Crowdfunding Loses its Appeal after the Facebook IPO

As Facebook’s shares continue to slump, recriminations over its busted IPO continue with no end in sight.  It might also prompt fresh concern about the JOBS Act, which loosens the rules on capital raising.

Regulators and plaintiffs’ attorneys are circling Facebook and its advisors.  Bankers, company officials, early stage investors and Nasdaq are all coming in for criticism. Even the glassy eyed retail investor is being blamed for assuming Facebook was a risk free way to be a hedge-fund titan for a day and make a quick killing.

But here’s the thing: For all the finger pointing, it’s likely that the Facebook and its bankers complied with the IPO rules. Yes, Facebook’s disclosures weren’t all that clear, and the underwriting banks’ analysts kept their earnings downgrades away from the public, but all this was acceptable under the rules.

The rules are set to change, and in ways that don’t favor retail investors.  So if small investors are feeling burned Facebook, just wait until bankers start crowdfunding growth companies under the provisions of the new JOBS Act.

Under the law, enacted just weeks ago, companies with under $1 billion in revenue will be able to tap the public markets without many of the restrictions that govern IPOs today. They’ll be exempt from disclosure and corporate governance requirements. Small companies will also be able to crowdsource their funding – soliciting investors via the Internet – without filing a registration statement. The information disadvantage for retail investors looks likely to grow worse under the new law.

Many of the protections put in place in 2003 after the collapse of high flying tech companies are also eliminated. (Ironically, the JOBS Act would permit underwriters to publish research on companies before an IPO, which some have argued would have been useful for retail investors eyeing a flyer on Facebook.)

The SEC is not very enthusiastic about the JOBS Act, and it has begun to gather public comments as it develops rules to implement the law. Facebook’s disappointed shareholders should be writing to Mary Schapiro.



Disclosure is an Attitude

I recently had lunch with a senior executive from a big accounting firm who complained about the criticism his firm was facing over audits it conducted at big companies that later were found to have big problems.

In all these cases, the executive said, there was a “well established body of accounting practice” that permitted the company to forestall disclosure or keep certain items off the balance sheet or bury an important fact in a fine-print footnote.

As it turned out, the things these companies obscured were pretty important to investors.  Once the off-balance-sheet liabilities were known, the company’s valuation tumbled, executives were fired and lawsuits and recriminations ensued – for the board and its auditor.

The accountants’ defense that “we were just following the rules” just doesn’t fly.  For one thing, the so-called “rules” on disclosure don’t exist.  The SEC does not provide a strict threshold for disclosure, choosing instead to let companies determine what should be released.  The burden is, appropriately, on the company’s board to make the right judgment, consistent with its fiduciary obligation to shareholders.

More than that, auditors ought to stand up as professionals and insist on disclosure when important issues are involved.  Sadly, there are few examples when they’ve done so.

It’s not all the fault of the auditors.  Ultimately, it’s up to the board.  Disclosure isn’t a matter of meeting a test or ticking a box.  Disclosure is an attitude.  A company decides it is going to keep investors informed or not.

Disclosure failures have been at the heart of spectacular corporate failures, from Enron nearly a decade ago, to Lehman Brothers in 2008, and it’s again in focus in the aftermath of Facebook’s bungled IPO.  There, Facebook filed a revised prospectus with a vague statement about user growth was outpacing advertising – an oblique way of saying its revenue growth was slowing.

Did the SEC filing by Facebook meet the legal requirement to disclose a material fact? Probably. (Although that question seems headed for the courts.) Was the statement sufficient to inform investors about the true state of Facebook’s profit outlook?  No, it wasn’t.

The adequacy of J.P. Morgan’s disclosures has also been questioned following its $2 billion trading loss from a complex hedging strategy.

Ultimately, the decision to make a disclosure comes down to management and the board and whether they want to state the facts openly or hide behind obscure accounting practices.

I know in which company I’d want to invest.

Advice for Eduardo Saverin

Here is some advice for Eduardo Saverin and misunderstood billionaires everywhere: Just. Be. Quiet.

Stung by criticism that he relinquished his U.S. citizenship to evade tax on his fortune, Mr. Saverin gave an interview to the New York Times.  He no doubt believed that a sit-down with a Times reporter to “set the record straight” would reverse the impression that he is lucky, greedy and aimless.  It did not.

He comes across as, well, lost:

Of all the founders, Mr. Saverin has had perhaps the greatest difficulty figuring out how to build on what is likely a once-in-a-lifetime experience.

On the tax issue, Mr. Saverin essentially confirms reports that he wanted to avoid paying U.S. tax by giving up his citizenship and establishing residence in Singapore.  He also awkwardly tries to explain how he has been spending his time and money since leaving Facebook:

What has gotten attention, though, is his billionaire playboy lifestyle in glittering Singapore. Thanks to the interconnected world Mr. Saverin helped to create, the Internet is full of people sharing photos and stories of him embraced by statuesque women and drinking expensive Champagne. “It’s a misperception, especially the playboy,” he said. “I do have a Bentley. I do go out. I’d rather not go into personal details.”

Oh, and that movie was all wrong about him, too:

He also said the depiction of him in the movie “The Social Network” was distorted. “It was more art than documentary,” he said. As to his purported betrayal by Mark Zuckerberg, chief executive of Facebook, the dramatic core of the movie, Mr. Saverin said: “There was no burning there. Mark is a phenomenal guy.”

Mr. Saverin is not alone in having a misplaced belief in his own persuasive powers.

Corporate chieftains, hedge-fund titans and technology wizards often believe that with enough time, coffee and charm, a reporter can be persuaded to take a sympathetic view of their plight.  If it’s People magazine, maybe; but not The New York Times.

The better course for Mr. Saverin would be to do something useful – start another wildly successful company or give a bundle to charity or support a cause he feels passionate about.  All of that is much tougher than a press interview, of course.

The lesson is, until you change the facts, don’t expect a different story.  Until then, please suffer a little adverse press coverage quietly and in the comfort of your enormous yacht.




What’s Next for the FX Lawsuits Against State Street and Bank of New York?

Although it didn’t make the headlines last week, State Street suffered a setback in its long-running legal dispute over the fees it charges clients for foreign exchange services when a District Court judge in Boston denied its motion to dismiss the suit.

State pension funds in Arkansas and California have sued State Street, alleging that they were for years systematically overcharged by the bank for foreign exchange transactions.

State Street has not set aside a reserve against potential claims in these cases, according to a regulatory filing, and its public statements indicate it will contest the lawsuits.  It also has said that the outcome of these suits could have a “material adverse effect” on its future financial results.

This issue also dogs Bank of New York Mellon Corp., which is facing similar suits from state pension funds in Virginia and Florida.  It reported a decline in first-quarter foreign exchange revenue of 21% versus a year ago, and in January settled with federal prosecutors, agreeing to amend its marketing material by eliminating the reference to providing “best execution” in foreign exchange.

Both banks are in a very tough spot.  The outcome of a court trial is risky and would present sensitive bank documents for everyone to see.  There are bound to be embarrassing emails and other material that the banks would not want revealed.  Bank of New York in particular could face some very juicy evidence gathered by a whistle-blower.

But a settlement is also difficult without opening the door to further claims from clients or regulators, who, as State Street notes in its 10-K, are already taking a look at the matter:

“Since the commencement of the litigation in California, attorneys general and other governmental authorities from a number of jurisdictions, as well as U.S. Attorney’s offices, the U.S. Department of Labor and the Securities and Exchange Commission, have requested information or issued subpoenas in connection with inquiries into the pricing of our foreign exchange services.  We continue to respond to such inquires and subpoenas.”

For both banks, the best way to end the litigation – and the uncertainty it creates for its clients and shareholders – is to reach a global settlement that addresses changes in business practices and monetary restitution.  That will take leadership by their CEOs, but the alternative is months, perhaps years, of costly legal skirmishes in courtrooms around the country, while clients take their business elsewhere.

An aggressive settlement strategy, coupled with a credible communication plan, could bring this unpleasant story to a close.

The Rise of the Undead: E.F. Hutton Returns

E.F. Hutton is set to return to the brokerage world, according to a report in The Wall Street Journal.  Backed by former Hutton executives, the long-dormant name is being revived and the firm is set to launch later this year.

E.F. Hutton’s return is a measure of how badly damaged major financial brands are in the aftermath of the financial crisis.  Although Hutton was tarnished by a check-kiting scandal in the 1980s, the brand retains wide public recognition and favorability.

Given the public’s dismal regard for financial firms today, it wouldn’t surprise me to see other dormant financial brands resurrected.  Could we see Paine Webber once again? DLJ?  Dillon Read?  AG Becker?  (Ok that last one’s a reach.)  Morgan Stanley worked hard to bury the Dean Witter name, but it wouldn’t surprise me if imaginative marketers are hatching plans for its revival.

Beyond the search for an unsullied name, the return of these brands also speaks to a desire for greater clarity in the financial services industry.  Everyone knew what firms like E.F. Hutton did; they had a clear business focus and a mission that was well understood by clients.  Nowadays, it’s hard for customers – large and small – to be sure if a giant bank really knows their business and is committed to them.

E.F. Hutton might become the first hot start-up with a hundred-year history.

Launching Sony’s Turnaround

Kazuo Hirai just might have the toughest job in the corporate world.  Named CEO of Sony in February, his task is to turn around the struggling electronics conglomerate after years of strategic drift and financial losses.  He’ll have to revive the brand, excite consumers with new products and revamp operations – all while competing with nimble global giants like Apple and Samsung.  That’s a tall order.

In a corporate turnaround, it’s vital that the CEO communicate clearly and with conviction.  So give credit to Hirai, who outlined his strategy in a worldwide videoconference this week.  His remarks demonstrated four important elements for communicating effectively in a turnaround:

1.  Present a simple plan.  Fixing Sony is complex to execute but should be simple to communicate.   Clear, uncomplicated communication makes the plan memorable and sound achievable – two important goals for launching a turnaround.  Hirai’s remarks were built around just three simple points:

“There are three points I would like to discuss about how to bring about change. The first is acknowledging the issues at hand. The second is the key initiative to transform the electronics business and the third is the management’s structure to execute these key initiatives.”

2.  Articulate the company’s strengths.  When the road to recovery is tough, it’s important to remind people of what the company has going for it.  Hirai spoke about the assets that will drive Sony’s turnaround:

“How we go about making this happen will determine if Sony will be back. And whether or not we can do that lies entirely with Sony’s strengths. They are one, a business reach and brand recognition that span the globe; two, technological strength in imaging, gaming and other fields; three, content and business know-how in film, music and games; four, and lastly, something I believe in very strongly, what I call the Sony DNA – the will to drive new value that is in so many of our talented employees.”

3.  Acknowledge tough decisions.  No one could have missed Hirai’s emphasis on the need for change – he used the word 18 times in his presentation.  He announced sweeping cost cuts and layoffs that would trim headcount by 10,000.  He also cleaned house in the executive ranks, eliminating entire layers of management in some divisions.  Those are just the first of many difficult decisions; others await on R&D, product development and marketing.

4.  Make it personal.  The most effective CEO speeches speak from the heart.  (See the Stanford commencement address by Steve Jobs for perhaps the best example.)  Hirai didn’t have the audience shedding tears, but he spoke openly about the challenges facing Sony and his personal determination to revitalize the company:

“Since I was nominated President and CEO in February, I have received laurels of encouragement from investors, analysts, the press and other stakeholders. They want Sony to change and to support Sony’s process of change in transformation. So do the employees. They want to restore Sony to its former glory and go further beyond. Sony will change. I have fully dedicated myself to changing Sony.”

Good communication is just as important to the success of a turnaround as new products and efficient operations.  Communication keeps everyone on the same page, speeds decision-making and rallies the team when setbacks arise.

Hirai has made a good start in his first weeks.  He’ll need to keep the communication going, with regular updates and tangible proof that his measures are working.

What the Best Buy Announcement Doesn’t Say

The announcement by Best Buy Co. that its CEO Brian Dunn resigned is significant for what it doesn’t say.

Although it was awkwardly announced just as the stock market was opening, the company’s news release was direct, brief and included positive comments from Dunn and interim CEO Mike Mikan.  The statement was also quick to defuse any suggestion of a broader conflict or new problem that sparked Dunn’s exit.

But the statement said nothing about the company’s future strategy, which suggests big changes could be in the offing.  Best Buy’s business model has been under strain as consumer buying has shifted away from big retailers.  But it still has a sizeable market share, a top brand and high levels of consumer trust.  That Best Buy said nothing about these assets suggests that it has completely lost confidence in its strategy.

That might give a new CEO ample space to reshape the company, but it leaves shareholders, staff and suppliers wondering about the company’s future.