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For The Association of American Law Schools Annual Meeting January 2010. Speech not given and Bob did not attend. New Orleans Speech January 7, 2010 Corporate Governance, Fiduciary Duties and Social Responsibility “[S]ocio-economics does not entail a commitment to any one paradigm or ideological position, but it is open to a range of thinking that treats economic behavior as involving the whole person and all facets of society within a community evolving natural context.” In the 2003 film The Corporation by Mark Achbar, corporations are described as having may of the traits found in people clinically defined as psychopaths. Callous unconcern for the feelings for others Incapacity to maintain enduring relationships Reckless disregard for the safety of others Deceitfulness: repeated lying and conning of others for profit Incapacity to experience guilt Failure to conform to social norms with respect to lawful behavior. The corporation is designed to make money without regard to human life, the social good, or the impact of the corporation’s activities on the environment. Corporation by laws impose a legal duty on corporate executives to make the largest profits possible for shareholders. Law and economics and cost benefit ratios provide the operational vocabulary. This paper will suggest that a more spacious view of inveterate and unchanging legal concepts – such as the law of trusts – provide a framework for the construction of ethical corporations. We will suggest that ethical corporate behavior is characterized by three principal norms. Health – concern for the well being and biological survival of human participants Care of Infants – Concern with the long term - of sustainability Fairness – inter generational, inter national, and between the various components of the corporate constellation. Sharing of risks and benefits. We will sketch the outlines of a possible path to ethical corporations in today’s United States. #1 – One of the major challenges of our time is to assure to all the benefits of the wealth creating corporate system while at the same time protecting society from its adverse consequences. #2 – The prevailing legal system in America describing the governance of corporations is largely a matter of state law. Its driving dynamic empowers and requires management to maximize shareholder values, as defined by the cost/benefit analyses so beloved by the 1 For The Association of American Law Schools Annual Meeting January 2010. Speech not given and Bob did not attend. law and economics community. This dynamic places incentive for corporations to “externalize liabilities” - to place as many of the costs of corporate functioning as possible on to others. In the film, The Corporation, I summarize: “The corporation is an externalizing machine, in the same way that a shark is a killing machine. There aren’t any questions of malevolence or of will. The enterprise has within, and the shark had within it, those characteristics that enable it to do that for which it is was designed.” The unhappy face of “federalism” seemingly condemns us to a “race to the bottom” in the effort to improve corporate standards – that has certainly been the fate of corporate governance attempted reforms over the last half century. #3 – Management controls both the board of directors and the corporations’ lobbying and political contribution policies. This confers on management vast leverage in dealing with the state, its own creator and supervisor. The Supreme Court has removed all restraint on direct corporate involvement in politics. This has made “reform” of the prevailing corporate system most problematic. Indeed, years into the Crisis of 2009-2010 we are still experiencing endless equivocations and delays from the SEC, the Federal Reserve and other government agencies whose enforcement failures were such an important cause of the disasters. Reality is that we suffer from ownerless corporations – the single element in the corporate constellation adequately independent, motivated and skilled to require accountability from management has been muted. This phenomena has occurred partly as crime and partly as tragedy. #4 – By sheer hazard, the preponderance of the outstanding voting stock of publicly traded companies in America is held by trustees - fiduciaries the extent of whose responsibilities and prerogatives are defined under existing federal laws – principally, The Employees’ Retirement Income Security Act of 1974 (ERISA) and The Investment Company Act of 1940 (Investment Company Act). #5 - I asked Senator Jack Javitts, one of the “Fathers of ERISA” how they had managed to combine a rationalized retirement system with a legitimizing ownership base for portfolio companies. Never accused of modesty, Jack nonetheless was prompt to say: “Bob, we never thought of it.” Today, institutions own 76% of the total equity and yet J.W. Hurst’s forty year old description rings true. “As the number of institutional investors increased, some prophets said that these investors, moved by their stakes and informed by their expertise, would begin to play in earnest the supervisory roles of the legendary stockholder…Already under responsibility to those for whose benefit they held shares, professional fund managers did not seem anxious to incur further responsibilities to their fellow shareholder in the companies in which they invested. At bottom, the position seemed unstable…. Meanwhile the relative passivity of these big investors underlined the general failure of shareholding to supply the steady surveillance by which stockholders were supposed to legitimate the power wielded in business corporations.” (87-88) Reality is that these big investors are not the flesh and blood individuals whom the theorists look to for legitimating private power. They are trustees, usually institutions, the scope of whose responsibility is set forth in enabling federal statutes which plainly were not at all focused on the implications on the governance of corporations. Most of these 2 For The Association of American Law Schools Annual Meeting January 2010. Speech not given and Bob did not attend. institutions are parts of financial conglomerates. Often, the relative financial importance of the fiduciary component in the conglomerate is less significant than other functions with the result that the inevitable conflicts of interest are resolved to the detriment of the beneficiaries of the employee benefit plans and mutual funds. #6 - In the early 1970s, famous 2nd federal circuit court judge Henry J. Friendly ruled that institutional trusts were personal and could not be transferred. He was overruled in an amendment to the Securities Act in 1975. In 1985 UK Judge Robert Megarry ruled in Cowan v. Scargill that trustees must administer property exclusively for the benefit of participants. These two judicial recognitions of the association of ancient trust law and the newly emergent institutional investors are like road signs to a way long deserted. Money management became the most lucrative and important industry in the US and UK. Legal niceties defining trustee duties as expressed in ERISA – administer “for the exclusive purpose” and “for the sole benefit” of plan participants – were shunted aside into insignificance in the chase to maximize assets under management. The underlying notions of “fiduciary” which underlay the money management industry were unmistakably superseded by the appetite of the trustees to maximize the assets that they managed. Trustee has become an historical noun rather than a current mode of conduct. #7 – The opportunity exists even today to recognize a federal law of trusts comprising the rights and obligations of fiduciaries under existing statutes – preeminently, those creating employee benefit plans, mutual funds and bank trusts. The President could convene the Chair of the SEC, the Secretary of Labor, the Chairman of the Federal Reserve and the Attorney General and announce simply: “It is in the public interest that the trustee owners of companies act like stewards for the welfare of their beneficial owners. This requires that all fiduciaries, the scope of whose responsibilities are defined by existing federal law, should require that the companies in their portfolios conduct their business so to optimize the long term value of the owners’ holdings. The Attorney General is here to evidence that this government intends to enforce the fiduciary responsibilities of the owners of America’s publicly traded companies.” It is within the current competency of those in office to manifest a new federal law of ownership that will have the effect of providing normative standards in the direction and management of companies that supersede the frail standards imposed by current state law and through vigorous and intelligent use of the power of ownership to create a new form of corporate governance. #8 - Ownership rights and responsibilities are part of the “plan assets” which trustees are obligated to administer in the exclusive interest of beneficiaries. The US agencies responsible for enforcing beneficiaries’ rights have conspicuously been co-opted by the financial conglomerates they are supposed to regulate. The Investment Company Institute has notoriously dominated the SEC for decades and in recent times the Chamber of Commerce has elicited shameful fiduciary retreat from the Department of Labor. The emergence of fiduciaries as the “legendary shareholder” has been further inhibited by the reality that trustees are risk averse, trustees cannot be compensated for successfully taking risks and, in recent times, trustee organizations have largely been acquired by financial conglomerates with attending conflicts of interest. That said, a healthy wealth producing corporate system needs the involvement of informed owners. 3 For The Association of American Law Schools Annual Meeting January 2010. Speech not given and Bob did not attend. #9 - Our chronicle of shareholder activism has brought us to the point where clearly the power exists in ownership to inform the process of managing the enterprise. What does not exist is a language of accountability. Managers are not bad people. They can manage what they can measure. It is up to the rest of us to reform the system of measurement from the manifest inadequacies of the present system of accounting. The primary obligation trustees, operating pursuant to the newly declared Federal Fiduciary Law, is to generate an holistic accounting system so that all corporations can have the confidence of functioning in a way compatible with society’s needs. Today’s managers could ethically manage tomorrow’s enterprises if we can internalize externalize costs and account appropriately for assets like intellectual property. There has been encouraging progress in the field of environmental costs. #10 - The United Nations Environment Program sponsored a report Fiduciary Responsibility – July 2009 – that directly confronts the obligation of trustees to consider what have traditionally been “external costs” ( at page 11). The law firm Freshfields expands the traditional scope of definition of fiduciary responsibility to include a spacious concept of operating rules. It concludes not only that this concept is within the competence of traditional trustees, it states clearly that it is their obligation - an obligation that is legally enforceable by beneficiaries. 1. Fiduciaries have a duty to consider more actively the adoption of responsible investment strategies 2. Fiduciaries must recognize that integrating ESG issues into investment and ownership processes is part of responsible investment, and is necessary to managing risk and evaluating opportunities for long-term investment. 3. Fiduciaries will increasingly come to understand the materiality of ESG issues and the systemic risk it poses, and the profound long-term costs of unsustainable development and its consequent impact on the long-term value of their investment portfolios. 4. Fiduciaries will increasingly apply pressure to their asset managers to develop robust investment strategies that integrate ESG issues into financial analysis, and to engage with companies in order to encourage more responsible and sustainable business practices. The whole question of specifying the precise interests of shareholders is complicated by the diversity of the shareholder population, ranging from holders for a nano second pursuant to a computer algorithm to those permanent holders in index funds. A certain arbitrariness is necessary – many reasons, not the least of which is relative size, suggest that the typical beneficiary of a defined benefit plan with eighteen years before retirement and a desire not only to have the funds for a comfortable life, but also the desire to live in a clear, civil and conscious society. Designating such an individual beneficiary class will enable courts and enforcement agencies to put content into the new holistic accounting vocabulary. 4 For The Association of American Law Schools Annual Meeting January 2010. Speech not given and Bob did not attend. #11 – J. D. Suss1 argues for the transformation of existing human systems: “From my perspective, a new, reinvigorated consciousness is the ideal fountainhead out of which truly citizen-centered global public policy, institutions, and institution-building can be born, nurtured, and maintained. From the stance of a world view that embraces a more relational/participatory consciousness the avaricious consumerist/ materialist, Cartesian frame-of-reference, e.g. the status quo values and agenda of a growing, global corpocracy would no longer be viable.” #12 - By defining the scope of fiduciary responsibilities in increasingly holistic terms, which can be expressed in ethical terms - concern for health, a long term perspective, and fairness - the driving dynamic of corporations can be changed through the effective involvement of shareholders, acting in their legendary function as “stewards”. 1 September 11, 2007, J.D. Suss – http://spyoptaelip.blogspot.com 5