Yahoo and the Investment Act of 1940 from the San Jose Mercury News. I believe this same legislation from the past is applicable to Softbank:
Posted at 12:19 a.m. PDT Monday, June 5, 2000
Archaic law puts Yahoo in a bureaucratic maze
BY SCOTT HERHOLD
Mercury News Technology Columnist
When I covered municipal government years ago, I once did a story about archaic laws still on the city's books. Though I've forgotten most of them, one sticks in memory: Cab drivers were required to keep a bale of hay in their trunks for their horses.
Nobody enforced it, of course. But I was reminded of that rule as I pondered the case of Yahoo Inc. (YHOO), which has engaged in a long dance with the Securities and Exchange Commission over just how it is defined.
You might think of Yahoo as a successful search engine and portal with memorable ads and good management. You might think of it as a utility, providing Web calendaring, bill payment and e-mail. As an investor, you might consider Yahoo the premiere fount of cranky message boards.
But until now -- more on this in a second -- Yahoo has been an investment company in the eyes of the Washington bureaucrats, something akin to a mutual fund. They've got Yahoo CEO Tim Koogle pegged as Peter Lynch, the famed investor.
And the Santa Clara firm, if you'll forgive a bad pun, has lots of company. With scanty revenues but deep reserves, a number of Internet start-ups, particularly holding companies with multiple interests, have fallen victim to the same definition.
The reason is a 60-year-old piece of legislation called the Investment Company Act of 1940, or the ``40-Act,'' as insiders know it. That act, one of the last New Deal measures to correct securities abuses stemming from the 1929 crash, set down standards for the way that mutual funds promoted and priced their securities -- and reported results.
It also limits the range of investments an operating company like Yahoo can make. In today's economy, it's not infrequently applied to high-tech companies that resemble mutual funds only because they have so much cash on hand. So investors who believe that company executives should have freedom to move quickly in investing elsewhere should pay heed.
The legislation declares that a firm can be classified as an investment company when it owns securities that exceed more than 40 percent of its total assets. The act imposes stringent reporting requirements on the firms within its definition.
When Yahoo went public back in 1996, it did so with a balance sheet dominated by cash invested in short-term instruments -- 95 percent of its total assets. Although it had generous funding, its emerging business wasn't yet profitable -- and wasn't capital intensive.
Perplexed by this new model, the SEC classified the company under the 40-Act. According to CFO Gary Valenzuela, that has required that Yahoo keep the bulk of its cash in government securities like T-bills -- and restricted its investments in other businesses.
Now it isn't as if this is a body blow for Yahoo, which reported having $1.175 billion in cash and marketable securities last March 31. The company has a conservative investment policy. Valenzuela says Yahoo would invest in high-grade commercial paper were it not classed an investment company.
But as revenues increase and it is able to show a solid history of profits, Yahoo is understandably interested in escaping from the 40-Act.
``Every year, we've gone back and said, `Look at our business, we're generating profits,' '' Valenzuela said. ``And every year, we're caught up in this bureaucratic maze.''
It looks, finally, like Yahoo is about to get relief: The SEC has given it a temporary exemption from the act, an exemption that could become permanent after a period of public comment ends this month.
The 40-Act, however, has continued to restrict the movement of tech firms. In the early 90s, biomed firms had to seek a broad exemption from the act based on their spending for research and development.
Before CMGI (CMGI), an Internet holding company, postponed the planned IPO of portal AltaVista this spring, it warned that the act might restrict its ability to sell a majority stake in the portal to others.
And when Idealab, the Pasadena-based venture firm, filed an IPO prospectus in April, it laid out its plans for avoiding the scrutiny of the 40-Act, warning that a failure to do so could hurt prospects.
In Washington, an SEC spokesman, John Heine, said that an SEC task force had looked at the 40-Act in 1992 and concluded that it was still flexible enough to meet the demands of the current era.
``The phenomenon of this kind of situation coming up is not new at all,'' Heine said. ``There's a process that's been used again and again in situations where it's appropriate to exempt a company from the 40 act.''
Here's my take: Investors ought to take notice when a company begins behaving like a venture capital firm, making substantial amounts by holding securities in other companies. This raises questions about the direction of operating profits.
But this should be a matter for the individual investor -- and not automatically a reason for restricting the company's freedom of movement. We don't need the bale of hay in the trunk.
``This act was designed for the world 60 years ago,'' said Marc Morgenstern, a Cleveland securities lawyer who does work in Silicon Valley. ``It's literally a statute from another era. The intersection with today's world is uncomfortable and unnecessarily limiting.''
GOOFED: I said when I started this column that I would tell you when I was wrong. And to my chagrin, it's happened: Last Thursday, I wrote that Exodus Communications CEO Ellen Hancock had learned about Mirror Image, a Massachusetts company in which Exodus invested, by reading a newsletter from New Economy prophet George Gilder. Relying on a New Yorker profile of Gilder, I didn't check my facts. Exodus had begun exploring an investment in Mirror Image before the Gilder newsletter appeared.
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Scott Herhold's Stocks.comment appears every Monday and Thursday. Write him at the San Jose Mercury News, 750 Ridder Park Drive, San Jose, Calif. 95190; e-mail sherhold@sjmercury.com; phone (408) 920-5877.To read the columns online, see www.siliconvalley.com/columns/stockscomment/
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