I want to thank all of you that have taken the time to e-mail responses to my last several articles. The impressive thing is that almost all responses have been very informative in either describing personal situations of management greed and lack of performance, or in suggesting topics for future articles. Please continue with the feedback.
               
Today I want to talk a little more about a stock that has been in the news recently, Computer Associates (CA). As the news media and the analyst community searches for the next stock to contract “Enronitis” this one has moved to the forefront, not to mention the fact that the Chairman of the New York Stock Exchange, Mr. Richard Grasso, and former U.S. Senator Alfonse D’Amato, sit on the board. The story breaking last week in both Long Island’s Newsday and The New York Times was that the U.S attorney for the Eastern District of New York and the FBI were opening an investigation as to whether the company violated criminal fraud laws through its accounting practices. Share prices were, of course, off about 20%. A more detailed analysis is contained in an article by Rebecca Burne of theStreet.com entitled “Computer Associates Again Forced to Play Defense.” In it she describes the accounting process as something called “pro forma pro rata.” Basically, the company changed from an accounting method of recognizing all revenue from a multi-year software contract in the first year, to recognizing the revenue over the life of the contract. Makes perfect sense, except the part where you go back and restate income as if you were doing it this way all along, essentially counting revenue a second time. This resulted in third quarter pro forma income of $417 million, or $.71 per share vs. GAAP losses of $231 million, or $.40 per share. Unbelievable!!
             
As you might expect, this is a story that caused me to dig deeper into the recent history of this company and management team. It turns out that in August, 2001, a dissident shareholder by the name of Sam Wyly led a vigorous campaign to oust the entire board of Computer Associates and replace them through the proxy system with ten new members. The bylaws of Computer Associates are somewhat unusual in that the terms of all directors are up at the same time, with most companies staggering the terms. The stated reasons for the proxy fight were:

• Lack of performance in CA stock price over a five year period.
• Excess executive compensation.
• Accounting practices. The charges actually used the term “phony bookkeeping” which overstated earnings over time.
• Poor customer relations.

The proxy battle raged for weeks, with both sides mounting an aggressive and expensive campaign, complete with full-page ads in The Wall Street Journal and The New York Times. I must ask the question: In a proxy fight among competing potential board members, why does one side have to pay their own expenses, while the company pays for the other? The terms of Mr. Grasso and the other incumbents were over, and I assume the bylaws allow any shareholder to run, maybe with the requirement of a certain amount of signatures. If the “challenger” gets on the ballot in keeping with the bylaws, where is the legality or morality of the company management using company funds to favor one side? The challenging group led by Mr. Wyly eventually cut back to running only four candidates instead of the original ten, but the entire company slate was able to prevail in the vote totals. It is interesting that in a company press release, the company stated that even four new members would be unacceptable, as the resulting “divisive” board would now vote 6-4 on issues. It would never do to have only six rubber stamps, they need ten! Let’s see now, the chairman of the NYSE sits on the board of a listed company, is challenged publicly for his board seat citing phony accounting practices and absurd compensation, has the company pay essentially for his campaign, the company is now being investigated by the law, and instead of asking him to quit that board the NYSE board approves his appointment to the Home Depot board.

One of my recent e-mails asked, “How does this happen?” Based on my six years of board service at the CBOE and all that I have been able read on the subject, it is a combination of shrewd small group dynamics on the part of management, and large egos and love of being pampered on the part of board members.  When a chairman begins to under-perform, it is not easy for a man of ego to admit the mistake in hiring the bum in the first place. “He can’t be a bum, pillars of society like myself and the rest of this august body used due diligence in the selection process, paid a search firm huge cash, gave the hard interview, etc.  Why would a person of obvious talent and experience like myself give millions of shareholder dollars to a bum?” To admit he is the wrong guy or the policies misguided is essentially to indict myself.  Management of course never misses an opportunity to stroke the board members, so it becomes a two-way dance. At times individual board members probably do recognize problems with management, but there never seems to be the time or opportunity in a well run board meeting to get up the backbone to say, “I have been sitting here listening to this bleep for three years, I hear a lot about raises and stock options, and not much about new ideas to benefit anyone other than you. If it does not change by the next meeting, either you will resign or I will, very publicly.” As harsh as it is, that would mean a 65-plus aged guy cutting his throat in regards to this and future board service, with only a lifetime of gin rummy at the club to look forward to.

Another e-mail asked the real tough question, “What is the solution?” I cannot actually specify “the” solution necessarily, but I think it lies somewhere in the shareholder/management loop. The problem, it seems, is the fact that companies have grown too large and management too aloof from the people that essentially hire and pay them, the shareholders. It does not seem the solution to have elected or appointed government officials charged with the responsibility of monitoring corporate management. Prosecution of fraud, yes, but insuring anything else, no. Sometimes I find it helpful to bring problems down to a simpler size. What if several of us decided to start a restaurant? We would raise capital and hire someone to run the place, and, if successful, raise more capital and open more locations. If somewhere along the growth line we allowed the manager to select the board, pay himself excessively, and stop paying us any disbursements, whose fault would that be? Ours. As long as there was no fraud, why would or should the government become involved? Maybe a simple snail mail or e-mail campaign by shareholders to board members saying, “ Hey Mr. Board Member, remember me, you work for me and I am watching” would be a good place to start. This would especially hold true for fund managers and large shareholders. From my experience, if these previously sheltered board members thought for a second that the normal shareholder knew who he was and had the nerve to find him it could make a huge difference. At least until I can think of something else.
   
As for the NYSE board, get real, and if there is any disagreement from the top you may want to avail yourself of any number of qualified candidates to replace your current chairman.

As always, I would love to hear your thoughts on this topic and any suggestions you may have for future articles.  I can be reached at tph@ptihedge.com.
   

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