Public Company, Private Fiefdom?

In issuing one of its quarterly reports last year, Ferrofluidics Corp. offered to send shareholders a 1992 brokerage report on the company. No wonder. The report forecast that Ferrofluidics, a small and struggling maker of high-tech industrial seals based in Nashua, N.H., would skyrocket: Sales would quintuple by 1996, to $150 million, and operating profits would go up tenfold. Ferrofluidics promised that the report was "based on independent research."

Or maybe not so independent. The Securities & Exchange Commission is investigating whether the company secretly commissioned and paid for the report, which legal experts say might have violated securities laws. That spurred a broad SEC probe into a raft of questionable practices at Ferrofluidics, ranging from possible stock manipulation to breach of disclosure obligations.

The most serious questions involve longtime Chairman and CEO Ronald Moskowitz, who recently retired after a committee of outside directors conducted an internal investigation and called for his ouster. Moskowitz says: "I deny any wrongdoing" in conjunction with the SEC investigation. But public documents show that Moskowitz treated publicly-traded Ferrofluidics like a private fiefdom, to be milked for personal gain.

In the past five years, Ferrofluidics has posted total losses of $17.7 million. It lost $10.4 million on sales of only $29.6 million in the last fiscal year. But with the board's docile approval, Moskowitz and his family trusts have reaped more than $16 million in pay, bonuses, perks, and profits from exercise of stock warrants over the five-year period. In fiscal 1992 alone, Moskowitz and family entities made at least $8.9 million from Ferrofluidics.

And that's not all. At times, Ferrofluidics has lent Moskowitz millions and guaranteed his personal bank loans. The company's second-largest single asset is a $15 million insurance policy on Moskowitz' life. A son, Jeffrey, was paid a hefty commission as an insurance broker for selling Ferrofluidics a $6 million joint life-insurance policy on Moskowitz and his wife, Phyllis.

In an era of heightened attention to corporate governance standards and "pay for performance," the Ferrofluidics saga demonstrates that small companies dominated by a strong individual can still run roughshod over investors. Indeed, from a peak of 44 in 1983, the stock now sells for less than 8. "This ranks up there with the most egregious situations I've ever seen," says A. Camille Nichols, president of Investors' Fiduciary Services Inc., an Atlanta-based adviser to institutional investors on corporate pay and performance issues.

Moskowitz, who co-founded Ferrofluidics in 1968 and says he has a PhD in electrical engineering and applied physics, defends his compensation as "appropriate" in light of the company's circumstances. "I'm the world's leading expert in ferrofluids," he says. "My compensation was not modest, but it was modest in comparison with what professional athletes and entertainers make. In any given year, it may have come out on the high side. But in others, it was on the low side. Over 25 years, I was not outrageously compensated."

To buttress the claim that his compensation was within normal bounds, Moskowitz says Ferrofluidics' board sought advice from Towers Perrin, a respected compensation consulting firm. But Bruce B. Hanson, a vice-president at Towers Perrin's Boston office, says his firm was retained by Ferrofluidics only once, in 1987, and then only to advise on Moskowitz' pay--not his warrants or other benefits. Still, Hanson has continued to follow the company and says Moskowitz' compensation "is probably the most out of line I've encountered in 20 years of compensation consulting."

Ferrofluidics was founded in 1968 to develop "ferrofluid" technology licensed from NASA. The technology entails suspending microscopic iron particles in special fluids, then applying a magnet to manipulate the fluids. Moskowitz and a former partner figured it could be used to make seals for mechanical spindles or rotors: A magnet applied to the rim of a ferrofluid seal creates an airtight closure. By the time it went public in 1981, Ferrofluidics was growing fast. Its products caught on in such industries as chipmaking and disk drives. Today, nearly every computer hard drive contains a tiny ferrofluid seal. From 1983 to 1985, sales tripled, from $10.8 million to $31.3 million.

Moskowitz started living well. He bought a large house near company headquarters and another near Palm Beach, Fla. In 1985, he and a partner broke ground on Harris Pond, a real estate development in Merrimack, N.H., with retail space, offices, and 144 condo units. But the project soured, and many of the units were unsold when the New England real estate market crashed in 1989. It was, says Moskowitz, "the worst investment I've ever made."

In that period, Moskowitz' compensation started soaring. In September, 1988, proxy material showed that he owned just 600,000 shares and warrants for additional shares, or 16.6% of Ferrofluidics' stock. But by July, 1989, the board had granted him warrants for an additional 1.1 million shares. Unlike most incentive stock options that have a long vesting period to encourage future performance, Mosko-witz' warrants were immediately exercisable and could be transferred. "The warrant program effectively circumvented the purposes of stock-option plans," says consultant Nichols.

Trying to sugar coat the warrants, proxy statements said the CEO had agreed to give up large amounts of future pay in exchange for them. In fiscal 1990 and 1991, for example, Moskowitz "waived" $2 million in exchange for warrants. He still made over $1.6 million in those years combined. The waiver, says Hanson, "was glaringly unorthodox."

Moskowitz' employment contract had other provisions that would make many CEOs envious. His July, 1990, contract guaranteed him a $400,000 base salary, a $24,000 home-office allowance, $20,000 for club dues, and $36,000 for his three company cars. The company also agreed to pay for a full-time household employee at Moskowitz' home.

"GOOD SALESMAN." For a company of its size, Ferrofluidics spent a bundle on life insurance. True, companies often buy term insurance that pays the company a death benefit if an important executive dies. In 1988, for example, Ferrofluidics bought a pricey whole-life policy--a $5 million premium for a $15 million death benefit--to insure Moskowitz. But under the terms of this policy, Moskowitz' estate would have received $5 million from the policy, plus accumulated earnings.

Why did Ferrofluidics' directors approve these transactions? Several directors were longtime Moskowitz associates. But outside directors also went along, including Robert P. Rittereiser, a former chief executive of E.F. Hutton Group and a director since 1989. Rittereiser declined to comment. Dean Kamen, another outside director, says he never saw the details of Moskowitz' employment contract. But, he says, Moskowitz always presented transactions to the board as being neutral toward him and a plus for the company. Moskowitz, says Kamen, "was a very good salesman." One former director says Moskowitz totally dominated the board.

While Moskowitz' paycheck got fatter, Ferrofluidics' fortunes were floundering. Troubles began in 1986, mainly because the disk-drive industry was moving offshore and component prices were falling. Potential new applications for ferrofluids didn't materialize as quickly as hoped. After posting a loss in 1986, Ferrofluidics sold its key Japanese subsidiary for a big one-time gain in 1987. That was the year Ferrofluidics' revenues peaked, at $35 million. A disastrous British acquisition fueled further declines. Ferrofluidics stock tumbled from 201 2 in late 1989 to 5 by late 1990.

The slumping stock put renewed pressure on Moskowitz' finances, for the company's stock was his main asset. He also was deeply in debt to Boston-based Wainwright Bank & Trust Co. The bank's 1990 proxy statement shows that Moskowitz, a director of the bank, had borrowed $5 million for personal use as of Mar. 8, 1990.

Complicating things even further, Moskowitz' finances had become so intertwined with Ferrofluidics' that both were in danger of going down in flames. The problem: Back in 1989, Ferrofluidics had guaranteed a $6.9 million loan Moskowitz had taken out from Fleet Bank to exercise warrants. But by mid-1990, Moskowitz' loan collateral was nearly worthless. Ferrofluidics' auditors were pressing for a $5 million write-off of the loan guarantee in fiscal 1990. That would have been disastrous, though, because the company was already planning a $13 million restructuring charge. "There was a lot of fear that if Ron went down, the company could go down as well," says Alvan F. Chorney, a Ferrofluidics senior vice-president and longtime director.

In a complex series of transactions in October, 1990, Ferrofluidics lent Moskowitz even more money to pay off part of his Fleet loan. In return, Fleet reduced the company's obligation to guarantee Moskowitz' loan. That allowed Ferrofluidics to take just a $1.4 million write-off on the loan guarantees, far less than the $5 million auditors had been demanding.

NEW WARRANTS. The board gave Moskowitz' anemic personal balance sheet another infusion. Two days before the Fleet loans were restructured, it agreed to cut the exercise price on 950,000 of his warrants from an average price of $12.86 to the then-market price of $5. That turned nearly worthless warrants into something much more valuable. A few days later, the board issued Moskowitz an additional 550,000 new warrants, also exercisable at $5.

Moskowitz denies that the deal was aimed at bailing him out of his personal financial troubles. He says he was under no legal obligation to pay off the Fleet loan early. But he felt that a $5 million write-off "would have been imprudent" for the company. "As Ron Moskowitz, I shouldn't have done it," says Moskowitz. "But it was my fiduciary duty to look after the interests of the company." The repricing and issuance of warrants, he adds, was done by the board "in recognition of that."

Fortunately for Ferrofluidics and Moskowitz, the company's reported earnings bounced back in 1991. It posted $3.6 million in profits on $24.4 million in revenues. The improvement stemmed in part from the restructuring and several large onetime gains, including a $930,000 credit that resulted from Moskowitz repaying part of the loans that had been written off.

At the same time, the company's prospects seemed to be brightening because of a push into the petrochemical industry. By putting its seals on refinery pumps, Ferrofluidics argued the industry could dramatically cut vapor emissions. Several large oil companies have since tested new pumps sold by a joint venture of Ferrofluidics and BWIP Holding Inc.

The petrochemical initiative was the basis for the Mar. 30, 1992, brokerage report that the SEC is now investigating. The report was written by free-lance securities analyst Sheldon S. Traube and published by Dickinson & Co., a Des Moines-based brokerage. It forecast the joint venture would bring in revenues of $145 million and a staggering $48 million in operating income in fiscal year 1996. Moskowitz claims that jibed with the company's internal estimates. Yet BWIP says the venture expects to sell 150 pumps in 1993, less than one-tenth the number that Traube forecast for this year.

Over-optimism is not a crime. Secretly funding an analyst's report might be. Insiders confirm that Ferrofluidics paid Traube about $5,500 to write the report. Speaking in general terms only, the SEC's chief of enforcement, William R. McLucas, says that a company that pays for securities research could be in violation of stock-manipulation rules. What's more, he maintains, SEC regulations require full disclosure of the source and amount of such payments. The Mar. 30 Dickinson report contained neither.

Thomas M. Swartwood, Dickinson's general counsel, says: "I am not aware of any payments made to Dickinson & Co. by Ferrofluidics. I don't know if they paid Traube or not." Jeffrey T. Golenbock, Traube's lawyer, says: "Mr. Traube did nothing wrong." Ferrofluidics won't comment on the report but admits it requested and paid for a follow-up report from Dickinson when it realized it couldn't meet the 1992 forecast. The new report, which disclosed it was written "for cash compensation," cut the estimates for fiscal 1991 and 1992 but maintained the forecast for 1996.

OPTIMISTIC. Even before the report, optimism about the petrochemical move helped buoy the stock past 14 in late 1991. Two Moskowitz family trusts began exercising their $5 stock warrants and sold shares up to $18. In total, the family entities reaped gains of at least $8.2 million from stock sales in 1991 and 1992. Moskowitz sold an additional 225,000 shares in early 1993 for a profit of $2.7 million. The family's stake in the company, which reached 66% in 1991, is now about 11%. The funds flowing into his family coffers enabled Moskowitz to pay back the Fleet-related loans to Ferrofluidics by June 1, 1992. By the end of 1992, his debts to Wainwright Bank had been cut to $2.2


Despite his forced retirement in September, Moskowitz shouldn't have any more personal balance-sheet problems. He recently sold the rest of the Harris Pond condo units at a cut-rate price, ending that debacle. And under the terms of his retirement, he retains many valuable perks, including a four-year consulting contract that starts at $250,000 a year and goes down by $50,000 per year.

Moskowitz' departure has left Ferrofluidics weakened but still standing. Paul F. Avery Jr., an outside director, has taken over as chairman and CEO. The company faces potentially steep liabilities from the shareholder suits, which the company says it will vigorously contest. But it says its banks are standing firm. And its fans remain enthusiastic, convinced that the environmental seal will eventually take off.

Many Ferrofluidics employees are happy to see Moskowitz gone. Some have learned a valuable lesson. "You probably could teach six months of business and corporate ethics at Harvard on this story," says one insider. With Moskowitz out of the way, perhaps Ferrofluidics can invest in its technology instead of enriching its chairman.

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