Department of Shareholder Primacy?

Department of Shareholder Primacy?

This week, the Department of Labor (DOL), headed by Eugene Scalia, announced a proposed rule intending to “update and clarify” the DOL’s investment duty regulations relating to ERISA Plans. DOL intends to impose a ban on any fiduciary managing an ERISA plan if they have anything but pure profit as a primary investment goal.

The new DOL clarifications intend to put ESG in its place (down to the sub-basement) by proposing that ERISA plan fiduciaries, if following their “duties of prudence” may not consider “non-financial objectives” (e.g. ESG) if those goals “subordinate return or increase risk for the purpose of non-financial objectives.” 

Clearly DOL seems to understand better than the growing surge of people now looking for impact investments. We are all now being schooled by DOL that those considerations are non-financial – meaning that they have no connection to any sort of financial bottom line.

DOL wants to make very clear that material economic risks like ESG considerations are not goals to be followed under “generally accepted investment theories.” And though DOL declines to cite what those generally accepted theories might be, we can easily assume they are referring to ‘Uncle Milty’ Friedman’s Capitalism and Freedom manifesto that gave prominence to the Shareholder Primacy campaign successfully waged on us since the late ‘70s.

No one should be too surprised by what DOL is trying to do here, especially with Mr. Scalia now firmly entrenched. As Senator Minority Leader Chuck Shumer stated during Scalia’s confirmation hearing process, “Mr. Scalia’s life work has been utterly opposed to the mission of the agency to which he’s nominated. He has sided repeatedly with the large corporate interest against the working people.”

But wait! Didn’t Senate HELP Chairman Lamar Alexander (R. Tenn.) say, during Scalia’s nomination hearing that “[i]t is important for the Department of Labor to create an environment to help employers and employees succeed in today’s rapidly changing workplace…”?? 

Perhaps the confusion is that Alexander is using Newspeak while we are still trying to make sense of things in English.

Indeed, offering rules to weaken attempts to allow retirement accounts to invest in companies that are focused more on the long term betterment of our planet, society (employees, stakeholders and better governance models) and our local communities certainly could be seen as contrary and anemic by those following Uncle Milty’s “generally accepted investment theories.” But those are raw, blatant and childish attempts at protecting the beloved Shareholder Primacy ideals. (Hey, if we can’t get enough judges to rule that Shareholder Primacy is the law of the land, let’s get it inserted in any rules we have power over). 

These kinds of shrill attacks on any attempts to reign in our hyper-capitalist ways may still have some short term successes, but the trend is now turning away from that system that is destroying our ability to live decent healthy lives – and to see why ending injustices at all levels will actually preserve, not diminish, our future health.  Even if this rule is imposed, savvy investment fiduciaries may understand that they will always keep as a priority the “financial considerations relevant to the risk-adjusted economic value of a particular investment or investment course of action” and avoid any “subordination of the interests of plan participants and beneficiaries in retirement income and financial benefits,” while also looking hard at the ESG factors that they understand will meet those goals over the long term.

In announcing the proposed rule, Scalia says that “[p]rivate employer-sponsored retirement plans are not vehicles for furthering social goals or policy objectives that are not in the financial interest of the plan, Rather, ERISA plans should be managed with unwavering focus on a single, very important social goal: providing for the retirement security of American workers.”  Oddly, he left out making America Great Again, but whatever.

As the DOL press release states at the end, “[t]he mission of the Department of Labor is to foster, promote and develop the welfare of the wage earners, job seekers and retirees of the United States; improve working conditions; advance opportunities for profitable employment; and assure work-related benefits and rights” (emphasis added). Might efforts to help employees succeed in their workplace create better long-term financial results? Wouldn’t giving employees a seat at the governance table give companies a better chance of long-term success by enriching the environments of the workplace, their health and safety? I wonder if Senator Alexander understands that those efforts might, at first blush, look like they are reducing short term profits, but instead, establishing long term success for a company. 

And maybe, just maybe, regular folks with retirement accounts and their fiduciaries see that as well. 

Clearly, Mr. Scalia feels that no other goal but Shareholder Primacy is important enough to consider. Not the fiduciary, nor the beneficiary with funds in a retirement account who may beg to differ. Scalia wants to make clear that only he and his DOL gang know what is best for retirees, and impacts caused by a warming planet, employees treated like serfs, and patriarchal rulers of boards obviously have no significant effect on those financial results.

Mr. Scalia and those that put him and his boss in power for now should pause to reflect on Martin Luther King, Jr.’s reminder that “the arc of the moral universe is long, but it bends toward justice.” Funding goals that bend toward justice for all seems like a good, material and sound financial objective to us, and is becoming a generally accepted investment theory.

Why Financial, Legal, and Business Professionals Should be Champions of Community Capital

Why Financial, Legal, and Business Professionals Should be Champions of Community Capital

At this week’s ComCap17 Conference in Monterey, CA, one of the sessions that I participated in dealt with the roles of financial, legal, and business professionals as it relates to community capital.

Our panel was moderated by my old friend, Michael Shuman, and we were joined by other professionals who provide technology (Amy Wan), platforms (Youngro Lee), regulatory oversight (Faith Anderson from the state of Washington), and a refreshing and much-needed approach to community investment advisory services, which Angela Barbash of Michigan’s Revalue Investing provides.

Revalue Investing is a great example of an advisor leading this movement of new professionals who are willing to work with individuals to help them understand the risks and rewards when contemplating local, unlisted investments in companies that the large advisors refuse to consider. Revalue overcomes the large advisors’ risk aversion and limitation of liability by deploying smart disclosure methods. They know that by remaining agile, nimble and sized-right for communities, they can navigate through those risks without laying down heavy-handed restrictive practices.

My contribution to the session was that for community capital to be successful, we need professionals to participate with a different mindset and approach compared to what otherwise happens in a globalized and anonymous hyper-capitalist system that has almost nothing in common with community capital. Today’s uber-financialized economy does, however, have one essential connection back to communities – it needs to plug in everywhere so that it can extract far more than it contributes. That is one of the essential ingredients behind the myth of shareholder primacy.

Many of today’s professionals like to boast about their ability to charge as high of fees as whatever the market will bear. And because that approach mirrors how their clients behave, there is a built-in circular support system that gives no outward thought to how their actions directly contribute to our accelerating global crises, including the depletion of essential resources, climate change and state failures.

One important antidote to this flat-world mentality is the work happening on the ground, in communities, all over the world. Work by people who understand the value of strengthening community bonds, and fostering the recognition that without each other’s support, we end up as weak as our weakest link in the community chain.

Successful community capital markets are going to require professionals to operate under a new paradigm, and businesses in turn need to self select out of the professional system that contributes to damages to their communities by utilizing those professionals that have committed to work for fair and reasonable wages. This new paradigm no longer tests the limits of what businesses can bear, but instead adopts a reformed service model that does not force those companies to have to pass on the higher costs to their customers, and their community.

With few exceptions, community support relies on its own members, not from those extracting wealth from the community and into the out-of-town bank accounts of a very small group of exceedingly wealthy families. That kind of extraction leaves in its wake an ever increasing income and wealth gap that multiplies the damages to the health and well-being of a community, and professionals who don’t work to counter this impact are in turn contributors to it, and partly responsible for the effects.

We need a new breed of professionals who come to work each day with a different kind of commitment, and a revised expectation of compensation. These professionals must help the rest of the community to understand that for a community capital market to thrive, we have to think about a different way of investing in ourselves, where “returns” and “exits” are not the primary reason to support businesses, and where people primacy takes the place of the old shareholder primacy myth. As Michael Shuman added, this may call for the adoption a professional’s fiduciary responsibility to the community itself, not just to any one client.

This kind of self-imposed fiduciary responsibility to the community would mean curtailing work that is at odds with the needs of the community. It would call on professionals to select out of providing services that contribute to the extraction, and to bring their fees into alignment with those that need their help. It would call on professionals to challenge the myths, like shareholder-primacy – myths that foster the continued support of the extractive economy, and to examine and build practices around a more fair and just society.

These approaches by no means require taking a vow of poverty. For professionals to be truly effective for their community, they should align their mission and their compensation with the same expectations as those community members they serve.

Doing well by doing good may not go as far as community needs it to go. Doing well enough and doing good may be more to the point.

A Call for Systemic Impact

A Call for Systemic Impact

Foundations, Families and Funds can play a very important role in helping to redirect capitalism toward a more fair and just application, while also finding the right social enterprises to support.

By playing a more comprehensive role in the creation and support of Community Capital Markets, these funding sources can build impact into a systemic approach. In addition to investments they make into the social enterprises either directly or through other intermediaries, they can also facilitate opportunities for the 90% of households that are prevented from participating in the private capital markets by investing in the structures that form alternative capital markets open to everyone.

We are better informed today than ever before about the rapidly expanding wealth and income gaps. Many recent studies show the top 10% of U.S. households now have over 75% of all the wealth in America. The next 24% of American households make up almost all the rest of all the wealth, leaving the bottom 40% with 0% wealth, and the bottom 60% with a whopping 3%! And the gap is growing fast, not shrinking, which portends many new challenges to our society.

Clearly we need to think about whether the current approaches are working, and if not, shift the paradigm.

As economists like Thomas Piketty have thoughtfully surmised, this growing gap will not improve without either government intervention or opportunities similar to what the wealthy have had – i.e. the same chances to invest and to begin to grow some wealth of their own. For anyone out there who follows the current dysfunctional state of our government, I would not hold out much hope for the first option anytime soon.

Regardless of the causes, our current state of affairs seems to point toward us having to right this very serious problem ourselves, and right it we must.

In the U.S., our government actually limits 90% of households from having any access to the private capital markets, leaving their investment options only in either the public capital markets, or alternatives that I’ve written about here, via Direct Public Offerings, or perhaps through the new state and federal crowdfunding options.

The irony is that, in the interests of protecting the 90%, only the very wealthy 10% continue growing their wealth. They have access to opportunities that far surpass anything found in the public capital markets. The 10%er’s may also use the public capital markets to hedge, speculate, or even arbitrage if they like, but their real wealth generation comes mostly from those private markets. But neither of these kinds of markets helps us to form the systemic structure we need to build healthier communities.

Which leads me back to how Foundations, Families and Funds can help.

The list of impact investors is growing every day, and we will all continue to work toward better identification of who is truly acting as a social enterprise, e.g. companies building business models to tackle some of the most difficult and seemingly intractable social and environmental problems, including climate change, poverty, water, energy and real estate, etc.

I refer to the entrepreneurs above as our new community of social enterprises, which includes those with a clearly defined mission, who are focusing on achieving impact at scale for all stakeholders (workers, customers, community, environment), but who also understand the importance of connecting via deep impact into their local populations. These kinds of entrepreneurs place a high degree of importance on the generation of mission aligned revenues (from clients or others who’s mission is aligned), and tracking/publicly reporting on their impact on a regular basis (transparency).

It’s encouraging to know that many investing organizations are now looking to make real impact via their investments by seeking out these entrepreneurs, even if we’re still in the nascent stages of trying to square that with the goal of getting back “market rate returns.” Leslie Christian just posted a great blog on this conflict here.

However, supporting those entrepreneurs with an investment is only one of two key components we need to have a healthy Community Capital Market. Focus also needs to be provided to the 90% of households so they can participate as well, even if half or more of them currently have no wealth to employ as investments into a market. These households need opportunity, which they are now starting to see with the alternative investment vehicles mentioned above, but even more important, they need experience, education and understanding in terms of what it means to be an impact investor – one that may not need those “market based returns,” whatever that means.

We need a whole system approach in place for community investors and community entrepreneurs to be able to find each other, which is what a Community Capital Market can be.

10 years ago, my good friend Don Shaffer (now at RSF Social Finance) and I embarked on a project to develop Local Stock Exchanges. I wrote about the need for these in several publications and even took a position at the Boston Stock Exchange to mirror a national exchange at a local level. But looking back, there is one critical element I got wrong. We don’t need to replicate the public capital markets with a lively secondary trading component that fosters speculation and arbitrage (using the need for liquidity to justify the madness they have become). We need a much more simple system in place that allows for the efficient transfer of individual’s savings into socially responsible companies, allowing for modest healthy returns, and some reasonable offerings of an exit if necessary. We need to power it with the right tools, education and mentors to help guide the ones that have not had access until now. We also need to reconsider what a capital market needs to be today, and not fall for the trap of manic returns and unlimited growth.

Foundations, Families and Funds can get behind this new kind of capital market by funding the system that can facilitate the Impact we need, and if they desire, they can also play a member-based role in how we operate it – much like exchanges used to be structured, before they turned into the same shareholder primacy driven entities that list on them today.

Wealthier Investors Are an Essential Part of Community Capital Markets

Wealthier Investors Are an Essential Part of Community Capital Markets

The Securities and Exchange Commission has recently estimated that approximately 10% of all U.S. Households are now in the “Accredited Investor“ category (for individuals, that means $1m in net worth not counting primary residence, or $200k of income). Assuming that’s accurate, there are now over 12 million households in the U.S. that meet the definition of Accredited Investor (“AI”).

The SEC defines the AI to determine their eligibility to invest in Private Placement offerings (i.e. funding rounds of securities that are sold not through a public offering (IPO), but rather through a private offering, and mostly to a small number of chosen investors). And as the private placement market edges toward $60 billion of deals a year, that may seem to most people as a sizable amount to participate in, with lots of opportunities to get in on the next big home run deal.

Some of those AIs, however, have begun to look for more than just a company swinging for the fences, but rather companies that look out for profits, people andthe planet. The rise of socially responsible or impact investing has now begun to take hold. And there are now more financial advisors becoming familiar with these kinds of investments, and helping their clients to find such deals.

Unfortunately, financial advisors feels constrained (for good reasons) to only show their clients deal opportunities of a certain size and nature. Many even limit their scope to only companies traded on public markets so that they reduce the risk of breaching their fiduciary duty to their clients. Other more adventurous advisors will brave the private investment landscape, where, with the right amount of due diligence, they can recommend impact deals to their clients that will also provide something close to market returns (whatever that really means).

But there’s another opportunity for AIs to make a significant impact. They can invest AND play an essential role in the stabilization, growth and resilience of the communities they live in or relate to. They can do this by participating alongside of the rest of the non-accredited investor community into investments offered by community entrepreneurs.

The kinds of investments I refer to here are Direct Public Offerings and certain state securities crowdfunding opportunities, both of which allow for investors to directly interact and engage with the entrepreneur/issuer. I wrote recently about this in previous blogs here, and also earlier today in a Locavesting article. As these crowdfunding offerings and the platforms they list on become more populated, investors will begin to find it easier to find offerings. Also, as we help clients obtain their approvals for DPOs, we post the offerings up on our CEX site so that investors can more easily find the issues and link to their sites.

The role AIs can play to support these much needed community enterprises cannot be emphasized enough. For one thing, as companies begin to turn more to using tools like DPOs to raise their funds, the size of the raise is going to increase well above the $1 million limit that the state or federal crowdfunding laws impose. DPOs, if done via the Intrastate exemption, are typically unlimited, as long as the state regulators approve them, and we are starting to see many more offerings in the $5-10 million range. Companies offering stock will want to limit the number of non-accredited investors to 500, and the total number of investors to 2,000, or face becoming “publicly reporting,” which is expensive to maintain. This means the offerings truly need the AIs to meet their targets.

Another key reason is the experience AIs may be bringing to these offerings. Clearly just because one is an AI does not mean one has the financial expertise of a typical VC or Angel who do this for a living or hobby. But there is no doubt that many AIs have some experience with investments, and likely more than their non-accredited counterparts. This can be very important when a company is even considering how to structure their offering, if they can learn beforehand what an AI will want to see before they participate.

And then there is, of course, the leverage an AI can bring to the offering, just by signing on and showing up. Some AIs provide the “prime to the pump“ so that the offering can take hold. Some even offer a matching approach. It can be an important signal to the non-accredited investors that they don’t have to shoulder the offering alone. Also, regardless of the wealth divide that exists, every member of the community can come together to make an offering successful. AIs can be an important kind of hero to this movement, while still obtaining enough of a return. Their participation can also lend the right kind of pressure to the entrepreneur to keep them on their toes, and striving to meet their mark.

AIs might do their own homework (due diligence), as they look at these investments, or they may be able to find a new breed of financial advisor who are willing to help analyze the offering, even if they stop short of making recommendations and risk their duty. And there are also new pioneers, like Marco Vangelisti, who has taken it upon himself to begin offering daylong workshops for community investors.

Marco is a veteran of global finance who walked away from the industry in 2009 after a 25-year career, and is now helping communities around the country understand the role investors can play in support of community. He created Essential Knowledge for Transition – an initiative to empower communities with a basic understanding of the large systems affecting our lives. Marco’s next workshop will be in Irvine CA the 7th of May, and after that, we intend to try cloning him so that we can help ALL kinds of investors, AIs and non-accrediteds alike, everywhere, to align their investments with their values, and create the world we want, and need.

Invest  in Who You Know – Part 2

Invest in Who You Know – Part 2

Most people don’t have the ability, flexibility or funds to invest like a professional, and a more common approach for ‘investing in what you know’ takes the form of how well you can follow a company, mainly by looking at what you (or others who you trust) know about the company, or what the company has disclosed or reported about itself.

In the public markets, this means what a company publicly reports, and we (or the analysts) will read their “Form 10-Qs” and “10-Ks,” which publicly reporting companies must file with the SEC every quarter and year, respectively. We might also listen in on their webcasts, track their progress in the news, and even monitor their competition as a comparison.

The SEC reporting is still based mainly around financial information, with much less attention devoted to other material actions and impacts, but this is starting to change. There’s a lot of great work underway by organizations such as the Global Reporting Initiative (GRI), and Sustainable Accounting Standards Board (SASB), who are creating sustainability performance measures for these publicly reporting companies, and then monitoring and reporting on them separately. The largest database of corporate sustainability reports is still the UN Global Compact Initiative, which they publish on their website.

For private companies, there are also some new approaches, such as the GIIRS rating system for companies or funds, allowing companies to voluntarily report measurements on social and environmental impacts. B-Lab’s “B Corporation” label allows a company to do a self-assessment, which they claim leads to “B Analytics to help investors consider whether a company is properly managing its socially responsible impacts, with as much rigor as their profits.”

While these new reporting approaches try to help investors assess whether companies are meeting certain “sustainability” standards, trying to define these standards are can be a daunting task, especially as the definitions are too murky or continue to change and new reporting tools are created.

We first saw screening tools applied to companies (e.g. no oil, weapons or bad actor sovereignties) in an attempt to label the good ones as “socially responsible investments.” Then came the dawn of “sustainability,” which sounds good, but has many different definitions. Nor has “triple bottom line,” “ESG” (environmental, social, governance), or even “Impact” given us clarity in terms of a definitive metrics-based idea for understanding whether a company is really contributing to our world in a positive and replenishing way, or simply another extractor of resources leading us closer to the demise of our species.

Even if the definitions or surveys are well thought out, is a company’s reporting enough for us to rely on to know that they are really making the kind of “impact” we want to see? When a company receives a “good company” sort of label, in whatever new socially responsible format we like, does that mean that the label was strict enough to ferret out all of its behaviors? Can companies fudge, omit, or cleverly interpret the ratings questions so that the answers fit the right frame they want to display?

While the efforts to bolster transparency about private companies is a great step in the right direction, reliance on only the reporting approach to make investment decision poses meaningful risks. Borrowing the famous quote from Albert Einstein, I would refer to this as the investment equivalent of Spooky Action at a Distance. A potential investment candidate may have received high marks from an outside rating group, and only later might we find them to be acting in ways we deem distasteful. Maybe we didn’t realize they were hoarding revenues offshore to avoid paying U.S. taxes, or providing their services to any kind of planet damaging company while espousing high-minded values, or grabbing federal funds while really only focusing on driving profits to its shareholders.

How do we know from a label whether a company truly practices all of the values they received high ratings on? Similarly, how do we know from a report whether they might be making certain private compromises to what they publicly report in order to bolster their bottom line?

If we don’t know the people behind the company, we may be left with only our faith in the reports, provided mainly or only from information supplied by the company itself, with little if any recourse for misrepresentations or omissions (except possibly a future rescission of their seal of approval, or being publicly shamed for their hypocrisy). Unfortunately, there are likely as many forms of greenwashing today as there are new efforts to heighten transparency, so relying only on modern internet-based tools or chat groups should be done at every investor’s peril.

Some who work directly in the area of socially responsible investment advising have seemingly given up on trying to identify the right term or the right actions, now hoping they can simply determine whether a company is behaving “responsibly.” And perhaps it really may be more meaningful to apply a “smell test” than to blindly rely on a label or a report. To paraphrase SCOTUS Justice Potter’s famous line from the Jacobellis pornography case…trying to define terms like Sustainability, Impact, or Socially Responsible using shorthand descriptions can quickly become unintelligible. But, like Justice Potter, perhaps we can apply that same personal test… I know it when I see it!

And that then begs the question…how do you see it? One very well tested method is to invest in who you know, and that means being able to find and get to know the companies, and the team, before you invest. Community capital markets provide just that opportunity. Community capital markets enable companies and investors, connected geographically or in fellowship, to engage with each other on a personal level. These kinds of capital markets can take the spooky out of the action, by bringing a personal touch to our awareness, and engaging with each other in financial transactions that support each other.