National Presto was almost like a long-forgotten high school friend. Berkshire owned
it in the 1970's, pre-Amex and Coke. So what’s our old friend (and one of Buffett’s former darlings) National Presto been up to? And what’s behind their current ‘pay pretty much all excess cash flow each year’ dividend policythey seem to have adopted?
A quick check reveals that National Presto had a pretty exciting decade, from 1996 through 2006. And not in a good way, from a legal or regulatory standpoint. National Presto was sued by the SEC, had their auditors resign as a result of their SEC troubles, and when they then couldn’t get audited opinions on time, were late with financial statements and threatened with delisting.
What caused all this? Why did the SEC go on a five-year crusade against this otherwise conservative and innocuous company?
It turns out that National Presto's decade of travails started when then 78-year old Melvin Cohen responded with what might be characterized as Munger-like diplomacy to an inquiry by the Deputy Controller of New York State.
The miffed Deputy Controller then planted the seeds that would eventually trigger an SEC investigation, and when the by-then 83-year-old didn’t appropriately acquiesce to the SEC, the agency – with the uncanny ability to prioritize its efforts that it demonstrated all last decade, took its revenge. As the US Court of Appeals actually phrased it five years later, when it finally ruled to exonerate Presto, “the agency (or its senior staff) is in a snit..”.
The actual chain of correspondence might be rather comical if we set aside the thought that much of the rest of the financial world was beginning to spin entirely out of control as this all progressed.
National Presto’s transgression? They had attitude -- but since there are apparently no laws that our public servants could invoke for that, they were charged with something of a technicality: they had more than an allowable amount of ‘cash and securities’ on their balance sheet (specifically too much of a ‘securities’ component, because for example, their municipal bonds could not be categorized as excludable 'government bonds', nor their CD's as 'cash' - putting them above the allowable '40%' limit). They failed to request permission (in the form of an exemption from the Investment Company Act of 1940) from the SEC, and so were hammered.
Their compliance problems from that then just snowballed out of control.
But it's better just to read this and form your own opinion (though a caution: this is lengthy).
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The trail, from the beginning:
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August 29, 1996
Mr. Melvin S. Cohen, Chairman
National Presto Industries Inc...
Dear Mr. Cohen:
…the $77 billion New York State and Local Retirement Systems (“Systems”) is committed to achieving superior performance over the long term. With over $37 billion in domestic equities, including 43,200 shares of National Presto Industries Inc. we are concerned when the long term performance shows continued signs of lagging behind the Industry.
To monitor long term performance we have implemented an extensive analysis and review process……Our most recent objective screening and subjective review has raised concern regarding National Presto Industries Inc.’s performance. We are writing the Board to learn your reaction to our concerns and to obtain assurance that actions are being taken to enhance and maintain performance on a long-term basis. Indeed, with such an assurance, we believe, the reed for direct shareholder involvement in any other corporate other corporate governance matter is significantly reduced.
Since the Board’s response will be a factor in our monitoring process, we encourage you to maintain the line of communication we hope this latter has established. Your cooperation in providing a reply within the next two weeks would be greatly appreciated.
Sincerely,
John E. Hull
Deputy Comptroller
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September 9, 1996
Dear Mr. Hull:
In response to your letter of August 29, it seems apparent that your belief that this company is underperforming its industry is predicated upon a false definition of the constituents of that industry.
The problem to which reference is made is not uncommon. Quite frequently, we find our company cast with producers of consumer consumables, such as Proctor and Gamble with manufacturers of major appliances, or with huge conglomerates such as Black & Decker and Premark International, both of whom do indeed have a segment of their business engaged in competition with us, but whose results, in those areas, are neither clearly defined nor controlling their respective destinies.
Should our assumption be correct, you may want to narrow your definition of the industry in which this company competes to producers of durable housewares, and, to be even more precise, consumers of durable electric housewares. Our arena does not extend to consumable items or to major appliances.
You may not be aware that over an extensive period of time this company has consistently outperformed most of its peers in terms of returns on sales and significant areas measured by accountants. We do not purport to influence the stock market, and regard those who keep one eye on Wall Street as failing to concentrate an their businesses which are difficult to run in any event, without dissipating talent and energy chasing a market will-o'-the-wisp.
So that you will appreciate our performance against our immediate peers, I am enclosing comparative data for those who are properly recognized as our competitors….Additional enclosures that should be of interest relate to two of the recognized pre-eminent companies in our industry, Sunbeam and Rubbermaid, both of which are troubled, indeed. Finally, so that you may observe that our industry is beleaguered even offshore, I am enclosing an article relating to an international leader, Krups, and a very recent clipping from The Wall Street Journal demonstrating that companies in our industry from Japan and Thailand are market laggards.
There was a time when we disdained comparative performance with other members of our industry, since we found such a study inappropriate. However, with the changes in distribution which have occurred in recent years, resulting in the pre-eminence of discount retailers such as Wal-Mart and Target, we must now accept that "price is king", and absent new product introductions of a revolutionary nature (which unfortunately are increasingly rare), profit opportunities have been seriously leveled.
In the last analysis, we recognize, as we believe you should, that our industry is under siege, with none of us showing any immediate promise of acceptable profitability. Under the circumstances, while we would regret losing you as a shareholder, would be fully sympathetic with a decision on your part to seek better returns elsewhere, and admit that doing so might be a part of your long-term responsibility.
Because of the rules of law that preclude our sharing “additional insight as to the future direction of the business or governance strategy” with any one shareholder rather than all simultaneously, our directors must regrettably decline any further comments. I believe, however, that if you read the last several annual and quarterly reports, the information you are seeking can be found in the appropriate public declarations.
Sincerely yours,
Melvin S. Cohen
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November 13, 1996
Mr. Melvin S. Cohen, Chairman
National Presto Industries, Inc.
Dear Mr. Cohen:
As indicated in my letter of August 29, 1996, the Now York State Common Retirement Fund is concerned about the performance of National Presto Industries, Inc., and will be monitoring the corporation to determine whether actions are being taken to enhance and maintain performance on a long term basis.
Our investment staff recently completed a thorough review of National Presto’s performance…. we note that the company's stock returns have been consistently negative, and its performance has been disappointing. At the same time, there are positive signs – such as the introduction of three new products – which encourage us to give management an opportunity to demonstrate its ability.
The Fund remains greatly concerned about issues of corporate governance. Ws are particularly disturbed that none of the directors are non – management independents with no direct relationship with the company. We firmly believe that independence encourages board members to act in the best interest of shareholders.
Similarly, we are disturbed that National Presto’s board does not include a separate compensation or nominating committee. Such committees, when they consist of independent directors, can ensure the quality of director nominees as well as provide shareholders a means to be involved in the nomination and compensation process.
Finally, because the Common Retirement Fund holds equity through index funds, we do not have the option to sell our shares in National Presto, contrary to the suggestion in your letter of September 9, 1996. For that reason, we remain committed to close monitoring of performance and communication with portfolio companies to obtain the reassurances that might preclude the need for direct shareholder involvement in other corporate governance matters.
I look forward to hearing from you.
Sincerely,
John Hull
Deputy Comptroller
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November 22, 1996
Dear Mr. Hull:
Quite frankly, I was hoping that my letter to you of September 9 would put to rest any need for further correspondence.
So that you will not be laboring under false premises with respect to our three new products, I an enclosing a copy of our most recent press release which indicates that results are proving disappointing.
Your study of our company should have revealed that the family of which I am the patriarch holds approximately 30% of its stock. It should be obvious, therefore, that prodding from the outside is totally unnecessary. Try as I might, I can see no advantage to either of us by your proposed monitoring. It is unneeded, distracting and hence most unwelcome.
You are quite wrong in your assessment of our outside directors. Our newest director…. is a commercial banker, having had no previous relationship to our family or this company…. Walter Ryberg is a former Vice President for Sales, who has been disassociated from us, in all respects, for 13 years…. John Sirianni is an investment banker who handles only occasional transactions for the company or our family. All…have been selected for their independence and maturity of judgment.
While some huge corporations may be in need of the committees to which you refer, they would be as useful for us as a flea on the hair of a tail of a dog. Any concern with respect to compensation should be quickly dissipated, if you look at our forms filed with the SEC which show that both officer and director compensation is among the lowest, if not the lowest, of all companies of our size on the New York Stock Exchange.
From the fact that your shareholdings are derivative, with the primary shareholder being the fund in which you invested, I believe your quarrel lies with it, rather than us. If you disapprove of the mix in which the fund has invested, please express your disappointment, chagrin or recommendations to the fund manager. An alternative would be to substitute a fund which does not include our equity.
Please believe me, it is my desire to avoid rudeness, under any circumstances. Nevertheless, we should both recognize that correspondence between us is proving fruitless, and is consuming time, which could otherwise be properly devoted to our respective more direct concerns. Perhaps yours could be aimed at more individual stock selection (as opposed to the indiscriminate mix found in indices, such as the Mid-Cap 400) which would provide the flexibility in stock selection and rejection which you apparently sorely desire, but cannot secure in your present sterile posture.
Sincerely yours,
Melvin S. Cohen
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Sometime after, the New York Society of Security Analysts entered the picture. In their work product, they included all of the correspondence above, which they conveniently happened to have on hand for the project.
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New York Society of Security Analysts Committee On Corporate Governance and Shareholder Rights
FORUM: Discussion Papers Regarding National Presto Industries, Inc.
July 1999
NYSSA is proud to provide a forum for analysis and debate on issues relating to corporate governance and shareholder rights…
Over the past five months members of the New York Society of Security Analysts ("NYSSA") have been working on a special project examining how potential changes in a publicly traded company's corporate governance practices might increase shareholder value…. Our intention was that this project would provide a real world, practical application of corporate governance principles for the training of NYSSA's analyst membership.
[excerpts]
What We Are Doing?
We want to analyze corporate governance issues on a similar level as corporate finance issues in the decision to buy, hold, or sell a stock. Our purpose is to provide analysts and investment managers with the tools to evaluate this type of investment situation…..
Why National Presto Industries?
For its test case, the Committee decided to draw up a list of companies with a combination of two conditions: first, a controversy concerning the management of shareholder assets, and, second, the existence of relevant corporate governance issues. The Committee considered 20 to 30 companies, eventually reducing it to a short list of a few companies based on published reports of corporate governance issues and potential value enhancement opportunities associated with proposed changes in uses of assets.
We finally selected National Presto Industries (the "Company"), based on a variety of considerations which included the following:
• Approximately 93 percent of 1997 stockholders equity, and 80 percent of the Company's total assets, were in cash or cash-equivalents.
• The Company had been maintaining similar levels of cash without growing its operating business for over a decade.
• The Chairman and President of the Company are a father and daughter who control approximately 29% of the stock, including approximately 23% held in a voting trust for family members.
• The Company had enacted several entrenchment provisions, including supermajority voting requirements, a staggered board and a poison pill.
• The six member board included three Company officers and, according to the 1998 proxy statement, met only twice during the past year.
• More than half of senior executives’ total compensation, which was generally below industry norms, consisted of "discretionary" bonuses based entirely on subjective judgment, without any formulas, defined performance criteria, or ties to shareholder value.
• Although the Company was small and not covered by any major analysts, it was familiar to many investors because of its position in an S&P index and some 1998 news coverage.
• There was a wide range of differing views among investors concerning the Company’s management policies and prospects.
• Management had demonstrated a willingness to vigorously express its views regarding corporate governance issues in response to past investor inquiries and attempts by shareholders to effect change
Highlights of the Compensation Committee Report presented in the Company’s 1999 proxy statement are as follows:
• The Company has not relied on stock incentives as a principal part of its compensation program for its executives. The rationale for this policy, according to the Company, is that Mr. Cohen, Ms. Cohen, and Mr. Bartl already own substantial amounts of company stock in relation to their compensation levels.
• The Company does not employ an outside compensation consultant.
• Annual bonuses are not based on upon a percentage or other formula utilizing revenues, income or other financial data as predicates.
• The Company has maintained salary levels below competitive levels.
• The Company has used the same compensation philosophy approach for more than 25 years and is not considering changing the philosophy.
• The defined benefit pension plan results in a maximum annual benefit of only $30,000 per year.
• There are no employment agreements.
The net result of this compensation program is that National Presto could have difficulty in attracting senior executive talent.
[The analysis continued with an assortment of recommendation by the NY Society member-analysts who participated in this project. Examples:]
NPK’s biggest customer is Wal-Mart, which accounted for 44% of 1998 revenues. This figure has risen steadily during recent years. NPK’s increasing dependence on Wal-Mart is worrisome. This development is largely due to the loss of business from other customers: For example, Caldor and Service Merchandise….
…significant reduction in advertising expenditures from $13 million in 1997 to less than $7 million in 1998.(5) In fact, NPK has embarked on a new advertising strategy that deemphasizes network television.
Although the new strategy is less expensive, it is not yet clear if it will be more effective. The 1998 sales decline may have been one unintended consequence.
In order to boost sales significantly in the long run, NPK needs to develop and market new products….
Finally, and most importantly, NPK’s working capital management policy can be described as excessively conservative. The company’s most recent balance sheet shows $241 million in cash, cash equivalents and marketable securities, which comes out to about $32 per outstanding share of common stock. This is more than 92% of shareholders’ equity and more than 81% of total assets…..
…Investing the cash reserves, about $241 million in 1998, in a suitable low risk, low growth business….If the company invested the $241 million alternatively in conservative ventures generating only 10% returns, the pre-tax income would equal $24.1 million.
Several alternatives to increase the return on shareholders’ assets….
Since the purpose of this analysis is not to choose a particular action for the company to implement, it is not necessary here to evaluate or rank these suggestions:
. New Product Development.
. Major Acquisition.
. Series of Small Acquisitions.
. Increased channels of distribution for the company’s products to reduce the company’s reliance on Wal-Mart.
. Stock Repurchase.
. Special Cash Dividend.
. Sale of Company.
. Take the Company Private.
…the chairman has stated in the 1998 Annual Report that the Company is considering the possibility of an increased role for their dormant subsidiary, National Defense Corporation: “A multitude of problems throughout the world may require military solutions. Under these circumstances, 1999 could prove a timely period for renewed efforts by this Company’s executives in pursuit of an elevated military role”.
Regarding management's willingness to change their use of shareholders' assets, some other concerns were raised:
1. The president of the company serves as both a corporate director and as the sole trustee of a family voting trust. Does this dual service raise issues regarding possible conflicts of different fiduciary duties?
2. The company might qualify as an investment company.
3. Some past institutional investors I spoke with were not able to open a dialogue with the Chairman …
…leads me to believe that existing management is not willing or able to take the necessary actions to increase shareholders' wealth.
..Shareholders could request an inquiry by the SEC to determine if the company is operating as an investment company and therefore would have to be registered as such under the Investment Company Act of 1940.
…Regarding the possibility of the SEC requiring the Company's compliance with the Investment Company Act, based on our understanding of SEC procedures as discussed at work group meetings, we should not expect the SEC to disclose the status of any inquiries unless it takes formal action.
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National Presto's Maryjo Cohen responded to a draft of the report:
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June 22, 1999
Mr. Gary Lutin
Dear Mr. Lutin:
As promised, the enclosed material comments upon your submissions of April 26, 1999.
Shortly after receipt, I advised that just a quick reading revealed numerous factual errors, as well as dubious conclusions. My weekend review, which provided time for a careful examination, unfortunately leads me to believe that my initial impressions were charitable. Frankly, if I had been aware of the amount of work and hence time required to satisfy my obligation, I would not have undertaken the task. I became so tired that I may have failed to comment upon other obvious errors or false conclusions…..
…Perhaps your authors, none of which appear to be CFAs, lacked motivation or found reporting on NPK of insufficient complexity or general interest to merit a study in the first instance. If the latter is at the root of their difficulty, I must say I concur fully with them. Certainly their problem could not have been lack of transparency, since data supporting my comments upon factual matters are readily available in public documents.
Most people in your position would take their markdown and abandon the project. Such abandonment seems the appropriate course in that the project presumably was directed to the subject of corporate governance. Following the necessary editorial modifications to Mr. Tully's report, comments upon corporate governance are very few, and those that remain have been obviated by the overwhelming shareholder vote at our May 18, 1999 Annual Meeting endorsing our company's practices (to which Mr. Tully is opposed). Moreover, not a single broad educational value is served by the group, despite the fact that this was the second stated objective of the study. Finally, your report is confrontational, judgmental and critical of a company's practices, all of which appear to be out of harmony with the Society's policy in opposition thereto.
Should you decide that the report is still worthy of publication in any written form, I would appreciate receiving a copy, fully reflecting my analysis. My expectations in that regard stem from your repeated assurances that "anything you provide will be incorporated in the presentation of project material to be made available to NYS SA members and to the public".
While I recognize as strictly within your discretion the choice of format whereby the presentation of project material can be made available to NYSSA members and to the public, I think it would be helpful if my analytical comments appeared opposite or immediately following the exact statement(s) of the analyst, to which they relate.
Sincerely yours,
NATIONAL PRESTO INDUSTRIES, INC.
Maryjo Cohen, President
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Sometime after this, the SEC entered the picture. Apparently someone alerted the agency of the NY Society’s concerns that National Presto might be operating as an unregistered investment fund in disguise. The ensuing litigation activity with the SEC stretched for five years. The NY appellate court eventually overturned the earlier lower court decisions against National Presto. The appellate court’s summary was lengthy, but it nicely recapped the history, summarized the impact on National Presto, and clarified the various issues.
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United States Court of Appeals, Seventh Circuit.
Argued September 20, 2006.
Decided May 15, 2007.
Before EASTERBROOK, Chief Judge, and POSNER and EVANS, Circuit Judges.
1. Investment Company Act of 1940…Any issuer that owns "investment securities" worth 40% of its total assets is an investment company under § 80a-3(a)(1)(C) unless some other provision of the Act takes it outside the definition. For this purpose, however, "Government securities and cash items" are omitted from both the numerator and the denominator.
2. National Presto Industries….used to make everything it sold. During the 1970s it began to divest its manufacturing facilities and to contract production to third parties….Presto was left with a pile of cash, most of which it retained with a long-term plan to acquire other businesses, and a shrunken book value of operating assets. Financial instruments were 86% of its total assets by 1994 and 92% in 1998. Since 2000 Presto has purchased two manufacturers of military supplies and two makers of diapers and puppy pads. But in 2003 financial instruments still represented 62% of its physical and financial assets.
3. All of Presto's consumer products…are made by subcontractors, so although it has a substantial operating income it does not have operating assets to match—and the Investment Company Act's main test is asset-based. When the firm refused to register as an investment company—and make the changes to its corporate structure, management, and financial reporting required of investment companies—or request an administrative exemption, the SEC filed this suit to seek an injunction that would require compliance….The firm has complied pending appeal.
4. …Presto replaced enough of its existing portfolio with "Government securities and cash items" to bring investment securities under the 40% threshold…..
5. …the district judge…entered an injunction unconditionally requiring Presto to register as an investment company. The judge did not explain why….obliging it to register as an investment company even when its investments do not require this is hard to fathom except as a form of punishment for Presto's conduct in past years, and civil injunctions are not supposed to punish litigants.
6. The unconditional injunction has caused considerable trouble…..Presto's auditor, Grant Thornton, resigned because the SEC questioned its certification of Presto's financial statements as those of an operating company. Now that Presto is officially an investment company, Grant Thornton has refused to allow the statements it certified to be used for any purpose. This has disabled Presto from complying fully with either the Investment Company Act or the Securities Exchange Act of 1934. Without the financial statements, it is unable to file quarterly and annual reports. It has hired another auditor, but recreating and re-certifying financial statements for many past years is expensive and time consuming. Meanwhile stock exchanges have threatened to delist its stock because Presto is out of compliance with both statutory and exchange-based financial-reporting requirements.
7. …Now that it has complied with the injunction by registering as an investment company, can't it deregister and go back to its preferred status as an operating company, subject to registration under the Securities Exchange Act, no matter what happens on appeal? Deregistration requires the consent of the SEC, however, and although Presto filed the appropriate papers with the agency in January 2006 the SEC has failed to act on them.
8. One senses from this prolonged silence, and the tenor of the SEC's brief and oral argument, that the agency (or its senior staff) is in a snit because Presto declined to do what many other firms with excess liquid assets have done—apply to the agency for an exemption…Microsoft, for example, holds more than 40% of its assets in the form of investment securities but received permission to operate outside the 1940 Act…. a firm's refusal to kowtow to an agency is not a good reason to force its investors to bear unnecessary costs….Why is the SEC bent on grinding down a corporation that it appears to acknowledge would not mislead or otherwise injure investors by using the governance and reporting devices appropriate to an operating company?
9. Because Presto remains registered as an investment company while the SEC sits on its hands, there is a live case or controversy, because a remedy is possible: we could end its registration forthwith. Moreover, if we hold that Presto's former portfolio does not bring it within the Investment Company Act, it will be free to rejigger its investments; the old investments likely had a higher rate of return, which is why Presto switched only after the district court's opinion.
10-24
Let us begin, then, with Presto's argument that even before the recent changes to its portfolio, enough of its investments were "Government securities and cash items" to keep its "investment securities" under the 40% trigger….."Government securities" is a defined term…..According to Presto, pre-refunded municipal bonds ("refunded bonds" for short) fit this definition. Presto held these instruments in quantity...The Treasury bonds held in trust lead Presto to call the refunded bonds themselves "Government securities." It should be apparent…that they do not fit the statutory definition…municipal bonds issued by a city that plans to repay using U.S. bonds are still municipal bonds….Mutual funds may treat refunded bonds as if they were "Government securities" ….. How can refunded bonds be "Government securities" for one purpose but not the other?, Presto asks.
"Cash items" also are excluded when calculating the 40% ratio, and Presto maintains that "variable-rate demand notes" should be treated as "cash items." ….In contrast to the detailed statutory definition of "Government securities," the Investment Company Act does not define "cash items." Presto maintains that variable-rate demand notes are equivalent to cash because of the weekly opportunity to sell the instruments at par for cash….The reason that such investments are not treated as cash or its equivalent, however, is that the market price the instrument will fetch when sold is variable….Certificates of deposit and time deposits typically would not be considered cash items absent convincing evidence of no investment intent…..A variable-rate demand note does not fit this definition. Presto chose to invest in variable-rate demand notes rather than,….
25. Presto therefore comes within the 40% test and is an investment company unless one of the (many) statutory exceptions applies. The one on which Presto relies is § 80a-3(b)(1): "Any issuer primarily engaged, directly or through a wholly-owned subsidiary or subsidiaries, in a business or businesses other than that of investing, reinvesting, owning, holding, or trading in securities." Presto is actively engaged in several businesses. A visitor to its web site for consumers (http://www. gopresto.com) will find sales promotions, warranty information, and instruction manuals for pizza ovens and coffee makers but nary a hint that someone would want to buy Presto's stock as a means to own a derivative interest in refunded municipal bonds or variable-rate demand notes. But is Presto "primarily" engaged in selling pressure cookers, deep fryers, popcorn poppers, diapers, and ordnance rather than the business of holding securities? The statute is unhelpful; "primarily" is not a defined term. No regulation fills the gap.
26. Sixty years ago the SEC announced that it would consider five factors to decide whether a firm that sold off its operating assets and chose not to distribute the proceeds to its stockholders had become what people today call an "inadvertent investment company…
27. …..what matter are the company's history, the way the company represents itself to the investing public today, the activities of its officers and directors, the nature of its assets, and the sources of its income. Of these, all but the fourth favor Presto. Founded in 1905, Presto was an active manufacturer of industrial, consumer, and military products until the 1980s, when it started to subcontract manufacturing activities. It remains an active manufacturer of absorbent goods and military ordnance and sells a line of kitchen goods under its own trademarks.
28. As far as we can see, this is the first time that the SEC has argued that a firm with such a substantial ongoing presence in product markets is an inadvertent investment company….. one could not say that Presto had withdrawn from active business operations….. It continued selling both consumer and military products. It changed from a manufacturer to a firm that was (principally) a designer and marketer of products assembled by others, but this did not make Presto less an operating enterprise. Many other firms have made a similar transition (Apple comes to mind) without being thought to have evolved into mutual funds.
29. Presto presents itself to the public (and to investors) as an operating company. That's how its web site, its annual reports, and its publicity all depict it….. An investor in the market for a mutual fund, a hedge fund, or any other investment pool would not dream of turning to Presto, whose net income can increase or decrease substantially as a result of business successes or reverses. The price of Presto's stock moves in response to changes in its operating profits rather than the slight annual changes in its investment income. The SEC has not identified even one confused investor who bought stock in Presto thinking that he was making an investment in a closed-end mutual fund whose assets were the securities that Presto holds.
30. "Activities of Officers and Directors,"….likewise favors Presto. ….Presto estimates that 95% of its managers' time is devoted to running its consumer-products and military-ordnance businesses. The SEC has not offered any contrary evidence….
31. …Gross income at Presto is dominated by receipts from its consumer and military sales. More than 90% of Presto's gross receipts for every year covered by the record (1994 through 2003) comes from its sales of products. In 2003, for example, Presto recorded about $125 million in sales, yielding a net profit of $18.9 million; total receipts from investment securities that year were $4.2 million.
32. Only net income helps the SEC's position: the agency calculates that, over the decade covered by the record, 50.22% of Presto's net profits were derived from investments in securities. …..Presto was "primarily" an operating business when the injunction issued. Whatever classification may have been appropriate in the 1990s (when more than half of net profits came from investments) cannot support an injunction issued in 2005, when at least 60% of net profit was coming from consumer and military sales
33.…. the nature of Presto's assets….favors the SEC, for more than 60% of Presto's assets were investment securities during every year covered by the record….Yet looking primarily at accounting assets has a potential to mislead…. no investor would perceive such a firm as a substitute for a closed-end mutual fund; its stock returns would continue to depend on its operating profits and losses.
34-37...Reasonable investors would treat Presto as an operating company rather than a competitor with a closed-end mutual fund. The SEC has not tried to demonstrate anything different about investors' perceptions or behavior. It follows that Presto is not an investment company.
38. The judgment of the district court is reversed. Presto, which registered as an investment company only under judicial compulsion, now is free to drop that registration and operate under the Securities Exchange Act of 1934 whether or not the SEC gives its formal approach to that step.
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Anyway – the company still has a large cash & securities position – however each year it pays out whatever excess cash flow it happens to have, in the form of an annual 'special dividend'.
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references:
http://openjurist.org/486/f3d/305/securities-exchange-commis...
http://www.shareholderforum.com/nyssa/Published/NPK/analyst_...
http://wenku.baidu.com/view/fa722b3383c4bb4cf7ecd1d8.html
it in the 1970's, pre-Amex and Coke. So what’s our old friend (and one of Buffett’s former darlings) National Presto been up to? And what’s behind their current ‘pay pretty much all excess cash flow each year’ dividend policythey seem to have adopted?
A quick check reveals that National Presto had a pretty exciting decade, from 1996 through 2006. And not in a good way, from a legal or regulatory standpoint. National Presto was sued by the SEC, had their auditors resign as a result of their SEC troubles, and when they then couldn’t get audited opinions on time, were late with financial statements and threatened with delisting.
What caused all this? Why did the SEC go on a five-year crusade against this otherwise conservative and innocuous company?
It turns out that National Presto's decade of travails started when then 78-year old Melvin Cohen responded with what might be characterized as Munger-like diplomacy to an inquiry by the Deputy Controller of New York State.
The miffed Deputy Controller then planted the seeds that would eventually trigger an SEC investigation, and when the by-then 83-year-old didn’t appropriately acquiesce to the SEC, the agency – with the uncanny ability to prioritize its efforts that it demonstrated all last decade, took its revenge. As the US Court of Appeals actually phrased it five years later, when it finally ruled to exonerate Presto, “the agency (or its senior staff) is in a snit..”.
The actual chain of correspondence might be rather comical if we set aside the thought that much of the rest of the financial world was beginning to spin entirely out of control as this all progressed.
National Presto’s transgression? They had attitude -- but since there are apparently no laws that our public servants could invoke for that, they were charged with something of a technicality: they had more than an allowable amount of ‘cash and securities’ on their balance sheet (specifically too much of a ‘securities’ component, because for example, their municipal bonds could not be categorized as excludable 'government bonds', nor their CD's as 'cash' - putting them above the allowable '40%' limit). They failed to request permission (in the form of an exemption from the Investment Company Act of 1940) from the SEC, and so were hammered.
Their compliance problems from that then just snowballed out of control.
But it's better just to read this and form your own opinion (though a caution: this is lengthy).
_____________________________________________________
The trail, from the beginning:
_____________________________________________________
August 29, 1996
Mr. Melvin S. Cohen, Chairman
National Presto Industries Inc...
Dear Mr. Cohen:
…the $77 billion New York State and Local Retirement Systems (“Systems”) is committed to achieving superior performance over the long term. With over $37 billion in domestic equities, including 43,200 shares of National Presto Industries Inc. we are concerned when the long term performance shows continued signs of lagging behind the Industry.
To monitor long term performance we have implemented an extensive analysis and review process……Our most recent objective screening and subjective review has raised concern regarding National Presto Industries Inc.’s performance. We are writing the Board to learn your reaction to our concerns and to obtain assurance that actions are being taken to enhance and maintain performance on a long-term basis. Indeed, with such an assurance, we believe, the reed for direct shareholder involvement in any other corporate other corporate governance matter is significantly reduced.
Since the Board’s response will be a factor in our monitoring process, we encourage you to maintain the line of communication we hope this latter has established. Your cooperation in providing a reply within the next two weeks would be greatly appreciated.
Sincerely,
John E. Hull
Deputy Comptroller
_______________________________________________________________
September 9, 1996
Dear Mr. Hull:
In response to your letter of August 29, it seems apparent that your belief that this company is underperforming its industry is predicated upon a false definition of the constituents of that industry.
The problem to which reference is made is not uncommon. Quite frequently, we find our company cast with producers of consumer consumables, such as Proctor and Gamble with manufacturers of major appliances, or with huge conglomerates such as Black & Decker and Premark International, both of whom do indeed have a segment of their business engaged in competition with us, but whose results, in those areas, are neither clearly defined nor controlling their respective destinies.
Should our assumption be correct, you may want to narrow your definition of the industry in which this company competes to producers of durable housewares, and, to be even more precise, consumers of durable electric housewares. Our arena does not extend to consumable items or to major appliances.
You may not be aware that over an extensive period of time this company has consistently outperformed most of its peers in terms of returns on sales and significant areas measured by accountants. We do not purport to influence the stock market, and regard those who keep one eye on Wall Street as failing to concentrate an their businesses which are difficult to run in any event, without dissipating talent and energy chasing a market will-o'-the-wisp.
So that you will appreciate our performance against our immediate peers, I am enclosing comparative data for those who are properly recognized as our competitors….Additional enclosures that should be of interest relate to two of the recognized pre-eminent companies in our industry, Sunbeam and Rubbermaid, both of which are troubled, indeed. Finally, so that you may observe that our industry is beleaguered even offshore, I am enclosing an article relating to an international leader, Krups, and a very recent clipping from The Wall Street Journal demonstrating that companies in our industry from Japan and Thailand are market laggards.
There was a time when we disdained comparative performance with other members of our industry, since we found such a study inappropriate. However, with the changes in distribution which have occurred in recent years, resulting in the pre-eminence of discount retailers such as Wal-Mart and Target, we must now accept that "price is king", and absent new product introductions of a revolutionary nature (which unfortunately are increasingly rare), profit opportunities have been seriously leveled.
In the last analysis, we recognize, as we believe you should, that our industry is under siege, with none of us showing any immediate promise of acceptable profitability. Under the circumstances, while we would regret losing you as a shareholder, would be fully sympathetic with a decision on your part to seek better returns elsewhere, and admit that doing so might be a part of your long-term responsibility.
Because of the rules of law that preclude our sharing “additional insight as to the future direction of the business or governance strategy” with any one shareholder rather than all simultaneously, our directors must regrettably decline any further comments. I believe, however, that if you read the last several annual and quarterly reports, the information you are seeking can be found in the appropriate public declarations.
Sincerely yours,
Melvin S. Cohen
_____________________________________________________________________
November 13, 1996
Mr. Melvin S. Cohen, Chairman
National Presto Industries, Inc.
Dear Mr. Cohen:
As indicated in my letter of August 29, 1996, the Now York State Common Retirement Fund is concerned about the performance of National Presto Industries, Inc., and will be monitoring the corporation to determine whether actions are being taken to enhance and maintain performance on a long term basis.
Our investment staff recently completed a thorough review of National Presto’s performance…. we note that the company's stock returns have been consistently negative, and its performance has been disappointing. At the same time, there are positive signs – such as the introduction of three new products – which encourage us to give management an opportunity to demonstrate its ability.
The Fund remains greatly concerned about issues of corporate governance. Ws are particularly disturbed that none of the directors are non – management independents with no direct relationship with the company. We firmly believe that independence encourages board members to act in the best interest of shareholders.
Similarly, we are disturbed that National Presto’s board does not include a separate compensation or nominating committee. Such committees, when they consist of independent directors, can ensure the quality of director nominees as well as provide shareholders a means to be involved in the nomination and compensation process.
Finally, because the Common Retirement Fund holds equity through index funds, we do not have the option to sell our shares in National Presto, contrary to the suggestion in your letter of September 9, 1996. For that reason, we remain committed to close monitoring of performance and communication with portfolio companies to obtain the reassurances that might preclude the need for direct shareholder involvement in other corporate governance matters.
I look forward to hearing from you.
Sincerely,
John Hull
Deputy Comptroller
___________________________________________________________________
November 22, 1996
Dear Mr. Hull:
Quite frankly, I was hoping that my letter to you of September 9 would put to rest any need for further correspondence.
So that you will not be laboring under false premises with respect to our three new products, I an enclosing a copy of our most recent press release which indicates that results are proving disappointing.
Your study of our company should have revealed that the family of which I am the patriarch holds approximately 30% of its stock. It should be obvious, therefore, that prodding from the outside is totally unnecessary. Try as I might, I can see no advantage to either of us by your proposed monitoring. It is unneeded, distracting and hence most unwelcome.
You are quite wrong in your assessment of our outside directors. Our newest director…. is a commercial banker, having had no previous relationship to our family or this company…. Walter Ryberg is a former Vice President for Sales, who has been disassociated from us, in all respects, for 13 years…. John Sirianni is an investment banker who handles only occasional transactions for the company or our family. All…have been selected for their independence and maturity of judgment.
While some huge corporations may be in need of the committees to which you refer, they would be as useful for us as a flea on the hair of a tail of a dog. Any concern with respect to compensation should be quickly dissipated, if you look at our forms filed with the SEC which show that both officer and director compensation is among the lowest, if not the lowest, of all companies of our size on the New York Stock Exchange.
From the fact that your shareholdings are derivative, with the primary shareholder being the fund in which you invested, I believe your quarrel lies with it, rather than us. If you disapprove of the mix in which the fund has invested, please express your disappointment, chagrin or recommendations to the fund manager. An alternative would be to substitute a fund which does not include our equity.
Please believe me, it is my desire to avoid rudeness, under any circumstances. Nevertheless, we should both recognize that correspondence between us is proving fruitless, and is consuming time, which could otherwise be properly devoted to our respective more direct concerns. Perhaps yours could be aimed at more individual stock selection (as opposed to the indiscriminate mix found in indices, such as the Mid-Cap 400) which would provide the flexibility in stock selection and rejection which you apparently sorely desire, but cannot secure in your present sterile posture.
Sincerely yours,
Melvin S. Cohen
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Sometime after, the New York Society of Security Analysts entered the picture. In their work product, they included all of the correspondence above, which they conveniently happened to have on hand for the project.
___________________________________________________________________
New York Society of Security Analysts Committee On Corporate Governance and Shareholder Rights
FORUM: Discussion Papers Regarding National Presto Industries, Inc.
July 1999
NYSSA is proud to provide a forum for analysis and debate on issues relating to corporate governance and shareholder rights…
Over the past five months members of the New York Society of Security Analysts ("NYSSA") have been working on a special project examining how potential changes in a publicly traded company's corporate governance practices might increase shareholder value…. Our intention was that this project would provide a real world, practical application of corporate governance principles for the training of NYSSA's analyst membership.
[excerpts]
What We Are Doing?
We want to analyze corporate governance issues on a similar level as corporate finance issues in the decision to buy, hold, or sell a stock. Our purpose is to provide analysts and investment managers with the tools to evaluate this type of investment situation…..
Why National Presto Industries?
For its test case, the Committee decided to draw up a list of companies with a combination of two conditions: first, a controversy concerning the management of shareholder assets, and, second, the existence of relevant corporate governance issues. The Committee considered 20 to 30 companies, eventually reducing it to a short list of a few companies based on published reports of corporate governance issues and potential value enhancement opportunities associated with proposed changes in uses of assets.
We finally selected National Presto Industries (the "Company"), based on a variety of considerations which included the following:
• Approximately 93 percent of 1997 stockholders equity, and 80 percent of the Company's total assets, were in cash or cash-equivalents.
• The Company had been maintaining similar levels of cash without growing its operating business for over a decade.
• The Chairman and President of the Company are a father and daughter who control approximately 29% of the stock, including approximately 23% held in a voting trust for family members.
• The Company had enacted several entrenchment provisions, including supermajority voting requirements, a staggered board and a poison pill.
• The six member board included three Company officers and, according to the 1998 proxy statement, met only twice during the past year.
• More than half of senior executives’ total compensation, which was generally below industry norms, consisted of "discretionary" bonuses based entirely on subjective judgment, without any formulas, defined performance criteria, or ties to shareholder value.
• Although the Company was small and not covered by any major analysts, it was familiar to many investors because of its position in an S&P index and some 1998 news coverage.
• There was a wide range of differing views among investors concerning the Company’s management policies and prospects.
• Management had demonstrated a willingness to vigorously express its views regarding corporate governance issues in response to past investor inquiries and attempts by shareholders to effect change
Highlights of the Compensation Committee Report presented in the Company’s 1999 proxy statement are as follows:
• The Company has not relied on stock incentives as a principal part of its compensation program for its executives. The rationale for this policy, according to the Company, is that Mr. Cohen, Ms. Cohen, and Mr. Bartl already own substantial amounts of company stock in relation to their compensation levels.
• The Company does not employ an outside compensation consultant.
• Annual bonuses are not based on upon a percentage or other formula utilizing revenues, income or other financial data as predicates.
• The Company has maintained salary levels below competitive levels.
• The Company has used the same compensation philosophy approach for more than 25 years and is not considering changing the philosophy.
• The defined benefit pension plan results in a maximum annual benefit of only $30,000 per year.
• There are no employment agreements.
The net result of this compensation program is that National Presto could have difficulty in attracting senior executive talent.
[The analysis continued with an assortment of recommendation by the NY Society member-analysts who participated in this project. Examples:]
NPK’s biggest customer is Wal-Mart, which accounted for 44% of 1998 revenues. This figure has risen steadily during recent years. NPK’s increasing dependence on Wal-Mart is worrisome. This development is largely due to the loss of business from other customers: For example, Caldor and Service Merchandise….
…significant reduction in advertising expenditures from $13 million in 1997 to less than $7 million in 1998.(5) In fact, NPK has embarked on a new advertising strategy that deemphasizes network television.
Although the new strategy is less expensive, it is not yet clear if it will be more effective. The 1998 sales decline may have been one unintended consequence.
In order to boost sales significantly in the long run, NPK needs to develop and market new products….
Finally, and most importantly, NPK’s working capital management policy can be described as excessively conservative. The company’s most recent balance sheet shows $241 million in cash, cash equivalents and marketable securities, which comes out to about $32 per outstanding share of common stock. This is more than 92% of shareholders’ equity and more than 81% of total assets…..
…Investing the cash reserves, about $241 million in 1998, in a suitable low risk, low growth business….If the company invested the $241 million alternatively in conservative ventures generating only 10% returns, the pre-tax income would equal $24.1 million.
Several alternatives to increase the return on shareholders’ assets….
Since the purpose of this analysis is not to choose a particular action for the company to implement, it is not necessary here to evaluate or rank these suggestions:
. New Product Development.
. Major Acquisition.
. Series of Small Acquisitions.
. Increased channels of distribution for the company’s products to reduce the company’s reliance on Wal-Mart.
. Stock Repurchase.
. Special Cash Dividend.
. Sale of Company.
. Take the Company Private.
…the chairman has stated in the 1998 Annual Report that the Company is considering the possibility of an increased role for their dormant subsidiary, National Defense Corporation: “A multitude of problems throughout the world may require military solutions. Under these circumstances, 1999 could prove a timely period for renewed efforts by this Company’s executives in pursuit of an elevated military role”.
Regarding management's willingness to change their use of shareholders' assets, some other concerns were raised:
1. The president of the company serves as both a corporate director and as the sole trustee of a family voting trust. Does this dual service raise issues regarding possible conflicts of different fiduciary duties?
2. The company might qualify as an investment company.
3. Some past institutional investors I spoke with were not able to open a dialogue with the Chairman …
…leads me to believe that existing management is not willing or able to take the necessary actions to increase shareholders' wealth.
..Shareholders could request an inquiry by the SEC to determine if the company is operating as an investment company and therefore would have to be registered as such under the Investment Company Act of 1940.
…Regarding the possibility of the SEC requiring the Company's compliance with the Investment Company Act, based on our understanding of SEC procedures as discussed at work group meetings, we should not expect the SEC to disclose the status of any inquiries unless it takes formal action.
____________________________________________________________________
National Presto's Maryjo Cohen responded to a draft of the report:
_____________________________________________________________________
June 22, 1999
Mr. Gary Lutin
Dear Mr. Lutin:
As promised, the enclosed material comments upon your submissions of April 26, 1999.
Shortly after receipt, I advised that just a quick reading revealed numerous factual errors, as well as dubious conclusions. My weekend review, which provided time for a careful examination, unfortunately leads me to believe that my initial impressions were charitable. Frankly, if I had been aware of the amount of work and hence time required to satisfy my obligation, I would not have undertaken the task. I became so tired that I may have failed to comment upon other obvious errors or false conclusions…..
…Perhaps your authors, none of which appear to be CFAs, lacked motivation or found reporting on NPK of insufficient complexity or general interest to merit a study in the first instance. If the latter is at the root of their difficulty, I must say I concur fully with them. Certainly their problem could not have been lack of transparency, since data supporting my comments upon factual matters are readily available in public documents.
Most people in your position would take their markdown and abandon the project. Such abandonment seems the appropriate course in that the project presumably was directed to the subject of corporate governance. Following the necessary editorial modifications to Mr. Tully's report, comments upon corporate governance are very few, and those that remain have been obviated by the overwhelming shareholder vote at our May 18, 1999 Annual Meeting endorsing our company's practices (to which Mr. Tully is opposed). Moreover, not a single broad educational value is served by the group, despite the fact that this was the second stated objective of the study. Finally, your report is confrontational, judgmental and critical of a company's practices, all of which appear to be out of harmony with the Society's policy in opposition thereto.
Should you decide that the report is still worthy of publication in any written form, I would appreciate receiving a copy, fully reflecting my analysis. My expectations in that regard stem from your repeated assurances that "anything you provide will be incorporated in the presentation of project material to be made available to NYS SA members and to the public".
While I recognize as strictly within your discretion the choice of format whereby the presentation of project material can be made available to NYSSA members and to the public, I think it would be helpful if my analytical comments appeared opposite or immediately following the exact statement(s) of the analyst, to which they relate.
Sincerely yours,
NATIONAL PRESTO INDUSTRIES, INC.
Maryjo Cohen, President
_____________________________________________________________________
Sometime after this, the SEC entered the picture. Apparently someone alerted the agency of the NY Society’s concerns that National Presto might be operating as an unregistered investment fund in disguise. The ensuing litigation activity with the SEC stretched for five years. The NY appellate court eventually overturned the earlier lower court decisions against National Presto. The appellate court’s summary was lengthy, but it nicely recapped the history, summarized the impact on National Presto, and clarified the various issues.
_______________________________________________________________________
United States Court of Appeals, Seventh Circuit.
Argued September 20, 2006.
Decided May 15, 2007.
Before EASTERBROOK, Chief Judge, and POSNER and EVANS, Circuit Judges.
1. Investment Company Act of 1940…Any issuer that owns "investment securities" worth 40% of its total assets is an investment company under § 80a-3(a)(1)(C) unless some other provision of the Act takes it outside the definition. For this purpose, however, "Government securities and cash items" are omitted from both the numerator and the denominator.
2. National Presto Industries….used to make everything it sold. During the 1970s it began to divest its manufacturing facilities and to contract production to third parties….Presto was left with a pile of cash, most of which it retained with a long-term plan to acquire other businesses, and a shrunken book value of operating assets. Financial instruments were 86% of its total assets by 1994 and 92% in 1998. Since 2000 Presto has purchased two manufacturers of military supplies and two makers of diapers and puppy pads. But in 2003 financial instruments still represented 62% of its physical and financial assets.
3. All of Presto's consumer products…are made by subcontractors, so although it has a substantial operating income it does not have operating assets to match—and the Investment Company Act's main test is asset-based. When the firm refused to register as an investment company—and make the changes to its corporate structure, management, and financial reporting required of investment companies—or request an administrative exemption, the SEC filed this suit to seek an injunction that would require compliance….The firm has complied pending appeal.
4. …Presto replaced enough of its existing portfolio with "Government securities and cash items" to bring investment securities under the 40% threshold…..
5. …the district judge…entered an injunction unconditionally requiring Presto to register as an investment company. The judge did not explain why….obliging it to register as an investment company even when its investments do not require this is hard to fathom except as a form of punishment for Presto's conduct in past years, and civil injunctions are not supposed to punish litigants.
6. The unconditional injunction has caused considerable trouble…..Presto's auditor, Grant Thornton, resigned because the SEC questioned its certification of Presto's financial statements as those of an operating company. Now that Presto is officially an investment company, Grant Thornton has refused to allow the statements it certified to be used for any purpose. This has disabled Presto from complying fully with either the Investment Company Act or the Securities Exchange Act of 1934. Without the financial statements, it is unable to file quarterly and annual reports. It has hired another auditor, but recreating and re-certifying financial statements for many past years is expensive and time consuming. Meanwhile stock exchanges have threatened to delist its stock because Presto is out of compliance with both statutory and exchange-based financial-reporting requirements.
7. …Now that it has complied with the injunction by registering as an investment company, can't it deregister and go back to its preferred status as an operating company, subject to registration under the Securities Exchange Act, no matter what happens on appeal? Deregistration requires the consent of the SEC, however, and although Presto filed the appropriate papers with the agency in January 2006 the SEC has failed to act on them.
8. One senses from this prolonged silence, and the tenor of the SEC's brief and oral argument, that the agency (or its senior staff) is in a snit because Presto declined to do what many other firms with excess liquid assets have done—apply to the agency for an exemption…Microsoft, for example, holds more than 40% of its assets in the form of investment securities but received permission to operate outside the 1940 Act…. a firm's refusal to kowtow to an agency is not a good reason to force its investors to bear unnecessary costs….Why is the SEC bent on grinding down a corporation that it appears to acknowledge would not mislead or otherwise injure investors by using the governance and reporting devices appropriate to an operating company?
9. Because Presto remains registered as an investment company while the SEC sits on its hands, there is a live case or controversy, because a remedy is possible: we could end its registration forthwith. Moreover, if we hold that Presto's former portfolio does not bring it within the Investment Company Act, it will be free to rejigger its investments; the old investments likely had a higher rate of return, which is why Presto switched only after the district court's opinion.
10-24
Let us begin, then, with Presto's argument that even before the recent changes to its portfolio, enough of its investments were "Government securities and cash items" to keep its "investment securities" under the 40% trigger….."Government securities" is a defined term…..According to Presto, pre-refunded municipal bonds ("refunded bonds" for short) fit this definition. Presto held these instruments in quantity...The Treasury bonds held in trust lead Presto to call the refunded bonds themselves "Government securities." It should be apparent…that they do not fit the statutory definition…municipal bonds issued by a city that plans to repay using U.S. bonds are still municipal bonds….Mutual funds may treat refunded bonds as if they were "Government securities" ….. How can refunded bonds be "Government securities" for one purpose but not the other?, Presto asks.
"Cash items" also are excluded when calculating the 40% ratio, and Presto maintains that "variable-rate demand notes" should be treated as "cash items." ….In contrast to the detailed statutory definition of "Government securities," the Investment Company Act does not define "cash items." Presto maintains that variable-rate demand notes are equivalent to cash because of the weekly opportunity to sell the instruments at par for cash….The reason that such investments are not treated as cash or its equivalent, however, is that the market price the instrument will fetch when sold is variable….Certificates of deposit and time deposits typically would not be considered cash items absent convincing evidence of no investment intent…..A variable-rate demand note does not fit this definition. Presto chose to invest in variable-rate demand notes rather than,….
25. Presto therefore comes within the 40% test and is an investment company unless one of the (many) statutory exceptions applies. The one on which Presto relies is § 80a-3(b)(1): "Any issuer primarily engaged, directly or through a wholly-owned subsidiary or subsidiaries, in a business or businesses other than that of investing, reinvesting, owning, holding, or trading in securities." Presto is actively engaged in several businesses. A visitor to its web site for consumers (http://www. gopresto.com) will find sales promotions, warranty information, and instruction manuals for pizza ovens and coffee makers but nary a hint that someone would want to buy Presto's stock as a means to own a derivative interest in refunded municipal bonds or variable-rate demand notes. But is Presto "primarily" engaged in selling pressure cookers, deep fryers, popcorn poppers, diapers, and ordnance rather than the business of holding securities? The statute is unhelpful; "primarily" is not a defined term. No regulation fills the gap.
26. Sixty years ago the SEC announced that it would consider five factors to decide whether a firm that sold off its operating assets and chose not to distribute the proceeds to its stockholders had become what people today call an "inadvertent investment company…
27. …..what matter are the company's history, the way the company represents itself to the investing public today, the activities of its officers and directors, the nature of its assets, and the sources of its income. Of these, all but the fourth favor Presto. Founded in 1905, Presto was an active manufacturer of industrial, consumer, and military products until the 1980s, when it started to subcontract manufacturing activities. It remains an active manufacturer of absorbent goods and military ordnance and sells a line of kitchen goods under its own trademarks.
28. As far as we can see, this is the first time that the SEC has argued that a firm with such a substantial ongoing presence in product markets is an inadvertent investment company….. one could not say that Presto had withdrawn from active business operations….. It continued selling both consumer and military products. It changed from a manufacturer to a firm that was (principally) a designer and marketer of products assembled by others, but this did not make Presto less an operating enterprise. Many other firms have made a similar transition (Apple comes to mind) without being thought to have evolved into mutual funds.
29. Presto presents itself to the public (and to investors) as an operating company. That's how its web site, its annual reports, and its publicity all depict it….. An investor in the market for a mutual fund, a hedge fund, or any other investment pool would not dream of turning to Presto, whose net income can increase or decrease substantially as a result of business successes or reverses. The price of Presto's stock moves in response to changes in its operating profits rather than the slight annual changes in its investment income. The SEC has not identified even one confused investor who bought stock in Presto thinking that he was making an investment in a closed-end mutual fund whose assets were the securities that Presto holds.
30. "Activities of Officers and Directors,"….likewise favors Presto. ….Presto estimates that 95% of its managers' time is devoted to running its consumer-products and military-ordnance businesses. The SEC has not offered any contrary evidence….
31. …Gross income at Presto is dominated by receipts from its consumer and military sales. More than 90% of Presto's gross receipts for every year covered by the record (1994 through 2003) comes from its sales of products. In 2003, for example, Presto recorded about $125 million in sales, yielding a net profit of $18.9 million; total receipts from investment securities that year were $4.2 million.
32. Only net income helps the SEC's position: the agency calculates that, over the decade covered by the record, 50.22% of Presto's net profits were derived from investments in securities. …..Presto was "primarily" an operating business when the injunction issued. Whatever classification may have been appropriate in the 1990s (when more than half of net profits came from investments) cannot support an injunction issued in 2005, when at least 60% of net profit was coming from consumer and military sales
33.…. the nature of Presto's assets….favors the SEC, for more than 60% of Presto's assets were investment securities during every year covered by the record….Yet looking primarily at accounting assets has a potential to mislead…. no investor would perceive such a firm as a substitute for a closed-end mutual fund; its stock returns would continue to depend on its operating profits and losses.
34-37...Reasonable investors would treat Presto as an operating company rather than a competitor with a closed-end mutual fund. The SEC has not tried to demonstrate anything different about investors' perceptions or behavior. It follows that Presto is not an investment company.
38. The judgment of the district court is reversed. Presto, which registered as an investment company only under judicial compulsion, now is free to drop that registration and operate under the Securities Exchange Act of 1934 whether or not the SEC gives its formal approach to that step.
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Anyway – the company still has a large cash & securities position – however each year it pays out whatever excess cash flow it happens to have, in the form of an annual 'special dividend'.
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references:
http://openjurist.org/486/f3d/305/securities-exchange-commis...
http://www.shareholderforum.com/nyssa/Published/NPK/analyst_...
http://wenku.baidu.com/view/fa722b3383c4bb4cf7ecd1d8.html
