The Price Of Transparency

By Steve Zwick/Cologne

Pity the poor Haffa brothers, Florian and Thomas. Around this time last year the two Bavarian businessmen were closing in on the purchase of the late Jim Henson's Muppet empire--a $680 million deal that brought Kermit the Frog, Miss Piggy and the denizens of Sesame Street into the fold of their company, EM.TV & Merchandising. They were the toast of the high-flying Neuer Markt, a sub-exchange that the Deutsche Borse (German Stock Exchange) set up for sky-bound new issues like theirs.

Look at 'em now. The Neuer Markt is floundering with the rest of world stock markets, Florian is out of his job as EM.TV's chief financial officer, and both men are under investigation for fraud and face a possible wave of lawsuits.

It wasn't like this in good old Germany Inc., where a tangled old-boy network didn't let members fall by the wayside. Troubled operations were discreetly set right without any blood spilled in the executive suites. Today financial woes have cost as many as 50 CFOs their jobs and put a few behind bars.

For the Haffas, trouble began in December, when they "adjusted" projected 2000 earnings down from $250 million to just $24 million, shortly after telling investors that all was well. Shares of EM.TV bottomed out at about $3.75, down from last February's high of $111.60. Allegations flew that insiders had unloaded shares before revealing the true state of the firm's finances. "A lot of old-style owners think small shareholders are just there to fork out money and go away," says Mark Tungler, a lawyer with the German Shareholder Protection Association, which is preparing a lawsuit against the Haffas. "Well, the rules have changed."

The cozy German boardroom culture began to crumble in 1995 when the country finally adopted laws on corporate transparency and governance--mandated by the European Union seven years earlier. Among them was a provision allowing German companies for the first time to use American or international accounting practices within Germany. The new laws also set up a nationwide regulator, the Federal Securities Supervisory Office. The difference between U.S. and German accounting standards first became obvious when Daimler-Benz listed on the New York Stock Exchange in 1993. Under U.S. rules, Daimler-Benz lost nearly $579 million in the first half of 1993, while under Germany's reporting requirements--which allowed the company to hide money-losing assets--it seemed to have a $102 million profit. When Deutsche Borse launched the Neuer Markt, it required U.S. or international accounting practices.

The 1995 law also said companies had to reveal all the known risks of their business--so-called ad hoc disclosure. "It seems clear that a lot of Neuer Markt guys were publishing only good news, which is a violation of the ad hoc disclosure rules," says Marco Becht, co-author of a forthcoming book, The Control of Corporate Europe. "In the U.S., the SEC has always been pretty ruthless with companies that didn't come clean."

Since the Federal Securities Supervisory Office's inception a half-decade ago, investigations have led to 14 criminal convictions for insider trading. But many insider-related activities are simply violations of club rules in Germany and not criminal offenses. Thomas Haffa, for example, sold $18 million worth of shares within six months after EM.TV floated new shares in November 1999. That violates Deutsche Borse's "lock up" rules forbidding large shareholders to cash in so quickly, but it doesn't bring in the cops.

Increasingly, small investors who find themselves holding a lemon like EM.TV don't just get mad. They sue. Author Becht believes the use of civil suits could erupt into open warfare in Europe between small shareholders and the old-guard, large-block shareholders who dominate industry--in many cases, old families that haven't come to terms with their status as stewards of publicly traded industries.

For its part, the Deutsche Borse is tightening Neuer Markt rules on reporting and insider trading even further. As of Jan. 1, corporate quarterly reports are to be standardized--but, critics point out, still not audited. Starting in March, managers will have to file a formal report when they sell shares in their companies. Deutsche Borse's website, neuermarkt.com will soon offer access to both the exchange's database and that of U.S. information provider Multex. Retail investors will be able to call up free analysts' reports and compare companies in the same industry worldwide--something Multex has been offering in the U.S. for years. And both Deutsche Borse and the Berlin Stock Exchange are building Internet-friendly order-entry systems that will let retail customers see how their orders get filled.

But all of these devices are just gimmicks if investors don't trust the underlying information. That trust will come only if the powers that be police themselves.