MICROSOFT FINANCIAL FRAUD Updated 10/6/99 Conclusion Microsoft is a great company with terrific employees who have achieved great success. Sadly, many of these brilliant people have been blinded by the stock price and unable to see that they have become the key architect of the greatest financial fraud/pyramid scheme this century. It is not uncommon for participants in pyramid schemes to lose their emotional bearings. My close friends who work at Microsoft are particularly upset over my work and it is possible that even Bill Gates and Steve Ballmer do not realize the implications of their financial practices. The fundamental problem is that Microsoft is incurring massive losses and only by accounting illusions are they able to show a profit. You might ask yourself, what would happen to Microsoft's stock price if the public suddenly realized that they lost $10 billion in 1999 rather than earning the reported $7.8 billion? If 80 percent of its stock value or roughly $400 billion is the result of a pyramid scheme, one might also ask what kind of effect this could have on the retirement system. It is also important to note that this is a relatively new situation that did not occur before 1995. Microsoft has always been a highly valued stock and that might have been justified prior to 1995. An Overview of Financial Fraud at Microsoft This situation is not about stock valuation, product quality or whether or not Microsoft has monopoly power in its markets. Nor is it part of a pro or anti-Microsoft movement. This situation is instead a shining example of financial fraud and corruption enabled by bad government policy. If not quickly and aggressively addressed, we will all be losers as credibility in our financial markets is destroyed. In July, I met SEC Chairman Arthur Levitt here in Portland, Oregon, and provided him a complete summary of my findings. This summary has also been provided to Robert Parry and Alan Greenspan of the Federal Reserve, Treasury Secretary Summers, Secretary of Labor Alexis Herman and both Joel Klein and Phil Malone of the Department of Justice. This month I also provided a summary of findings to the largest public pension funds, their investment advisors, state budget officers and representatives from leading bond rating agencies, including Duff and Phelps. I specifically asked these pension managers to remove Microsoft from their indexed portfolios based upon the S&P 500 as a step toward demonstrating fiduciary commitment to plan participants. Two other situations this century involving similar techniques include those of Charles Keating, who first destabilized and then later plundered the Savings and Loan system and Charles Insull who was President of Edison Electric, the great technology company of the 1920's. Insull was a national hero in the 20's yet came to be recognized as a symbol for what caused the great depression in the 1930's. Sadly, his good intentions and significant charitable and civic causes did not include ensuring the financial integrity of his company. He died of a heart attack in 1938, penniless, in a Paris subway station, exhausted from years of fighting lawsuits for fraud. Interestingly, he was never convicted. Many believe that the stock market crash of 1929 caused the Great Depression yet history clearly shows that it was instead simply bad government policy that was manipulated by leaders such as Insull. The Original Purpose of My Study In the summer of 1998 I began examining global capital flows due to the rapid movement of capital and crushing effect on developing countries. While everyone was analyzing the speed at which capital moved, no one was trying to answer the basic question, where did it end up? Upon completing my study I was able to conclude that a primary contributor to global economic instability was an elaborate financial pyramid scheme being utilized by the Microsoft Corporation, which others are now rapidly seeking to emulate. Frankly, I was astonished myself. I contacted Steve Ballmer's assistant several times along with other Microsoft representatives, including the editor of their Slate magazine, before publishing the results of my study in a press release on PR Newswire. The Independent, a major UK Newspaper, based their story on this study and shocked many readers. My study also included projecting that Microsoft would begin issuing "watered stock" in an effort to disguise and diffuse the pyramid. Watered Stock On 9/23/99, the same day Steve Ballmer, for whom I have tremendous respect for his honesty and integrity, publicly said that Microsoft's stock price was absurd and "false", the company also filed a registration with the SEC to make Expedia a separate company. This is a dramatic watershed event in the history of our financial markets. Either the SEC, Federal Reserve or Treasury department step up and cancel this registration statement or we begin aggressively moving toward a full scale economic meltdown for the following reasons. Disclaimer: Due to the dramatic implications of my study results and potential legal ramifications for Microsoft, I must emphatically state that the following is my opinion based upon my understanding of the facts. I assume no responsibility whatsoever for any investment related decision or misinterpretations of the tax law I have made in this analysis. Expedia is a company with $38 million in sales for which it incurred a loss of almost $20 million for the fiscal year ended June 30, 1999. What Microsoft is also doing is loading Expedia up with $150 million in stock option debt, making Expedia a "watered stock," and requiring employees that transfer to Expedia to exchange unvested Microsoft stock options for new Expedia options. What these employees may not realize is that Microsoft will also charge this option expense to earnings as they become vested, creating an expense of $150 million. This is remarkable because Microsoft does not charge its own income statement for such vesting options. Imagine how the Expedia employees might feel if within 6 months their options are the equivalent of worthless paper due to this staggering expense overhang. For this reason and several others noted in a letter to Arthur Levitt, Chairman of the SEC, I have asked that the Expedia IPO be cancelled. The fundamental challenge is that Microsoft itself is a "watered stock" and must be deflated by at least 50, perhaps 80 percent, to restore credibility to the financial markets as a matter of monetary policy. Reasons supporting this conclusion will be discussed later. To Steve Ballmer I would say, perhaps we could have a brief discussion regarding some ways to manage this situation. By now it should be clear that farming me off to your legal staff was not a good decision. A Breakthrough With The Independent Editorial In October of 1998 a prominent British publication, the Independent newspaper, published a lead editorial, citing my study and concurring with me that Microsoft had erected a financial pyramid scheme in which employees were prepaying their own wages and the retirement system was being plundered. I can still remember the editor's voice who interviewed me and his startled realization that my study was credible. I later sent my study results and follow-up work to The Economist and several leading business publications here in the US, more than a dozen times, regularly calling once a month and leaving detailed messages. Another breakthrough could have occurred when CNBC asked me to be on a panel discussion with Caspar Weinberger yet the show was cancelled due to the controversial nature of the content. The Economist Story Legitimizes My Study This is Bill Gates' favorite publication on finance and economics and generally believed to be the leading such publication in the world. In an 8/7/99 cover story, The Economist noted that a proper accounting at Microsoft would result in a loss of $18 billion for 1998 rather than the reported earnings of $4.5 billion. If you are not an accountant, don't waste the time pretending you are, trust The Economist, the earnings are not real. Don't let yourself be intimidated or deceived by financial analysts, TV commentators, bullies on Internet forums or Microsoft's elaborate public relations campaign. Bill Gates trusts The Economist and you should too. I have sent Abbey Joseph Cohen and Rick Sherlund of Goldman Sachs my material for 9 months and neither has publicly divulged this situation. Microsoft's Response to My Study Microsoft's perspective is best reflected by Bob Herbold, Chief Operating Officer, to whom the CFO reports. Bob very sincerely replied, "Bill, everyone is doing it." My response was that Microsoft is a leader and that others are now seeking to emulate these fraudulent practices they have legitimized. Naturally Bob was not pleased by my perspective and that was our final conversation. A second informal response of Microsoft's, PR Newswire's largest client, was telling PR Newswire to stop issuing my press releases. I do regularly call Pam Edstrom, director of Microsoft's public relations, Steven Holley, lead outside counsel with Sullivan and Cromwell and Bob Herbold prior to releasing any new information on my study. They no longer respond to any of my inquiries, which is disappointing. Although I am very confident of my findings, it would be nice if they could issue a formal statement or response to let me know their reaction to my findings. Why Deflating Microsoft's Stock Will Be Good for Microsoft and the Economy The media would like you to believe that what is good for Microsoft's stock is good for the country, yet that is false. One key impact of Microsoft's scheme is to suppress the stock values of many other companies practicing honest accounting. Investors are less interested in these companies because compared to Microsoft they look less profitable. This artificial inefficiency progressively destabilizes the economy and the media fuels this by not disclosing Microsoft's real earnings. A good example might be Allstate Insurance who last week announced earnings would be less than expectations and saw their stock drop sharply. Allstate is still significantly more profitable than Microsoft. A second reason is that investment managers have gotten lazy and been corrupted, narrowing their holdings to a few leaders like Microsoft, and focusing on fee generation rather than good investment management. On-line brokers are also earnings massive fees due to the high trading volumes since they earn a spread on every transaction in addition to the nominal transaction fee. On a longer term basis, Microsoft will benefit from deflating its stock as capital moves more equitably, both here in the U.S. and abroad, thereby stimulating a broader based economic growth and more vibrant markets for their products. They may even find recruitment easier. It is true that other tech companies will also be affected yet the effect at Microsoft dwarfs the others. In addition, most of these companies are much smaller than Microsoft and can grow out of the problem as they expand. Also unique to Microsoft is that roughly half of the stock is still owned by management and employees. That is why it is imperative that the SEC act quickly before more of this stock gets pushed into the retirement system. Tools Available to Deflate Microsoft's Stock 1) Require restatement of earnings since 1995 to fully account for stock options, both on the income statement and balance sheet. History clearly shows that footnote disclosure is not adequate to deflate the stock. 2) Do not allow tracking stocks, spin-offs or "watered stock" to be issued, an example of which is Expedia, for 10 years. 3) Prohibit Microsoft from buying back its own stock, instituting stock splits or selling put contracts and engaging in other hedging activity for 10 years. These are tricks used to manipulate the stock price and have contributed greatly to building the financial pyramid. It might make sense to outlaw this practice all together. 4) Prohibit Microsoft from offering employee stock options or any employee based ownership program for 10 years. The truth is most people go to Microsoft for stock options. This will require paying more real wages and more accurate financial results and therefore deflate the pyramid and increase competition. It might also introduce more equity among their own employees; i.e., perhaps officially employing sub-contractors would be good for internal morale at Microsoft. 5) Ask to have Microsoft removed from your 401K, 403B or public pension retirement fund, including funds based on the S&P 500 and other indexes. Removing them from this index will greatly reduce demand for the stock and deflate the price. This would be rather simple for a large public pension fund. They could issue a statement to members saying their S&P 500 index has everything except Microsoft due to concerns over their financial practices. Sometimes we forget that for the system to work we must take action. One effect of the pyramid they are building is that it is using cash from the retirement system to sustain itself while the founders aggressively diversify as noted in a recent cover story in Fortune magazine. It is also likely that Social Security funds will be the next level or source of funds for the pyramid if reforms are not initiated. 6) Request to have me as a guest on your talk show, radio station or other media outlet or speak at your convention. You might also send my Web site link to friends and people of influence such as other business leaders, political leaders and journalists, both here in the U.S. and abroad. Let's create an information pyramid of our own in the true spirit of democracy to raise the dialogue here. 7) Write a letter to your Congressman and local newspaper along with posting messages on Internet forums. Please include my Web site address in all your communications. My site contains no cookies and I do not sell access data to anyone for any reason. Department of Justice Case Breaking up Microsoft, setting product limitations and other such measures will simply not work unless you address the financial side. AT&T and Standard Oil had real assets while Microsoft has smart dedicated people and a pyramid scheme of which the public is completely unaware. They also have good products and patents but any technologist knows that the speed of change subjects them to rapidly becoming obsolete. When these people leave, the assets are gone and they are now leaving in large numbers. It is time that the Department of Justice focus on the real product issue and the product is not Windows but rather Microsoft's stock itself. Deflating Microsoft's stock price 50-80 percent will help greatly in resolving concerns over Microsoft's perceived monopoly. Most remarkable is that it could be done if the DOJ engaged in several high profile public disclosures. How would the public feel, for example, upon knowing that Microsoft took a tax deduction of $9 billion in 1999 for wage expense that is not charged to earnings. This could be the greatest example of corporate pork this century, from a company that prides itself on seeking the "freedom to innovate." Financial Pyramid Building Techniques Being Used by Microsoft: I am a big believer in stock option programs in that many companies use them responsibly. At Microsoft, stock option accounting is only one of many pyramid building techniques, what I call a cash generating component.Additional pyramid building techniques include the following: 1) Earnings Management: The first and most important tool Microsoft uses is the manipulation of earnings to ensure analysts expectations are met. According to an ABC News 1/22/99 article by Michael Martinez, Microsofts own internal auditor, a respected 30 year veteran and former partner of Deloitte and Touche, was fired in 1996 after informing management that their earnings manipulations were illegal and violations of the SEC and FASB laws. He was given the option to resign or be fired and later settled for $4 million after suing under the Federal Whistle Blowers Act. 2) Speculating on Their Own Stock: Microsoft issues a massive amount of put options. During the same quarter ended 3/31/99, Microsoft sold put contracts on their own stock for $400 million, basically betting that the stock will not decline. They need not worry because they are allowed to cook the books. Of Microsofts significant cash balance, it is also a financial fact that more than 80 percent of that cash did not originate from product sales but rather from tax benefits associated with the exercise of stock options, employees prepaying their own wages, and the sale of put contracts on its own stock. Microsoft's financial innovation is making a mockery of financial integrity, ethics, and the securities laws, just as Insull did in the 1920's. . 3) Convincing Employees to Take Less Real Wages: Microsoft aggressively markets stock options to new employees in an effort to take wage expenses off the books. They also know that they can pocket the exercise price employees will be required to pay to take ownership of the stock. What also seems clear is that Microsoft is still aggressively marketing its stock option program to new recruits. To quote an email received, I am about to begin employment at Microsoft and the stock option was the selling factor. Does your article overall state that it will be bad for me and will fail me in my retirement planning? Is Microsoft fulfilling its disclosure obligations to its own employees, especially those that have put their entire 401K balance in Microsoft stock? This explains how 22 percent of Microsoft's massive cash balance has actually come from its own employees in the form of them prepaying their own wages through stock option exercise prices. 4) Publicly touting the stock: In a recent earnings release, CFO Greg Maffei jokingly cited 10 reasons why Microsoft is a $1 trillion company. A common strategy here is to have top executives issue conflicting statements, one talking up the stock and the other talking it down and then within a few days financial analysts all come out with buy recommendations on the stock due to a small decline. They are making a mockery of financial integrity, ethics, and the securities laws. 5) Controlling the media. After issuing several press releases on PR Newswire, Microsoft told the service to stop issuing my press releases. Microsoft is PR Newswire's largest client. PR Newswire is owned by Miller Freeman of the UK, a large media company that publishes many computer related publications including Information Week in addition to Microsoft focused journals such as the Windows System Developer.

-- dd (q@2.d), October 14, 1999

Answers

CON'T..

Miller Freeman does indeed function as if it were a department of Microsoft itself. 6) Stock Option Accounting: It is important to note that any discussion of stock option accounting must address two completely different and independent situations. The first is to analyze the impact of options exercised and already retired and the second is to analyze the remaining options debt outstanding. My study focused on both whereas most media coverage only focused on the remaining options debt outstanding. Options Exercised and Retired: When stock options are exercised, the options are retired as the employee takes ownership of the stock. The value of these retired options should not be a subject of debate. Upon exercise, the options are valued at the market price of the stock less the exercise price and the employee pays W-2 taxes on this gain, even if the stock is not sold. The company then takes a tax deduction for wage expense for the same amount. What is surprising is that not a dime of this expense is charged to earnings at Microsoft, which they could voluntarily do. This amount alone for 1999 should exceed $10 billion even though net income is only $7.8 billion. Remaining Options Debt Outstanding: The remaining unexercised stock option liability is a completely separate issue and a debt just as real as the current stock quote, especially if half of the options are currently vested and exercisable. We all know that stocks can be over and under valued yet the market gives us a price on any given day and that is the price. The Black Scholes and related footnote disclosure is a great mathematical model yet has become nothing but a Trojan Horse for plundering the retirement system. What the Treasury Department and Federal Reserve might concern itself with is that this debt, $60 billion at Microsoft, has no interest cost that hits the income statement and increases $800 million with each $1 increase in the stock price. Simply put, Microsoft is somewhat immune to Federal Reserve interest rate hikes, which explains why the stock is increasing as the Fed raises rates and continues creating a Long Term Capital like debt pyramid. 7) Purchasing future sales via equity investments: Another earnings management tool being used by Microsoft is the purchase of future sales via equity investments in other companies. Here is my understanding of how that works. I could be wrong on this and therefore the best thing to do would be confirm these claims with their CFO, Greg Maffei. First of all, Microsoft makes a $250 million investment in WebMD for an 11 percent equity stake and part of the deal is that WebMD commits to $100 million of advertising on MSN network. At the same time, Microsoft agrees to subsidize an equal amount in medical prescriptions for people using WebMD. Of course there are a few other interesting aspects of this transaction, of which I wont address in this report. You have basically bartered a purely paper transaction and current accounting rules will allow you to recognize the entire $100 million as revenues for MSN network, even though you are just trading checks. That is, you are trading subscription subsidies for advertising revenues. Advertising revenues are indeed the political currency of the 1990s. Keating spent his dollars buying influence in Washington D.C. Microsoft is buying influence on Madison Avenue. 8) Managing the financial analyst community. Another excellent earnings management technique is the management of the analyst community. This can be done by directing investment banking business associated with acquisitions to a variety of firms based upon their opinion of the stock. Microsoft purchased more than 33 companies in 1998. A good example here might be Rick Sherlund of Goldman Sachs, often noted as the guy who can move tech stocks. One might ask why Mr. Sherlund refers to Microsoft as a company with no debt when they clearly have a contractual obligation, just as real as todays stock price, of $65 billion to their employees. Fidelity Investments, one of Microsofts largest shareholders and also provider of their 401K retirement plan, has been silent on this issue. 9) Trying to Discredit Those Seeking to Expose the Scheme: Microsoft fired its internal auditor, regularly bullies reporters and has told numerous publications that I am an extremist. This might explain why reporters are afraid to print the facts, for instance that Microsoft took a $9 billion tax deduction for wages in 1999 and didn't charge a dime of this amount against earnings. 10) Money Laundering: Microsoft has been aggressively investing cash pilfered from the retirement system in a variety of new businesses, many outside the U.S., including cable investments in Brazil and England. We read about the Russian government robbing its citizens of $10 billion in IMF loans. What about the impact of the retirement system being pilfered and being set up for a Savings and Loan like debacle? 11) Corruption of Higher Education: Microsoft is making massive cash infusions to leading Universities and impairing the system's independence. In the last year alone Microsoft has given MIT more than $50 million in grants, focusing on key growth areas including storage services and software to provide course instruction over the Internet. In the past we were able to rely on these Universities to stimulate key debates yet now they are silent on this pyramid issue. Two Universities that should be ashamed of themselves for not only not disclosing this situation yet also fostering its development are Harvard and Stanford. They are contributing greatly to the complete corruption of our financial markets. Microsoft is a Cash Machine but Where Does the Cash Come From? Several Impacts from Microsoft's Financial Pyramid Scheme Include the Following: This scheme led by Microsoft is having many unexpected impacts, a few of which are noted here. This list will be expanded on a weekly basis so please visit again. 1) Government Will Be Defunded. Beginning next year education defense and other key programs will have to fight over a sudden and sharp drop in tax receipts. Corporate tax receipts are already down 6 percent while individual receipts are up 6 percent. Since these bogus deductions are able to be carried over and offset against future quarter's earnings, this difference will accelerate in the future and leave various government agencies fighting for a smaller pool of resources. This was forecast in the study. Also to consider are massive AMT tax credits that individuals who paid tax upon exercising options will be carrying forward into next year and offsetting ordinary income tax. Analyzing this situation should be a top priority for both the Federal Reserve and Treasury given the upcoming budget negotiations. Their is a unique irony that Bill Gates recently dedicated $1.5 billion to minority student scholarships and at the same time is leading a massive fraud that will effectively defund public education in many states. 2) The Retirement System Is Being Plundered. Most new investment in Microsoft is coming from the 401K, 403B and public pension participants through large funds such as Fidelity, State Street, Barclays and Janus. These fund families will make their fees whether the stock goes up or down and they are clearly not meeting their fiduciary responsibility to plan participants. I would caution them and their consultants and advisors including Buck, Callan and William Mercer to do a risk assessment based upon the 404C fiduciary requirements. The Savings and Loan debacle took down not only many banks yet also their consultants, accountants and law firms. 3) Business Owners Are Exposing Their Personal Assets By Not Paying Enough Attention To Their 401K. ERISA 404C has severe sanctions against employers who are not adequate stewards of their 401K plans, specifically those that do not meet the prudent fiduciary expectation. Such lawsuits are already beginning, the corporate veil is no protection and the law also allows for treble damages. Most CFO's put 401K plans on their "to do" list, check it off and move on to the next thing. Putting me on your 401K committee is an excellent way to eliminate this risk. 4) The Dollar Is Being Devalued In Relation to the Yen. The Japanese have struggled for 10 years to recover from their own version of accounting fraud and they know that now is not the time to accommodate our monetary desires without first forcing us to face up to the corruption in our own markets. Simply put, Japan is becoming our own personal IMF and will devalue our currency until reforms are initiated. As noted before, what caused the Japanese banking crisis was not plunging real estate values nor bad monetary policy, but rather accounting fraud in which companies put phony assets on the books, in particular software research and development costs. These costs should have been charged to earnings. Loans were made off these bogus assets which helped bank stock values increase, leading to margin lending by consumers to buy the stock, often borrowing off real estate values to get the shares. When the loans could not be repaid and it was realized that there were no real assets backing them, the system collapsed. It was a startling public display of Alan Greenspan's need to brush up on accounting when he actually said in his Jackson Hole speech that corporate profits were understated due to not capitalizing software costs. Those of us familar with this industry know software is subject to rapidly becoming obsolete with most products requiring constant upgrades to stay competitive. Due to this obvious need for the Federal Reserve to better understand key issues in determining share values, Parish & Company will release a major announcement next week formally requesting that the Federal Reserve Board be expanded by one non-voting member from the mutual fund industry. This will include nominating John Bogle, founder of the Vanguard family of mutual funds, to be considered for this role. 5) False Inflation is Emerging. This paper wealth, rooted in a bogus tax deduction that grossly overstates earnings, is driving Microsoft's stock price which in turn greatly expands the purchasing power for luxury goods and services. Most inflation is now in services and luxury goods and not reflected in the CPI. I call this false inflation because it is a result of a scheme, not economic fundamentals. Given the capacity to increase supply due to more efficient production and heightened global competition, it is tough to raise prices. Only monopolies are indeed able to even keep prices at current levels. We therefore have a reality of low inflation competing with a pyramid scheme creating an illusion of inflation. This is not good for any of us, especially the investment industry. 6) The Integrity Of The Markets Is Being Destroyed. This is perhaps the greatest risk and again what led to the Great Depression in the 1930's. It is fact that Roosevelt wanted to nationalize the accounting profession and make all auditors government employees due to a complete loss of confidence in the accounting profession. Frequently Asked Questions Regarding My Analysis 1) Who are the key people to focus on addressing this situation? Alan Greenspan and Robert Parry of the Federal Reserve, Arthur Levit and Lynn Turner of the SEC, Alexis Herman from the DOL and Larry Summers from the department of Treasury. 2) Where is the stock given to employees coming from? More than 90 percent of it is coming from the equivalent of a photo copy machine in the back office. 3) Why do you call this a pyramid scheme? I don't see the various levels? Top level Bill Gates, bottom level 401K, 403B and public pension retirement plan participants. Microsoft employees and various other levels reside in between. The share price is being leveraged higher by an undisclosed debt pyramid which is common to all such schemes. 4) Why hasn't the media fully disclosed this situation, especially the massive bogus tax deductions? Microsoft is the biggest business press advertiser and has a brilliant PR team. Just imagine negotiating the printing of this story with your editor. As Bill Moyers has noted, "Free Press for Sale." It is also important to remember that Microsoft has millions of avid supporters due to new opportunities they have created in the computer world. 5) Aren't you afraid of being sued by Microsoft? That is a possibility yet courts these days frown very heavily upon malicious law suits. This would also give me an expanded platform and an opportunity to counter sue. What I would like to do is work together with Microsoft to improve the retirement system in this country. Sadly, they just don't seem to get it and perhaps are suffering from a "not invented here" syndrome so prevalent in large corporations. They don't necessarily have to be a big long-term loser, yet are certainly now positioning themselves to be just that. 6) What are some of the legal risks to Microsoft and are you contacted by many law firms? Not a day goes by when I am not contacted at least a couple of times by large law firms, usually based in New York, Philadelpia and other large cities. I am constantly irritated by their lack of interest in my goal of reforming the retirement system; they instead focus on where a potential fee bonanza might be. Some of basic questions regarding legal risks to Microsoft include the following: a. Could Microsoft be sued under the RICO law for racketeering with media and investment companies to price fix their stock? I am not an attorney but there are some interesting cases here and very broad applications of RICO such as the anti-abortion group being successfully sued after bombing clinics. It was also successfully used to sue absentee landlords in New York City. RICO was originally intended to fight organized crime or the MOB. If I were Microsoft I would be very careful regarding who I am selling those put contacts to and also make sure clear lines of independence are held in relation to supporting organizations. RICO specifically requires collusion between more than one organization and so keeping clear lines of separation between Sullivan and Cromwell, Deloitte and Touche, Waggener Edstrom, PR Newswire, Goldman Sachs, Fidelity and Janus should be a top priority. Given that I have publicly informed all of above on repeated occasions of my claim of significant financial fraud at Microsoft, that should make the importance of this all that more obvious. b. What about this 404C risk? Can Microsoft be sued here? The real exposure here is for whomever signs the annual 5500 report, usually the business owner or top management. Although investment companies talk about reducing fiduciary risk, I have never seen a 5500 report signed by an investment company. In the end, the sole trustees for purposes of the law are usually business owners and top management. Most do not have a clue regarding the risks they are taking, especially the reality that ERISA can easily pierce the corporate veil, going after personal assets, and makes a special point of providing for treble damages. c. If you brought a legal action against Microsoft, what would you do? If unable to come to some sort of compromise on retirement system reforms I would want to sue them for impairing my ability to function as a competent investment advisor. Of course any competent judge would immediately throw out a case like this, perhaps even fining me for filing a nuisance suit. Such an action would most likely be too abstract for the courts to appreciate. 6) What if I am interested in hiring you as my advisor and has this helped your business? Actually, this has involved a huge sacrifice for my business. People don't want to hear this, especially in Portland, Microsoft's back yard. I have many friends who work there in addition to many friends' children who work there. There is also somewhat of a "crackpot factor" that scares some potential clients. My existing clients are very happy however and have received excellent returns. My business is structured as follows. We select a top quality discount broker with the broadest access to mutual funds, stocks and other investment alternatives. You pay me .75 percent a year as your fee based advisor. I then recommend a portfolio focused on top quality, well diversified low cost investments. This includes mutual funds (usually Vanguard), individual stocks, Treasuries or whatever else might seem appropriate in building or sustaining your particular financial house. A key focus is as few portfolio changes as possible in order to minimize tax consequences and maintain a laser focus on quality companies with proven track records and excellent management. This also includes analyzing new business opportunities, key business related growth decisions, insurance, etc. 7) What are your specific goals with respect to pursuing this effort regarding Microsoft? I would like to lead the establishment of common sense reforms to the retirement system and then sit on major corporations' 401K committees as the equivalent of an outside board of director. This would give me an opportunity to indirectly help millions of Americans better prepare for retirement and also demonstrate that I could serve individual management members as their independent fee based investment advisor. It would also send a crystal clear message to employees that their plan is in good hands. This would free up management to worry less about their 401K, 403B or public pension funds and eliminate their fiduciary risk. Can you imagine some investment company trying to not do right by management and employees in a plan for which I sat in as a member of the 401K committee? I apply all the same level of conceptual and practical perspectives being utilized in the Microsoft analysis to my efforts with respect to retirement plans. 8) Are you just a frustrated bean counter, envious because you are not a large holder of Microsoft stock? No. I am a concerned citizen hoping these wonderful economic times will not be scarified for the sake of a pyramid scheme that benefits far fewer people than most realize. Being an investment advisor in the 1930's was probably not much fun. I like what I do and it is an excellent extension of my background and interests. A good investment advisor gets to be a builder, journalist, psychologist and coach all wrapped in one. A most interesting and productive endeavor. 9) What led you to uncover this pyramid scheme, it all seems quite remarkable? Teaching classes on International Finance in Latin America and experiencing severe economic dislocations first-hand coupled with helping a few clients determine a strategy for exercising their stock options. I tried to draw a line between a Paraguayan friend Enrique who no longer receives his social security checks due to government corruption and the highest capitalized investment which happened to be Microsoft. In the old days money stolen from the Treasury in developing nations went to Swiss bank accounts yet today it seems to be coming to the U.S. and primarily to the stock market. A defining moment was an Arthur Andersen alumni gathering listening to a workshop on the stock option topic. It was the look of fear in the presenter's eyes during a break when I showed her a graph of Microsoft based upon my analysis. Enough is enough, I thought as she later referred to Microsoft's outstanding accounting practices. 10) Why aren't you advising the Federal Reserve and others involved in this situation? They have not asked for nor responded to my offer to advise them. Bankers generally have a hard time managing conflict which is why they opt for the security and stability of banking. Many people go into accounting for the same reason. I am often told that in person I seem quite different than in print. That probably results from not having much support regarding my views and a frustration factor at seeing what may occur unless reforms are initiated. 11) How do you feel about Bill Gates' foundations? I applaud Bill's efforts in this respect and did actually make a proposal early last fall that he give 80 percent of his stock back to employees via the stock option plan and let them make their own charitable giving decisions. I suggested starting with $4 billion. He instead gave an equal amount to a foundation managed by his father. What I would like to see is the foundation fund a project aimed at achieving common sense reforms in the retirement system, including an expanded safe harbor provision for employers that offer plans with 5 specific types of fund choices in addition to whatever other selections they provide. Note: This list of questions and answers will be expanded weekly, so please visit again and send in your ideas for expanding or clarifying it. The following related resources are also available.

-- dd (q@2.d), October 14, 1999.

http://www.billparish.com/msftfraudfacts.html

-- st (s@e.k), October 14, 1999.

Haven't you ever heard of the word "paragraph"? Has it ever occurred to you how difficult it is to read something as long as this when it's all in a single paragraph?

-- cody (cody@y2ksurvive.com), October 15, 1999.

dd:

Wow! I know you believe in freedom of speech, but are you ready to engage legions of belligerent Microsoft lawyers?

-- Randolph (dinosaur@williams-net.com), October 15, 1999.

You maybe interested in checking out this thread and ponder the above.

 Greenspan's Jackson Hole speech

-- Brian (imager@home.com), October 15, 1999.

then again, I might not.

Anybody intelligent enough to impart valid information is also intelligent enough to know how to communicate said knowledge in a coherent, easily digestible fashion. Have to agree with the above comment about paragraphs.

Run-on talking, and run-on typing, are classic symptoms of neurotic thinking. The whole post is therefore suspect.

-- Chicken Little (panic@forthebirds.net), October 15, 1999.

"Have to agree with the above comment about paragraphs."

Oh, this is just great.

I remember my first day here. It took me a while. And I wasn't trying to copy/paste, just trying to put my $.02 in.

Typical polly answer. Attack the message format, not the message.

F***ing moron.

Pay attention people. Notice: just another polly distraction.

Tick... Tock... <:00=

-- Sysman (y2kboard@yahoo.com), October 15, 1999.

I won't attack anything.. please just use paragraphs! Luckily, the threads all automatically have blockquote tags inserted.

-- mil (milleniun@yahoo.com), October 15, 1999.

It's NOT dd's fault about paragraphs. I've found (depending where I've copied from) ... that I'll copy something WITH paragraphs, but when it's posted in the forum ... the paragraphs disappear, and copy runs together.

So now, just to be double sure, I manually go back and put 3 lines between paragraphs, to ensure what's viewed here is in paragraph form.

I hope someone takes the time to re-format this very important article. Though it was difficult to read, I read it ... and it ain't pretty.

MARKET'S GONNA BE VERY, VERY UGLY TODAY.

-- Cheryl (Transplant@Oregon.com), October 15, 1999.

Maybe the reason they put out such crap is that they don't have the money to fix it? Poor babies!!

-- A (A@AisA.com), October 15, 1999.

Let's see...

MICROSOFT FINANCIAL FRAUD

Updated 10/6/99

Conclusion

Microsoft is a great company with terrific employees who have achieved great success. Sadly, many of these brilliant people have been blinded by the stock price and unable to see that they have become the key architect of the greatest financial fraud/pyramid scheme this century. It is not uncommon for participants in pyramid schemes to lose their emotional bearings. My close friends who work at Microsoft are particularly upset over my work and it is possible that even Bill Gates and Steve Ballmer do not realize the implications of their financial practices.

The fundamental problem is that Microsoft is incurring massive losses and only by accounting illusions are they able to show a profit. You might ask yourself, what would happen to Microsoft's stock price if the public suddenly realized that they lost $10 billion in 1999 rather than earning the reported $7.8 billion? If 80 percent of its stock value or roughly $400 billion is the result of a pyramid scheme, one might also ask what kind of effect this could have on the retirement system. It is also important to note that this is a relatively new situation that did not occur before 1995. Microsoft has always been a highly valued stock and that might have been justified prior to 1995.

An Overview of Financial Fraud at Microsoft This situation is not about stock valuation, product quality or whether or not Microsoft has monopoly power in its markets. Nor is it part of a pro or anti-Microsoft movement. This situation is instead a shining example of financial fraud and corruption enabled by bad government policy. If not quickly and aggressively addressed, we will all be losers as credibility in our financial markets is destroyed.

In July, I met SEC Chairman Arthur Levitt here in Portland, Oregon, and provided him a complete summary of my findings. This summary has also been provided to Robert Parry and Alan Greenspan of the Federal Reserve, Treasury Secretary Summers, Secretary of Labor Alexis Herman and both Joel Klein and Phil Malone of the Department of Justice. This month I also provided a summary of findings to the largest public pension funds, their investment advisors, state budget officers and representatives from leading bond rating agencies, including Duff and Phelps. I specifically asked these pension managers to remove Microsoft from their indexed portfolios based upon the S&P 500 as a step toward demonstrating fiduciary commitment to plan participants.

Two other situations this century involving similar techniques include those of Charles Keating, who first destabilized and then later plundered the Savings and Loan system and Charles Insull who was President of Edison Electric, the great technology company of the 1920's. Insull was a national hero in the 20's yet came to be recognized as a symbol for what caused the great depression in the 1930's. Sadly, his good intentions and significant charitable and civic causes did not include ensuring the financial integrity of his company. He died of a heart attack in 1938, penniless, in a Paris subway station, exhausted from years of fighting lawsuits for fraud. Interestingly, he was never convicted.

Many believe that the stock market crash of 1929 caused the Great Depression yet history clearly shows that it was instead simply bad government policy that was manipulated by leaders such as Insull.

-- Mac (sneak@lurk.hid), October 15, 1999.

More...

The Original Purpose of My Study

In the summer of 1998 I began examining global capital flows due to the rapid movement of capital and crushing effect on developing countries.  While everyone was analyzing the speed at which capital moved, no one was trying to answer the basic question, where did it end up? Upon completing my study I was able to conclude that a primary contributor to global economic instability was an elaborate financial pyramid scheme being utilized by the Microsoft Corporation, which others are now rapidly seeking to emulate.  Frankly, I was astonished myself.  I contacted Steve Ballmer's assistant several times along with other Microsoft representatives, including the editor of their Slate magazine, before publishing the results of my study in a press release on PR Newswire. The Independent, a major UK Newspaper, based their story on this study and shocked many readers. My study also included projecting that Microsoft would begin issuing "watered stock" in an effort to disguise and diffuse the pyramid.

Watered Stock

On 9/23/99, the same day Steve Ballmer, for whom I have tremendous respect for his honesty and integrity, publicly said that Microsoft's stock price was absurd and "false", the company also filed a registration with the SEC to make Expedia a separate company. This is a dramatic watershed event in the history of our financial markets.  Either the SEC, Federal Reserve or Treasury department step up and cancel this registration statement or we begin aggressively moving toward a full scale economic meltdown for the following reasons.

Disclaimer: Due to the dramatic implications of my study results and potential legal ramifications for Microsoft, I must emphatically state that the following is my opinion based upon my understanding of the facts.  I assume no responsibility whatsoever for any investment related decision or misinterpretations of the tax law I have made in this analysis.

Expedia is a company with $38 million in sales for which it incurred a loss of almost $20 million for the fiscal year ended June 30, 1999.  What Microsoft is also doing is loading Expedia up with $150 million in stock option debt, making Expedia a "watered stock," and requiring employees that transfer to Expedia to exchange unvested Microsoft stock options for new Expedia options.  What these employees may not realize is that Microsoft will also charge this option expense to earnings as they become vested, creating an expense of $150 million.  This is remarkable because Microsoft does not charge its own income statement for such vesting options.  Imagine how the Expedia employees might feel if within 6 months their options are the equivalent of worthless paper due to this staggering expense overhang.  For this reason and several others noted in a letter to Arthur Levitt, Chairman of the SEC, I have asked that the Expedia IPO be cancelled.

The fundamental challenge is that Microsoft itself is a "watered stock" and must be deflated by at least 50, perhaps 80 percent, to restore credibility to the financial markets as a matter of monetary policy.  Reasons supporting this conclusion will be discussed later. To Steve Ballmer I would say, perhaps we could have a brief discussion regarding some ways to manage this situation.  By now it should be clear that farming me off to your legal staff was not a good decision.

A Breakthrough With The Independent Editorial

In October of 1998 a prominent British publication, the Independent newspaper, published a lead editorial, citing my study and concurring with me that Microsoft had erected a financial pyramid scheme in which employees were prepaying their own wages and the retirement system was being plundered.  I can still remember the editor's voice who interviewed me and his startled realization that my study was credible.  I later sent my study results and follow-up work to The Economist and several leading business publications here in the US, more than a dozen times, regularly calling once a month and leaving detailed messages.  Another breakthrough could have occurred when CNBC asked me to be on a panel discussion with Caspar Weinberger yet the show was cancelled due to the controversial nature of the content.

The Economist Story Legitimizes My Study

This is Bill Gates' favorite publication on finance and economics and generally believed to be the leading such publication in the world. In an 8/7/99 cover story, The Economist noted that a proper accounting at Microsoft would result in a loss of $18 billion for 1998 rather than the reported earnings of $4.5 billion.  If you are not an accountant, don't waste the time pretending you are, trust The Economist, the earnings are not real.  Don't let yourself be intimidated or deceived by financial analysts, TV commentators, bullies on Internet forums or Microsoft's elaborate public relations campaign. Bill Gates trusts The Economist and you should too.  I have sent Abbey Joseph Cohen and Rick Sherlund of Goldman Sachs my material for 9 months and neither has publicly divulged this situation.

Microsoft's Response to My Study

Microsoft's perspective is best reflected by Bob Herbold, Chief Operating Officer, to whom the CFO reports. Bob very sincerely replied, "Bill, everyone is doing it."  My response was that Microsoft is a leader and that others are now seeking to emulate these fraudulent practices they have legitimized.  Naturally Bob was not pleased by my perspective and that was our final conversation.  A second informal response of Microsoft's, PR Newswire's largest client, was telling PR Newswire to stop issuing my press releases.  I do regularly call Pam Edstrom, director of Microsoft's public relations, Steven Holley, lead outside counsel with Sullivan and Cromwell and Bob Herbold prior to releasing any new information on my study.  They no longer respond to any of my inquiries, which is disappointing.  Although I am very confident of my findings, it would be nice if they could issue a formal statement or response to let me know their reaction to my findings.

Why Deflating Microsoft's Stock Will Be Good for Microsoft and the Economy

The media would like you to believe that what is good for Microsoft's stock is good for the country, yet that is false.  One key impact of Microsoft's scheme is to suppress the stock values of many other companies practicing honest accounting.  Investors are less interested in these companies because compared to Microsoft they look less profitable. This artificial inefficiency progressively destabilizes the economy and the media fuels this by not disclosing Microsoft's real earnings.  A good example might be Allstate Insurance who last week announced earnings would be less than expectations and saw their stock drop sharply. Allstate is still significantly more profitable than Microsoft.

A second reason is that investment managers have gotten lazy and been corrupted, narrowing their holdings to a few leaders like Microsoft, and focusing on fee generation rather than good investment management.  On-line brokers are also earnings massive fees due to the high trading volumes since they earn a spread on every transaction in addition to the nominal transaction fee.

On a longer term basis, Microsoft will benefit from deflating its stock as capital moves more equitably, both here in the U.S. and abroad, thereby stimulating a broader based economic growth and more vibrant markets for their products. They may even find recruitment easier. It is true that other tech companies will also be affected yet the effect at Microsoft dwarfs the others.  In addition, most of these companies are much smaller than Microsoft and can grow out of the problem as they expand.  Also unique to Microsoft is that roughly half of the stock is still owned by management and employees. That is why it is imperative that the SEC act quickly before more of this stock gets pushed into the retirement system.

Tools Available to Deflate Microsoft's Stock

1)  Require restatement of earnings since 1995 to fully account for stock options, both on the income statement and balance sheet.  History clearly shows that footnote disclosure is not adequate to deflate the stock.

2)  Do not allow tracking stocks, spin-offs or "watered stock" to be issued, an example of which is Expedia, for 10 years.

3) Prohibit Microsoft from buying back its own stock, instituting stock splits or selling put contracts and engaging in other hedging activity for 10 years. These are tricks used to manipulate the stock price and have contributed greatly to building the financial pyramid. It might make sense to outlaw this practice all together.

4) Prohibit Microsoft from offering employee stock options or any employee based ownership program for 10 years. The truth is most people go to Microsoft for stock options. This will require paying more real wages and more accurate financial results and therefore deflate the pyramid and increase competition. It might also introduce more equity among their own employees; i.e., perhaps officially employing sub-contractors would be good for internal morale at Microsoft.

5)  Ask to have Microsoft removed from your 401K, 403B or public pension retirement fund, including funds based on the S&P 500 and other indexes.  Removing them from this index will greatly reduce demand for the stock and deflate the price.  This would be rather simple for a large public pension fund.  They could issue a statement to members saying their S&P 500 index has everything except Microsoft due to concerns over their financial practices. Sometimes we forget that for the system to work we must take action. One effect of the pyramid they are building is that it is using cash from the retirement system to sustain itself while the founders aggressively diversify as noted in a recent cover story in Fortune magazine. It is also likely that Social Security funds will be the next level or source of funds for the pyramid if reforms are not initiated.

6)  Request to have me as a guest on your talk show, radio station or other media outlet or speak at your convention. You might also send my Web site link to friends and people of influence such as other business leaders, political leaders and journalists, both here in the U.S. and abroad. Let's create an information pyramid of our own in the true spirit of democracy to raise the dialogue here.

7) Write a letter to your Congressman and local newspaper along with posting messages on Internet forums.  Please include my Web site address in all your communications. My site contains no cookies and I do not sell access data to anyone for any reason.

Department of Justice Case

Breaking up Microsoft, setting product limitations and other such measures will simply not work unless you address the financial side. AT&T and Standard Oil had real assets while Microsoft has smart dedicated people and a pyramid scheme of which the public is completely unaware. They also have good products and patents but any technologist knows that the speed of change subjects them to rapidly becoming obsolete.  When these people leave, the assets are gone and they are now leaving in large numbers.

It is time that the Department of Justice focus on the real product issue and the product is not Windows but rather Microsoft's stock itself. Deflating Microsoft's stock price 50-80 percent will help greatly in resolving concerns over Microsoft's perceived monopoly.  Most remarkable is that it could be done if the DOJ engaged in several high profile public disclosures.  How would the public feel, for example, upon knowing that Microsoft took a tax deduction of $9 billion in 1999 for wage expense that is not charged to earnings. This could be the greatest example of corporate pork this century,  from a company that prides itself on seeking the "freedom to innovate."

-- Mac (sneak@lurk.hid), October 15, 1999.

And finally (crossing fingers...)

Financial Pyramid Building Techniques Being Used by Microsoft:

I am a big believer in stock option programs in that many companies use them responsibly. At Microsoft, stock option accounting is only one of many pyramid building techniques, what I call a cash generating component.Additional pyramid building techniques include the following:

1) Earnings Management: The first and most important tool Microsoft uses is the manipulation of earnings to ensure analysts expectations are met.  According to an ABC News 1/22/99 article by Michael Martinez, Microsofts own internal auditor, a respected 30 year veteran and former partner of Deloitte and Touche, was fired in 1996 after informing management that their earnings manipulations were illegal and violations of the SEC and FASB laws.  He was given the option to resign or be fired and later settled for $4 million after suing under the Federal Whistle Blowers Act.

2) Speculating on Their Own Stock: Microsoft issues a massive amount of put options. During the same quarter ended 3/31/99, Microsoft sold put contracts on their own stock for $400 million, basically betting that the stock will not decline.  They need not worry because they are allowed to cook the books. Of Microsofts significant cash balance, it is also a financial fact that more than 80 percent of that cash did not originate from product sales but rather from tax benefits associated with the exercise of stock options, employees prepaying their own wages, and the sale of put contracts on its own stock.  Microsoft's financial innovation is making a mockery of financial integrity, ethics, and the securities laws, just as Insull did in the 1920's.
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3) Convincing Employees to Take Less Real Wages:  Microsoft aggressively markets stock options to new employees in an effort to take wage expenses off the books.  They also know that they can pocket the exercise price employees will be required to pay to take ownership of the stock.  What also seems clear is that Microsoft is still aggressively marketing its stock option program to new recruits.  To quote an email received,  I am about to begin employment at Microsoft and the stock option was the selling factor. Does your article overall state that it will be bad for me and will fail me in my retirement planning?  Is Microsoft fulfilling its disclosure obligations to its own employees, especially those that have put their entire 401K balance in Microsoft stock? This explains how 22 percent of Microsoft's massive cash balance has actually come from its own employees in the form of them prepaying their own wages through stock option exercise prices.

4) Publicly touting the stock:  In a recent earnings release, CFO Greg Maffei jokingly cited 10 reasons why Microsoft is a $1 trillion company.  A common strategy here is to have top executives issue conflicting statements, one talking up the stock and the other talking it down and then within a few days financial analysts all come out with buy recommendations on the stock due to a small decline. They are making a mockery of financial integrity, ethics, and the securities laws.

5) Controlling the media. After issuing several press releases on PR Newswire, Microsoft told the service to stop issuing my press releases.  Microsoft is PR Newswire's largest client. PR Newswire is owned by Miller Freeman of the UK,  a large media company that publishes many computer related publications including Information Week in addition to Microsoft focused journals such as the Windows System Developer. Miller Freeman does indeed function as if it were a department of Microsoft itself.

6)  Stock Option Accounting: It is important to note that any discussion of stock option accounting must address two completely different and independent situations.  The first is to analyze the impact of options exercised and already retired and the second is to analyze the remaining options debt outstanding.  My study focused on both whereas most media coverage only focused on the remaining options debt outstanding.

        Options Exercised and Retired: When stock options are exercised, the options are retired as the employee takes ownership of the stock. The value of these retired options should not be a subject of debate. Upon exercise, the options are valued at the market price of the stock less the exercise price and the employee pays W-2 taxes on this gain, even if the stock is not sold. The company then takes a tax deduction for wage expense for the same amount. What is surprising is that not a dime of this expense is charged to earnings at Microsoft, which they could voluntarily do. This amount alone for 1999 should exceed $10 billion even though net income is only $7.8 billion.

        Remaining Options Debt Outstanding: The remaining unexercised stock option liability is a completely separate issue and a debt just as real as the current stock quote, especially if half of the options are currently vested and exercisable. We all know that stocks can be over and under valued yet the market gives us a price on any given day and that is the price. The Black Scholes and related footnote disclosure is a great mathematical model yet has become nothing but a Trojan Horse for plundering the retirement system. What the Treasury Department and Federal Reserve might concern itself with is that this debt, $60 billion at Microsoft, has no interest cost that hits the income statement and increases $800 million with each $1 increase in the stock price. Simply put, Microsoft is somewhat immune to Federal Reserve  interest rate hikes, which explains why the stock is increasing as the Fed raises rates and continues creating a Long Term Capital like debt pyramid.

7) Purchasing future sales via equity investments: Another earnings management tool being used by Microsoft is the purchase of future sales via equity investments in other companies.  Here is my understanding of how that works. I could be wrong on this and therefore the best thing to do would be confirm these claims with their CFO, Greg Maffei.

First of all, Microsoft makes a $250 million investment in WebMD for an 11 percent equity stake and part of the deal is that WebMD commits to $100 million of advertising on MSN network.  At the same time, Microsoft agrees to subsidize an equal amount in medical prescriptions for people using WebMD.  Of course there are a few other interesting aspects of this transaction, of which I wont address in this report. You have basically bartered a purely paper transaction and current accounting rules will allow you to recognize the entire $100 million as revenues for MSN network, even though you are just trading checks. That is, you are trading subscription subsidies for advertising revenues. Advertising revenues are indeed the political currency of the 1990s.  Keating spent his dollars buying influence in Washington D.C.  Microsoft is buying influence on Madison Avenue.

8) Managing the financial analyst community.  Another excellent earnings management technique is the management of the analyst community.  This can be done by directing investment banking business associated with acquisitions to a variety of firms based upon their opinion of the stock.  Microsoft purchased more than 33 companies in 1998. A good example here might be Rick Sherlund of Goldman Sachs, often noted as the guy who can move tech stocks.  One might ask why Mr. Sherlund refers to Microsoft as a company with no debt when they clearly have a contractual obligation, just as real as todays stock price, of $65 billion to their employees. Fidelity Investments, one of Microsofts largest shareholders and also provider of their 401K retirement plan, has been silent on this issue.

9)  Trying to Discredit Those Seeking to Expose the Scheme:  Microsoft fired its internal auditor, regularly bullies reporters and has told numerous publications that I am an extremist. This might explain why reporters are afraid to print the facts, for instance that Microsoft took a $9 billion tax deduction for wages in 1999 and didn't charge a dime of this amount against earnings.

10)  Money Laundering:  Microsoft has been aggressively investing cash pilfered from the retirement system in a variety of new businesses, many outside the U.S., including cable investments in Brazil and England. We read about the Russian government robbing its citizens of $10 billion in IMF loans.  What about the impact of the retirement system being pilfered and being set up for a Savings and Loan like debacle?

11)  Corruption of Higher Education:  Microsoft is making massive cash infusions to leading Universities and impairing the system's independence.  In the last year alone Microsoft has given MIT more than $50 million in grants, focusing on key growth areas including storage services and software to provide course instruction over the Internet. In the past we were able to rely on these Universities to stimulate key debates yet now they are silent on this pyramid issue.  Two Universities that should be ashamed of themselves for not only not disclosing this situation yet also fostering its development are Harvard and Stanford.  They are contributing greatly to the complete corruption of our financial markets.

Microsoft is a Cash Machine but Where Does the Cash Come From?

Several Impacts from Microsoft's Financial Pyramid Scheme Include the Following:

This scheme led by Microsoft is having many unexpected impacts, a few of which are noted here.  This list will be expanded on a weekly basis so please visit again.

1)  Government Will Be Defunded.  Beginning next year education defense and other key programs will have to fight over a sudden and sharp drop in tax receipts.  Corporate tax receipts are already down 6 percent while individual receipts are up 6 percent.  Since these bogus deductions are able to be carried over and offset against future quarter's earnings, this difference will accelerate in the future and leave various government agencies fighting for a smaller pool of resources.  This was forecast in the study.  Also to consider are massive AMT tax credits that individuals who paid tax upon exercising options will be carrying forward into next year and offsetting ordinary income tax.  Analyzing this situation should be a top priority for both the Federal Reserve and Treasury given the upcoming budget negotiations.

Their is a unique irony that Bill Gates recently dedicated $1.5 billion to minority student scholarships and at the same time is leading a massive fraud that will effectively defund public education in many states.

2)  The Retirement System Is Being Plundered.  Most new investment in Microsoft is coming from the 401K, 403B and public pension participants through large funds such as Fidelity, State Street, Barclays and Janus.  These fund families will make their fees whether the stock goes up or down and they are clearly not meeting their fiduciary responsibility to plan participants. I would caution them and their consultants and advisors including Buck, Callan and William Mercer to do a risk assessment based upon the 404C fiduciary requirements.  The Savings and Loan debacle took down not only many banks yet also their consultants, accountants and law firms.

3)  Business Owners Are Exposing Their Personal Assets By Not Paying Enough Attention To Their 401K.  ERISA 404C has severe sanctions against employers who are not adequate stewards of their 401K plans, specifically those that do not meet the prudent fiduciary expectation.  Such lawsuits are already beginning, the corporate veil is no protection and the law also allows for treble damages.  Most CFO's put 401K plans on their "to do" list, check it off and move on to the next thing.  Putting me on your 401K committee is an excellent way to eliminate this risk.

4)  The Dollar Is Being Devalued In Relation to the Yen.  The Japanese have struggled for 10 years to recover from their own version of accounting fraud and they know that now is not the time to accommodate our monetary desires without first forcing us to face up to the corruption in our own markets.  Simply put, Japan is becoming our own personal IMF and will devalue our currency until reforms are initiated.

As noted before, what caused the Japanese banking crisis was not plunging real estate values nor bad monetary policy, but rather accounting fraud in which companies put phony assets on the books, in particular software research and development costs.  These costs should have been charged to earnings. Loans were made off these bogus assets which helped bank stock values increase, leading to margin lending by consumers to buy the stock, often borrowing off real estate values to get the shares. When the loans could not be repaid and it was realized that there were no real assets backing them, the system collapsed.

It was a startling public display of Alan Greenspan's need to brush up on accounting when he actually said in his Jackson Hole speech that corporate profits were understated due to not capitalizing software costs.  Those of us familar with this industry know software is subject to rapidly becoming obsolete with most products requiring constant upgrades to stay competitive.

Due to this obvious need for the Federal Reserve to better understand key issues in determining share values, Parish & Company will release a major announcement next week formally requesting that the Federal Reserve Board be expanded by one non-voting member from the mutual fund industry.  This will include nominating John Bogle, founder of the Vanguard family of mutual funds, to be considered for this role.

5)  False Inflation is Emerging.  This paper wealth, rooted in a bogus tax deduction that grossly overstates earnings, is driving Microsoft's stock price which in turn greatly expands the purchasing power for luxury goods and services. Most inflation is now in services and luxury goods and not reflected in the CPI. I call this false inflation because it is a result of a scheme, not economic fundamentals. Given the capacity to increase supply due to more efficient production and heightened global competition, it is tough to raise prices. Only monopolies are indeed able to even keep prices at current levels. We therefore have a reality of low inflation competing with a pyramid scheme creating an illusion of inflation.  This is not good for any of us, especially the investment industry.

6)  The Integrity Of The Markets Is Being Destroyed.  This is perhaps the greatest risk and again what led to the Great Depression in the 1930's.  It is  fact that Roosevelt wanted to nationalize the accounting profession and make all auditors government employees due to a complete loss of confidence in the accounting profession.
 

Frequently Asked Questions Regarding My Analysis

1)  Who are the key people to focus on addressing this situation?
Alan Greenspan and Robert Parry of the Federal Reserve, Arthur Levit and Lynn Turner of the SEC, Alexis Herman from the DOL and Larry Summers from the department of Treasury.

2)  Where is the stock given to employees coming from? More than 90 percent of it is coming from the equivalent of a photo copy machine in the back office.

3)  Why do you call this a pyramid scheme?  I don't see the various levels?
Top level Bill Gates, bottom level 401K, 403B and public pension retirement plan participants.  Microsoft employees and various other levels reside in between.  The share price is being leveraged higher by an undisclosed debt pyramid which is common to all such schemes.

4)  Why hasn't the media fully disclosed this situation, especially the massive bogus tax deductions?
Microsoft is the biggest business press advertiser and has a brilliant PR team. Just imagine negotiating the printing of this story with your editor.  As Bill Moyers has noted, "Free Press for Sale."  It is also important to remember that Microsoft has millions of avid supporters due to new opportunities they have created in the computer world.

5)  Aren't you afraid of being sued by Microsoft?
That is a possibility yet courts these days frown very heavily upon malicious law suits.  This would also give me an expanded platform and an opportunity to counter sue.  What I would like to do is work together with Microsoft to improve the retirement system in this country.  Sadly, they just don't seem to get it and perhaps are suffering from a "not invented here" syndrome so prevalent in large corporations.  They don't necessarily have to be a big long-term loser, yet are certainly now positioning themselves to be just that.

6) What are some of the legal risks to Microsoft and are you contacted by many law firms?
Not a day goes by when I am not contacted at least a couple of times by large law firms, usually based in New York, Philadelpia and other large cities.  I am constantly irritated by their lack of interest in my goal of reforming the retirement system; they instead focus on where a potential fee bonanza might be. Some of basic questions regarding legal risks to Microsoft include the following:

      a.  Could Microsoft be sued under the RICO law for racketeering with media and investment companies to price fix their stock?  I am not an attorney but there are some interesting cases here and very broad applications of RICO such as the anti-abortion group being successfully sued after bombing clinics.  It was also successfully used to sue absentee landlords in New York City. RICO was originally intended to fight organized crime or the MOB.  If I were Microsoft I would be very careful regarding who I am selling those put contacts to and also make sure clear lines of independence are held in relation to supporting organizations.  RICO specifically requires collusion between more than one organization and so keeping clear lines of separation between Sullivan and Cromwell, Deloitte and Touche, Waggener Edstrom, PR Newswire, Goldman Sachs, Fidelity and Janus should be a top priority.  Given that I have publicly informed all of above on repeated occasions of my claim of significant financial fraud at Microsoft, that should make the importance of this all that more obvious.

    b.  What about this 404C risk? Can Microsoft be sued here?  The real exposure here is for whomever signs the annual 5500 report, usually the business owner or top management.  Although investment companies talk about reducing fiduciary risk, I have never seen a 5500 report signed by an investment company.  In the end, the sole trustees for purposes of the law are usually business owners and top management.  Most do not have a clue regarding the risks they are taking, especially the reality that ERISA can easily pierce the corporate veil, going after personal assets, and makes a special point of providing for treble damages.

    c.  If you brought a legal action against Microsoft, what would you do?  If unable to come to some sort of compromise on retirement system reforms I would want to sue them for impairing my ability to function as a competent investment advisor.  Of course any competent judge would immediately throw out a case like this, perhaps even fining me for filing a nuisance suit.  Such an action would most likely be too abstract for the courts to appreciate.

6)  What if I am interested in hiring you as my advisor and has this helped your business?
Actually, this has involved a huge sacrifice for my business.  People don't want to hear this, especially in Portland, Microsoft's back yard.  I have many friends who work there in addition to many friends' children who work there.  There is also somewhat of a "crackpot factor" that scares some potential clients. My existing clients are very happy however and have received excellent returns.

My business is structured as follows.  We select a top quality discount broker with the broadest access to mutual funds, stocks and other investment alternatives.  You pay me .75 percent a year as your fee based advisor.  I then recommend a portfolio focused on top quality, well diversified low cost investments.  This includes mutual funds (usually Vanguard), individual stocks, Treasuries or whatever else might seem appropriate in building or sustaining your particular financial house.  A key focus is as few portfolio changes as possible in order to minimize tax consequences and maintain a laser focus on quality companies with proven track records and excellent management.  This also includes analyzing new business opportunities, key business related growth decisions, insurance, etc.

7)  What are your specific goals with respect to pursuing this effort regarding Microsoft?
I would like to lead the establishment of common sense reforms to the retirement system and then sit on major corporations' 401K committees as the equivalent of an outside board of director.  This would give me an opportunity to indirectly help millions of Americans better prepare for retirement and also demonstrate that I could serve individual management members as their independent fee based investment advisor. It would also send a crystal clear message to employees that their plan is in good hands.  This would free up management to worry less about their 401K, 403B or public pension funds and eliminate their fiduciary risk.  Can you imagine some investment company trying to not do right by management and employees in a plan for which I sat in as a member of the 401K committee?  I apply all the same level of conceptual and practical perspectives being utilized in the Microsoft analysis to my efforts with respect to retirement plans.

8)  Are you just a frustrated bean counter, envious because you are not a large holder of Microsoft stock?
No.  I am a concerned citizen hoping these wonderful economic times will not be scarified for the sake of a pyramid scheme that benefits far fewer people than most realize. Being an investment advisor in the 1930's was probably not much fun. I like what I do and it is an excellent extension of my background and interests.  A good investment advisor gets to be a builder, journalist, psychologist and coach all wrapped in one.  A most interesting and productive endeavor.

9)  What led you to uncover this pyramid scheme, it all seems quite remarkable?
Teaching classes on International Finance in Latin America and experiencing severe economic dislocations first-hand coupled with helping a few clients determine a strategy for exercising their stock options.  I tried to draw a line between a Paraguayan friend Enrique who no longer receives his social security checks due to government corruption and the highest capitalized investment which happened to be Microsoft. In the old days money stolen from the Treasury in developing nations went to Swiss bank accounts yet today it seems to be coming to the U.S. and primarily to the stock market. A defining moment was an Arthur Andersen alumni gathering listening to a workshop on the stock option topic. It was the look of fear in the presenter's eyes during a break when I showed her a graph of Microsoft based upon my analysis. Enough is enough, I thought as she later referred to Microsoft's outstanding accounting practices.

10) Why aren't you advising the Federal Reserve and others involved in this situation?
They have not asked for nor responded to my offer to advise them.  Bankers generally have a hard time managing conflict which is why they opt for the security and stability of banking. Many people go into accounting for the same reason. I am often told that in person I seem quite different than in print. That probably results from not having much support regarding my views and a frustration factor at seeing what may occur unless reforms are initiated.

11)  How do you feel about Bill Gates' foundations?
I applaud Bill's efforts in this respect and did actually make a proposal early last fall that he give 80 percent of his stock back to employees via the stock option plan and let them make their own charitable giving decisions.  I suggested starting with $4 billion.  He instead gave an equal amount to a foundation managed by his father.  What I would like to see is the foundation fund a project aimed at achieving common sense reforms in the retirement system, including an expanded safe harbor provision for employers that offer plans with 5 specific types of fund choices in addition to whatever other selections they provide.

Note:  This list of questions and answers will be expanded weekly, so please visit again and send in your ideas for expanding or clarifying it.
 

The following related resources are also available.

Right-click to download a Simplified Spreadsheet (Excel 95 format), with supporting data and charts.

Back to Parish & Company Home Page

-- Mac (sneak@lurk.hid), October 15, 1999.

dd -

That was a little experiment. FYI, I was using "View Source" in Netscape to just cut-and-paste the original HMTL into the Submit window. Works fine.

Thank you for that article, by the bye. Amazing. I shall ponder it over the weekend.

-- Mac (sneak@lurk.hid), October 15, 1999.

Here is the article referred to - fair use for educational purposes only.

Share and share unalike - from the ECONOMIST 7-Aug-99

Share and share unalike

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Company bosses and, increasingly, employees love share options. But their economic drawbacks may outweigh their advantages

ONCE upon an Arabian night, sultans were paid their weight in gold. Today, such an approach to pay would leave the typical boss of a large American company sorely disappointed. Bosses now prefer to be paid in share options, which are far more valuable than mere metal. Tipping the scaleslets be kind, and ignore those boardroom lunches at around 200 pounds, and with gold now at about $258 a troy ounce, the average chief executive of one of Americas top 200 firms would take home just over $750,000 in gold. In fact, in 1998 he made a pre- tax profit of $8.3m by exercising executive share options, which give the right to buy a fixed number of his companys shares at a fixed price in what is now a rising market. At the end of last year, he also had total unrealised profits on stock options of nearly $50m.

Inevitably, such gigantic sums have provoked envy. AFL-CIO, the main American trades-union federation, points out that, thanks largely to share options, the average American chief executive now takes home 419 times the wage of the average factory worker. In 1980, he made 42 times as much.

But put to one side questions of justice and inequality. Force down the thought that the chief executives enormous share options may demoralise the deputy chief executive and make the company harder to manage. Ignore the bleating bondholder, who sees his risk rise as companies borrow to buy back shares to give to executives. The fundamental question is whether share-option schemes are doing what they were designed to do: aligning the interests of managers with those of owners, motivating bosses to do their level best by shareholders.

Are share options working? Are other shareholders seeing gains from handing over so much equity to their managers? Or are bosses receiving the largest peacetime transfer of wealth in history simply for being in the right job at the right timenamely, during Americas strongest equity bull market ever? Indeed, could share options be encouraging bosses to behave in ways that are contributing to a bubble in share prices which, should it pop, will leave everyone worse off?

Options, options everywhere

Share-option awards to company bosses have grown at a breathtaking pace in America. (They have increased in other countries too, but even in Britain and France they are tiny next to Americas.)

The 200 largest American companies granted shares and share options to employees amounting to 2% of their outstanding equity during the year to June 1998, according to Pearl Meyer & Partners, an executive- compensation consultancy. When these awards are added to those made in previous years, the total of shares and share options still "live" in incentive schemes at the end of 1998 amounted to 13.2% of corporate equity, or around $1.1 trillion (see<DEST="CSF573" ref = chart ). As recently as 1989, annual awards totalled about 1% of company shares, and all accumulated awards were 6.9%. Now, almost every big firm uses equity as a management incentive, up from around half ten years ago.

For some companies, the picture is even more dramatic. Last year, Apple Computer granted shares and options equal to nearly 18% of its total shares, Pacificare Health Systems made grants of 13% and Lehman Brothers awarded almost 12%. Lehmans total outstanding equity allocations to executives and other employees amount to over half its shares. Only Merrill Lynch, another Wall Street giant, has committed a higher proportion of its shares to equity incentives: nearly 53%. Fifteen of Americas largest 200 companies have set aside more than a quarter of the shares they usually have outstanding.

While share options for lower-ranking employees have also grown quickly, most of the value goes to a handful of top managers. Chief executives have extended their lead, thanks to the birth of the "mega-option". These are options which, if used, would be worth at least $10m. In 1998, 92 of Americas 200 leading chief executives (up from 34 in 1996) were given mega-options, with an average minimum value if exercised of $31m.

Using the formula to value options that was developed by Fischer Black and Myron Scholes, share-option grants accounted for a record 53.3% of the compensation given by Americas top 100 companies in 1998 to their chief executives. This compares with 26% in 1994, and a mere 2% in the mid-1980s.

To some, these statistics are grounds for celebration. Starting in the 1960s, there was growing concern that the split between those who owned big firms and those who ran them might be hurting the economy. Shareholders in public companies mostly had small stakes in each, and thus little ability to restrain managers from furthering their own interests, the argument ran. A thirst for power might lead bosses to pursue takeovers that expanded their empires but reduced the value of shareholders stakes; a hunger for status might encourage them to build grandiose headquarters or fleets of executive jets.

Some economists argued that the solution was to make owners and managers as much alike as possible by paying a large part of the managers remuneration in shares. Unlike most of economists bright ideas, this one spread, though only gradually during the 1980s before taking off in the 1990s. Those urging better corporate governance supported it, and the bull market in shares convinced bosses of the potential benefits of this incentive to better performance.

At first glance, it has paid off handsomely. As executive share options and other share schemes have soared in America during the 1990s, so too have corporate profits and share prices. In 1998, the profits of companies in the S&P 500 share index were double what they had been in 1990. The index is now nearly four times higher than it was at the start of the decade. Surely, such spectacular gains justify paying bosses a fortune?

Alas, the relationship among these three trends is not the simple cause-and-effect that some economists and executive-pay consultants suggest. And the trends themselves are not all they are cracked up to be.

Only perform

First, it is hard to tell whether profits have, in fact, risen all that much, for the cost of most executive share-option schemes is not fully reflected in company profit-and-loss accounts. Attempts by the Financial Accounting Standards Board ( FASB ) to require firms to set the cost of options against profits were killed by corporate lobbyists in 1995. They argued that if the cost of option schemes were treated in that way, fewer of them would be awarded, fewer people would have reason to maximise shareholder value and the economy would suffer.

FASB did, however, manage to make firms include a footnote in their accounts detailing the share options awarded during the year. Smithers & Co., a research firm in London, calculated the cost of these footnoted options and concluded that the American companies granting them overstated their profits by as much as half in the financial year ending in 1998. In some cases, particularly that of high-tech firms (which tend to be generous with options), the disparity is even greater. For instance, Microsoft, the worlds most valuable company, declared a profit of $4.5 billion in 1998; when the cost of options awarded that year, plus the change in the value of outstanding options, is deducted, the firm made a loss of $18 billion, according to Smithers.

Some maintain that these numbers exaggerate the problem: there is genuine dispute over how best to calculate and account for the cost of executive options. But this is quibbling. Warren Buffett, a well-known American investor, put the case succinctly for tightening the rules on share-option schemes in the recent annual report of his investment company, Berkshire Hathaway. "Accounting principles offer management a choice: pay employees in one form and count the cost, or pay them in another form and ignore the cost. Small wonder then that the use of options has mushroomed," he observes. "If options arent a form of compensation, what are they? If compensation isnt an expense, what is it? And, if expenses shouldnt go into the calculation of earnings, where in the world should they go?"

Bubble trouble

So much for profits. What of share prices? The price of an equity, in theory, reflects the profits that are expected in future. If reported profits have been overstated, investors may have overestimated future profits when valuing shares, and paid too much for them.

Most economists reckon that investors are not impressed by accounting twists and turns. Numerous studies have shown that the market usually responds only to "real" events. For instance, share prices were not affected when FASB recently required firms to account for health-care benefits for workers after retirement, a change that looked huge but made no difference to their real liabilities. Options are a real economic cost, and investors take that cost into account each time options are granted.

Now, they have no excuse not to do so; but was this always the case? In the mid-1990s, when the use of share options soared, the accounting problem received little attention. In 1996, for example, headlines in the financial press were full of rising corporate profits in America; yet, says Andrew Smithers of the eponymous research firm, if the cost of share-option schemes had been properly accounted for, it would have been clear that corporate profits had fallen from the previous year. This, he suggests, was the point at which a stockmarket bubble began to expand that has yet to pop.

There are other ways, too, in which share-option schemes may have helped to nudge share prices upwards. Companies are buying back their shares in the market in order for employees to exercise their options. In 1998, firms announced repurchases of $220 billion-worth of shares, compared with only $20 billion-worth in 1991. At the same time, they are borrowing more. Indeed, although net new issues have picked up a bit of late, many companies are still borrowing to buy back their own shares.

This seems strange at a time when shares are more expensive than ever before, and interest rates, though low in nominal terms, are high in real terms. Surely, it would make more sense to raise money by selling shares at current high priceswhich is what bright investment bankers at Goldman Sachs have done in floating their firm and some other companies appear to be doing as well.

A recent study of share repurchases by George Fenn and Nellie Liang, of the Federal Reserve, found that much of the recent surge in buy-backs reflects an attempt to return cash to shareholders in a way that raises the value of executive stock options more directly than a simple increase in the dividend would do. Others see the buy-backs in a more sinister light. They say that companies often buy their own shares aggressively at times when the market looks about to tumble, thus helping to reverse its direction.

Perhaps this is all as it should be: managers spotting the chance to bolster their firms share price and return cash to shareholders. On the other hand, managers with share options may be using their firms resources to increase the short-term value of their own holdings. And that sounds suspiciously like the sort of abuse that many reckon went on before share options supposedly aligned bosses interests with those of owners.

Though corporate profits may be duller than billed, and share prices a touch hyped, what of the claim that managers, thanks to the incentive of shares and share options, are working harder for shareholders?

All shall have prizes

It is hard to argue convincingly that most firms improving fortunes in recent years are down to the efforts of managers as individuals or as a group. The American economy recovered from recession, interest rates were low, inflationary pressures were dormant, spending was strong because consumer confidence was high (due partly, it must be admitted, to high share prices). All these things were beyond the control of corporate bosses.

Nor does the link between executive performance and pay look rock- solid. Many top managers have got rich simply because their companys share prices rose in line with the market. A recent study by Kevin Murphy, one of the first economists to argue for paying bosses with shares, concludes that "there is surprisingly little direct evidence that higher pay-performance sensitivities lead to higher stock performance."

It is possible, of course, that share options encouraged most companies to become more profitable, and so some of the rise in the market as a whole reflected the additional efforts of the market as a whole. But American firms have mostly run a mile from share options designed to reward market-beating or above-average performance. One powerful reason for this is accounting rules. The cost of granting an option with a performance benchmark (one that specifies, for example, that a companys share price must outperform the average in that industry before its bosses collect) must be set against profits, unlike the cost of pure options.

One of the few firms to use rigorous performance-related options is Level 3 Communications. Its bosses cannot cash in their options unless its share price rises by more than the S&P 500 ; they then receive a rapidly sweetening deal as the gap widens.

Graef Crystal, an economist who specialises in executive pay, has calculated the impact a similar scheme would have had on all the S&P 500 companies between 1995 and 1998. Under a conventional option plan, 86% of chief executives would have received an average of $8m apiece over the period. With a scheme similar to that at Level 3, only 32% of them would have received a dime.

An indication of how little executives like having to perform for their money is the frequency with which share options are repriced when the firms share price tumbles below the strike price originally agreed. When share prices plunged in the late summer of 1998, many firms repriced their options just in time to enjoy massive gains when the market rebounded. James Record, an analyst with SNL Securities, a research firm, found that 17 financial-services firms lowered their strike prices last autumn, by one-third on average; since then, their share prices have, on average, trebled.

Many Internet companies, their shares now fallen by half from their recent highs, are considering repricing their share options. They may be less lucky than their predecessors: FASB has changed the rules and, from later this year, the cost of repriced options must be written off against profits in the company accounts. Even properly accounted for, however, the fact that firms reprice managers options reduces to nonsense the comparison of bosses with owners, who cannot write off downside risk so blithely.

The aim of share options is to increase the executives exposure to the undiversified risk of his firms shares, so that he faces personal financial hardship if its share price falls. Do these schemes really bind managers to their firms fortunes?

Managers cannot sell their shares too quickly, for fear of panicking the market. But the number of executives selling is higher than before, according to Craig Columbus of Primark, a firm that tracks such share-trading. It is becoming the norm for bosses to sell a parcel of shares every quarter. And some figures suggest that top executives may be getting quietly out of the market while ordinary employees are keener than ever on entering it: though grants of shares and share options rose to a record level in 1998, the overall stock of shares in company incentive schemes did not, for the first year in over a decade. Since share options for lower-level employees have grown rapidly, it seems that their bosses may be reducing their stakes.

There are other ways, too, for managers to weaken the link between personal and corporate financial health. They may diversify their risk by holding a portfolio of different assetsif they have enough cash. Derivatives offer another route. In the early 1970s, when executive share options promised so much, financial derivatives were in their infancy. Now, according to a study from Arizona State University, executives are making increasing use of them to escape restrictions on exercising or selling their share options, especially when they know that bad news about their firm is pending. The rules governing the disclosure of such trades are ambiguous. Certainly, they are a fast-growing business for Wall Street investment banks.

Other options

It is possible that the problem of share options will sort itself out. If there is a share-price bubble, it will one day burst. If there is not, share prices are unlikely to keep rising so quickly in any event. Bosses pay should fall to less audacious levels either way.

Even so, there needs to be much harder thinking about what to reward, and how much. Nell Minnow of LENS , an investment fund, now wishes that in the early 1990s, "when we asked for pay for performance, wed been a lot more specific". A few more customised options with specific targets have recently appeared, though most of them, admittedly, accompany bigger-than-ever mega- options.

That leaves the question of how large the share component of a salary package needs to be in order to motivate its recipient. Would current pay-outs be less inspirational if they were half as big? Experience has shown that it is impossible fully to align the interests of managers with those of shareholders anyway. So why go so far down that road?

Ultimately, reforming executive pay in ways that encourage genuinely superior performance depends on two groups: institutional investors and auditing bodies. Big pension funds and insurers have the clout to make compensation committees be tough. So far they have barely used it. And accountants must create a level playing-field for all executive compensation. It is absurd that different kinds of share-option schemes have different accounting rules, and worse than absurd that most schemes are not written off against profits like ordinary pay. Investors and auditors may both be more willing to lay down the law in an earthbound stockmarket than in a perpetually rising one. It would certainly be the right option.

-- kermit (colourmegreen@hotmail.com), October 15, 1999.