Fiduciary Analyst expands scope of Lennar concerns with new report

February 4, 2009 by root

Independent Qualified Investment Fiduciary
Audits | Training | Expert Witness
www.fiduciaryexpert.com
CHRIS MCCONNELL & ASSOCIATES
Disclosure May Be Lurking At LEN, So What’s the BFD?
Chris McConnell, principal of Chris McConnel l & Associates, an
Accredited Investment Fiduciary Analyst (AIFA) in Los Angeles,
California, has identified a case study in the making that continues
to move his investigation and analysis of current issues involving
breach of fiduciary duty (BFD) forward. A potential bad “Land”
bank problem has been lurking beneath the surface at Lennar Corp
(NYSE:LEN) for years. This may raise the specter of BFD for
executives at LEN. Hundreds of off balance sheet, joint ventures
hold various interests in land assets and related debt obligations.
This allowed for a more favorable financial presentation but is
reminiscent of the Enron era.
As a result, a potential quintuple conflict-laden fiduciary liability
scenario arises. Is LEN a full-fledged five-flavor case study of BFD,
a financial crime, a Cinderella story, or the saga of a recovering
homebuilder in the making?
In an arrangement with the Fraud Discovery Institute (FDI),
McConnell has been asked to help dissect the admittedly complex
implications of the LEN case for shareholders, bondholders, other
stakeholders and fiduciaries. He believes, based on the
information and advice he has gathered following a 2008 10-k
review, that (NYSE:LEN) is currently in compliance with GAAP, loan
covenants and other regulations. However, compliance may be
described as minimal and perhaps less than shareholder friendly.
It is hoped that LEN soon returns to prosperity for the benefit of
all, including the unconsolidated joint venture partners.
Five flavors of fiduciary responsibility: wearing more than
one fiduciary hat leads to potential conflicts.
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LEN executives and directors may jointly and severally owe a
mélange of prudent fiduciary duty not limited to the following
parties:
1) Shareholders, 2) employees – is it still prudent to own LEN
shares in their 401k plan? – potential conflict with other
shareholders, 3) joint venture partners – potential conflict with
shareholders, 4) bondholders -- especially later if in the zone of
insolvency, 5) to the beneficiaries of their own family trusts or
foundations which own LEN shares – again potential conflict with
shareholders.
What should a fiduciary do? Eliminate or manage around conflicts,
second, fiduciaries depend on disclosure. Fiduciary duty is the
highest standard known under the law. It is predicated upon trust;
a fiduciary must place his own interests in second place, behind
those of the principal. This is referred to as the duty of loyalty;
other duties are care, skill, impartiality and caution with assets and
any other requirement per the contract or instrument.
What intrigued McConnell about LEN is that it operates in many
facets of what’s ailing the US economy right now, notably
homebuilding and credit. They served many first time and moveup
homebuyers in the over 55 adult communities, following its
acquisition of US Home, Inc. earlier this decade. LEN determined
early on that land acquisition was a key industry profit driver. With
a lead over its competitors, LEN obtained control of over 300,000
future lots – for instance, El Toro Marine Base in Orange County,
CA and Newhall Land in the Santa Clarita Valley, CA. LEN’s profits
grew due to ventures like these, often held in off balance sheet
entities, many with joint venture partners. An aggrieved Joint
Venture partner has engaged FDI to investigate potential fraud at
LEN.
Performance attribution is a key to dissecting past results
and future insights into stocks. What is LEN? What “drove”
its profits like few others in the boom years?
For many banks, broker/dealers, hedge funds, and other public
companies, including Enron and Worldcom, which seemed to
magically outperform rivals quarter after quarter, problems like off
balance sheet entities, leverage (debt), aggressive if not
questionable capitalizations and revenue recognition concerns
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waited. Similarly, questions about the quality of earnings were
pervasive. We’ve seen this scenario before, perhaps not yet at
LEN, but we recognize an emerging pattern.
LEN is a two-sided coin: Side one shows that since year end 2006
over $4 Billion or nearly 40% in write-downs on a $12 Billion asset
base have been recorded. Side two is a cloudy picture of
uncertainty, revolving around asset values and liabilities; perhaps
future write downs to come. Only LEN executives know the
solutions; surely they realize their fiduciary duty to maximize
shareholder value and yet these concerns have been floating
around for several years now.
Additionally some analysts’ concerns include:
• Accounting treatment erodes the quality of earnings; perhaps
with cost and expense shifting to off balance sheet entities
• LEN has been able to increase debt and leverage in some joint
ventures, in turn allowed it to take cash out; however, in a
declining real estate environment may be imprudent.
• LEN has experienced increased leverage and financial risk off in
the JV’s while at the same time enhancing its own financial
picture.
• Ironically, however, if LEN can reap $100 million from a since
terminated bankrupt JV, the man on the street may then ask
why don’t they look similarly to book gains from all the other
joint ventures?
• Partnerships pay LEN a substantial amount in management fees,
raises a potential conflict, control issues and or adequacy of
reporting for related party transactions.
• With hundreds of millions in potential recourse exposure,
shareholders are at risk of having a material amount of debt
come onto (a shrinking) balance sheet. However, if LEN is able
to go after other partners for up to two hundred million dollars of
it, is this realistically recoverable given this industry
environment?
• In the early boom years, gross margins from land sales have
varied widely from about 1% to 36%; earnings from land
development ranged from 9% to 20%.
• What’s remains fenced off in the joint ventures for now
potentially complicates and may stretch compliance with its
lenders’ recently tightened financial terms.
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Valuation models used during the boom years triggered huge
bonus checks, LEN’s CEO earned over $40 million in cash
compensation (and owns 190,000 shares, with no purchases since
2007). According to McConnell, “No one that I know of at any
financial services or real estate entity ever raised his or her hand
upon receiving a bonus check during the boom years and said,
“It’s too much.” Similarly, LEN will face continuing scrutiny in its
future reporting of net realizable values of unsold homes and land
that use off balance sheet or joint ventures with leverage and or
recourse. LEN and its auditors Deloitte & Touche must recognize,
although it’s not currently required, that more transparent
disclosures in the full light of day is the disinfectant that’s needed;
otherwise, bloggers (and others) may inquire.
Issues for fiduciaries – trustees, investment advisers,
mutual funds and regulators and public policy makers
include:
• Corporate governance rating of 26.4% or “D”
• CEO’s family controls 47% of voting power
• Unconsolidated joint ventures, and ongoing questions of
reporting transparency
• Warranty reserves dropped by $35 million; in the context of
LEN’s lawsuit filed against a Chinese supplier and pending
consumer complaints
• CEO cash compensation versus shares owned, scant insider
holdings
• The impact of the Graham Leach Bliley Act and the role of
financial intermediaries or disintermediaries
It’s sometimes helpful to check out how an entity holds itself out
to its customers and McConnell notes that LEN’s sales pitch to
would-be homebuyers states: “Everything’s included”®, including
the tag lines “Everything you want”… “Everything you need….we
included it, look for the ‘crystal clear’ box at our Welcome Home
Center”… Really? There appears to be a not-too-subtle contrast
here to investors’ uncertainty related to off balance sheet assets
and liabilities NOT in its financial statements. Financial disclosures,
like these tag lines, are clearly under management control;
curiously for the time being, fuller disclosure is a problem--and
remains in the shadows.

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