Archive for Sunday, June 1, 2003

Shareholders need more freedom to elect directors

June 1, 2003

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To the beleaguered shareholders of WorldCom Inc., it probably looks like piling on. On top of the devastating 99 percent fall in stock price since the company's accounting scandal became public last year, the company is now the target of a $500 million fine, the largest fraud levy in U.S. history.

Surely, WorldCom shareholders are entitled to some sympathy. They were the main targets of the company managers' accounting gimmickry, which made the huge long-distance carrier appear far more prosperous than it was and drove the stock price heavenward. When the book doctoring was discovered, the share price went into a tailspin, leaving all those who bought at the high prices with terrible losses.

Shareholders don't usually get anything in such cases: They are last in line behind a parade of lenders, vendors and other creditors the company owes money.

As a practical matter, shareholders have only two options. First, they can sell and subtract the losses from gains on other investments -- reducing their federal tax bills.

The second option: Hold the shares and hope for a recovery -- though chances of that seem slim in this case since the stock is down so far.

To be hardnosed about it, shareholders in WorldCom, or any company in such straits, should consider that from one point of view they got off easy.

Shareholders are, after all, the company's owners.

If a shareholder owned a small business guilty of fraud, she might be personally liable for the debts, fines and lawsuit liabilities. But shareholders in publicly traded companies have no personal liability. The worst that can happen is their share price falls to zero; the rest of their financial lives is untouched.

WorldCom shareholders and employees who lost jobs weren't the only victims. Competing telecom companies complain, quite rightly, that phony accounting enabled WorldCom to set a standard that competitors had to meet. That meant destructive price reductions and other cost-cutting. Some attribute the entire industry's problems to this cause. Many carriers remain shaky.

For investors, the main WorldCom lesson is clear: Don't put too many eggs in one basket. As a rule, a small investor should never have more than 5 percent or 10 percent of her holdings in one stock. Mutual funds make it easy to spread your money among dozens, hundreds, even thousands of stocks.

The second lesson is that shareholders ought to be treated like the company's owners in all respects. If they take the losses when a company is mismanaged, they should have real authority to choose the management.

Technically, they do. Shareholders vote for the directors who hire and fire the top executives. But there's typically only one director candidate for each open seat, and the candidates are picked by the other directors, who generally rely on the recommendations of the chief executive officer.

We'd never permit a system like this for ordinary political office and certainly wouldn't propose it for Iraq, Afghanistan or any other country that needs Democracy with a big D.

If WorldCom shareholders want to put their wrath to productive use, they should lobby Congress, the Securities and Exchange Commission and other regulatory organizations for reforms to make it easier for groups of investors to nominate director candidates to challenge the insiders.

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