Price Gouging = Capitalism?

If it takes three incidents to confirm a trend, the pharmaceutical industry is most certainly immersed in a trend.

And what is that trend? MyLan CEO Heather Bresch would call it capitalism. When asked why she increased the price of the severe allergy treatment EpiPen from $100 to $600 per unit, she responded “I am running a business. I am a for-profit business. I am not hiding from that.

Let’s paraphrase her sentiment. In essence, Ms. Bresch justified her decision to sextuple drug prices on sick consumers who desperately need her product with the assertion: “That’s capitalism.”

And in the pharmaceutical industry, she isn’t alone. Recently, Turing increased the price of its anti-parasite medication Daraprim from $13.50 to $750.00 a pill. And Valeant Pharmaceuticals more than quadrupled the price of its blood pressure medication Nitropress after it purchased the drug from a rival firm.

That’s capitalism, eh? Apparently, the business executives of these organizations do not believe that they are running afoul of any price gouging laws or regulations by increasing their prices in this manner. Nevertheless, it remains to be seen whether any of these firms can sustain such brutal business strategies over the long run.

After all, it’s difficult to name any organization that has prospered over the long term by increasing sales prices to unaffordable levels while alienating desperate users. That’s why, for instance, Uber voluntarily capped its “surge prices” in Washington DC when the Metrorail public commuter service shut down for emergency repairs.

And Uber went much further than establishing a simple price cap. It announced: “We will work around the clock to keep DC moving tomorrow. We are extending uberPool to the entire metropolitan area during the closures to maximize every car on the road while also keeping prices down for riders. Passengers using uberX to travel with neighbors or co-workers can use the Fare Split option to share the cost of their trip.”

Did Uber’s executives voluntarily take such steps out of an altruistic desire to help their customers? That is one possible explanation. Another explanation, though, is that Uber’s executives may have feared a public backlash over any price gouging activities. That is a very rational concern, and Uber’s executives undoubtedly made a very sound business decision.

In light of that decision, the behavior of Ms. Bresch and her colleagues may strike us as being extremely short sighted. Although price gouging may be legal and profitable in the near term, it cannot help but compel customers to despise their suppliers in the long term.

And no for-profit business can possibly prosper for long when surrounded by stakeholders who hate it. That’s why global banking organizations like Goldman Sachs are dedicating significant resources to public relations initiatives that are restoring their brand reputations after their financial crisis collapses.

To be sure, price gouging firms like MyLan, Turing, and Valeant are undoubtedly for-profit capitalist businesses. But more consumer friendly firms like Uber and Goldman are capitalist businesses too, and they will likely earn more profits than their price gouging pharmaceutical colleagues over the long run.

Goldman Sachs and Facebook: No Americans Allowed!

Goldman Sachs and Facebook are veritable American icons that bestride their respective industries. Goldman, for instance, has survived its searing caricature as a great, greedy vampire squid; it continues to dominate the financial industry from its world headquarters in lower Manhattan. And Facebook, likewise, has survived a film portrayal of its founder, President and CEO as a ruthless social climber; it now dominates the social media sector of the internet from its Silicon Valley base.

This pair of quintessential American firms joined forces last week, with Goldman selling $1 billion of Facebook shares. Given each firm’s powerful position in the American economy, it would have been reasonable to assume that the stock sale would have focused on American investors. Surprisingly, though, Goldman actually arranged to restrict its sale to buyers who were located outside of the United States.

In other words, Americans were the only investors in the world who were denied the opportunity to purchase Facebook stock! But why would Goldman, with Facebook’s approval, refuse to sell stock to American investors? And why would American regulators sit by and allow these firms to cater exclusively to foreigners?

Avoiding Prosecution

Oddly enough, Goldman reportedly feared being charged with legal violations by the United States Securities and Exchange Commission (SEC) if it sold Facebook stock to Americans, and thus refused to do so in order to reduce the risk of prosecution. In other words, Goldman believed that the SEC actually preferred that it cater exclusively to foreign investors.

To be specific, Goldman believed that it might have been accused of violating two distinct regulations if it sold Facebook shares to investors in the United States. One involved the rather arbitrary number 500; under SEC regulations, any American company that is owned by 500 or more investors must disclose its financial statements to the general public.

Because Facebook did not wish to make such disclosures until some time next year, Goldman created a single Special Investment Vehicle (SIV) that invested in Facebook; it then sold shares in the SIV to outside investors, thereby avoiding the restriction. Nevertheless, Goldman was concerned that the SEC might not count this SIV as a single investor because it actually represents the ownership interests of many client investors.

The second law involved a prohibition against private companies engaging in “general solicitation and general advertising” activities to attract investors; apparently, such activities are only permissible when conducted by publicly traded firms and not by privately owned firms. Although Goldman assiduously avoided any such formal activities, word of the transaction leaked out and set the public financial press on fire. The news leaks stoked immense public interest and reporting about the sale, and thus Goldman feared that the SEC would treat its private activities as public solicitations.

So Goldman, with Facebook’s approval, decided to eliminate any chance of prosecution involving a breach of one or both of these regulations by simply refusing to sell any stock to American investors. In fact, Americans who responded enthusiastically to a preliminary Goldman sales pitch were later contacted and told “thanks but no thanks; we are no longer willing to sell shares to you!”

Future Transactions and Public Policy

How will Goldman’s and Facebook’s “foreigners only” policy affect future equity sales transactions? One ramification, clearly, is that the continuation of this policy would drive ownership shares of successful American organizations into the hands of foreign investors. Last week’s sale, for instance, involved the placement of $1 billion of stock for a firm (i.e. Facebook) that was valued at $50 billion, thereby banishing 2% of the iconic American firm’s equity from the portfolios of American investors. As a result, 2% of all of Facebook’s future profits, dividends, and gains from increases in market capitalization will be claimed by foreigners.

In addition, this policy might help drive future stock sales transactions into the hands of foreign banking institutions and away from Goldman and other American firms. Facebook’s executive team was reportedly displeased about Goldman’s difficulties in managing this equity sale; in the future, they and other firms might simply opt to hire foreign banks to manage such transactions, particularly those that continue to exclude American investors.

Furthermore, the SEC’s professional judgment may be called into question as well. After all, why bother with a 500 investor threshold for public reporting purposes if this regulation can be easily skirted through the creation of a single SIV that purchases stock on behalf of multiple parties? And why ban American firms from engaging in general solicitation and advertising activities when such information might help address rumors that are circulating in the press about their private placements?

From a public policy perspective, the biggest question of all might involve whether American regulators are appropriately positioned to protect American investors in an increasingly global environment. Ultimately, an entirely new regulatory system might be preferable to one that denies American citizens the right to invest in their own home-grown firms.

Goldman Sachs’ Risk: The Press Hates Us!

If you were Goldman Sachs CEO Lloyd Blankfein, what would you be doing right now?

No, this is not a personal question, though you might enjoy speculating about how you’d spend the $53.4 million bonus that Blankfein earned in 2006. This is a business question: how would you spend your time?

Considering the overwhelming levels of instability and volatility that percolate throughout the world of global finance, you would probably spend a lot of time worrying about risk. But what type of risk would you focus on?

The risk that Goldman’s investment portfolio might (once again) plummet in value? Or that a critically important external party doing business with Goldman, like AIG, might (again) collapse? Or that the global economy might lurch into a double dip recession and drive up losses?

All of these risks are undoubtedly high on Blankfein’s list, but Goldman surprised the financial world last week by publicly acknowledging a different concern. Namely, they proclaimed that bad publicity represents one of the most significant critical risk factors they confront today.

A Long History

In a sense, Goldman’s pronouncement about bad press places them squarely within in a longstanding tradition of blame the messenger, a game that numerous people and organizations have played over decades of mass media coverage. For instance, General Motors spent years complaining that the press refused to cover news about their improving product lines, even as they blindly fell through their fiscal black hole towards bankruptcy. And President Richard Nixon once bitterly proclaimed that the press “won’t have Nixon to kick around any more” after he lost the 1962 election for Governor of California.

Nevertheless, public relations specialists have long (and accurately) noted that mass media strategies are often highly effective mechanisms for managing risk. Nixon himself once sidestepped calls for his resignation from the Vice Presidency of the United States by making a national televised speech about Checkers, his family’s pet dog. And firms like McDonald’s have skyrocketed to global dominance on the strength of mass media campaigns that feature McDonaldLand characters like Ronald McDonald, Mayor McCheese, and the Hamburglar.

So it’s no surprise that a global firm like Goldman Sachs, one that epitomizes the type of aggressive Wall Street investment house that made billions of dollars on risky trades and then received billions more in government bailout funds, would worry about bad publicity. But why would they publicly acknowledge their concerns about such a risk?

Going Public

Goldman’s decision to “go public” in a media sense with their concerns about poor publicity can actually be traced back to its 1999 decision to “go public” in an ownership sense. It was then, at the peak of the Clinton era bubble in technology and finance, that the private partnership of Goldman Sachs decided to launch an Initial Public Offering of its shares to public investors.

At the time, that decision was perceived as a brilliant feat of financial timing and engineering, considering that Goldman received top dollar for the sale of its own stock near the peak of a stock market bubble. But by becoming a publicly traded firm, Goldman voluntarily agreed to accept a wide range of disclosure requirements that are imposed by the U.S. Securities and Exchange Commission on all public corporations.

One particular disclosure requirement involves the need for publicly traded firms to issue periodic financial statements to the public, accompanied by a retrospective management discussion and analysis of historical trends and a prospective assessment of significant risk factors. As a public company, Goldman was required to file its annual report (known as a Form 10-K) last week, and thus was compelled to disclose the risk of bad press in the section that contained their assessment of risk factors.

The COSO Cube

Of course, the simple disclosure of a risk in a Form 10-K does not necessarily shed insight about why a firm is compelled to disclose it in the first place. In other words, firms are not necessarily required to reveal their internal risk management deliberations, nor to describe how they reached a decision to “go public” with certain concerns by adding specific issues to their disclosures of significant risk factors.

To glean some insight into how such decisions are made, it is necessary to understand the integrated framework of Enterprise Risk Management that has been developed by the American accounting profession. COSO, a consortium of five major accounting trade organizations, has developed a three dimensional cube that describes this decision making process.

The process doesn’t contain any surprises. It simply emphasizes the need to understand one’s internal environment and business objectives before identifying specific risk factors, and then to prioritize and focus on factors that cannot be addressed easily through crisis prevention or response activities.

Thus, Goldman must now believe that its internal people and priorities will inevitably continue to place them at risk of incurring public enmity; they must also believe that there is relatively little that they can do to prevent or address such events. In other words, Blankfein himself must be looking forward to many more days of bad publicity in the future.