to be achieved by good business practices. Government and regulation are very poor at trying to define what is ethical, moral or best practice. For that you need the business community to take the lead; until that happens you will see a lot of cynicism from investors.
The problems start within the business community so the solutions need to start there, too. No matter what gets done, there will always be companies that do bad things or have bad things happen to them.
There is a shared responsibility between shareholders, regulators and the business community to establish a unified concept of what is appropriate and what is not. This must go beyond what constitutes legal and illegal.
What advice would you give to IROs and general counsel facing compliance issues?
The most critical advice is to assume you are a shareholder in your own company. What is it that you would like to know when these situations arise?
If you think about disclosure in terms of us against them, you are bound to get it wrong. Think about disclosure as a way to keep people informed and to allay unnecessary concerns while flagging legitimate issues.
