Author: Phil Mattera

Shareholder Litigation Not Yet Extinct

Once feared class-action lawyers Melvyn Weiss and William Lerach have been disgraced after pleading guilty to charges of paying off plaintiffs, but the type of lawsuit they promoted—the shareholder derivative action—is not extinct. It has just come to light that the Coca-Cola Company recently agreed to pay $137 million to settle such a suit in which plaintiffs led by two union pension funds accused the soft-drink company of artificially inflating sales figures to boost its stock price.

The case, in which Lerach (photo) was originally one of many lawyers involved, was filed in October 2000 in federal court in Atlanta (Northern District of Georgia, Case No. 00-cv-02838-WBH; later consolidated with another action). The lead plaintiff, the Carpenters Health & Welfare Fund of Philadelphia, held about $80 million in Coca-Cola stock at the time. The company dismissed the charges as “ridiculous” in a press release and later claimed in its 10-K filing that it “has meritorious legal and factual defenses and intends to defend the consolidated action vigorously.”

At the center of the case were allegations of “channel stuffing” (pressuring bottlers to make large purchases of concentrate beyond their needs) and failing to write down the value of impaired assets in places such as Russia and Japan.

Coca-Cola has not made it clear why it decided to settle a case it had fought for nearly eight years. The capitulation was all the more surprising in that it occurred shortly after the company prevailed in Delaware Supreme Court in another derivative suit brought by the Teamsters in 2006. In that case, the union charged that Coca-Cola used its control (35%) over its largest bottler, Coca-Cola Enterprises (CCE), to maximize its own profits at the expense of CCE’s shareholders.

The company also faced a lawsuit brought against it and several affiliates in federal court in Miami concerning the murder of trade unionists at Coca-Cola bottling plants in Colombia. The company got the case dismissed, but it is still being challenged by the tenacious Campaign to Stop Killer Coke (which uses the provocative photo above on its website), the aim of which is to pressure Coca-Cola to get the bottling plants to end their alleged cooperation with Colombian paramilitary groups believed to be behind the murders.

Disclosure Issues Bedevil Climate-Change Debate

Big business is talking more these days about the need to reduce greenhouse gas (GHG) emissions. Even long-time global warming denier Exxon Mobil feels the need to publicize what it is doing in this regard. Claims of reductions in GHG are not, however, meaningful unless those emissions are being estimated consistently to begin with.

A study issued yesterday by the Ethical Corporation Institute raises questions about how much we really know about the volume of GHG being generated by large corporations. According to a press release about the report (which is available only to those willing to fork over more than 1,000 euros), there are “staggering inconsistencies in how companies calculate and verify their greenhouse gas emissions.” The report found, for instance, that companies responding to the fifth annual Carbon Disclosure Project questionnaire used more than 30 different protocols or guidelines in preparing their emissions estimates. The report, it appears, surveys this potpourri of measurement techniques but does not attempt to resolve the differences.

The absence of consistency has not prevented the Carbon Disclosure Project from trying to use current reporting to understand the larger framework of GHG trends. In May, the Project issued the first results of its Supply Chain Leadership Collaboration, an initiative in which large companies such as Nestlé, Procter & Gamble and Unilever urge their suppliers to report on their own carbon footprint. It is unclear how much effort is made to ensure these results are reported in a uniform manner.

Along with the need for improved GHG reporting, there are growing calls for companies to disclose the liability risks (and opportunities, if any) associated with those emissions. Recently, a broad coalition of institutional investors and major environmental groups once again urged the U.S. Securities and Exchange Commission to clarify the obligations of publicly traded companies to assess and fully disclose the legal and financial consequences of climate change. The statement was aimed at reinforcing a petition filed with the SEC last year on climate-change disclosure.

Climate-change liability risks no longer exist just in the realm of the theoretical. Lawsuits have been filed against the major oil companies for conspiring to deceive the public about climate change—including one brought in the name of Eskimo villagers in Alaska who are being forced to relocate their homes because of flooding said to be caused by global warming.  Famed climate scientist James Hansen recently declared at a Capitol Hill event that oil and coal company executives could be guilty of “crimes against humanity.” If that isn’t a risk worth reporting, what is?

Newly released RAND report on Iraq Misses the Boat on Contractors

A RAND Corporation report written in 2005 but withheld until this week paints an unflattering portrait of U.S. government planning for postwar Iraq. The Army, which commissioned the report, reportedly kept it under wraps to avoid antagonizing then-Defense Secretary Donald Rumsfeld.

The 273-page document also looks at the role of contractors in the initial period after the U.S. invasion (through June 2004), but for some reason it is much gentler in its treatment of the private-sector participants in the disastrous reconstruction effort. The report notes the slow progress in restoring Iraq’s oil industry and its output of electricity, but the contractors in charge of those efforts—KBR for oil and Bechtel for power, with additional work on electricity commissioned from Washington Group International, Fluor and Perini—are not directly blamed. Instead, the Coalition Provisional Authority and U.S. Agency for International Development come out looking bad, and delays are attributed to the poor security situation.

Stuart BowenThere is, however, one company that RAND does not handle with kid gloves—Bechtel, in connection with a school building contract. Military commanders, the report says, “complained that school reconstruction under the Bechtel contract was proceeding too slowly, that work was sometimes substandard, and that subcontractors were overpaid” (p.227).

RAND can perhaps be excused for largely missing the boat about contractor screw-ups in Iraq, given that the main revelations came to light after the study was drafted. It was right after RAND completed its research that Stuart W. Bowen Jr. (photo), the special inspector general for Iraq reconstruction, issued the first in a series of scathing audits about both the contractors and the agencies that were supposed to be overseeing their work.

The RAND report reinforces what we know about the shortcomings in the U.S. government’s handling of postwar Iraq, but it will take another account to tell the whole story of the role of contractors in that debacle.

Mission Not Yet Accomplished for U.S. and UK Oil Majors in Iraq

U.S. and British oil majors such as Exxon Mobil, Chevron, BP and Shell can’t wait to unfurl their own “mission accomplished” banner in Iraq, signaling that they have been given access to the country’s massive oil reserves that have been largely neglected in the past five war-torn years. Recent signs suggested they were well on their way. One New York Times article on June 19 reported they were “in the final stage of negotiations,” while another this morning revealed that U.S. government advisers in Iraq have been involved in designing those deals.

Today was supposed to be the day that Iraq would finally begin making good on the principal that “to the victors go the spoils.” Instead, the U.S. and UK companies, like children trying to raid the cookie jar just before dinner, had their hands slapped by Iraqi Oil Minister Hussein al-Shahristani. Award of the initial contracts, designed to cover technical services, was put off, the minister said, because the companies “refused to offer consultancy based on fees as they wanted a share of the oil.”

Instead, Shahristani released a list of 35 companies from around the world that have been prequalifed to bid on the bigger prize—contracts involving long-term drilling rights in six of the country’s major oil fields. Exxon Mobil and the other majors had to suffer the indignity of being put on a par not only with smaller U.S. producers (such as Anadarko and Occidental) but also companies from countries such as Japan (Nippon Oil), Italy (Eni), Russia (Lukoil and Gazprom Neft), China (CNOOC and Sinochem), Spain (Repsol YPF), Norway (Statoil Hydro), India (ONGC), Malaysia (Petronas Gas) and Indonesia (Pertamina). Also on the list was France’s Total S.A., which had already been mentioned along with the U.S. and UK majors as a contender for the technical services contracts.

Iraq excluded oil companies such as France’s Perenco and U.S.-based Calibre Energy that had signed disputed agreements with officials in Iraq’s Kurdish region. Yet it is interesting that Shahristani’s prequalified list includes two companies that were accused of being involved with kickbacks paid to the government of Saddam Hussein in connection with the United Nations oil-for-food program during the 1990s: China’s Sinochem and Russia’s Lukoil, each of which were prominently featured in the final report of an independent investigation led by Paul Volcker.

Is it possible that Iraq is more inclined to reward companies that allegedly collaborated with the Saddam Hussein regime than major oil producers from the countries that “liberated” his nation from that regime but continue to occupy it five years later?

A Bad Rating for the Raters

Short of direct shareholder activism, one of the most common methods used to promote corporate governance reform is the creation of rating systems. The notion is that companies will institute changes to rectify a bad rating, or else they will be pressured to do so by institutional shareholders that use the evaluations in their investment decisions.

For this to work, the rating systems need to be able to identify corporate governance shortcomings in a coherent way and be consistent in their evaluations. One might think that the diagnosis is a straightforward matter and that the challenge lies in getting companies to change. Yet a new report issued by the the Rock Center for Corporate Governance at Stanford University apparently finds a wide degree of variation among the ratings offered by different services.

I say “apparently,” because the report, despite being described in some detail in an article posted today by Fortune magazine (which presumably received an advance copy), has not appeared on the Center’s website as of this writing.

According to Fortune, the study found that the ratings of a given company by the leading services—RiskMetrics Group’s ISS Governance Services, The Corporate Library, GovernanceMetrics International (GMI) and Audit Integrity—can vary wildly. For example, pharmaceutical giant Pfizer is said to have received a perfect score of 100 from ISS at one point but a less impressive D from the Corporate Library at the same time. Lockheed Martin got 9.5 out of 10 from GMI but the worst possible grade from the Corporate Library.

Fortune quoted study co-author Robert Daines as saying that “[good] governance is a little bit like porn. I can spot it when I see it, but it is hard to say what it is.” If that’s the case, perhaps institutional shareholders should stop paying hefty fees to the rating services and use their own judgment—or else rely on corporate accountability groups with clear principles rather than black-box systems to determine what’s wrong with the way companies are run.

UPDATE: I’ve now learned that the Stanford study is available online here.

SEC filings should be clearer and more detailed

Securities and Exchange Commission Chairman Christopher Cox yesterday announced the launch of an effort to “examine fundamental questions about the way the SEC acquires information from public companies, mutual funds, brokers, and other regulated entities, and the way it makes that information available to investors and the markets.”

Surprisingly, the grandly named 21st Century Disclosure Initiative is to be headed by William D. Lutz, an emeritus professor of English at Rutgers University-Camden. True, Lutz has a law degree and is said to be familiar with securities law, but he is known mainly as a critic of corporate and bureaucratic doublespeak.

There is plenty of gobbledygook in SEC filings that could be made more intelligible, but the bigger disclosure problem is the failure to require companies to divulge more on certain aspects of their operations. For years, initiatives such as Corporate Sunshine Working Group have been pressing for fuller reporting on a corporation’s social and environmental impact. The group’s website contains a six-page expanded disclosure schedule, including items such as:

* lists of major customers and suppliers (beyond the current limited requirements);

* detailed information on violations of labor laws, anti- discrimination laws, etc.; and

* more detailed reporting on actual environmental violations and potential environmental liabilities.

There’s more that could be added to the list. For example, it would be very helpful to analysts of state corporate tax compliance to know how much a company paid in taxes in each state. Although the information may be available (with some difficulty) from other sources, it would also be useful to know how much a company has received in tax abatements, tax credits and other subsidies from each state and from the federal government.

Another type of data that can be found elsewhere (usually for a price) but should be in filings such as 10-K annual reports or proxies is a list of a company’s largest institutional shareholders with information on whether they or their money managers vote their shares. The names of a company’s major creditors can sometimes be found by looking at revolving credit agreements included as exhibits, but they should be presented clearly in the debt section of the financial statements.

In short, there is a lot of vital information about publicly traded companies that should be made readily available to investors and other stakeholders. Presenting that data in plain English would be even better.

Sharing the Clean-Car Prize

John McCain’s suggestion yesterday that the federal government offer a $300 million prize for the development of a next-generation battery for plug-in hybrids or electric cars is being derided in some quarters as bringing a “game-show ethos to American politics.” It is also awkward that Daniel Yergin’s definitive account of the oil industry’s quest for domination was entitled The Prize.

The idea of offering a cash award for a technological innovation is hardly unprecedented. Such bounties, however, are usually offered by private entities such as the X Prize Foundation. What McCain is forgetting is that when a prize is offered by government—that is, when taxpayer money is the source of the reward—the public should get some direct benefit for its “investment.” A benefit, that is, beyond the fact that the new technology would be available for sale.

This is the principle behind the proposal put forth by people such as James Love of the Consumer Project on Technology to replace privately financed drug research with taxpayer-funded prizes. Pharmaceutical researchers would get substantial sums for the creation of new treatments that create demonstrable improvements in health conditions. This does not, however, create windfalls for the winners. Drugs that receive the prize—which was incorporated into a bill introduced last fall by Vermont Sen. Bernie Sanders—would not have patent protection and thus would be widely available at a cheap generic price.

There’s no indication that McCain has this trade-off in mind. He presumably would want the winners of the battery competition to be rewarded twice—with the prize as well as the patent.

Until prizes and other “carrot” approaches succeed in bringing about cleaner cars, some government “sticks” will remain necessary. One disclosure-based version of the latter is being introduced in California. The state’s Air Resources Board announced last week that, beginning next January, every new car put on sale in California will be required to carry a label informing potential buyers of the vehicle’s environmental impact. The label will rate the car based both on its emissions of greenhouse gases and its contribution to smog. The Board already has a website that provides data on the cleanest, most fuel efficient cars on the market.

Compared to his dismaying embrace of expanded offshore oil drilling last week, McCain’s clean-battery-prize idea is not completely foolhardy. But he shouldn’t forget that the role of government is to put a check on business shortcomings—if only through mandated disclosure—rather than fostering more winner-take-all “solutions.”

Prosecuting Individual Fraudsters is Fine, But What About Their Employers?

If there were an index showing the status of the financial profession in U.S. society, today would be recorded as a plunge. Three separate legal developments together convey the message that asset management, mortgage banking and private banking are all riddled with corruption.

In New York, two previously high-flying hedge fund managers at Bear Stearns were arrested by the FBI, handcuffed, subjected to a humiliating perp walk and indicted on criminal charges of fraudulently misleading investors about their exposure to subprime mortgage-backed securities.

In Washington, Deputy Attorney General Mark Filip announced that a nationwide investigation of mortgage fraud has resulted in the filing of charges against more than 400 individuals.

In Fort Lauderdale, Bradley Birkenfeld, a former official in the private banking operation of Swiss bank UBS, pleaded guilty to charges of conspiring to help wealthy U.S. clients evade taxes by concealing assets. There have been reports that Birkenfeld may divulge the names of thousands of other clients who also cheated Uncle Sam.

Apart from corruption, what these cases have in common is that prosecutorial zeal is being directed at individuals alone and not the institutions whose interests they were serving. Prosecuting bad apples is all well and good, but the Justice Department needs to be reminded that in many cases the barrel itself is corrupt.

In the case of mortgage fraud, at least, the FBI may be on the right track. Director Robert Mueller announced today that the bureau is investigating some “relatively large companies,” including mortgage lenders, investment banks, hedge funds, credit-rating agencies and accounting firms.

Let’s hope this investigation is for real—and that it results in some serious charges rather than deferred-prosecution-agreement slaps on the wrist. Maybe then the financial sector will begin to clean up its act.

Republicans’ Offshore Drilling Plan Would Expand Dysfunctional System

The response to the politically opportunistic call by the Bush Administration and John McCain to expand offshore oil drilling is being framed primarily in environmental terms. The drilling, which would do nothing in the short term to address soaring gasoline prices, would indeed create serious risks for the coastlines of Florida and California and would worsen global warming.

Yet there is another compelling reason to oppose the plan: the federal system of offshore leasing has been characterized by gross mismanagement that has allowed big oil companies to avoid paying billions of dollars in royalties. There is no reason to doubt that an expansion of drilling leases would bring more of the same.

For those who missed this particular scandal, here is some background. Commercial offshore oil drilling was pioneered in the late 1940s by Kerr-McGee Corp. While little thought was given to environmental issues at the time, there were disputes between the federal government and coastal states over which should control the leasing process. The 1953 Outer Continental Shelf Lands Act gave the states control over the first three miles (more for Texas and the Gulf Coast of Florida), and the feds took over after that up to the 200-mile territorial limit.

There wasn’t much controversy over offshore drilling until 1969, when an undersea well off the coast of Santa Barbara, California suffered a blowout and leaked 200,000 gallons of oil that contaminated 35 miles of coastline. This led to state and federal restrictions on offshore drilling in new areas. Periodically over the past 30 years, the oil & gas industry and its allies in Congress have tried to ease the limits but were shot down.

Defeated in its effort to get access to more offshore areas, the industry sought to make its existing drilling more profitable by pressing for reductions in the royalties it had to pay the federal government through the Interior Department’s Minerals Management Service (MMS). In the mid-1990s, when energy prices were relatively low (oil was at about $16 a gallon barrel), Congress gave in to industry pressure and passed legislation in 1995 providing “royalty relief.”

The law contained safeguards to prevent a windfall for drilling companies by terminating the relief when oil prices rose above a certain level, but Clinton Administration officials failed to include those provisions in some 1,000 deepwater leases it signed in 1998 and 1999.

That oversight would come to haunt the federal government. As oil prices rose in 2004 to the point at which royalty relief should have ended on those leases, the cost to the Treasury in lost revenue rose to billions of dollars. Once the situation became publicly known, thanks to reporting by Edmund Andrews of the New York Times, some oil companies agreed to renegotiate the leases, while others such as Exxon Mobil and Chevron refused.

Complicating the situation, Kerr-McGee (now part of Anadarko Petroleum) later brought a legal challenge against the safeguards, making the dubious argument that Congress never intended to give MMS the authority to impose them. Last year the drillers received a favorable ruling in the case, prompting the Government Accountability Office to estimate recently that, if the decision is upheld, the loss of revenue from leases signed from 1996 through 2000 could be as high as $53 billion.

The federal government is also likely being cheated on leases signed after 2000. In 2006, several MMS auditors publicly charged that they had been pressured by their superiors to terminate investigations of underreporting of royalties related to leases not subject to royalty relief.

This is the dysfunctional system that the Republicans want to expand. One is tempted to ask: Is this really about increasing oil supplies—or creating another giveaway for Big Oil?

Piercing the Corporate Veil of Secrecy

Congratulations to Wikileaks, Wal-Mart Watch and a handful of other web resources for being chosen by Portfolio magazine as the “top anti-corporate sites.” Specifically, the magazine is featuring sites that have done the most to distribute confidential—and often embarrassing—corporate documents or otherwise publicize material that companies want kept quiet. “From anonymous whistle-blowers who post secret documents online to fan sites that spill trade secrets,” Portfolio writer Kim Zetter says, “websites and their owners can be a major thorn in the side of corporations that find comfort behind a veil of secrecy.”

Wikileaks is focused on piercing that veil. The site was at the center of controversy a few months back when Swiss bank Julius Baer tried to get it taken offline after it posted documents that purportedly showed how the bank’s Cayman Islands branch helps wealthy clients hide assets and launder money. Much of the web community rallied to the defense of Wikileaks, and the censorship move was defeated.

Wal-Mart Watch, of course, is one of two national campaigns aimed at reforming the giant retailer. Aside from producing its own critiques of the retailer (including one to which I contributed), the group has used its site to publicize internal company documents leaked to it. Among these was a memo in which the company discussed controlling health care costs by methods such as making physical activity part of every job, apparently so that those in poorer shape would not apply.

The other sites singled out by Portfolio are:

* Mini-Microsoft, a anonymous blog written by a Microsoft employee who skewers management and highlights waste and inefficiency at the software behemoth.

* Brenda Priddy and Company, a automobile outfit that is not necessarily critical of carmakers but which manages to take clandestine photographs of their prototype vehicles and sell them to other websites and magazines for distribution well before the companies are ready to go public.

* Farmers Insurance Group Sucks, a site produced by a disgruntled customer who now publicizes lawsuits against the company, complaints to state insurance agencies, and unflattering insider testimonials.

* HomeOwners for Better Buildings, a site that exposes the shortcomings of the residential construction business, especially KB Homes. It is filled with homebuyer horror stories and has an “Implode-O-Meter” that tracks companies in the industry experiencing bankruptcy or other forms of distress.

* AppleInsider and MacRumor, which make it their business to report on new Apple products and features being developed by the secretive company.

Zetter has only scratched the surface, and she seems to realize it. She says to her readers: “If you have suggestions for other pesky sites that are a reliable source for inside information about a company or industry, please let us know. We’ll write about the best ones in a follow-up article.” So go ahead and let Zetter know about the wider world of the corporate-critical web.