Year: 2010

Child Climbing Mount Everest

Jordan Romero is thirteen years old. And he is departing on April 5 for his trip to climb Mount Everest.

That would be an extraordinary feat. But is it ethical to allow such a young person to put himself in such a dangerous situation?

(In case you are wondering, the current record for the youngest person to climb Mount Everest is held by Ming Kipa Sherpa, a 15-year-old Sherpa girl.)

How young is too young to take on such a dangerous task? I don’t think many people would be concerned about a 21 year old trying the climb. Maybe a few more would be concerned about an 18 year old and probably many more would be concerned for 16 year old.

One issue ethical issue is the death rate on Everest. By the end of 2009, Everest had claimed 216 lives. You can probably add in hundreds of lost toes and some lost fingers if you are inclined to include permanent maiming as part of the consequences.

On the other hand, young Mr. Romero has already reach the summit of 19,340-foot Kilimanjaro (Africa), 7,310-foot Mount Kosciusko (Australia), and 18,510-foot Mount Elbrus (Europe), 22,834-foot Aconcagua (South America) and 20,320-foot Denali (North America). If Jordan can climb Everest and Antarctica’s Vinson Massif, he will become the youngest person to have climbed the Seven Summits, the highest points on each continent. He has some experience and skill.

I would guess that if he succeeds he will be lauded. If he commits the ultimate failure and dies on Mount Everest then there will be an enormous outcry.

He is not climbing alone. His father, Paul, and Paul’s partner, Karen, are part of his climbing team. Both of them are adventure racers.

Age has been a problem before. They needed to get a court order to allow them to climb Mount Aconagua. Apparently Argentina has a strict age requirement of 14.

You have to wonder what the motivation is? Is it the young Mr. Romero’s passion to climb? Or is his father pushing him too far?

From a business ethics perspective, you might lay fault with the team’s guide for Mount Everest. A guide would want to make sure that the client has sufficient high altitude climbing knowledge and experience to succeed on the mountain. A good guide would be a gatekeeper, keeping unqualified people off the mountain. Of course there is an ethical issue since they don’t get paid when they say no.

Unfortunately, Romero’s team is climbing alone. In order to save money, they are not using a professional guide.

For me, the failure to use a guide is completely unacceptable. That shows that ambition is outweighing common-sense. Romero is clearly going to be in the most dangerous situations he as ever encountered. Mount Everest is substantially higher and more dangerous than the other peaks. A responsible parent would insist on proper safety precautions. Having an experienced guide should be one of those safety precautions.

It sounds like they are going to attempt the climb, so I wish them good luck and good health. I just wish they wouldn’t go.

Sources:

Supreme Court Rules on When Mutual Fund Fees are too High

The Supreme Court issued its opinion in Jones v. Harris Associates, addressing the standard for when mutual fund fees are too high.

Background

Under §36(b) of the Investment Company Act of 1940 the “the investment adviser of a registered investment company shall be deemed to have a fiduciary duty with respect to the receipt of compensation for services, or of payments of a material nature, paid by such registered investment company.”

The traditional standard was that a breach of fiduciary duty occurs when the adviser charges a fee that is “so disproportionately large” or “excessive” that it “bears no reasonable relationship to the services rendered and could not have been the product of arm’s-length bargaining.” Gartenberg v. Merrill Lynch, 694 F.2d 923 (2nd Cir. 1982)

The Jones v. Harris case starts with the claim that the fees are excessive because they far exceed those charged to independent clients. Like many investment advisers, Harris charges less for institutional clients that invest in funds similar to its Oakmark funds. The plaintiffs take the position that a fiduciary should not charge a different price to its controlled clients than it does to its independent clients.

Judge Easterbrook in the Seventh Circuit rejected the Gartenberg standard and crafted a new one.  The court adopted a standard that an allegation that an adviser charged excessive fees for advisory services does not state a claim for breach of fiduciary duty under § 36(b), unless the adviser also misled the fund’s board of directors in obtaining their approval of the compensation.

Decision

The Supreme Court concludes that

“Gartenberg was correct in its basic formulation of what §36(b) requires: to face liability under §36(b), an investment adviser must charge a fee that is so disproportionately large that it bears no reasonable relationship tothe services rendered and could not have been the product of arm’s length bargaining.”

They also make it clear that the burden of proof is on the party claiming the breach, not the fiduciary.

The Supreme Court found fault is looking almost entirely at the element of disclosure. The result is that the Supreme Court overturned the Seventh Circuit and remanded it back for further proceedings.

What does the standard mean?

The Investment Company Act does not necessarily ensure fee parity between mutual funds and institutional clients. Courts need to look at the similarities and differences in the the services being provided to different clients.

Courts should not rely too heavily on comparing fees charged by other advisers. Fees may not be the product of arm’s length negotiations.

A court should give greater deference to fund fees when a board’s process for negotiating and reviewing compensation is robust. “[I]f the disinterested directors considered the relevant factors, their decision to approve a particular fee agreement is entitled to considerable weight, even if a court might weigh the factors differently.” If a fund adviser fails to disclose material information to the board, the court should use greater scrutiny.

“[A]n adviser’s compliance or non-compliance with its disclosure obligations is a factor that must be considered in calibrating the degree of deference that is due a board’s decision to approve an adviser’s fees.”

The result is that courts should defer to the “defers to the informed conclusions of disinterested boards” and hold “plaintiffs to their heavy burden of proof.”

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Making the Case for Compliance at Private Companies

More focus has been aimed at the need for compliance programs at public companies. Of course, that focus has been largely drive by the requirements of Sarbanes-Oxley. The other focus comes from highly regulated industries like financial services that require compliance programs.

That doesn’t mean that private companies can ignore compliance. There are many more private companies than public companies.

An article by Corpedia caught my eye: Making the Case for Compliance Programs at Privately Held Companies. (Since I work at a private-held company.)

As the article points out, the Federal Sentencing Guidelines do not change based on the ownership structure of the company. Private companies would need to take the same steps as private companies if they want to get credit for having an effective compliance program.

Another big reason for a compliance program is not discussed in the article. Under the Stone v Ritter and Midland Grange decisions, company officers and directors can be held responsible for the illegal conduct of employees. These cases follow up the case in expanding liability for company directors.

An effective compliance program would presumably reduce or prevent any illegal activity and shield the directors and officers from liability by showing that the illegal conduct was by a rogue employee.

One factor to keep in mind is that many private companies lack a meaningful board of directors. For many private companies, the board of directors really means the company’s principal. If there is a board, it may consist largely of family members, insiders and company officers. All the talk about access to the board of directors is lost on those us running compliance programs inside private companies.

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Mutual Fund Advertisements and Social Media

If you want to have a good fishing, go where the fish are

Much has been made about FINRA’s Regulatory Notice 10-06 and how that will affect the social media use by registered representatives. Looking beyond the broker/dealers, I thought it would be interesting to see what mutual fund companies are doing with social media. I’ve started seeing some mutual fund companies starting to dip their toes into web 2.0.

Key Regulations Governing Advertising of Mutual Funds

Mutual funds are highly regulated under the Investment Company Act and the Securities Act. The interests in the funds themselves are securities and are governed by the Securities Act. As a security, that means under Section 5.(b)2 of the Securities Act you can only use a prospectus to advertise it.

Under Rule 482, the SEC allows mutual funds some additional flexibility is advertising their products. If an advertisement meets the disclosure requirements of the rule, then the advertisement will be deemed a “prospectus.” (Which means you won’t be illegally selling securities.)

Required Disclosure under Rule 482

There is long list of requirements in the advertisement. Here are just some of them:

  • Point out that investors need to consider the investment objectives, risks, and charges and expenses of the investment company carefully before investing.
  • Explains that the prospectus and, if available, the summary prospectus contain this and other information.
    identifies a source from which an investor may obtain a prospectus and, if available, a summary prospectus;
  • You should read the prospectus carefully before investing.
  • Advertisements that includes performance data have to point out that past performance does not guarantee future results (along with extensive limitations on how you can disclose performance)
  • Money market funds must point that they are not federally insured and you can lose money. (Hello Reserve Fund!)
  • Disclosure statements can’t be in fine print

Filings

Advertisements then need to be filed with the SEC under Rule 497 or with FINRA. (Most do the FINRA filing.) You have to file the advertisement with  FINRA within 10 days of first use or publication [FINRA Rule 2210(c)].

How can you do all of this with web 2.0?

You can’t.

One key aspect of web 2.0 is that it allows anyone to be a publisher. But now you’re a publisher without any training on how to be a publisher. In the case of mutual fund companies, publishing will have to go through a long process of review and approval before content can be published. Failure to comply has serious consequences.

That doesn’t mean that mutual fund companies cannot use social media. It just means they can only use is it certain ways.

Syndicate Content

If you’ve gone through the trouble and expense of creating compliant content, you should make it available in as many ways as possible. You obviously can’t push all of the required disclosures through the 140 characters of Twitter. But you can send links back to your website where you can make all of the disclosures. If you have video, you can publish the video on Facebook and YouTube.

If you want to have a good day fishing, you need to go where the fish are. (See the picture above.) Push your content to potential customers in the places where they are. Some of them (many of them?) may be spending time on Web 2.0 sites.

Examples

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Photo © Adrian van Leen for openphoto.net CC:PublicDomain

Compliance Bits and Pieces for March 26

Here are some interesting stories from the past week:

The Difference Between Wrong and Illegal by Charles H. Green

Do you know the difference between a wrong action and an illegal action? If you don’t, you are not alone. But neither are you to be trusted.

Ghostblogging will be the death of social media in the law by Kevin O’Keefe in Real Lawyers Have Blogs

We’re just scratching the surface of what social media can do for lawyers and law firms. But rather than learn how to harness this powerful relationship building tool, one with its roots in traditional client development, I’m finding some lawyers and law firms would rather pay to have someone else participate in social media for them.

Advisors Allowed to Get Social by Mark Astarita in onWall Street

As social media sites have become more popular with the general public, advisors have been drawn to them. But firms have generally banned their use because of advertising restrictions, and the lack of clear guidance from the regulators as to their use. That partially changed in January, with FINRA’s release of Regulatory Notice 10-06-Guidance on Blogs and Social Networking Web Sites. The notice dealt with five main areas.

Cahill taps firms tied to state pension investor By Aaron Lester, Michele Richinick, and Walter V. Robinson in the Boston Globe

Cahill, in an interview, expressed no qualms about receiving campaign contributions from companies that have or want business from the [Massachusetts] treasurer’s office and the five agencies he oversees, including the pension board. In fact, he acknowledged that he and his campaign aides routinely seek contributions from such companies.

Judge Uncorks True Feelings About Compliance Monitors by Matt Kelley in Compliance Week

Most events in federal court are terribly dull, the carefully scripted culmination of legal briefs fired back and forth among various parties for years. But once in a great while, a judge goes a little nuts—as happened last week with the new hero of compliance officers everywhere, District Court Judge Ellen Segal Huvelle.

Bribery in Britain

The British government is working on a new Bribery Bill “to reform the criminal law of bribery to provide for a new consolidated scheme of bribery offenses to cover bribery both in the United Kingdom (UK) and abroad.”

The Bribery Bill would replaces the offenses under the Public Bodies Corrupt Practices Act 1889, the Prevention of Corruption Act 1906 and the Prevention of Corruption Act 1916 with two crimes. The first makes it a crime to bribe another person. The second makes it a crime to accept a bribe.

The Bribery Bill also creates a discrete offense of bribery of a foreign public official and a new offense where a commercial organization fails to prevent bribery. This would create a British version of the US Foreign Corrupt Practices Act and and bring the United Kingdom compliant with its obligations under the OECD.

There is an affirmative defense for the failure of a commercial organization to prevent bribery: “adequate procedures.” The Bribery Bill requires the Secretary of State to publish guidance about procedures that a company can put in place to prevent bribery.

The Bribery Bill is widely expected to come into force later this year.

According to research from the Eversheds, many businesses are unaware of this new Bribery Bill, with 60% of businesses unaware that failing to prevent bribery will be a criminal offense.

Sources:

Should You Invest in Ethical Companies?

2010 World’s Most Ethical Companies

Yesterday, I was excited to see that the World’s Most Ethical Companies for 2010 had outperformed the S&P 500. Ethisphere went back five years and charted the performance. They found a 53% return for the 2010 class of companies, compared to a 4% return in the S&P.

The hindsight of looking back on the performance is great. It’s telling me that I should have bought stock in those companies five years ago. We all know that hindsight is 20/20. I was curious to see if inclusion on the list is an indicator of future performance.

Should I run out and buy the companies on the 2010 list?

I decided to go back and check the performance of the companies on the first edition of Ethisphere’s list: 2007 World’s Most Ethical Companies.

Great news for ethical investing

The group of public companies on Ethisphere’s 2007 World’s Most Ethical Companies dramatically outperformed the broader market.

If you bought one share in each of the 52 companies on June 1, 2007, you would have realized a -6.34% return. In comparison, the S&P 500 had a -19.57% return and the Dow Jones Industrial Average had  a -15.80% return.

If you bought $100 worth of shares in each of the companies instead of 1 share each, your return drops to -9.83%. The difference is due almost entirely to the presence of Google and its lofty share price. (I used the Berkshire Hathaway B shares because the astronomical price of the Berkshire Hathaway A shares would have dwarfed the one share results.)

Methodology

I used SPY SPDRs, an index fund that tracks the S&P 500, and the SPDR DIAs, an index fund that tracks the Dow Jones Industrial Average.

There are 52 stocks on Ethisphere’s 2007 list that were public companies then and now. Two other companies on the list were public, but went private: Sun Microsystems and Bright Horizons. I omitted those two. There were another 38 companies that were private or whose shares were only available on foreign exchanges. I also omitted those 38 from my calculations.

I used the adjusted close price from Yahoo’s historical prices for the 52 companies, SPY and DIA shares, which adjusts the close price for dividends and splits.

Here is the spreadsheet with the underlying values: http://spreadsheets.google.com/pub?key=t5Tg37_FEqFq71zqApUq0Pw&output=html. Feel free to double-check my math or challenge my methodology.

What does it mean?

I own some of the shares on the list, so I’m well aware that almost as many companies underperformed. (After all, it is an average return.) Eighteen of the 52 companies performed worse than the SPY shares. There does not seem to be a clustering of returns or any one big or gain in the group of 52. It seems to me that these ethical companies, as a group, just outperform the broader market.

If I had more time, I might go back to the 2008 list and the 2009 list to see how those companies have done over a shorter term.

Daimler Charged with FCPA Violations

Daimler AG, the parent company of Mercedes-Benz, has been charged with violations of the Foreign Corrupt Practices Act.

The Department of Justice accuses the company of engaging in a long-standing practice of paying bribes worth tens of millions of dollars to foreign officials in over 22 countries.

There is an April 1 hearing in U.S. District Court in Washington D.C.

Daimler is accused of making “hundreds of payments” between 1998 and January 2008 to officials in 22 countries, including China, Croatia, Egypt, Greece, Hungary, Indonesia, Iraq, Ivory Coast, Latvia, Nigeria, Russia, Serbia and Montenegro, Thailand, Turkey, Turkmenistan, Uzbekistan and Vietnam.

Daimler is accused of having “interne Fremdkonten” or third party accounts with over 2000 in place at the time of the Chrysler merger in 1998. There is also mention of cash desk in Stuttgart that sounds a lot like the suitcase room at Siemens, where executives could fill up suitcases of cash to pay bribes.

In China the “819 account” was used to pay special commissions. The account number’s last three digits were “819.”

In addition to the payment of bribes, Daimler is also accused of improperly accounting for the funds in violation of the books and records provisions of the FCPA.

It looks ugly for the company.

Here is a copy of the Information Filing in US v. Daimler AG – hosted on JD Supra:

Sources:

Financial Overhaul Moves Forward

Senator Dodd

With the health care reform now out of the hands of Congress, there is now movement with financial overhaul. Senator Dodd introduced the Restoring American Financial Stability Act of 2010 last week  without a Republican co-sponsor [Dodd Goes Solo].

Instead plugging in amendments, the Senate Banking Committee voted on straight party lines to advance the bill as introduced by Senator Dodd. The bill is moving so fast that it has not even made into the Thomas system for tracking legislative activity. The vote on Monday night lasted less than 25 minutes.

According to reports, Republicans filed more than 200 amendments on Friday, but withdrew all of them and let the bill pass quickly through committee. I assume the strategy will be to attack the bill in the full Senate instead of in the Banking Committee.

UPDATE: There were 114 pages of amendments made to the bill. Most look like clean-ups and small changes that do not have a big impact on the bill.

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World’s Most Ethical Companies 2010 Edition

2010 World’s Most Ethical Companies

Ethisphere Institute just announced its list of the World’s Most Ethical Companies for 2010.

Of the 100 companies on their list, 26 are new to the list. The sole winner for the real estate industry is Jones Lang LaSalle. For the financial services industry there were three companies: American Express, The Hartford and The Principal Financial Group.

A tidbit that caught my eye was the comparative performance of the companies. Ethisphere claims that the “2010 World’s Most Ethical Companies have outperformed the S&P 500 by delivering a 53 percent return to shareholders since 2005—compared to the S&P’s four percent shareholder loss over the same period.”

It’s interesting to see that these companies consistently outperformed the broader in good times and bad. I’m tempted to go back through all of the past winners to see how it would have worked out by investing in these companies over the years. (If I could just find the time to do so.)

Ethisphere’s looks at 7 categories under their “Ethics Quotient”:

  1. Corporate citizenship and responsibility (20%)
  2. Corporate governance (10%)
  3. Innovation that contributes to public well being (15%)
  4. Industry leadership (5%)
  5. Executive leadership and tone from the top (15%)
  6. Integrity track record and reputation (20%)
  7. Internal systems and ethics/compliance program (15%)