AIG, Cuomo, and a Possibly Haunted Hunting Lodge

Perhaps you heard about the $86,000 trip AIG executives took, post-bailout, to an English hunting lodge named Plumber Manor. Surely AIG could have defended itself by pointing to some of the joint’s poor reviews on TripAdvisor: One visitor termed the service “appalling,” while another complained of “massive cobwebs hanging from the bathroom ceiling.”

But, after getting a nasty letter from New York State Attorney General Andrew Cuomo, AIG head Ed Liddy decided to skip the cobweb defense. Pronouncing the company "very grateful for the guidance of Attorney General Cuomo," Liddy promised not to spend any more on “junkets” and said he'd help get back some of the millions in severance paid to ousted executives like former CEO Martin Sullivan.

In his letter, Cuomo threatened legal action if AIG didn’t cooperate. News reports implied Cuomo had discovered some secret weapon in New York law that allowed him to snatch excess compensation back from overpaid executives. “Where have you been all my life, secret clawback law?” I wondered.

However, Cuomo’s “new toy,” as law professor Dale Oesterle called it on his blog, turned out to be something old: calling AIG's expenditures a “fraudulent conveyance” under New York’s debtor/creditor statute. This is a tool you’d find in the laws of every state. The idea is that a business that’s going bankrupt can't give out cash to its friends and then greet creditors at the door with an empty piggy bank and mournful puppy eyes.

According to the skeptical Professor Oesterle, Cuomo’s trick would work only if he could prove AIG was insolvent when it signed the compensation deals, which was long before the bailout in some cases. (If so, the wording of Cuomo’s letter was kinda sloppy; he talked about money being spent “as the company slipped towards insolvency.”)

But law professor Jonathan Lipson cheered Cuomo on, scorning “accounting and bankruptcy wonks" who say "proving insolvency is a fool’s errand.” In fact, Cuomo is thinking “WAY TOO SMALL,” says Professor Lipson. (His caps, not mine.) He argues that, since all the profits made by some banks and investment banks over the last few years have vanished, maybe “they actually weren’t so healthy financially after all. Which may mean that all those bonuses and crazy severance packages... should, in theory, be as vulnerable as Joe Cassano’s $1 million/month consulting fee at AIG.”

I’m not afraid of cobwebs, so I suggest we all repair to Plumber Manor for Halloween and discuss these legal niceties by the fire.

Late-breaking News

We wish there were an award for Least Informative Disclosure About a Government Investigation, because then we could nominate Manpower Inc. (MAN).

Three years ago, Manpower announced that French authorities had begun an investigation into possible violations of French and EU competition laws. According to a December 2004 press release, an official of this French agency showed up at the company’s Paris office wielding a search warrant and looking for “evidence of price fixing and allocation of market share within the French market.” Since then, the company has mentioned the investigation in its 2005 and 2006 10-Ks, but hasn't provided any new details.

Last week we finally got an update on the situation. In a terse 8-K filed Friday, Manpower said French authorities have now issued something called a “Statement of Objections.” So what does this mean? It is, the 8-K helpfully informs us, “a further step in the proceedings.” Oh, OK, thanks.

It’s not Manpower’s fault, we must assume, that the investigation is taking so long. Given the 35-hour workweek and long summer vacations that are de rigueur in France, it could be years before we get another update.

Boardroom Dramas

I’m looking forward to December's release of The Golden Compass even though it stars Nicole Kidman, who gets on my nerves. The movie is based on Philip Pullman's fantasy novel in which every human shares his or her soul with an animal sidekick, called a daemon.

It would be cool if outside directors had daemons - not in the form of animals, but nerdy accountants who would study the numbers and whisper in their ears at board meetings. But in the real world, this NY Times article published over the weekend asked whether Merrill Lynch’s board – more specifically, its finance and audit committees - had peered closely enough at the firm’s risk management practices.

The basic question, which goes well beyond Merrill and its $8.4 billion subprime-related charge (likely to be dwarfed by Citigroup’s writedown), is how much oversight outside directors can and should provide, short of becoming the corporate equivalent of “helicopter parents.”

It’s a question well worth asking (and, some may say, litigating). But Merrill's transactions were complex, which will make it really tough for a judge, or anyone else, to evaluate this board's actions; much tougher than it was in, say, the case against Disney's board a couple of years ago. If you remember that one, shareholders sued after the board obligingly blessed a $140M severance payment for Disney President Michael Ovitz, whom CEO Michael Eisner had hired with wild enthusiasm only 14 months earlier. (I still think someone should make a movie of the Eisner/Ovitz fallout called “Mean Girls II: The Senior Executives,” and it should include a re-enactment of the corporate outing at which, according to Mr. Eisner, Mr. Ovitz “declined to participate in group activities.”) Through a kindly interpretation of Delaware law, the judge managed not to hold Disney's directors liable, but he sure had the facts down.

Merrill’s debacle, by contrast, involves a multitude of intertwined mind-numbing financial dealings, and the board's oversight job was pretty challenging. It's odd that they didn't appoint a chief risk officer for the firm so there'd be someone to fire besides the CEO. But once you get past that simple observation, it will take a long time to sort out what this board did or didn't do wrong.

Some other Wall Street firms apparently did a better job of risk management than Merrill, thus staving off the evil armies of subprime-linked debt. We may never know what role, if any, outside directors played in this victory, and whether they had help from The Golden Compass’s armored bears.

Mean Muggles

Even if you didn’t love the Harry Potter series, it was sad to see it end. I’m sure they got really weepy at Scholastic Corporation (SCHL), publisher of the magical epic. In its first-quarter earnings release a couple of weeks ago, the company - in language worthy of Harry and his adolescent friends - termed sales of Harry Potter and the Deathly Hallows “phenomenal.”

And indeed, proceeds from the book were totally awesome, bumping Scholastic’s quarterly revenues up 75% over the prior year. Unfortunately, the company didn’t know the spell for converting all that cash into profits and reported a loss of 7 cents per share. (Their excuse was that they normally lose money in the first quarter because schools are out and they can’t sell books to unsuspecting third-graders through those fake school "book clubs." Personally I think this is kind of a dorky business model, though as a blogger I probably should not be using the term “business model.”)

Late in the summer, while everyone was plowing through Deathly Hallows, Scholastic was hit with a class action suit alleging securities fraud. The plaintiffs’ lawyers (a group less popular than Dementors in many quarters) sent out a press release to brag about it, but Scholastic just disclosed the lawsuit this week in its first-quarter 10-Q.

The 10-Q says Scholastic hasn’t yet responded to the complaint. It remains to be seen whether this is just another ho-hum strike suit. The gripe is that between March 2005 and March 2006, Scholastic gave an overly rosy impression of its prospects while failing to write down certain assets and reserve enough for bad debts, among other alleged screw-ups, and that Scholastic insiders traded on info they kept from the public. The lead plaintiff is an institutional investor, though hardly a household name: the Alaska Laborers Employees Retirement System. The complaint adds as defendants Scholastic's eternal Chairman/CEO/President Richard Robinson (son of the company’s founder) and former CFO Mary Winston, who left in July of this year with $1.2M in severance payments.

I hope Scholastic is busy hiring defense lawyers, or practicing Defense Against the Dark Arts. Or maybe there's no difference.

Pretty Please

The summer wasn't bad, thank you. We got some rest and managed to avoid most of the season’s global warming hot spots.

Unlike us, the Delaware Court of Chancery worked hard over the past few months. One of its summer projects was this decision in the InfoUSA Inc. litigation, commenced by spoilsport shareholders displeased by Chairman/CEO Vinod Gupta’s dedication to the proposition that the company’s money is there for his enjoyment.

The court's opinion dealt with a concept known as “demand futility.” Demand futility has nothing whatsoever to do with your attempts to convince the person manning the DMV window to renew your driver's license. It refers to the fact that, in order for shareholders to start a lawsuit in the form of a “derivative action” (an important tool for activists) they must persuade a judge it would be futile to demand that the directors sue themselves instead.

Believe it or not, establishing futility can be quite difficult. Shareholders generally don't have a right to discovery at this stage, yet must come up with detailed and specific allegations that a majority of the directors are biased (because, say, Mr. Gupta has been giving them free office space) or that the board has behaved so badly it might not be protected by the very forgiving standards of the “business judgment” rule. (Yes, that one is on the Proxyland oxymoron list.)

In this case the plaintiffs succeeded. The Honorable William B. Chandler III, after making gallant efforts to excuse the board’s behavior, admitted the company's directors might have motivation to discourage a lawsuit. Among other things, they'd approved a 10-K that said the company had paid a Gupta-owned entity for “usage of aircraft,” despite being informed by the audit committee chair that Mr. Gupta had spent much of the dough on personal residences and a yacht. (The boat's all-female crew merited a fascinating footnote in the opinion, as did the company’s interactions with a certain former President.)

Very very gradually, the esteemed Delaware courts are starting to accept that when shareholders ask, “hey, is it OK if we sue you?” some boards will say “no” for less than noble reasons.

But at least shareholders receive an answer. That’s more than you get at the DMV, where after failing for days to make eye contact with anyone, you become convinced you do not exist and therefore have no need for a driver’s license, so you slink away and donate your car to charity. Perhaps we'll solve global warming after all.

Two Degrees and a Separation

Shares of Radio Shack were up nearly 5 percent on the news that CEO/President David Edmondson had resigned after confessing that two college degrees he’d listed on his resume did not, alas, exist.

Embarrassing, yes. Litigation-worthy, maybe not. As I previously blogged, the Fourth Circuit ruled a couple of years ago that such resume-padding was not material under the securities laws, in a case where the CEO's phony degree was from Syracuse University. Given that Edmondson’s delusional diplomas were from Billy Bob’s Bible School, plaintiffs' lawyers hoping to get rich from this one may need assistance from a higher power.