Commentary: Lessons Of The "Hollinger Chronicles"

There are always signs of trouble. Here's what investors should look for

The independent board report on Conrad Black's reign at Hollinger International (HLR ) is like a blast from the past. While the rest of the corporate world has been dutifully embracing governance reform and beefing up board procedures, Black was blithely using the company he controlled through a minority stake as his personal ATM, as detailed in the report. Apparently, Black didn't get the message that greed was out.

The "corporate kleptocracy" that flourished there, according to the report, allowed Black and his associates to pocket more than $400 million in seven years -- almost every penny of profit Hollinger earned. And it has vaulted Black into the pantheon of corporate gluttons, right up there with Dennis Kozlowski, Bernie Ebbers, and Ken Lay. Black's company denies the allegations. In hindsight, all such spectacular scandals look glaringly obvious, with plenty of red flags to warn off investors. The Hollinger case -- which featured a pocket-lining CEO, an "ineffective and careless" board, and a corporate structure that made Hollinger ripe for the picking -- is instructive for investors eager to avoid the next debacle. Four lessons from the "Hollinger Chronicles" stand out:

BEWARE OF CEOS WITH A CONTROLLING STAKE. Black owned only a sliver of Hollinger International, but under the two-tier stock structure, each one of his shares entitled him to 10 times the voting power of lesser public shareholders. That, the report says, allowed him to control Hollinger "absolutely."

Among recent flameouts, Adelphia Communications Corp. (ADELQ ) also had a two-tiered equity structure. Governance experts say companies with dual stock classes like Hollinger are a bad bet for shareholders. They often lack the kind of independent boards that are needed as a check on managerial excess.

KEEP AN EYE ON EXECUTIVE PAY. Warren E. Buffett has called executive pay the acid test of governance. It's a test Hollinger failed. In addition to approving transactions that funnelled nearly $300 million to Black & Co., and turning a blind eye to his profligate use of perks, the company, according to the report, failed to disclose 96% of the pay received by the top five executives from 1996 to 2003. That kind of poor disclosure raised the suspicions of institutional investors and led to Black's unmasking. But a closer examination of the perks the company did disclose should have raised more eyebrows. Black received more than $248,000 in perks in a single year, including directors' fees, maintenance for homes in New York and Chicago, cars and drivers, and his personal use of corporate aircraft.

THE BOARD MATTERS. Directors, says governance activist Nell Minow, have a "duty of curiosity." But the Hollinger board, consisting of Black's social, business, and political pals, seemed tuned out. According to the report, the executive committee didn't discuss -- or even read -- documents it was signing that approved transactions benefiting Black and costing Hollinger millions. "It is difficult to imagine a more flagrant abdication of duty," the report states.

When a board is hand-picked by the top dog, shareholders need to be especially on guard. Hollinger's board was star-studded: It included Henry A. Kissinger, former Secretary of State, and national security expert Richard N. Perle. But clearly it didn't make the effort to put Hollinger and Black under the microscope.

COMPLEXITY SHOULD SET OFF ALARMS. Before Enron's collapse, Kenneth L. Lay and Jeffrey K. Skilling won accolades for turning a slow-growth utility into a hot energy-trading business. Few outside the company understood what they were doing, but who cared? Enron was booking big profits, and the stock was soaring.

Hollinger's structure and pay schemes were likewise impenetrable. Black controls Hollinger through Ravelston, a holding company that owns 78% of the stock of Hollinger Inc., which controls a majority stake in Hollinger International. Hollinger International paid Ravelston management fees -- wildly excessive, according to the report -- that were allocated to Black and others. In addition, Hollinger paid Black and others "noncompete fees." As a result, even the most diligent shareholder would be hard-pressed to figure out who got what. One thing is painfully clear, though: Conrad Black and his pals got plenty.

By Louis Lavelle

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