The facts in the case are simple.  Earlier this year Audit Integrity moved Hertz on to its watch list for companies in financial distress.  Hertz demanded a retraction and sent a copy of the letter to 19 other firms that made the list, encouraging them to join Hertz  in “protecting the investing public.”  Then Hertz sued Audit Integrity for defamation.  (See Sue Reisinger, “Hertz GC Sues Analyst Who Said Company Could Go Bankrupt”)

Audit Integrity responded with an open letter to the SEC.  James Kaplan, Chairman of Audit Integrity, wrote “As Hertz’s ultimate goal was to silence an independent research firm calling regulatory and investor attention to the company’s real and material financial risk, the matter warrants an investigation by the Securities and Exchange Commission.”

Quite frankly, the court should just toss out the case.  Any introductory student of mine can compute the Altman Z-score and indeed discover that Hertz is in financial distress.  Its 2008 10-K is quite revealing, with net income a negative $1.2 billion and EBIT a negative $164 million.  Retained earnings has a deficit of almost one billion dollars.  And its capital structure is heavily tilted on the debt side as its debt-equity ratio exceeds 10.  Any neophyte would agree with Audit Integrity.

Altman’s Z-score model for non-manufacturers is:

 Z = 6.56 * WC/TA + 3.26 * RE/TA + 6.72 * EBIT/TA + 1.05 * BVE/TD

where WC = working capital
TA= total assets
RE = retained earnings
EBIT = earnings before interest and taxes
BVE = book value of equity and
TD = total debts.

One interprets the Z-score as follows.  If Z>2.6, then we predict the firm is healthy and relatively free from financial distress.  If 1.1<Z<2.6, the company is in the indeterminate zone.  It faces some financial distress, but more investigation is needed to determine how serious it is.  But, if Z<1.1, then the model predicts that the firm faces a serious chance of going into bankruptcy.

When I plug Hertz’s 2008 numbers into the model, I obtain a Z-score of 0.417.  Altman’s model therefore predicts bankruptcy.  I guess Hertz should sue Professor Altman for inventing such a model.  After all, if the firm goes under, it must be his fault.

A few years ago Senator Wyden expressed concerns about corporate managers who attempt to intimidate those who issue research reports critical of them and their operations.  He correctly stated that the impact of such retaliation could have an adverse reaction on the publication of objective research, which in turn could have a negative impact on the quality of information that is employed by the investment community and could lead to an inefficient allocation of resources.

Chairman Cox responded to the Senator on September 1, 2005.  He stated that he shared Sen. Wyden’s concerns about issuer retaliation and its adverse impact on the investment community.  He promised to tackle the issue, but never did. 

Mary Schapiro, it is your turn.  Are you going to embrace the mission statement of the SEC and be an advocate for investors or are you going to be like your predecessor and say one thing but behind the scenes enable managers and directors to defraud the investment community?

Issuer retaliation is an incredible problem in this country.  If it isn’t stopped, independent investors will stop performing independent research analyses.  And there will be more and more Enrons bursting on the scene. 

Mary, where are you?  Where do you stand on the issues of the day?