In past instances, Toyota tackled the issue head on. In 2008, after the frames of certain trucks were found to be rusting, Toyota determined it could not fix the problem. Instead, the company decided to buy back the trucks for one and a half times their value.

Rather than costing Toyota customers, the move built brand loyalty.

In her soon to be released book, “The Economics of Integrity,” (Harper Studio) financial journalist Anna Bernasek devotes a chapter to examining how Toyota’s “relentless focus” on quality and the customer made it the most successful auto maker in the world.

Deal Journal caught up with Bernasek to discuss Toyota’s history and how it is coping with the current crisis.

Deal Journal: Do you have and thoughts on how Toyota can fix its image?
Bernasek: I have a quirky idea. When J&J had the issues with Tylenol, it redesigned the packaging to have tamper-proof packaging. That was soon adopted by the industry. Well, what if Toyota went to at least the Japanese or Asian car makers — I am not sure the U.S. car companies would get on board — said let’s design the same pedal and make it standard. So if the issue happens again, its not the design. It’s an industry standard.

Deal Journal: Toyota has historically been known for its quality. How did it build up that type of brand recognition?
Anna Bernasek From the start, Toyota was all about quality and catching problems. That culture has really built the brand. Toyota became synonymous with quality. It goes back to its philosophy that it is concerned with the best way to deliver value to the customer, to the shareholder, to the dealer and to every person involved with Toyota. It focused on giving the customer what they wanted honestly and openly.

The whole thing with Toyota and quality is that Toyota delivered on what they promised. That forms a bond of trust with the customer. And it took decades to build that bond.

That culture pervaded every aspect of the company. Toyota set everything from the factory floor to the internal organization to focus on and to deal with problems as they arise.

Deal Journal: The latest recall is not Toyota’s first. How has Toyota dealt with past mass problems with its cars or trucks?
Bernasek: In the past, Toyota has gone out of its way to put the customer first. In the case of the Tacoma, Toyota found this issue of rusting in the truck’s frame. These were trucks that were around a decade old. Toyota said it would give the owners of these trucks a certain amount of money back — in some case $10,000 or $15,000. That was an example of how Toyota dealt with these issues where it went above and beyond what was called for. But it cared about building a relationship with the customer.

Deal Journal: What does that tell us about how Toyota will deal with the issues surrounding the latest recall?
Bernasek: I think the difference in this case — specifically the pedal and the acceleration — is that there is no smoking gun about what is wrong. They have been criticized as slow to respond. But Toyota has had all its engineers on it, and they have not been able to find a major problem. There hasn’t been any thing definitively wrong.

I think what exacerbated the situation was that spectacular crash when the fellow was calling 911. I think Toyota didn’t understand how that can catch people’s imaginations.

Deal Journal: Toyota became the biggest auto maker in the world a few years ago, did it lose sight of its culture of catching problems in the pursuit of becoming the biggest?
Bernasek:I don’t think so. I think it is so ingrained in their culture to put the customer first. It is just so much of their culture that shifting away from that for growth…I don’t see it.

I think they can recover from it quickly. It depends on whether they will continue to be open, explain things fully and are prompt with fixes. A lot will depend on the next six months. But I definitely think they can recover.

Morningstar-Footnoted: The blog founded by Michelle Leder, which has spent more than six years combing through SEC filings to find information buried in the fine print, is being acquired by Morningstar. Leder writes in a note to readers: “For readers already familiar with the site, few things will change. I’ll continue to run things from footnoted world headquarters in Peekskill, N.Y., as an employee of Morningstar, and there will be more of the same great content regular readers have come to expect. One small change will be that in the near future, footnoted.org will become footnoted.com, though both domain names will get you to the same place. In addition, some of footnoted’s content will appear on Morningstar.com, exposing their loyal audience of avid investors to the footnoted brand.”

Boomtime buyouts: While a number of the mega-buyouts from 2006 to 2007 have wiped out investors, some have made it through the crisis. Despite that, PE firms still have still have plenty of work to do to prove to investors that mega-funds and mega-buyouts can deliver decent returns, writes Preqin.

Will Telecom M&A comeback 2010? From DealZone: “The U.S. wireless sector will likely see some deals born of necessity, but that doesn’t spell the return of M&A to the telecommunications sector as a whole.”

Airgas-Air Products: Airgas formally rejected Air Air Products & Chemicals unsolicited $5.1 billion offer to buy the company, saying th deal “significantly undervalues Airgas.” See the press release here.

Typically top executives freeze most stock-trading activity in the middle of negotiations, as they may be in possession of material, non-public information. That can serve as fodder for shareholder attorneys, who typically scrutinize executives’ actions in the middle of merger battles.

McCausland exercised 150,000 options with a strike price of $5.5 and another 150,000 options with a strike price of $8.99 on Jan. 5, when the Airgas stock price was $48.22. That gave him a paper profit on those options of about $12.2 million. Those shares are worth more now, with Airgas trading today at $61 a share.

Under tax rules, McCausland would pay a tax on ordinary-income for the difference between the option strike price and the price at which it is exercised. Any appreciation after that exercise could accrue as a lower-rate capital gain in certain circumstances.

Yesterday, Airgas sent a letter to Air Products, rejecting its $60-per -share unsolicited offer. It said the the proposed deal “very significantly undervalues Airgas and its future prospects.”
An Airgas spokesman said the company’s internal and outside counsel reviewed McClausland’s options exercise.

About half of McCausland’s options were set to expire in mid-May. For that reason, said University of Chicago Booth School of Business finance professor Steven Kaplan, “it’s unusual, but probably okay.”

“He still has an incentive to make the deal go through,” because the value of his shares depend on the deal closing.

There was less time pressure for the other 150,000 options, which would have expired in May, 2011.
Airgas spokesman said the fact that Mr. McCausland, who is the company’s largest shareholder with a roughly 9.3% stake, is holding onto the shares indicates his belief in Airgas’s long term prospects. The exercise may also add to his ability to deliver votes in any upcoming contest for control of Airgas.

Many of the corporate-governance issues of the past decade, such as say-on-pay and proxy access, have gained greater traction in the wake of the worst economic downturn in since the Great Depression. The U.S. government has put executive compensation under increased scrutiny; the SEC is requiring increased disclosure on the relationship between risk and a company’s compensation practices; while shareholders are putting forth a greater number of proposals.

And as interesting as this year is likely to be, next year may well be more so. To sort through the all the issues and new rules facing boards, Deal Journal turned to Samuel Wolff, a partner at law firm Akin Gump Strauss Hauer & Feld.

Deal Journal: What impact is the financial crisis having on boards?
Samuel Wolff: This year we have the convergence of pressure by activist and institutional investors, public scrutiny of executive compensation, Congressional hearings and legislation, and new SEC regulations. These activities and trends are not necessarily new, but are increasing in intensity and interacting with each other–largely in response to the financial crisis–to a degree we have not seen before. These forces are converging and will put pressure on corporate boards.

DJ: Executive compensation has been a hot-button issue for many years. How has the financial crisis impacted the discussions within the corporate boardroom?
Wolff: The financial crisis has caused the government to focus on the relationship between compensation and risk. SEC rule changes are requiring companies–and not just financial firms–to look more closely at that relationship. The focus on risk is not a new thing. What is different is the focus on the relationship between risk and compensation. Boards and compensation committees are now looking more closely at whether their compensation practices incentivize inappropriate risk-taking.

Executive compensation has increasingly been under fire over recent years. The financial crisis has accelerated pressure on corporate boards in this area. Say-on-pay is a very important issue that has been given momentum by the financial crisis and that is increasingly on board’s radar screens. The crisis has also caused regulators to think about the role of compensation committees and compensation consultants.

DJ: Say-on-pay and proxy access have received a lot of attention, but have yet to go into effect. What impact are these potential rules having on corporate boards?
Wolff: There are few companies that have instituted say-on-pay provisions outside of TARP. A handful of companies have followed an alternative approach and provided biennial or triennial say-on-pay. I don’t think that’s the way the law is heading and generally, I think companies are waiting to see what’s going to happen with say-on-pay in Congress. It’s a fluid situation right now. It’s straightforward in the House but the fate of the legislation in the Senate is unclear; the Banking Committee has not marked up its bill yet. Right now it unclear how it’s going to come out on the Hill; but if there is a financial reform law it would not be surprising at all if it includes say-on-pay.

Say-on-pay is probably the most common shareholder proposal, so boards will also be feeling some pressure from shareholders on this issue.

DJ: What about proxy access?
Wolff: Proxy access is a major rule proposal; if adopted it will be a major change in U.S. securities law. The focus to date has been on having input into the SEC’s regulations through the comment process. The comment period as extended just ended last month.

If the rules are adopted as proposed, public companies generally are not going to be too happy about them. Many companies think the share ownership requirement (one percent for large accelerated filers) is too low, and the holding period (one year) too short. There is some sentiment that the shareholder ownership position should be unhedged. More generally, many companies think the government should allow some type of “private ordering,” through which companies with shareholder approval can design their own systems or even opt out.

DJ: What rule change that has gone into effect this year is likely to have big impact this year?
Wolff: One of the biggest changes is an amendment to a New York Stock Exchange rule. The change eliminated broker discretionary voting in uncontested director elections. This affects all public companies, not just NYSE companies. Prior to this year, brokers were allowed to vote uninstructed shares in uncontested director elections–in other words, where investors didn’t tell the broker how to vote. More often than not, these shares were voted in favor of the board’s nominees. The SEC approved the rule change so that brokers no longer have discretion to vote uninstructed shares in director elections. That is a large percentage of the votes–I’ve seen estimates of about 20%. For companies that have majority vote requirements, it will be harder to get to a majority.

They can see, for instance, that CIC holds shares of American International Group, Apple and Citigroup, as well as the same sorts of index funds many small investors buy to get broad exposure to different markets. What insights can investors glean about the fund’s strategy and how the people who run it view the markets? Here are some answers to these and other questions naturally raised by CIC’s disclosure.

Is China building strategic stakes in big U.S. companies like Apple and Coca-Cola Co. through its sovereign-wealth fund? Unlikely. CIC held just 30,000 shares of Apple at the end of 2009, representing an insignificant amount of the 907 million shares outstanding. The same calculation works for the other U.S. blue-chip holdings: each is a tiny number, mostly less than 1%. The exceptions are its negotiated investments in companies such as Morgan Stanley and BlackRock. In both those cases, the company’s management sought out and welcomed CIC’s investment.

Chinese companies attempting to buy big stakes in U.S. businesses have at times met with political resistance and rejection, and CIC’s management is aware of the sensitivities that would be raised by its own presence as a major shareholder in certain companies. In fact, CIC management has said so in the past.

So, how much of CIC and China’s overall portfolio does this represent?

A relatively small portion. The $9.6 billion invested in U.S.-listed equities is less than 10% of CIC’s $110 billion allocated for international investments. It is an even smaller fraction of the Chinese government’s overall portfolio if you consider the $2.27 trillion in reserves held by the State Administration of Foreign Exchange at the end of September. The U.S. Securities and Exchange Commission is concerned with U.S. public-market investors, so stakes in unlisted holdings by CIC aren’t included. Many of the holdings disclosed in the filing are shares in foreign companies with American depositary receipts or exchange-traded funds whose underlying assets are outside the U.S.

Does that mean China is bearish on the U.S. market?
Hard to say. It is likely that CIC has much more invested in the U.S. and elsewhere on its behalf by outside managers. Some estimate CIC has put more than $25 billion into markets through outside managers. CIC hasn’t released any indication of the size of those allocations in 2009, which will probably only be disclosed in its annual report later this year. It has also placed billions of dollars into fixed-income products, hedge funds and private-equity funds. None of those are covered by its 13F filing with the SEC.

Senior CIC officials, including Chairman Lou Jiwei, have said they believe there are better investment opportunities in emerging markets, including China. Many foreign investors take a similar view, and U.S. investors pumped a record amount of money into overseas mutual funds last year. However, CIC retains large stakes in U.S. financial firms including Morgan Stanley and Blackstone Group, despite the decline in the value of those investments.

What does the filing tell us about CIC’s strategy?
It appears CIC is giving its in-house portfolio managers a chance to construct investing strategies with a tiny proportion of CIC’s own money to deploy into relatively blue-chip companies that they believe either have strong growth prospects or are undervalued. Names on the list such as insurer AIG and Citigroup were hit hard in the financial crisis and would benefit from a rebound in the U.S. economy. Interestingly, CIC held a $5 million stake in Burlington Northern Santa Fe Corp., a company that at the end of 2009 was in the middle of a takeover offer from Warren Buffett’s Berkshire Hathaway. The strategy of holding stakes in companies in the middle of takeovers is called “merger arbitrage.” It is a common hedge-fund strategy and depends on the ability of a fund to read the likelihood of a deal being completed better than the market.

Is China’s sovereign-wealth fund becoming more transparent by making such a disclosure?
The SEC requires any institutional investors holding more than $100 million in U.S.-listed securities to submit the same sort of 13F filing that CIC made. So it is fair to say CIC wasn’t doing this because of a desire for transparency, even if transparency is the end result.

In fact, CIC’s president, Gao Xiqing, has said he doesn’t believe it is smart for CIC to reveal its holdings and positions because it allows the market to move against them. This is a similar view that many hedge funds take, and they also have to file Form 13Fs to the SEC, which are usually disclosed. A few managers, such as Buffett, sometimes receive exemptions because they are pursuing trading strategies that take place over extended periods of time, which they argue could be adversely impacted by other market participants knowing certain holdings. But that is ultimately the SEC’s call, not the manager’s.

China’s massive national investment fund provided the closest look yet at its politically sensitive holdings in a securities filing yesterday. The filing revealed that it has accumulated small stakes in more than 60 U.S. companies, such as Coca-Cola, Apple and Goodyear. Yet CIC has apparently focused its biggest bets disproportionately outside the U.S.

Below Heard on the Street columnist Andrew Peaple discusses the filing:

Goldman Sachs Group’s PR crew has been keeping up the fight against any criticism that it acted improperly leading up to and during the global financial crisis. The latest effort is a point-by-point dissection of a New York Times article last weekend about cash payments it says Goldman demanded from American International Group starting in the summer of 2007, which the newspaper suggests started the New York insurer’s slide toward ruin.

Goldman spokesman Lucas van Praag, writing in the Huffington Post, points out nine “errors” in the article and then presents the “facts.” (Many of van Praag’s comments were included in the original Times article, but he reiterated them in the Huffington Post item anyway.)

The AIG-Goldman conflict has been examined in multiple newspaper articles and in Congressional hearings. The Times article expands on the subject by obtaining internal communications from AIG executives at the time, describing their frustration that Goldman was valuing AIG-held securities at what they and others (notably BlackRock) believed to be lowball prices.

While van Praag’s makes some interesting points, the Huffington Post piece reads more like a “he said, she said.” Perhaps the most effective retort would have been to highlight a passage straight from the Times article: “Several former Goldman partners said it was not surprising that Goldman sought such tough terms, given the firm’s longstanding focus on risk management.”

Throughout the AIG negotiations, Goldman was acting in its self interest, raising capital and hedging against the coming mortgage storm. It may not look pretty in hindsight, but negotiating a tough deal was arguably in the best interest of Goldman’s shareholders.

Unmentioned by Van Praag but likely bolstering the Goldman defense is that analysts and investors were publicly questioning AIG’s valuation of its mortgage derivates at the same time that Goldman was challenging them at the negotiating table.

AIG’s optimism turned out to be misguided. The rising wave of mortgage defaults was eventually going to force down AIG’s marks, regardless of how tough Goldman’s negotiated.

Goldman Sachs

Hitting Goldman Where It Hurts: U.S. proposals to ban banks from using their capital to acquire stakes in companies would have the biggest impact on Goldman Sachs, which has the world’s largest private-equity operation. [WSJ]
Related: Goldman Sachs and Canada’s Onex Partners paid $3.3 billion for airplane maker Hawker Beechcraft Corp., betting the wealthy would splurge on a new generation of private jets. Since then, the Wichita, Kan., company has come crashing down to earth. [WSJ]
Goldman-AIG: Goldman responds to the New York Times article. [Huffington Post]

Financial Institutions

Wall Street’s Race to the Bottom: Elizabeth Warren writes: “This generation of Wall Street CEOs could be the ones to forfeit America’s trust. When the history of the Great Recession is written, they can be singled out as the bonus babies who were so short-sighted that they put the economy at risk and contributed to the destruction of their own companies. Or they can acknowledge how Americans’ trust has been lost and take the first steps to earn it back.” [WSJ]

Sen. Robert Menendez wrote to the Fed last July asking it to approve a bank takeover that would have kept two of his campaign contributors from losing their investments in the ailing bank. [WSJ]

Rakoff on BofA-SEC Pact: A federal judge said he hopes to rule by Feb. 19 on whether to approve a $150 million settlement between Bank of America and the SEC over the bank’s disclosures before its acquisition of Merrill Lynch. [WSJ]

UBS: The Swiss bank reported its first quarterly profit in more than a year, but its key private-banking business continued to hemorrhage wealthy clients. [WSJ]

Fannie and Freddie: With no blueprints for the future and no clear exit strategy for the government, the two companies are focusing for now on the U.S. loan-modification program. [WSJ]

Getting out from under the government thumb: A panel of lawmakers said the U.K. may sell its stakes in RBS and Lloyds in five years. [Bloomberg]

PNC: The bank’s warrants held by the U.S. bailout program may raise $253.3 million for taxpayers. [Bloomberg]

Regulators

FSA: Hector Sants resigned as chief executive of the Financial Services Authority, the financial regulator that he helmed through the credit crisis but which faces an uncertain future. [WSJ]

Buyside

CIC: China’s massive national investment fund provided the closest look yet at its politically sensitive holdings, in a securities filing that revealed that it has accumulated small stakes in more than 60 U.S. companies but has apparently focused its biggest bets disproportionately outside the U.S. [WSJ]

Pay-to-play: Markstone Capital will return $18 million and Wetherly Capital will return $1 million to the New York state public pension fund. [WSJ]

DE Shaw: The hedge fund has established an in-house team to look at buying portfolios of distressed assets. [FT.com]