The past decade wasn’t kind to America’s investors. So why not turn the table and make the 2010s the “decade for the shareholder”?
Investors were riding the dot-com wave from the 1990s when that bubble burst in the second quarter of 2000. Stock prices plummeted. Investors fled the markets and new public offerings began a precipitous decline to a level that remains today. That was just the beginning; on Dec. 3, 2001, Wall Street darling Enron declared bankruptcy, followed closely by the demise of WorldCom, Global Crossing, and many others. Investors, including their employee shareholders, were devastated.
Congress responded by passing the Sarbanes-Oxley Act of 2002, and for the next year the Securities and Exchange Commission worked to implement the legislation with a primary focus on enhancing the integrity of the audit process and reliability of issuers’ financial reports. Companies then spent millions of dollars over the next few years bringing themselves into compliance with the rules. The result? Today, there are questions whether all of this has been worth it. As former SEC Chairman (and fellow Compliance Week Columnist) Harvey Pitt says: “No matter how smart, intelligent, or diligent directors are, if someone in management is intent on committing fraud, it will be a long time before the directors will learn of the existence of that fraud.”
The drumbeat continued. In 2003, then-New York Attorney General Eliot Spitzer reached a settlement with 10 major brokerage firms that broke up the cozy relationship between sell-side research and investment banking. No longer could rock-star analysts make millions in bonuses by bringing business to the banking side of their firms with their often inflated “buy” recommendations. That led to a decline of the quality and quantity of brokerage-firm research, and the resulting reduction in research coverage where today more than two-thirds of U.S.-listed companies have no sell-side coverage! Institutional investors filled the research gap by increasing their own capability. Retail investors have had to survive on substantially less information on which to make informed investment decisions.
By mid-decade, the SEC implemented a new rule on disclosure of executive compensation that created the Compensation Discussion & Analysis as part of the Form 10-K. While the Commission’s intent was to shed light on a board’s decision-making process for compensating the top five executives, it didn’t take long for those crafting the CD&A to figure out how to obfuscate the process and make the compensation disclosure opaque for shareholders.
In March 2008, Bear Stearns collapsed under the weight of bad investments in various collateralized securities backed by sub-prime mortgages. These derivative products, including credit default swaps, were created by Wall Street’s math wizards and were so complex not even the credit rating agencies, much less a bank’s board of directors, could unbundle them to assess their true risk. Lehman Brothers became another victim for many of the same reasons, including a marginalized board and too much leverage. By early September 2008, Wall Street faced a crisis of unknown dimensions that triggered the largest federal bailout of the financial industry in history.
So, the decade ended with employees and shareholders making a modest recovery from the precipitous hit that their 401(k) plans and investment portfolios took during the financial crisis, but those relying on their investments to finance their retirement will never fully recover.
What Lies Ahead?
In December, the SEC issued revised rules designed to enhance compensation disclosure by, among other provisions, requiring a narrative discussion of how compensation relates to the company’s risk exposure. The Commission will also insist on companies providing enhanced disclosure so investors can better understand the value of stock and options awarded to the top executives.
It will take a fundamental behavior change on the part of Wall Street and Corporate America regarding how they treat investors.
Companies had a chance to do it right the first time, and now they have a second chance. One lesson they might want to remember: Companies that have been more forthcoming with shareholders on executive compensation have generally enjoyed investor support for their compensation plans, according to governance researchers.
The SEC will also require companies to explain in their proxies why they have chosen the type of leadership structure they have—for example, keeping the chairman and CEO roles combined or separating them. The SEC will likely pass a rule this year requiring shareholders meeting certain criteria access to the proxy for nominating directors.
A major change this year, particularly for small to mid-size companies, will be implementation of the amended New York Stock Exchange Rule 452—better known as the “broker-voting” rule. No longer will brokers be allowed to vote the uninstructed shares for their retail clients (votes that generally were cast in favor of management). The absence of these votes will give activist shareholders more weight in “withhold” vote campaigns against specific directors and could also make it more difficult for companies with a large retail investor base to achieve an annual meeting quorum.
Potentially the most profound reform of the decade came at its end: In December, the House passed a bill on a 223 to 202 vote that would provide extensive financial reform measures. In the Senate, Sen. Christopher Dodd, chairman of the Senate Banking Committee, has introduced his version of financial regulatory reform. There will be negotiations in the Senate by both sides of the aisle to reach agreement on a compromise bill that will then have to be reconciled with the House legislation.
One must keep in mind that legislative and regulatory initiatives only go so far in reforming Wall Street for the benefit of shareholders. It will take a fundamental behavioral change on the part of Wall Street and Corporate America regarding how they treat investors. What could possibly have been going through the minds of those at Goldman Sachs and Morgan Stanley, who created synthetic securities like credit default swaps that they sold to investors, while quietly shorting those same products believing they would probably fail—and thus made billions on their short sales while their investors suffered heavy losses? (The New York Times&rsquo Gretchen Morgenson and Louise Story recently reported these practices based largely on anonymous statements by current and former insiders at these firms.)
Ed Morler author of The Leadership Integrity Challenge: Assessing and Facilitating Emotional Maturity explains it this way: People adopt their moral values based largely on those considered acceptable within their primary peer group. If Wall Street executives in firms that took federal bailout funds believe that paying huge bonuses is acceptable among their peers, they will do so, absent some major external force such as federal or Congressional oversight or major adverse public reaction that causes them to change their ways.
Morler contends that changing corporate behavior takes a strong leader with real courage and emotional maturity to reach within and do the right thing. He contends that only a few executives among the powerful on Wall Street and in Corporate America have the courage to be true leaders, and reach beyond the comfort zones of their peer groups to do what’s right for investors and society as a whole.
So, given that investors provide the capital that allows publicly traded companies to accomplish their strategic purpose, dedicating this decade to doing what’s right for shareholders just might be a laudable, mutually productive, and morally correct objective.
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