The developing infrastructure to service HSA’s

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Health Savings Accounts (“HSA’s”) are still a new concept in health care finance, but McKinsey & Company partners Paul Mango and Vivian Riefberg write in this Wall Street Journal ($) article that there are promising developments in the insurance infrastructure that suggest that HSA’s are going to have a larger effect on America’s broken down third party payor system of health care finance than many experts are currently predicting.
The authors point out that the quickly emerging financial industry surrounding HSA’s will eventually compete effectively with typical third party payor health insurance and that this competition will force traditional insurers to improve their performance or suffer. After describing four areas of the financial service industry that are developing in regard to HSA’s, the authors observe the following:

In each of these four businesses, incumbent health insurers’ positions are open to attack from new entrants. They will need to decide whether to try to build the new skills themselves, acquire them, or partner with others. The growth and popularity of the new HSAs is exceeding expectations, so resolving these questions quickly will be vital. Insurers, asset managers and banks have already announced several key acquisitions and alliances that will exclude others from locking up the best partnerships.
The smart money is already moving fast to stake out its place in the new marketplace. Hold on for what promises to be an interesting ride.

Could several large traditional health insurers that fail to adapt to the changing marketplace in health care finance turn into the health care insurance equivalent of legacy airlines? Stay tuned.

Criminalizing greed, dishonesty, and mendacity

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Last week, I received the following email from a reader who was responding to this earlier post:

You had this comment on your website, today.

“In what alternative reality is it that a busy law dean and expert on ethics can be expected to spot accounting fraud?”

Do you recall that Tom Peters sent his MBA back to Stanford because the its Dean who had taught him accounting was the Chairman of the Enron Audit Committee.
It is not that these people are too lazy or overworked; its greed, dishonesty, and mendacity.

For those who do not follow the Enron affair closely, Robert Jaedicke is the former Stanford Business School dean who was the chairman of the Enron Board’s audit committee during the period in which it approved Enron’s transactions with Andrew Fastow‘s infamous special purpose entities that were used to create between $30 and $40 billion of off-balance sheet debt. Tom Peters is a well-known author and management specialist who at one time inquired about sending his MBA back to Stanford as an objection to Mr. Jaedicke’s Congressional testimony, but I don’t believe he ever followed through on it.
Over the weekend, I have been trying to come up with a thoughtful reply to the above email. Then, this morning, I discovered that Professor Ribstein has already performed the task for me in his typically insightful manner. Check it out.

Gingrich takes on health care issues

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This NY Times article reports on former House speaker Newt Gingrich‘s interest in reforming American health care and health care finance. Nothing earth shattering here, but it’s good to see a leading conservative thinker examining issues — particularly in the health care finance field — that desperately need attention.

Paul O’Neill on Social Security reform

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Former Bush Administration Treasury Secretary Paul O’Neill criticized the Bush Administration for a lack of meaningful policy analysis in his book, The Price of Loyalty. Mr. O’Neill is a bright and independent thinker about matters of financing governmental policy, so it’s prudent to consider his ideas carefully.
In this NY Sunday Times op-ed, Mr. O’Neill proposes a debt-financed transition of the current Social Security system under which those younger than their mid-thirties would save in broad-based, low-cost index funds, on a trajectory that would return to them a $1 million annuity at retirement. Mr. O’Neill calculates that this would would require about $1 trillion in temporary financing. In short, stop the existing system for new entrants, phase out the existing system as older citizens die, and cover the transition costs with debt to be repaid out of the absence of traditional benefits to the younger entrants in future years. This is a similar plan to the one that Arizona State economics professor and Nobel Prize winner Ed Prescott proposed in this earlier post.
The most interesting observation in the op-ed is Mr. O’Neill’s blunt and disdainful analysis of the politics of Social Security reform:

As I write this I can imagine the chorus of pundits saying, “This isn’t politically possible.” Why not? Because it is too complicated for people to understand? Or because the only way to approach change in our society is through small incremental steps, like the president’s tepid notion of a limited, voluntary diversion of Social Security taxes into small private accounts?
Baloney, I say. What stands between a truly worthy aspiration for our society and its realization is political leadership with the courage to dream big.

Looking upstream and downstream in prosecuting accounting fraud

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This this NY Times article reported last week that nine executives from a several food supply companies have been charged with crimes for their part in a revenue pumping scheme at U.S. Foodservice, a subsidiary of the Dutch company Royal Ahold N.V.. All the executives are accused of participating in a scheme to inflate U.S. Foodservice’s profits by confirming to the company’s auditors that the company was owed millions of dollars more in rebates than was actually the case. According to the article, most of the executives are expected to plead guilty.
The U.S. Foodservice case reflects a growing trend in white collar criminal prosecutions — i.e., employees of a company doing business with a target company being accused of participating with the target company’s employees in an accounting scheme to inflate the target company’s profits. The same approach was taken in the recent Enron-related Nigerian Barge case, in which four Merrill Lynch executives were convicted of participating in an accounting fraud with various Enron sharpies.
On the surface, the cases appear to be similar. The U.S. Foodservice prosecution appears to involve blatantly fraudulent conduct in which vendor representatives falsified documents so that U.S. Foodservice auditors would be misled regarding the true amount of the company’s revenues. The documents were clearly false because the vendors had no legal obligation to provide the rebates set forth in the documents. Based on the false documents, the U.S. Foodservice’s auditors booked illusory revenue that inflated profits.
Similarly, the Nigerian Barge case also involved an oral side deal that was not disclosed to Enron’s auditors. As a result, the government successfully contended at trial that Enron was able to take advantage of the accounting benefit of selling the three Nigerian energy production barges to Merrill Lynch even though it secretly remained obligated to repurchase the barges. But for non-disclosure of the oral side deal, Enron would have had to book lower than expected earnings, which would have resulted in lower stock price, lower compensation to the executives involved, etc.
Thus, the two cases appear to have much in common — false documents, undisclosed side deals, and false disclosures to auditors. But the nuances reflect significant differences between the cases, and those differences point to the dangers of criminalizing common business transactions, particularly in the anti-business environment fueled by anti-Enron animus.
Unlike the apparent false documents in the U.S. Foodservice case, there was a real question during the Nigerian Barge trial whether the contract under which Enron sold the barges to Merrill Lynch was true or false. This is particularly important because the written contract included a standard provision that specifically provided that any prior oral agreements between the parties — which would include the oral side deal in which Enron agreed to repurchase the barges — were superceded by the written contract that included no such obligation. Thus, if the written contract was enforceable, then Merrill Lynch could not have required Enron to repurchase the barges. If Merrill could not have enforced the oral side deal, Merrill was truly at risk with regard to the transaction, and Enron’s accounting for the transaction was at least arguably correct. If that’s the case, then what’s the crime?
Undaunted, the Nigerian Barge prosecution trotted a few former Enron executives who had previously copped pleas to the witness stand to testify regarding the existence of the oral side deal and to opine that Merrill was not truly at risk with regard to its acquisition of the barges. The prosecution put on no evidence that the written contract was unenforceable. Rather, the prosecution focused the jury on the horrors of Enron and the bad judgment that a couple of the Merrill Lynch defendants had used in investing personally with former Enron CFO Andrew Fastow in a special purpose entity that ultimately ended up with the barges. Finally, the prosecution case was buttressed by U.S. District Judge Ewing Werlein‘s questionable decision to exclude a key defense expert, who would have opined that Merrill Lynch was truly at risk in regard to the barge transaction because the written contact rendered unenforceable the oral side deal for Enron to repurchase the barges.
In the end, the jury in the Nigerian Barge trial convicted five of six of the defendants, including all four of the former Merrill Lynch executives. Interestingly, the Enron in-house accountant — who was the only defendant in the case who ratified the supposedly faulty accounting of the underlying transaction to Enron’s auditors — was acquitted. The trial court’s ruling that excluded the defense expert testimony regarding Merrill’s risk in the underlying transaction will be one of the central issues on the appeal of the convictions.
Thus, few would quibble with the proposition that clear fraudulent conduct should be vigorously prosecuted. But such clear cases of criminal fraud should not be confused with ones that are based more on playing to the jury’s anti-business bias than proving the fraudulent nature of the underlying transaction. The difference is that the type of conduct that apparently occurred in regard to U.S. Foodservice would surely be prosecuted regardless of what companies were involved. However, it is highly unlikely that the defendants involved in the Nigerian Barge case would have ever been prosecuted had any company other than Enron been involved in the underlying transaction.

Baylor-Methodist split — heading to court?

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Todd Ackerman reports in this Chronicle article on the latest flare-up in the divisive Texas Medical Center divorce of Baylor College of Medicine and the Methodist Hospital after a highly-productive 50 year marriage. Here are the earlier posts on this increasingly acrimonious split.
The latest salvo in the divorce was the accusation by Baylor President Peter Traber that Methodist’s new medical school affiliate — Cornell Medical School — is meeting with Baylor professors to induce them to leave Baylor for Methodist and Cornell. The Chronicle reports that Dr. Traber’s letter made the following accusation:

“Cornell has been actively involved in trying to convince Baylor faculty members to leave the college. The dean of Cornell has personally visited with and/or contacted Baylor faculty members in an attempt to recruit them to the Methodist Physician Organization and Cornell faculty positions.”

Legal translation: “Knock off the bribes or else we’re going to lay a tortious interference lawsuit on your lap.”
Other than the accusations of unethical conduct, things are just fine between Baylor and Methodist, as the Chronicle article notes:

Oddly, both Traber and [Methodist President Ron] Girotto reported that recent negotiations ? they resumed last week after mediators threw up their arms in December ? were the most productive they’ve had.

The option the Stros were wise not to grant

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Professor Sauer over at the Sports Economist blog has brought in some additional blogging mates. From their initial posts, the new bloggers are going to be making some nice contributions to this already smart blog.
In this first post, new blogger Brian Goff analyzes the “no-trade” clause demand that has been widely reported as one of the reasons why the Stros’ negotiations with Scott Boras over Carlos Beltran reached impasse shortly before the deadline to consummate a deal.
Professor Goff insightfully points out that the no-trade demand was in the nature of an option in which Boras was demanding that the Stros’ take on additional risk with regard to the Beltran contract. The reason that this may have been a sticking point in the negotiations is that such options are notoriously difficult to price in baseball contracts, and the valuation is different between the player and the ballclub. This is undoubtedly correct, although the pricing on this particular no trade clause probably was made a bit easier by the fact that Boras only needed to protect Beltran for the time until 2009, at which point Beltran could have vetoed any trade as a 10 and five player under the MLB Collective Bargaining Agreement.
So, regardless of whether the no trade demand was a dealbreaker, the Stros have lost out on a player who sure would have looked good next to Berkman and Oswalt in a Stros’ uniform for years to come. But as noted in this earlier post, a good case can be made that the Stros are better off over the long haul in failing to make the deal.
Beltran’s career numbers are .284BA/.353OBA/.490SLG over seven MLB seasons. Those are excellent numbers, but its hard to make that performance justify a $17 mil a year contract over the next the next seven years. In comparison, Vladimir Gurrerero‘s statistics through seven seasons — and just a year before he signed a $70 million, five-year deal with Anaheim — were .322/.386/.588. Guerrero is not as good a fielder as Beltran, and questions about his back certainly held down his value a bit. But the Angels still got a player with noticeably better career hitting stats for $3 million a year less than the Mets will be paying Beltran.
So, while Beltran’s career stat line might take off, my bet is that the Mets will be paying a boatload of money for Beltran by the end of the decade while not getting anywhere close to the hitting production that they had hoped for. In other words, sort of like the Stros’ current situation with Bags.
The Stros are clearly in a rebuilding mode after a very good run over the past decade. Had the club been able to sign Beltran at the Mets’ price for just a couple of years, then the Stros should have pulled the trigger and done the deal. That would have meant that Beltran’s deal would have been coming off the Stros’ payroll at about the same time as Bags and Bidg retire, leaving the Stros with the payroll flexibility to make some moves to transition into the post Bidg-Bags era.
On the other hand, if the Stros had signed Beltran, they could have found themselves in a similar financial straightjacket in 2010 that they presently face with Bags. Although the Stros will not be as good a hitting club in 2005 without Beltran (and, frankly, they were not all that good a hitting team until the last 45 games of the 2004 season), the $100 million they saved on not signing him gives the club the liquidity it needs to make several constructive personnel moves over the next couple of seasons. If the Stros make those moves prudently, then they will likely rebound just fine from the disappointment of not signing Beltran.
As many a savvy businessman has confirmed to me over the years, sometimes the best deal for the company is the one that gets away.

HP combines PC and printer units

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Despite the fact that the market attributes virtually no value to its $19 billion acquisition of Houston-based Compaq Computer Corp two and a half years ago, Hewlett-Packard Co. announced today that it is combining its printing unit with its personal-computer division, effectively ending speculation for the time being that the company might sell various units of the company and refocus primarily on its profitable printing unit.
HP shares rose 1 cent to $19.96 in morning trading on the New York Stock Exchange. In comparison, HP’s closing stock price was $18.22 on May 6, 2002, the day on which the Compaq merger was consummated. This has led one sage analyst to remark that “HP paid $19 billion for the privilege of hardly making any money” in the personal computer business.
As noted in this earlier post, HP chairman Carly Fiorina publicly stated last month that the company’s board had considered breaking up the technology giant on three different occasions. However, Ms. Fiorina, who was the leading advocate of the Compaq acquistion, stated that the board each time decided the company’s diversified portfolio of technology products helped the company to moderate business fluctuations in the cyclical technology sector.
H’mm. I doubt any of those fluctuations in the technology sector to date would have cost HP the $19 billion it spent on Compaq.

Bill Gates or Steve Jobs, can you please help?

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This NY Times article reports on the FBI’s longstanding and intractabe computer network problems. Amidst the dismay over the national security concerns that this problem presents, there is a good thesis topic here for some public policy grad student somewhere.

The lagging reform movement in corporate governance

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The NY Times’ Kurt Eichenwald, who has been covering the Enron scandal and other post-Dotcom business busts over the past several years, reviews in this NY times article the current status of the lagging government reform movement in regard to corporate governance.
Although the article accurately summarizes the fits and starts of such governmental reforms, it does not get to the real heart of the matter until almost the end:

The problem, . . . is that shareholders – the true owners of a corporation – are virtually powerless to effect change in a board unless they begin expensive and hard-to-win proxy battles. Shareholders are not given the right to vote for an alternative candidate for director, or to vote against one advanced by the company. They can either vote yes, or not vote at all.
Responding to such concerns, the S.E.C. proposed rules essentially allowing shareholders to propose their own candidates for director in companies with proven weaknesses in their procedures for electing directors. At the time it was introduced, William H. Donaldson, the S.E.C. chairman, heralded the proposal as a “significant step.”
Quickly, the proposal brought widespread opposition from the business community, which argued that the effort was intended to allow unions with huge stakes in corporations through their pension funds to force social policy issues to the forefront on corporate boards.
“We think introducing a special-interest agenda into the boardroom isn’t good governance or good for shareholders,” said Mr. Hirschmann of the Chamber of Commerce.

Here, Mr. Eichenwald misses the point. He sees a political battle in what is really a problem of investors and their counsel lazily relying on an obsolescent business model. As Professor Ribstein, one of the blawgoshere’s foremost experts on this issue, commented in this recent post:

I believe an important lesson from all this is that our current model of corporate governance just isn?t working, and that we delude ourselves if we think that Sarbanes-Oxley is going to fix it. . .
Among other problems, Sarbox banks on an absence of conflicts, not the presence of expertise and incentives to actually do a good job. . .
As for expertise, corporate boards will continue to be the playgrounds of do-gooder social responsibility activists who have other things on their minds than actually understanding and doing the nitty gritty of business and finance. In what alternative reality is it that a busy law dean and expert on ethics can be expected to spot accounting fraud? . . . all the other layers of responsibility our laws impose just increase the opportunities for shirking and finger pointing.
So what?s the answer? First, we need high-powered market-based incentives that would be provided by the return of an active market for corporate control. Second, as I?ve been saying (e.g., here) we need to encourage alternative business structures that take near-absolute power over corporate earnings away from corporate executives and give it to the firm?s owners.

Professor Ribstein’s thoughts are spot on. The reform that truly needs to occur is in the marketplace as investors and deal lawyers reevaluate the the way to implement the controls necessary to protect the investor’s investment. That reform is going to take time due to the practical difficulties of changing existing businesses to a better structure. But over time, this reform will have much more far reaching and effective results in the marketplace than anything that government can come up with.
A good way to start this reform movement is for investors to begin demanding of their counsel that they require more responsive business structures as a condition of their investment. The desire of a entreprenuer to raise capital for his business often overwhelms the entreprenuer’s desire for an inefficient and value-limiting business structure. But investors need to take the lead in demanding the more efficient structures. Otherwise, the current status quo of reliance on the inefficient corporate model will continue.
On a related issue, don’t miss Professor Bainbridge’s comments here on how the traditional business judgment rule is being gradually peeled away to foist increased liability on outside directors.
By the way, it was a rather large oversight that Mr. Eichenwald did not approach Professor Ribstein or Professor Bainbride for their comments on these issues. A little Googling while researching the issues would have helped. ;^)