Questions Remain Over Hewlett\'s Big Charge on Autonomy Acquisition

The $5 billion fight over accounting allegations at Hewlett-Packard shows no sign of abating.

In November, H.P. took a $8.8 billion charge as it wrote down its acquisition of Autonomy, a British software company that it acquired in 2011. H.P. said that “more than $5 billion” of the charge was related to accounting and disclosure abuses at Autonomy. H.P. added that a senior executive at Autonomy pointed to the questionable practices after Mike Lynch, Autonomy's founder and former chief executive, left H.P.

Mr. Lynch denied the allegations. In November, he said the accounting moves that H.P. highlighted were legitimate under international accounting rules, and he demanded that the company be more specific in how it arrived at the $5 billion number. H.P. on Thursday released its annual report for its 2012 fiscal year, noting that the United States Justice Department “had opened an investigation relating to Autonomy.”

The report discusses the methodology it employed when making the $8.8 billion charge, but it did not break out exactly how the alleged accounting improprieties were behind $5 billion of that charge.

Mr. Lynch seized on that. In a statement on Friday, he said that H.P.'s report had “failed to provide any detailed information on the alleged accounting impropriety, or how this could possibly have resulted in such a substantial write-down.”

This accounting rabbit hole has real world consequences.

H.P. management, led by the company's chief executive, Meg Whitman, has proceeded with a feisty certainty since the outset of this spat. If the $5 billion figure is not ultimately substantiated, shareholders may doubt H.P. management's judgment. Also, annual reports are supposed to be exactly the place that investors can go to get their questions answered.

The fact that the $5 billion part of H.P.'s case is not repeated there should give shareholders pause. The report avoids words and phrases that would help a reader understand just how much of an impact the alleged improprieties had. The report says lower financial projections for Autonomy contributed to the write-down. In one part, it said those financial projections “incorporate” H.P.'s analysis of what it believed to be improper accounting. In another section, the report says the changed financial projections were “driven” by the alleged abuses.

That sort of language led Mr. Lynch to say in his Friday statement that, “H.P. is backtracking.”

H.P., however, says it's doing nothing of the sort. In a statement released after Mr. Lynch's on Friday, the company. said, “As we have said previously, the majority of this impairment charge, more than $5 billion, is linked to serious accounting improprieties, disclosure failures and outright misrepresentations.”

The statement also appeared to respond to the criticism that more details about the $5 billion should have appeared in the annual report. H.P. said the report, “is meant to provide the necessary overview of H.P.'s financial condition, including our audited financial statements, which is what our filing does.” The company added, “We continue to believe that the authorities and the courts are the appropriate venues in which to address the wrongdoing discovered at Autonomy.”

Sifting through the Autonomy weeds could obscure the bigger question: Was everything above board at Autonomy? H.P. may have overstated the impact of what it calls improprieties in the charge. But Autonomy may still have had unreliable numbers that overstat ed its value at the time of its acquisition.

Mr. Lynch says the poor performance of Autonomy once it was part of H.P. was down to H.P.'s mismanagement. But it could also have been because the new owners were not benefiting from the accounting that they have since questioned.

In some ways, the most intriguing detail in this mystery is the supposed whistle-blower who brought the accounting issues to management's attention. This person may have been able to show how what he or she believed to be chicanery was hidden from the accounting firms that checked Autonomy's books.

H.P. has enough performance issues that its executives will probably see the Autonomy issue as a distraction and shareholders may get little extra detail. By the sounds of it, that probably won't satisfy Mr. Lynch.

“It is time for Meg Whitman to stop making allegations and to start offering explanations,” is how he signed off his Friday statement.

Imagining a Future of Lower Hedge Fund Fees

Anticipated publication of this column around 2020:

The most surprising thing about the demise of 2-and-20 hedge fund fees is how long it took. Neither losses in the 2008 credit crunch nor the feeble returns during the ensuing seven-year euro zone crisis did much to bring down the archetypal fee structure: 2 percent management fee and 20 percent of gains. Now, though, it can finally be said: 2-and-20 is dead.

Back in September 2012, the average hedge fund still charged 1.6 percent annually in management fees and collected 18.7 percent of any gains, according to data provider Preqin. Through November that year, the average global hedge fund investor earned just 2.6 percent, according to the HFRX global index maintained by Hedge Fund Research. In 2011 investors lost nearly 9 percent. The average annual return from 2009 to 2012, supposedly recovery years following the losses of more than 20 percent in 2008, was a measly 3 percent.

A few investors - including huge institutions like California's giant pension fund, Calpers - managed to negotiate better deals. More often, funds that did badly simply shut down, while investors often signed up for new funds at the usual fees in the hope that the high-return strategy so elegantly set out for them by the latest persuasive trading titan turned out to work.

And a few duff years did little to dent demand. Hedge fund assets reached $2.2 trillion by the third quarter of 2012, some 17 percent above the 2007 pre-crisis peak. By 2015 they were still rising.

Yet it now looks as if those traumatic years marked the beginning of the end for the image of hedgies as superhuman traders. Faced with unpredictable markets, heavy central bank intervention and increasing red tape, some managers simply gave up. Pioneer Stanley Druckenmiller closed his fund in 2010, noting tellingly that managing more than $10 billion didn't allow him to make the kind of returns he wanted. Some others did the s ame or returned money to outside investors. A wave of insider-trading scandals further tarnished the sector's image, casting doubt along the way about the legitimacy of some top managers' returns.

It didn't help that hedge funds were becoming an industry. After the 2008 collapse, regulators and investors alike watched funds more closely. Managers needed to have large businesses to justify the required information and compliance systems, and diverse ones to avoid concentrated risks that might scare cautious institutional investors like pension funds. As Mr. Druckenmiller had foreseen, big firms ended up making lower returns, on average. And for the fund firm bosses, management fees approaching 2 percent made a large-scale business a ticket to riches even without stellar returns.

Investors initially settled for modest returns during good years and capital protection in bad times. But then many realized that the 2-and-20 fee structure was out of kilter. Pension fund managers' own rising liabilities made them tougher in claiming a higher proportion of the investment returns on their money. The most sophisticated ones set up their own in-house managers, staffed with refugees from shrunken investment banks and unlucky hedge funds.

Now in 2020, there's still a lot of money run by hedge funds. But there's a clear bifurcation. It's hard to distinguish parts of the industry from traditional asset managers like BlackRock and Fidelity - and those behemoths have snapped up some funds. In this branch, firms can still charge a management fee of 1 percent. But performance fees have shrunk to 5 percent or less, often after a minimum risk-free return is reached, in recognition of the more earthbound expectations investors now have of performance.

The other wing of the industry consists of hedge funds that have essentially gone back in time to something closer to the original concept - impressive returns in all market conditions, with fees to match as long as the returns are forthcoming. In the 1960s, Warren E. Buffett ran a fund charging no management fee but taking 25 percent of investment gains above a 6 percent threshold return.

In 2012 Guy Spier, whose $100 million-plus Aquamarine Capital Management has a class of shares that follows Mr. Buffett's old structure, referred to the “microscopically small proportion of investment managers who decline to charge a management fee.” Eight years on, there are more of them, though it's the harder and lonelier - if arguably the most investor-friendly - of the two hedge fund roads. Neither would look familiar to a manager who retired hugely wealthy in the early part of the past decade. But as places to invest, at least both now have fees that are a better fit.

Neil Unmack is a columnist and Richard Beales is an assistant editor at Reuters Breakingviews. For more independent commentary and analysis, visit b reakingviews.com.

State Court Review Sought in Argentine Debt Dispute

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Mergers That Benefit Market Structure

Larry Tabb is the chief executive of the Tabb Group, a financial markets research and strategic advisory firm, and TabbForum, a capital markets community Web site.

A recent editorial in The New York Times looked at the proposed acquisition of the New York Stock Exchange by the IntercontinentalExchange and that of Knight Capital by Getco. The editorial argued the following: that these acquisitions and the promotion of high-speed trading put smaller investors at risk; that the regulatory infrastructure is not sufficient to oversee the combined futures and securities exchanges; that acquisitions of this type created larger derivatives players that escalated systemic risk and posed a risk to taxpayers, and that the two acquisitions were tied to the little progress in developing comprehensive rules to stave off another financial crisis.

These ideas are misguided. Here's why:

Let's start with the Knight-Getco deal. While the private Getco is buying the public Knight, this will be a reverse merger and the merged company will be public, hence more transparent and with greater oversight by the Securities and Exchange Commission. The consolidated entity also will face the scrutiny that all public companies face - not only from the S.E.C., but from securities analysts and, most of all, investors.

Yes, it is true that electronic trading is controversial, and yes, problems stemming from electronic trading cost Knight $440 million and precipitated this takeover. Academic literature, however, has praised electronic trading for making the markets more efficient, especially for retail investors. While the efficiency created by fragmentation may make it more challenging for large asset managers to acquire blocks of stock, for individuals buying hundreds or even thousands of shares, electronic trading has made investing more democratic, transparent, faster and much less expensive.

Investors, by definition, invest â€" and traders trade. An investor holding a stock longer than a few hours is only benefited by greater trading volumes; greater volumes demonstrate increased price competition, enabling the market to validate more efficiently the price at which everyone trades. A more efficient price means a more accurate price for everyone.

Investors with short holding periods are by definition traders. Smaller traders, it is true, are disadvantaged by electronic firms. These electronic firms invest millions of dollars to ascertain the right price of every asset they trade by the millisecond. This investment generally enables investors to receive more accurate prices and pay substantially lower commissions. But it is day traders who are disadvantaged by high-speed trading â€" not intermediate or longer-term investors.

Then there is the regulatory issue. Neither the Knight-Getco merger nor an acquisition of the New York Stock Exchange by ICE will make it harder or easier for regulators to audit the markets.

Admittedly, both the S.E.C. and the Commodity Futures Trading Commission are not equipped to monitor fully the vast amount of today's trading. That said, there are outstanding proposals to develop a consolidated audit trail that will enable regulators to capture, monitor and police all securities and futures transactions more adequately.

But what about the oversight challenges posed by mixing futures and securities entities regulated by different agencies? Securities markets are regulated by the S.E.C.; the futures and commodities markets by the C.F.T.C. Both share derivatives oversight depending on the underlying product. Because they trade securities, futures and derivatives, Getco and Knight are already regulated by both agencies.

The consolidation of the se two companies will not impact oversight and may actually make it easier to oversee joint operations, because they will be consolidated under one organization and are likely to combine some of their infrastructures.

Regulatory jurisdiction has more bearing on the ICE-N.Y.S.E. acquisition. While the Big Board is primarily overseen by the S.E.C. and ICE by the C.F.T.C., in reality it is much more complex. Besides owning three equity exchanges and two options exchanges in the United States, the parent of the N.Y.S.E., NYSE-Euronext, owns equities and futures markets in Europe as well. Euronext is a composite of four equities exchanges (Paris, Brussels, Amsterdam and Lisbon) and one futures exchange. This organization is not only monitored by the four national securities regulators but by the European securities and futures regulators as well; and because it is located in London, it also is regulated by the Financial Services Authority of Britain.

ICE, besides bei ng an Atlanta-based futures exchange, owns a credit default swap clearinghouse, overseen by the Federal Reserve. It also owns ICE Futures Europe (the old International Petroleum Exchange); ICE Trust Europe (C.D.S. clearing) and other European financial assets. All these entities are heavily regulated in the United States and Europe.

Just because these firms combine does not mean that any of the myriad central banks or securities or futures regulators will give up an inch of oversight scope.

Another misconception is the idea that a combination of these firms will create larger derivatives operations that could post a threat to taxpayers because their failure could threaten the broader economy. While the acquisition of NYSE Euronext by ICE is all about derivatives, it is about transparent exchange-traded and centrally cleared derivatives â€" not the opaque, bilateral, over-the-counter transactions that interconnect global banks. The transactions that ICE and NYSE Euronext will be trading through this new entity will be like any other exchange-traded, centrally cleared product. It will be traded in the open, with pre- and post-trade market data and transactions sent to a central clearinghouse that will collect margin and manage risk.

This deal is creating exactly the kind of market infrastructure that the regulators in the United States and Europe have been trying to promote.

So while many of us in the financial markets pine for days past when people traded stocks and derivatives were something you learned (or not) in calculus class, those days are gone. Just like we remember wit h fondness the days of the '57 Corvette, the Porsche Roadster or the '69 GTO, those cars, while fun, were unsafe, noisy, uncomfortable and problematic. Technology, communications and advanced-processing techniques rendered those machines obsolete â€" just as they have done to the trading floors, practices and products of years past.

Pearson to Take Stake in Nook Unit

Pearson, the British publisher and education company, announced on Friday that it was investing $89.5 million in Barnes & Noble‘s digital Nook business for a 5 percent stake.

The investment follows a $300 million investment in the e-reader by Microsoft in April.

Will Ethridge, the chief executive of Pearson North America, said in a statement: “Pearson and Barnes & Noble have been valued partners for decades, and in recent years both have invested heavily and imaginatively to provide engaging and eff ective digital reading and learning experiences. This new agreement extends our partnership and deepens our commitment to provide better, easier experiences for our customers.”

The Nook has been trying to challenge Amazon‘s dominance of the e-book market. The latest investment gives it backing from one of the world's largest education companies, as well as the publisher of The Financial Times newspaper. Shares of Barnes & Noble were up sharply in pre-market trading.

After the Pearson investment, the bookseller Barnes & Noble will own 78.2 percent of the Nook unit and Microsoft will own 16.8 percent. Pearson will also be granted warrants to buy an addition 5 percent of Nook at a pre-investment valuation of $1.79 billion.