ProfessorBainbridge.com

Fannie Mae is Corporate Turkey of the Year

Citizens Against Government Waste (CAGW) today named Fannie Mae its 2004 Corporate Turkey of the Year in recognition of how it has cooked the books in its growing accounting and corporate governance scandal.  Fannie Mae is a government-sponsored enterprise (GSE), mashed together by Congress and endowed with tens of billions of dollars worth of special privileges and exemptions.  Fannie Mae has been under scrutiny over the last several years because its securities enjoy the implied backing of the taxpayer, yet Fannie Mae (like its corporate cousin Freddie Mac) is exempt from many of the regulatory and accountability rules other major financial companies must comply with.

“Fannie Mae has used its special taxpayer-backed privileges and exemptions to leverage itself into a massive mortgage empire with virtually no outside supervision or accountability,” CAGW President Tom Schatz said.  “Now, it appears the company is showing the feathers we associate with Enron and Worldcom, putting taxpayers at enormous risk in order to receive huge executive bonuses and artificially inflate its stock price.  It is unconscionable that Congress has stood by and allowed Fannie’s corporate executives to game the system for personal gain, especially in one of the most vital and sensitive sectors of our economy, housing.” ...

In September, Fannie Mae’s regulator at the Department of Housing and Urban Development stated that Fannie Mae had engaged in “cookie jar” accounting in order to present gravy earnings to its investors, improperly accounted for its hedging transactions, and manipulated its accounting rules in order to trigger compensation bonuses for its top executives.  Fannie Mae may now have to carve down its earnings by $9 billion.  Fannie Mae, which had been operating under a voluntary disclosure agreement with the Securities and Exchange Commission, missed its deadline for filing its third-quarter earnings report because its accounting firm, KPMG, refused to certify the statement. (Link) 

Fannie Mae is a disaster waiting to happen. The trouble is that it is neither fish nor fowl. Fannie Mae's government connections insulate it from discipline by markets and investors. Worse yet, the markets believe (with some justification) that the federal government has (implicitly) guaranteed fannie Mae's debts, which allows it to also avoid by market discipline by borrowing at below-market rates. Moreover, because the board includes political appointees, it is further insulated from investor discipline. The solution is privatization. Let it run as a for-profit corporation in a competitive market, with full disclosure. If it is not privatized, however, increased regulatory scrutiny will be essential. (See an excellent paper by two economists entitled Competition for Fannie Mae and Freddie Mac.)

Update: Paul at Dog Eared Town has more, with examples of what looks like at least misfeasance.

Wal-Mart's Woes, Online Shopping, and the Economy: A Comment

Bad news at Wal-Mart panicked some observers into worrying that the holiday shopping season will be a bust this year, dragging down the economy.

Wal-Mart said sales had not met expectations in the week ended on Black Friday -- the day after Thanksgiving and one of the year's biggest shopping days. (Source: CNN Money)

It turns out, however, that the holiday shopping season is booming almost everywhere except Wal-mart:

Near-record crowds turned out for the holiday shopping season's Thanksgiving weekend kickoff, bringing with them unexpectedly robust sales gains to many malls and retail chains across the country.

Except, surprisingly, at Wal-Mart Stores Inc.  (Source: WSJ($))

This is an important story because Wal-Mart's vast size has made it a bellwhether for the retail segment and, indeed, for the market as a whole. We thus need an alternative version of the story in which Wal-mart's troubles actually indicate that the economy is doing well.

Here's one possibility that occurs to me: Whenever I've shopped at Wal-Mart, its product mix has always struck me as being decidedly down market, even as compared to other big box stores. (CostCo, for example, has a well-deserved reputation as, of all things, a fine wine merchant.) Wal-Mart products seem cheap both in price but also quality. During economic bad times, price may dominate consumer decisionmaking, which gave Wal-Mart a huge advantage. As the economy improves, however, perhaps consumers are willing to spend a few bucks more to get a more up-scale product than Wal-Mart offers.

Consumers may be getting tired of Wal-Mart's product selection, especially in hot holiday categories such as electronics, computers, apparel and athletic footwear.

"It's great if you attract lower income shoppers looking for low prices, but what if those shoppers who were really struggling between 2000 and 2003 now have jobs? They might be spending more and looking for different merchandise...maybe something Wal-Mart doesn't have," said Richard Hastings, retail analyst with Bernard Sands. ...

For example, Wal-Mart's challenge to the Sony plasma screen TV is a slightly lower-priced alternative priced at $4,935 from Tatung. "Wal-Mart doesn't have the type of brands that generate consumer excitement." (Source: CNN Money)

In contrast, returning to the CostCo example:

Costco sells more fine wine than anyone else, and doing so has become a key part of its strategy to lure more upscale shoppers. Someone who spots a deal on a 1993 Dom Perignon ($80) may also pick up a pair of Waterford goblets for $60. Exploiting such buying patterns has helped Costco to push its average checkout ticket to $109, compared with $60 to $80 at competing warehouse clubs, according to Bill Dreher, a senior retail analyst at W.R. Hambrecht. (Source: Time)

It'll be interesting to compare CostCo's sales figures to those of Wal-Mart for the holiday season as a whole. If CostCo out-performs Wal-Mart on key retail metrics like average checkout price, sales per square foot, gross margin return on inventory, or same store sales, we'll have pretty good evidence for the proposition that it is product mix that is proving to be Wal-Mart's problem.

An alternative hypothesis that bears consideration is the growth of on-line retailing. Certainly, the numbers so far for this holiday season suggest an uptick in the number of shoppers buying online:

Online shopping visits reached a record high this year on Thanksgiving Day, with the ensuing "Black Friday" coming in second, according to HitWise, an analysis firm that monitors Web traffic. Shopping and classifieds Web sites claimed 11.39 percent of all U.S. visits on Thanksgiving Day, breaking the 2003 high of 8.96 percent set on the holiday last year, according to Bill Tancer, vice president of research. (Source: Always on)

Let's not get carried away, however. The actual number of people shopping online remains quite small relative to those braving the crowds in bricks-and-mortar stores:

The day after Thanksgiving, as consumers trooped out in droves to traditional stores and malls to mark the start of holiday selling season, remained busy for online retailers. Nielsen//NetRatings reported 13.3 million people visited online stores on Friday, or 11 percent more than a year ago. EBay.com drew 5.4 million, followed by Amazon.com at 2.6 million and Walmart.com at 1.4 million. (Source: Always on)

The number of folks who braved the crowds to go the mall is ten times greater:

The National Retail Federation (NRF) reported a blockbuster weekend, with 133 million shoppers flooding stores hunting for popular electronics, clothing and music. (Source: E- commerce)

So don't go running out to buy tech stocks just yet. Indeed, the advantage of bricks-and-mortar stores may be even more pronounced than the raw figures suggest. At least some of the 13 million on-line shoppers may not have bought anything; instead, they may just have been using the Internet as a research tool:

"Even diehard holiday shoppers that weather the Black Friday crowds at sunrise know to research the Web for product selection and price comparisons before heading out to the mall," Ken Cassar, director of client analytics, Nielsen//NetRatings, said. (Source: E-commerce)

In sum, my guess is that Wal-mart's woes are unique to it rather than, as in the past, suggesting a systemic problem with the economy. I'd also guess that online e-commerce has a ways to go before it can be invoked to explain any decline in retail sales.

Update: Sean Hackbarth has an alternate theory.

Stout on Disney

My UCLA law school colleague Lynn Stout has a very thoughtful op-ed in today's LAT on the shareholder suit against Disney's board over the huge executive comp payout to Michael Ovitz. Her key point is a very important one:

Many observers see the case as a trial over whether Disney board members made a stupid decision. And it certainly seems they did. First, they followed the advice of Disney's imperial CEO, Michael Eisner, and hired Ovitz ? once known as "the most powerful man in Hollywood" ? as Disney's president and Eisner's heir apparent. Then, 14 months later, the board fired him, again at Eisner's behest. But because the board did not fire Ovitz for gross dereliction of duty or illegal behavior ? "cause" ? Ovitz was entitled to a $140-million consolation prize under the terms of his contract. It is this payout that prompted the lawsuit accusing Disney's board (which included Ovitz and Eisner) of breaching their fiduciary duties.

The case seems easy. The Disney board made a huge and costly mistake. It should be held liable. Shareholders should be made whole. Right?

Wrong. The Disney case is a hard one, due to a basic doctrine of corporate law called the business judgment rule. This rule allows disinterested corporate directors to make foolish, even disastrous, decisions without being second-guessed by courts, so long as their process was reasonable and their decision "informed." The rule says, in effect, that it is the process, not the outcome, that matters.

Exactly right. If you want to learn more about the business judgment rule, check out my law review article The Business Judgment Rule as Abstention Doctrine. And if that's not enough for you, check out my treatise Corporation Law and Economics (makes a great holiday gift), which offers up over 60 pages on the business judgment rule.

I am not making this up

Martha Stewart is becoming quite the jailbird gourmet and whips up dishes with illicit ingredients she smuggles back to her cell by stuffing them down her bra, according to a newspaper report Friday.

The New York Post, which cited anonymous letters by disgruntled fellow inmates, said the domestic queen -- imprisoned at the federal facility in Alderson, W.Va. for lying about a well-timed stock sale -- has been caught with such contraband as brown sugar, powdered sugar, cinnamon, butter and other food, all stashed away inside her locker.

Inmates tell the Post that Stewart sneaks condiments and small items out of the cafeteria and back to her quarters by "stuffing them in her bra," then uses a kitchenette with a microwave to fashion the culinary treats. (Source: CNN Money)

I'm speechless. Well, not quite. The woman has become a self-parody, whose life is starting to resemble a SNL skit.

Academic blogging

I'm sure all academics who blog occasionally wonder whether their Dean/Department Chair will give them credit for time spent blogging when it comes to tenure, promotion, or merit raises. (I do.) If you're one of those who wonder, be sure to check out this post by John Quiggin for its link to a major recap and also its interesting observations on the incorporation of blogging into more mainstream academic activities.

I am not making this up

Martha Stewart is becoming quite the jailbird gourmet and whips up dishes with illicit ingredients she smuggles back to her cell by stuffing them down her bra, according to a newspaper report Friday.

The New York Post, which cited anonymous letters by disgruntled fellow inmates, said the domestic queen -- imprisoned at the federal facility in Alderson, W.Va. for lying about a well-timed stock sale -- has been caught with such contraband as brown sugar, powdered sugar, cinnamon, butter and other food, all stashed away inside her locker.

Inmates tell the Post that Stewart sneaks condiments and small items out of the cafeteria and back to her quarters by "stuffing them in her bra," then uses a kitchenette with a microwave to fashion the culinary treats. (Source: CNN Money)

I'm speechless. Well, not quite. The woman has become a self-parody, whose life is starting to resemble a SNL skit.

Specter Spanked?

In his Political Capital column for today's WSJ($), Alan Murray notes the vast importance of tort reform for the business lobby:

Now that the wolves of organized labor have been defanged, it is the hyenas of the trial bar who loom largest in the nightmares of corporate CEOs. Most can recite by heart the results of a Tillinghast-Towers Perrin survey that says torts cost the U.S. economy nearly $250 billion a year. They know from personal experience the headaches that class- action lawsuits have caused in their boardrooms.

For big business, the defeat of the trial lawyers was Election Day's sweetest victory. The tort bar provided heavy funding to the Democratic Party, Senate Minority Leader Tom Daschle and Democratic vice presidential candidate John Edwards. The U.S. Chamber of Commerce boasts that it backed legal-reform candidates in 16 state Supreme Court and attorney general races around the country, and won 15 of those races.

In the election's wake, business lobbyists have been salivating over the prospect that legal-reform bills would be the first measures to benefit from a new political climate. First up, they argue, should be a bill to curb class-action lawsuits, which enjoys the support of a majority of senators and nearly passed earlier this year. Soon to follow, they hope, could be bills to create a fund for resolving asbestos-related lawsuits and a measure to rein in medical- malpractice suits.

I won't rehash the arguments here; I'll content myself with disclosing that I regard tort reform as good politics (defunding the left's biggest bankrollers) and good policy.

Murray goes on to note, however, concerns that likely Senate Judiciary chair Arlen Specter would oppose tort reform (a point that's been noted in these pages, as well):

[The] business lobbyists worry their victories might be diluted if Sen. Specter claims the Judiciary chairmanship. He supported the class-action bill and worked hard to reach an asbestos settlement, but he also is one of the rare Republicans who enjoys support from the Association of Trial Lawyers of America. Lawyers and lobbyists were the top contributors to his Senate campaign this year, providing nearly $1.8 million in campaign cash. His son, Shanin Specter, is a well-known trial lawyer in Philadelphia, and his firm, Kline & Specter, which specializes in lawsuits against doctors, provided $93,250 in contributions to Sen. Specter's re-election, according to the Center for Responsive Politics.

"Why would Republicans, after defeating [Sen. John] Kerry, Edwards, and Daschle...hand the Judiciary Committee gavel to someone who shares this triumvirate's disdain for tort reform?" asked Tad DeHaven of the National Taxpayer's Union in an open letter to senators.

Fortunately, Murray suggests that the kerfuffle over Specter led by pro-life forces may force Specter to modify his position not only on judges, but also on tort reform:

In the end, Sen. Specter probably will get his chairmanship. And he will repay his obligations, not to the trial lawyers who funded his campaign, but to the senators who elected him chairman. He will support the President's judicial nominees, regardless of their positions on abortion. He will move quickly to limit class- action lawsuits, complete an asbestos settlement and possibly even curb medical-malpractice suits. As a result, 2005 could become a watershed year for reining in the excesses of the U.S. tort system.

From his lips ....

Stan Henderson

I had many fine teachers in law school, but one who stood out as possessing a particularly impressive combination of teaching skill, scholarship, and general all-around human decency was Stanley Henderson. On the occasion of his retirement, he has penned a typically lovely essay ruminating on the art of being a law teacher. Here's a taste:

We educate law students through cases, and every case tells a story of people and their problems. And every class has a story of its own. It must be remembered that the ideas making up our common law are “constructed” ideas. The problem, as you know, is that they are also undergoing constant “reconstruction.” So we who “do law” live with much ambiguity and uncertainty. Our task in the Academy is to discover, and to understand, what it is that gives “commonness” to our common law.

That is why the inquiring element—the putting of hard questions—is therefore central to the enterprise. It is, after all, the “hard” cases that increase our confidence in identifying the “easy” cases. ...

The point to be underscored is that, whatever the time period, it is passion and commitment that bring one to law study in the first place. And that is what carries one through law school and beyond, whatever the career path. ...

You now know that we teachers spoke the truth when we told you that we could do no more than prepare you for a lifetime of self education.

We “passed on the culture” mainly by sowing seeds. But the real game—the discovery of self and a sense of purpose, of proportion—was always yours, when you sat here in rows, and when, in the years since, you have faced into the headwinds, at times fierce.

An aspiring law teacher could do worse than to emulate this gentle yet demanding man.

Stan Henderson

I had many fine teachers in law school, but one who stood out as possessing a particularly impressive combination of teaching skill, scholarship, and general all-around human decency was Stanley Henderson. On the occasion of his retirement, he has penned a typically lovely essay ruminating on the art of being a law teacher. Here's a taste:

We educate law students through cases, and every case tells a story of people and their problems. And every class has a story of its own. It must be remembered that the ideas making up our common law are ?constructed? ideas. The problem, as you know, is that they are also undergoing constant ?reconstruction.? So we who ?do law? live with much ambiguity and uncertainty. Our task in the Academy is to discover, and to understand, what it is that gives ?commonness? to our common law.

That is why the inquiring element?the putting of hard questions?is therefore central to the enterprise. It is, after all, the ?hard? cases that increase our confidence in identifying the ?easy? cases. ...

The point to be underscored is that, whatever the time period, it is passion and commitment that bring one to law study in the first place. And that is what carries one through law school and beyond, whatever the career path. ...

You now know that we teachers spoke the truth when we told you that we could do no more than prepare you for a lifetime of self education.

We ?passed on the culture? mainly by sowing seeds. But the real game?the discovery of self and a sense of purpose, of proportion?was always yours, when you sat here in rows, and when, in the years since, you have faced into the headwinds, at times fierce.

An aspiring law teacher could do worse than to emulate this gentle yet demanding man.

More on Senate stock trades

I reported a few weeks ago on a study finding an unusual level of stock trading profits being made by US Senators, which implied that they were traing on the basis of inside information learned on the job. Securities Litigation Watch now reports that the SEC has decided not to go forward with an investigation:

As reported in this article in Sunday's Philadelphia Inquirer, the authors of the study conclude that these results "suggest that senators are trading stock based on information that is unavailable to the public, thereby using their unique position to increase their personal wealth...." The study adds that it is as if "senators knew appropriate times to both buy and sell their common stock."  The article quotes Ziobrowski  as stating in a recent interview that "there is cheating going on, at a 99 percent level of confidence."

The Inquirer article states that according to Ari Gabinet, head of the SEC's Philadelphia Office, "agency staff reviewed a draft of the study in March but decided not to press the issue because it is hard to win insider-trading cases without detailed knowledge of what, if any, privileged information the subjects received and proof insiders used it to trade. The SEC lacked such information in the senators' case."

Huh?  Yes, it's hard to win insider trading cases but the SEC does so routinely by using its subpoena power to gather documents and testimony that often will provide "detailed knowledge of what, if any, privileged information the subjects received and proof insiders used it to trade."

The article also points out that "the SEC may have little incentive to tangle with the Senate, given their relationship. Senators approve members of the SEC's governing body, as well as the agency's budget."

Gee, you think? If it had been anybody else than US Senators, the SEC would have been sending out subpoenas and combing trading records and generally doing its thing. Anyway, kudos to SLW for a great followup on an interesting story.

Mandatory Disclosure and Vaccines

In my article Mandatory Disclosure: A Behavioral Analysis, I argued that one problem with the SEC's rules requiring disclosure from corporations is that managers likely will make better decisions than regulators about what needs to be disclosed:

[Mandatory disclosure] functions in ways not unlike price controls. A regulatory regime is unlikely to peg prices at the equilibrium point at which marginal cost and marginal benefit are equal. As with any legal rule, the mandatory disclosure regime thus is likely to be under- and/or over-inclusive. Under-inclusive disclosure rules harm investors by denying them information they need. Over-inclusive rules harm investors by requiring the firm to spend money on unnecessary disclosures, which essentially comes out of the investors’ pockets. Investors presumably do not want management to engage in disclosure that produces diminishing returns; i.e., investors will not want management to spend a dollar on disclosure unless that expenditure produces at least a dollar’s worth of benefit to the shareholders. Under a regime of voluntary disclosure, management has an incentive to provide disclosure until it achieves that equilibrium. Because management’s wealth is closely tied to the firm’s financial well-being, it has an incentive to achieve an efficient trade-off between lowering the cost of capital and spending money on disclosure. The government has no comparable incentive. …

As a practical matter, legislators and regulators necessarily have less information about the needs of a particular firm than do that firm’s managers and directors. A fortiori, legislatures will make poorer decisions than the firm’s directors.

My thanks to an alert reader for sending me a real world example that I think proves my point (from USA Today):

The national stockpile of vaccines for children, planned as a cushion against shortages or emergencies, is seriously understocked, health officials say.

The problem isn't money. Funding to buy a six-month supply of recommended childhood shots from vaccine makers is available through the Vaccines for Children Program, which has allotted $172 million for the purpose. The glitch, says Stephen Cochi, acting director of the Centers for Disease Control and Prevention's Immunization Program, is a Securities and Exchange Commission accounting regulation that bars vaccine makers from claiming sales to the stockpile program as revenue until they're delivered to the customer — in this case, the CDC.  ...

Under SEC rules, companies can't record sales as revenue while the vaccine remains in the factory. The rules do allow for exceptions, but the vaccine stockpile doesn't meet one of the criteria. The "unintended consequence," Cochi says, is that three of the four vaccine makers have pulled out of the program, leaving only Merck.

Ian Spatz, Merck's vice president for public policy, says the company is sticking with the program, but it would like to see the regulation change because it could discourage drug companies from participating. "Imagine, for all the products Merck sold, if we couldn't record them as revenue," he says. "Our shareholders would not be pleased."

No [expletive deleted]. Is it me or this just nuts? Companies have spent money on raw materials, labor, and capital equipment to make vaccines. The Government has paid the manufacturers for the drugs. Yet, under the SEC rules the manufacturer can't recognize those payments as revenue until the drugs are actually removed from the factory for use. Meanwhile, so as to reduce the risk that the perishable vaccines will be damaged or spoiled, the Government requires the company to keep the vaccines in the factory until the very last minute before use. According to UPI, this can "mean a delay of up to a year in recognizing revenue from the contracts, potentially hurting officially reported profits and earnings per share and, by extension, stock prices."

Al Gore's Socially Responsible Mutual Fund

Former U.S. Vice President Al Gore and an ex-CEO at Goldman Sachs Asset Management have launched an investment firm to seek out companies taking a responsible stance on big global issues like climate change.

London-based Generation Investment Management has been set up to tap growing demand for an investment style that blends traditional equity research with a focus on other factors such as social and environmental responsibility and corporate governance. ... The founders ... have pledged to contribute 5 percent of its profits to a charitable foundation focused on exploring issues of sustainable economic growth. (Source)

A certain segment of my readership likely will roll their eyes at this news. Those readers might want to consider an alternative investment; namely, The Vice Fund, whose prospectus proudly states:

The Advisor selects securities of companies using a two-part test:

(1) First, the Advisor looks for companies that derive a significant portion of their revenues from products often considered socially irresponsible, and

(2) Then the Advisor selects companies from this group based on their financial soundness and potential for growth.

For the first part of the test, the Advisor selects companies that have significant involvement in, or derive a substantial portion of their revenues from, industries such as tobacco, gambling, defense/weapons and liquor.

Judges Nix US News Survey

Paul Caron posts this interesting note:

The New Jersey Administrative Office of the Courts has issued a directive to all New Jersey state court judges to refrain from filling out the reputational survey for the U.S. News & World Report law school rankings:

In Directive #33-65, issued July 8, 1966, Administrative Director McConnell advised the judges of the Supreme Court?s conclusion that it would be inappropriate for judges to participate in the rating of attorneys as part of Martindale-Hubbell?s attorney rating system. That Directive remains in effect.

This Directive is to advise judges that it would be similarly inappropriate to provide ratings of law schools as part of US News & World Report?s survey of "America?s Best Graduate Schools". Judges in your vicinage may have received a request this month to complete a questionnaire rating the various law schools throughout the United States, including New Jersey?s three law schools. Please advise the judges in your vicinages as to the inappropriateness of completing and submitting that survey.

The US News law school survey is deservedly controversial (don't ever get Brian Leiter started on it), but I wonder on what possible grounds New jersey can do this. Don;t judges have free speech rights? I take it that the missive is intended only as advisory rather than mandatory (note the key word "inappropriate"), but even guidance can have a chilling effect. In addition, I wonder whether the authors of the guidance considered the possible effect pointed out by Brian Leiter:

As it stands, of course, removing the New Jersey judges from the pool will simply penalize the New Jersey law schools, which are, presumably, rated more highly by New Jersey judges than judges in neighboring jurisdictions.

Prospective law students considering a NJ law school thus will have to guesstimate the extent to which the law schools under consideration would have ranked higher if NJ's judges had not been dissuaded from participating.

News Corp Adopts a Poison Pill

Spooked by Liberty Media's plans to double its holdings of News Corp stock, the latter's board of directors has just announced the adoption of a poison pill. (What's a poison pill you ask? Go here for an explanation.) CNN/Money explains:

Under the plan, News Corp. investors can buy one share, for every share they already own, at half price should any party come to own a 15 percent stake in the firm's voting shares. Liberty's current option to double its voting stake is exempt, but any additional increase would trigger the plan. The same applies to the Murdoch family's stake, subject to a 1 percent margin. ...

At the start of the year, Malone bought 9 percent of News Corp.'s voting shares, without telling Murdoch. Last week he did the same, acquiring the right to buy another 8 percent. Malone can still exercise that right. But if he goes any further the defense is triggered. Every News Corp. investor, apart from Malone, will be able to buy shares in the firm at half price.

As the CNN/Money article further points out, this move was made possible by News Corp.'s decision to reincorporate in Delaware. I gather that poison pills are of dubious validity in Australia, where News Corp. used to be incorporated. (Any Australian readers knowledgeable in corporate law want to help us out here? If so, email me on the poison pill's validity. Thanks!)

BTW, for liberals hoping that a Malone takeover of News Corp. would mean changes at Fox News, don't count on it:

[Malone's] political heroes are Ronald Reagan and Dwight Eisenhower, since he shares their notions about how big government and big taxes sap initiative. Yet, calling himself "a libertarian," he disagrees with Reagan-style conservatives who want the government to tell a woman that she may not have an abortion. ... The bulk of the Malone estate is earmarked for the creation of a foundation whose purpose will be to invest in education that promotes "initiative and free enterprise."

... He repeats the word "socialistic" like a mantra, saying that he picked it up from Rush Limbaugh, whom he applauds for a willingness "to say politically incorrect things." He uses the term "socialistic" to berate liberals, and even moderates, who support government social-welfare programs. He wants NBC, CBS, and ABC to be uprooted from New York, so they will be less insular. "There's a huge diversity of values in this country between what people in central Manhattan think of the values of our society and what people in Peoria think the values of our society are," he says. "I think Manhattan thinks that single parents are fine. I think it's a much more socialistic world there, where the government does everything for you." (Source)

The vast bulk of his political giving goes to Republicans. So I don't think you could expect him to turn Fox News into CNN-lite.

Anyway, I'm not sure I'd bet on Malone in this fight. Granted, Al Gore once called John Malone the "Darth Vader" of telecoms. But Murdoch is still the emperor. As one liberal media watchdog site opines:

The News Corporation is often identified with its head, ultra-conservative Rupert Murdoch, whose family controls some 30 percent of its stock. Murdoch's goal is for News Corporation to own multiple forms of programming--news, sports, films and children's shows--and beam them via satellite or TV stations to homes in the United States, Europe, Asia and South America. Viacom CEO Sumner Redstone says of Murdoch that "he basically wants to conquer the world."

And he seems to be doing it. Redstone, Disney CEO Michael Eisner, and Time Warner CEO Gerald Levin have each commented that Murdoch is the one media executive they most respect and fear, and the one whose moves they study. TCI's John Malone states that global media vertical integration is all about trying to catch Rupert. Time Warner executive Ted Turner views Murdoch in a more sinister fashion, having likened him to Adolf Hitler.

Hitler seems a bit extreme. I might go as far as Palpatine though. (Yes, I know Vader wins in the end. Drop it.)

Insider Trading in ETFs?

An email from a reader raised a very interesting question:

I was just at a local conference and saw a presentation  on exchange traded funds. The paper examined whether there are differences in the adverse selection component of the bid-ask spread between three classes of securities: broadly diversified ETFs such as Spiders, more focused ETF (such as some of the industry sector ETFs companies like Barclays distribiute) and actively managed closed end funds.  He found that the adverse selection costs are greatest for the closed-end funds, followed by those for the focused ETFs, followed by those for the closed-end funds.

 

A question arose during the presentation on the application of insider trading law to ETFs.  Suppose Bill Gates had material non-public information about a critical shortage of microchips.  Instead of trading in Intel stock, he chose instead to trade in an ETF composed of an index of 10 firms such as Intel and AMD. Would he be in violation of existing law?

I'm not aware of any SEC enforcement action on such facts. In theory, however, I suppose a case could be brought. Assuming Gates is not an insider of the ETF, the relevant theory of liability would be misappropriation of market information relevant to the price of the ETF. Rule 10b-5, which governs insider trading, applies to fraud in connection with the purchase or sale of "any security." Under the Supreme Court's decision in US v. O'Hagan, a fiduciary?s undisclosed use of information belonging to his principal, without disclosure of such use to the principal, for personal gain constitutes fraud in connection with the purchase or sale of a security and thus violates Rule 10b-5. If Gates had obtained the information from a source to whom he owes fiduciary duties (e.g., Microsoft) and he failed to dislcose his trades to Microsoft, liability presumably could follow.

For more on the misappropriation theory, check out my article In sider Trading: An Overview.