Clean Up This Mess
By James B. Stewart
SmartMoney.com - Common Sense
Tuesday July 16, 5:14 pm Eastern Time
IS IT ANY WONDER a crisis in investor confidence is dragging the market to new lows? We've had to face the spectacle of once-respected, even idolized, chief executives being led from their multimillion-dollar, art-studded homes in handcuffs. ImClone Systems' (NASDAQ:IMCL - News) former chief executive, Samuel Waksal, arrested at 6:00 in the morning, was reduced to begging not to be cuffed in the presence of his 28-year-old daughter.
I remember vividly when handcuffs last figured so prominently on Wall Street: On Feb. 12, 1987, arbitrager Robert Freeman was arrested and handcuffed in his Goldman Sachs (NYSE:GS - News) office and charged with insider trading related to the Ivan Boesky case. But there's a big difference between then and now: The specter of crime has moved from the arena of swashbuckling corporate raiders, cutthroat arbitragers and evangelizing junk-bond kings into the corporate suite.
During the 1980s the boardrooms of major corporations remained, for the most part, sanctuaries of integrity. Chief executives were in many cases the victims of fraud, not the perpetrators. Now we have the recent parade of chief executives under investigation: Kenneth Lay at Enron (Other:ENRNQ - News), Dennis Kozlowski at Tyco (NYSE:TYC - News), John Rigas at Adelphia (Other:ADELQ - News), Waksal at ImClone and, most shocking of all, Martha Stewart.
Let's look at the Martha Stewart case for a moment, since the doyenne of stylish living has so loudly proclaimed her innocence. The Wall Street Journal reported that Stewart, a close friend of Waksal, sold her entire ImClone stake of 3,928 shares on Dec. 27, 2001, the day before the company announced that the Food and Drug Administration had rejected its all-important cancer drug. That's the same day that Waksal's relatives dumped their stock and exactly one day after Waksal himself learned the FDA would refuse to review the company's cancer-drug application.
Stewart's lawyer denied that Stewart had any information about the FDA's decision or engaged in insider trading. Rather, he told the Journal that this was a routine stop-loss order to her broker to sell the stock at $60 a share, an order placed "more than a month" before the sale.
But then the Journal reported that Stewart's broker is telling a different story: that the stop-loss order was placed sometime in mid-December. Moreover, the order was oral and was never entered into Merrill Lynch's computer system, so there are no account records to support either version.
Maybe this is just innocent confusion. Merrill Lynch has suspended the broker and his assistant pending further investigation and has indicated that the firm doesn't believe a stop-loss order ever existed. Records of the day's trading in ImClone shares also show that the stock dropped below $60 well before Stewart's sell order was executed, casting further doubt on the existence of such an order.
My advice to Stewart and her broker is to get their stories straight and, above all, tell the truth. As the recent Arthur Andersen conviction vividly demonstrates, the cover-up can be worse than the crime. (Waksal, meanwhile, was charged with perjury as well as insider trading.)
In any event, whether or not Stewart placed the order to sell at $60 in late November or mid-December, she certainly had exquisite timing. ImClone shares did drop below $60 on Dec. 27, closing that day at just over $58, down more than $5 from the previous day's close on heavy selling by members of Waksal's family. Of course, the real plunge came on news of the FDA's action, on Dec. 31, when the stock plunged to just over $43 a share.
But Dec. 27 wasn't the only day ImClone shares fell below $60. ImClone first rose above $60 on Oct. 22. By Oct. 25 it was at nearly $63, but it dropped all the way back to $56 on Oct. 30. It pierced $60 again the next day, then dipped below it again on Nov. 1, 9 and 12. Had Stewart entered her stop-loss order at any point before Nov. 12, the trade would have been executed then at the latest. So the window for her to have entered a stop-loss order consistent with her explanation is a six-week period from Nov. 13 to Dec. 25. (Obviously, if she entered such an order after Waksal learned of the FDA's adverse decision, it wouldn't amount to a defense.)
Does Stewart's defense pass the common-sense test? I leave that to you to decide. Stewart is constitutionally entitled to a presumption of innocence, but investors don't have the luxury of waiting. In the wake of Enron, Tyco and Adelphia, the market rendered a verdict of "guilty" long before any legal action had been initiated. Clearly, Martha Stewart's investors have reached some kind of decision: After news broke of her ImClone transaction, Martha Stewart Living Omnimedia (NYSE:MSO - News) shares lost a quarter of their value, plunging to just over $14 from $19 a share. An obvious concern is whether a company so closely identified with its founder could function if she were indicted or, worse, convicted. As an investor, I wouldn't go near this stock right now.
Over the years I've written about many insider-trading cases, which I find fascinating because the participants are usually so wealthy. There's no rational financial motive for a Martha Stewart to have sold those shares on inside information. Even if she did save about $240,000, the approximate value of her entire ImClone investment, that's pennies for someone estimated to be worth over $1 billion.
In a similar vein, why would Dennis Kozlowski, the now-disgraced CEO of Tyco, stoop to evading sales tax on millions of dollars of art purchases — if in fact he did — when he has reaped profits of over $200 million on sales of his stock alone? Why would he need Tyco to buy him an $18 million apartment on Fifth Avenue when he could easily have bought it himself?
I'm not a psychologist, but let me volunteer one guess: Too many chief executives don't believe they're bound by the laws and rules that apply to the "little people," as convicted felon Leona Helmsley once so memorably put it. This attitude is only encouraged when corporate boards shower their executives with perks once reserved for royalty: private chefs and dining rooms, limousines and chauffeurs, Gulfstream IV jets and crews, club memberships, palatial homes and, we now learn, Old Masters to adorn the walls.
As an investor I was disturbed by another recent article in the Journal reporting that General Electric (NYSE:GE - News) owns four apartments in the posh Trump International Hotel & Tower in New York City. Questioned by reporters, GE said one of the apartments, for which it paid over $2 million, is used by NBC Chairman and CEO Robert Wright and his wife, and that Wright is not obligated to declare the value of the use of the apartment as income.
At the risk of getting a subpoena, I can report that I attended a lovely party in that very apartment. If there was a business purpose to the party, it escaped me, though I suppose one could argue that any party attended by a journalist qualifies as a business affair. That issue aside, I'm an investor in GE as of last month, when, as promised in this column, I bought GE shares when the Nasdaq dropped below 1600. I felt GE had been unfairly tarred with the Tyco brush, and I had faith in the integrity of its management. Why must I now worry about what Bob Wright reported on his income tax?
I have a simple proposal for the SEC and Congress: Ban noncash executive compensation. If a company wants to buy its top executives mansions or apartments, fine. Raise their salary, and let them pay for the real estate and report the money as compensation. The same for clubs, jets, cars — get rid of it all. In many cases these perks are subtly corrupting anyway, since they cause the recipients of such largesse to lose sight of their own identity separate from that of the corporation. As Louis XIV put it, "L'etat, c'est moi."
Shocking as so many of these revelations have been, I applaud their disclosure. The market's reprisal is swift, but it is also remarkably effective. A few prison terms will go a long way toward changing the culture of the executive suite. And I believe there will be a silver lining to these dark days. The scandals on Wall Street in the 1980s and the ensuing cleanup, traumatic at the time, restored investor confidence and paved the way for the great bull market of the '90s. It's too bad that handcuffs may be the necessary catalyst, but as investors, we may have to absorb a few such shocks so we can begin to regain the confidence that makes America's financial markets work. |
