Long-term Matters: Stop enabling corruption
My invitation to Prague last November had one drawback. The seminar was about corporate and political corruption. How depressing. Still, invited by the liberal Brookings Institution and the conservative American Enterprise Institute and convened by a leading US ambassador, how could I refuse?
The conference focused on growing corruption in eastern Europe. But developments elsewhere, including the West - the ethical implosions at NewsCorp and MF Global - were not ignored.
Most agreed that institutional investors act as enablers of legalised bribery. But we could also be part of the solution. A well-diversified portfolio has exposure both to the corporation that wins through bribery and the more ethical company that loses - this justifies action. And no one thought our end beneficiaries wanted to live with Russian-style market/political norms.
One obstacle is that the perpetrators are often powerful and the challenge to prove wrongdoing almost impossible. It is well known that when auditors get too close to a client, self-censorship increases. GE, for example, has used the same auditor - KPMG - for 100 years. KPMG was even ‘lending' staff to work on GE's internal audit. Unsurprisingly, this is only one of several ethical scandals reported at "one of America's most admired companies". (GE is often found in SRI/sustainability funds.)
In a re-run of David and Goliath, a small pension fund tried to table a resolution on this matter but the SEC sided with GE and blocked it (see http://cfa.is/AjZy3i). Coincidentally, Ben Heineman, GE's former senior vice-president and general counsel, has written a great book entitled ‘High Performance with High Integrity' in which he says: "High-performance corporations put relentless financial pressure on their employees to increase net income, cash flow, stock price - pressure that can often cause corruption when unconstrained by high integrity."
This case highlights issues for investors.
Only targeting companies one by one is an ineffective way to deal with systemic flaws. Major investors should push for regulatory action with market-wide impact, in this case enforced auditor rotation, as looks likely in the EU. Indeed, global investors have good reasons for pushing for co-ordinated international regulation, eg, convergence of the anti-bribery legislation. And individual analysts should ask management probing questions, thus indicating their concern. Given that conflicts of interests can be a big problem - and not just in the US (normally well-governed Dutch funds and the mis-stated Shell's reserves) - major funds could dilute the political risk by collaborating as a matter of routine, perhaps even nominating a peer from outside the region to lead.
The SEC's decision has the hallmark of self-censorship. Without doubt, GE has much influence - its CEO chairs the President's Council on Jobs and Competitiveness. Heineman has also written on the risks associated with corporate political influence. He spells out several criteria for good practice, such as disclosure of spending, avoiding direct payments, etc. Investors could use these criteria in their valuation and governance decisions. This means ensuring that their mainstream research suppliers - sell-side and credit-rating agencies - cover these corporate governance issues. Sadly, some firms that did do such research - like Deutsche Bank and JP Morgan - have stopped. This is a wake-up call for the boards of PRI and ICGN given their stated commitments to use client influence to change the way research supply-chains work.
Speaking about the US but in comments that have global relevance, Heineman says: "The ultimate campaign spending dilemma facing corporations, in my view, is how to find and support such candidates in a year which - due in no small part to inflammatory and unlimited campaign spending - is more likely to exacerbate partisanship than moderate it." His message is that crony capitalism threatens democracy. Thus, investors could push boards to take public interest more into account when lobbying. Reporting on political expenditures is fine as a first step but what is really needed is a justification of lobbying expenditure in relation to long-term shareowner value.
It is time for investor action, and the best way to win back the moral high ground is to adopt a ‘start in my back yard' approach to investment to demonstrate a zero tolerance approach to corruption in our own supply chains.
Raj Thamotheram is an independent strategic adviser, co-founder of PreventableSurprises.com and president of the Network for Sustainable Financial Markets