Stock Buy-Outs

[Corduroy Frog]

There might be a more appropriate forum for this, but if you prepare taxes, you should have a minimal exposure to stocks, bonds and other investments.

I have a personal portfolio, and control others that I don't own. A common strategy is to always mix about 1/3 of the stocks which are "small" - under $300MM in market capitalization, so long as the customer can afford the risk that comes with it.

I've watched the performance of these small stocks over the last 20 years. A few of them go bust, but I show that the weighted average of these outperform the big guys. It has commonly been the fate of a small stock to be bought out -- happens sometimes to large ones like Chrysler recently. Indeed, part of their admirable performance is attributable to a rise in price when they are being courted for a buy-out. However, I am alarmed by what seems to be a growing trend.

In the last 2-3 years, instead of a stock-swap where the holder winds up with stock in a larger company, the buyer is a private investment company who buys the stock with cash. The seller has to pay taxes on the cash.

I have sold (involuntarily) 4 stocks this year for cash and NONE for stock in return. I will have to report capital gains. One of these was Yankee Candle - almost a household name. Another was Swift Transportation, a trucking company so large that they bought out many truck lines themselves before being purchased by a private group. Both of these were small at one time and I did well on them.

Someone in the securities business - can you tell me what is going on? This has always happened occasionally, but not like the present. Do the large power concentrations not want ordinary investors to own anything?

[Corduroy Frog]

Veritas and Sea-Tax

To you securities-gurus in the Great Northwest -

you wanna give this topic a try?

[veritas]

Mr Frog

I work strictly with mutual funds and for the most part in retirement accounts. But you bring up an interesting point which may be a trend. Just read an article from American Funds which spoke of Leveraged Buyouts and the large amounts of private equity looking for a place to go.

Somehow after reading the article It came to mind of what is going on in the subprime market.

[sea-tax]

Sorry Mr. Frog like my southerly neighbor I am a mutual fund guy and do not track or follow individual issues. Interesting perspective you have on the small caps.
With a tax practice I simply can not have sufficient time to track individual issues.
Plus most of my clients are retirement plans so they are in it for the longterm.

[ED SMITH]

The answer is SOX or SARBOX.

In case you didn't know, it is the Sarbanes-Oxley act, particularly section 404, that puts a heavy burden on companies, especially small ones to comply with all of its provisions.

Congress in its infinite stu... er wisdom, drew up a one size fits all piece of legislation to correct the ills of the Enron, Worldcom debacles. There are certainly some useful provisions, if you don't mind another layer of big brother, but even the authors, Sen. Sarbanes and Rep. Oxley admit that it was hastily drawn up and that parts of it were ill conceived.

It puts a proportionately large burden on small companies to comply. Private equity companies by not issuing stock don't have the burden of compliance with SOX and thus avoid its possible consequences.

For your summer reading:

http://www.economist.com/displaystory.cfm?story_id=9545905

[veritas]

Good info

Thanks Ed..........

[Corduroy Frog]

Sarbanes Oxley

So when you buy bug spray, the bugs can smell too so they find somewhere else to hide.

Not much experience with Sarbanes Oxley - been awhile since I've been away from public accounting. Been told it is just more hoops to jump through. Lots of want ads for accountants are insisting on SOX experience or knowledge.

Amazing how government fails to enforce existing regulations, then resorts to even more and complicated legislation for the law-abiding folks to put up with. Ditto for the IRS - more broad-based audits and compliance testing for abuses on their part and they wouldn't have to write more regulations and Cir. 230 stuff to try to make tax collectors out of practitioners.

[Corduroy Frog]

More

I guess I'm beating the subject to death, but I had occasion to talk with someone earlier today whom I consider is well-connected with mergers and acquisitions.

Apparently, what Ed Smith brings to the table is dead on target. Sarbanes-Oxley legislation makes the traditional, behind-the-scenes corporate management very subject to disclosure and scrutiny. This uncomfortable posture ranges from corrupt fraud schemes like Enron to innocent private information.

Given the choice between this and simply going private to avoid the scrutiny, the heavy officers, board of directors, shareholders, etc. just say, "OK we'll go private." That way the time-worn modus operandi (corrupt or not) can continue in cloak and dagger fashion.

And the "sell-outs" are often not a matter of a company changing hands. The officers, board of directors, and controlling shareholders simply gather up their own money, along with what they will receive from selling their existing shares, and form a "private equity group." Then these same people send out notices to all shareholders telling them that the board of directors recommend a sale, and if the "buyout" is approved, their stock will be purchased for cash.

Another government-led reform "gangs aft aglee", and the usual corporate behavior is preserved. And the Frog-ism rings true again, "The more things change, the more things stay the same."

[bigdadder]

Buyouts

Excellent post Mr Frog.
I agree completely with your point of what is happening.
But I don't view it as a big deal ---Pay the low capital gains tax and
reinvest in another company. Your higher basis will transfer with your new purchase. Otherwise buy all small stock companies inside of a Roth Ira.

[Snaggletoof]

Resurrection

Just when you thought it was safe -- I'm resurrecting this old thread about Sarbanes-Oxley.

Reason being - the recent discussion about the NAEA letter, the "more likely than not" issue, and Bart's recent poll. As tax preparers, we have a parallel in the world of publicly traded auditing industry - Sarbanes-Oxley Act, passed in 2003, only their situation may be much worse.

My CPA friends tell me the SARBOX Act is ridiculous. and when it was passed, the entire public accounting industry was shaken to its very foundation. Earlier in the post it was mentioned that many of the smallcap stocks are being bought out by private equity firms, possibly to escape SARBOX compliance. Is this a major factor in today's economy? It's not just small firms. 81% of Chrysler Corporation was purchased by one of these private equity groups. Guess who they now have as President? The guy who was brutally terminated by Home Depot with $210 million in severance pay.

How did the AICPA react to this? They felt like they had no choice other than to comply. The results? Auditing fees soared. My stockbroker investigated a party he knew was in one of these private groups. The purchased company had nearly $2B in market capitalization, and had spent $80,000 in auditing fees in 2004. In 2005, their auditing fee was almost $750,000, ostensibly because of SARBOX. In 2006 the decision was made to go private, and their auditing fee was $0.

The net result of this may be that the auditing industry serving publicly-trade companies may lose business. And for the firms that are no longer publicly traded, Sarbanes-Oxley accomplishes none of its objectives -- the Enrons can find their own private environment to flourish another day.

This is slightly off-topic from taxes, but all of us in tax preparation encounter other economic venues, such as stocks. Additionally, we are finding ourselves in a similar situation with the MLTN mentality -- dealing with a leviathon government that is again on the verge of creating more problems than it solves.

Tax practitioners who adhere to the 8275 process will lose customers. The ever-accommodating "guy across town" will gain our customers, and you better believe this guy is not going to turn anyone in to his dogcatcher. And nothing ever happens to him because the IRS chooses to try to solve the problem sitting in Washington writing regulations such as this, instead of getting off their butts and going out in the field and investigating these abuses that they complain about.

Any comments about what our industry can do? Any tandem solutions, such as empowering NAEA and NATP? Empower them to do what? Ideas??? CPAs encouraged to respond too.