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Guest Post: Anti-Investor Supreme Court Decision and the SEC

By Jeff McCord of The Investor Advocate

Impending SEC Recommendation on Anti-Investor Supreme Court Decision a Bellwether on Regulator’s View of “Public Interest”

In one of its filings prior to U.S. Judge Jed Rakoff’s celebrated November 28th refusal to rubber stamp an SEC-Citicorp deal allowing the bank – a “recidivist offender” — to escape significant damages and an admission of wrongdoing for what may have been egregious, knowing fraud in Citi’s sale of bad mortgage-related assets to unwitting investors, the SEC incredibly asserted that “the public interest . . . is not part of [the] applicable standard of judicial review [of the proposed Citicorp settlement.]” To that, Manhattan federal Judge Rakoff simply responded: “This is erroneous.” [see Rakoff ruling here ]

Just a few years’ ago, the idea that a federal judge would need to remind a federal regulatory agency that the judicial and executive branches work on behalf of the public interest would have seemed ludicrous. Now, it is long over-due.

An impending SEC recommendation to Congress (due in January) on whether an anti-US investor Supreme Court decision (Morrison, discussed below) should be overridden will help answer a timely question: has the Commission heard and understood Judge Rakoff’s admonition?

“Prosecuting Bus Boys and Nannies rather than Wall Street Bandits”

When it comes to the need to hold Wall Street fraud perpetrators accountable in the public interest, the Justice Department itself received a wake-up call from one long-time Member of the House Judiciary Committee, Zoe Lofgren (D-CA,16th District), who in May said prosecutors were more focused on immigration offenses than the on-going financial crisis:

The Department [of Justice] is spending its resources prosecuting nannies and bus boys who are trying to get back to their families. And, yet we have not brought any prosecutions of the bandits on Wall Street who brought the nation and the world to the brink of financial disaster. (Bloomberg)

Led by Lofgren, the California delegation of Democratic Members of Congress on October 10 called for Administration officials and the Federal Reserve to conduct an investigation into “systemic wrongdoing by financial institutions” in the mortgage markets.

Regulators Must Believe in Regulation to Prosecute White Collars, Professor Says

In a story on Judge Rakoff’s ruling, even the reliably establishment FORTUNE magazine opined:

For decades, financial wrongdoers have been able to skip public accountability, and slide out from under the consequences by paying out a sometimes substantial sum and moving on to the next deal.

Like Judge Rakoff’s obvious conclusion that the SEC should work on behalf of the public interest, University of California professor of criminology and law Henry N. Pontell made this “goes without saying” observation in a New York Times interview:

When regulators don’t believe in regulation and don’t get what’s going on, there can be no major white-collar crime prosecutions.

Denying US Investors’ Recourse When Foreign Stock Issuers Defraud Them

In what may be a bellwether on the SEC’s understanding of “what’s going on” in relation to its mission of protecting investors in the public interest, in January the Commission must recommend to Congress whether or not it should override one of the most notorious anti-US investor Supreme Court decisions to come out of a Court not known for acting in the interests of investors, consumers or the public. Specifically, the Dodd-Frank Act directs the SEC to review and make recommendations on Morrison v. National Australia Bank Ltd, a 2010 decision that denies U.S. investors the legal right to hold accountable any foreign listed company (such as Toyota, BP, Sony, DaimlerChrysler or Deutsche Bank) that defrauds them in a securities transaction — even if the wrongdoing takes place on U.S. soil. The decision has caused many meritorious investor lawsuits to be tossed from U.S. courts, denying Americans recourse.

Many pension funds, retirement plans, investor and public interest groups have written letters asking the SEC to recommend Congress override Morrison. Fourteen public pension funds managing more than $700 million in retirement funds for teachers, policemen, firemen, and other public servants in California, Colorado, Delaware, Florida, North Carolina, Maryland, Pennsylvania, Rhode Island and other states made a common sense argument:

[Morrison should be reversed because under that decision, foreign companies] can market their shares to American investors, can obtain a significant portion of their market capitalization from American investors, can file their financial statements with the [SEC], and can even engage in fraudulent conduct on U.S. soil, yet cannot be held liable under U.S. law to the victims of their fraud.

And, the pension funds (like Judge Rakoff and more than one professor) reminded the SEC that its mission as stated on its own website is “to protect investors and maintain fair and orderly markets.” The Exchange Act that established the SEC actually says protecting “the public interest and the interest of investors” are the objectives of the law.

Prudent Fund Management Practices “Turned Upside Down” by Supremes

For decades, to discharge their fiduciary responsibility, public pension funds have invested only in securities, including foreign stocks and bonds, protected under United States securities laws. And, prior to Morrison for more than twenty years, modern portfolio management practices dictated that pension funds reduce risk through investment diversity – both by country and industry.

For pension funds, investing in foreign based companies such as Toyota, Nokia, BP and others had been common and considered prudent,” explains Salvatore J. Graziano, a partner at the law firm of Bernstein Litowitz Berger and Grossman, LLP and president of the National Association of Shareholder and Consumer Attorneys. “Fund managers knew that if a foreign company they invested in committed fraud, corporate governance abuses, or other wrongdoing within the United States or harmed U.S. investors, they could hold such a company and its managers accountable and seek recovery of their investment losses in U.S. District Courts. These fund management practices and investor protections were turned upside down in 2010 by Morrison.

Watch SEC on Morrison

Has the Administration heard and absorbed the messages sent to it by Judge Rakoff, many of America’s largest pension funds, professors and millions of polled individuals that its’ Wall Street policies may have strayed from the public interest? In coming weeks, watch what the SEC recommends to Congress regarding Morrison.
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Originally published at The Investor Advocate


By Jeffrey R. McCord of The Investor Advocate


“Occupy” Annual Meetings and Court Rooms

The spectacular fall and bankruptcy of Jon Corzine’s MF Global Holdings within clear sight of mostly inactive regulators reminds us that “the system is still far too vulnerable and the work of regulatory reform far from finished,” to quote a NEW YORK TIMES editorial on the subject . But, how to continue regulatory reform in a world in which one House of Congress is controlled by anti-regulatory zealots and existing regulators are too often afflicted by chronic DC/NY revolving door syndrome?

In frustration, President Obama has finally begun using Executive Orders to try to accomplish more positive economic change. And, as we all know, he was preceded and prodded by the growing ranks of the Occupy Wall Street movement spreading nationwide and into Europe.
As their visibility and perceived importance of OWS increase, more arm chair generals (me included) are putting forth a lengthening agenda of reforms we hope protestors will demand. One percipient OWS observer hit a big nail on the head when he identified the following economic pressure point progressives should slam:

“If I had to give the Occupy Wall Street movement a piece of advice, I would tell them to focus their growing chorus against Wall Street excesses on corporate governance reform. . . . [That] may sound innocuous, or tedious, or overly academic, but if this movement wants to put the fear of God into the corporate chieftains who are looking down from their towers in Manhattan at the masses below, needs to take the time to explain to its foot soldiers exactly how power is wielded in a modern corporation.”

That suggestion from Kris Broughton, an independent journalist, blogger and national media commentator who also uses the moniker “brown man thinking.” (See ) And, his African-American heritage may have informed his choice of this agenda item usually overlooked by progressives. But, it was activism by individual and institutional investors (in the form of company annual meeting ballot initiatives and shareholder voting and litigation) that helped end the abomination of legal racial oppression and separation of races in South Africa, and achieve expansion of civil rights at home.
Shareholder Activists Help Defeat Apartheid .

One of the first effective blows against apartheid in South Africa by the international community was wielded by the Episcopal Church in 1971. As a shareholder in General Motors Corporation, then a profitable corporate behemoth standing astride the world, instead of ignoring the voting rights its share ownership bestow, the Church:

“introduced a shareholder proposal . . . requesting that General Motors cease operations in South Africa, a nation then enforcing a very strict apartheid, including total separation by race in the workplace (jobs, pay, drinking fountains, etc). The registrant’s [General Motors’ subsequent] proxy statement [mailed to all shareowners] revealed that one of GM’s directors, the Rev. Leon Sullivan, had voted against the Board’s decision to oppose the [South African] shareholder proposal. At the annual meeting, Rev. Sullivan came down from the dais and spoke in favor of the shareholder proposal. The upshot of the ‘conflict’ on GM’s Board was the creation, by a coalition led by General Motors, but consisting of almost all of the major U.S. corporations operating in South Africa, of the ‘Sullivan Principles,’ a code of conduct to abolish apartheid in their South African workplaces.”(See more at: , the Interfaith Center on Corporate Responsibility.)

That radical and successful non-violent action initiated by a mainstream Christian denomination ultimately led faith-based organizations from virtually all major religions within the United States to form The Interfaith Center on Corporate Responsibility (ICCR). Today, it is comprised of 275 members and affiliates — including faith-based institutional investors such as pension funds, foundations, hospital corporations, economic development funds, asset management companies and colleges — that have investment portfolios collectively valued at more than $100 billion. They own shares in most major corporations and actively use the governing rights those shares convey to promote honest and socially responsible management of companies in which they invest. ICCR board member Jeffrey Dekro of Jewish Funds for Justice, for instance, is a catalyst for investment in low-income community development.

Fighting Capitalist “Heresies” With Capital
Back in 2002, when most investors and citizens were still angry from the last round of egregious corporate fraud and abuse (think Enron, Global Crossing, WorldCom, Adelphia Communications, etc), the NEW YORK TIMES reported on the interfaith group’s shareholder activism by focusing on ICCR executive Sister Patricia Daly, a member of the Catholic Dominican order:

“Sister Daly views her work as following in the tradition of the Dominican order, founded in the 13th century by St. Dominic to fight heresies and untruths. ‘We’re dealing with some of the heresies and untruths of capitalism,’ Sister Daly said.”

Risk Metrics Group, a profit-making associate member of Sister Daly’s ICCR, provides research and advice to governments, corporations, academics, institutional investors and others seeking unbiased actionable information on securities markets and companies that issue securities. Although recently acquired by a larger consulting firm (Institutional Investor Services, Inc.), Risk Metrics remains a leader in providing clients with decision-making data on corporate governance matters. And, the number of institutional investors willing and interested in fostering corporate management reform has expanded far beyond the ranks of the faith-based.

“Short-term Profit Maximization is not a Sustainable Model”

In an interview, Lucas Green, an attorney and a research director for Institutional Investor Services Inc.’s corporate governance unit, said socially aware shareholders can and should exert a positive influence on how corporations are governed. Today, institutions – particularly pension funds serving employees, academic personnel and union members – are using more than proxy ballots to force change at poorly and dishonestly governed companies. They are going to Federal court, where, like civil rights activists and environmentalists before them, they use class actions to unite all shareholders in tackling a corporation’s embedded executives.

Admittedly, the prospect of strategic corporate proxy battles, institutional investor led litigation, and such key “corporate governance” issues as management compensation packages are enough to make the eyes of many OWS protestors (and most other citizens) glaze over. But, the ISS’s Lucas Green explains how the interests of Main Street are aligned with some of the nation’s largest public and union pension funds pushing for real change:

“One only has to look back to the Enron, WorldCom and more recent scandals to see the relevance of how corporations are governed to the interests of all investors including individuals and the overall health of our economy. Experience demonstrates that a corporate structure that places the highest value on short term profit maximization and short term stock price gain is not a sustainable model. Executive compensation packages should encourage long-term, sustainable growth and health.

“The interests of public pension funds, which are often among the largest investors in any given corporation and which seek effective, honest corporate governance focusing on the long term, are aligned with the public interest in several ways. The beneficiaries of pension funds themselves are typically individual employees and, more broadly, the funds in their role as big investors can also exert a positive influence on securities markets and the economy.”

Adjusting United Healthcare’s Moral Compass
As an example, in his lengthy paper on litigation in corporate governance, Mr. Green cites a lawsuit led by the California Public Employee’s Retirement System (CALPERS), a huge pension fund with about $236 billion in assets under management, that helped force extensive reform in the way the giant healthcare insurer United Healthcare Group, Inc. is managed. (See Green’s study at )

A few years ago, amid a federal investigation (in 2006) into the illegal back-dating of stock options to enrich senior United Health managers, a separate New York State Investigation (in 2008) of alleged fraud in consumer healthcare billing, and other allegations of fraud in the sale of its securities to investors, CALPERS and other investors successfully pursued a class action against United Health in federal court that in 2009 won the following:
— $925.5 million for allegedly defrauded shareholders;
— creation of a more independent board of directors to exercise better oversight of United Health management;
— reform of United Health executive compensation packages to discourage future wrongdoing.
Pension Funds Can Do Better Than SEC at Thwarting Wrongdoing
Ample research in recent years demonstrates that class action lawsuits led by such powerful investors as CALPERS can achieve better results at holding wrongdoers financially accountable and in deterring future misbehavior than even the Securities and Exchange Commission (SEC). For nearly a decade, two law professors, James Cox of Duke University, and Randall Thomas of Vanderbilt, have studied the role of institutional investor-led lawsuits in combating fraud and other corporate abuse. In a joint paper published last year, they concluded:

“[P]rivate suits headed by an institutional lead plaintiff . . . appear to [target bigger corporate wrongdoers and achieve] better settlements and lower attorneys’ fees awards
[than lawsuits led by individual investors]. SEC enforcement efforts, while significant, have tended to focus on weaker [and smaller corporate malefactors as] targets, suggesting that the big fish get away.”

What Can Peasants Do When Pitchforks are Parried by Police?
What can individual citizens – including our OCW surrogates serving at the front — do to reform corporate governance? The fortunate few who are still covered by pension funds
should contact their funds’ managers and encourage them to join the fight for reform. Citizens who are active in Christian, Jewish, Muslim and other faith-based organizations should ask their religious leaders to mobilize congregate financial resources and inherent strength in numbers of individuals to challenge corporate crime in both shareholder meetings and courts.

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Joined the GE Capital Board in 1997

The cause of that “small tax bill”:

Immelt said a small tax bill for 2010 was due to more than $30 billion in losses related to GE’s financial services business during the financial crisis. In 2009, GE Capital’s losses were so large that it company overall lost money on its U.S. operations.

GE’s federal taxes, Immelt said, would rise as the performance of its financial arm improves. [emphasis mine]

Heckuva job, Jeffrey.

In Other News, 90% of VeloNews Readers Consider Themselves Above-Average Cyclist

Floyd Norris discovers a mathematical impossibility:

Asked to rank, on a scale of one (excellent) to five (poor), the ability of their board’s compensation committee to “effectively manage C.E.O. compensation, 83 percent of the directors chose one or two, and only 4 percent picked four or five.

But asked, “In general, do you believe U.S. company board are having trouble controlling the size of C.E.O. compensation?” 58 percent thought the boards were having trouble, while 34 percent disagreed and the rest were unsure.

Since CompComs generally benchmark against the packages of CEOs in “similar” companies, you have to be really stupid or ignorant as a Director to believe you do it right while your competitors don’t.

But don’t think the Directors know they are incompetent:

Even if directors are not doing a good job, it is not a good idea to give others a say, at least to most directors. More than three-quarters are against giving shareholders a vote on C.E.O. compensation….

As for their own pay, the directors split almost down the middle: 45 percent thought pay should rise, and 53 percent thought it should not. The other 2 percent thought director pay should be reduced. If their identities leak, they are unlikely to be renominated.

Michael Jensen is rolling over in his grave, despite not being dead yet.

In the name of shareholders

One of the memes used to justify corporate actions is ‘things are done to increase shareholder value’. We all know ‘value’ can be interpreted in different ways, oft times after the fact of actions since shareholder participation has rather cumbersome mechanisms for participation. Maybe a new way will emerge to aid greater participation of more shareholders in what is done in their names.

The NYT frames the question this way:

Sure, in theory, investors could vote for the people who serve on the board, many of whom are paid handsomely to oversee management and set executive pay. But investors don’t have any say on the nominees. Nor do they have much of a real choice even if they do vote. Say you withhold a vote for a candidate running uncontested. It doesn’t matter, since directors can win without a majority.

And if you chose not to vote? Your broker is allowed to cast your ballot without your permission, and brokers typically vote in line with management.


But the tide is beginning to turn, albeit slightly. In recent years, more companies have adopted a “majority rules” requirement, meaning a single vote can no longer elect the entire board, even if all other votes are withheld (though some companies retain the power to reinstate directors). And starting this year, brokers can no longer vote shares held in their customers’ accounts without permission.

On top of that, more voter resources are beginning to sprout on the Web that aim to educate smaller investors, demystify the issues on the ballot and make voting easier.

Are TBTF Banks Out of Danger? The Market Doesn’t Think So

Down here it’s just winners and losers
And don’t get caught on the wrong side of that line

This will be a long post. Even with all the pictures above the fold.

It started with a finger exercise during my daughter’s swim team practice:

Just in case you thought I was picking on The Big C in my previous post, let us look at the other major financial institutions (Too Big to Fail, or TBTF, Banks) over the same time period.

The Remaining Investment Banks:

While Goldman Sachs—as with most of the other so-called Winners—shows a significant upturn and major gains since the beginning of 2009, Morgan Stanley’s appreciation has been rather less apparent. However, both have returned only to approximately the price they held during the interregnum (after Bear Stearns fell but while Lehman Brothers ignored the warning and decided not to right the ship).

The Mortgage Lending Leaders:

Both firms show an increase in stock performance beginning in Q1 of 2009. Wells Fargo had a precipitous dive after LEH filed bankruptcy, but recovered in a similar amount of time. JPMorganChase, having acquired Bear for either a song or too much money, remains below the level it reached during the interregnum, but solidly in the middle of its range since 2006.

The Consumers-as-Profit-Center (“Retail”) Banks:

As is apparent, Capital One’s stock decline was not precipitated by the proximate solvency crisis itself, but rather by the decline in earnings and profits, and deflation in wages, that was in full swing by early 2006. While Bank of America does not have that preamble, it sees a similar decline in its stock price from the middle of 2007. By the time the recession is officially declared, the trend has started. And while Bear’s fire sale to JPM causes a decline in bank stocks, it is not until LEH that BAC mirrors its competitors above. More like MS than GS, BAC’s recovery to less than one-half of its pre-recession trading price suggests that the market is less confident than management that the firm’s major issues are behind it.

But one thing abides. The market isn’t happy.

Even as we might divide this squad into Winners (GS, JPM, WFC), Losers (C, MS), and Also-Rans (COF, BAC), six of those seven (exception: JPM) appear to be viewed by the market as no stronger than they were during the interregnum, the time when everyone was waiting to see if the other shoe would drop.

There are certainly other reasons the stock price might be down: insider selling at the firms is at record or near-record levels, and sooner or later people will figure out that when insiders are selling at 82:1 levels is not the best time to buy. Their loans are down (post on that coming soon) while, as Linda notes at ataxingmatter:

A recent study suggests that big banks in the TBTF category now enjoy a significant cost-of-funds spread compared to other banks. That is, they can borrow money more cheaply, leading to greater ability to make profits, than can other banks, because of the implicit guarantee that the federal government will step in and save them because they are TBTF and pose a systemic risk. That advantage may amount to as much as 48% of the TBTF banks’ profits this year (or as ‘little’ as 9%, on very conservative assumptions). The government, by the way, gets nothing for this implicit guarantee–unlike a commercial guarantor, it is not being paid a regular premium for the service.

So maybe investors believe that this advantage will go away. (Or, as noted above, maybe investors have figured out that the Big Banks aren’t taking advantage of this opporunity, expecting that it will never go away.)

The one certainty is that, with all of their advantages (the refusal of the Administration to support cramdowns for non-investment properties, leading to perverted accounting that makes banks solvent and mortgageholders underwater at the same time on the same property; the continuing payment of interest on Reserves in a deflationary environment, which has created a perverse incentive for the TBTF Banks not to lend; charging their smaller competitors for the TBTF Banks’s failures by raising their FDIC contribution and collecting three years of it upfront after not having saved for a rainy day; having Administration economic policy run by Larry Summers, whose last foray into the financial markets was too embarassing even for him to explain (h/t Felix); Ben Bernanke having decided that doing only half his job should be enough (h/t Brad DeLong); and the general delusion that the banks are necessary to and helping with a recovery. And that’s off the top of my head.

As The Epicurean Dealmaker observed last week vin a post eeryone should read:

Chancellor [of the Exchequer Alistair] Darling could not have been clearer:

“I’m giving them a choice. They can use their profits to build up their capital base, but if they insist on paying substantial rewards, I’m determined to claw money back for the taxpayer,” he said.

[H]e plans to do this by making banks choose between their employees and their shareholders…

Economists have made this point repeatedly: the first priority of people who run a business should be their responsibility to their shareholders. (See Steve Randy Waldman’s post yesterday for a clear explanation. And then see the post he pulled from comments after that, which saves me the trouble of hoisting from another person’s comments again for the real ramifications of TARP and the bailout. Why do Megan McArdle and the Administration hate the troops?)

Paying large bonuses while the banks themselves remain near insolvency is bad for the shareholders. Goldman Effing Sachs realizes that, even if they didn’t quite go far enough.

Why do I believe the state of the TBTF Banks ranges from near insolvency (C, MS) to on the edge of insolvency? The market tells me so.