Dirty Water 5


Disclosure: Short Cadiz (CDZI). This post expresses personal opinion about the company’s political strategy. It is not an investment thesis. Cable Car has no relationship with any of the individuals mentioned herein.

When a public company attacks a short seller, buyer beware.

After years of litigation and bureaucratic wrangling, management’s mounting frustration with the drawn-out approval process for the Cadiz water project is understandable. Proponents of the company’s increasingly long-shot project must have been upset by the October 2015 Bureau of Land Management (BLM) decision preventing it from using an obscure loophole to sidestep a federal environmental review.

Under the circumstances, Cadiz’ aggressive and expensive political response could be forgivable. However, the company’s August 2016 decision to engage in a coordinated smear campaign against an investor and a junior BLM staffer was unfair. The company’s disappointment at political setbacks does not justify public character assassination, nor does Cadiz advance its cause by making unfounded accusations.

Through a FOIA request, Cadiz obtained a series of emails between a BLM employee and Thomas McGannon, a partner at an investment adviser researching the water project. Cadiz issued a press release claiming the emails revealed the BLM decision “lacked objectivity” and provided the documents to the Wall Street Journal, peddling a thoroughly biased interpretation that accused the BLM and Mr. McGannon of impropriety. Perhaps swayed by its own political preferences (Senator Diane Feinstein, D-CA, is the lead opponent of the Cadiz project), the Journal published an unconscionable editorial, “The Pipeline and the Short Seller,” that unjustifiably accused Mr. McGannon of insider trading. The editorial noted that Cadiz provided the emails to the author, and Cadiz quickly amplified the editorial with another press release.

Call for retraction

Investors more accustomed to the investigative journalism the Journal is known for should be offended by the use of its mouthpiece for a company with a history of stock promotion at the expense of the reputation of a member of the investment community. I believe the Wall Street Journal owes Mr. McGannon an apology and retraction for its arguably defamatory editorial. The editorial falsely stated that “one Cadiz investor had inside information that could have allowed him to make a killing” and that the BLM “shared non-public information” with him.

In my opinion, the information exchanged in the emails was neither material nor non-public. Parts of the exchange sought informal views on whether proposed project modifications would be subject to BLM jurisdiction, not any indication of how the BLM might rule on an alternative. The rest concerned primarily procedural updates on the timing of BLM deliberations, not any indication of the likely outcome.

Administrative process timelines are a matter of public record. While agencies have FOIA procedures for releasing more extensive material including internal documents, which are also public information, it is entirely proper for government employees to share quotidian process updates with any member of the public who calls or writes to ask. Investors routinely interact with government agencies in this manner. Furthermore, there is nothing wrong with requesting information that an agency can choose not to release. Erik Pignata, the BLM employee with whom Mr. McGannon corresponded, made clear in one email that he could share only scheduling details, not the outcome of internal BLM discussions.

The Journal also makes hay of the time elapsed between emails and the fact that Mr. McGannon and Mr. Pignata also spoke on the phone. This amounts to an entirely unsubstantiated suggestion that the BLM FOIA office broke the law by failing to release relevant records. There is nothing in the FOIA response that suggests any emails are missing. And while it is theoretically possible that a phone conversation could have revealed non-public information, there is no evidence whatsoever for such an inflammatory suggestion.

According to Cadiz, the company’s requests for status updates from the BLM went unanswered. If their correspondence was also directed to Mr. Pignata and if he did not provide timeline details to Cadiz, he erred in not being equally responsive. Yet despite Mr. McGannon’s expression of opinions, there is nothing in the messages that indicates any substantive bias against the project from Mr. Pignata or his superiors at the BLM. Only a single comment from Mr. Pignata, after the decision was announced, implied that one controversial aspect of the local environmental review might have been “shady.”

The editorial was published in August, but I’m just now writing about it because it took time to receive a reply to my own FOIA request. I obtained the same series of emails by requesting the response provided to Cadiz. I am publishing that response in full here, as the Journal might have done instead of selectively quoting out of context. In my view, Mr. McGannon is at most guilty of being a bit overeager and irritating in his persistence, but you can be the judge of that for yourself:

PDF icon Read the emails

Why wade in?

Character is everything in the investment management industry. Even the whiff of impropriety, no matter how unfounded an accusation of wrongdoing, has been known to damage careers, prompting job losses and even investor redemptions. Publicly accusing an investor of misappropriating private information is particularly invidious, as it plays to popular misconceptions about what actually constitutes criminal insider trading. The reputational damage is done by the mere suggestion of cheating. The Journal editorial would implicitly criminalize a great deal of routine due diligence.

While I am wary of criticizing a company as litigious as Cadiz, I feel strongly that the public shaming of a fellow investor is unjust. I regularly seek public information from government agencies, as do my peers in investment research and investigative journalism. That is not wrong, and it should not be portrayed as being somehow insidious. Irrespective of the ultimate approval status of the Cadiz water project and Cable Car’s investment outcome, Cadiz sets a dangerous precedent.

As if the risks of short selling were not high enough, Cadiz has introduced the added possibility of the news media and even Congress (see below) being enlisted in a campaign of reputational damage against critics. Based solely on the project economics and its history, a large number of short sellers have independently reached the same conclusions as the Pump Stopper article cited by Mr. McGannon in one of his emails. The Pump Stopper article mentions unsuccessful attempts by the author to contact Cadiz as well as FOIA requests, which are publicly available. These imply that Cadiz was able to determine the identity of the article’s author, strongly suggesting that the campaign against Mr. McGannon was retaliatory in nature. The Journal should have known better than to get involved.

I have never knowingly interacted with Mr. McGannon, and I do not know if he was the source of the anonymous report. I know nothing of his character. However, I think it manifestly unfair for an individual’s reputation to be tarnished in this manner.

Cadiz protests too much

What passes for acceptable mudslinging in the corridors of Washington can be more damaging to non-politicians. Perhaps the reason for the company’s willingness to attack the BLM and a third-party investor is that Cadiz and its legal counsel/part-time CEO, Scott Slater, are no strangers to lobbying and backroom politics.

Mr. Slater is a shareholder of the law firm of Brownstein Hyatt Farber Schreck LLP (BHFS), which has been the company’s primary legal services provider since he joined as General Counsel in 2008. BHFS has a large corporate and government relations practice that includes significant lobbying work. The firm also operates a political action committee funded by shareholders of the firm, BHFS-E, PC PAC. The PAC makes about $400,000 of bipartisan contributions per election cycle.

Although Mr. Slater became CEO in 2013, he remains employed by BHFS and free to provide other services for them while collecting a $300,000 annual salary from Cadiz. On top of Mr. Slater’s salary, Cadiz pays an additional $300,000 annual retainer to BHFS for legal services relating to the project.

The retainer is a minimum commitment; the actual fees paid to BHFS by Cadiz have not been disclosed in aggregate but are considerably higher. For example, federal filings show Cadiz makes a $110,000 quarterly payment to BHFS for lobbying representation alone, while BHFS has simultaneously represented the company in various legal challenges to the project. Cadiz lobbying payments to BHFS began in Q4 2010 and have ranged from $400,000-440,000 every year since. In total, CDZI shareholders have compensated BHFS at least $2.4 million through June 2016 just for representation in Washington, although in five quarters the disclosures indicated that BHFS was compensated despite performing no lobbying activity.

What’s more, BHFS is eligible to receive incentive compensation based on project approval milestones. The firm has already earned three incentive awards since 2009, a total of 259,312 shares worth over $1.8 million at current market prices. They are eligible to receive a further 200,000 shares worth over $1.4 million upon achievement of additional milestones.

Mr. Slater’s unique employment situation makes BHFS a related party to Cadiz, a status that has been omitted from the related party disclosures in the company’s annual reports and proxy filings. Curiously, it was not until the second quarter 10-Q filed on August 8, 2016 that the company explicitly acknowledged BHFS as a related party in an SEC filing. I will leave it to securities lawyers to debate whether item 404(a) of regulation S-K provided a sufficient exemption from disclosing the total payments to BHFS.

CDZI, a company with only 10 full-time equivalent employees, spent $12.6 million on general and administrative expenses excluding stock-based compensation in 2015 and $9.0 million in 2014. Shareholders ought to know just how much of that went to Mr. Slater’s law firm.

Statement on apparent bias

Readers familiar with CDZI will have noticed that I have not yet mentioned the letters sent by Jason Chaffetz (R-UT) of the House of Representatives Oversight and Government Reform Committee to the BLM and Whetstone Capital. Partly that is because the committee’s activities appear to be rather more focused at the moment on another manufactured government email controversy and are unlikely to go anywhere. Yet the letters present the same concerns as the Cadiz press releases and Journal editorial. They also raise the separate question of why a Congressional committee would so readily adopt a financially interested company’s misleading insinuations of wrongdoing when describing innocuous correspondence.

It is probably only a coincidence that Representative Chaffetz has received 3 donations totaling $5,000 from BHFS-E, PC PAC. Cynthia Lummis (R-WY), his co-signer, received $1,000 from the PAC in 2013.

According to Federal Election Commission records, Mr. Slater has been an unusually prolific donor to politicians. He has given at least $78,977 of his personal funds to political committees and candidates for federal elective office, including $26,817 through the BHFS-E, PC PAC. I do not wish to insinuate that there has been any explicit quid pro quo from politicians in response to Mr. Slater’s or the PAC’s donations. Nevertheless, political contributions are a potential source of bias. The significant flow funds from CDZI investors to BHFS makes their political action activities important to consider as well.

Cadiz has focused its lobbying efforts during the current session on trying to insert an appropriations rider that would nullify the BLM decision. These efforts were primarily oriented toward Department of Interior appropriations legislation, which eventually passed the House but has been deferred to the lame-duck session by the most recent continuing resolution. I believe the language is highly unlikely to become law due to Senator Feinstein’s continuing opposition.

Interestingly, Cadiz’ second quarter lobbying disclosure form for BHFS added a new category of lobbying activities relating to the “Senate FAA authorization bill and amendments.” Obviously, the FAA reauthorization bill had nothing to do with water in the California desert, but BHFS evidently tried unsuccessfully to add a rider to that legislation sometime during the second quarter.

The Senate version of the bill was sponsored by John Thune (R-SD), Chair of the Commerce, Science, and Transportation committee. Mr. Slater donated $1,000 to Senator Thune on June 1, 2016, his first and only donation to the Senator. BHFS had not supported him since 2010. Senator Gary Peters (D-MI), a junior member of the committee who had not received any money from BHFS since 2011, made headlines in March for inserting other unrelated amendments into the legislation. On May 15, 2016, Mr. Slater donated $1,000 to Senator Peters. Neither senator faces a competitive reelection contest at the moment, giving Mr. Slater’s donations the appearance of an overt attempt to gain influence during concomitant lobbying efforts sponsored by his company.

Cadiz has also tried to win support from California’s federal Congressional delegation. Tim Sheehan, Cadiz CFO, supported Wendy’s Greuel’s unsuccessful House bid in 2014. Richard Stoddard, former CEO, donated to John Tavaglione’s ill-fated 2012 bid. Tavaglione is a Riverside county supervisor who has supported the project publicly. Both candidates for Barbara Boxer’s Senate seat this year have received contributions from either Mr. Slater or Keith Brackpool, Cadiz’ board chairman. To be fair, receipt of donations does not guarantee preferential treatment; even Senator Feinstein received $4,500 from the BHFS-E, PC PAC in 2012 (though nothing since).

In all, 19 current and former representatives are listed by the company on its most recent project support list. No doubt Cadiz has also supported local officials on the list as well, but since FEC data is more readily available, consider just the listed federal supporters of the Cadiz water project. At least 10 of these representatives have accepted money from Cadiz insiders through the second quarter of 2016:

Cumulative contributions from Cadiz insiders to stated supporters of Cadiz water project

Representative District Status BHFS-E, PC PAC Slater Other CDZI Executives Total
Jim Costa D-Fresno in office - 7,400 32,200 $39,600
Duncan Hunter R-El Cajon in office 5,500 - - 5,500
Darrell Issa R-Vista in office 4,000 - - 4,000
Ed Royce R-Hacienda Heights in office 4,000 - - 4,000
Ken Calvert R-Corona in office 2,500 500 500 3,500
Paul Cook R-Yucca Valley in office - 2,000 1,000 3,000
Linda Sanchez D-Cerritos in office 1,000 - - 1,000
Loretta Sanchez D-Santa Ana in office - 1,000 - 1,000
Gary Miller R-Redlands retired - 1,000 - 1,000
Doug LaMalfa R-Auburn in office 500 - - 500
Tony Cardenas D-Panorama City in office - - - -
Tom McClintock R-Roseville in office - - - -
Scott Peters D-San Diego in office - - - -
Collin Peterson D-Minnesota in office - - - -
Dana Rohrbacher R-Huntington Beach in office - - - -
Norma Torres D-Ontario in office - - - -
Mimi Walters R-Laguna Niguel in office - - - -
John Campbell R-Irvine retired - - - -
Gloria Negrete-McLeod D-Ontario retired - - - -
Totals $17,500 $11,900 $33,700 $63,100

In the company’s words, apparently now a “palpable dark cloud” hovers over the Congressional decision-making process.


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