Regulations Work – Applaud SOX and Dodd- Frank

Regulations Work – Applaud SOX and Dodd- Frank

Last week the National Association of Corporate Directors (NACD) pre-released some results of its 2015–2016 Public Company Governance Survey.  One major finding is that the makeup of Boards is changing, for the betterment of investors – and most likely everyone else in business.

Boards once had members that almost never changed.  Little was required of Directors, and accountability for Board members was low.  Since passage of the Securities Act of 1933, little had been required of Board members other than to applaud management and sign-off on the annual audit.  And there was nothing investors could do if a Board “checked out,” even in the face of poorly performing management.

But this has changed.  According to NACD, 72% of public boards reported they either added or changed a director in the last year.  That is up from 64% in the previous year.  Board members, and especially committee chairs, are spending a lot more time governing corporations. As a result “retiring in job” has become nearly impossible, and Board diversity is increasingly quite quickly.  And increased Board diversity is considered good for business.

Remember Enron, Arthur Anderson, Worldcom and Tyco?  At the century’s turn executives in large companies were working closely with their auditors to undertake risky business propositions yet keep these transactions and practices “off the books.”  As these companies increasingly hired their audit firm to also provide  business consulting, the auditors found it easier to agree with aggressive accounting interpretations that made company financials look better.  Some companies went so far as to lie to investors and regulators about their business, until their companies failed from the risks and unlawful activities.

Sarbanes-OxleyAs a result Congress passed the Sarbanes Oxley act in 2002 (SOX,) which greatly increased the duties of Board Directors – as well as penalties if they failed to meet their duties.  This law required Boards to implement procedures to unearth off-balance sheet items, and potential illegal activities such as bribing foreign officials or failing to meet industry reporting requirements for health and safety.  Boards were required to know what internal controls were in place, and were held accountable for procedures to implement those controls effectively.  And they were also required to make sure the auditors were independent, and not influenced by management when undertaking accounting and disclosure reviews.  These requirements were backed up by criminal penalties for CEOs and CFOs that fiddled with financial statements or retaliated on whistle blowers – and Boards were expected to put in place systems to discover possibly illegal executive behavior.

In short, Sarbanes Oxley increased transparency for investors into the corporation.  And it made Boards responsible for compliance.  The demands on Board Directors suddenly skyrocketed.

In reaction to the failure of Lehman Brothers and the almost total bank collapse of 2008, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010.  Most of this complex legislation dealt with regulating the financial services industry, and providing more protections for consumers and American taxpayers from risky banking practices.  But also included in Dodd-Frank were greater transparency requirements, such as details of executive compensation and how compensation was linked to company performance.  Companies had to report such things as the pay ratio of CEO pay to average employee compensation (final rules issued last week,) and had to provide for investors to actually vote on executive compensation (called “say on pay.”)  And responsibility for implementing these provisions, across all industries, fell again on the Board of Directors.

Thus, after 13 years of regulatory implementation, we are seeing change in corporate governance.  What many laypeople thought was the Board’s job from 1940-2000 is finally, actually becoming their job.  Real responsibility is now on the Directors’ shoulders.  They are accountable.  And they can be held responsible by regulators.

The result is a sea change in how Boards behave, and the beginnings of big change in Board composition.  Board members are leaving in record numbers.  Unable to simply hang around and collect a check for doing little, more are retiring.  The average age is lowering.  And diversity is increasing as more women, and people of color as well as non-European family histories are being asked onto Boards.  Recognizing the need for stronger Boards to make sure companies comply with regulations they are less inclined to idly stand by and watch management.  Instead, Boards are seeking talented people with diverse backgrounds to ask better questions and govern more carefully.

Most business people wax eloquently about the negative effect of regulations.  It is easy to find academic studies, and case examples, of the added cost incurred due to higher regulation.  But what many people fail to recognize are the benefits.  Thanks to SOX and Dodd-Frank companies are far more transparent than ever in history, and transparency is increasing – much to the benefit of investors, suppliers, customers and communities.  And corporate governance of everything from accounting to compensation to industry compliance is far more extensive, and better.  Because Boards are responsible, they are stronger, more capable and improving at a rate previously unseen – with dramatic improvement in diversity.  And we can thank Congress for the legislation which demanded better Board performance – to the betterment of all business.

Economically, is Obama America’s Greatest Modern President?

With the stock market hitting new highs, some people have
already forgotten about the Great Recession.  If you recall 2009, things looked pretty bleak
economically.  But the outlook has changed dramatically in just 4 years.  And it has been a boon for investors, as even the safest indices have yielded a 250% return (>25% annualized compound return:)

Growth of $1,000 ChartSource: Bulls, Bears and the Ballot Box at Facebook.com

Meanwhile, trends have reversed direction with unemployment falling, and consumer confidence rising:

Confidence-Unemployment Chart

Source: Bulls, Bears and the Ballot Box at Facebook.com

Since this coincides with President Obama’s first term, I asked the authors of “Bulls, Bears and the Ballot Box,” (available on Amazon.com) which I reviewed in my October 11, 2012 column, to capture their opinions on how much Americans should attribute the equity
upturn, and improved economic prospects, to the President as we enter his second term.

Interview with Bob
Deitrick
, co-Author "Bulls, Bears and the Ballot Box" (BBBB):

Q– Bob, how much credit should Americans give President
Obama for today’s improved equity values?

BBBB – Our research reviewed American economic performance
since President Roosevelt installed the first Federal Reserve Board
Chairman
– Republican Marriner Eccles.  We observed that even
though there are multiple impacts on the economy, it was clear that policy
decisions within each administration, from FDR forward, made a clear difference on performance. And
relatively quickly. 

Presidents universally take credit when the economy does
well (such as Reagan,) and choose to blame other factors when the economy does
poorly (such as Carter.)  But there
was a clear pattern, and link, between policy and financial market performance. 

Although we hear almost no one in the Obama administration
taking credit for record index highs, they should.   Because the President deserves
significant credit for how well this economy has done during his leadership. 

The auto rescue plan has worked.  American car manufacturers are still dominant and employing millions directly and in supplier companies.  Wall Street reform
has been painful but it has re-instated faith amongst investors. 
The markets are far more predictable than they were four years ago, as VIX numbers demonstrate greater faith and less risk. 

Even for small investors, such as thoughs limited to their 401(k) or IRA investments, the average annual compound
return on stocks under President Obama has been more than
24% since the lows of March, 2009. 
This is a better result than either Clinton, Reagan or FDR who were the
prior winners in our book. 

Q– Bob, what policies do you think were most important
toward achieving today’s new highs?

BBBB – Firstly, let’s review just how bad things were in
2009.  In 2000 America was completing the longest
bull market in history. But by
the end of President Bush's tenure the country had witnessed 2 stock market crashes, and the DJIA had fallen 58%.  This was the second worst market decline in history (exceeded
only by the Great Depression,) and hence the term “Great Recession” was born.

In 2000, at the end of Clinton’s administration, the
Consumer Confidence Index was at a record high 140. 
By January, 2009 this index had fallen to an historic low of 25.3.  Comparatively, when Reagan took office
at the end of the economically weak Carter years the Confidence Index
was still at 74.4!  Today this
measure of how people feel about the country is still nowhere near 2000 levels,
but it is almost 3 times better than 4 years ago.

Significantly, in 2000 America had a budget surplus.  By 2009 surpluses were long gone and the
country was racking up historic deficits as taxes were cut while simultaneously
outlays for defense skyrocketed to cover costs of wars in Iraq and
Afghanistan.  Additionally, banks
were on the edge of failing due to unregulated real estate speculation and massive derivative losses.

Today the Congressional Budget Office is reporting a $200B decrease in the deficit almost entirely due to increased revenue from a growing economy and higher taxes on the wealthiest Americans.  The deficit is now only 4% of the GDP, down from over 10% at the end of Bush's administration – and projections are for it to be only 2% by 2015 (before Obama leaves office.)  America's "debt problem" seems largely solved, and almost all due to growth rather than austerity.

We can largely thank a fairer tax code, improved regulation and consistent SEC enforcement.  Also, major strides in health care reform – something no other President has accomplished – has given American's more faith in their future, and an increased willingness to invest.  

Q– To which President would you compare Obama’s economic
performance?

BBBB– By all measures, President Obama has outperformed
every modern President. 

The easiest comparison would be to President Reagan, who’s
economic performance was superb.  Even though Obama's performance is better.

Reagan had the enormous benefit of two major factors:

  1. a significantly better economy than Obama inherited, even if afflicted by inflation
  2. and his two terms coincided with the highest performing
    demographic years of the Baby Boomer generation.

Today's demographics have shifted dramatically.  The country is much older, with fewer
young people supporting a much larger near-retirement age group.  This inherent demographic fact makes
creating economic growth monumentally harder than it was 30 years ago.

Few people think of Reagan as a stimulus addict.  Yet, his administration’s military
build-up added $1trillion of stimulus to the national debt ($2.3trillion adjusted for
inflation) – the opposite of what is happening during the Obama years.  Many like to think
that it was tax cutting which grew the economy, but undoubtedly we now know
that this dramatic defense and infrastructure (highways, etc.) stimulus had more to do with igniting economic growth.  Reagan's spending looked far more like FDR than Herbert Hoover!

Ronald  Reagan tripled the national debt during his tenure, creating what today's Congressional austerity advocates might have called "a legacy of unpayable debt for our grandchildren.” But, as we saw, later growth (during Clinton) resolved that debt and created a budget surplus by 2000.

Q– Bob, President’s Obama detractors liken the Affordable
Care Act (i.e. Obamacare) to an Armageddon on business, sure to kill economic
growth and plunge the country back into recession.  Do you agree?

BBBB– To the contrary, ACA levels the playing field and will
be good for economic growth.  Where
previously only large corporations could afford employee health care plans, in
the future far more employees will have far more equitable coverage.  Further, today employees frequently are unable to leave a
company to start a new business because they would lose health care, which in
the future will not be true.

One leading indicator of the benefits of ACA might be the performance of healthcare and biotech stocks, which are up 20-30% and leaders in the current market rally.

Q– What policies would you recommend the Obama
administration follow in order to promote economic growth, more jobs and
greater returns for investors during the second term?

BBBB-  Obama needs to make the cornerstone of his second term creating new job growth.  That was the primary platform of his candidacy, and it is a platform long successful for the Democratic party.  If President Obama can do this and  govern effectively, this could be his real legacy.