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Smulyan's pledge of stock could put company on line:

June 23, 2008

Emmis Communications Corp.'s newly filed proxy statement includes this unsettling disclosure: CEO and controlling shareholder Jeff Smulyan has 99 percent of the 5 million company shares he owns as collateral for a personal bank loan.

"If Mr. Smulyan defaults on the line of credit and the pledge is foreclosed, the sale of shares...could result in a change in control of the company," the proxy notes.

Similar language appeared in the company's proxy statement a year ago. But since then, the stock has fallen 73 percent, and Smulyan has upped his collateral by 1.6 million shares.

Company spokeswoman Kate Snedeker declined to elaborate on the latest disclosure, which says nothing to suggest Smulyan, 61, is crosswise with his lender. But a corporate governance expert says Smulyan never should have struck a lending agreement that had the potential of putting control of the company on the line.

'Irresponsible behavior'

"That is irresponsible behavior-[potentially] ceding control of the company to a third party simply because you need to collateralize a loan," said Paul Hodgson, senior research associate for the Maine-based Corporate Library.

Likewise, Hodgson said, the board never should have allowed him to put up such a large percentage of his holdings.

The company would not elaborate on Smulyan's lending arrangements, but Securities and Exchange Commission filings show that the value of his collateral has tumbled even as he pledged more shares. As of a year ago, when the stock traded for $10, he had pledged 66 percent of his holdings-a stash worth $34 million. The shares now trade for just $2.65, and his pledged collateral is worth less than $14 million.

While Smulyan surely didn't anticipate the stock would fall so far that he'd end up pledging nearly all his stock as collateral, "somebody should have stepped up and said that could happen," Hodgson said. "That somebody should have been the board."

Executives' use of company shares as collateral is far from new in corporate America. The practice allows managers to make big-ticket purchases or to diversify into other investments without selling company stock. Many executives are reluctant to sell shares in their own companies, in part because market watchers often view sales as a bearish signal about future performance.

Such pledges occurred largely outside public view until 2006, when the SEC began mandating disclosure on the grounds that they shed light on executives' exposure to risk, which could have a bearing on their performance and decision-making. In the wake of the mandate, many compensation consultants began telling client companies to discourage executives from pledging any shares.

"Pledges may reveal potential conflicts between company and shareholder interests," Mark Reilly, a partner at Chicago-based 3C Compensation Consulting Consortium, noted in a 2006 article in Workspan, a compensation and benefits trade magazine.

Risks of leverage

Indeed, highly leveraged executives can put boards of directors in a tough spot. Conseco Inc.'s board in early 2000 felt compelled to make a $23 million personal loan to then-CEO Stephen Hilbert, after that company's declining stock price spawned margin calls in his investment accounts. The board extended the financing so that Hilbert would not have to cash in a block of Conseco stock-a move that would have rattled investors as they awaited release of 1999 financial results.

Emmis' new proxy shows that Smulyan's pledged shares aren't his only use of leverage. He also owes Emmis nearly $1 million under a loan it extended before the Sarbanes-Oxley Act of 2002 banned such arrangements.

Investor uneasy

In an SEC filing last fall, Emmis investor Frank Martin, senior partner of Elkhart-based Martin Capital Management, fretted: "Of concern to us is that if the CEO has his back up against the financial wall, his judgment ... may be impaired," a scenario that might prevent investors from getting full value for their stock.

In an interview with IBJ late last year, Smulyan scoffed at the doomsday scenario. He noted that in the fiscal year that ended Feb. 29, he voluntarily worked for just $1 in salary-a show of unity with the company's battered shareholders.

"I can say now, vigorously, that I don't have an issue, but Frank never lets facts get in the way," he said. "If I were really squeezed, would I forgo my salary? Think about it logically."

Since then, Smulyan has returned to his regular compensation-he's slated to earn $905,000 in salary this fiscal year. And the stock's decline has continued, falling another 50 percent.

The new proxy heightens Martin's unease.

In a June 16 letter to the company, he wrote: "We can imagine ... a single bank by its unilateral action affecting a change in control that might not be in the best interests of all shareholders."
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