Cracking Down on Collective Bargaining - Institutional Investor Style

After Dodd-Frank's corporate governance reforms, it appears that the opposition to governing corporations in the interests of anything else except short term profits and executive insiders isn't content to merely challenge the SEC's proxy access rules before SCOTUS.

Now, a movement to reign in proxy advisory firms. 

Institutional investors like pension funds hire these companies to monitor corporate performance and to provide advisory services on upcoming shareholder votes.  As most institutional investors are heavily diversified (often required by law to be so), they need this sort of service to do their jobs properly.  Think of it as enabling collective action.

Certainly, reforms that require these advisory firms to be transparent and to refrain from entering into conflict-of-interest transactions (when they're hired by a firm who invests on its own behalf, as well as by the firm's own investors) make sense.   After all, it makes sense for Moody's and S&P, who get paid by the very same firms whose securities they are rating.

The thing is: oversight failure over Moody's & S&P leads to unacceptable systemic risk.  People bought AAA rated securities toilet assets on Moody's good recommendation.

Riskmetrics, ISS et al don't tell investors to buy trash.  They don't tell investors how to invest their funds.  Rather, they tell investors where executive compensation is out of whack, when getting rid of a staggered board would make sense.  Their services, in other words, are to help investors after they've bought securities.

So it would make sense, given their different purposes, that they would be subject to different regulations. 

Don't let the hubbub coming out confuse you.  Advisory services aren't the same villain as the credit ratings agencies.  And so they should be punished as if they are.

The other governments we should pay attention to

FT Editorial Page:

Shareholder values

How shareholders choose to vote is above all a private matter. Investors are free to tell the companies they own to pursue goals besides profit. One goal can be concern for safety and the environment: complaints from faith-based and other investors in BP have grown louder since the Deepwater Horizon explosion and oil spill. Another is fair pay: the Church Investors Group wants pay ratios between top executives and the lowest-paid tenth of employees to fall below 75 .

Is such shareholder activism also in the public interest? It could be. If more owners thought, like some faith-based investors, that they had a duty of stewardship, they could provide a useful check on managers. No lofty motives are needed for this to be in the interest of shareholders, whose money is after all the first to be lost to overly risky strategies or to remuneration that extracts more value from a company than it adds.
Whether it is good for society at large, too, depends on what shareholders use their activism for and to what degree they succeed. As to the former, taking a stand on executive pay is a healthy change from the usual apathy. Depending on the warmth of relations between executives and pay committees, “pay for performance” often turns into pay without the performance. Incentives are easy to game and can undermine people’s intrinsic motives for doing a good job.
If more institutional investors join the activist game it could even have an effect. Crude caps on pay multiples may not be the best solution. But they would hardly scare executives away. Most institutions are “universal investors” and if the same rules apply to all their holdings, managers feeling under the thumb would have nowhere else to go. Unless it is where ethical investors fear to tread: tobacco, alcohol and pornography. Perhaps it is all a divine plan to put greedy executives on the wages of sin.

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So, Carl Levin's Read Michael Lewis

Today's FT reports that Carl Levin's senate investigation committee is referring a few cases to DOJ for prosecution.  Namely, cases based on the fact that banks like Goldman and Deutsche were selling toxic assets while at the same time going short on those assets.

It reads straight out of The Big Short.  With even a shout-out to Greg Lippman.

Good to know that the Senate investigations' committee is has just as many investigative resources as a single author.

Auction-Rate Securities Settlements - Paying off the Richies, but not Your 401(k)

Another comment on the Morgenson/Story piece in today's NYT:

In one of the SEC's rare prosecutions of the shenanigans leading up to the financial crisis, the SEC extracted compensation from banks that hoodwinked investors into buying "acution-rate securities" by promising that they were liquid and safe.  But only for retail investors, i.e., investors rich enough to trade on their own accounts.  The rest of us -- anyone with a pension fund or 401(k), got screwed:

But Mr. Alvarez suggested that the S.E.C. soften the proposed terms of the auction-rate settlements. His staff followed up with more calls to the S.E.C., cautioning that banks might run short on capital if they had to pay the many billions of dollars needed to make all auction-rate clients whole, the people briefed on the conversations said. The S.E.C. wound up requiring eight banks to pay back only individual investors. For institutional investors — like pension funds — that bought the securities, the S.E.C. told the banks to make only their “best efforts.”

This shift eased the pain significantly at some of the nation’s biggest banks. For Citigroup, the new terms meant it had to redeem $7 billion in the securities for individual investors — but it was off the hook for about $12 billion owned by institutions. These institutions have subsequently recouped some but not all of their investments. Mr. Alvarez declined to comment, through a spokeswoman.

Perhaps the SEC was hoping the pension funds would fulfill their fiduciary duties and sue these banks themselves for securities fraud.  We should look forward to a wealth of new caselaw in the coming years.  

Financial Crisis Prosecution: Elephants in the Room, Farting yet still invisble

The NYT's Gretchen Morganson and Louise Story posted an "expose" today about the embarassing dearth of financial crisis criminal prosecutions.  Pointed is their description of the cosy, crony-capitalistic structure of banks and other financial isntitutions and the so-called regulators that ostensibly babysit them -- as well as their identification of the anti-regulatory cultural consciousness that herded regulators into inaction.

The  excuse offered up by regulators that has the most purchase, though, is the fact that even should they get money from these companies, that money would come straight out of the accounts holding taxpayer-funded bailouts.  Or, worse yet, would undermine financial stability.

Even if that's true and salient -- which assumes, of course, that financial engineering, especially to this degree, has some sort of overall social benefit:

Clawing back the hefty paychecks of the individual financial executives, traders, and dealers wouldn't implicate such issues.  And they're the individuals whose risky behavior the regulators are supposed to regulate to begin with.  Financial institutions aren't just some giant non-human hive-mind that has a life of its own.  It's the people working for them that do the bad things.

Moreover, the law does not limit fraud actions to corporate behavior.  The individuals involved in the fraud, theoretically, are liable too.  In fact, corporations only face liability for fraud because the law holds them, as employers, vicariously liable for the acts of their employees. 

Certainly, the securities laws don't offer the same kinds of claims as plain vanilla common law fraud -- execs, for example, aren't always individually liable for misstatements in the company's 10-Ks -- but there are other tools in the toolbox.

Meanwhile, wall street pay is through the roof.  Still.

Free Speech, As Long As It's The Right Kind of Speech

Petitioners' reply briefing in the Biz Rountable v. SEC, is pretty cute.  Scarily cute.

From the folks at Race to the Bottom:

The petitioners contend further that the shareholders most likely to use the rules [governing proxy access] are union and government pension funds, which have a history of using shareholder activism to pursue non-investment-related objectives that depart from other shareholders’ interests. The petitioners fault the Commission for claiming that the rules further shareholder rights, when the mandatory rules instead disenfranchise the vast majority of shareholders, who may wish to avoid the tremendous costs that proxy access would impose on their company.

The rules violate not only the APA, the petitioners explain, but also the First Amendment by forcing corporations to carry the campaign-related speech of others who necessarily oppose the company’s position, even when that speech is false and misleading. The Commission was obligated to tailor its rules to avoid infringing constitutional rights, but the Commission failed to take First Amendment rights into account when crafting the rules.

While we sputter, a few points.

First.  When the Supremes gave corporations free speech rights, they necessarily gave certain shareholders the power to force others to "carry the campaign-related speech of others."  Unless, of course, the Court meant that shareholders should always vote unanimously.   Shareholders elect directors.  Directors decide how corporate free speech is exercised.  If shareholders don't like the speech, they can vote out the directors.  But it's majority rule.  Someone's going to feel like their voice got drowned out.  That's the nature of the beast.

Second.  Ostensibly, a corporation's right to free speech hinges on the free speech rights of individual investors.  If this is the case, since when must those investors confine their speech to investment-only objectives?  Because that's what the Biz Round says when it bristles at shareholders voting for "non-investment related objectives."

It's sort of like telling people they cay only vote according to their tax interests.

That certain special-interests lobbies "drown out" (or, in the Biz Round's parlance, "disenfranchise") the voices of other voters is nothing new in democracy.  Can we really call society undemocratic because AARP gets more lunch dates with congressmen than does Mr. Smith writing to Washington?  The squeaky wheel gets the oil.  It is, at the very least, amusing -- and blatantly hypocritical --  to hear the corporate lobby whining about the power of "special interests" lobbies, when they represent the biggest and most powerful of them.

Remembering Williams v. Geier and Tenure Voting

Back in the Long Term Capital Management days, Delaware courts were grappling with all sorts of protective devices cooked up by corporate boards (and Martin Lipton) that served as fortresses against the Gordon Gekkos of Wall Street.

One of the many gems of corporate jurisprudence emanating from the courts, Williams v. Geier, dealt with a management and majority-shareholder approved plan to grant weighted voting rights to long term shareholders.

At the time, the minority investors screamed.  Indeed, their cause was a bit sympathetic, especially because the corporate board and the majority of shareholders were dominated by a single family.  Minority shareholders, in this kind of situation, can get the shaft.
But here's the thing.  In Williams v. Geier, the Delaware Supreme Court noted that the board, in giving better voting rights to long term shareholders, was perfectly reasonable corporate policy.  That policy was not one aimed at short-term profits, but instead long-term, sustainable business strategies.  Even if the pursuit of long-term growth  disenfranchisws short-term investors, the Court thought it was still a-ok.  Or, in corporate law parlance, a perfectly legitimate exercise of a board's business judgment that could only be rebutted in the face of evidence of a breach of fiduciary duty.

Notable in this case is it the Justices' dissent: the priority given to long-term interested shareholders over the "equally legitimate investment objectives" of short term investors provoked their ire.

It's very much open to debate, of course, whether the short-termism of minority investors is an "equally legitimate investment objective."  Such short-termism, after all, lead to the kind of financial mysticism that leads to financial crises.
Something to chew over as we finally start paying attention to the fact that not all shareholders are created equal.

What they're teaching the kiddies in law school these days

From Hal Scott's textbook on international finance, v. 17th ed. -- for real:

[public officials regulating fraud aren't as good at enforcement than markets] may be true in developing countries but does not translate to the us where public enforcement officials are not corrupt or captured, and are very well trained (due largely to the revolving door with the private sector).

Is this a joke? Bad editing?  The author, certainly, has an underdeveloped sense of irony and the oxymoronic.


The scary thing is: he came out with the new version precisely to take account of the financial crisis.

History Doomed to Repeat Itself Every 2 Years

Risky debt abounds once again on the capital markets, according to the FT.

So, we've already figured out that there isn't going to be much in the way of regulatory reform.  But one would think that the industry would at least be a little gun shy.

Is  this the result of the so-called "moral hazard" of government bailouts?  For once, perhaps the conservatives were right.  Perhaps government really can't take the place of markets in some situations.  Sometimes, people need to go broke to learn a lesson.

Michael Lewis, in an interview he gave regarding his fantastic historical account of the financial crisis, The Big Short, speculated that perhaps the mess wouldn't have been so bad had investment banks not gone public.  If they had remained partnerships, perhaps the mess wouldn't have been so bad.  Partners in a partnership generally don't let their employees throw billions of company dollars on a roulette table -- especially when odds are much worse than 50/50.   Because what's getting thrown away is the partners' own money.

Not so with corporate executives.  They haven't got any skin in the game.  Their diversified public shareholders? They can pull anything over on those dupes. 

With public corporations, we're left to the government as the only watchdog.

Oy vey.

The Benefits of Technology Into the Laps of Shareholders

Krugman's column today emphasizes that no matter how much "education" students receive (I mean the kind that trains folks for highly-skilled jobs, which is necessary, but not sufficient, for a real eduction), there always remains the spectre of outsourcing and out-moding that comes from globalization and technology advances.

So what can we do to make sure that these turn of events doesn't lead to mass poverty and mind-numbing inequality?

Certainly, redistributive tax policies and collective bargaining helps.  Unfortunately, an effective response is one that must be globally coordinated.  Else we will hear that famous "giant sucking sound" that is the race to the bottom.

The crux of the problem, though, lies with what drives our economy to make these technological advances.  Competition among industry, of course, drives firms to acquire increasing returns of scale, greater efficiencies, and lower costs of production (including technological advances and lower wages).  Where do the profits go?

To shareholders.

What can shareholders do? They can re-invest in capital markets.  They can invest abroad.  Generally, they go where the returns on their investments seem best.  To companies that do the best at cutting costs and increasing efficiencies.

But who are the shareholders?

Certainly, many wall streeters and other members of the upper echelon of wealth.

But they are also many of the rest of us: anyone with a pension fund or 401(k).  Who have a choice and a voice.

If the government doesn't do anything about the non-economic policy of the kind of free market capitalism that's bringing us to these turn of events, the shareholders can.

On Shifting Economies

The newest range among young people -- farming.  It's not unusual to see hipsters flee the cities to go farm somewhere -- whether it's as a group of migrants abroad, or in a small plot of land in Maine.

Though many terrible things can be said of industrial farming -- the Meatrix comes instantly to mind -- that American youth are embracing this form of work seems to reflect the inevitable economic shift arising as a result of globalization.

For much of the last century, farms turned into Agribusiness, and family-owned farms, just large enough to be handled by a few workers, was the lot of the "developing" world.

Perhaps it's time we re-think our definition of which states are the "Developed" and "industrial" kind, and which are not.

The Dangers of Relying on Economic Serendipity

Back when workers, investors, executives and their creditors all relied upon the success of each other for future prosperity, our system of corporate governance worked pretty well better. 

Companies paid workers well, because those workers bought the company's products.  Creditors of the company were on board; their loans would only be made good if the company was in the black. 

And if investors wanted to make money on their savings, they'd invest in these companies.  Wanting those companies to do well, so that they can make that profit, they'd also look kindly on paying workers living wages.

Thus, a hands-off approach to corporate governance, along with an absent-minded (or malicious?) neglect of unions, seemed to work.  In fact, many went so far as to conclude that because of these laissez-faire attitudes, American was assured a future of enduring prosperity.

But it only worked because the companies relied on the prosperity of their own workers.  Or, at least, were forced to through collective bargaining.  And investors, in turn, relied upon the prosperity of those companies. 

In other words, it only worked because of a historical accident: an economy functioning in isolation, on a continent separated from its developed-country peers by entire oceans. 

Enter globalization. 

Suddenly, a company can propsper without the purchasing power of the American consumer.  If it can cut costs and gain competitive advantage by moving to cheaper labor markets, why not? They can suck American consumers dry and, if the pot runs out, well, there are these growing middle classes in India and China.

Moreover, investors can now move their capital freely.  If there's more profit to be made in Bangladesh or Burma or Croatia, that's where they'll go.  The increased capital investment, in turn, leads to changes those countries' comparative advantages -- likely to  investment in longer-term projects that will give them comparative advantage in more sophisticated industries.  Or in any industry whatsoever -- including those industries that America used to embrace. 

With the opening of borders, America's future doesn't look so bright.   We don't have any claim to the world's capital investment.  We don't have any fences limiting the customer base of industry.  In other words, we're out in the deep water with the rest of what we so quaintly referred to as the "Third World."

And our "serendipity" style of corporate and labor governance hasn't got a lifeline to throw us.

Might we look to Western Europe as an example, whose corporate governance regime includes a greater safety net, and whose members started integrating economically decades ago?

Puke

Daley (chief of staff JP Morgan stooge) opinion column in today's FT -- talking about how "pro-business" Obama is.  Citing, inter alia, proposed free trade treaties and the elimination of discretionary spending.

You know, the stuff that hurts working people and the environment.

Wells Fargo - A Bit of Sunshine?

U.S. banking regulators are discussing new rules that would require banks that originate home loans to require larger down payments before they may fully "securitize" the balance.  They aim to make sure lenders, asset-backed security investors and borrowers all have skin in the game.

In other words, if lenders make subprime loans (that require little down payment), they have to suck up some of the credit risk of the borrowers, rather than passing it all on to someone else through derivatives.  As we have all learned to our great regret, those other investors remained ignorant of that credit risk -- whether because they relied on bogus credit agency ratings or because they just rode the real estate asset bubble like everyone else.

The rest is demand and supply: lots of investors wanting home loan securities drive up the price.  Which causes lenders to make more and more of them.  More and more subprime loans.  Which, of course, drive up real estate prices.

Unsurprisingly, most banks are fighting this proposed regulation kicking and screaming.  Some even have the gall to assure us that the financial crisis "self-correction" already caused lenders to fix their lending and securitization practices.

But one bank stands out:

The notable exception has been Wells Fargo, which has pushed for even tighter underwriting standards than the regulators seem to favour. In a recent letter to regulators, Wells Fargo argued that borrowers should be required to make down payments of at least 30 per cent before banks are allowed to fully sell the loans to investors.

“The point we are making, unlike others, is that risk retention is a good idea,” John Gibbons, an executive vice-president with Wells Fargo Home Mortgage, told the Financial Times. “Rather than being something rare or unusual, it should be common in the mortgage industry to align the interests of lenders, borrowers and investors.”

Priorities of the NYT - Today's Front Page

Because the cleanliness of the Wisconsin capital building is what's really newsworthy.