Monday, April 21, 2014

Say-on-Pay and Corporate Social Responsibility, By: Jennifer Roeske

     In the business section of today's New York Times, there is an article about the G.M. exhibits at this past weekend's New York International Auto Show and the fact that consumers who attended seemed unshaken by the company's decision to delay the recall of millions of potentially defective cars. Even if consumers are still confident, I expect that shareholders are not.  Today's Times printed another story reporting that the recent G.M. recalls will impact the company's bottom line and that profits are expected to decline sharply. Perhaps shareholders, understanding the connection between companies that deal responsibly with consumers and profitability, will communicate with the company about socially responsible behavior.

     Recently, a St. John's law student, Jennifer Roeske, wrote a short piece about shareholder involvement in corporate governance matters and the impact that involvement may have on pay decisions.  I am including her piece in this post.

          "Corporate social responsibility is controversial. While some believe it is necessary to help the communities that corporations affect and see it as a way to gain an altruistic public image, ultimately it affects shareholders’ bottom line. Some shareholders may want a greater return on their investment, and therefore disapprove of corporations deviating from a focus on the “bottom-line.” This is especially true for short term investors, or investors who depend on dividends to support themselves or their loved ones.
            Say-on-Pay is an internal mechanism that shareholders can use to let the corporation know whether or not they approve of its practices. It allows shareholders an “advisory vote” on the compensation of the top five executives of a corporation. In the U.S., experience has shown that the majority of corporations receiving a failing vote work strenuously to correct any deficiencies and to determine what issues shareholders had with the proposed executive pay package. Say-on-Pay opens the lines of communication between shareholders and the corporation, specifically the executives and the board. It gives shareholders a voice in corporate policy. This can include a corporation’s stance on corporate social responsibility. If shareholders are dissatisfied with the conduct of a corporation, they can vote down executive pay packages to show their dissatisfaction.
            The effectiveness of Say-on-Pay is a topic of hot debate. However, thus far in the U.S. companies have reacted to failed Say-on-Pay votes by fixing deficiencies and communicating with shareholders, eventually receiving a passing vote in the subsequent year. Last week, the financial post featured an article regarding the rise of theSay-on-Pay movement in CanadaWhile currently Canada does not require this type of vote, many companies have adopted them on their own. Additionally, the article discusses the weight these votes are carrying with boards; they are not ignored. Boards are increasingly aware of the risk of reputational damage if it ignores a shareholder vote. While the approval rating of packages on the whole is high, looking at the failed votes shows that shareholder opinion is taken seriously by corporations. Therefore, Say-on-Pay can be used by shareholders as a way of letting the corporation know their stance on corporate social responsibility."  

Saturday, April 19, 2014

The Virtues of Private Securities Litigation: An Historic and Macroeconomic Perspective

Financial market crashes of historic proportions and swindles and frauds of historic proportions go hand in hand. Two giants in the field of economics made essentially this point long ago: Harvard economist John Kenneth Galbraith in The Great Crash 1929 and MIT economist Charles P. Kindleberger in Manias, Panics and Crashes. Each of these books notes that fraud temptations expand during euphoric economic times (for the fraudfeasor as well as the victim) and that the revelation of market chicanery after the inevitable crash deals further blows to investor confidence causing rapid contraction in capital flows. Economic devastation follows. These books are classics and should be read by every business student and economic policymaker.

Recent evidence from the world of finance and economics demonstrates the wisdom of these works. Thus, a recent paper in The Review of Financial Studies found that firms engaged in fraud pretend to be legitimate and invest and hire excessively during the period of ill-gotten gains and then shed employees and investment when the inevitable crash follows, exacerbating the boom and the bust. MIT finance professor, Andrew Lo, states that booms induce "cocaine addict" responses where profits lead many to underestimate risks (including lawmakers and regulators). Another study found that the Private Securities Litigation Reform Act (which made securities fraud difficult to impossible to prove) led to more accounting chicanery, like that seen during the Enron and WorldCom era of massive securities fraud.

This is all consistent with the massive frauds underlying the subprime lending frenzy. In the largest settlement in history, JPMorgan Chase paid the US Government $13 billion for admitted material misrepresentations in connection with mortgages peddled to Fannie Mae and Freddie Mac as well as other investors. (Better Markets filed a challenge to this deal.). BOA paid $9 billion to settle similar claims just last month. The Wall Street Journal estimates that total bank exposure for bogus mortgage backed securities totals $85 billion. Other massive frauds committed by subprime lenders, including the megabanks, have consistently been noted on this blog. It is beyond cavil that much of the capital flowing into the subprime mortgage business came from duped investors, victims of Wall Street fraud.

The simple truth is that our lawmakers and the judiciary diluted enforcement of the federal securities laws pursuant to the PSLRA as well as a series of draconian cases and thereby gave the green light to more securities fraud. More securities fraud means more financial instability with all its consequent macroeconomic devastation.

We must restore private rights of action under the securities laws.

All of this sums up a law review article entitled The Virtues of Private Securities Litigation that I just posted on SSRN (available here for free download) that applies all of this evidence to the subprime debacle and concludes that there is an overwhelming case that PSLRA materially contributed to the crisis and that restrictions on private securities litigation should be lifted.

Here is the abstract:
In the wake of the Great Depression, the federal securities laws operated to mandate disclosure of material facts to investors and extend broad private remedies to victims of securities fraudfeasors. The revelation of massive securities fraud underlying the Great Depression animated the federal securities laws as investment plunged after 1929 and failed to recover for years. For over sixty years after the enactment of the federal securities laws, no episode of massive securities fraud with significant macroeconomic harm occurred. The federal securities laws thereby operated to facilitate financial stability and prosperity, in addition to a superior allocation of capital. Unfortunately, as memories faded and inequality soared, corporate and financial elites (with the active aid of lawmakers) launched a sustained attack upon private enforcement of the securities laws. Soon thereafter the horrors of the Great Depression returned and massive securities fraud triggered the Great Recession of 2008 as economists would predict. This Article argues for a rollback of the war on private securities litigation to at least the 1980s based upon history and economic science. This would at least restore sensible pleading standards, impose liability on all participants in securities frauds (including aiders and abettors) and allow the states to impose more demanding standards of liability on wrongdoers in financial markets.

Wednesday, April 16, 2014

How Home Ownership Keeps Blacks Poorer Than Whites

Vice Provost Dorothy Brown
In an important article penned in late 2012 by Emory Law Professor and Vice Provost Dorothy Brown, she argues that home ownership continues to be a wealth building tool for white homeowners but does not benefit African American homeowners in the same way.  Her article continues to resonate in 2014 as real estate markets have seemingly rebounded in many communities across the nation, but not significantly for African American communities.  Writing for Forbes magazine, Brown posits:

"Home ownership has been an important vehicle in creating a solid white middle class, but it has not done the same for most black homeowners, because blacks and whites buy homes in very different neighborhoods. Research shows that homes in majority black neighborhoods do not appreciate as much as homes in overwhelmingly white neighborhoods. This appreciation gap begins whenever a neighborhood is more than 10% black, and it increases right along with the percentage of black homeowners. Yet most blacks decide to live in majority minority neighborhoods, while most whites live in overwhelmingly white neighborhoods."

Brown continues by arguing that this divide and the wealth gap between black and whites is not as much about class as it is about race:

"If you think this is class and not race, you are wrong. A 2001 Brookings Institution study showed that 'wealthy minority neighborhoods had less home value per dollar of income than wealthy white neighborhoods.' The same study concluded that 'poor white neighborhoods had more home value per income than poor minority neighborhoods.' The Brookings study was based on a comparison of home values to homeowner incomes in the nation’s 100 largest metropolitan areas, and it found that even when homeowners had similar incomes, black-owned homes were valued at 18% less than white-owned homes. The 100 metropolitan areas were home to 58% of all whites and 63% of all blacks in the country."

Finally, Brown describes that these studies are supported by significant research and that at bottom, the real estate market penalizes integration:

"Those conclusions are supported by a large body of research. Put simply, the market penalizes integration: The higher the percentage of blacks in the neighborhood, the less the home is worth, even when researchers control for age, social class, household structure, and geography." 

For those that argue that we live in a post-racial society, and that the election of President Obama has finally cleansed our nation of the lingering effects of slavery, Jim Crow, "separate but equal" and the discriminatory prison industrial complex, well, they have some explaining to do.