Lessons From Looters

The boring background
Several of us Fools have reported on alleged misdeeds at Hollinger International (NYSE: HLR  ) for a period spanning the past few months. We've contrasted it with squeaky-clean Washington Post Company (NYSE: WPO  ) and other steady earners such as Gannett (NYSE: GCI  ) and New York Times Company (NYSE: NYT  ) . If you need a refresher course, Hollinger is the media company that recently held a publishing empire including far-flung enterprises such as Tribune Company (NYSE: TRB  ) competitor the Chicago Sun-Times, as well as The Jerusalem Post, and the paper that got Ravelston owner Conrad Black his Lordship, The Daily Telegraph.

Late last year, allegations arose that charged Black and his subordinates with bilking the company through a variety of unseemly third-party payments and under-the-table deals. This eventually led to Black's resignation as CEO, though he still controls the company via its shareholder-unfriendly structure. Here's how that works:

Hollinger International is controlled by Canadian parent Hollinger Inc. The control is granted through a share structure that cedes majority voting power to the Canadian parent, though the number of shares it owns is a minority. Hollinger Inc. is in turn controlled by a holding company, Ravelston, which owns most of its shares. Ravelston is owned by Conrad Black. In addition to the compensation Black received by sitting in various management positions throughout the entire pyramid of companies, his holding company received substantial management fees from Hollinger International.

This week, Black and Co. reaped the whirlwind when Hollinger's special committee released its report on what it describes as extensive looting of Hollinger cash and properties.

The final bill? Oh, only $400 million, or roughly 95% of the company's earnings from 1997 to 2003.

Needless to say, the world is not amused. The headlines have called the former Hollinger heavy just about anything you can imagine. Fool legal gets very edgy whenever I use the words like klepto or thief. So, for the record, let me just state that I am not calling Mr. Black, nor his accused compatriots, kleptos or thieves, even if that's the kind of thing you might find elsewhere on the Internet.

I think it's enough just to take a brief look at the report.

The juicy details
The committee, chaired by Gordon A. Paris and counseled by former SEC chair Richard Breeden, was titled "A Corporate Kleptocracy." (Hey, maybe we can use the word klepto.) It starts out by saying, "Hollinger does not appear ever to have been run in accordance with accepted governance principles in the world of public corporations" and points out that Black had, in 1982, been found by the SEC to have made false and misleading statements in SEC disclosure documents while trying to take over the Hannah Mining Company.

It continues, "Hollinger was a Company where abusive practices were inextricably linked to every major development or action."

Some of the more noteworthy schemes included:

  • "Taking $9.5 million of corporate cash in late 2000 without notice to Hollinger's Board, which was accomplished with falsified closing documents used to provide a pretext for the transfer. Kipnis, the internal lawyer, facilitated the unauthorized transfer of cash with falsified documents and was paid a $100,000 special bonus at Radler's direction."

  • "Taking $5.5 million of corporate cash in early 2001 without notice to Hollinger's Board, which was accomplished by creating fictitious agreements not to compete with one of Hollinger's wholly owned subsidiaries. The phony payments were then backdated to the prior year, which enabled them to be hidden through accounting offsets."

OK, so they had their hands in the till. That pales in comparison to their more creative grabs. Moves such as the ones below would make Tyco International's (NYSE: TYC  ) Dennis Kozlowski proud.

  • "Causing Hollinger to spend $9 million over a five-year period to purchase papers and memorabilia of former U.S. President Franklin D. Roosevelt without authorization, in furtherance of Black's personal interests [editorial note: Black was writing a biography of FDR.], and using the materials to decorate his personal residences in Palm Beach, New York, and other locations."

  • "Black and his wife 'swapped' Park Avenue apartments with Hollinger. The apartment owned by the Blacks (which they had purchased for $499,000 two years earlier) was 'priced' in the swap by crediting it with 70% appreciation from its acquisition cost. The apartment owned by Hollinger (which it had purchased for $3 million six years earlier) that the Blacks were acquiring was 'priced' in the swap by crediting it with zero appreciation. Both apartments were in the same building, though the apartment owned by Hollinger was greatly superior due to its size and location on a higher floor.... The apartment Hollinger took back in the rigged swap was then used to house personal domestic staff for the Blacks, personal friends visiting New York and on occasion visiting executives for corporate purposes."

But these capers paled in comparison to the granddaddy of them all, the outside management fees.

  • "Filing proxy statements and other disclosure documents with the SEC that contained false statements, or omitted to include material information regarding fees and other forms of compensation.... For example, the compensation table in Hollinger's proxy statements does not show Black and Radler as receiving any compensation from Hollinger as their share of $226 million in management fees from 1996-2003.... Hollinger failed to disclose in its proxy statement as much as 96% of the compensation the Committee believes was received by its top five officers."

Foreshadowing -- it's not just for Lit class
Interestingly enough, that last bit is not quite true. Sure, there was no mention of the management fees in the compensation table, but it was spelled out in the more boring verbiage that came before. Along with plenty of other hair-raising situations.

I know it's not politically correct to blame the victim for the crime, but I'm going to come perilously close to doing that right now. To be sure, shareholders could not have known about the incredible extent of this alleged malfeasance. But I took a look at the firm's last couple proxy statements, and there's more than enough in there to arouse suspicion.

The 2003 proxy statement starts with a mundane-looking shareholders' meeting schedule including "to elect 12 directors...." Reading further reveals the horrible situation for Hollinger shareholders: They had no rights. I quote: "Hollinger Inc. has sufficient voting power to approve the Director Election Proposal regardless of the vote of any other stockholders."

It continues to explain that Conrad Black controls the company and that he does not intend to relinquish control of the company.

Fools, when one person has total control over a company in which you are a part owner, that's always a bad sign.

But there were further clues. Further down the page, we note that the parent company borrowed $26 million from Hollinger International and loaned it to an unnamed subsidiary of the parent company. There follows some swapping of stocks of various issues (all the way down to series E!) and the assurance, unsupported by any documentation, that:

  • "The revisions to these debt arrangements received an independent fairness opinion and were unanimously approved by the Audit Committee and the independent Directors of the Company as a market value transaction."

That might sound OK if you trust the audit committee, but a little gem from the next paragraph should have struck fear into any shareholder's soul. In describing the likelihood of future-related transactions, it says that "it is possible that conflicts of interest will be involved and resolved by the Audit Committee."

Given the dearth of detail in the deal immediately preceding this bold declaration, it should have been tough for any investor to have faith in the Audit Committee's ability to report on resolutions of these conflicts.

The money trail
Following came the most damning portion of the proxy. It describes the $25 million (Canadian) paid to Black's Ravelston for "management services." This amount comes on top of the huge salaries paid to Black and his wife by other subsidiaries of the firm. Skimming only the largest, we find: $719,000 from the Daily Telegraph. Another $276,000 for Lady Black from the Chicago Sun-Times. Add in $103,000 for a New York condo, a Hollinger International salary of $462,000, 375,000 stock options, plus another $249,000 worth of stock options from a separate executive compensation plan. (Whew.)

In 2002, Black and Ravelston took in somewhere around $30.6 million dollars in income that was disclosed in the proxy! The firm's operating income that year was only $57 million, and the net loss tallied $239 million.

Maybe hindsight is 20/20, but no one would have needed reading glasses to see that this was no place to invest a nest egg. The filings reeked of impropriety. There didn't need to be a $400 million scandal to put this company on the "do not touch" list.

The moral of the story
Learn from the looters. Often, they leave tracks that are very easy to find. Read those annual reports and proxy statements. Every time you invest. If something doesn't smell right, it's probably not. If your suspicions aren't born out later, you won't have lost any money. But handing over your hard-earned dollars to a management team that's lining its own pockets at your expense is sheer folly and a guaranteed way to redistribute wealth from the bottom up, even when everything they're doing is legal. You can do better than that.

For more Foolish commentary:

Fool Seth Jayson has worked for Hollinger publications, but he has no position in any company mentioned. View his Fool profile here. The Motley Fool is Fools writing for Fools.


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