U.S. Corporate Governance Report

August 10, 2017

U.S. Department of Labor Implements the Fiduciary Rule

Despite massive efforts to stop it, the Department of Labor’s fiduciary rule went into effect on June 9, 2017.  According to Reuters, the rule “has been heavily criticized by Republicans and Wall Street amid concerns it may make investment advice too costly.”1  The ‟concerns” Reuters refers to are “that the diversion of fees, often undisclosed, made possible by conflicts of interest, also undisclosed, will have to stop, returning to the customers the money that should have been theirs in the first place.”

Goldman Sachs on the Rise of ESG Investing:2

    At Goldman Sachs, the growth of [Environmental, Social and Governance (‟ESG”)] investing has been significant, and it has accelerated since the acquisition of Imprint Capital, a leading ESG advisor, in 2015. We have seen a virtuous cycle in which demand has driven product and service innovation, creating new models for success and driving further demand. As a result, our assets under supervision in dedicated ESG strategies have grown significantly, to $6.5 billion by the end of 2016.

    Fundamental to this growth is an increased understanding that a disciplined approach to ESG investing can drive competitive risk-adjusted returns – just as with any other investment. Risk/return profiles of ESG portfolios now mirror the markets and span asset classes, fueling the evolution of impact investment strategies that meet conventional risk/return hurdles, but also include social and environmental impacts that are both intentional and measurable.

NOTE: IRRCi has a new paper on investor approaches to ESG.3

Uber’s Bro-Culture Founder-CEO and a Director Resign

For years, concerns have been expressed about the “bro” culture at Uber, but the attitude of analysts and insiders seemed to be “boys will be boys.”  Perhaps there was a rueful headshake now and then, but apparently the board believed that the same qualities that made co-founder/CEO Travis Kalanick brash and boorish also made him visionary and dynamic.  That was until programmer Susan J. Fowler wrote about her “one very, very strange year” of virulent mistreatment, ultimately leading to the departure of Kalanick as CEO (though he remains on the board, for now).4  A male director who made a sexist joke at a meeting about sexism also resigned. 

NOTE: At TechCrunch, veteran CEO/director Betsy Atkins explained how “[a] better boardroom can reverse Uber’s cultural woes.”5  Also, an article by Bethany McLean (the reporter who broke the Enron scandal story), published in Vanity Fair, focuses on how the corporate culture at Wells Fargo led to widespread violations of law and ethics.6

FTSE Russell Index Considers Dropping Companies with Non-Voting Shares

When does a stock stop being a stock?  The three essential ownership rights that accompany the stock certificate are proxy voting, litigation, and transferability/liquidity.  If you remove proxy voting, is it still stock or is it a bond without a promised return?  FTSE is considering the exclusion of non-voting shares from its Russell index.7 This could force companies like Alphabet Inc., Facebook Inc. and Ford Motor Co. to choose between keeping their places in broad stock benchmarks or changing their share class structures. The proposal calls for setting a minimum threshold for the percentage of voting control attached to company shares in an index. For example, a company whose Class A shares in an index control 40% of the total votes might be excluded from FTSE Russell’s main indexes, like the Russell 3000 or Russell 2000, if the threshold were higher than that.

Matt Levine Blames Index Funds for Changing the Focus of Airlines from Customers to Investors

ValueEdge Advisors Chair Bob Monks has written at length about “drone investors” who hold no more of a company’s stock than its proportion in the index and provide no oversight or market response to prevent management drift and self-dealing.8  Matt Levine comes to the same conclusion in his article about the failure of the airlines:9

[C]ross-ownership of many U.S. airlines by the same diversified institutional investors – index funds and “quasi-indexers” – discourages the airlines from competing on price and quality, and encourages them to focus on margins. An airline that cuts fares or spends money on better service to win market share isn’t necessarily doing its shareholders any favors: The increased market share comes at the expense of other airline companies that the shareholders also probably own.

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I think the ‟index funds ruin capitalism” story is best read as just one strand of a larger ‟financial capitalism ruins capitalism” story, and while the index funds story is still pretty niche, the financial capitalism story has become very popular. In this story, managers and investors have stopped thinking of companies as companies, as human networks of employees and customers and investors, and now think of them instead as numbers, as sets of financial factors to be optimized. There are many explanations for this: Developments in graduate business education, or the rise of corporate activism, or the cultural role of Wall Street. But the basic story is that companies used to balance the interests of workers, customers and investors; now they have adopted a fully investor-centric model in which profits are the only goal and customer service and workers’ rights are sacrificed. Sheelah Kolhatkar writes that “the investors-above-all doctrine seems to have triumphed over the more inclusive approach.”

The Biggest Institutions Are Adding to Their Governance Resources

The Financial Times reports:

    BlackRock, Vanguard and State Street have expanded their corporate governance teams significantly in response to growing pressure from policymakers and clients to demonstrate they are policing the companies they invest in.

    The move by the world’s three largest asset managers, which together control nearly $11tn of assets, will help address fears that investors are not doing enough to monitor controversial issues around executive pay and board diversity at the companies they invest in.

World’s Worst Reason for Not Docking a Fired CEO’s Pay Used as a Defense in Court

United Continental Holdings, the parent company of United Airlines, fired its CEO for corruption in connection with the New Jersey “Bridgegate” scandal. The City of Tamarac, Florida Firefighters Pension Trust Fund sued because the company did not clawback his pay. Gretchen Morgenson writes in The New York Times:10

    In a letter to the pension fund, a lawyer for United explained that it would harm the company to give the board “unfettered discretion to recoup compensation” in cases involving wrongdoing. “Where such discretion is out of step with industry norms,” the letter said, it would “make it difficult for United to recruit and retain top talent, particularly at the senior management level.”

    In other words, clawing back severance awarded to executives amid a bribery investigation is not industry practice. And if United pursued such a recovery, the airline would be an outlier and unable to hire good people.

Young Consumers – and Possibly Shareholders – Are More Inclined to Respect Companies that Support Their Values

The conventional wisdom is that CEOs and other corporate spokespeople should stay away from taking positions on politics and policy that could alienate some customers.  But a new report from the global public relations firm Weber Shandwick and KRC Research shows that millennials are more interested than their predecessors in corporate officials who make public statements on social issues. The Washington Post reports:11

In the survey, 56 percent of millennials said CEOs and other business leaders need to engage on hotly debated current issues more today than in the past, compared with just 36 percent of Gen Xers and 35 percent of baby boomers.

    Forty-seven percent of millennials said CEOs have a responsibility to speak up on social issues that are important to society, compared with just 28 percent of Americans in older generations. And millennials were the only generation in the survey in which the percentage of those who said they view CEOs more favorably for taking public positions actually expanded since last year, rather than declined.

1    http://www.reuters.com/article/us-usa-congress-fiduciary-idUSKBN18J0HA
2    http://www.goldmansachs.com/s/esg-report/content/esg-investing/
3    http://files.constantcontact.com/27d4e85b001/2c4fba38-950d-43c3-8d3c-521d7a9375bc.pdf
4    https://www.susanjfowler.com/blog/2017/2/19/reflecting-on-one-very-strange-year-at-uber
5    https://techcrunch.com/2017/06/17/a-better-boardroom-can-reverse-ubers-cultural-woes/
6    https://www.vanityfair.com/news/2017/05/wells-fargo-corporate-culture-fraud
7    https://www.wsj.com/articles/proposal-puts-focus-on-share-class-structure-1497873601
8    https://www.amazon.com/Citizens-DisUnited-Investors-Corporate-American/dp/1939282101/ref=as_li_ss_tl?s=books&ie=UTF8&qid=
9    https://www.bloomberg.com/view/articles/2017-05-30/airlines-stock-splits-and-voting
10  https://www.nytimes.com/2017/06/09/business/united-airlines-ceo-scandal-lawsuit.html
11  https://www.washingtonpost.com/news/on-leadership/wp/2017/07/24/what-millennials-want-from-their-ceos-activism/?utm_

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