The GMI Blog

Small Print

By Paul Hodgson – CCO and Senior Research Associate

Small Victories...

Company Analyst Kyle Whisler, who found this surprising announcement in Air Lease’s 2012 proxy statement, asked: “Might the work we're doing have contributed to what is perceived as a ‘governance best practice’?” It sure does Kyle. Mos Def.

Air Lease Corporation recently recommended shareholders to vote for a three-year frequency for Say on Pay.  The majority of shareholders did what they were told. However, the board responded with this:

Notwithstanding the majority of votes in favor of holding the advisory vote on named executive officer compensation every three years the Board of Directors has decided to hold the advisory vote every year in response to the significant number of shares voted in favor of an annual vote and a desire to adopt what is now perceived to be a governance best practice.

To recoup or not to recoup

Compensation Analyst Manager Scott Patterson, who found this fudge in Sabra Health Care’s 2012 proxy statement, commented: “Sabra Health Care seems to have an issue with commitment.”

Time-Based Units, FFO Units, and TSR Units granted under our long-term equity award program are each subject to the terms of our recoupment, clawback or similar policy as may be in effect from time to time, and to any similar provisions of applicable law.

Look, if you’re going to have a policy, have a policy, just one, not one for each award, not a new one each year. SEC ain’t gonna like that one.

IP-uh-Oh, or ‘I wish we had a time machine’

Events Team Leader Mark Magee found this example of 20/20 hindsight in a Huffington Post article on May 22^nd.

Nasdaq OMX Group Inc admitted in a call with its member brokerage firms on Tuesday that it put the wrong fix for a technical glitch related to Facebook's IPO in place on Friday, which led to trading disruptions for much of the day.

Nasdaq believed it had the correct solution to fix the problem that delayed trading in the stock for thirty minutes, Eric Noll, Nasdaq's head of transaction services, said in a statement to Reuters.

The statement from Nasdaq contradicted a Wall Street Journal report earlier Tuesday that said Nasdaq would have "pulled the plug" on the historic IPO had it known the extent of the technical problems that would follow during the day's trading.

"If we had known that our solution was inadequate, we would have fixed the solution with the right solution before moving forward," Noll said in the statement.

Yeah, like, if we’d know we were going to make a mistake, well, then, we, like, wouldn’t have made it. Hey, Jamie Dimon, there IS 20/20 hindsight!

GMI Ratings Governance Issue | Chinese Estates (Holdings) Ltd.

After news that Chinese Estates Holdings Limited's chairman and CEO Joseph Lau must go to court in Macau over money laundering and bribery allegations, his board said Thursday that it's in the Hong Kong property company's best interest for him to remain in his current roles. The recent bribery scandal isn't the first sign of trouble that investors could have heeded.

Lau allegedly bribed Ao Man-long, a former government official in the region, around 20 million Hong Kong dollars in order to buy five plots of land next to the Macau International Airport in June 2005, according to news reports. Lau denied the charges and asked the Macau court to throw out the suit based on lack of evidence. On Wednesday May 23 the court rejected his request and accepted the prosecution's allegations for a hearing, according to a regulatory filing. The Hong Kong Stock Exchange suspended trading in Chinese Estates's shares the next day at the company's request.

On May 24 Lau said in a statement that he and the company have agreed that he "will continue to be able to discharge his duties as Executive Director" and devote sufficient time to management. Lau, his son Ming Wai Lau, and his sister Amy Lau, who make up half the board, will abstain from voting in meetings related to the bribery allegations. The board also plans to appoint Chinese Estates' group financial controller Kwong-wai Lam and its manager of sales and leasing Sze-wan Sue Chan as additional executive directors "as soon as practicable." It is forming a committee tasked with watching the development of the lawsuit and its potential impact on Chinese Estates' land development project.

The company had said in a filing April 17 that the Macau proceedings will not affect its business and normal operations.

Investors have battered the stock. Chinese Estates has fallen more than 21% in the year to date to around $9.82 per share, underperforming its benchmark.

It's not the first time that Chinese Estates has had a scandal. After Lau's brother Thomas received a 34 million Hong Kong dollar fine in December 2006 for insider trading, he had to resign from his position as director of Chinese Estates' board, according to news reports.

Lau's financial statements about his company reflect an AGR score of 35 as of September 2011, which indicates more risk than 65% of comparable companies. The AGR was a 14 in June 2010. GMI gives Chinese Estates a D on its corporate governance.

Region: Asia-Pacific
Industry: Financials
Sector: Real Estate Operations
Market Cap: HKD 20,754.9mm (Mid Cap)

ESG Rating: D
AGR: Aggressive (35)

 

GMI Ratings Governance Issue | Morgan Stanley

Morgan Stanley is being probed over whether its analysts gave privileged information to clients ahead of Facebook’s initial public offering. Even after supposedly eye-opening events such as the financial crisis of 2008, the banking firm continues having run-ins with regulators.

 

Morgan Stanley analysts had discussions with institutional investors about the social networking company’s revenue prospects before its IPO on May 17th. They advised clients to dial back their expectations, the New York Times reported. Some big institutions did that while others placed large orders, and retail investors clamored. Meanwhile Facebook and its bankers went ahead to price the deal at $38 a share, ending up with the embarrassing result of lower than expected demand, the New York Times said. Facebook shares were trading at $32.06 apiece intraday on Wednesday.  

 

Regulators are investigating. Massachusetts’ Secretary of the Commonwealth William F. Galvin, for example, on Tuesday issued a subpoena to Morgan Stanley in connection with the matter. Investors claimed Morgan Stanley and others misled them in the purchase of the company's stock and filed suit Wednesday, Bloomberg reported.

 

Morgan Stanley and Facebook didn’t respond to a request for comment within press time.

 

Obviously it’s too early to know whether Morgan Stanley is guilty in this one. Regardless, it’s astonishing that the bank has managed once again to get into a situation that regulators deem worthy of questioning. The lawsuits have been coming for years and they don’t seem to stop. In April 2003, for example, Morgan Stanley was one of ten investment firms to collectively pay $875 million to settle allegations that they engaged in practices that maintained inappropriate influence by investment banking over research analysts. Then in January 2005 the Securities and Exchange Commission announced that Morgan Stanley and another firm would have to pay $40 million relating to allegations that they pushed customers to buy stock at higher prices in the aftermarket of IPOs.

 

Morgan Stanley has had its wrist slapped too many times to be a plausible victim of justice. The financial services firm agreed to pay $102 million to Massachusetts homeowners after the state’s attorney general’s office investigated its securitization and financing of subprime loans, the regulator said in June 2010. The Financial Industry Regulatory Authority said just this May that it fined Morgan Stanley $1.75 million and $604,584 in restitution for the way they sold leveraged and inverse exchange-traded funds to their customers. These are only a couple examples from a list that’s so long, you could make a chart with it.

 

Despite the continuing regulatory issues, Morgan Stanley’s stock price has recovered nearly 41% from its low in October 2008 to trade at $12.92 per share intraday Wednesday.

 

GMI gives the firm an F on its corporate governance. Morgan Stanley’s financial statements reflect an AGR score of 17, indicating higher risk than 83% of comparable companies. The AGR was a 1 in June 2009.

Region:  North America

Industry: Financials

Sector:   Investment Services

Market Cap: $ 29,567.7mm (Large Cap)

ESG Rating:  F

AGR:   Aggressive (17)

GMI Ratings Governance Issue | Cree Inc.

Investors sold shares in Cree Inc. Tuesday after news that CFO John Kurtzweil quit for a smaller technology firm. The LED lighting company’s financial statements have reflected the high risk of surprises since June 2010.

 

Kurtzweil resigned yesterday as CFO, but he plans to continue as a Cree employee until June 15 to assist with the transition of his responsibilities. “The decision to leave Cree was a very difficult one for me as the past six years have been personally rewarding," Mr. Kurtzweil said in a company statement Tuesday. "At this point in my career, however, I decided to move to Extreme Networks, a smaller firm where I can have a more hands-on role in growing the business."

 

Cree said it is now searching for Kurtzweil’s replacement. In the interim, Cree has appointed Michael McDevitt, who joined the firm in 2002 as corporate controller and has also served as Cree's director of financial planning and as director of sales operations. McDevitt had another stint as interim CFO in September 2006, after Cynthia B. Merrell resigned from the role in August 2005.

 

Turnover in senior management, particularly CFO turnover, can bode ill. The stock fell 5.6% to $27.38 per share intraday on Tuesday.

 

It wasn’t the first time investors sold the stock lately. Cree’s earnings per share forecast on April 17 for the fourth quarter missed analyst estimates, according to news reports. As the management copes with transition and struggles to set prices in a competitive market, Cree also reportedly disappointed analysts with its guidance in January this year, in October, August, April, March and January 2011, and in October 2010.

 

Cree’s managers have been taking aggressive steps lately that increase the chance of mistakes. For example, Cree said on August 17, 2011 that it was buying the outdoor lighting company Ruud Lighting, Inc. for around $525 million. Since the company paid more than Rudd’s book value, it reported intangible assets that it expects to have someday later amounting to $613.8 million as of Sept. 2011, up from $326.2 million as of June 2011. If it turns out that Cree overestimated what Ruud Lighting will eventually do for its earnings, the company will have to surprise investors with that news someday.

 

That’s not the only area of uncertainty. In April, for example, Cree said it will be selling LED streetlights to municipalities. As the company bets its future on such new products, it estimated in June 2011 that its inventory will be worth $176.5 million once sold. That’s up from $112.2 million in the same period of 2010.

 

CEO Charles M. Swoboda said in a conference call on April 17 that his team is now working to convince people who are used to buying the traditional technology to use his new streetlights. Building an LED streetlight can cost around $200 for certain applications, he said. He’s trying to cut the cost of his product in half by making changes such as using higher performance LED technology and building more efficiently. “Obviously, we're always making a tradeoff of how much can we -- how aggressive can we be on the new lighting systems, to not only take costs out but also get the customers to think differently about how quickly to move to LED,” he said. “And I think as we start to get closer to some of these price points that make the economics much more obvious, I think we'll have a chance to let some of the innovation on the LED systems side give us a little bit more traction.”

 

In the meantime, Cree’s stock has unusually high accounting and governance risk. Its financial statements reflect an AGR score of 4, indicating more risk than 96% of comparable companies. The AGR has been aggressive since June 2010, when it was a 21. GMI gives the company a C on its corporate governance overall.

 

Cree didn’t immediately respond to a request for an interview.

 

Region: North America

Sector: Technology

Industry: Semiconductors

Market Cap: $ 3,725.0mm (Mid Cap)

ESG Rating: C

AGR: Very Aggressive (4)

 

A Solution to ExxonMobil's Say on Pay Woes

By Paul Hodgson - CCO and Senior Research Associate

Last year, almost a third of shareholders voted against ExxonMobil’s Say on Pay resolution.

This is well below average levels of support for Say on Pay, even among other oil companies some of whom actually paid their CEOs more than ExxonMobil despite being much smaller, and, as the company claims, much easier to run companies.

Proxy advisory firm exhortations to vote against the same Say on Pay resolution at the 2012 annual meeting caused Exxon to issue not only a written special proxy, but even to run a special webcast to defend their compensation policies.

We are already on record – indeed we frequently use it as a shining example – as congratulating the company on the lengthy restriction and retention periods attached to its restricted stock grants. Restriction periods of five years, 10 years, or through retirement are far more draconian than are found almost anywhere else and the company is rightly proud of them.

So why are shareholders so miffed about executive compensation at Exxon?

Could it be the $55 million in pensions amassed by CEO Rex Tillerson? Could it be the $122 million in unvested restricted stock?

Or could it be that they would like the restricted stock tied, and I mean really tied, to performance?

This is what the company said in the webcast:

The Compensation Committee has carefully considered this result as well as shareholder feedback on executive compensation through a wide-ranging dialogue between management and numerous shareholders, including the Company's largest shareholders.

There was no consensus recommendation for any specific change to the design of our compensation program.

Dialogue included discussion on whether the Company should consider the use of formula-based pay tied to shorter-term metrics, such as 1- and 3-year TSR.

We believe that applying a short-term, formula-based approach to ExxonMobil’s compensation program would undermine the uniquely long-term requirements of our proven business strategy, which are characterized by investment lead times that can span decades.

Well, they were asking the wrong people.

No shareholder in their right mind would be interested in replacing five and 10-year restricted stock with performance shares based on three-year TSR. That’s ridiculous. Let me say here and now that most of this problem would go away if the company retained the restriction periods and applied performance conditions to them. Yesterday, speaking to a reporter, I suggested a 5-10 year return on capital employed (ROCE) metric against the company’s closest industry peers, and low and behold, on the webcast the company indicated that this was its favorite metric.

Who said anything about lack of consensus?

I’d encourage them to give me a call, except, of course, GMI Ratings doesn’t do consulting for corporations.

GMI Ratings gives ExxonMobil an ESG rating of D, largely driven by poor compensation and environmental scores, though its AGR is average.

GMI Ratings Governance Issue | Zijin Mining Group

The China Securities Regulatory Commission (CSRC) recently fined and warned Zijin Mining Group for failing to disclose properly a toxic waste leak which occurred in July 2010. The toxic waste leak at the Zijinshan Copper Mine killed 1,890 tons of fish in the Ting River and caused RMB 32M in economic damage. The leak occurred on July 3, 2010, but the company did not report it until nine days later on July 12, 2010. The CSRC issued warnings to five directors, including the chairman, and three directors were fined.

The Ministry of Environmental Protection's investigation of the July 2010 toxic waste leak concluded that Zijin Mining disregarded official warnings from as long ago as September 2009, which indicated that the volume of waste water entering the Ting River was too high. The company also received a notice to repair a water quality monitoring system which would detect the increase in waste water flowing into the river.

To make matters worse, after the toxic waste leak was disclosed, there were reports that Zijin Mining attempted to cover it up by trying to bribe reporters. These reports turned out to be true as China's General Administration of Press and Publication conducted an investigation and confirmed that Zijin Mining and local government officials offered bribes to reporters.

Just three months later, in September 2010, a tailing pool dam in Maoming City in Guangdong Province owned by Xinyi Zijin Mining Company collapsed. The consequent flood of water killed 22 people and destroyed 523 homes. Xinyi Zijin Mining is a subsidiary of Zijin Mining. Authorities from the Guangdong Provincial government investigated the incident and found that non-compliance with regulations by Xinyi Zijin Mining directly contributed to the dam's collapse.

Zijin Mining does not have either a risk management committee of the board or a committee responsible for environmental, health, and safety issues, and despite these disasters, the board has made no effort to establish such committees.

In case there is an impression that such occurrences are par for the course for a mining company, these disasters have had a significant adverse effect on the company's stock price. Zijin Mining's share price was HKD 3.93 in June 2010, prior to the toxic waste leak. On May 11, 2012, the shares traded at HKD 2.30, a 41percent decline.

Zijin Mining is currently rated as having a Very Aggressive AGR score of 7, indicating higher accounting and governance risk than 93 percent of companies in the Asia-Pacific. The company has an equity performance ranking of 2, indicating that we believe it will underperform the market.

GMI Ratings gives Zijin Mining an ESG rating of F.

Region: Asia-Pacific

Industry: Basic Materials

Sector: Precious Metals / Minerals

Market Cap: HKD 15,200.6mm (Mid Cap)

ESG Rating: F

AGR: Very Aggressive (7)

 

“We told you so, didn’t we?”

By Paul Hodgson - CCO and Senior Research Associate

Normally we’re saying this about the latest collapsed company, that we have typically been rating poorly for at least the last 24 months. This time, however, it’s about SEC disclosure regulations.

In this letter that I wrote on 27 March 2006, I indicated that companies should be disclosing realized compensation, not estimated future values for option and stock awards in the main compensation table.

This is what I said:

As far as the Summary Compensation Table is concerned, it would seem that the best way forward would be to have two such tables: one that indicates monies received in the year; and the other that discloses the target, future level of compensation aimed at by present grants and awards. In order to achieve this level of homogeneity, both the value of any restricted stock grant and the number of stock options awarded should be removed from the current and proposed Summary Compensation Table. The value of any restricted stock that has vested in the year should be included in the ‘earned compensation’ table – a very different value from the ‘grant date value’ of the total award. In the ‘future compensation’ table, the amortized annual value of any present restricted stock grant should be included. This has the added advantage of obviating the distortions to pay levels that occur because of the boom and bust effect of irregular stock grants.

In this way, all the ‘apples’ will be in one table, and all the ‘oranges’ will be in another. Even under the current arrangements, the summary compensation table is a mix of apples and oranges.

As readers know, this plea fell on deaf ears, with most commentators, companies, shareholders, consultants and, more importantly, the SEC disagreeing with us.

Now, in an article in last week’s Agenda Week, it seems like everyone has finally caught up with us, with a number of companies already presenting realized compensation tables, and other agencies and consultants realizing what a useful piece of data this is. However, there seems to be a lack of distinction between realized pay and realizable pay. The two are very different. Realized pay is vested stock, exercised options, bonuses paid out. Realizable pay is the value of outstanding equity that has not vested nor been exercised but is just sitting and waiting. It’s another useful piece of data, but realized pay it is not.

GMI Ratings Governance Issue | Carnival Corp.

The lone survivor of a drifted fishing boat is suing Carnival Corp., alleging that one of its cruise ships ignored him and his friends when they waved for help. Once again, the Miami-based company's shoddy governance has cost lives. For investors, this means the risk of losing money.

18-year-old Adrian Vasquez, 24-year-old Oropeces Betancourt, and 16-year-old Fernando Osorio went out to sea from Rio Hato, Panama in February. Their small fishing boat lost power and they drifted for around two weeks. Parched and weakened, they passed a luxury cruise ship called the Star Princess on March 10. They waved for help, even tying a shirt to a pole to get attention, and some birdwatchers on the ship's deck noticed. The passengers told a crewmember, who reported the emergency to the ship's bridge -- but then the Star Princess sailed on. Osorio died within hours, and five days later so did Betancourt. Almost two weeks later a fishing boat rescued Vazquez near the Galapagos Islands, and he filed suit against Carnival on May 7 in the Miami circuit court, according to the complaint.

Carnival said in a statement May 14 that they began investigating as soon as they became aware. They suspect that the Star Princess' captain was never notified because of "unfortunate" miscommunication. "This is an upsetting and emotional issue for us all, as no employee on board a Princess ship would purposefully ignore someone in distress," Carnival said. They pointed out that the company has rescued others at sea more than 30 times over the last decade.

But messing up once is already too many times, and Carnival has had other accidents as well. On January 13, its cruiser the Costa Concordia hit a rock near the Italian island of Giglio and turned on its side. Before the more than 4,200 people aboard had finished evacuating, Captain Francesco Schettino allegedly abandoned ship; he was later arrested and accused of manslaughter. At least 30 people died in the accident. The ship remains in the water and will take up to a year to remove, according to court documentation and news reports.

After the Concordia accident Carnival planned to cut its 2012 profit by between $155 million and $175 million. Bookings for its entire fleet, excluding Costa European business, fell by a mid-teens percentage in the 12 days following, the Associated Press said Jan. 30.

Of course headlines like these make customers nervous to board ships. What's more serious is that after suffering one tragedy, Carnival has failed to prevent another months later. This suggests the company has ongoing management issues, making it capable of who knows what other kinds of mistakes down the line.

To be fair, Carnival said in April that Pier Luigi Foschi will retire on July 1 from his role as CEO of the Costa group, which had operated the Concordia. The company said it was part of a long-term succession plan for him to leave once he reached his current age of 65.

He will keep his seat on a board that GMI has flagged for years as having dubious supervisory capacity. Carnival's chairman and CEO Micky Arison, along with his family, controls over a third of the company's voting power. Seven directors are long-tenured with over a decade of service, and five have at least two decades of service. Good old pals like these aren't as likely to ask tough questions and demand accountability for accidents such as the Concordia's.

In part due to these red flags, GMI has given Carnival a D on its corporate governance since July 2003. It's AGR score is a 71 and indicates average accounting and governance risk. Investors could have paid attention to such problems before this year. Carnival's stock has sunk by 5.8% so far in 2012 to trade at nearly $31 per share intraday on Friday, underperforming its benchmark the S&P 500 index.

Hopefully the captains of Carnival's cruise ships will be more on the lookout next time.

Region: North America

Sector: Cyclical Consumer Goods / Services

Industry: Hotels / Motels / Cruise Lines

Market Cap: $ 19,235.4mm (Large Cap)

ESG Rating: D

AGR: Average (71)

Small Print

By Paul Hodgson - CCO and Senior Research Associate

Dimon in the Rough

From Events Team Leader Mark Magee: a selection of quotations from “that conference call” with JPMorgan’s CEO Jamie Dimon regarding that $2 billion loss, and counting.

"We're willing to bear volatility, and um, that's life."

"Just because we're stupid doesn't mean everybody else was."

"We're not in a business where we are not going to make mistakes. We are going to make mistakes... I could never promise you no mistakes."

"Even hindsight's not 20/20, but with hindsight, yes, obviously we should have been paying more attention to it."

Actually I quite like the fact that he is a little less than buttoned up. Then again, that’s probably why he won’t give up even one of his three job titles, so maybe it’s not such a good thing.

The Daily Coffee Grind

Mark also spotted this piece of “no idea how the 99% live” commentary from another hard-done-by CEO

"A lot of people don't understand that I have no other income other than selling stock or borrowing against it," said Mr. Stiller, in a phone interview from his home in Palm Beach, Fla.

"I went for a year where I couldn't sell any shares," Mr. Stiller said. "Lavish is all relative."

Hey, thanks, Green Mountain CEO Robert Stiller, for letting us know that. Lavish is all relative. Let them eat cake. Not quite the same ring, but the same sentiment.

Another Piece of Reputational Damage Unlimitation

Director of Ratings Naveen Reddy – a Small Print first, if I’m not mistaken – spotted this Reuters article.

Princess Cruises has been hit with a lawsuit accusing it of "outrageous conduct" and "callous disregard for human life" for failing to rescue three young men aboard a disabled Panamanian fishing boat, two of whom later died at sea.

Not a good year for Carnival. You’d think with one disaster already it’d be careful to avoid another.

Oh, I'm Sorry. Would You Like to Try Again?

Mark also submitted this entry.

American International Group Inc. (AIG), the insurer majority owned by the U.S. Treasury Department after a 2008 bailout, declined to reveal legal costs in response to the only investor who asked a question at its annual meeting.

Only one shareholder asked a question at AIG’s annual meeting? One? Was anyone there from the Treasury? And why did it decline to answer? Never mind a shareholder’s right to know, this is a publicly-owned company. Every American citizen has a right to know.

The Tom Sawyer Whitewashing the Fence Clause

Compensation Analyst Ashley Kotzur found this while trawling through the Las Vegas Sands 2012 proxy statement, and kudos to Mark for coming up, against his own stiff competition, with one of the funniest headlines we’ve ever had on Small Print. Just damn clever.

The Company also permits its named executive officers to use Company personnel for home repairs during business hours on a limited basis. The Company requires that these executives reimburse it in full for these services. There is no incremental cost to the Company for any of these benefits.

Some of this stuff just beggars belief. Home repairs? Company personnel have so little work to do for their actual employer that they can pop round to fix the wiring for their bosses' cable TVs? Croupier by night, plumber by day. Bouncer cum landscaper? Well, at least it gets them out during the day….

Facebook’s Zuckerberg: Never Mind the Shares, What About the Options

By Paul Hodgson - CCO and Senior Research Associate

[This blog first appeared on Forbes.com]

The compensation committee report in Facebook’s proxy statement is pretty standard for an internet IPO. Low cash compensation, at the lower quartile of its peer group, total compensation, including equity, at the 99^th percentile….

Mark Zuckerberg earned about a million dollars in cash during 2011, and received no additional equity compensation “because our compensation committee believed that his existing equity ownership position sufficiently aligns his interests with those of our stockholders.” Which is an understatement of stupendous proportions.

But then, Mr. Zuckerberg already has 120,000,000 stock options that were awarded on November 8, 2005 and are fully vested.

That’s more stock options than I remember ever having seen ever awarded to a single individual on one day.

What happened there? He awarded himself stock options over his own shares?

The exercise price of these options is 6 cents.

A note to the table indicates that Mr. Zuckerberg is exercising half of them today.

In connection with our initial public offering, Mr. Zuckerberg will exercise this stock option with respect to 60,000,000 shares of Class B common stock and will then offer 30,200,000 of those shares as Class A common stock in our initial public offering.

Even at the initial asking price of $38 that’s a profit of $2,276,400,000. And, yes, those zeroes are correct. And the profit could be bigger if the stock price increases.

No wonder he’s having to sell some to pay his tax bill.

But the stock options are not Facebook's only governance issue, as I have already said.

GMI Ratings has not given a governance grade to Facebook yet but now the IPO has gone forward we will be doing so, and let me tell you, on the record thus far it will not be a good one.