pomtalk

Surprise (or Not): Executive Compensation Rises, Since Financial Crisis

    According to a new report on executive compensation, the average value of executive compensation rose by 37% for c-suite executives, since the financial crises began in 2008.  Stock awards now comprise over half of the executives’ pay package.  The greatest growth was at MidCap companies, 63%, followed by S&P 500 firms, 54%.  The recent report, entitled “Stocking Up: Post-Crisis Trends in U.S. Executive Pay", was issued by ISS, a provider of corporate governance solutions to the global financial community, including executive pay consulting services.  The report concluded that the increase in stock awards more than off-set the decrease in bonus awards and “golden parachutes”.   The report – based on total annual compensation of the top five highest-paid named executive officers at Russell 3000 companies from 2008-2010 – revealed the following key findings:

• A growing reliance on stock-based compensation has significantly altered the make-up of executive pay packages.
• The proportion of pay for executives made up of stock rose from 19% to 28%.
• The proportion of pay in the form of stock options rose from 16% to 23%.
• The average value of stock and option grants rose by 108% and 89%, respectively, while, concurrently, average bonus values have declined 7%.
• All other pay, which includes payments in connection with tax gross-ups and exit compensation, is down by more than 20% .
• The average value of pay packages has grown by 37 %, with the greatest growth at S&P MidCap companies (63%) followed by S&P 500 firms (54%).

SEC Drops Use of “Neither Admit Nor Deny” Settlement Language, in Some Cases

    Reversing a long standing corporate-friendly practice, the Securities and Exchange Commission (SEC) will no longer allow corporate fraudsters to settle civil fraud charges by paying a fine without admitting wrongdoing.   More specifically, the SEC will no longer allow defendants to say they neither admit nor deny civil fraud or insider trading charges when, at the same time, they admit to or have been convicted of criminal violations.   However, the SEC will still use the “neither admit nor deny” settlement language when the SEC alone reaches a civil settlement, absent related criminal charges, which accoounts for a large majority of SEC settlements. 

    Recenlty, in November, a Federal District Court judge in New York specifically and sharply criticized the SEC’s use of this “neither admit nor deny” settlement language and rejected the SEC’s proposed $285 million settlement with Citigroup for securities fraud.  According to Judge Rakoff, the “neither admit nor deny” settlement language, contained in the Citigroup settlement, deprived the court of the facts necessary to determine if the punishment was adequate because it meant that there were no established facts on which to base a decision.  See Pomtalk Post entitled “Judge Rejects ‘Pocket Change’ ‘No-Admit/No-Deny’ SEC Settlement with CitiGroup", Dec. 05, 2011.  

See also New York Law Journal article entitled “Rakoff's Decision in 'SEC v. Citigroup': What's All the Fuss About?”, Jan. 17, 2012, by Stanley M. Grossman. 

For more information, in general, see NYT article entitled “S.E.C. Changes Policy on Firms’ Admission of Guilt” and WSJ article entitled “SEC Modifies 'Confirm Nor Deny'”.

Stress for the New Year!

Recent years have brought unprecedented fraud and economic crisis.  As a result, investors large and small are rethinking their investment strategies.  Considerations are not solely focused on potential profitability and growth but also on whether a company is more vulnerable to fraud or other crisis.  Enter the stress test.  As reported on December 14, 2011 on CFO.com, though it is not yet a fully integrated risk management procedure, stress testing has become important- not just for regulatory compliance- but for business planning and strategy setting.  A company that performs stress testing can provide investors with increased transparency and a clearer picture of risk management.  To read more, click here.

NYC Demands Tougher Compensation Policies from Wall Street Giants

New York City Comptroller John C. Liu and the NYC Pension Funds submitted shareholder proposals to JPMorgan Chase & Co., Goldman Sachs Group Inc. and Morgan Stanley requesting that they “hold senior executives financially accountable for losses that result from excessive risk-taking or improper or unethical product.”  The proposals would strengthen the banks’ existing clawback policies “that allow them to recoup incentive pay from employees who act improperly,” and would also “prevent the perverse incentives and bad practices that were at the heart of the financial collapse of 2008” by increasing executives’ accountability; holding supervisors responsible for bad behavior; and disclosing clawback actions.

 
JPMorgan, Goldman Sachs and Morgan Stanley were targeted as “they are among the largest and have each come under scrutiny for improper practices leading up to the financial crisis.”  Moreover, each company “has paid more than $100 million over the past 18 months to settle state or federal charges in connection with mortgage securities.”  Indeed, an article by Bloomberg News reported that Goldman Sachs agreed to pay $550 million in July 2010 to settle the government’s claims it misled investors concerning financial products connected to subprime mortgages.  Similarly, JPMorgan agreed to pay $153.6 million to settle a suit in June.  Also, “Morgan Stanley agreed to pay $102 million in June 2010 to settle claims by Massachusetts that the firm financed and securitized unfair residential loans.”

According to Comptroller Liu, “No one should profit to be rewarded with bonuses when engaged in improper or unethical behavior.  These tougher clawback provisions will not only recover money that shouldn’t have been paid in the first place, but also set the tone for a stronger standard of conduct for company executives as well as their bosses.”

SEC Charges Execs with Fraud at Fannie & Freddie

Following up on our September post "Big Bucks, No Whammies?" about the SEC's apparent inaction on the wells notices they had served to the execs of Fannie & Freddie. We write to report that Whammies finally came with  Friday's headlines . The SEC brought fraud charges after all, not just against Daniel Mudd, former CEO of Fannie Mae but also five others now charged with deliberately misleading government officials about the extent of their subprime exposure.

The NYTimes explores the charges in greater detail and there are new reports that an FBI investigation into the same conduct is underway which means the guys could face criminal charges.    Following the SEC announcement speculation had already begun that Mudd would soon step down as CEO at Fortress Investment Group (FIG).

“Can you really run a trading and investment firm with a guy accused of fraud in the corner office?”   a Fortress employee was reported to have asked.  Apparently not when the accusations become official. (UPDATE:  Mudd took leave as CEO of Fortress on Wednesday December 21)

Mudd has been on the board at Fortress since 2007,and was appointed CEO of Fortress when he left Fannie amid scandal after the bailout in 2008 Fortress is a publicly traded hedge fund which recently introduced new subprime mortgage bonds onto the market.... 

Judge Rejects “Pocket Change” “No-Admit/No-Deny” SEC Settlement with CitiGroup

    On Monday, Nov. 28, a Federal Judge, using tough language, rejected the SEC and Citigroup's proposed $285 million settlement over toxic mortgage-backed securities.  In general, US District Judge (NYC) Jed Rakoff said because of the lack of details provided he could not tell whether the deal was “fair, reasonable, adequate and in the public interest,” as required by law.  In addition, the Judge concluded that the $285 million fine was “pocket change to any entity as large as Citigroup.”  Citigroup made $160 million from the toxic transactions and investors lost $700 million.

    More importantly and specifically, Judge Rakoff criticized the SEC for allowing Citigroup (and other companies) to settle cases without admitting wrongdoing.  He went on to say that the SEC “has a duty, inherent in its statutory mission, to see that the truth emerges” and the public has a right to know what happens in cases that touch on "the transparency of financial markets whose gyrations have so depressed our economy and debilitated our lives."  The Judge concluded (after spending hours trying to assess the settlement) that he simply had not been given "any proven or admitted facts upon which to exercise even a modest degree of independent judgment."

    Here at Pomlaw, we strongly agree that these so-called “no-admit/no-deny” settlements are no real deterrent to future bad behavior because they do not extract a heavy enough price, in dollars or reputation.”  “[W]ithout any admission, there is no way to know if the remedies — including fines and pledges by Citigroup not to violate antifraud laws in the future — will, indeed, protect investors and ensure the integrity of markets.”   See NYT’s editorial, “The S.E.C.’s Enabling”. 

    For more information see NYT article and opinion entitled, respectively “Judge Blocks Citigroup Settlement With S.E.C.” and “The S.E.C.’s Enabling” and WSJ article and opinion entitled, respectively “NY Judge Rejects $285M SEC-Citigroup Agreement”  and “Rakoff's SEC Rebuke”.  See also, Judge Rakoff’s Decision in SEC v. CitiGroup (SNDY 11-18-11).

PCAOB Continues to Find Audit Deficiencies Among Big Four Accounting Firms

Nearly a decade after the accounting world was turned on its ear by the Enron and Worldcom scandals, it appears there are still worrisome issues with audits conducted by the industry’s biggest firms.  The Public Company Accounting Oversight Board (“PCAOB”)—the body created in the wake of the earlier scandals to oversee the accounting agency—issued recent reports detailing its study of audits performed by Big Four firms PriceWaterhouseCoopers (“PWC”) and KPMG.  Those reports found a troubling rate of audit deficiencies at both firms; detailing flaws in 28 of 75 audits by PWC and 12 of 54 audits by KPMG.  In some cases, the flaws went to the heart of the audit.  The reports note that PWC, in some cases, “failed to obtain sufficient appropriate audit evidence to support its audit opinion,” and that KPMG sometimes failed “to identify, or to address appropriately, financial statement misstatements, including failures to comply with disclosure requirements.”  The PCAOB study, which examined audits from 2010, also found that the deficiency rates for both firms were higher than in previous years. 

The PCAOB’s findings are good reminder that even audits conducted by the largest accounting firms are susceptible to significant error.  It is clear that the auditing industry still has a way to go before investors can rely on any accounting firm’s stamp of approval.

Profiling a Fraudster

This summer, KPMG issued a report entitled, Who is a Typical Fraudster?  where it analyzed 348 actual fraud investigations conducted by KPMG member firm in 69 countries to narrow down the profile of a typical fraudster.  Interestingly, according to the study, 26% of the case studies analyzed by KPMG were committed by chief executives.  Moreover, 74% of the fraudsters exploited weak internal controls.  In the end, the old motivations of greed and personal gain still dominate, particularly when fraudsters need to conceal losses or poor performance.

A typical profile of a fraudster:
1. Male
2. Between 36 and 45 years of age
3. Commits fraud against his own employer
4. Works in the finance function or in a finance-related role
5. Holds a senior-management position
6. Employed by the company for more than 10 years
7. Works in collusion with another perpetrator

Wall Street’s “Moral Minority”

A New York Times article has revealed that long before Occupy Wall Street, the Sisters of St. Francis of Philadelphia were battling Wall Street over corporate responsibility. For the last thirty years, the Sisters have used the investments in their retirement fund to become Wall Street’s moral minority.

Using their status as shareholders, the nuns fought with Kroger over farm worker rights, with McDonald’s over childhood obesity, and with Wells Fargo over lending practices. They have met face-to-face with the heads of Lockheed Martin, BP, and General Electric. Most recently, they advised Goldman Sachs executives that the bank should protect consumers, rein in executive pay, increase its transparency, and remember the poor.

With their moral authority, the Sisters of St. Francis “can really bring attention to issues,” said Robert McCormick, chief policy officer of Glass, Lewis & Company, the proxy voting firm. “You haven’t seen shareholder activism until you see a nun battling it out with the CEOs. They can be devastating,” said Michael Passoff in a 2005 article on religious shareholder activists. Passoff works in the Corporate Social Responsibility Program for As You Sow, a leading organization in the strategizing and organizing of shareholder campaigns.

The nuns have been waging this war since 1980, when St. Francis Sister Nora Nash formed a committee with her community to combat troubling developments at the businesses in which they invested their retirement fund. The Roman Catholic order of over 500 nuns has teamed up with other orders and faith-based investing groups on shareholder resolutions. Much of Sister Nora’s activism takes place under the Interfaith Center on Corporate Responsibility, an umbrella group which includes Jews, Quakers and Presbyterians.

Sister Nora said that she and the order “want social returns, as well as financial ones.” She added, “when you look at the major financial institutions, you have to realize there is greed involved.”

The full New York Times article can be found here.

Rating Agencies Going Scot Free

Law360 in a recent article (subscription required) asked, “why are the ratings agencies still getting a free pass?”  They point out that blame for the 2008 financial meltdown has been passed from foolish homeowners, to unscrupulous mortgage originators, to the willfully blind Fannie Mae and Freddie Mac, to greedy banks, to regulators asleep at the switch.  Thus far, it seems, Moody’s, S&P, and Fitch have managed to stay out of the spotlight.  This, despite the fact that “[t]he rating agencies were essential to the smooth functioning of the mortgage-backed securities market[,]” according to the January 2011 Final Report of the National Commission on the Causes of the Financial and Economic Crisis.  In fact, says Law360, “[i]naccurate AAA credit ratings introduced risk into the U.S. financial system and constituted a key cause of the financial crisis.”

Despite these conclusions, the rating agencies have largely escaped the consequences.  The anticipated federal oversight of the agencies “has been spotty at best,” and litigation efforts against them have been stopped short.  The Dodd-Frank Act amended Section 10(b) of the ’34 Act specifically to permit claims against the ratings agencies.  But, so far, the SEC has neglected to issue any regulations to implement the amendment.  Law360 takes a position with which we heartily agree:  “The SEC will hopefully turn its fuller attention to this issue in the months ahead.  Some important inroads have been made through private litigation in recent years, but more can and should be done.”