Of the various companies caught up in the Galleon Hedge Fund matter, the headline that caught our attention was from Reuters and exclaimed, “McKinsey shocked by insider-trading allegations.” It has a whiff of Claude Rains, in the role of Captain Renault, expressing shock at the gambling in Casablanca. This is why.

One one hand, McKinsey has strict standards barring its consultants from trading stocks or funds that relate to the companies they are advising, a source close to the company said. The company's partners sign off each year on the policies. On the other hand, according to the Reuter’s story, McKinsey was aggressively recruiting college graduates by offering them new investment options, including getting a stake in a pool of McKinsey clients that gave the firm equity instead of cash for their consulting services. “A slippery slope,” says Lawrence White, a professor at the New York University's Stern School of Business.

McKinsey is looking at headline risk. The Financial Times' Newssift sentiment index reports that for the past week, the 9 article in the business press on McKinsey that included the word reputation were evenly divided at 33% each positive, negative, and neutral giving a positive/negative ratio of 1.0. For the month before the scandal broke, of the 11 articles, four were positive and two were negative for a p/n ratio of 2.0. (For comparison, Johnson & Johnson (NYSE:JNJ), the reputation leader for early 2009, had a one-year p/n ratio of 8.3)

Ironically, earlier this year, consultants from McKinsey authored an article on the importance of reputation management. The article called for substantive business process controls, and highlighted the limitations of public relations. Perhaps this is why McKinsey, so far, has been tight lipped?

Former Fed Chairman Greenspan noted last year that in a market system based upon the intangible asset of trust, reputation has significant value. Madoff aside, trust is having a hard time on Wall Street. We share two recent stories of reputation malignment (vilification?) in the Financial services sector.
 
The first, reported by the Financial Times last Thursday, is that one in five hedge fund managers misrepresents their fund or its performance to investors during formal due diligence investigations, according to research from New York University's Stern School of Business. Researchers found that the most common misrepresentations by hedge fund managers was the amount of money they had entrusted to their funds; Performance and regulatory and legal histories are also often misrepresented.
 
The second, which broke widely on Friday, involves allegations of trading on insider information at the hedge fund, Galleon Group. According to prosecutors, co-conspirators of fund founder Raj Rajaratnam include a McKinsey & Co. consultant, an IBM (NYSE:IBM) senior vice president, an Intel Corp. (NASDAQ:INTC) treasury manager and two executives from the New Castle hedge fund group of the defunct Bear Stearns.

The reputation angle obviously interests the Society. But there is more. What really interests us is how McKinsey, IBM, and Intel will manage the headline risk. Will their intangible asset risk management systems allow them to characterize the malfeasance as the product of rogue actors? Or will they be held culpable for the non-compliance of their employees?

Stay tuned.

We all know instinctively, if not by experience, that five minutes of headline risk can destroy years of reputation building. The IAFS is interested in the business processes that build reputation, the processes that transform perceptions into reputation, and how that value can be maximized. We focus on the intellectual properties that comprise business processes for innovation, safety, security, ethics, sustainability, and quality. We focus on artifacts of these processes, such as patents and trademarks, and we focus on metrics.

While the most important commercial metrics are financial, there are leading indicators of reputation that inform on reputation development through its value chain. That value chain is discussed in an article in issue 36 of the journal produced by the Society's publication partner, IAM magazine, IA Metrics for the Other IP Market. The value chain schematic from that article is reproduced below.





Today's note calls our readers' attention to a metric of public impression comprising, as shown above, "media tone." The source of the media tone metric is the Financial Times' new product now in beta, Newssift. From a recent Newssift blog, we provide a link, without addtional comment, on the FT's media tone metric, sentiment, as used to report on the retail sector.

To recap the leader of the most recent FT/Newssift blog, "How are discount retailers weathering the economy? Fresh on the heels of news that Wal-Mart missed its sales expectations, we’re using Newssift to explore sentiment in the discount retail sector."

For those who have participated in the Society's monthly call, Mission:Intangible Monthly Briefing, you will appreciate that the above fits well with our summer-of-metrics theme. Comments on the FT media tone instrument are welcome.

We dedicate most of the time and effort of this communication channel to a discussion of the intangible assets that underpin reputation. Usually, the subject matter involves corporate behavior.  Awareness of issues associated with corporate behavior may come to light because of government regulatory action. More often, it is the result of NGO-driven publicity. In a break with tradition, the subject of today's note comprises NGO transparency. 

An on-line Wall Street Journal op-ed posted earlier this week alleged that Human Rights Watch, a 30-year old NGO dedicated to defending and protecting human rights, sent its leading Middle East official, Sarah Leah Whitson, to extract money from potential Saudi donors by bragging about the group's "battles" with the "pro-Israel pressure groups." The ongoing dialogue appears to affirm the allegations.

NGOs are important actors in both the geopolitical and commercial worlds. They encourage and monitor corporate compliance with many of the best practices comprising key business processes that underpin reputations for ethics, safety, and sustainability. They are respected and feared by much of the business community. Their primary tool is the threat of headline risk. Their moral authority depends on their reputation for independence. Their value is ephemeral. Loss of reputation and moral authority can be catastrophic.

Ronelle Burger and Trudy Owens from the University of Nottingham recently published a study that was motivated by “widespread calls for NGOs to become more accountable and transparent.” They conclude that “… NGOs with antagonistic relations with the government may be more likely to hide information and be dishonest.“

Human Rights watch has an antagonistic relationship with the Israeli government. The Israeli government wasted no time questioning HRW's "moral compass. "

Quis custodiet ipsos custodes?

On June 30 2008, Margaret (Peggy) M. Foran was appointed to executive vice president, general counsel and corporate secretary of Sara Lee Corp (NYSE:SLE).  In addition to overseeing the company’s worldwide legal activities, Peggy led Global Business Practices, risk management, internal audit and insurance activities, as well as environmental, safety and sustainability efforts. In our parlance, she was Sara Lee’s risk and reputation officer. She reported to Brenda C. Barnes, chairman and chief executive officer, Sara Lee Corp. On June 9th, after less than one year on the job, she abruptly stepped down “for personal reasons.”

What’s going on in the background? Dogs -- hot dogs, to be exact. There is the May 2009 lawsuit filed by Sara Lee against Kraft Foods (NYSE:KFT) for false advertising – the so called hot dog wars. There is the concurrent recall of 1700 pounds of Sara Lee Ball Park brand hot dogs for mislabeling.  Hardly steamy stuff.

Is there some reputational risk lurking for which an indication or warning might be found in the Steel City Re IA (Corporate Reputation) Index?. The Index, which correlates with reputation surveys such as those published by Forbes, Fortune, and Harris Interactive, captures the financial implications of stakeholder behaviors and expectations of stakeholder behaviors as determined by corporate reputation. The Index is a good leading indicator of financial performance and returns on equity.

 

The Steel City Re Index shows that the reputation metric has been hovering in the 40th percentile amond the 48 companies in the Packaged foods & meats sector this past year. Although there is a distinct upward movement from the 40th to the 50th percentile co-incident with Ms. Foran's appointment, the trend has otherwise been downward until a recent recapture of lost ground. Although EWMA volatility has been declining, it is still at 4log orders of magnitude. Economically, over the past twelve months, SLE has underperformed its peers by 16.5%. In short, the mystery is why the dog didn't bark.

By our indications and warnings metrics, this type of economic underperformance in the setting of an already low reputation index increases the risk of business process corner-cutting -- actions that can lead to business process failures and expose a company's reputation to a myriad of perils and headline risk.

Ms Foran joined Sara Lee with a stellar reputation of her own. In CEO Barnes' welcome announcement last year, she said "During her three-decade long career, Peggy has earned the respect of corporate leaders, stakeholders, directors, investors and peers. She is recognized worldwide as a true leader with a reputation for the highest levels of personal integrity." She had tours of duty at Pfizer, ITT, and JP Morgan. 

We'll be following this one closely.

This note explores whether a proposed transaction by a $75B beverage company, Pepsi Inc. (NYSE:PEP), is motivated by costs savings, brand enhancement, or reputation protection. Seeing no perceptible movement in the reputation index of either the company or its arch rival, we conclude that notwithstanding which of the three was the initial trigger, the greatest value may be in reputation risk management.

On 20 April 2009, Pepsi proposed buying the outstanding shares it does not own in its two largest bottlers, Pepsi Bottling Group (PBG.N) and PepsiAmericas (PAS.N), in a $6 billion cash and stock deal. Many in the financial press suggested it was a cost-cutting initiative. Jon Baskin, a marketing iconoclast, a keynote speaker at the Society’s 2008 annual conference, and the author of the book, “Branding OnlyWorks on Cattle,” opined that the move represented brilliant, strategic branding. In Jon’s words:

Think about it. New packages and formulations, available at new and different locations, priced and supported in novel ways...all thanks to a holistic approach to the brand, vs. some archaic top-down application that sees it only as image and words. It's these actions, and real investments, that will build sustainable, long-term brand growth.

Cost savings and long-term brand growth are both good things, reflect well on management and enhance reputation. So, with two weeks having now elapsed during which the market has had an opportunity to digest the news, and while the deal is still in the negotiation phase (the bottlers rejected it on Monday), we called on the Steel City Re corporate reputation index to see what impact the news has had on the reputations of Pepsi and its arch rival, The Coca Cola Company (NYSE:KO).

As shown in the charts below, the short answer is “not much.” Pepsi tops the fifteen-member Soft drink sector; Coke is in the 92nd percentile. Volatility is nil. In fact, in the midst of the most tumultuous market since the great depression, these two iconic firms emerge with nearly identical profiles comprising exceedingly stable reputation metrics. With Pepsi and Coke’s market caps at $75B and $100B respectively, are they too big to budge?






Big, yes, but not too big to trip and fall. As we see it, both pay exquisite managerial attention to their reputations. Ethics, quality, safety, security and sustainability are all watchwords. Innovation is alive and well. So the competition between these two is analogous to that of two chess grandmasters. They see all, know all, and understand the implications of every move and its derivatives. The game, therefore, is waiting for one or the other to make a mistake. It is a game where risk management is the winning play. And given the relative values of the physical assets and intangible assets at the two companies, reputation loss arising from a business partner where visibility and control are weaker – supply chain headline risk, if you will – is one of the major risks we believe needs to be managed.

So let us put our own spin on Pepsi’s announced acquisition: from an intangible asset finance management perspective, it is a prudent move to manage reputation risk arising from a third party. While it may not increase Pepsi’s brand value or enhance its reputation, it may prevent the sort of reputation loss that destroyed nearly 14% of Coke’s value 10 years ago.