Wednesday, April 29, 2009

Mark-to-market accounting IV

IMHO, the move toward mark-to-market accounting, a gradual process through much of the 1990s and into this century, was a good idea, driven by business realities and, in its final stages, by a sensible reaction to the ludicrous bookkeeping of the late Enron Corp.

If a management's valuation model relates to reality it ought to be possible to get quotes backing that up. If it is not possible, then it is very likely management is either trying to pull something at the expense of somebody or has deluded itself, and neither possibility sounds like a sound basis for accounting rules.

"Oh, but some assets can't be sold right away except at fire sale prices!"

Market-based valuation doesn't require immediate sale. It is my understanding that conversations between corporate folk (CF) and auditors looking for GAAP compliance often go something like this.

CF: We can't mark these assets to market.

A: Why not?

CF: Nobody's buying them. So there's no market except a fire sale one.

A. How long do you think it might take you to get a non-fire sale price?

CF: Maybe six months.

A: So how much do you think you might be getting if you had started asking around for quotes six months ago?

That dialog comes (adapted by yours truly) from Einhorn's recent book.

With this, I leave the issue of mark-to-market accounting, and I'll try to get back to the chronicling of proxy fights next week.

Tuesday, April 28, 2009

Mark-to-market accounting III


On April 9 the FASB issued its final staff positions "to improve guidance and disclosures on fair value measurements and impairments," i.e. the modifications to mark-to-market.

You can see the relevant press release here.

Effects were felt immediately. Indeed, the changes were beginning to have an impact before they were finalized. I was at the Manhattan office of Kaye Scholer on April 2, the day the prelimary draft was under discussion by the FASB.

Kaye Scholer, a law firm prominent in the alt-invest world, was hosting a seminar on
“Using Private Equity and Hedge Fund Structures and Strategies to Invest in Distressed Assets.”

The consensus at the seminar was that the government, by pressuring the FASB in this direction, had cut off its nose to spite its face. For the same government was trying -- still is trying -- the get private party participation in what it calls the PPIP (public-private investment program), in which a government-organized consortium is supposed to buy 'toxic assets' from banks in order to hold them until their toxicity wears off ans re-sell them then at a profit.

In the meantime (so runs the theory) the sale of these assets by the banks will improve the balance sheets of said banks, making them more willing to make loans, and getting the wheels of commerce rolling again.

But for PPIP to work, mark-to-market accounting should still be in force. The significance of M2M is precisely that it gives banks an incentive to sell assets they aren't prepared to hold, and let somebody else, somebody more daring and speculative, perhaps a hedge fund, (or perhaps PPIP, a nineteenth century Brit lit figure in the form of a 21st century acronym) hold them instead.

The FASB decision, and other ongoing efforts by elected officials and regulators to relax mark-to-market accounting rules, would reduce banks’ incentives to sell distressed assets at prices that would make them attractive to private investor participants in the PPIP, and would thus undermining the viability of the program.

We haven't heard much from PPIP since. He's expecting a fortune from Miss Haversham but she no longer has any incentive to bestow it. (Okay, I've got the plot a bit wrong there, but I'm working with the 21st century template as best I can.)

Final thoughts on mark-to-market tomorrow.

Monday, April 27, 2009

Mark-to-market accounting II

On Thursday, April 2, the FASB met to discuss a new staff position, FSP, addressing the issue and in part modifying the system, addressing objections to M2M.

The FSP outlined how a reporting entity could determine whether a market is inactive and whether a transaction is not distressed in the sense pertinent to the application of SFAS 157. In terms of Angel’s metaphor, this is an effort to exorcise the ghost of Arthur Anderson from future auditor/reporting-entity interactions.

It established a two-step process. The first step involves the consideration of seven factors that would indicate the inactivity of a market. These factors are:
• Few recent transactions (based on volume and level of activity in the market)
• Price quotations are not based on current information
• Price quotations vary substantially either over time or among market makers (for example, some brokered markets)
• Indexes that previously were highly correlated with the fair values of the asset are demonstrably uncorrelated with recent fair values
• Abnormal (or significant increases in) liquidity risk premiums or implied yields for quoted prices when compared with reasonable estimates (using realistic assumptions) of credit and other nonperformance risk for the asset class
• Abnormally wide bid-ask spread or significant increases in the bid-ask spread
• Little information is released publicly (for example, a principal-to-principal market).

The proposed FSP said that the entity shall consider the significance and relevance of each factor, yet it cautions that the list is not all-inclusive; “other factors may also indicate that a market is not active.”

If the entity concludes after step 1 that the market is not active, it has created a rebuttable presumption that a quoted price is associated with a distressed transaction. Yet it must as step 2 consider evidence that would rebut that presumption. This would be evidence that (a) there was sufficient time before the measurement date to allow for usual and customary marketing activities for the asset and (b) there were multiple bidders for the asset. If both of those factors are present, then the presumption of distress is defeated.

In the absence of one or the other of those defeating factors, the presumption of distress prevails. “When that is the case, the reporting entity must use a valuation technique other than one that uses the quoted prices without significant adjustment.

The board told its staff, "you're doing good work, but you need to go back to the drawing board and modify this a bit." That's actually my paraphrase.

Specifically, the board said the staff should “eliminate the proposed presumption that all transactions are distressed (not orderly) unless proven otherwise.” The final FSP should also require an entity to disclose a change in valuation technique, and the related inputs, resulting from the application of this FSP and to quantity the effects of that change if practicable.

Sunday, April 26, 2009

Mark-to-market accounting I

SFAS 157, issued by the FASB in 2006, became effective for financial assets and liabilities issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. It defined fair value as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” This definition applies to assets that are held for trading – not to assets held for investment or to maturity.
From this definition of fair value follows a three-level hierarchy of valuation based upon the type of inputs available:
• Level One inputs include directly observable market data, such as quoted prices in an active and unimpaired market;
• Level Two is applied when a market is impaired (such as the market for bonds at mid maturity), and value is derived indirectly from the prices of Level 1 assets;
• Level Three is applied when the market is inactive (such as the market for mortgage-backed securities in recent months) and value can be derived from management projections and modeling.
For a more complete account, see “Mark-to-Market Accounting in the Absence of Marks,” The Hedge Fund Law Report, Vol. 2, No. 1 (January 8, 2009).
Many institutions have complained that this system, combined with the incentives of auditors, is far too niggardly in allowing managements to move down the hierarchy from one to two, and from two to three.

They found academic support too, for instance from James Angel, Associate Professor of Finance, McDonough School of Business, Georgetown University.

I spoke to Mr. Angel not long ago, and he asked me to consider a hypothetical asset that a bank or hedge fund has purchased for a dollar.

“The management believes in its heart of hearts that its present value is $0.75. But nobody is buying that sort of asset right now, except for a bottom-fisher who offers them a nickel. Under mark-to-market strictly applied, it is worth a nickel.”

But, Angel continued, the fact that management chooses to hold on to it is evidence that it is in fact worth more than a nickel. “Its value is somewhere between 5 and 75 cents. I believe in a mark-to-management approach that would explicitly take account of management’s own view of asset value.”

More tomorrow.

Wednesday, April 22, 2009

Pershing Square and Target

On April 6, Pershing Square Capital Management filed a preliminary proxy statement with the SEC regarding the upcoming annual meeting of Target Corp. (NYSE: TGT).

Its contentions are as follows:

"Despite the fact that Target’s two principal business lines are retail and credit cards, Target currently has no independent directors with senior, executive-level experience in these two businesses. Similarly, despite the fact that Target is one of the largest owners of retail real estate in the country, there are no independent directors on the company’s board with substantial real estate expertise. The board also has no significant shareholder representation, with the current directors owning less than 0.3% of the company’s outstanding common stock. As such, we believe that the current board is suboptimal from a shareholder and corporate governance perspective."

Pershing Square (i.e. William Ackman's) own nominees are: Jim Donald; Richard Vague; Michael Ashner; Ronald Gilson, and Ackman himself.

Target's board has 13 seats. One of them is now vacant. The incumbent board proposes to reduce the size of the board to 12 -- thus eliminating, rather than filling, the vacant seat.

If Target gets its wish in that respect, only four seats rather than five will be up for grabs at the next annual meeting. Ackman, writing to shareholders, has said: "We cannot conceive of a good reason to reduce the size of the board, for it will curtail the ability of shareholders to add strong board candidates of their choosing to the current board. As such, we urge you to vote against Target’s board reduction proposal."

One of the Pershing nominees, Ronald Gilson, has impressive academic credentials. He is a professor in the law schools of both Stanford and Columbia. [Which leads me to suspect he spends an awful lot of time flying over Kansas.] He's also the author of major casebooks covering corporate finance and corporate acquisitions.

One survey of citations in law journals puts Gilson at number 31st on the list of mostr frequently cited authors. (He's been cited 3,062 times.)

In case you're curious -- and why shouldn't you be? -- the single most frequently cited author in law jourals is Richard Posner. That fails to surprise me.

Tuesday, April 21, 2009

Credit Agencies Roundtable

The SEC held its roundtable last week, in four panels, "To Examine Oversight of Credit Rating Agencies."

If you missed it, you might be wondering, what did the much maligned "big three" agencies: Moody's, S&P, and Fitch, have to say for themselves? Was it just, "yes, we gave AAA ratings to securities that might have been structured by cows, but it was all first amendment protected, nyah nyah"?

Well ... not quite. (Though you can get your fill of the first amendment issue in a page C1 story of the Wall Street Journal this morning.)

Here, I'll try to give you the money quote from the statement of each of the Big Three's reps at this roundtable.

From Fitch came Stephen W. Joynt, who said: "Finding the right balance in assigning ratings of major global financial institutions during the current global financial crisis has proved challenging." He then made the point that Fitch built into its ratings the assumption that the US government wouldn't let the largest of these institutions fail. When it did let Lehman Brothers fail, all bets were off.

Or, in Joynt's words: "we have generally assumed that government support would be
forthcoming for financial institutions in peril, and it has been. Lehman Brothers was a notable exception; like most market participants we expected a ‘government engineered’ solution that did not materialize."

Raymond McDaniel, the CEO of Moody's Investors Service, defended the issuer-pays model that each of the Big Three uses. For the most part, he says, issuer-pays works better than the preceding regime of investor-pays did (or, by implication, than the later would if instituted again).

And from S&P there was Deven Sharma, who said in essence that people shouyld stop second-guessing them with hindsight. They're doing an essential job and doing it well, by gum.

Well, okay, he was a bit more eloquent: "Accountability standards that allowed for second-guessing of judgments made in good faith could have the unintended consequences of compromising the independence of those judgments (to prevent against fear of later criticism) and hindering analytical innovation, both of which would be harmful to the markets as a whole. Accordingly, we strongly believe that any accountability measures should focus on an [the agency's] adherence to its policies and procedures, not on second-guessing ratings judgments through regulatory action or private litigation."

Actually, the most coherent defense of the big three at the roundtable came from a representative of the AFL-CIO sitting in on the "competition" panel. He asked his listeners first to consider why the agencies are valuable.

The “cost of investing in fixed income markets” would go up significantly, especially for small investors, if the raters should vanish, and a money market manager’s role would become much like that of a hedge fund manager; his services would no longer be “a commodity” and become much more “high value added.” That would be good for the money market managers, but bad news for retail investors.

“Given all that,” he said, he is not an enthusiast of competition in the credit rating field, because should “full competition” be encouraged “the equivalents of Madoff’s accountant …will step in.” Here he was making a reference Friehling & Horowitz, CPAs, P.C., the small auditing shop that is alleged to have participated in Bernard Madoff’s Ponzi scheme by only purporting to conduct the appropriate audits.

Intriguing point, which also ties into network effects, economies of scale, etc.

Monday, April 20, 2009

Hooper Holmes

Hooper Holmes, of Basking Ridge, NJ, is a consultant for the health insurance industry, founded in 1899. It was originally known as the National Insurance information Bureau. It is described on its website as having a "vision," to wit, "collecting personal health data and transforming it into information enabling our customers to take actions that manage or reduce their risks and expenses."

It plans to expand its board of directors from seven members to nine. Ronald V. Aprahamian, accordingly, has requested that the company put him on one of the newly-created board seats. He also has a nominee for the other open seat: Larry Ferguson, veteran of a "nearly 30 year career in the healthcare technology industry," one filing tells us.

I'm still trying to get a fix on this apparently looming proxy contest. I'll come back to it shortly.

For now, I'll just quote Aprahamian's statement: "Hooper Holmes' financial performance has been inadequate for quite some time and its stock price has steadily declined over the last years. My nominees will bring a fresh, owners' perspective to the various alternatives that could remedy this situation. I remain hopeful that the Hooper Holmes' Board of Directors will reconsider its position and thereby choose to avoid an unnecessary, costly and distracting proxy contest against nominees that are advocating for the broad interests of all shareholders."

Sunday, April 19, 2009

The Economy of Renaissance Florence

Richard A. Goldthwaite has written The Economy of Renaissance Florence, a volume of 659 pages just out from the Johns Hopkins University Press.

I learned a new word early on in my reading of this book: maremme. Apparently, it is Italian for "bayou," -- a marshy area near a seashore. Florence, an inland city, isn't in a maremme, but if you follow the Arno down stream to the sea you'll pass through one on the way there.

Anyway, due in part to the maremme the region is rich in the sort of plants that yield the dyes used to color cloth in the days before synthetic chemistry: saffron, woad, madder.

I learned another new word in the same passage: transhumant. Or rather, I believe I had heard this one before somewhere but it hadn't really stuck. This time I suspect it will. Transhumant, from the Latin humur, for ground, is an adjective for the seasonal migration of livestock from one grazing ground to another, as from summer grazing in the mountains to winter grazing in the lowlands. Sheep can spend their winters in a maremme, for example.

The Tuscan landscape was ideal for the transhumant herding of flocks.

The nearness of high and low elevations, then, along with the presence of those dye-relevant plants, were among the natural resources that encouraged the development of Florence.

Now I know.

Wednesday, April 15, 2009

Merger arbitrage

A word about merger arb. On July 10, 2008 Dow Chemical announced that it had contracted to buy Rohm & Haas for $78 a share in cash. ROH stock increased by 60% on the day of the announcement, closing at $73.62. The difference between $73.62 and $78 thereafter represented the arbitrage opportunity.

The deal offered travellers a bumpy road. In general, the risks of merger arbitrage are (a) that the deal will not happen, due to a regulatory barrier or stockholder cold feet or other cause, or (b) that the deal will eventually happen, but on terms or after a delay that will have sucked the profit opportunity out of it.

Obviously, the quicker the better for an investor going long on the target. [The other side of the classic merger arb play, especially when an exchange of shares at a fixed ratio is involved, is going short on the buyer -- but that isn't applicable to ROH].

In this matter, the merger didn't finally close until April 1, 2009. At a modified sales price of $78.97, that amounts to an annualized recovery of about 9%.

No disaster, but surely less than they had hoped for last summer.

Tuesday, April 14, 2009

Amylin fight: Where it stands

In order to improve their odds of surviving the proxy contest against Carl Icahn on the one hand, and Eastbourne Cap Management on the other, the board at Amylin (NASDAQ: AMLN) threw two of its members to the proverbial wolves.

The slate that the company is recommending to the stockholders does not include company co-founder Howard Greene or ex-CEO Ginger Graham.

Greene didn't sit around waiting for his term to elapse. He fired off a letter of resignation April 7, saying: "A majority of you decided we could not win our proxy fight if we did not replace two ex-CEO Board members, including me. Even if I agreed, the obvious and appropriate choice to not stand for election would be our Chairman, who has presided over the loss of shareholder value that sparked the proxy fight." He will not vote his own shares in favor of that chairman, Joseph Cook.

Yesterday, Greene spoke to a San Diego based reporter, Bruce Bigelow, about the "perfect storm" that in his view has engulfed the company since the emergence of what he calls "unsubstantiated pancreatitis concerns about BYETTA" last year.

He said though that he is confident the management of the company can pull the ship through.

Meanwhile, this proxy fight has become a test case for a particular takeover defense, a variation on the 'poison pill' known as the 'poison put.'

Whereas a traditional poison pill operates by giving certain rights to the non-bidding shareholders should a takeover be attempted, a poison put operates by giving certain rights to bondholders in that event. The point is the same, though: to make a takeover (or, in cases such as this, a majority change in board membership) prohibitively expensive.

We'll keep an eye on this fight as it unfolds.

Monday, April 13, 2009

Amylin fight: Byetta fall-out

Amylin Pharmaceuticals Inc., a Delaware chartered company with its headquarters in San Diego, Calif., will hold its annual shareholders meeting May 27.

It could be a contentious affair. On March 30, the SEC gave "no action" relief to each of two activist shareholders that will allow them to include each other's nominees on their own proxy cards -- to present a unified opposition slate, so to speak. So that unified opposition slate now includes 10 nominees for the 12 seats on the board.

Last year, Amylin's diabetes drug Byetta (which the company co-markets with Eli Lilly) became the subject of highly publicized safety concerns. The FDA said that it was working on a stronger warning label for the drug, and the value of Amylin stock, which had been moving close to $35, dropped to below $20 within the month.

Here's a link to a stock chart that includes that that precipitous drop.

You'll also see from that chart that though the price briefly regained its equilibrium at $20, it resumed a downward drift by early October. That can' really be held against the leadership of the company, though, because all US equities headed south last October.

More recently, good news about Byetta has enabled the stock to make a modest recovery.

I'll say something about the blow-by-blow of the proxy fight tomorrow.

Sunday, April 12, 2009

Defeat for Ramius

Orthofix International NV has declared victory over the rebels.

Orthofix is a medical device manufacturer, headquartered in Boston, Massachusetts but organized in accord with the laws of the Netherlands Antilles.

At a special general meeting of its shareholders, April 2, the incumbent board members won re-election as against the four nominees of Ramius.

In its statement Thursday, Orthofix said: “The Board of Directors and management team of Orthofix are thankful that shareholders chose to reject the short-term focus of the Ramius proposals, instead voting to support the Company’s long-term strategic plan to deliver shareholder value.”

One of the Ramius proposals was that Orthofix should sell its Blackstone Medical division, a maker of spinal implant products that Othofix purchased in 2006, taking on a heavy debt load in the process.

Before the meeting, Robert Gaines-Cooper had spoken up on behalf of retaining Blackstone. Gaines-Cooper, Group Chairman of Venner Capital SA, said that a spine strategy is crucial to Orthofix' future, and that Blackstone is "poised for a solid 2009 and beyond."

Anyway, the management now has a green light for their spinal strategy. The shareholder vote has presumably strengthened their backbone.

Wednesday, April 8, 2009

Delaware Supreme Court news

In an important decision last month, the Delaware Supreme Court rejected post-merger
stockholder claims that directors failed to act in good faith in selling the company.

Delaware, unfortunately, is living down to its reputation as an entrenched management's favorite state, and this decision -- Lyondell Chemical v. Ryan -- will compound that.

The decision, written by Justice Berger, rejects attempts to impose personal liabiolity on directors EVEN on the assumption that they did nothing to prepare for an imnpending offer and upon receiving the offer entered into a merger agreement with a no-shop provision and a 3.2% break-up fee.

Lyondell had moved for summary judgment in the Court of Chancery. That court had refused to grant summary judgment, setting the stage for a trial. But the state's highest court has now short-circuitesd any trial, holding that "the directors are entitled to the entry of summary judgment."

This is precisely the sort of decision that ticks me off, and that has me convinced there has to be a serious shareholder-rights movement, which would among other goals put pressure upon managements to incorporate in places other than Delaware. For the record, you can find the decision yourself here.

Tuesday, April 7, 2009

TCI Goes Short on Japan

I've written of TCI before here. In a post last May for example, I mentioned TCI's proxy contest among shareholders of the Japanese power company J-Power. The management prevailed against TCI in that contest, largely because Japan's government came to their aid. TCI sold its stake in J-Power in October, taking a US$130 million loss.

Now I read that TCI has changed its tack as to its Japanese positions. In order to be a corporate activist, an investor essentially has to be long -- has to own voting equity. But TCI has switched (according to a recent Bloomberg story) to a predominantly short strategy in regards Japan.

TCI has about US$1.2 billion in cumulative short positions in 13 Japanese stocks, including some of that country's biggest names: Toshiba Corp.; Sharp Corp.; Mizuho Financial; Sony Corp., and so forth.

Its short position in Toshiba was worth 39.5 billion yen (US$396 million) at the close of business Wednesday, April 1.

In October of last year the government imposed new requirements on short selling, including disclosure rules, so this data is now available through the Tokyo Stock Exchange's website, though as I say I've lazily taken it from Bloomberg's story.

Here are links, first to Bloomberg;

then to the TSE's English-language page.

Monday, April 6, 2009

Adrenalina proxy fight resolved

Pacific Sunwear, the Anaheim, Calif. based clothing retailer aimed at teens and young adults, announced that Adrenalina has withdrawn its slate, ending a proxy context for control of PacSun's board of directors.

Adrenalina, remember, is the Florida based company that calls itself the "extreme store." It is headed by Ilia Lekach.

Lekach met PacSun's leading independent director and other bigwigs, and after the meeting all was sweetness and light. Or as Lekach said in a statement, he "appreciated the opportunity to meet with [Peter Starrett] ... and to communicate my ideas for strenghtening PacSun's business."

Adrenalina has not had a great year (see the stock chart above) and it is possible they are fortunate PacSun resisted their embrace -- they might have had a tough time raising the money they would have needed to pay off on last year's bid had it been accepted.

Sunday, April 5, 2009

Credit Agencies Roundtable

The SEC will hold a roundtable on credit rating agencies one week from Wednesday, April 15, at 10 AM, at the agency's DC headquarters.

Here are the particulars.

10:10 a.m. — Panel One: Current NRSRO Perspectives: What Went Wrong and What Corrective Steps Is the Industry Taking?


Daniel Curry, DBRS
Sean Egan, Egan-Jones Ratings
Stephen Joynt, Fitch Ratings
Raymond McDaniel, Moody's Investor Service
Deven Sharma, Standard & Poor's

11:30 a.m. — Panel Two: Competition Issues: What are Current Barriers to Entering the Credit Rating Agency Industry?


Ethan Berman, RiskMetrics Group
James H. Gellert, RapidRatings
George Miller, American Securitization Forum
Frank Partnoy, University of San Diego
Alex Pollock, American Enterprise Institute
Damon Silvers, AFL-CIO
Lawrence J. White, New York University

12:30 p.m. — Lunch Break

1:15 p.m. — Panel Three: Users' Perspectives


Deborah A. Cunningham, Securities Industry and Financial Markets Association
Alan J. Fohrer, Southern California Edison
Christopher Gootkind, Wellington Management
James Kaitz, Association of Financial Professionals
Kurt N. Schacht, CFA Institute
Bruce Stern, Association of Financial Guaranty Insurers
Paul Schott Stevens, Investment Company Institute

2:45 p.m. — Panel Four: Approaches to Improve Credit Rating Agency Oversight


Richard Baker, Managed Funds Association
J├Ârgen Holmquist, European Commission
Mayree C. Clark, Aetos Capital
Joseph A. Grundfest, Stanford Law School
Glenn Reynolds, CreditSights
Stephen Thieke, Group of Thirty

The roundtable is expected to end at approximately 4:15 p.m. with concluding remarks by Erik R. Sirri, Director of the SEC's Division of Trading & Markets.

Wednesday, April 1, 2009

PwC is Out as Overstock's Auditor

A recent Form 8-K filed by, the internet retailer, says that the audit committee of the board has dismissed PricewaterhouseCoopers llc as the company's independent registered public accounting firm.

The form doesn't say much as to why they have parted ways, unless this counts: "In 2008 the Company and Audit Committee discussed with PwC the existence of a material weakness in the Company’s internal control over financial reporting and disclosure controls and procedures...." Overstock has since concluded that it has "remediated" that material weakness as of December 31, 2008.

PwC has signed off on this account. "We agree with the statements concerning our firm in such Formn 8-K," it says in a brief statement attached as an exhibit to the Overstock filing.

Grant Thornton is stepping into the shoes of PwC now. Good luck to them.

A change in auditors can be a sign of underlying troubles. That is not an original observation of mine. It comes from, inter alia, the New York State Society of CPAs">.

I have, by the way, no position in any individual stock at all. My modest nest egg is invested in broad-based equity indexes. Furthermore, I am not now or ever giving stock advice. Anyone who makes investing decisions based on what they see in a blog is ... well ... presumptively imprudent.

My only previous mention of Overstock in this blog concerned the settlement of some litigation in which they were the plaintiff. You can find more discussion of this very intriguing company's history in my other blog.

So all I will say to conclude is that it is possible that in months to come the switch in auditors in March 2009 will be seen as a milestone.