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PRAISE FOR
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The New Investor Relations 2
Expert Perspectives on the State of the Art 3
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Edited by Benjamin Mark Cole 5
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“This compendium by various experts adds significantly to 8
the body of knowledge related to contemporary investor relations 9
issues.” 10
LOUIS M. THOMPSON, JR. 11
President & CEO, National Investor Relations Institute 12
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“Executives of today’s public companies find themselves in two 15
businesses: their business, and the investor relations business. This 16
book is a useful tool for success in that second business.” 17
FREDRIC M. ROBERTS 18
Former chairman, National Association of Securities Dealers (NASD) 19
President and founder, FM Roberts & Co. 20
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“This compendium of guidance is required reading for all 23
those involved with public companies, whether they be blue chip 24
or microcap. Fifteen experts offer practical advice for dealing with the 25
new world of shareholder relations. These practitioners provide prac- 26
tical investor relations lessons on critical topics including IPOs, crisis 27
management, stock buybacks, M&A, the Internet, investments, pri- 28
vate placements, the press, rating agencies, and even chat rooms.” 29
THOMAS FOREST FARB 30
General Partner and Chief Financial Officer, Summit Partners 31
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“At last, here is a commonsense guide to an endeavor celebrated 34
little for common sense.” 35
MICHAEL J. KOSS 36
President and CEO, Koss Corporation 37
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A LSO AVAILABLE FROM B LOOMBERG P RESS
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2 Putting Investors First:
3 Real Solutions for Better Corporate Governance
4 by Scott C. Newquist with Max B. Russell
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6 Due Diligence for Global Deal Making:
7 The Definitive Guide to Cross-Border Mergers and Acquisitions,
8 Joint Ventures, Financings, and Strategic Alliances
9 edited by Arthur H. Rosenbloom
10
11 PIPEs:
12 A Guide to Private Investments in Public Equity
13 edited by Steven Dresner with E. Kurt Kim
14
15 Full Frontal PR:
16 Getting People Talking About You, Your Business, or Your Product
17 by Richard Laermer with Michael Prichinello
18
19 Investing Under Fire
20 edited by Alan R. Ackerman
21
22
A LSO BY B ENJAMIN M ARK C OLE
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The Pied Pipers of Wall Street:
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How Analysts Sell You Down the River
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A complete list of our titles is available at
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www.bloomberg.com/books
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1
BLOOMBERG PROFESSIONAL LIBRARY
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1
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11 PART 1: UNDERPINNINGS OF THE NEW ORDER
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13 1 Fundamentals of Investor Relations 3
14 Donald Allen, The Allen Group
15 What’s the Point? 4
16 Background on Corporate Disclosure 5
17 Understanding Disclosure and Materiality 6
18 Creating and Maintaining a Disclosure Policy 7
Regulation Fair Disclosure (Reg FD) 9
19
The Softer Side of Corporate Reporting 10
20 The Art of the Message 12
21 Targeting the Right Audiences 15
22 Outreach to the Investor 18
23 Need for Flexibility and Adaptability 21
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26 2 IR for Blue-Chip Companies: The New Look 23
27 Heather Harper, Hollis Rafkin-Sax, and Bryce Goodwin
28 Edelman Financial Communications
29 Where Are the Blue Chips Hiding? 24
30 A Buyer’s Market 26
31 Return of the Balance Sheet 27
32 Playing Defense 27
Investor Relations Today 28
33
Financial Reporting and Disclosures 30
34 Marketing the Company’s Investment Thesis 32
35 Corporate Governance Communications 33
36 Public Presence 36
37 Outlook for the Future 39
3 Litigation IR and the Duties of Corporate 1
Disclosure and Governance 41 2
Theodore J. Sawicki, Esq., and Scott P. Hilsen, Esq. 3
Alston & Bird LLP 4
How We Got Here 43 5
Restatement 46 6
Change in Investor Demands 46 7
The IR Challenge 53 8
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4 The IR-PR Nexus 59 11
David Silver, APR, Silver Public Relations 12
The New Paradigm 60 13
Reputation 62 14
Gatekeepers 63 15
Key Responsibilities 63 16
Regulation FD 65
17
Regulation G 66
The Need for Coordinated IR and PR Teams 67 18
The Rise of Public Relations 67 19
The Advent of Investor Relations 70 20
Today’s Integrated Function 71 21
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PART 2: IR IMPLICATIONS 24
FOR SELECTED FINANCING SCENARIOS 25
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5 Sustained Stock Buybacks: An IR Tool for
28
Mature Companies 77
29
Neil G. Berkman, Neil Berkman Associates
30
The Mergers Fallacy 79
31
Why Not Buy Back Stock? 81
32
Advantages of a Permanent Repurchase Program 82
Countering the Counter-Arguments 85 33
Float Consideration 87 34
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1 6 Investor Relations in M&A Transactions 89
2 John F. Hartigan, Esq., Morgan, Lewis & Bockius, LLP
3 Regulation M-A 90
4 Business Combinations 91
5 Proxy Solicitations 91
6 Cash Tender Offers 92
Benefits of the Amendments 93
7
Flexibility in Timing 93
8 Investor Access in Tender Offers 94
9 Potential Risks Created by the Amendments 94
10 Antifraud Provisions 96
11 “Plain English” Requirement 97
12 Regulation FD 97
Scope of the Rule 98
13
Materiality 99
14 Reg FD in Practice 100
15 Interplay Between Regulation FD and Regulation M-A 102
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19 7 Investor Relations for Private Placements 105
Alexander L. Cappello, Cappello Capital Corp.
20
Role of the IR Team 105
21
The Importance of Being Discreet 107
22
Don’t Oversell and Don’t Leak 107
23 Be Prepared for the Unexpected 109
24 Do What You Say You Will Do 110
25 Don’t Be Arrogant 111
26 You May Get Away With It, But Not for Long 112
Reap Dividends From Being Forthcoming and Honest 113
27
Don’t Let an Investment Banker Be Your IR Department 114
28
Generate Goodwill With Investors 116
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32 8 Investor Relations for the IPO 119
Douglas M. Sherk, EVC Group
33
Be Optimistic, But Be Realistic, Too 121
34
Getting Started 121
35
Peer Group 123
36 Operating Metrics 123
37 Analysis 124
Drawing Comparisons 125
Back to Those Operating Metrics 126 1
Revenue Forecast Reality Check 127 2
No Rose-Colored Glasses 127
3
Disclosure Policies and Procedures 128
4
Guidance 129
Disclosure and Crisis IR 130 5
The Presentation 132 6
IR Infrastructure 133 7
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4
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12 PART 4: SPECIAL CASE PERSPECTIVES
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14 12 IR for Non-U.S. Issuers Accessing the U.S.
15 Capital Markets 183
16 Sidley Austin Brown & Wood LLP, as edited by
17 Thomas E. McLain, Esq., and Yoshiki Shimada, Esq.
18 Preparing to Offer Securities in the United States 184
19 The Team 184
20 The Business Profile 184
The Jurisdiction of Incorporation 186
21
Corporate Governance and Disclosure 187
22
Accounting Matters 189
23 Communications With Investors and the Public 190
24 Press Releases 190
25 Materiality Standards 191
26 Duty to Disclose 191
Selective Disclosure 192
27
Antifraud Rules Under the 1934 Act 193
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Internal Controls 193
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32 13 Investor Relations and Microcap Companies 195
Ralph A. Rieves, Emerging Companies Research Institute
33 and John R. Lefebvre, Jr., Shareholder Relations
34
Attracting the Individual Investor 195
35
What Do We Really Know About Microcap Risk and Return? 196
36
Are Microcaps Diversification Plays? 198
37 The Size Effect 199
What Risk Premium? 200 1
Targeting Advisers to High-Net-Worth Investors 201 2
The Retail Broker 202 3
Brokers to Avoid 203
4
Attracting Institutional Investors 204
Understanding the Microcap Investment Manager 204 5
The Profit Challenge for Microcap Investment Managers 204 6
Benchmarking 205 7
Where Are the Market Makers? 206 8
The Cyberspace Aggravation 207 9
10
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14 IR and the Credit-Ratings Process 209 12
Clifford M. Griep, Standard & Poor’s 13
Role of Ratings Agencies 210 14
Composition of the Ratings Analysis 211 15
Quantitative and Qualitative Components 211 16
Rating Assignment 213 17
Request for a Rating 213
18
Conduct of the Management Meeting 216
Typical Agenda 217 19
When Capital Markets Tighten 218 20
Surveillance and Ongoing Maintenance Coverage 219 21
22
23
15 The Information Investment Managers Want 24
From Public Companies 221 25
Christopher N. Orndorff, CFA 26
Payden & Rygel Investment Co. 27
Institutional Investor Universe 222 28
Functional Categories 223 29
Strategy Orientation and Size 223 30
Institutional Investor Information Needs 226 31
Electronic Communication 226
32
Conference Calls 227
Face-to-Face Meetings 228 33
Know Your Stock and Its Place in the Universe 231 34
35
36
INDEX 235 37
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About the Contributors 3
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Donald Allen is founding partner of The Allen Group, an investor rela- 9
tions consulting firm based in Laguna Hills, California. Prior to forming 10
the consultancy, Allen worked for several public companies as director of 11
corporate communications and investor relations. He most recently held 12
that post with Quest Software, FileNET Corp., and Wonderware Corp. 13
He began working in IR in 1970 at Digital Equipment Corp. following 14
a stint in public relations and financial communications at Xerox Corp. 15
He began his career as a journalist with United Press International. Allen 16
holds a B.A. degree from the University at Albany, has studied in the 17
M.B.A. program at the University of Southern California, and has com- 18
pleted the Advanced Investor Relations Program at the Goizueta 19
Business School at Emory University. Allen serves on the Board of 20
Directors of the National Investor Relations Institute (NIRI), based in 21
Vienna, Virginia, is a member of NIRI’s Senior Roundtable, and serves 22
as the NIRI board’s representative to the Canadian Investor Relations 23
Institute (CIRI). He is also President of the Orange County (California) 24
chapter of NIRI, serves on the Board of Directors, and is a member and 25
former director of the Orange County chapter of the Public Relations 26
Society of America. (Chapter 1) 27
28
Neil G. Berkman is president of Berkman Associates, a Los Angeles– 29
based investor relations firm he founded in 1988. He notes that many of 30
his firm’s clients, companies of all sizes in a variety of industries around 31
the country, have implemented stock repurchase programs. Previously, 32
he established and managed the Los Angeles office of a New York–based 33
investor relations firm. From 1977 to 1981, Berkman was senior econo- 34
mist at the Federal Reserve Bank of Boston, where he conducted 35
research on topics in macroeconomics and monetary policy, and pub- 36
lished numerous articles in the New England Economic Review, as well 37
xiii
xiv ABOUT THE CONTRIBUTORS
1 was managing editor of the Georgia State University Law Review. While
2 in law school, Hilsen clerked for Justice Leah Sears of the Georgia
3 Supreme Court. He received an M.B.A. from Georgia State University
4 and a B.A. from the University of Florida. (Chapter 3)
5
6 John R. Lefebvre, Jr. has twenty-five years of experience in the securities
7 industry, having been trained by Merrill Lynch in the late 1970s. His
8 Colorado-based firm, Shareholder Relations, has performed investor rela-
9 tions work for more than seventy clients in twenty different industries
10 since 1988. Shareholder Relations runs cost-effective, pragmatic investor
11 relations campaigns designed to raise investor awareness and broaden the
12 shareholder base and has advised clients on matters as diverse as investor
13 relations, corporate development, and corporate finance. The website of
14 The Harvard Business Review said that Investor Relations for the
15 Emerging Company (a guidebook coauthored with Ralph Rieves) was
16 “a must read for anyone even thinking of going public.” (Chapter 13)
17
18 Thomas E. McLain is a partner in the Los Angeles office of Sidley
19 Austin Brown & Wood LLP. McLain’s practice concentrates on
20 international business and technology transactions. He advises both
21 international and domestic entities in joint ventures, private equity
22 investments, strategic acquisitions and investments, privatizations,
23 and restructurings. Significant transactions include negotiating the
24 rights to build Tokyo Disneyland, establishing the joint venture to
25 build and operate Osaka Universal Studios, and representing the Koran
26 Asset Management Corporation to sell portfolios of nonperforming
27 real estate loans and to restructure the foreign assets of Daewoo
28 Corporation. McLain is a trustee and member of the Executive
29 Committee of the Asia Society and chairman of The Asia Society
30 Southern California Center, a member of the Board of Directors and
31 Executive Committee of the Library Foundation of Los Angeles, and
32 a member of the Steering Committee for the Japan-American Young
33 Leaders Project of the U.S.-Japan Foundation. He has served as a
34 commissioner of the Japan-U.S. Friendship Commission and the
35 United States-Japan Conference on Cultural and Educational Inter-
36 change, as a director of the U.S.-Japan Bridging Foundation, and as
37 member of the Board of Visitors of the Terry Sanford Institute
ABOUT THE CONTRIBUTORS xix
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1
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Introduction 3
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9
T HE LANDSCAPE FOR WALL S TREET and publicly held American 10
corporations in the past several years has changed more than at any 11
time since the Great Depression, and with that, the operating envi- 12
ronment for investor relations professionals. Arguably, only the early 13
years of the Great Depression, with the seminal Securities Act of 14
1933 and the Securities and Exchange Act of 1934, resulted in 15
greater alterations for public companies than the reforms and changes 16
in sentiment resulting from the post-1990s meltdown on Wall Street. 17
Yet as important as relatively recent legal and regulatory changes 18
are—such as Regulation Fair Disclosure (Regulation FD) or the 19
Sarbanes-Oxley Act—Wall Street and publicly held companies were 20
already entering an environment much different from that existing 21
just a generation ago. A most notable advent has been the prolifera- 22
tion of financial media, especially electronic services. Few Americans 23
need to be reminded of the ubiquity of cable television, which ren- 24
dered “narrow casting” economically feasible. Amid the flood of new 25
shows were the all-financial stations, which now routinely air in news- 26
rooms and trading houses across the nation, seemingly incessantly. 27
And the Internet, with its marvelous ability to immediately present 28
and then archive news stories, press releases, and data, and its “chat 29
rooms” about company stocks—and rumor-mongering online 30
traders—was virtually unknown only a decade ago. Now, every com- 31
pany must consider the effectiveness of its website, at the minimum. 32
There has also been a floodtide of new business publications, as 33
well as a beefed-up Wall Street Journal, and a new national daily, 34
Investor’s Business Daily. Many major daily papers have expanded 35
their business coverage. One could contend, with just a little hyper- 36
bole, that it is difficult to live in any major city in America and not be 37
xxvii
xxviii INTRODUCTION
One can guess that in the years ahead, the intertwined fortunes 1
of stocks and wanna-be retirees will lead to a gathering level of 2
interest and concern about Wall Street, corporate governance, 3
and accounting standards, as has already begun. 4
Like so many other business sectors, Wall Street has been glob- 5
alized during the past twenty years. Many foreign corporations 6
now seek listing on U.S. exchanges, and many foreign compa- 7
nies often wish to buy U.S. companies. Oftentimes, such enti- 8
ties will have to learn to comply with the increasingly rigorous 9
U.S. regulatory mandates and accounting standards. 10
Though recently cooling, the last decade saw an unprecedent- 11
ed upsurge in mergers of public companies, a trend one can 12
expect to revive a bit when economic conditions allow— 13
although the M&A salad days may be over for good: Too many 14
mergers have not panned out, a fact that will force public com- 15
panies to concentrate on generating returns for shareholders 16
through improved operations, organic profits, or even share 17
buybacks. 18
New funding mechanisms have emerged, including much more 19
sophisticated financing for mergers and acquisitions (which 20
helped the M&A boom of the 1990s), and more recently, pri- 21
vate investments in public equity, or PIPEs. 22
Wall Street has become increasingly litigious, with seemingly 23
every stock plunge or accounting scandal bringing an onslaught 24
of lawsuits. 25
Proxy wars are likely to become more common, due to ever 26
more forceful shareholder activism. Mergers or expansion cam- 27
paigns that appear to be empire building and not in the inter- 28
ests of shareholders are more likely to be challenged. 29
30
Given all of the above developments, I have selected a retinue of 31
investor relations or Wall Street professionals to present their expert 32
opinions on the current status of investor relations, or IR. The roll 33
call is as follows: 34
Don Allen, IR practitioner and board member of the National 35
Investor Relations Institute bats lead-off, in Part 1, “Underpinnings 36
of the New Order.” Allen, together with IR authorities Heather 37
xxx INTRODUCTION
higher valuations. Like so much on Wall Street, that trend has turned 1
a bit quiescent for now, but nothing is permanent on the Street. 2
Moreover, there is talk of a tidal wave of Asian companies seeking 3
U.S. listings as the behemoth economy of China expands. Sidley 4
Austin Brown & Wood’s Tom McLain and Yoshiki Shimada explain 5
the requirements of doing business in a style acceptable for a U.S. 6
listing, which may compel foreign entities into some serious refor- 7
mulations of business practices. At times, something so elemental as 8
enforceable contracts with suppliers is missing in foreign companies, 9
warn Shimada and McLain. Any IR professional helping an offshore 10
company seek a U.S. listing should read this chapter, which intro- 11
duces the book’s Part 4, “Special Case Perspectives.” 12
Next up in this section of the book, Ralph Rieves, author and IR 13
consultant, with his colleague John R. Lefebvre Jr., contributes a 14
chapter on IR for emerging public companies, filled with guidance 15
both sage and timely, in light of recent events. Although readers, by 16
this point in the chapter lineup, may feel a bit beat about the head 17
with admonitions to be honest and frank, Rieves and Lefebvre point 18
up that emerging companies, too, must walk the walk if they want to 19
survive on Wall Street (and stay out of the courtroom or worse). 20
And though sometimes overlooked in this context, dealing with 21
the bond-rating agencies is also a critical part of IR, but it requires a 22
much different approach than that generally applicable in the equities 23
market. A fact perhaps not widely known, the credit-rating agencies 24
are privy to much information that is effectively “classified” and 25
would not otherwise be disclosed, except to all market participants. 26
In fact, there is a special clause in Regulation FD that allows the rec- 27
ognized rating agencies to have access to otherwise nonpublic infor- 28
mation, writes Chris Griep, of Standard & Poor’s, in Chapter 14. The 29
credit-rating agencies, like so much of Wall Street, have come under 30
fire of late, for not raising red flags early enough on such huge deba- 31
cles as WorldCom. One can assume a “get-tough” stance from rat- 32
ings agencies going forward, and nothing in this, the penultimate 33
chapter of the book, suggests otherwise. IR professionals are going 34
to have to play ball with the ratings agencies, and on their terms. 35
Finally (and maybe it should have been first), this volume includes 36
a chapter from a money manager, presenting a fresh consumer view on 37
xxxiv INTRODUCTION
Underpinnings 12
13
14
1 Fundamentals 2
3
4
of Investor Relations 5
6
7
DONALD ALLEN 8
The Allen Group 9
10
11
12
13
14
15
3
4 THE NEW INVESTOR RELATIONS
1
2 Understanding Disclosure and Materiality
3 The 1933 and 1934 acts define two types of disclosure: structured
4 and unstructured. Structured disclosure refers to explicit information
5 about a company’s operating results and must be provided in a pre-
6 cise manner, as stipulated in required SEC documents such as Form
7 10-K (annual financial report), Form 10-Q (quarterly financial
8 report), Form 8-K (event reporting), and other documents such as
9 registration statements, prospectuses, proxy statements, and the man-
10 agement discussion and analysis (MD&A) section of the annual
11 report to shareholders. The intent of setting such reporting standards
12 for all public companies was to provide a structure that allows
13 investors to easily compare corporate reporting and, in theory, better
14 evaluate a company’s performance relative to its peers and to other
15 industries.
16 Unstructured disclosure describes information that companies
17 may disclose at will, within certain broad guidelines. These implicit
18 disclosure obligations are defined under the general antifraud provi-
19 sions of the 1933 Securities Act, Rule 10b5, and include media such
20 as annual reports, letters to shareholders, press releases, advertise-
21 ments, speeches, investor meeting presentations, conference calls,
22 and telephone conversations with investors or analysts.
23 Because hard and fast rules are not specified under the act,
24 unstructured disclosure can have untoward results, especially if some
25 investors learn material facts that others don’t, or some investors con-
26 tend they were misled. Two major factors affect this type of unstruc-
27 tured disclosure: the definition of “material” information and what
28 constitutes an “insider.” In general, material information is knowl-
29 edge that would cause an ordinary person to make a decision to buy,
30 sell, or hold a stock. It’s basically any information that might change
31 someone’s evaluation of your stock—either upward (to buy), down-
32 ward (to sell), or reinforcing an opinion to hold the stock.
33 An insider is someone who is deemed to have material informa-
34 tion prior to its public disclosure and who thus cannot trade based on
35 that information—and cannot pass the information along to anyone
36 else to trade on it. There are several famous cases of insider trading.
37 For example, in a classic case involving IBM’s acquisition of Lotus
FUNDAMENTALS OF INVESTOR RELATIONS 7
1
2
FIGURE 1-1 Reg D Disclosure Requirements 3
4
Corporate information must be disclosed broadly to all audiences simul- 5
taneously. 6
Selective disclosure of material information is prohibited. 7
What is “material” often can be unclear, so when in doubt, disclose. 8
Selective earnings guidance will be the element most likely to trigger SEC 9
enforcement action. 10
11
12
a company. But theory is very different from practice, and potential 13
investors usually want to know considerably more about a company 14
than just what’s happened in the past. 15
In addition, formal financial reporting documents such as Forms 16
10-K (the annual report) and 10-Q (the quarterly report) are 17
required to include information about potential risk factors. These 18
risk disclosures, even when disclosed in dull boilerplate, can cast a 19
dark light on even the best prospects. The SEC also is exerting 20
greater pressure for the management discussion and analysis 21
(MD&A) section of the annual report to anticipate scenarios in which 22
revenues do not hit targets, and what that would mean in terms of 23
capital availability—in short, in what scenario would the company 24
run out of money? 25
To offset the negative, even “doomsday” impact of some of this 26
reporting, many IR programs create documents and presentations 27
that are based on the SEC disclosure documents, but that don’t 28
include the risk factors or the harsher portions of the MD&A. Such 29
presentations allow for more than mere reporting on activities. They 30
can provide a forward look at where a company is headed and how 31
management plans to get there. 32
This approach often involves discussions about nonmaterial infor- 33
mation that can help analysts and institutional investors create the 34
“mosaic” from which they form an opinion about a company’s 35
future. Just as a mosaic involves the creation of a large image from 36
many small pieces of tile, the mosaic theory allows analysts and 37
12 THE NEW INVESTOR RELATIONS
1 investors to create the big picture of operations from many small tid-
2 bits of information that, by themselves, wouldn’t be considered
3 material.
4 For example, there are many professional investors who believe
5 that predicting the future is close to impossible, so they back compa-
6 nies that have excellent management in place, come what may. To
7 reach such investors, management can be made accessible, at which
8 point managers should communicate their drive for profitable per-
9 formance, while honoring all corporate governance and disclosure
10 standards. Indeed, proactively assuring Wall Street that, due to exist-
11 ing conservative accounting practices, there will not likely be down-
12 ward earnings re-statements can be a wise course (in substance, as
13 well as in terms of IR).
14 Within SEC guidelines, there is considerable latitude to use non-
15 financial information to help “market” a company and its stock. This
16 can take the form of news releases, annual reports, company profiles,
17 investor relations Web pages, fact books, speeches at financial confer-
18 ences, and even shareholder information packets. It’s all a matter of
19 defining who you are as a company and what type of investment
20 opportunity you therefore represent to potential investors. Once
21 these elements are defined, do targeted research to find those
22 investor types and begin communicating with them. It’s a classic mar-
23 keting situation—only now you’re marketing your company, not just
24 your products. Your target audiences hopefully will want to hear all
25 about you and they’ll want to get to know your top management and
26 build relationships with them in the process.
27
28
29 The Art of the Message
30 Message development focuses mainly on why a company is a good
31 investment prospect. As noted, a lot of important company facts have
32 nothing to do with financial information. To go beyond merely
33 reporting the results of operations, however, consider the investors’
34 perspective and develop answers to the basic questions they will ask.
35 Be prepared to tell them why they should invest in your company. If
36 they’re already shareholders, explain why they should continue to
37 hold the company’s stock or perhaps buy more. And provide analysts,
FUNDAMENTALS OF INVESTOR RELATIONS 13
1 ❏ Show how your margins give you cost or price advantages and,
2 therefore, higher profitability and cash generation.
3 ❏ Show the advantages of your strong marketing and sales organ-
4 izations.
5 ❏ Explain your corporate culture and how it’s helped to build a
6 smart management team as well as an extraordinary family of employ-
7 ees. Included in this idea of culture should be that the company follows
8 strict ethical and corporate governance standards. This minimizes the
9 risk of a “time bomb” in the form of earnings restatements or a sudden
10 exodus of top management. Investors increasingly want to know that
11 management is ethical.
12 ❏ Show how you not only have the ability to generate strong
13 internal, organic growth but also have the management capabilities to
14 make heavily screened acquisitions that can help the business grow
15 and round out your market offerings through external additions of
16 new technologies, products, or other elements. However, be aware
17 that the M&A growth story is a tattered one, as the vast majority of
18 M&A campaigns flop. Talk along the lines of a few, very heavily scru-
19 tinized acquisitions, or that (if market values fall low enough) you are
20 buying on the cheap, well below replacement cost.
21 ❏ Show that the administration knows how to manage money, so
22 you’re able to fund future operations as well as earn income on
23 invested cash. A permanently funded stock buyback program can be
24 a component of this money management expertise. Such a program
25 also shows shareholders you care about them, not just about build-
26 ing a bigger empire. The name of the game is increasing earnings per
27 share, not expanding executive profiles and compensation.
28 ❏ Show that your company knows how to find new applications
29 for its existing technology and products.
30 ❏ Show that you can enter new markets to capitalize on existing
31 or related skills.
32 ❏ Show that you’re globally oriented, positioned to take advan-
33 tage of world markets and greater growth opportunities.
34
35 This type of information is the foundation on which you’ll create
36 multiple media opportunities for reaching prospective investors. Such
37 information will find its way into everything you publish and say.
FUNDAMENTALS OF INVESTOR RELATIONS 15
1
Need for Flexibility and Adaptability 2
Perhaps the greatest attribute you can develop in your investor rela- 3
tions program is to be flexible and adaptable over time. Good IR is a 4
moving target, and although you should do your best to operate 5
within the perimeters of the regulations promulgated by the SEC and 6
FASB, not all of your communications efforts will be planned in 7
advance. There will be times when you’ll need to implement crisis 8
communications activities—such as responding to financial or market 9
crises related to your information programs or providing a response 10
about the implications of unplanned corporate events such as prod- 11
uct defects, recalls, plant disasters, or labor issues. For this reason, it’s 12
important that any major IR program includes good “inbound” 13
communications to company management. No one can work well in 14
a vacuum, so everything that executives do must be done relative to 15
the environment in which they operate. Management doesn’t decide 16
a company’s value, shareholders do. 17
Some IR shops annually poll their largest ten or twenty share- 18
holders with standard questionnaires, to find out how management 19
and the company are viewed. Often they discover that a certain 20
planned venture or corporate executive is not well received. That’s 21
why feedback to management is more important than ever. It’s essen- 22
tial to have an IR person or staff personnel who can maintain good 23
contact with the investment community and advise management on 24
what should be done, rather than the other way around. That com- 25
munications loop must be closed in order to achieve the most suc- 26
cessful investor relations program possible. 27
28
29
30
31
32
33
34
35
36
37
1
2 IR for Blue-Chip 2
3
4
Companies: The New Look 5
6
7
HEATHER HARPER 8
HOLLIS RAFKIN-SAX 9
10
BRYCE GOOD WIN 11
Edelman Financial Communications 12
13
14
15
23
24 THE NEW INVESTOR RELATIONS
fidence and built reservoirs of goodwill that can insulate them from 1
the effects of momentary spikes in negative public opinion. 2
Historically, companies that came to be considered blue chips 3
seemed to hold the distinction almost indefinitely. However, actions 4
at companies such as Enron and WorldCom showed that breeches of 5
trust can and will revoke membership in the blue-chip club. Similarly, 6
the rise of entrepreneurs and the Internet in the late 1990s present- 7
ed challenges to established business models, taking its toll on the 8
ranks of companies once considered invincible blue-chip performers. 9
As a result of these recent business dynamics, we have seen a rad- 10
ical transformation in the leading blue chip sectors. For example, 11
numerous companies in the quintessential blue-chip industry—utili- 12
ties—plunged into deregulated markets and speculative trading to 13
compete with the faster growing companies of the 1990s. In the 14
process, these firms fundamentally altered not just their business 15
models but also their basic investment thesis in an attempt to remain 16
attractive to investors. At the same time, Microsoft—just a fledgling 17
start-up in 1975—now has a market capitalization of more than $250 18
billion, is paying a dividend, and ranks high on many investors’ lists 19
of dependable new economy blue chips. 20
In facing these market changes, it is certain that previously 21
unquestioned industry leaders can no longer take their position for 22
granted. Now, more than ever before, market leaders and emerging 23
companies that seek to join the blue chips as peers have to actively 24
and effectively communicate their accomplishments in the areas of 25
returns, risk, and reputation that truly define the blue-chip category. 26
With accounting scandals and widespread allegations of aggressive 27
bookkeeping, investors are questioning quality of returns as well as 28
actual reported figures. As the market scrutinizes earnings quality and 29
the Securities and Exchange Commission (SEC) helps weed out cases 30
of misleading financial reporting, the other two factors that define 31
the blue-chip category—low risk and first-rate reputation—are 32
becoming an even higher priority for investors. Addressing these 33
areas of investor interest in an effective way is an increasingly sophis- 34
ticated and complex task, considering the dynamics in the market, 35
proliferation of media and information sources, new securities regu- 36
lations, and the changing role of securities analysts. 37
26 THE NEW INVESTOR RELATIONS
41
42 THE NEW INVESTOR RELATIONS
1
2
FIGURE 3-1 Lawsuits Filed Against Public Companies 3
4
Year Number of Filings9 5
1996 122 6
1997 167 7
1998 245 8
1999 207 9
2000 201 10
2001 48310 11
2002 18011 12
13
14
these cases lead to settlement—and a job for an IR professional 15
explaining to investors and rating agencies the true fallout of the set- 16
tlement. 17
Also worth noting is that the stakes are higher than ever before. 18
Public companies that were sued in 2001 lost more than $2 trillion in 19
market capitalization combined during the class period (the period in 20
which shareholders lost value), which was 157 percent greater than 21
the losses of all the companies sued in shareholder class actions in 22
2000.12 Cisco Systems, Inc. has the dubious honor of leading the 23
pack with a loss of $331 billion in market capitalization during its 24
class period from August 1999 to February 2001, followed by Intel 25
Corporation with a $231 billion loss.13 Enron Corp. placed sixth 26
with a $60 billion drop in market capitalization.14 No wonder 27
investors are peeved. 28
These vast losses have, not surprisingly, led to a dramatic increase 29
in the size of settlements. Prior to the passage of the Reform Act, the 30
average settlement in a securities class action was just under $8 mil- 31
lion.15 By 2001, the average settlement value increased almost 150 32
percent to $17.2 million.16 When allegations of improper accounting 33
practices are added to the mix, lawsuits filed in 2001 cost 280 per- 34
cent more to settle than nonaccounting cases.17 It is clear that proper 35
accounting procedures, good corporate governance, and solid IR 36
have a role in minimizing legal costs. 37
46 THE NEW INVESTOR RELATIONS
1
2 Restatement
3 The most dreaded word in financial reporting is restatement. In
4 today’s litigious environment, a company that restates financial state-
5 ments, except perhaps as a result of an accounting change, virtually
6 guarantees that it soon will be a defendant in a securities class action.
7 IR professionals would be well-advised to prepare battle plans well
8 before a restatement is issued. Restatements are considered by plain-
9 tiffs’ lawyers as nothing less than an admission by the company’s
10 management and auditors that its accounts were materially misstated.
11 It therefore should come as no surprise that the most significant set-
12 tlements have resulted from restatements. For example, Cendant Corp.
13 recently restated earnings and was compelled to settle a class action for
14 $2.83 billion.18 MiniScribe Corp. settled a restatement case for $550
15 million, and Waste Management Inc. settled for $220 million.19
16 Restatements have increased every year since the Reform Act,
17 from 116 in 1997 to 270 in 2001.20 Investor relations professionals
18 may wish to note that no industry sector is immune to restatements.
19 From 1997 to 2001, 25 percent of companies in the manufacturing
20 sector restated financial statements, 16 percent of all software com-
21 panies announced a restatement, and 10 percent of service companies
22 had a restatement.21 Thus, it is highly advisable for investor relations
23 professionals to have contingency plans on the shelf, in the event of
24 a restatement. Of course, IR professionals should always counsel
25 clients that conservative accounting procedures, indeed procedures
26 relatively immune to restatement, might be a course well worth con-
27 sidering.
28
29 Change in Investor Demands
30 Whereas the revolution of securities laws in the 1930s focused on
31 periodic disclosures, the paradigm shift in 21st century disclosure
32 philosophy is that of instant transparency. No longer are public com-
33 panies allowed to reserve disclosures for periodic filings. With the
34 dawn of instantaneous communication through the Internet, web-
35 casting conference calls, real-time market participation, the wire serv-
36 ices, and the growing practice of “preannouncements” (making early
37 announcements that the company will not make quarterly earning
LITIGATION IR: CORPORATE DISCLOSURE AND GOVERNANCE 47
1 out suggesting that directors and officers are making themselves bul-
2 let proof, despite wrongdoing. The reality of increased executive lia-
3 bility, it should be noted, can also be a legitimate angle for an IR
4 professional to pursue. “I don’t think the chief executive would do
5 anything to endanger his own finances,” is an argument with merit.
6 Another consequence resulting from changing investor demands
7 has been reforms to executive compensation practices. The primary
8 source of executive compensation over the past decade has been stock
9 options.44 Options ten years ago accounted for only 27 percent of
10 median compensation to CEOs, compared to 60 percent today.45
11 Some critics have contended that one effect has been to push execu-
12 tives into focusing on short-term stock price gains instead of valuing
13 the long-term health of a company.46 Some have also complained that
14 CEOs and CFOs, worried about their options, approved accounting
15 procedures which inappropriately propped up stock prices. However,
16 stock options remain an appealing way to align executive and share-
17 holder interests, something IR professionals need to emphasize to
18 investors.
19 Still, when corporate executive salaries and bonuses reach stratos-
20 pheric levels, IR personnel are the first to hear complaints. Indeed,
21 some famous investors with followings, such as Warren Buffett, have
22 lamented about executive compensation. IR professionals will have to
23 work in a climate in which big compensation carries with it not an
24 aura of great success but a whiff of cronyism, or even corruption.
25 Executives like Kenneth Lay of Enron Corp. and Bernard Ebbers of
26 WorldCom, Inc. made millions, even hundreds of millions, while
27 their companies crumbled, leaving shareholders and employees
28 empty-handed. Jack Welch, the retired chairman of General Electric
29 Corp., was provided with a retirement package—since amended in
30 the harsh light of the bear market—that included a $9 million-a-year
31 pension, use of a company jet, a shining new Mercedes-Benz, and
32 tickets to premiere events.47
33 Moreover, the disparity between executive and corporate earnings
34 has dramatically increased, surely causing even more disgruntled
35 investors. According to a recent study of twenty-three companies
36 under investigation for accounting practices, the top executives pock-
37 eted $1.4 billion in compensation during the past three years, while
LITIGATION IR: CORPORATE DISCLOSURE AND GOVERNANCE 53
1 18. William Cotter and Chris Barbee, National Union Fire Ins. Co. of
2 Pittsburgh, Pa. 2002 D&O White Paper, 6.
3 19. Ibid.
20. William Cotter and Chris Barbee, 7.
4
21. Ibid.
5
22. Sullivan & Cromwell, memorandum entitled “Congress Passes Broad
6 Reform Bill in Substantially the Form Passed by the Senate Last Week:
7 President’s Signature Expected Shortly,” July 26, 2002.
8 23. H.R. 3763, 107th Cong. § 401(a)(2002)(enacted)(“Sarbanes-Oxley”).
9 24. Sarbanes-Oxley, supra note 23, § 409.
25. Sarbanes-Oxley, supra note 23, § 401(a). Pursuant to Title IV, Section 401
10
of the Act, the SEC must adopt these rules within 180 days of the enactment of
11
the Act.
12 26. Sarbanes-Oxley, supra note 23, § 401(b). Pursuant to Title IV, Section 401
13 of the Act, the SEC must adopt these rules within 180 days of the enactment of
14 the Act.
15 27. Sarbanes-Oxley, supra note 23, § 404(a).
28. Ibid. A similar requirement was enacted in 1991 and has been imposed on
16
depository institutions through Section 36 of the Federal Deposit Insurance
17
Act.
18 29. Sarbanes-Oxley, supra note 23, § 302(a).
19 30. Sarbanes-Oxley, supra note 23, § 304(a).
20 31. Sarbanes-Oxley, supra note 23, § 306(a).
21 32. Sarbanes-Oxley, supra note 23, § 804(a).
33. Sarbanes-Oxley, supra note 23, § 803.
22
34. 511 U.S. at 177, 114 S. Ct. at 1448.
23
35. Ibid.
24 36. Senators Richard Shelby (R-Ala.) and Richard Durbin (D-Ill) introduced
25 legislation in February 2002 that would have added liability to aiders and abet-
26 tors. The bill, however, was denied in a vote on the Senate floor. Similarly, the
27 House Financial Services Committee rejected a bill on a party-line vote that
would have clarified the Supreme Court’s decision. Shawn Zeller, “Holding the
28
Line on Investor Lawsuits,” National Journal (July 27, 2002).
29
37. Ibid.
30 38. Accounting Industry Oversight Board Before The House Committee on
31 Financial Services, 107th Cong. 2d Sess. (April 9, 2002), testimony of Professor
32 Donald C. Langevoort.
33 39. Dan Carney, “Don’t Toss This Stock-Fraud Law. Just Fix It,” Business Week
(August 5, 2002).
34
40. Lisa Girion, “Battling Over Shareholder’s Right To Sue,” Chicago Tribune,
35
August 6, 2002.
36 41. Ibid.
37 42. Ibid.
LITIGATION IR: CORPORATE DISCLOSURE AND GOVERNANCE 57
43. William Cotter and Chris Barbee, National Union Fire Ins. Co. of 1
Pittsburgh, Pa. 2002 D&O White Paper at 15. 2
44. Tim McElligott and Toby Weber, “Drum Beat of Reform Grows Louder,” 3
Telephony (September 23, 2002).
4
45. Ibid.
5
46. Ibid.
47. “Companies Should Heed Ethics Recommendations,” Austin American- 6
Statesman, September 23, 2002. 7
48. Sally Roberts, “CEO Pay Draws D&O Scrutiny, Underwriters Looking Closer 8
At Compensation, Corporate Boards,” Business Insurance (September 16, 2002). 9
49. Ibid.
10
50. Tim McElligott and Toby Weber, “Drum Beat of Reform Grows Louder,”
11
Telephony (September 23, 2002).
51. “Semantic Hair-Splitting May Stall Current Disclosure’s Adoption,” Investor 12
Relations Business (September 23, 2002). 13
52. Ibid (comments of National Investor Relations Institute Chairman Lou 14
Thompson). 15
53. Ibid.
16
54. Ibid.
17
55. Ibid.
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
1
59
60 THE NEW INVESTOR RELATIONS
1
2 The New Paradigm
3 In the wake of the Wall Street scandals about ersatz brokerage
4 research and creative accounting—and the resulting tougher regula-
5 tory environment—there is a new investor relations and public rela-
6 tions paradigm for public companies to follow, if they wish to use the
7 mass media to get their story to institutional investors and the 100+
8 million individual investors. The more than 8,000 public companies
9 listed on Wall Street must consider coordinating, if not proactively
10 merging, their IR and PR programs. There is little sense anymore in
11 treating institutional investors as important and serious through a
12 cogent and significant IR program, while having a Wild West—or
13 even unrelated or underfunded—PR campaign underway.
14 In addition, IR and PR professionals, while working and talking
15 with each other, must become familiar with the phalanx of new and
16 stringent federal regulations governing corporate disclosure. Ideally,
17 corporate managements should be secure in turning to their IR/PR
18 staffs for guidance on proper and timely disclosure (although IR and
19 PR staffers should never presume to walk on a legal counsel’s turf).
20 The convergence of IR and PR has become so important that not
21 combining those functions could have negative consequences for a
22 public company’s share price. Today it is a fiduciary responsibility of
23 management and directors to make sure IR and PR work together (at
24 the minimum), and certainly not at odds. Although certainly acceler-
25 ated by Wall Street ethics issues, the need for blending IR and PR has
26 been building since the 1980s. The market capitalization of public
27 companies is increasingly determined by “intangibles,” which include
28 a solid senior management team; employee satisfaction; and ethical,
29 but profitable, business partnership arrangements. But the most
30 important intangible is a company’s reputation. In particular, Wall
31 Street must trust management and its accounting procedures.
32 Some market studies indicate that as much as 40 percent of a com-
33 pany’s market capitalization is determined by the intangibles. That
34 percentage probably rose even higher in the late 1990s, although
35 maybe not for the right reasons. By the 1990s a typical company’s
36 book value represented less than half its market capitalization, which
37 still holds true in this decade.
THE IR-PR N EXUS 61
1 dated but also illegal. Given that reality, there never has been a bet-
2 ter opportunity for public relations and investor relations executives
3 to become trusted and important advisers to boards, CEOs, and
4 CFOs to help interpret and communicate important information
5 about a company’s financial health and reputation to the financial,
6 legal, and mass media.
7 This new role has been recognized within certain industry groups,
8 including the Washington, D.C.–based National Investor Relations
9 Institute (NIRI). NIRI recently created the Center for Integrated
10 Communication to deal particularly with issues of IR and PR inte-
11 gration. President Louis Thompson Jr. declared that the center
12 would advocate the importance of integrated corporate communica-
13 tion, conduct or foster research on integration as it relates to corpo-
14 rate value creation, and provide development opportunities for IR
15 and PR professionals.
16
17
18 Reputation
19 To get a premium price for a stock based upon the fundamentals,
20 there are three things that really count: (to borrow an approach from
21 real estate mavens) reputation, reputation, and reputation.
22 Every company has a story to tell, be it growth, or share buybacks,
23 or value. Presumably, that story should be self-evident to manage-
24 ment and IR and PR professionals, and not hard to repeat to
25 investors. (If you don’t know what your story is, you are soon going
26 to need a lot more than just IR and PR help.) The reputation of a
27 company determines how much faith Wall Street investors place in a
28 story. That reputation, by and large, is earned by being able to talk to
29 investors, analysts, and the financial media quickly, cogently, and
30 without an “attitude.”
31 Yet many a public company operates on a daily basis without
32 understanding the crucial importance of managing its number one
33 asset: reputation. Sometimes companies let calls from financial news
34 reporters go unanswered or refuse to comment on rumors, even ones
35 that are patently false. Recently a publicly held real estate investment
36 trust (REIT) listed on the Big Board did not respond to a reporter’s
37 question about whether a dividend would be maintained (a very
THE IR-PR N EXUS 63
1 handlers of the “dog and pony shows” on Wall Street. But not any-
2 more. Today’s IR and PR officers must understand regulatory man-
3 dates and obligations that affect their jobs, while at the same time
4 alertly fielding questions from institutional investors, analysts, and
5 the media.
6 The IR/PR team must also decide (with management approval)
7 how to package the company “story” so that it is consistent and true.
8 Shading the story for retail or institutional investors or the financial
9 media simply doesn’t hack it anymore. In addition, and as impor-
10 tantly, the IR/PR team must actively put management before
11 investors and the media (naturally, it helps if management is charis-
12 matic, but intelligence and earnestness will carry as much weight on
13 most days). With investors retreating from equities, and with more
14 than 8,000 public companies competing for the investor dollar, pub-
15 lic company management must be proactive in meeting with
16 investors and the media. Wallflowers rarely make the party happen.
17 Naturally, there will be managers who do not feel like being
18 “paraded around” to handle reporter’s questions, or being “brought
19 out on the carpet” in front of institutional investors. Their reserva-
20 tions will be greatest during or after any bad quarter. The IR/PR
21 team must try to convince management that running a public com-
22 pany inevitably entails public obligations, much like holding public
23 office. Part of the job, given the enormous power of institutional
24 investors and the pervasiveness of the media, is to be the company’s
25 face. Management teams cannot hide from investors and the media
26 and expect to be trusted. Shareholder value will suffer. Anything that
27 hurts market capitalization is a breach of fiduciary responsibilities to
28 shareholders.
29 At times, getting management on board is a difficult task. Many
30 managers are accustomed to being answered to, not the other way
31 around. However, the appeal of being in the media is also great. In
32 addition, institutional shareholders tend to be a rather genteel lot
33 when discussing matters affecting their stock value.
34 Meanwhile, it will fall upon the IR/PR team to develop new rigor
35 in regards to the chairman’s letter (which accompanies annual
36 reports) and, critically, the management discussion and analysis sec-
37 tion of annual 10-K and quarterly 10-Q filings. In particular, liquid-
THE IR-PR N EXUS 65
1 This was, and is, a seriously flawed response to Reg FD. Indeed,
2 some companies have been hammered on Wall Street, as they choose
3 to be mute, while the investing public is being drenched in media
4 stories about corporate fraud and accounting shenanigans.
5 The markets can be efficient only when company IR/PR officers
6 communicate sufficient and appropriate information to a wary invest-
7 ing public so that investors can understand, value, and feel comfortable
8 with a company’s stock. Therefore the IR/PR teams’ disclosure of
9 material information on an ongoing basis will be seen as maintaining
10 market efficiencies and fair valuations for those public companies.
11 On another level, Reg FD is good argument for the coordinating
12 of IR and PR teams. The same message has to be delivered simulta-
13 neously to everybody. A company cannot deliver materially different
14 messages to different groups of investors or analysts, or give material
15 information to institutional shareholders, but not to the financial
16 media. If IR and PR are not coordinated, mixed, possibly illegal, mes-
17 sages could result—to nobody’s benefit.
18
19 Regulation G
20 In 2003, the Securities and Exchange Commission (SEC) adopted
21 Regulation G regarding earnings release disclosure requirements. This
22 ruling affects both investor relations and public relations professionals
23 at publicly traded companies. In fact, its adoption was considered so
24 important that NIRI issued an executive alert on Regulation G for its
25 thousands of members.
26 The NIRI clarification is worth mentioning. Briefly, if a public com-
27 pany issues an earnings release, then the SEC requires the company to
28 furnish the earnings release under the new item 12 of an 8-K,
29 whether or not the earnings release contains non-GAAP information.
30 If a company uses non-GAAP information in the earnings release, the
31 information must be reconciled with the relevant GAAP information
32 in the release. GAAP information must be presented with the same
33 prominence as the non-GAAP information. Additionally, the release
34 must state why the non-GAAP information is relevant.
35 Public companies that present information regarding a completed
36 reporting period during an accessible conference call do not have to
37 provide this information in a Form 8-K after the conference call if:
THE IR-PR N EXUS 67
tions counsel until his death in 1995 at 103 years. In many regards, 1
Bernays laid the theoretical groundwork for the field of public rela- 2
tions in 1923 with his seminal work Crystallizing Public Opinion. 3
Much of his work remains cogent today, in that it recommends 4
proactive PR. 5
Bernays pioneered the technique of using “third party authori- 6
ties” to plead for his clients’ causes. “If you can influence the leaders, 7
either with or without their conscious cooperation, you automatically 8
influence the group which they sway,” he wrote. In order to promote 9
sales of bacon, for example, he conducted a survey of physicians and 10
reported their recommendation that people eat hearty breakfasts. He 11
sent the results of the survey to 5,000 physicians, along with public- 12
ity touting bacon and eggs as a hearty breakfast. 13
Bernays’s clients included President Calvin Coolidge, Procter & 14
Gamble, CBS, the American Tobacco Company, General Electric, and 15
Dodge Motors. To this day, corporations that commission “independ- 16
ent” studies are following in the footsteps of Bernays (although the 17
public has grown a lot more skeptical of industry-financed studies). 18
As important as these pioneers are, it is more important to 19
remember that they operated in an era before the huge upsurge of 20
financial media, particularly the electronic media. Giants they may 21
have been, but they didn’t have to wrestle with CNN, or Yahoo! 22
company websites and message boards. They navigated a world dom- 23
inated by general circulation newspapers and magazines, many of 24
which were susceptible to skilled PR campaigns, perhaps backed up 25
by advertising dollars. 26
As a result, corporate PR emerged first, and separately from IR, 27
and was thought of more in connection with marketing, government 28
relations, and general corporate image campaigns. 29
The public relations profession is changing rapidly, and for the bet- 30
ter. Bernays and Lee would be very impressed with how the reputa- 31
tion of the field is being elevated, most recently by the federal courts. 32
In a groundbreaking ruling in a federal court in New York in June 33
2003, the judge ruled that legal advice that is intended to shape pub- 34
lic opinion and that is part of discussions between lawyers and public 35
relations executives and individuals under investigation (such as 36
Martha Stewart, among other Wall Street corporate executives) is 37
70 THE NEW INVESTOR RELATIONS
IR Implications 12
13
14
for Selected 15
16
17
18
Financing Scenarios 19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
1
Mature Companies 7
8
9
10
NEIL G. BERKMAN
11
Neil Berkman Associates 12
13
14
15
W ALL S TREET AND THE financial media love the explosive earn-
ings-growth story, the next Microsoft, the next Amgen, the
Next Big Thing. They love the story, even though in reality the com-
16
17
18
pany they are chasing could be the next Tyco International, Worldcom, 19
Enron, or Global Crossing. 20
So how do you run an established, solid, profitable company and 21
keep the earnings-growth story alive? It’s common knowledge that 22
most merger-and-acquisition campaigns fail. Yet if your firm respon- 23
sibly sticks to its knitting, there is a strong possibility your stock will 24
be overlooked among the more than eight thousand publicly held 25
enterprises and trade at a lower price/earnings ratio than any num- 26
ber of flimsy but hyped unseasoned stocks. 27
Investors may be fickle, but they are your shareholders. In days 28
of yore, established companies paid good dividends and produced 29
slick annual reports to foster loyalty. Modern tax planning eschews 30
dividends, which, even after the 2003 tax cuts, on average, are 31
taxed at higher rates than capital gains. And hardly anybody is seri- 32
ously impressed by well turned-out annual reports in this era of 33
online filing with the Securities and Exchange Commission. 34
Nevertheless, it should be remembered that only a generation ago, 35
paying dividends regularly was seen as a reassuring sign of financial 36
strength. 37
77
78 THE NEW INVESTOR RELATIONS
1
The Mergers Fallacy 2
There are tempters aplenty for managements who seek overnight 3
facelifts for their mature companies. Wall Street is full of profession- 4
als who brandish merger plans as corporate fountains of youth. 5
Investment bankers are expert at identifying likely candidates and 6
arranging financing, and they will aggressively call upon public- 7
company executives unbidden. 8
Investment bankers know how to package and sell a proposed 9
acquisition to company management and investors. They know how 10
to make even the most mundane transaction look attractive, loaded 11
with a magic “synergy” that will sustain rapid growth for years to 12
come and be “accretive” to earnings. Besides, it’s fun to make acqui- 13
sitions. The road shows, the meetings with professional investors, the 14
travel are exciting, at least for a while. There is the undeniable thrill 15
of being at the helm of a larger company, having more underlings, the 16
perceived muscle to move into new markets and gain access to larger 17
lenders and institutional investors. And if the benefits turn out to be 18
more apparent than real, the remedy is simple: Do another deal, or 19
jump ship to another company, leaving shareholders to hold the bag. 20
This acquisition strategy always works for the bankers and the bro- 21
kers, whose fees are paid regardless of the outcome. The strategy even 22
works on rare occasions for the companies involved, although the 23
investment universe is littered with the remains of acquisitions gone 24
sour, synergies that failed to materialize, cost-reduction programs 25
that somehow didn’t lower costs, and once-lofty multiples that are 26
now nothing but painful memories. For an excellent account of the 27
perils of M&A mania, see Profit From the Core, by Chris Zook and 28
James Allen (Harvard Business School Press: 2001). 29
The M&A strategy is analogous to the hare in the fabled race 30
between the tortoise and hare. The prosaic alternative to the M&A 31
rush for huge profits is the share buyback plan, executed slowly and 32
relentlessly, just as the tortoise walks. It’s easier to increase earnings 33
per share when the share count is falling and you are demonstrating 34
to Wall Street that you have extra cash, and thus the financial 35
strength, to buy back shares every year. You are also demonstrating 36
to Wall Street that you would rather put money in shareholders’ 37
80 THE NEW INVESTOR RELATIONS
1
Countering the Counter-Arguments 2
The suggestion that a company initiate a stock repurchase program 3
often elicits groans from management, which may incorrectly see the 4
adoption of a buyback plan as an admission to Wall Street that the 5
company has exhausted its high-growth investment opportunities. 6
A typical response is “I didn’t raise money from the public to use it 7
to buy back my shares. I raised it to grow my company.” Managers 8
sometimes fear that the announcement of a buyback plan sends a 9
signal to Wall Street that their company lacks organic growth oppor- 10
tunities and will thus put pressure on the multiple. This is a serious 11
concern and one that calls for good investor relations. 12
One solution is to tell investors that they should watch the price 13
at which a company is buying back its shares. A plan to buy back 14
stock at or below tangible book value, for example, would probably, 15
and perhaps correctly, be perceived by Wall Street as a negative 16
signal. On the other hand, repurchasing shares at a substantial 17
multiple of earnings, albeit a multiple below some prior peak, signals 18
management’s belief that the current multiple does not fully reflect 19
the long-term growth opportunity. Thus stock buybacks offer a 20
subtle way for management to tell Wall Street that the growth expec- 21
tations built into the current stock price are too conservative. In this 22
context, a buyback is a bullish, and not a bearish, sign. 23
In one case, a small publicly traded California wine producer 24
leaked to the media that it would buy back its own shares whenever 25
they fell below $4 a share, and in fact it did. This effectively placed a 26
floor on the stock and helped keep some institutional investors on 27
board. When the company later stopped buying back shares at under 28
$4, the stock fell sharply. 29
If a company stops repurchasing shares when its stock reaches a 30
higher multiple, isn’t that a signal that management feels the stock is 31
fully priced? Yes, it is, which suggests the further question: Why 32
should Wall Street be expected to pay more for the shares than the 33
company itself feels they are worth? If, on the other hand, the 34
company continues to buy back shares at the higher multiple, the 35
consistent upward pressure on earnings per share will have a positive 36
and telling effect. This is because, without saying so directly, a man- 37
86 THE NEW INVESTOR RELATIONS
6 Investor Relations 2
3
4
in M&A Transactions 5
6
7
JOHN F. HARTIGAN, ESQ. 8
Morgan, Lewis & Bockius, LLP 9
10
11
12
13
14
15
89
90 THE NEW INVESTOR RELATIONS
1
Business Combinations 2
Before the amendments, a business combination or exchange offer 3
involving the issuance of securities was considered an offer of securi- 4
ties, triggering the registration requirements under the Securities Act. 5
So-called gun-jumping restrictions prohibited most statements 6
regarding such a transaction before a registration statement was filed. 7
Rule 165 of Regulation M-A creates safe harbors under the Securities 8
Act for communications in stock-for-stock mergers and exchange 9
offers. Under the rule, parties to a stock-for-stock merger or exchange 10
offer are not subject to a violation of Section 5(c) or Section 5(b)(1) 11
of the Securities Act for oral or written communications about a 12
transaction made prior to filing of a registration statement, during the 13
waiting period before effectiveness of the registration statement, and 14
in the posteffective period, so long as any written communication 15
from and including the first public announcement until the closing of 16
the transaction is filed upon first use. The rule further clarifies that 17
“an immaterial or unintentional failure to file or delay in filing” will 18
not result in the loss of the exemption as long as “a good faith and 19
reasonable effort was made to comply with the filing requirement” 20
and the filing requirement is satisfied “as soon as practicable after 21
discovery of the failure to file.” 22
The challenge for companies and their IR professionals is to be 23
familiar with current rules and regulations and to interface with coun- 24
sel to ensure that releases comply with those rules and regulations. 25
26
Proxy Solicitations 27
The M&A Release also removes restrictions on communications dur- 28
ing proxy solicitations. Before the amendments, persons intending to 29
initiate a proxy solicitation not involving a contested election or other 30
exempt solicitation were prohibited from making public statements 31
about their intentions until preliminary proxy materials were filed 32
with the SEC. In line with the new rule as applied to securities merg- 33
ers and exchange offers, there is safe harbor under the proxy rules as 34
well for communications in which target or acquirer stockholder 35
votes are solicited. The revised rule, which applies equally to security 36
holders and companies, allows oral and written communications 37
92 THE NEW INVESTOR RELATIONS
1
Benefits of the Amendments 2
In adopting the revised rules contained in Regulation M-A, the SEC 3
intended that the increased flow of information would help security 4
holders in making well-informed voting or investment decisions. 5
Another benefit the SEC expected as a result of the amendments was 6
a reduction in the occurrence of selective disclosure. By requiring the 7
filing of all written communications relating to a transaction, the 8
amendments would make the information available to a broader base 9
of investors. The SEC did not ignore the possibility that the amend- 10
ments may lead companies to use oral rather than written communi- 11
cations to sidestep the filing requirement. It concluded, however, 12
that the market would “likely demand that information be reduced 13
to writing and companies generally [would] want to disseminate 14
information broadly in order to sell their transaction to the market,” 15
thus reducing selective disclosure overall. 16
Note that the SEC adopted Regulation FD to deal specifically 17
with the problem of selective disclosure, as discussed later in this 18
chapter. 19
20
Flexibility in Timing 21
The M&A Release also provides bidders in exchange offers more flex- 22
ibility with respect to the timing of exchange offers. Prior to the 23
release, bidders were prohibited from commencing an exchange offer 24
until after the filed registration statement became effective. The 25
amendments allow the beginning of an exchange offer without hav- 26
ing to wait for its becoming effective, as long as the registration state- 27
ment has been filed. The SEC provided this added flexibility as an 28
incentive for issuers to file their registration statements sooner, which 29
would lead to increased public disclosure of information and a 30
decreased incentive to selectively disclose the information to a limited 31
number of investors. 32
The SEC recognized that by allowing an early offer, the amount 33
of time needed to complete an exchange offer would be shortened, 34
thereby shortening the time a security holder had to consider the 35
available information. The SEC believed that the investors would be 36
adequately protected in this instance by various rules. For example, a 37
94 THE NEW INVESTOR RELATIONS
investors might act prematurely, the risk was no different from what 1
it had been under the prior rules. As discussed above, for instance, 2
five business days were allowed between the announcement of a ten- 3
der offer and the filing of the required disclosure statement. Even 4
upon filing, the security holders might not have received the infor- 5
mation until several days after the filing, given possible delays and 6
vagaries in the delivery of that information, whether by mail or other 7
means. The amended rules permit the dissemination of transaction- 8
related information prior to the filing of a mandated disclosure 9
statement, as long as all written communications are filed. The SEC 10
stated in the M&A Release that these rules would provide investors 11
with more information and more time to come to a better informed 12
investment decision rather than lead to premature decisions. It is 13
important for the IR community to recognize that guidance from 14
legal counsel should be sought whenever communications relating to 15
an M&A transaction are involved. Careful planning and choreography 16
are required to comply with the rules. Written communications them- 17
selves, for example, must include a prominent legend that advises 18
investors to read the applicable registration, proxy, or tender offer, 19
filed or to be filed with the SEC, because they contain important 20
information. The legend must also advise that copies of the filed 21
document can be obtained for free at the SEC’s website and explain 22
which documents are available free from the filing person or issuer, 23
as applicable. 24
These written communications must be filed on EDGAR, the 25
SEC’s electronic filing system, on or before the date of first use, 26
which may require coordination with financial printers. Because the 27
process of filing requires some time, dissemination of the information 28
should be planned in advance, and to the extent possible, written 29
communications should be EDGARized ahead of time. Legal coun- 30
sel should always be contacted before the written communications 31
have been released and never after the fact. 32
Since certain communications may not appear to trigger the filing 33
rules at first glance, IR professionals should also be aware of the scope 34
of the rules’ coverage. Letters and e-mails to a company’s employees 35
discussing the effects of a potential merger on them, for instance, may 36
require filing. IR professionals should also be mindful when it comes 37
96 THE NEW INVESTOR RELATIONS
1
“Plain English” Requirement 2
In addition to these safeguards, the M&A Release puts into effect 3
another investor protection mechanism. The rule requires “plain 4
English” disclosures for all issuer and third-party cash tender offers, 5
cash mergers, and going-private transactions. 6
Disclosure documents for these transactions often include detailed 7
information that is difficult for investors, even sophisticated investors, 8
to understand. The required plain English summary term sheet is 9
intended to facilitate their understanding by providing a concise 10
summary of the important and relevant information regarding the 11
transaction, allowing investors to better inform themselves prior to 12
making a voting or investment decision. Again, IR professionals need 13
to review the “plain English” summary sheet carefully to affirm that 14
it is sufficiently clear and accurate. 15
16
17
Regulation FD 18
On August 10, 2000, a controversial set of rules was adopted by the 19
SEC called Regulation FD (for “fair disclosure”).4 20
The SEC provided three reasons for adopting the regulation: First, 21
the SEC wished to cure what it perceived to be an unfair advantage 22
given to market professionals and institutional investors at the expense 23
of the general investing public. The SEC believed that public compa- 24
nies were selectively disclosing material, nonpublic information to a 25
small group of Wall Street professionals before making the informa- 26
tion public. Those in possession of this information, in the view of the 27
SEC, could potentially make profits or avoid losses to the detriment of 28
investors not privy to the information, ultimately resulting in an ero- 29
sion of investor confidence in the integrity of the securities markets. 30
The second impetus that led to the adoption of Regulation FD 31
was the SEC’s concern that material nonpublic information was 32
being used as a tool by corporate management to influence analysts 33
and institutional investors to report favorably about a company or 34
else risk losing continued access to the selective information. A 35
prohibition on selective disclosure would relieve this pressure on 36
analysts, resulting in unbiased reports. 37
98 THE NEW INVESTOR RELATIONS
It should be noted that the SEC limited the application of the rule 1
to “enumerated persons” in an attempt to narrow the rule’s scope of 2
coverage. Communications to those persons who owe a duty of trust 3
or confidence to the issuers and would therefore be expected to 4
maintain confidentiality, including lawyers, accountants, and invest- 5
ment bankers, are excluded. Similarly, disclosures made to credit 6
rating agencies, those made to persons who expressly agree to keep 7
disclosed information confidential, and those made in connection 8
with most securities offerings registered under the Securities Act are 9
also excluded. It should be noted that communications continue to 10
be subject to prohibitions against insider trading under Rule 10b-5. 11
Regardless of whether the person is an “enumerated person,” selec- 12
tive disclosure of material nonpublic information could result in, for 13
example, tipper liability. IR professionals should educate themselves 14
and keep abreast of developments in this area. 15
16
Materiality 17
The major difficulty companies are having in following Regulation 18
FD is in determining what is material, especially in the preliminary 19
stages of initiating a business combination transaction, tender offer, 20
or proxy or consent solicitation. Unfortunately for IR professionals 21
and others, the SEC does not define “materiality” for purposes of 22
Regulation FD, rather leaving its interpretation to existing case law. 23
The FD Release cites the 1976 case, TSC Industries, Inc. v. North- 24
way, Inc., a seminal Supreme Court case holding that information is 25
material if “there is a substantial likelihood that a reasonable share- 26
holder would consider it important” in making an investment decision, 27
and a reasonable shareholder would have viewed the information as 28
having “significantly altered the ‘total mix’ of information made 29
available.” 30
This definition does not afford a bright-line or formulaic test for 31
companies seeking to initiate a transaction to apply. Instead, compa- 32
nies and their IR professionals would be well advised to consult with 33
experienced legal counsel in making a good faith determination of 34
what is “material” under facts and circumstances of a particular situ- 35
ation. Some commentators have suggested that the fact that a partic- 36
ular transaction is being considered by a corporation may, under 37
100 THE NEW INVESTOR RELATIONS
7 Investor Relations 2
3
4
for Private Placements 5
6
7
ALEXANDER L. CAPPELLO 8
Cappello Capital Corp. 9
10
11
12
13
14
15
105
106 THE NEW INVESTOR RELATIONS
just vetted the company and that a large institutional investor has just 1
placed a vote of confidence in the stock. 2
As for the rationale behind PIPE investors’ receiving a discount to 3
market, there are several explanatory responses. First and foremost, 4
the investor is being compensated for illiquidity. Often, the shares 5
sold in a PIPE are restricted and cannot be sold immediately. This can 6
apply even if the stock is unrestricted. After all, a large position in a 7
stock cannot be sold on a whim, and even slow sales of a large posi- 8
tion can drag down share prices. In short, a PIPE investor is a long- 9
term investor in a world in which everyone wants profits now and the 10
ability to sell in a minute. 11
The better the name and reputation of the investment banker and 12
the institutional investor, the more convincing these arguments will 13
be. The IR team should counsel management early to seek out blue- 14
chip names, when possible, for participation in PIPE transactions. 15
16
17
The Importance of Being Discreet 18
Despite the best efforts of investor relations experts and skilled 19
investment bankers, PIPEs have a way of getting clogged or bursting, 20
usually because of aggressive management, arrogant bankers, or some 21
combination of the two. The following real-world stories are good 22
illustrations of how PIPEs fail or succeed. 23
24
Don’t Oversell and Don’t Leak 25
Restaurant Corp. (a fictional name) is a publicly traded company and 26
a popular place to eat healthy food in a better-than-usual fast-food 27
environment. At some restaurants, customers wait in lines stretching 28
around the block for a chance to eat. Obviously, this was an idea that 29
could be franchised or duplicated coast-to-coast. Many of the cus- 30
tomers also purchased the company’s stock, following Warren Buffet’s 31
suggestion to invest in businesses you understand. Eventually, the 32
number of shareholders reached several thousand, increasing the 33
stock’s liquidity and profile. 34
At about the same time, the phenomenon of the Internet chat 35
room blossomed, and Restaurant Corp.’s chat rooms were very 36
active. At one memorable annual shareholders meeting, a large ball- 37
108 THE NEW INVESTOR RELATIONS
the picture and creating new problems for the IR experts who had 1
been selling the story of a successful restaurant chain. 2
The problem of material information showing up in chat rooms 3
seemed never to go away. Too many people who were close to insid- 4
ers always seemed to know significantly more than they should before 5
public announcements. Stock traded suspiciously at times. 6
Investor confidence in the company soon sagged, battered by 7
repeated reported losses and changes in business plans. Institutional 8
investors no doubt noticed the breaches in confidentiality. Eventually 9
the company had to merge with a much larger food service company 10
that brought in all new management. 11
The IR lesson: Don’t oversell a PIPE, don’t oversell a stock, and 12
have strict controls on the flow of information. 13
14
Be Prepared for the Unexpected 15
Global Electronics (a fictional name) was the third-largest computer 16
and electronics distributor in the world, when it undertook a $350 17
million PIPE transaction, this one for convertible preferred stock. A 18
major New York–based securities brokerage evidently took umbrage 19
at a small West Coast shop winning the assignment, and conducted a 20
smear campaign against the chosen firm. It contacted the ten largest 21
institutional shareholders in Global Electronics and repeated stories 22
raising questions about the underwriting firm’s competency and 23
ethics. The New York house went so far as to spread “research” that 24
the other company’s clients usually tanked. 25
The large shareholders started calling Global Electronics and ask- 26
ing the CEO why he selected the firm in question to do the job. The 27
West Coast firm had to work carefully with Global Electronics’s man- 28
agement for several weeks, to give them the true track record of its 29
clients. When provided with the facts, the company reprimanded the 30
sour bankers at the bulge-bracket firm and told the story to their 31
largest shareholders. 32
The IR lesson: Sometimes, IR is neither proactive nor defensive. 33
It’s just plain old warfare and hard work, and making phone calls, 34
talking to people, and battling misinformation. IR professionals need 35
to be aware that there can be disgruntled investment bankers, 36
snubbed analysts, or short traders who have agendas of their own. 37
110 THE NEW INVESTOR RELATIONS
1
2 Do What You Say You Will Do
3 International Pharmaceuticals Corp. (IPC, a fictional name) had been
4 brought public by the investment banking department of a major Wall
5 Street firm. It was followed by several analysts, but regrettably had
6 been dealt a severe blow by the Food and Drug Administration. The
7 FDA was taking about two years longer than expected to approve two
8 separate drug compounds. The cash flow from existing drugs was
9 being consumed rapidly by ongoing clinical development; IPC had
10 invested heavily in marketing and sales infrastructure in anticipation of
11 prompt FDA approvals for its two compounds.
12 The cost of carrying the additional overhead had severely
13 impacted the company’s liquidity, and it had some debt coming due
14 just months ahead. After intense due diligence, the adviser conduct-
15 ing the PIPE managed to place $115 million of convertible preferred
16 and $11 million of common stock with a few institutional investors.
17 Investors were running more than phantom risks—the unpredictable
18 FDA, for example—so their anticipated returns were hefty and thus
19 costly for the company. But the capital IPC earned allowed it to sur-
20 vive and move forward.
21 The role of the IR team was to be up front with investors about
22 the risk, while at the same time educating them about the drug com-
23 pounds and pointing out the meaty returns if the company per-
24 formed as slated. If the stock went up, the convertible preferred stock
25 would return plenty.
26 During the course of due diligence, the management of IPC dis-
27 closed to the PIPE advisers that a certain amount of assets would be
28 written down. These would be non-cash write-offs of an immaterial
29 amount. The company stressed that there would be no need for fur-
30 ther write-offs, much to the satisfaction of the investors.
31 As the PIPE team was gearing up for the placement to save this
32 company from running out of cash, Forbes, the national financial mag-
33 azine, ran a cover story on great short opportunities, with IPC near
34 the top of the list. About the time the PIPE advisers finished reading
35 the article, management called to explain that they had decided to take
36 a major write-off on a substantial percentage of its assets, exactly what
37 it had promised it wouldn’t do just a few weeks earlier.
INVESTOR RELATIONS FOR PRIVATE PLACEMENTS 111
1 investment capital and wanted to raise more. The FDA had yet to
2 approve any of its drugs, however. In a meeting with potential
3 investors, the firm’s management appeared to take offense at simple
4 questions, while tossing about obscure acronyms as if all in the audi-
5 ence had been deeply involved in life science research their whole
6 lives. The PIPE adviser doggedly lined up more and more investors
7 to look over the PIPE, which was not a bad deal on paper. There was
8 some promising research, to be sure, possibly of benefit to investors
9 and even to the practice of medicine. But the deal couldn’t get
10 funded. Potential PIPE investors noticed that company management
11 wasn’t overly concerned at having already spent more than $100 mil-
12 lion of investor money. Perhaps the management thought confidence
13 bordering on braggadocio would convince investors that the product
14 was a sure winner. The company didn’t raise any more money until
15 after it replaced its CEO. Under new management the company
16 became one of the best-performing biotechs globally in 2003.
17 The IR lesson: If you are burning through capital and need to raise
18 more, show that you recognize the seriousness of your situation to
19 investors. Be prepared to give away a lot of the company to get sur-
20 vival capital, be happy if you get it, and relate that attitude in your IR.
21 Professional investors in PIPEs are not impressed by arrogance; they
22 have seen plenty of it. On the other hand, it never hurts to look
23 earnest, even with professional investors. Sure, the business plan has
24 to be solid, but management counts, too. In a PIPE, management
25 has to be very accommodating to investors.
26
27 You May Get Away With It, But Not for Long
28 Despite recent press reports, most people who run publicly traded
29 companies are ethical and forthright in all of their dealings. They
30 know the penalties for dishonesty, and they also know that share-
31 holders deserve good corporate governance and transparency. There
32 are, however, management teams that think they can get away with
33 deceitful behavior. Such a team managed a company listed on the
34 New York Stock Exchange, which had a prestigious board of direc-
35 tors, and numbered among its largest shareholders a longtime mem-
36 ber of the Forbes 400 Richest Americans who enjoyed an excellent
37 reputation. The placement agent secured a $70 million convertible
INVESTOR RELATIONS FOR PRIVATE PLACEMENTS 113
1
2 Generate Goodwill With Investors
3 The management at a troubled but promising software company was
4 refreshingly candid. It bluntly stated that the company needed more
5 capital to launch a new range of products—and even that would be
6 no guarantee of success—or else it would need to merge with another
7 company. By carefully explaining to institutional investors the need
8 for the new product line, the financial adviser convinced PIPE buyers
9 of the company’s fundamental prospects. As usual in a PIPE, the
10 company had to offer an incentive: Investors would get not only a
11 yield but also a big upside if the company rallied. The management
12 successfully completed a very complicated transaction, placing $29.5
13 million in convertible preferreds.
14 A little more than a year later, virtually all of the convertible bonds
15 were still outstanding. But the software company’s new product line
16 had produced only marginal results. The firm would run out of cash
17 within a quarter or two, barring a tremendous surge in demand.
18 However, because the management had credibility with all the
19 investors, had always explained that this was a risky situation, and had
20 let them know each step of the way the progress the company was mak-
21 ing (or lack thereof), it still had some capital-raising options. The solid
22 IR with PIPE investors all down the line was now going to pay off.
23 The management sought advice on how to get the group of insti-
24 tutions who held the investment to agree to a short-term standstill/
25 lock-up in order to complete a merger with another industry player
26 that had an interest in acquiring the company. The six institutions
27 were asked to agree to the lock-up but, because the company was
28 publicly traded, were not told why.
29 The existing goodwill and trust were sufficient to allow the lock-
30 up to be accomplished in a few hours. The management was then
31 able to engineer a deal with its eventual acquirer. The deal saved
32 everyone’s investment and allowed the parties to cash out at a profit.
33 All this was only possible because of the superb investor relationships
34 that had been developed.
35 The IR lesson: When captaining a company, you never know what
36 storms you might encounter or in what directions you may sail. If
37 your investors like and trust you, your options for maneuvering will
INVESTOR RELATIONS FOR PRIVATE PLACEMENTS 117
8 Investor Relations 2
3
4
for the IPO 5
6
7
DOUGLAS M. SHERK 8
EVC Group 9
10
11
12
13
14
15
119
120 THE NEW INVESTOR RELATIONS
1
2 Back to Those Operating Metrics
3 While building market awareness on stage, companies should be
4 working backstage to ensure their ability to monitor the operating
5 metrics that were identified. In the beginning, the goal should be to
6 produce weekly reports on each metric. For those readers who
7 haven’t fainted or slammed this book shut after reading the previous
8 sentence, here’s why it is important to aim for weekly reports: A
9 quarter is only thirteen weeks long, and Wall Street is notoriously
10 impatient in the 21st century. Taking the pulse of the business fewer
11 than thirteen times during the quarter reduces your opportunities to
12 create and execute strategies that address emerging operating and
13 financial performance issues.
14 Monitoring the operating metrics of the business on a weekly
15 basis provides you with a better understanding of the developing
16 financial performance. You’ll also have more operating knowledge
17 from which to make decisions, including what to communicate if a
18 situation arises similar to the one faced by Flying High at the begin-
19 ning of this chapter. There may be nothing management can do in
20 the short term to correct a downdraft in the business. However, there
21 is a lot that management can do to protect credibility and long-term
22 shareholder value if a clear command of the issues facing the business
23 can be communicated.
24 Some operating metrics are not very volatile, and weekly moni-
25 toring will prove to be unnecessary. However, it can be argued that
26 the best time to make that judgment is after your company has been
27 public for at least two quarters. The key motive behind assessing
28 the operating metrics of your company on a weekly basis is to
29 understand how your business is doing relative to the plan you’ve
30 presented to your investment bankers and to Wall Street in general.
31 Putting systems into place for monitoring your operating metrics
32 before starting the S-1 drafting process will allow management to
33 gain a better appreciation of how the company’s financial perform-
34 ance compares with that of its peer group. Such an appraisal can
35 help both the board and management determine the market’s
36 appetite for the company’s shares and target areas that need partic-
37 ular management focus.
INVESTOR RELATIONS FOR THE IPO 127
1
Revenue Forecast Reality Check 2
There’s one more process that should be completed before conduct- 3
ing the contest to choose your underwriting investment bankers: the 4
Revenue Forecast Reality Check (“the Check”). The first step in this 5
procedure is to review the revenue forecasts of your peer group for 6
the past four consecutive quarters. This information can be found in 7
the analyst reports of the peer group companies. In addition, many 8
companies provide quarterly forecasts in SEC filings and during quar- 9
terly conference calls. Services such as ccbn.com—the website run by 10
the Corporate Communications Broadcast Network—also sell tran- 11
scripts of these calls. 12
The next step is to determine the peer companies’ actual revenue 13
results for the same past four consecutive quarters and compare these 14
with their forecasts, creating a ratio of forecast-to-actual revenue 15
results. Now, perform the same analysis on your own company’s per- 16
formance. Have your forecasts been higher or lower than actual 17
results? How does your ratio compare with the peer group average? 18
The answers to these questions can have implications for how your 19
IPO is received by the market. 20
21
No Rose-Colored Glasses 22
One of the greatest mistakes the management of an IPO company can 23
make is to provide potential investment bankers with optimistic rev- 24
enue forecasts. Once the underwriting process begins, going to the 25
underwriting team and letting it know that the 25 percent growth rate 26
you had expected is now looking more like 21 or 22 percent may 27
result in a bit less underwriter enthusiasm and passion for your com- 28
pany. Management has effectively planted a smidgen of doubt about 29
its control over operations and its ability to monitor and forecast the 30
performance of those operations. There is also the practical matter of 31
what type of valuation the market will give a 21 percent grower versus 32
a 25 percent grower. 33
There are other issues to consider. A peer group that has consis- 34
tently exceeded company guidance or analyst revenue forecasts has an 35
investor base accustomed to results that exceed expectations. Conse- 36
quently, Wall Street may very well expect your company’s actual 37
128 THE NEW INVESTOR RELATIONS
1 results during the first few quarters of its public life to be better than
2 analysts had predicted. Such expectations can create tremendous
3 pressures on management, especially if its own forecasts were
4 optimistic to begin with. Implementing the Check before sharing
5 forecasts with potential underwriters can reduce these pressures and
6 forestall investor disappointment, enhancing the market’s regard for
7 both the company and its management team.
8 Here’s a real-life example to consider. EVC Group conducted the
9 Check for a company whose peer group, on average, posted about 95
10 percent of their forecasted revenues. In other words, the peer group
11 often undershot expectations by 5 percent. This company forecast a
12 35 percent revenue growth rate for the next year. However, after the
13 Check results for the company’s peer group were presented to man-
14 agement, they decided to cut back revenue forecasts by 5 percentage
15 points, to a 30 percent growth rate. (This rate turned out to be the
16 company’s norm in recent years.) Six months later, the company was
17 having a very good year, growing at that 30 percent rate, not the
18 originally expected higher one. As a result, management gained a
19 reputation in the marketplace for having a solid command of the
20 business and fostering the fastest growth in its peer group, without
21 the added pressures or opportunity for disappointment the original,
22 higher forecast would have created. Good IR dictates sensible rev-
23 enue and profit forecasts, with an eye for potential shortfalls. This is
24 true in particular for IPO companies.
25
26
27 Disclosure Policies and Procedures
28 Disclosure Policies and Procedures (DPPs) provide the written
29 framework for all disclosure decisions. Most companies have some
30 form of DPPs, but they are typically informal. As a company prepares
31 to go public, underwriters of directors-and-officers (D&O) liability
32 coverage will require that the DPPs be put into writing. And since no
33 director in his or her right mind will serve on the board of a publicly
34 traded company without proper D&O coverage, your company is
35 going to need to create a formal DPP document.
36 Just like many other aspects of the IPO process, the creation of
37 corporate DPPs tends to follow a template and not be very effective.
INVESTOR RELATIONS FOR THE IPO 129
1
2
TABLE 8-1 Sample Operating Model 3
(Manufacturing Company) 4
5
Revenue 100% 6
Gross margin 52–53%* 7
SG&A 22–23%* 8
R&D 9%* 9
Operating income 15–17%* 10
Tax rate 30% 11
Net income 10–12%* 12
*Percentage of revenue 13
14
15
closed operating metrics, it considers material. The approval process 16
for the disclosure of all information, material or not, should also 17
appear in the DPP document. The company should form a disclosure 18
committee to ensure that the DPPs are regularly reviewed and 19
amended as appropriate. 20
General guidelines for handling a crisis situation should be includ- 21
ed in the DPP document as well. Some companies consider it pru- 22
dent to attach a crisis communications program. It is also wise to 23
identify the timeframe that will constitute the quarterly quiet period 24
once the company is public. For many companies, this blackout on 25
comment about financial or business performance or prospects 26
begins two weeks before the end of the quarter and ends after the 27
release of results and the conference call. 28
These are just a few examples of what goes into a thorough DPP 29
document. The general rule should be to create as explicit a docu- 30
ment as practicable and recognize that changes to the business will 31
most likely mean changes to the DPPs. Once they are created, the 32
policies and procedures need to be clearly communicated throughout 33
your company. Distributing the DPP document is the traditional 34
mode of communications. However, generating broad understand- 35
ing of the policies within your company requires a wider effort. Some 36
companies post the DPP document on their intranet and corporate 37
132 THE NEW INVESTOR RELATIONS
1 websites. Others conduct meetings to review the key points, and still
2 others require employees to sign a statement acknowledging that
3 they’ve read the document.
4
5
6 The Presentation
7 Whole books have been written on the presentation and the “road
8 show” (the presentation made in meetings with investors across the
9 country to pitch an offering) that companies should develop before
10 an IPO. This section discusses some general guidelines for these pre-
11 sentations.
12 Follow the sequence of activities outlined in this chapter.
13 Developing the pitch to investors before determining the operating
14 metrics, performing the Revenue Forecast Reality Check, or creating
15 the disclosure policies and procedures, presents two potential risks:
16 one, that information later determined to be best kept confidential
17 may be disclosed, and two, that forecasts may be made that later look
18 amateurishly optimistic. Worse, if aggressive outlooks are scaled back,
19 investors may conclude that the company’s prospects are souring and
20 that the IPO is being staged merely to give private-equity investors
21 an “exit strategy.” Once information is released or forecasts made, it
22 is very awkward to tell investors that a topic is off-limits.
23 You may use a laptop or printed version of the presentation during
24 a road show, but, keep in mind that it is the company, the fundamen-
25 tals, and the management team that generate maximum valuation for
26 an IPO, not the most beautiful presentation. Be aware as well that
27 most investment bankers, especially when few IPOs are coming to
28 market, want to control the presentation. It is easier for you to posi-
29 tion your company the way you want if you develop a presentation
30 that is used to interview investment bankers. Although this presenta-
31 tion will have other components, it should focus on the following six,
32 essential topics:
33 1. a brief definition of the company
34 2. its unique operating characteristics and why they create value
35 for the customer and for shareholders
36 3. the barriers to other companies replicating those character-
37 istics
INVESTOR RELATIONS FOR THE IPO 133
IR Tactics in 12
13
14
Crisis Scenarios 19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
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37
1
139
140 THE NEW INVESTOR RELATIONS
The interplay between the Street and the media became readily 1
apparent at the height of the dot-com boom, when an executive’s 2
appearance on CNBC’s Power Lunch would often result in his or 3
her company’s share price getting a boost in the afternoon trading 4
session. 5
Just as Wall Street has bonded with the media, so too must the IR 6
executive. Where traditional IR was based mainly on Street work and 7
contact, crisis IR also incorporates media, CEO positioning, messag- 8
ing, process control, and extensive consulting at a much higher level 9
than ever before. In short, investor relations is really morphing into 10
financial communications. 11
Ironically, the reaction of many companies’ executives to this 12
increasing flow of information has been to bury their heads even 13
deeper in the sand. That’s especially true since the implementation of 14
full-disclosure rules and, more recently, with the sight of chief finan- 15
cial officers of major companies being led away in handcuffs. The 16
result is a greater reluctance at many companies to talk. Increasingly, 17
executives are hiding behind quiet periods and speaking at only a 18
handful of well-choreographed press and analyst conferences. 19
One problem with this type of response is that it can be counter- 20
productive. Analysts who no longer get the level of detail to which 21
they’ve been accustomed start to feel left out. As a result, some may 22
resort to attacking companies via the media. Lack of corporate 23
communicativeness tends to push the investment and analyst com- 24
munity—to say nothing of the “shorts”—even further into the arms 25
of the media. 26
As information from companies becomes more difficult to obtain, 27
news organizations find themselves forced to rely more and more on 28
outside sources. This trend poses grave risks for public companies. 29
Not only does it allow a company’s image to be determined by third 30
parties, it also, and all too often, results in the publication of incor- 31
rect information, whether because an analyst was misquoted or sim- 32
ply misinformed. An important point to remember: Reporters are not 33
obligated to get your side of the story in their articles. They are only 34
obligated to provide you with the opportunity to respond. 35
36
37
142 THE NEW INVESTOR RELATIONS
1
2 Traditional IR Versus Crisis IR
3 People often ask me to define the difference between crisis investor
4 relations and traditional investor relations. More often than not, I
5 say, it’s nothing more than a phone call. I am reminded of the call a
6 retailing executive got from one of the country’s leading newspapers
7 asking him to comment on reports that vendors had stopped ship-
8 ping goods to his company because of concerns about its financial
9 viability.
10 “That is hogwash,” the executive said and slammed down the
11 phone.
12 The next day, the newspaper published a major article in which
13 three vendors were quoted, with attribution, as saying they had
14 stopped shipping goods to the retailer because of concerns over its
15 financial stability. The thirty-column-inch story also contained the
16 executive’s three-word response.
17 The company was immediately flooded with calls from other ven-
18 dors worried that they were going to become creditors to a company
19 that might be headed for bankruptcy. Although the company assured
20 the callers that the three vendors named in the article had actually
21 been cut off because of late delivery and quality problems, the story
22 so panicked the company’s other vendors that it became a self-fulfill-
23 ing prophecy. Vendors began demanding cash on delivery, and before
24 long, the company was forced into bankruptcy.
25 How could the problem have been avoided? For one thing,
26 instead of snarling an angry response and hanging up the phone, the
27 executive should have asked the reporter to name the vendors who
28 had supposedly stopped shipping goods. Had he done so, he would
29 have been able to explain why they were bad-mouthing his company.
30 The executive should also have offered to provide the reporter with
31 the phone numbers of fifty or one hundred other vendors who were
32 continuing to provide the company with credit on an ongoing basis.
33 Had he done this, chances are that the story would have either been
34 killed or taken a very different tack.
35 Another distinction between traditional and crisis investor rela-
36 tions is that while the former is about maintaining relationships with
37 Wall Street and keeping the Street apprised of the company’s
CRISIS INVESTOR RELATIONS 143
renew the credit facility, what this meant for the company, and what 1
the management team was doing to deal with the situation. We 2
drafted a second release saying the negotiation had been extended 3
and a third announcing that a deal had been struck with the banks. 4
We also prepared a variety of other documents, each aimed at one 5
of the company’s particular audiences: its investors, employees, cus- 6
tomers, creditors, vendors, and regulators. Why so many? Because if 7
any of these groups were sufficiently angry or panicky, they could 8
upset the apple cart, and nothing is more likely to anger or panic a 9
constituency in a crisis situation than feeling they have been left out 10
of the loop. 11
As it turned out, the recalcitrant bank finally came to its senses. 12
But because we were prepared, the company used this “good news 13
event” as an opportunity to communicate to shareholders—as well as 14
to all the other key audiences—the steps management was taking to 15
implement a long-term plan to restructure and strengthen the com- 16
pany and its balance sheet. 17
The stock rallied, despite a tough market. Often, when properly 18
executed, crisis IR is about taking lemons and making lemonade. 19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
1
10 The Art of 2
3
4
Winning Proxy Wars 5
6
7
Based on interviews with 8
JOHN C. WILCOX 9
10
Georgeson Shareholder Communications Inc.
11
12
13
14
15
149
150 THE NEW INVESTOR RELATIONS
ber of contests was 41 (1989), and the lowest was just three (1993). 1
The spike in the late 1980s was a reflection of the junk bond era 2
when ample financing was available for takeovers. Today, proxy fights 3
seem more ad hoc in nature, reflecting specific problems of gover- 4
nance or performance at the companies where they occur. 5
The challenges of initiating a proxy fight are daunting. Dissatisfied 6
investors often express reluctance to take their case to shareholders 7
because they believe proxy fights are impossible to win, expensive, 8
time consuming, risky, unpredictable, or that “the cards are stacked 9
in favor of management.” Indeed, even the simplest proxy war 10
against management, staffed by volunteer labor, costs at least 11
$250,000 to mount. 12
In today’s environment, most of these concerns can be overcome, 13
and proxy fights are expected to increase in the future, reflecting 14
greater focus on good corporate governance and increased activism 15
by frustrated investors. 16
17
What Is a Proxy Contest? 18
How do you define a proxy fight? In keeping with the standards of 19
the New York Stock Exchange (NYSE), a proxy fight is usually 20
defined as a contested solicitation campaign where a dissident mails 21
separate proxy materials and proxy cards. The most common type of 22
proxy fight is an election contest between two competing slates of 23
directors. Votes are solicited by two independent groups: manage- 24
ment and dissidents. However, as discussed below, hybrid proxy 25
fights can occur in many situations other than director elections. 26
Companies may have to deal with what are termed Trojan horse 27
proxy fights. For example, shareholders or dissident groups may 28
solicit votes against management initiatives. Or dissidents may solicit 29
support for a shareholder resolution under the shareholder proposal 30
rule—such as a proposal to rescind a company’s “poison pill.” In 31
response, the company would need to seek the support of sharehold- 32
ers with an aggressive countersolicitation. These are examples of 33
“hybrid” contests that do not involve a change of control and that 34
may not trigger special SEC and stock exchange rules governing 35
proxy fights. 36
Dissident activity is really not officially a proxy fight until some- 37
152 THE NEW INVESTOR RELATIONS
1
Preparing a Battle Plan 2
Before responding to the threat of a proxy fight, it’s critical to begin 3
early-stage activities. You should prepare a “battle plan” based on a 4
situation analysis—whether you represent management or dissident 5
interests. 6
First, you need to do an overall objective assessment of the situa- 7
tion—from both communication and tactical analysis standpoints. 8
You should know exactly: 9
Who are your shareholders? How is ownership shifting during 10
the period leading up to the “record date” (the date the com- 11
pany closes its books to determine which shareholders have 12
voting rights)? 13
What vote outcome is likely? Based on an analysis of the owner- 14
ship and the issues being contested, you and your advisers can 15
accurately forecast the vote outcome. A combination of surveys 16
and interviews can develop information on shareholder attitudes 17
toward the issues that will control the outcome of the contest. 18
What kind of campaign is required to achieve victory? This 19
strategic analysis will help determine whether you can muster 20
the resources to win. 21
22
The strategic analysis needed to formulate a battle plan is best 23
prepared by professional advisers in conjunction with on-staff IR 24
professionals. It will entail gaining a thorough understanding of the 25
following factors: 26
Shareholder profile. Who are you trying to reach and influence? 27
This is a critical starting point in any proxy contest. Since the out- 28
come of a proxy fight is often extremely close, this initial analysis is 29
crucial. 30
To prepare a shareholder profile, you should consult such infor- 31
mation sources as the most recent 13F and 13D filings, the deposi- 32
tory listings, the list of registered holders; the proxy statement, 33
records of management and insider holdings, and employee plans. In 34
addition, a detailed shareholder identification report can be prepared 35
by a professional proxy solicitor to cover accounts not normally 36
accessible through public records and filings. These accounts include 37
156 THE NEW INVESTOR RELATIONS
1 shares held in “street” name, that is, shares actually owned by indi-
2 viduals but held in the name of a brokerage; beneficial owners whose
3 holdings are not publicly disclosed (along with their custodial rela-
4 tionships and their voting and investment contacts); foreign
5 accounts; arbitrage positions; and hedge funds.
6 Some of this work can be done using readily available, “fast and
7 dirty” sources, at least in early stages of the analysis. For example, if
8 one looks at a company profile through the Yahoo! Web service, the
9 largest institutional shareholders and mutual fund holders are listed,
10 based on quarterly updates. Proxy statements, 13D, and 13F filings
11 are also available online, at www.sec.gov. Of course, a company’s IR
12 department should always know its largest shareholders. Should
13 questions arise, usually a few hours of work will be enough to get a
14 solid picture of who owns a public company. Of course, if a lot of
15 stock is trading hands, public sources will not capture the needed
16 updates on a timely enough basis.
17 Vote projection. To project the vote outcome, you need to know
18 the voting policies and practices of your institutional investors and the
19 other groups of shareholders that make up your ownership profile.
20 Institutional investors typically base their votes on economics, but
21 their decision may be influenced by other factors as well. Individual
22 registered holders are usually loyal to incumbent management. But
23 there is a long list of exceptions, such as instances in which a
24 company’s dividend has been cut, its stock price has plunged, scandal
25 has discredited management, compensation has been excessive, or a
26 takeover premium has been “lost.” Rockville, Maryland–based
27 Institutional Shareholder Services (ISS) reviews corporate proxy state-
28 ments and advises institutional investors on proxy voting decisions.
29 ISS’s voting recommendations should be carefully analyzed in the vote
30 projection. A proxy solicitation firm can provide insight into ISS’s
31 likely vote recommendations.
32 Stock watch/ownership tracking. Many companies monitor their
33 stock’s market activity continuously to track and determine the causes
34 of unusual trading. They also analyze ownership changes by carefully
35 reviewing depository listings and transfer sheets. Proxy solicitors
36 and professional stock watch firms have additional resources and
37 “tricks of the trade,” for tracking ownership changes. These activi-
THE ART OF WINNING PROXY WARS 157
1
2 Leveraging Your Investor Relations
3 Often IR executives are more familiar with investment analysts at
4 institutions than with the analysts’ counterparts who make voting
5 decisions. IR during a proxy contest is different from the traditional
6 crisis communications. It must be addressed to the audience of vot-
7 ing decision makers and deal with the specific contest issues. At the
8 same time, proxy IR involves many of the same considerations as
9 those coming into play during any other corporate crisis, including
10 the following:
11 maintaining ongoing business disclosure
12 maintaining ongoing IR activities
13 coordinating contest communications and advertising with
14 ongoing business PR activities and the media
15 dealing with the concerns of suppliers, customers, and employ-
16 ees whose confidence in the company may be shaken
17
18 Consider the following five questions. The degree to which you
19 can answer each in the affirmative may spell the difference between
20 success and failure in mounting an effective proxy fight.
21 1. Can you attract media coverage? A well-positioned, favorable
22 news story or feature can have a significant impact on public
23 opinion and the views of analysts and shareholders, especially
24 if carried in one of the major national financial papers.
25 However, favorable media coverage is a double-edged sword—
26 it can also lead to overconfidence. Don’t expect your positive
27 press clippings to do the work of an effective proxy solicitation.
28 Indeed, many professional investors regard financial journalists
29 as amateurs.
30 2. Can you write effective “fight letters”? These are the primary
31 “documents of persuasion” in a proxy contest. Writing fight
32 letters is a delicate balancing act that requires sensitivity to
33 shareholder views. On the one hand, you want to give dramatic
34 gravity to your position. On the other hand, you need to be wary
35 of using scare tactics to rebut opposing arguments. You don’t
36 want to win the contest and end up with a mortally wounded
37 company. The most important aspect of the letters is to sum-
THE ART OF WINNING PROXY WARS 163
marize your position and the key issues in a clear, succinct, and 1
meaningful way. Offer shareholders tangible benefits for your 2
position—and gain their confidence in your ability to execute 3
your strategy and deliver results. Imagine you are selling a 4
product or service, and “brand” your viewpoint with catchy 5
slogans or memorable headlines. 6
3. Can you tap into the power of advertising? You can leverage 7
the messages of your fight letters in ads in national and local 8
publications to reach both your shareholder audience and the 9
broader investment community. Proxy ads help you demon- 10
strate your commitment and determination to shareholders, 11
which is important in maintaining momentum in a solicitation 12
campaign. Look at some examples of clutter-breaking, effective 13
advertisements from well-known proxy contests. Bold headlines 14
grab shareholder attention. “DROP DEAD!” (RJR Nabisco); 15
“Show Us the Money” (ITT); “Don’t Be Conned By Kahn” 16
(ICN Pharmaceuticals), and perhaps the most famous of all, 17
“The Directors of Sears, Roebuck & Co.—NON-PERFORM- 18
ING ASSETS” (Sears/Robert Monks)—all are examples of 19
effective, high-impact headlines used in proxy fights. 20
4. Can you conduct effective face-to-face meetings with key 21
shareholders? There’s no substitute for meeting one on one 22
with voting decision makers at institutions that hold large 23
blocks of stock. Your proxy solicitor will prepare institutional 24
contact lists and arrange “road show” tours to reach key deci- 25
sion makers. This approach can also be effective with groups of 26
retail shareholders. For example, in the proxy contest for the 27
merger of Wachovia Corporation and First Union Corporation 28
in 2001, face-to-face meetings helped win the approval of 29
Wachovia’s regional shareholders. Reluctant shareholders need- 30
ed to be personally convinced that the merger was in their best 31
interests and that the hostile takeover attempt of Wachovia by 32
SunTrust was not. In that instance, Georgeson Shareholder 33
Communications set up a series of local town meetings in 34
strategic locations during which company officials presented 35
the merger proposal in person to shareholders and answered 36
their questions. 37
164 THE NEW INVESTOR RELATIONS
1 than addressing the issues that were raised. The dissident will argue
2 that the most important issue is management’s poor past perform-
3 ance, while management will argue that the most important issue is
4 the dissidents’ lack of qualifications. In such a situation, shareholders
5 are frustrated because neither side demonstrates how they will
6 improve performance. In the end, if neither management nor dissi-
7 dents convince shareholders why their position is better—only that it
8 is different from the opposition—the contest can become an exercise
9 in futility that undermines investor confidence and damages the com-
10 pany’s long-term prospects.
11 Ideally, instead of engaging in a war of words, both sides should
12 stake out the high ground and emphasize business over personal
13 issues. Unfortunately, in the heat of battle it is difficult to resist the
14 temptation to get personal and avoid responding to innuendo and
15 personal assaults. In this respect, a proxy war is no different from pol-
16 itics—people with good intentions end up slinging mud and thereby
17 alienating those whose votes they are trying to attract.
18
19 Every Shareholder Vote Is Critical
20 Even with millions of shares voting at an annual meeting or special
21 meeting, the difference between winning and losing may come down
22 to less than a single percentage point. The lesson: Every vote counts;
23 no investor should be overlooked in the search for votes.
24 One good strategy to avoid losing votes through revocations is to
25 make sure you throw the last punch. Send out a “fight letter” to
26 shareholders shortly before the shareholder meeting, depriving your
27 opposition of time for a rebuttal.
28 In close votes, don’t overlook chat rooms on the Internet. If
29 rumors are rife online, try to dispel them by making official news
30 releases. If serious issues are raised, address the issues seriously and
31 quickly in the same manner.
32
33 The Cost of Proxies
34 The out-of-pocket costs, regulatory requirements, and potential
35 liabilities of a large proxy solicitation deter all but the richest, best-
36 organized, and most committed dissidents. Investors relations
37 professionals generally do not need to concern themselves with gadflies
THE ART OF WINNING PROXY WARS 167
11 The Hewlett-Packard 2
3
4
Merger: A Case Study 5
6
7
KENNETH R. CONE 8
DANIEL R. FISCHEL 9
10
GREGORY J. PELNAR 11
DAVID J. ROSS 12
Lexecon Inc. 13
14
15
169
170 THE NEW INVESTOR RELATIONS
1
2 The Opposing Positions
3 Fiorina and other proponents of the merger contended that the
4 deal was beneficial because it provided HP with a more balanced
5 product and revenue mix and would not pose insuperable integra-
6 tion problems, although the track record of comparable mergers in
7 American industry is very mixed. Hewlett, by contrast, strenuously
8 argued that the deal would worsen HP’s product mix, making it less
9 profitable, and posed substantial integration risk. It is fair to say
10 that investors’ initial reaction to the deal was consistently negative.
11 On September 4, the first trading day after it was announced, HP’s
12 stock price plunged nearly 19 percent, from $23.21 to $18.87. A
13 day later, Moody’s Investors Service lowered HP’s credit rating two
14 notches, to A2. By November 5, HP’s stock price had fallen to
15 $16.89, more than 27 percent below its level before the merger
16 announcement. This decline represented a pretty clear thumbs-
17 down by Wall Street.
18 On November 6, the Hewlett family announced that it would
19 vote its stake against the merger, thus making the deal less likely to
20 be completed. HP’s stock price soared in response, rising more than
21 17 percent to close at $19.81. This was the pattern throughout:
22 Events that made the merger more likely to be completed were gen-
23 erally associated with stock price decreases while the opposite was
24 true for events that increased the probability that it wouldn’t go for-
25 ward. For Compaq shareholders, the reverse pattern was observed,
26 because the market perceived Compaq and its shareholders as the big
27 winners in the deal.
28 For the merger to be consummated, both HP and Compaq share-
29 holders had to vote in favor. Based on the market’s assessment of the
30 transaction, there was never any issue whether Compaq shareholders
31 would approve the deal. They did, and did so enthusiastically. But
32 HP shareholders were a different matter, particularly since Hewlett
33 and his associates owned approximately 18 percent of the stock,
34 which he pledged to vote against the merger. Thus, nearly one-fifth
35 of the shareholder vote was dead-set against the deal from day one.
36 To nix it, Hewlett had to convince just a little less than one-third of
37 other shareholders to vote with him. Nevertheless, HP shareholders
THE HEWLETT-PACKARD MERGER: A CASE STUDY 171
1
2 Optimistic and Pessimistic Shareholders
3 The existence of a market price for a stock does not necessarily mean
4 that all shareholders agree on the stock’s value. In theory, the stock
5 price could reflect the assessment of only the most pessimistic share-
6 holder and not the beliefs of the more optimistic voting majority.
7 Under this view, a majority of HP shareholders voted in favor of the
8 merger because they believed the deal would increase HP’s value,
9 while those who did not favor the deal determined the company’s
10 stock price by being active sellers.
11 The difficulty with this hypothesis is that it cannot fully explain
12 why the assumed optimistic majority who supported the merger
13 didn’t buy HP shares from the pessimistic shareholders, causing HP’s
14 stock price to rise. For those optimistic shareholders, HP’s $4.34
15 stock price decline when the deal was announced, and the further
16 declines when other events increased the probability that the deal
17 would be completed, created major profit opportunities. No reason
18 exists to assume that the institutional investors who supported the
19 deal were constrained by lack of capital or otherwise prevented from
20 betting on their beliefs. Apparently, there was no “silent majority” of
21 investors who strongly supported the deal because they believed HP’s
22 value would increase as a result.
23 For investor relations professionals, the lesson is that some share-
24 holders will need to be convinced to take a greater interest in the
25 unfolding events of a proxy tussle, and this may require strenuous
26 rounds of phone calls, faxes, e-mails, newspaper ads, and other solic-
27 itations. In addition, expert analysis probably should be presented to
28 shareholders. In the case of the HP-Compaq deal, it can be argued
29 that the silent majority sat on its hands or let management lead the
30 way. Moreover, as has already been stated, many institutional share-
31 holders have limited attention spans, because of their pressing com-
32 mitments to keeping abreast of entire portfolios of stocks, not just
33 particular issues within them.
34
35 Long-Run Versus Short-Run Investors
36 A related explanation for the favorable shareholder vote is that
37 sophisticated investors dismissed the negative stock price reaction to
THE HEWLETT-PACKARD MERGER: A CASE STUDY 175
1
2
FIGURE 11-1 Institutional Votes in the HP/Compaq 3
Merger 4
5
For Merger Against Merger
6
Money Managers / Banks 7
1 Alliance Capital (AXA Financial) 1 Bank of America Capital 8
Management
9
2 Banc One Investment Advisors 2 Brandes Investment Partners 10
3 Barclays Global Investors 3 Chicago Asset Management 11
4 Capital Research & Management 4 Davis Selected Advisers 12
5 Federated Investors 5 Dreman Value Management 13
6 General Motors Asset Management 6 Fifth Third Investment Advisors 14
7 L. Roy Papp & Associates 7 Matrix Asset Advisors 15
8 Putnam Investment Management 8 Parnassus Investments 16
9 State Street Corporation 9 Torray Companies 17
10 Victory Capital Management 18
11 Wachovia’s Evergreen Investment 19
12 Wells Fargo (Norwest Corporation) 20
Pension Funds 21
1 Florida State Board of Administration 1 CalPERS 22
2 PA Public School Employees 2 CA State Teachers’ Retirement 23
Retirement System System 24
3 State of WI Investment Board 3 CO Public Employees’ Retirement 25
Association 26
4 State Teachers Retirement System 4 New York Common Retirement 27
of Ohio Fund 28
5 NY State Teachers’ Retirement 29
System 30
6 Ontario Teachers’ Pension Plan Board 31
7 Public Employees Retirement 32
System of Ohio 33
8 State of Michigan Retirement 34
System 35
9 Teacher Retirement System of 36
Texas 37
178 THE NEW INVESTOR RELATIONS
1
2
3 FIGURE 11-2 Analyst Recommendations
4 in the HP-Compaq Merger
5
Analyst Support Merger?
6
7 Banc of America Yes
8 Deutsche Bank Alex. Brown Yes
9 Goldman Sachs Yes
10 Merrill Lynch Yes
11 Salomon Smith Barney Yes
12 A.G. Edwards No
13 ABN AMRO No
14 Bear Stearns No
15 Bernstein Research No
16 C.E. Unterberg, Towbin No
17 Credit Suisse First Boston No
18 Lehman Brothers N/A
19 Morgan Stanley Dean Witter No
20 Robertson Stephens No
21 UBS Warburg No
22
25
26
27
28 T HE FAILURE OF HP’ S SHAREHOLDERS to vote for what we con-
29 tend was their common interest in HP’s proxy fight is especially dis-
30 couraging because they had several unique advantages in this contest.
31 First, unlike in most proxy votes, where management represents the
32 only organized faction, the HP opposition was led by a highly moti-
33 vated shareholder whose name was on the company logo, who was a
34 member of the board, and who controlled or strongly influenced 20
35 percent of the vote, counting both family foundations. Walter
36 Hewlett waged a determined and expensive campaign in which he
37 hired top investment banking, legal, and public relations experts and
THE HEWLETT-PACKARD MERGER: A CASE STUDY 179
Special Case 12
13
14
Perspectives 15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
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183
184 THE NEW INVESTOR RELATIONS
1
2 Preparing to Offer Securities in the United States
3 The market-driven pricing and disclosure-based liabilities that are, to
4 varying degrees, part of every international securities offering may be
5 a surprise to a novice issuer. Non-U.S. issuers seeking to access the
6 U.S. capital markets for the first time may have borrowed money pre-
7 viously only from banks, governments, and supranational organiza-
8 tions or, in the case of businesses, may have raised equity capital only
9 from private investors.
10
11 The Team
12 First-time issuers likely are accustomed to negotiated transactions and
13 not to the investor protections afforded by U.S. securities laws and
14 regulations. To succeed in such an offering, which may entail new
15 and unfamiliar business practices and requirements, all parties need to
16 be flexible. The relationships among them must be largely coopera-
17 tive, not adversarial.
18 Officers of a non-U.S. issuer who are accustomed to establishing
19 the terms of a financing in a privately negotiated transaction or with
20 the benefit of an exemption from domestic securities laws will need
21 professional assistance to understand the regulatory requirements
22 and market practices designed to protect investors. IR professionals
23 must stress that shareholders sit at the apex of the U.S. public com-
24 pany pyramid, and insist that the IR team have access to all material
25 information, and play a role in when and how to disclose that infor-
26 mation in consultation with their advisers.
27 Foreign companies entering U.S. public capital markets also need
28 to be prepared for the amount of work required for their first U.S.
29 securities offering and the importance of adhering to the agreed
30 timetable. IR professionals may wish to point out that proper com-
31 pliance and the experience they gain from their first U.S. securities
32 offering will make succeeding U.S. securities offerings much easier.
33
34 The Business Profile
35 A non-U.S. issuer may be advised by securities firms and IR profes-
36 sionals to refine its business profile and clarify its business strategy to
37 facilitate its U.S. securities offering. The IR team needs a succinct
IR FOR NON-U.S. I SSUERS ACCESSING THE U.S. CAPITAL MARKETS 185
1
2 The Jurisdiction of Incorporation
3 In some cases, non-U.S. businesses establish a holding company or a
4 subsidiary to issue securities in the U.S. capital markets. Sometimes
5 this is because of legal, tax, or other issues in the home jurisdiction
6 that make it more desirable to obtain financing through an offshore
7 vehicle. In other cases, the requirements of the investors’ jurisdiction
8 drive the decision. IR professionals will need to understand these
9 reasons. Examples of the use of such vehicles follow.
10 Several non-U.S. issuers have raised equity through holding
11 companies established in the British Virgin Islands, Bermuda,
12 the Channel Islands, or the Cayman Islands. Some have done
13 so to obtain a corporate form in a jurisdiction with defined
14 shareholder rights that is better known to international securi-
15 ties investors than that of their home country. Others are seek-
16 ing to avoid having to comply with the requirements that their
17 own country’s legal system imposes on securities issued by a
18 domestic company. Still others have substantial international
19 business and set up holding companies in low-tax offshore
20 jurisdictions to minimize their corporate tax liability through
21 deconsolidation or other restructuring. In the case of an initial
22 public offering by a closely held non-U.S. issuer, the move off-
23 shore may be made to minimize the tax liability of the group of
24 shareholders that will control the issuer after the offering. Of
25 course, it is the job of IR professionals to clarify to the U.S.
26 investing public these legitimate reasons for seeking certain
27 jurisdictions.
28 For certain types of financing in the U.S. capital markets, such as
29 commercial paper programs and other investment-grade debt
30 offerings, debt issued by a Delaware finance subsidiary and guar-
31 anteed by the non-U.S. parent company increases the market of
32 eligible investors, even if the parent company is based offshore.
33 The reason is that many large U.S. institutional investors are lim-
34 ited by asset allocation models, corporate policy, or investment
35 charters in the amount of non-U.S. securities they may hold.
36 An offshore finance subsidiary may provide a convenient way to
37 enhance the credit rating of securities through overcollateral-
IR FOR NON-U.S. I SSUERS ACCESSING THE U.S. CAPITAL MARKETS 187
1
Materiality Standards 2
Although there is no standard that can be applied with mechanical 3
certainty, a fact will be considered “material” if there is a substantial 4
likelihood that reasonable investors would consider it important, as 5
part of the total mix of available information, in reaching their invest- 6
ment decisions. That is, information is material if investors would 7
attach actual significance to it in making their deliberations. It is 8
impossible to make a complete catalog of all material information, 9
but typical examples include significant mergers or acquisitions, stock 10
splits, adoption of a dividend policy or changes in dividends, major 11
increases or decreases in revenues or profits, important new contracts 12
or projects, and changes in senior corporate management or in basic 13
corporate business policies. 14
In this connection, courts have treated the confirmation of a gen- 15
eral market expectation as material information in some circum- 16
stances. For example, if an issuer confirms to one analyst the accuracy 17
of its projection that it will achieve a specific level of earnings, this may 18
trigger the obligation to make a general public announcement, even if 19
outside analysts are arriving at the same projection based on their own 20
analyses of published data. 21
22
Duty to Disclose 23
Good corporate practice generally calls for prompt public disclosure 24
of material events. There has been some discussion among legal 25
practitioners, however, concerning the extent to which the law 26
requires such disclosure. Under the 1934 Act, a non-U.S. private 27
issuer is required to report promptly on Form 6-K any information 28
not contained in its latest Form 20-F that the non-U.S. private 29
issuer (1) makes or is required to make public in its home country, 30
or (2) files or is required to file with a non-U.S. stock exchange on 31
which its securities are traded and that was made public by that 32
exchange, or (3) distributes or is required to distribute to its secu- 33
rity holders. The antifraud rules, such as Rule 10b-5 under the 34
1934 Act, prohibit material misstatements and omissions of facts 35
that need to be known to prevent the statements that are issued 36
from being misleading, given the circumstances under which they 37
192 THE NEW INVESTOR RELATIONS
1 were made. The rules do not, however, deal directly with total
2 silence.
3 An issuer with securities listed on a U.S. exchange is subject to an
4 additional affirmative obligation to make timely public disclosure of
5 material information.
6 Arguably, an issuer does not violate any legal requirements if, for
7 good business reasons, it delays an announcement of important
8 developments, absent special circumstances creating an affirmative
9 duty to disclose. An affirmative duty to disclose may exist when there
10 has been a leak of news or selective disclosure, when insider trading
11 has occurred, when the issuer is acquiring its own equity securities, or
12 when there is a rumor or a market report circulating for which the
13 issuer had some responsibility.
14 Notwithstanding the foregoing, the SEC’s enforcement policies,
15 as well as the trend of the law as interpreted by the courts, favor full
16 and fair disclosure. Accordingly, withholding material information is
17 not recommended unless there is a countervailing bona fide and
18 important business reason for doing so. In general, issuers subject to
19 the U.S. federal securities laws should adopt a policy of disclosing
20 material events on a timely basis. IR professionals can hardly overem-
21 phasize the importance of this policy.
22
23 Selective Disclosure
24 In 2000 the SEC adopted Regulation FD, which creates a reporting
25 obligation for all public reporting companies (other than non-U.S.
26 governmental issuers and non-U.S. private issuers), including closed-
27 end investment companies but not other investment companies. In
28 general, issuers subject to the new regulation must ensure that any
29 material nonpublic information intentionally disclosed to specified
30 persons outside the company is simultaneously disclosed to the pub-
31 lic at large (in the case of a “non-intentional” disclosure, public dis-
32 closure must be made “promptly”).
33 Although Regulation FD does not currently apply to non-U.S.
34 governmental and non-U.S. private issuers, the SEC stated in the
35 release adopting the new regulation that it intends to undertake a
36 “comprehensive review of the reporting obligations of foreign private
37 issuers” and, in the interim, reminded non-U.S. private issuers of
IR FOR NON-U.S. I SSUERS ACCESSING THE U.S. CAPITAL MARKETS 193
13 Investor Relations 2
3
4
and Microcap Companies 5
6
7
RALPH A. RIEVES 8
Emerging Companies Research Institute 9
10
JOHN R. LEFEBVRE, JR. 11
Shareholder Relations 12
13
14
15
195
196 THE NEW INVESTOR RELATIONS
1
2
FIGURE 13-1 Risk and Return Over 14 Years 3
(Period ending December 31, 2000) 4
5
14
6
Annual return (expressed as a percentage)
7
13
8
Source: Ibbotson Associates/The Emerging Companies Research
9
12 10
11
11 Large Cap 12
Mid Cap
13
Small Cap
10 14
Micro Cap
15
9 16
15 20 25 30 35 40
17
Risk measured by standard deviation
18
19
Does this mean that microcap stocks aren’t risky? On the contrary, 20
the graph shows that they are more than three times as risky as large- 21
cap stocks. Thus, these stocks are not for widows and orphans or for 22
persons at or nearing retirement age. Again, however, the point is 23
that listed microcaps are relatively risky, but not speculative. They are 24
an appropriate and reasonable asset class for people with discretionary 25
investment dollars. Focus your IR activities on their advisers. 26
Microcap enthusiasts also argue that microcap stocks are appeal- 27
ing as so-called alternative investments‚ because they are inefficiently 28
priced. Thus, they reason that this prevailing inefficiency provides 29
real diversification in a strategy employing stocks of differing market 30
capitalization. This presupposes some significant difference in market 31
performance from the larger-cap stocks. Is there any evidence in sup- 32
port of this? If so, how valid is the evidence over several market cycles 33
and macroeconomic cycles? And, in the spirit of prudent practice, 34
does past performance guarantee the validity of projecting these 35
attributes to this asset class? 36
37
198 THE NEW INVESTOR RELATIONS
1
2 Are Microcaps Diversification Plays?
3 The fact that almost no microcap company pays dividends simplifies
4 the consideration of whether microcap stock returns co-vary with the
5 returns of the largest cap stocks. What does not simplify this discus-
6 sion is that transaction costs associated with microcap investing are
7 very high.
8 Transaction costs and the related issue of small-float liquidity
9 aggravate and complicate every microcap IR challenge. Those issues
10 are there 24/7. If emerging growth companies ignore these omni-
11 present bugaboos in formulating share-price enhancing strategies,
12 they may not survive as public companies. Let’s review some research
13 on how these issues affect portfolio returns relative to other equities.
14 In 1998 the Plexus Group, a Los Angeles consulting firm, com-
15 pleted an extensive study confirming that transaction costs involving
16 the smallest cap stocks are much higher than the costs associated with
17 trading the larger-cap stocks. The study also confirmed that invest-
18 ment style would influence transaction costs. Other than brokerage
19 fees, what other transaction costs are there?
20 Market impact cost, which is measured by taking the difference
21 in the quoted price of the stock when the manager placed an
22 order and when the order was executed.
23 Delay cost, which occurs when the investor tries to wait for the
24 “best price” to make a trade with someone who is monitoring
25 the stock closely. The odds are about equal, even in engaging
26 in a waiting game, that an experienced investor or trader will
27 not get a better price. In the worst case, the order gets can-
28 celled.
29 Opportunity cost, which is a type of delay cost carried to its
30 extreme. This is the cost of missing out on or only partially fill-
31 ing the order.
32
33 These costs, as they relate to market cap and style strategies, are
34 summarized in Figure 13-2 with the cost components expressed in
35 basis points (0.01 percent).
36 Note the range of average transaction costs across investment
37 styles. Not surprisingly, large-cap value managers (who, by definition,
INVESTOR RELATIONS AND MICROCAP COMPANIES 199
1
2
FIGURE 13-2 Cost Patterns by Manager Style 3
Cost Components (in Basis Points) 4
5
Delay Delay Opportunity 6
(Manager (Trader Market (Missed
Style Timing) Timing) Impact Commission Traders) Total 7
Large cap value 1 13 8 15 28 65 8
Large cap growth 82 32 21 10 14 159 9
Index/passive 31 61 25 9 12 138 10
Source: Plexus Group
1 published papers arguing that stock in the smallest cap CRSP deciles
2 generated returns more than 5 percent higher than the returns of the
3 larger-cap stocks over the same periods. They construed this excess
4 return as the risk premium for holding the smaller-capitalized stocks.
5 This observation was discussed among academics in the context of
6 the Capital Asset Pricing Model (CAPM) and became known as the
7 size effect.
8 Enthusiasts for investing in smaller-cap companies (including
9 microcaps) always cite these studies. Their critics have countered
10 that transaction costs made the differences between absolute returns
11 negligible.
12
13 What Risk Premium?
14 The debates over risk/return aspects of the size effect thus have
15 focused on the actual costs of buying or selling the microcap stocks.
16 Critics have argued that these inherent transaction costs cancel out
17 much of the supposed risk premium. The subsequent Plexus research
18 indicates that with respect to small-cap growth stocks, the risk premi-
19 um is less than 2 percent (the Banz-Reinganum size effect of 5 percent
20 minus the Plexus small-cap growth costs composite of 3.1 percent).
21 So, the net risk premium is low for microcap companies. As to rel-
22 ative cyclical performance, are there times when microcap returns
23 vary significantly from the returns of the largest-cap stocks, deciles
24 1 and 2? Have there been periods when microcap stocks significantly
25 outperformed the blue chips over and above any so-called risk
26 premiums?
27 The answer is yes. The bad news is that risk and transaction costs,
28 of course, remain intrinsic characteristics of microcap stocks. Yet the
29 good news is that the returns have been proportionate to the risks
30 and co-vary with the larger-cap stocks. Look at Figure 13-3.
31 When returns comparisons are broken down into manageable
32 time segments, the argument in favor of cap size diversification holds
33 up. True enough, the relative performance periods illustrated in
34 Figure 13-3 are of unequal length. This reflects the smoothing out of
35 those periodic “bursts” and “busts” that occurred in the overall U.S.
36 market from 1969 to 2000. Subsequent periods likewise would be
37 configured for the systemic shocks sustained during the early years of
INVESTOR RELATIONS AND MICROCAP COMPANIES 201
1
2
FIGURE 13-3 Comparison of Returns Between CRSP 3
Source: The Emerging Companies Research Institute using data from
1
2 The Retail Broker
3 Institutions drive the markets, but never discount the role of those
4 brokers whose trade are individual investors. They provide the most
5 cost-efficient way to tell your story to the high-net-worth individual
6 market once, and then have it repeated scores of times. Moreover, a
7 broker is a compliance shield. Brokers know securities law. They
8 know what they can and cannot say. Brokers can insulate a company
9 from disclosure problems.
10 Institutions make purchases in large share lots, but not with a high
11 degree of frequency. Even though individuals trade stocks in smaller
12 lots, they tend to be long-term holders. They are less likely to sell in
13 the face of a small quarterly earnings decrease. If a stockbroker is con-
14 vinced that a stock’s price represents value, that broker will be
15 encouraging its purchase every trading day. Retail brokers and their
16 customers create daily volume for microcap stocks. Without this
17 activity, the company is less likely to attract the attention of institu-
18 tional investors.
19 Finding brokers who cater to high-net-worth individuals, essen-
20 tially a task of elimination, is less daunting than most IR profession-
21 als think. One reason is the manner in which brokers from the major
22 firms now conduct their business. Thirty-five percent of the brokers
23 dealing with HNWIs don’t earn commissions on stock transactions.
24 Their compensation is based on fees earned on the amount of their
25 clients‚ assets that they direct to investment managers and hedge
26 funds. These professionals are commonly known as fee-based con-
27 sultants or wrap-account brokers. This group is easily identified as
28 candidates for your first cut.
29 You also can eliminate brokers who have had less than five years’
30 experience working as a broker. At any given time, this is about 25
31 percent of the broker pool. They will not have earned the autonomy
32 to make their own recommendations. Another 25 percent that
33 should be eliminated are those brokers whose customers have low
34 tolerance for risk, such as those nearing retirement. Customers over
35 age sixty likely carry the overriding concern of capital preservation.
36 This suggested winnowing leaves about 15 percent of the broker
37 pool that represent stocks (not portfolios) to accredited or qualified
INVESTOR RELATIONS AND MICROCAP COMPANIES 203
1
2 Attracting Institutional Investors
3 The recent concerns of large mutual funds and investment manage-
4 ment firms about operating with economies of scale have resulted in
5 a number of corporate mergers. The resulting behemoths may be
6 enjoying economies of scale, but their trading decisions have become
7 more bureaucratic. They are not nimble.
8 Few of the mergers have involved microcap investment managers
9 or microcap-focused mutual funds, however. Microcap investment
10 managers remain a nimble group of competitors for large pools of
11 money. They are ready buyers of emerging company stocks that meet
12 their criteria.
13 The institutional microcap universe contains approximately sixty-
14 five target portfolios, of which about forty are emerging growth
15 mutual funds. The remaining fund pools are run by independent
16 managers with core strategies reliant on the microcap component and
17 by sector-style managers who hold some microcap companies.
18
19 Understanding the Microcap Investment Manager
20 All microcap managers seek superior returns, but their selection crite-
21 ria and search patterns will differ. They all want a high rate of annual
22 earnings growth (typically 20 percent plus), but they look at the earn-
23 ings in the context of another operating measure. Some favor high
24 rates of revenue growth, some will look for annual increases in free
25 cash flow, and still others want a pattern of increasing operating mar-
26 gins. A company should never approach a portfolio manager until the
27 company understands that manager’s selection criteria. Read the man-
28 ager’s prospectus and sales literature. Search the Web for transcripts of
29 interviews the media has conducted with the target manager.
30 About 15 percent of the microcap investment funds we follow use
31 computer-based screening models to select stocks. Generally, the
32 managers of these portfolios won’t welcome contact with anyone
33 from a company.
34
35 The Profit Challenge for Microcap Investment Managers
36 As has been noted, microcap investment managers bear high trans-
37 action costs, in fact, higher than those borne by any other type of
INVESTOR RELATIONS AND MICROCAP COMPANIES 205
1 microcaps against the S&P 600 rather than against the Russell 2000.
2 New research also exists suggesting that any negative impact from
3 being dropped from an index is short lived.
4 In connection with the float issue discussed previously, there is a
5 sunny side to the fact that a microcap stock is almost always in rela-
6 tively short supply. This fact, coupled with the rules governing micro-
7 cap margin accounts, makes it unlikely that microcap companies will
8 ever be targets of a short-selling bear raid. The shorts can get killed
9 trying to cover on a run-up.
10
11
12 Where Are the Market Makers?
13 Another issue, the structure of the market for microcaps, compounds
14 the transaction-cost challenge. The SEC issued a revised set of rules
15 in 1997 that changed the way orders were handled by the Nasdaq
16 system. The rules were intended to correct some practices that had
17 been allegedly increasing investor’s trading costs. Soon after those
18 rules were in effect, decimal trading was introduced. The combined
19 impact of the revised rules and the penny trades made it largely
20 impossible to make any money trading the smallest-cap stocks.
21 Microcap securities dealers subsequently shut down their trading
22 operations and ceased making retail markets in the Nasdaq Small Cap
23 Issues system.
24 A few large-capitalized dealer firms had been functioning as ware-
25 housing wholesalers to the smaller dealers. When the small dealers
26 stopped making markets, these wholesalers became the only game in
27 town. The new rules didn’t permit those few large dealers to make
28 any money on trades, either. They did, however, find a better way to
29 make money from their well-capitalized advantage. They began to
30 glean information from the flow of all those buy and sell orders that
31 now came to them.
32 There is now an oligopoly structure standing astride the Nasdaq
33 Small Cap Issues system that is not providing adequate liquidity for
34 that system’s listed stocks. Investment bankers who underwrite the
35 small-cap issues are now arranging to have some of those stocks listed
36 on the American Stock Exchange (AMEX). In some instances, com-
37 panies have left the Small Cap System for the AMEX.
INVESTOR RELATIONS AND MICROCAP COMPANIES 207
1 Authors’ Note
2
This article is based in part on ideas contained in our book, Investor Relations
3 for the Emerging Company, published by John Wiley & Sons, Inc. Information
4 for ordering that inclusive work on this subject can be found at www.wiley
5 finance.com. Readers who want more information on the research discussed in
6 this chapter can contact us at www.shareholder-relations.net.
7
8
9
10
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37
1
14 IR and the 2
3
4
Credit-Ratings Process 5
6
7
CLIFFORD M. GRIEP 8
Standard & Poor’s 9
10
11
12
13
14
15
209
210 THE NEW INVESTOR RELATIONS
1
2 Role of Ratings Agencies
3 Ratings agencies play a unique role in the capital markets, both by
4 tradition and, in some countries, because of regulation. In the United
5 States, for example, some four ratings agencies are sanctioned as
6 Nationally Recognized Statistical Rating Organizations (NRSROs)
7 by the Securities Exchange Commission (SEC). This recognition was
8 initiated in 1975 when ratings were first incorporated into the SEC’s
9 Net Capital Rule for broker dealers, and at the time simply reflected
10 that the ratings of certain firms, Standard & Poor’s, Moody’s, and
11 Fitch, were used nationally. Over the past thirty years however, the
12 SEC and other regulators have increasingly used credit ratings to help
13 monitor the risk of investments held by regulated entities.
14 In addition, many institutional and other bond investors hold
15 portfolios limited by credit rating, such as “BBB– or better,” in the
16 case of funds which hold only investment-grade bonds. Other funds
17 prefer the higher yield associated with bonds that are rated lower on
18 the totem pole.
19 The unique role of credit-rating agencies was highlighted by the
20 adoption in 2000 of SEC Regulation Fair Disclosure (Regulation
21 FD). Although not widely noticed in the financial media, Regulation
22 FD specifically exempts NRSROs, which routinely use nonpublic
23 information in their analysis. This access to otherwise nonpublic
24 information is one reason why credit-rating agency ratings are often
25 taken more seriously than “buy” or “sell” recommendations from
26 brokerage analysts. It is also worth noting that bond-rating analysts
27 are free of the conflicts of interest which so infamously plague bro-
28 kerage analysts.
29 A principal goal of IR professionals should be to establish an
30 ongoing dialogue with one or more of the NRSROs and thus to
31 build management creditability. A few warnings for IR professionals:
32 The credit-rating agencies keep files and records, and what has
33 been called “institutional memory” is elephantine.
34 The rating process is iterative, providing a large platform to
35 judge management’s ability and a company’s creditworthiness.
36 For example, credit-rating agencies will evaluate manage-
37 ment’s ability to anticipate and respond to competitive devel-
IR AND THE CREDIT-RATINGS PROCESS 211
1
2 FIGURE 14-1 Credit Rating Assignments
3
4 Credit Quality S&P Moody’s Fitch
5 Solid as a rock AAA Aaa AAA
6
7 Very fine quality AA+ Aa1 AA+
8 AA Aa2 AA
9 AA- Aa3 AA-
10
Strong capacity to pay A+ A1 A+
11
A A2 A
12
A- A3 A-
13 A A A
14
15 Adequate ability to pay; BBB+ Baa1 BBB+
16 lowest investment grade BBB Baa2 BBB
17 for banks BBB- Baa3 BBB-
18
Somewhat speculative; BB+ Ba1 BB+
19
risk exposure BB Ba2 BB
20
BB- Ba3 BB-
21
22 More speculative; B+ B1 B+
23 risk exposure B B2 B
24 B- B3 B-
25
26 Major risk exposure; CCC+ Caa1 CCC+
on verge of default CCC Caa2 CCC
27
CCC- Caa3 CCC-
28
29 Crucial risk exposure; CC+ Ca1 CC+
30 may have defaulted CC Ca2 CC
31 on interest payments CC- Ca3 CC-
32
33 Default or Imminent Default C C C
34
General default D D D
35
36 No rating requested NR NR NR
37
IR AND THE CREDIT-RATINGS PROCESS 215
1 the last two years of interim financial statements, and key regu-
2 latory filings
3 narrative descriptions of operations and products
4 a draft registration statement or offering memorandum, or
5 equivalent information (if available)
6
7 Written presentations by management, while not mandatory,
8 often provide a valuable framework for the discussion. Such presen-
9 tations typically mirror the format of the meeting discussions, as out-
10 lined below. When a written presentation is prepared, it is particularly
11 useful for a credit-rating agency’s analytical team to be afforded the
12 opportunity to review this before the meeting.
13 If additional information to clarify points discussed in the meet-
14 ing is not immediately available, it can be provided afterwards. In
15 any case, credit-rating agency analysts generally will have follow-up
16 questions that arise as the information covered at the management
17 meeting is further analyzed.
18 Confidentiality. A substantial portion of the information in com-
19 pany presentations is highly sensitive and is provided by the issuer to
20 the credit-rating agency solely for the purpose of arriving at a rating.
21 Such information is kept confidential by the ratings group. Even if
22 the assigned rating is subsequently made public, any rationales or
23 other information that NRSROs publish about the company will only
24 refer to publicly available corporate information. Confidential infor-
25 mation is not used for any other purpose or by any third party.
26
27
28 Conduct of the Management Meeting
29 Management meetings with companies new to the rating process typ-
30 ically last two to four hours, although sometimes longer if the com-
31 pany’s operations are particularly complex or if management and the
32 IR team try to substitute flash for substance. Short, formal presenta-
33 tions by management may be useful to introduce areas for discussion.
34 Standard & Poor’s preference is for meetings to be largely informal,
35 with ample time allowed for questions and responses. At management
36 meetings, as well as at all other times, Standard & Poor’s welcomes
37 questions regarding its procedures, methodology, and analytic criteria.
IR AND THE CREDIT-RATINGS PROCESS 217
1
Typical Agenda 2
The following is an outline of the topics that credit-rating agencies 3
typically expect issuers to address in a management meeting: 4
The industry environment and prospects 5
An overview of major business segments with reference to key 6
operating statistics, including comparisons with competitors 7
and industry norms 8
Management’s financial policies and financial performance goals 9
Distinctive accounting practices 10
A careful review of accounting methods has become more 11
important in recent years. Obviously, much greater scrutiny will 12
be given to unusual accounting procedures, and clarity, not 13
opacity, will be rewarded. IR professionals should ask them- 14
selves, and pose the question also for management: If a team of 15
credit-rating agency analysts finds itself puzzled trying to 16
understand our business, then who else is going to understand 17
our business? After all, very few money managers, and even 18
brokerage industry analysts, can afford to spend the time deci- 19
phering a company’s accounting, and no one else can get access 20
to otherwise privileged information. 21
Management’s projections, including income and cash flow 22
statements and balance sheets, together with the underlying 23
market and operating assumptions 24
In regard to management’s projections, it should be under- 25
stood that Standard & Poor’s (and other credit-rating agen- 26
cies’) ratings are not based on the issuer’s financial projections 27
or its view of what the future may hold. Rather, ratings are based 28
on Standard & Poor’s own assessment of the firm’s prospects. 29
But management’s financial projections are a valuable tool in the 30
rating process, as they indicate management’s plans, how man- 31
agement assesses the company’s challenges, and how they intend 32
to deal with problems. Projections also depict the company’s 33
financial strategy in terms of anticipated reliance on internal cash 34
flow or outside funds, and they help articulate management’s 35
financial objectives and policies, capital spending plans, and 36
financing alternatives and contingency plans. 37
218 THE NEW INVESTOR RELATIONS
1 The emphasis given to various risk factors may change over time,
2 reflecting changes in the competitive or economic environment or
3 changes in the business profile of the company. Occasionally, new risk
4 factors emerge. For example, the rating analysis of U.S. banks empha-
5 sized asset liability management in the late 1970s and early 1980s as
6 interest rates soared, while in subsequent recessions loan quality and
7 capital received more attention.
8
9 When Capital Markets Tighten
10 IR professionals should note that whenever capital markets are tight,
11 there is a heightened focus on liquidity for the corporate sector.
12 Consequently, company presentations to a credit-rating agency need
13 to provide detail on the company’s management of liquidity and
14 funding risks—including contingent commitments in debt, counter-
15 party or operating agreements that would be triggered by changes in
16 ratings, equity prices, or violation of financial covenants. IR profes-
17 sionals and company officials can expect credit agency analysts to ask
18 about how the company will fare, in terms of liquidity, if sales should
19 contract due to recessionary trends. Demonstrating adequate contin-
20 gency plans for dealing with a challenging business environment,
21 adverse or inhospitable markets, or conditional commitments serves
22 to underscore management’s preparedness and is supportive of sound
23 financial policies and creditworthiness.
24 Debt holders and credit-rating agencies may have a different take
25 on additional debt than shareholders. Tolerances for increasing debt
26 leverage may be acceptable to, or even welcomed by, equity holders,
27 whose upside—possible hefty returns—justifies the incremental risk.
28 For debt holders or other creditors who hold only a fixed claim on
29 company resources, incremental financial leverage may impair cash
30 flow coverages. The ratings process recognizes that management
31 must balance the needs of multiple constituencies and expects as
32 much in the data management provides. IR professionals should not
33 show one face to creditors and another to shareholders. Management
34 builds credibility through the consistency of presentations on strategy
35 and financial policy to all constituents; word tends to get around.
36 Decide on a prudent course and sell that course to both creditors and
37 shareholders.
1
15 The Information 2
3
4
Investment Managers Want 5
6
221
222 THE NEW INVESTOR RELATIONS
1
2
FIGURE 15-1 Institutional Investors 3
From an IR Perspective 4
5
Institutional Investors 6
7
8
Real Money Investors Momentum Players 9
10
F OCUS
11
12
Passive Active Long Buyers Short Sellers
13
14
15
Long-Term Medium-Term
Holding Period Holding Period 16
(2+ years) (6 months–2 years) 17
18
19
management. Some companies even screen out smaller institutional 20
investors from asking questions on quarterly-earnings conference 21
calls. This is a mistake for obvious reasons, many of which are detailed 22
below, but the practice nevertheless continues. 23
The first reason for not ignoring smaller institutions is that they 24
are still investors and can decide to sell. In soft markets, even mod- 25
est selling can drive prices down. We may have entered a sustained 26
period in which large institutions will not have more and more 27
money each year to throw around. Think about the net outflows 28
that the mutual fund industry has been experiencing month after 29
month. If small institutions decide to sell, the big investors may not 30
be there to sop up the shares. Indeed, they may be forced to be net 31
sellers, too. 32
Second, analysts and portfolio managers tend to move from large 33
firms to small ones, and vice versa. Large institutional investors may 34
shrink, particularly if their investment performance is poor, and small 35
institutional investors may grow. Hence it is important to treat all 36
institutional investors equally. 37
226 THE NEW INVESTOR RELATIONS
gets done and can create a lasting impression that may help the 1
investor make a more informed decision. 2
Often, a company has a chance to make a presentation at a con- 3
ference hosted by a brokerage house. These conferences may include 4
hundreds or thousands of investors and several dozen companies. 5
Company presentations typically are made to groups of 50 to 100 6
investors and often follow a strict format. A breakout session with a 7
smaller group follows the presentation. The advantage of a confer- 8
ence is that a company can reach a relatively large number of investors 9
in one or two hours. The disadvantage is that the company’s message 10
can get lost in the crowd, since investors are listening to up to six or 11
more presentations in one day. In such sessions, it must be conceded 12
that a little razzmatazz is in order, since it is necessary to stand out 13
somehow in the crowd. 14
A common venue for face-to-face meetings is the investment man- 15
ager’s office. An investor relations firm or a brokerage firm often 16
escorts client companies across the country to visit numerous institu- 17
tional investors. These meetings are usually very efficient, because the 18
investment manager typically has done some homework on the 19
company before the visit. There is debate in the industry as to whether 20
it is better to have an investor relations firm or a brokerage firm set up 21
the meetings with institutional investors on a company’s behalf. 22
Although there are positives to both approaches, it can be argued that 23
an introduction made by an IR firm provides the appearance of greater 24
independence on the part of the company and may translate to a 25
presentation that is more candid and free from conflict of interest. 26
Institutional investors prefer to keep a copy of the company presenta- 27
tions in their files and refer to them on a regular basis. 28
Analyst days are much like exclusive conferences held at the 29
company’s site. These are often well worth attending if the 30
investors are able to dedicate the time and make travel plans. The 31
downside to analyst days is that they generally attract only analysts 32
rather than portfolio managers or other investment professionals. 33
Although this is not necessarily a negative, it means that the company 34
has a limited audience. There is also the concern that most brokerage 35
analysts are Trojan horses, in search of investment banking work. 36
There may be a price to be paid for a “buy” recommendation. 37
230 THE NEW INVESTOR RELATIONS
price to fall inexplicably. Some will short the stock. Others will buy 1
or sell based solely on technical indicators, while others will buy or 2
sell as the stock moves from one index to another. And some invest- 3
ment managers will never buy your stock, because it is a type they 4
simply do not hold. Blue-chip managers, for example, generally 5
eschew small cap stocks. 6
The IR team must accept these realities and concentrate its 7
resources on those institutional investors who are making practical 8
judgments about buying and selling stocks that are similar to the 9
company’s. The team should develop a rapport with institutional 10
investors who are likely to buy and hold the company’s stock. And 11
remember, every such investor is important, not just those from large 12
funds. The corporate culture should impress money managers in per- 13
sonal meetings. That almost always means showing respect for good 14
corporate governance and shareholders. 15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
IR AND THE CREDIT-RATINGS PROCESS 219
1
Surveillance and Ongoing Maintenance Coverage 2
Credit ratings on publicly distributed issues are monitored for at least 3
three years. Companies that have requested the rating have the 4
option of surveillance, or being reviewed by the agency on what is 5
termed a “point-in-time” basis. Surveillance is performed by the 6
same credit analysts who work on the original rating assignment. To 7
facilitate surveillance, companies are requested to put the primary 8
analyst on mailing lists to receive interim and annual financial state- 9
ments and press releases. 10
The primary analyst then remains in regular telephone contact 11
with the company to discuss ongoing performance and develop- 12
ments. When these vary significantly from expectations, or when a 13
major, new financing transaction is planned, scheduling of an update 14
management meeting is appropriate. Also, Standard & Poor’s encour- 15
ages companies to discuss hypothetically—again, in strict confidence— 16
transactions that are perhaps only being contemplated (e.g., acquisi- 17
tions, new financings). Standard & Poor’s, and the other credit- 18
rating agencies, are generally frank about the potential ratings impli- 19
cations of such transactions. 20
In any event, management meetings are routinely scheduled at 21
least annually. These meetings enable ratings agency analysts to keep 22
abreast of management’s view of current developments, to discuss 23
businesses that have performed differently from original expectations, 24
and to be apprised of changes in plans. As with initial management 25
meetings, Standard & Poor’s willingly provides guidance in advance 26
regarding areas it believes warrant emphasis at the meeting. Typically, 27
there is no need for management to dwell on the sort of basic infor- 28
mation covered at the initial meeting. Apart from discussing revised 29
projections, it is often helpful to revisit the prior projections and dis- 30
cuss how actual performance varied, and the reasons for this variance. 31
A significant proportion of the meetings with company officials 32
take place on their own premises. This allows the credit-rating ana- 33
lysts to see members of management in their own environment, espe- 34
cially at the operating level. While no false fronts should be erected 35
by IR professionals or anyone else, company officers should be well 36
informed about the pending visit and be prepared. There have been 37
220 THE NEW INVESTOR RELATIONS
235
236 INDEX
41, 90, 96, 191–192, 193 Standard & Poor’s, 209, 210, 212,
Securities and Exchange Commission 214, 215, 216–217, 219
(SEC), 3 Barra Growth index, 231
creation of, 5 500 index, 231
disclosure statements, 6 Standards of Practice Handbook for
Net Capital Rule, 210 Investor Relations (NIRI), 7–9
printed materials, standards on, 19 statute of limitations, 49
pro forma reporting, 31 Steffens, Lincoln, 67
proxy fights and, 157 Stewart, Martha, 7, 69
0 Regulation Fair Disclosure, 9–10, stock ownership, first idea of, 5
1 11, 18, 47, 65–66, 97–103, structured disclosure, 6
2 192–193, 210 SunTrust, 163
3 Regulation G, 66–67
4 Regulation M-A, 90–97, 102–103 Tarbell, Ida, 67, 68
5 reporting requirements, 10–12 targeting the right investors, 15–18
6 Sarbanes-Oxley Act (2002), 20, tender offers, 92, 94
7 47–50 TheStreet.com, 59
8 Self-Regulatory Organization (SRO) 13D and 13F filings, 155–156
9 rules, 101 Thompson, Louis, 7, 54, 62
0 Shareholder Relations, 195 Thomson Financial, 34
1 shareholders TIAA-CREF, 35
2 activists, 28 Tiger Management, 26
3 list, 157 Trojan horse, 151
4 profiles, 155–156 TSC Industries, Inc. v. Northway,
5 proxy fights and identifying and Inc., 99
6 targeting, 155–156, 157, Tyco International Ltd., 35, 42
7 160–161, 166
8 proxy fights and meeting with key, Understanding Media: The
9 163 Extensions of Man (McLuhan),
0 Sherk, Douglas M., 119–135 59
1 Shimada, Yoshiki, 183–194 unstructured disclosure, 6
2 short sellers, 224
3 Sidley Austin Brown & Wood LLP, value investors, 16
4 183 Value Investors’ Club, 17
5 Silver, David, 59–74 Vinik, Jeffrey, 26
6 Silver Public Relations, 59 Vinik Asset Management, 26
7 Sinclair, Upton, 67
8 Sitrick, Michael S., 139–147 Wachovia Corp., 163
9 Sitrick and Company, Inc., 139, 143, Wall Street Journal, 71
0 146 Waste Management Inc., 46
1 size effect, 199–200 webcasts, 101–102
2 Soros Fund Management, 26 websites, use of, 226–227
3 Squawk Box, 59 Welch, Jack, 52
INDEX 243