Monday, March 31, 2008

New Governance, Compliance Standards for the financial industry in the making.

The Financial Stability Forum (FSF), which is a consortium of 26 National Authorities (including international financial institutions, Central Banks, regulatory and supervisory groups etc) met in Rome this past week, to contemplate on the current challenges facing the financial industry and the possible remedial measures that need to be in place in order to avoid a repeat of the current financial crises.

The FSF was put in place with a broad agenda for regulating, streamlining and stabilizing the international financial markets.

A few of the topics covered at the most recent meeting of the FSF held on March 29th include:

1.A report detailing the market weaknesses as well as ways to increase market resilience will be delivered to the Central Bank Governors of the G-7 countries. This report will indicate improvements in the current regulatory approach that may give rise to newer compliance requirements.The report outlines specific policy recommendations in the following areas: prudential oversight of capital, liquidity and risk management; transparency, disclosure and
valuation practices; the role and uses of credit ratings; the authorities’ responsiveness to risks and their arrangements to deal with stress in the financial system.

2. On the urging of the FSF, the hedge fund industry in both the U.K. and the U.S. are in the process of developing best practice standards. The level of adherence to these standards will be closely regulated and reported to the FSF.

3. The International Monetary Fund, (IMF) in close partnership with the Sovereign Wealth Funds (SWF) is coordinating work to identify a set of voluntary best practice guidelines, focusing on the governance, institutional arrangements and transparency of SWFs.A Sovereign Wealth Fund (SWF) is a state-owned fund composed of financial assets such as stocks, bonds, property or other financial instruments.SWFs are typically created when governments
have budgetary surpluses and have little or no international debt for eg. The Kuwait Investment Authority. The Organisation for Economic Co-operation and Development (OECD) is developing guidance for recipient countries’ policies toward investments from SWFs.
All these strategies clearly indicate that there will be an increase in the number and type of regulations geared toward the financial industry.Compliance laws will definitely go beyond Basel II and even the loosely regulated hedge fund industry will soon undergo a more comprehensive overhaul.

To add to this is the announcement by U.S. Treasury Secretary, Henry Paulson outlining the measures that he has in store for the ailing U.S. economy from a regulatory perspective:
1. Merge SEC and Commodity Futures Trading Commission bringing oversight of U.S. securities and futures markets under a single regulatory umbrella.

2. Eliminate the federal thrift charter, folding the Office of Thrift Supervision into the national bank regulator, the Comptroller of the Currency.

3. The blueprint also calls for a new Mortgage Origination Commission (MOC) with a director appointed by the president. "The MOC would evaluate, rate and report on each state's adequacy for licensing and regulation of participants in the mortgage origination process.

4. There would also be federal regulation of the insurance industry by establishing an Office of Insurance Oversight inside the Treasury Department.
Almost all of these recommendations will require legislation to put them into effect, and although according to Henry Paulson, increasing the number of regulations was not his intention in this overhaul, it seems obvious that this is going to be the case.

Keep checking back for updates.

Thursday, March 20, 2008

SocGen's Accounting: Innovative or Inventive?

Everybody has read, discussed and digested the multi billion euro trading loss that Societe Generale suffered a few months back. What has escaped public attention to a large extent is the subsequent accounting treatment of this loss.
The bank follows the IFRS (International Financial Reporting Standards) for the preparation of their financial statements and these have been audited by the company’s auditors (Messrs Ernst & Young and Deloitte).Investors and observers would have expected the huge trading loss that Societe suffered in January ’08 to be reflected in the first quarter financial results of this year.
According to Societe Generale’s special board committee that led its investigation into the trading incident, the trader had closed out most of his positions by the end of 2007. On that basis, such a trading loss should have been accounted for in the year that it occurred i.e. 2008. However, according to the bank’s Annual Report, it has been accounted for in the financial year 2007. This has been done by creating a provision equal to the amount of the trading loss in the consolidated 2007 income . Accounting for a loss that has not occurred in that relevant financial period is a very unconventional accounting treatment appearing to defy common accounting principles.

The Annual Report states,
“….. the Group considered that the application of IAS 10 “Events After the Balance Sheet Date” and IAS 39 “Financial Instruments: Recognition and Measurement” for the accounting of transactions relating to the unauthorized activities and their unwinding was inconsistent with the objective of the financial statements described in the F ramework of IFRS standards. For the purpose of a fair presentation of its financial situation , it was more appropriate to record all the financial consequences of the unwinding of these unauthorized activities under a separate caption in consolidated income for the 2007 financial year. To this end and in accordance with the provisions of paragraphs 17 and 18 of IAS 1 “Presentation of Financial Statements” the Group decided to depart from the provisions of IAS10 “Events After the Balance Sheet Date” and IAS 37 “Provisions, Contingent Liabilities and Contingent Assets”, by booking in the consolidated income for the 2007 financial year a provision for the total cost of the unauthorized activities.”

The International Accounting Standards include a rarely used provision related to ‘true & fair’ financial statements. This provision provides that “in the extremely rare circumstances in which management concludes that compliance” with the rules “would be so misleading that it would conflict with the objective of financial statements,” a company can depart from the rules. This is the loophole under which Societe Generale has decided to depart from the provisions of IAS 10 “Events occurring after Balance Sheet Date” and IAS 37 “Provisions, Contingent Liabilities and Contingent Assets”.

This departure in conventional accounting has been submitted to to the banking supervisorybody (Secrétariat général de la Commission bancaire) and to the market authority (Autorité des Marchés Financiers) to confirm its acceptability regarding the regulatory framework.

Keep checking The CG Factor for updates on this issue.

Tuesday, March 18, 2008

Credit Card Breach at Hannaford.

Corporate Governance (CG) is a term usually associated with CEO compensation, Board Composition, Director Independence etc. These are some of the factors that governance rating companies most commonly consider.

CG is the accountability or responsibility that a company has towards all its stakeholders. Now the word stakeholders conjures up images of shareholders, employees and other internal constituents of a company. An important often overlooked stakeholder is the customer and in the case of the retail industry, one of the most critical. Imagine a concentric circle within which you have the shareholders in the innermost circle followed by the management or employees, then the Board followed by vendors, customers, banks, regulators, and the circle gets bigger and the list gets broader. CG expectations mandate that the company presents itself as a responsible corporate citizen to not just its inner circle stakeholders but to the surrounding circles as well.

The credit card fraud at TJX and the most recent one (reported today)at Hannaford Bros Co., a grocery chain in the U.S. (a group company of Delhaize SA) are prime examples of instances where a company fails in fulfilling its responsibility towards its external stakeholders. The computer intrusion at TJX went on for 18 months before being discovered. The worst part was the audacity with which it was executed. There were 3 different ways in which the attack was carried out including one where the credit card processing terminal was replaced.

The Hannaford breach has reportedly affected close to 4.2 million credit and debit card numbers. The breach occurred at over 200 stores in the U.S. The modus operandi in this case as with TJX was breach during credit card transmission. Close to 2000 fraud cases related to this breach have already been reported. On the Hannaford company website, you will find the CEO’s apology to customers and a brief mention that they promise to cooperate fully with the authorities handling this probe. Now on the other hand if you visit the corporate website of Hannaford’s parent company (Delhaize SA), there is no mention of this credit card breach, no apology or update on steps being taken to combat this problem that was discovered on February 29th and this despite the fact that out of Delhaize’s 2545 stores, 1570 are based in the U.S. It would be interesting to find out whether the same procedures for credit card transmission were in effect in all its U.S. stores (beside Hannaford and Sweetbay, there is Food Lion). Another point to note, the company’s credit rating has been recently (Mar 11th) elevated by S&P to BBB- (investor grade positive outlook)from a BB+ (investor grade stable outlook).

Ironically, Hannaford was certified as PCI compliant last spring and once again in February

Wednesday, March 12, 2008

Spitzer and Bouton

Spitzer Vs Bouton.

This may seem like an odd comparison, one is in public service and the other obviously as private sector as you can get. But it just came to me last night as i sat there reading about Gov. Spitzer's resignation. They are not that different...there are some obvious similarities in their position, responsibilities, role model like expectations that arise from being at the helm of large entities.

The biggest difference in spite of all these similarities is that Spitzer, (atleast from whatever is currently known ) did not put the state's economy at peril nor did he erode 'shareholder'(in this case taxpayer) value and yet we are looking at his upcoming resignation. Which is not too say he should not resign. On the contrary, this was expected and in fact surprising that it did not come any sooner.

Bouton, on the other hand is the chairman of SocGen and it was on his watch that SocGen suffered massive losses. The circumstances of such losses point towards inadequate human resource management, loose internal controls and inadequate reviews and supervision and maybe even collusion. Nevertheless, Bouton continues as the bank's chairman. Under his leadership, SocGen raised capital to make up for the losses, took cover under one of the most obscure and rarely used accounting rule thereby booking their losses in financial year 2007 and are now looking ahead.

Why are we not yet looking at his resignation? What makes him so different? Don't SocGen shareholders care that this can happen again or don't the French believe that Bouton has failed in his moral obligation as a corporate leader. I guess they just threw Corporate Governance out of the (french) window!

Tuesday, March 11, 2008

Tax Dilemma over Vodafone-Hutchinson transaction-Part I

The facts:
  • Netherlands based Vodafone purchased a controlling stake in Hutchinson Essar,an Indian company. The sale price of $11billion was paid to Hutchinson, a Hongkong conglomerate.
  • The acquiring company paid the full amount to the selling company without witholding any capital gains tax that according to the Income Tax authorities in India should have been witheld and paid to the Government.

Amount Involved:

  • The capital gains tax would be around $2billion on the $11 billion sale.
Government's viewpoint:
  1. The acquiring company, in this case Vodafone, should have witheld capital gains tax on the transaction. The logic? Because the 'capital asset' is on Indian land i.e Hutchinson Essar, has operating assets in India.
  2. The 2008 budget proposed an amendment in Indian Tax laws that would strengthen its case in such situations. This amendment has yet to be enacted and will be debated when the Indian Parliament starts its next session on April 15th. The likelihood that this proposed change in the Indian Tax Law will be passed without opposition is extremely high.

Vodafone's viewpoint:

  • The transfer of shares took place outside India and therefore the taxability of such a transaction is outside Indian jurisdiction.


  • This has big implications for the future of M&A's to thrive in India. India is just emerging as a big player in the M&A world. This is evidenced by the possible, maybe even imminent Tata Motors take over of Jaguar for an estimated $2bill, Tata Steel's 6.7 billion pounds takover of dutch rival Corus etc. Taxing capital gains on such transactions would not be regarded as very positive and encouraging signal.

Big Dates:

  • April 15th- Parliamet resumes its session and will consider enacting the proposed changes to the Indian Tax laws relevant to this case.
  • June 23rd- Date on which Bombay High Court will resume hearing on this case.

Helping hand or playing musical chairs?

The Fed alongwith other central banks (ECB, Bank of England etc) announced plans to make available through loans, an additional $200mil to the ailing financial industry. This is being hailed as a great 'innovative' and timely assistance to the 'poor' and credit beaten banks.....but hold on a minute, let's back up a bit...what did they say they would accept as collateral? ...Unbelievably, the collateral for these loans is going to be the very same subprime assets that that have been the cause to begin with.

Now i don't claim to be an economist but how does this move truly help the current situation? It just means transferring these subprime assets to yet another lender which in this case means ultimately transferring it to the taxpayers.

Doesn't anyone feel that the banks really need to take responsibility for this? What kind of a message is this sending? That if they do this the next time they will be bailed out again?

Friday, March 7, 2008

(Un)Independent testing- A real shocker.

The Senate, yesterday, passed a bill aimed at cleaning up the U.S. Consumer Product Safety Commission. The purpose of this bill is to better control quality of children's toys that enter the market by providing guidelines on the testing that goes into getting the product ready to be launched into the market and ultimately reducing the number of defective and unsafe toys. An effort in the right direction, but very weird to say the least. To explain it very simply, they plan to hand over the testing to "independent" labs who in most cases have had very close relationships with the very same manufacturers whose products they are expected to test independently. Convoluted or wot?

After reading about the Senate Bill's efforts to clean up the , i wrote back to the author whose article i read on on some of my is the email...


Your commentary on the recent Bill on consumer safety made for very interesting reading. It is truly shocking to see the utter ignorance of the authorities on the simple concept of independence. How are these laboratories supposed to provide an independent assessment despite their proximity to toy manufacturers? The ‘independent in house testing’ quoted by CTL’s President is more of an oxymoron. Corporate America, it appears is always struggling to understand the true meaning of ‘Independence’ whether it is auditor independence or ‘Independence of outside experts’. It is always testing ways to stretch the limits a little more.

There are different elements of Corporate Governance, the most popular being CEO compensation, director independence and takeover defenses. But key corporate behavior at the grassroot operation level may reveal greater inconsistencies than those revealed by years of research into other more arcane and obviously well controlled areas such as board composition or proxy voting.

I would just like to conclude by saying that analysts need to look beyond the usual and into more chronic, repeated and often overlooked offenses to understand the true value of a company.



Thursday, March 6, 2008

Corporate (mis)Governance: The saga continues....

The ritzy and often glamorized world of deal making on Wall Street gets another slap on its face. With Fidelity's managers fined for accepting gifts and favors in exchange for placing their trades through the 'donors' trading desks, corporate governance in America Inc. takes yet another blow. Measuring Corporate Governance is more than weighing the composition of the Board or succession planning or takeover defences. Corporate Governance includes ethics from the grassroot level upto the highest level of a company.

The main accused in question, the prominent and well known Mr.Lynch (ex manager of FIdelity's highly popular Magellan Fund) was asked to pay $15,948 in disgorgement and $4,183 in interest to settle allegations. Please!! WIll somebody please tell me how this will prevent Mr.Lynch and company from repeating this? This is not even a rap on the knuckles....Kudos to the SEC for following up with these practices and pursuing the accused and ultimately penalizing...but $15948? Fidelity was also asked to pay $8 million to settle claims. But where is this money going to come from anyway? From Mr.Lynch and company? No way...Ultimately the shareholders.....

Hmmmm........I wonder how these situations are taken into account by Corporate Governance rating agencies....GMI, Corporate Library, ISS are you listening guys?

Look out for the Corporate Governance (CG) dashboard with updates of this and other CG blunders.