naked capitalism

If you had any doubts that the US has become a corpocracy, two fresh rulings by the Supreme Court should seal any doubt. They are stunningly bad, in that they reduce or gut the reach of well-settled law over large companies, to the degree that it will take very little in the way of effort for companies to organize their affairs so as to escape liability for their actions in areas that affect large numbers of citizens.

The through line in both rulings is the creative and selective use of the notion of corporate “personhood”. That personhood has been the basis for the extension of a whole raft of rights to corporations, including, perversely, the Constitutional right of free speech. Yet the same notion which has been used to confer privileges that companies lack in other countries is at the same time being construed so as to vitiate accountability, when ordinary people find it mighty hard to escape the consequences of their actions. I’m certain the Founding Fathers, who were wary of concentrated power, would be spinning in their graves at the logic and effect of recent decisions on this front.

The first stunner is a ruling today in favor of WalMart on an employment discrimination class action lawsuit. It effectively weakens anti-discrimination laws as far as big companies are concerned. Per the New York Times:

In its majority opinion, the court essentially said that if lawyers brought a nationwide class action against an employer, they would have to offer strong evidence of a nationwide practice or policy that hurt the class. In the Wal-Mart case, the court wrote that the plaintiffs had not demonstrated that Wal-Mart had any nationwide policies or practices that discriminated against women.

I strongly suggest readers look at the piece “Fit vs. Fitness“. Discrimination is seldom overt; it usually takes the form of people hiring people just like them. The inherent problem is virtually all jobs are sufficiently complex that the performance assessment will involve subjective judgments. And that leads to mischief. For instance:

[T]here is evidence that subjective processes set a higher bar for minorities and women. For example, a 1997 Nature paper by Christine Wenneras and Agnes Wold, “Nepotism and Gender Bias in Peer-Review,” determined that women seeking research grants need to be 2.5 times more productive than men to receive the same competence score.

I guarantee there would be virtually no women or blacks in top law firms, corporate boardrooms and executive positions, Wall Street, or senior regulatory positions in the absence of government policy to make it hard and costly to keep them out. I started out in business a half a generation after women were first accepted into top tier organizations. I can tell you from my own and my peer group’s experience that we were hired reluctantly and viewed with considerable skepticism (as in maybe we could do the yeoman’s work, but forget about being able to build client relationships and bring in business). For instance, I had James Wolfensohn, who then ran Salomon’s corporate finance department, and later headed the World Bank, tell me that it was really silly for women to want to be on Wall Street; why didn’t I just get married?

And the evidence of bias against various groups in the absence of overt policy is very strong. For instance, what assignments you get and who you get to work with makes a great deal of difference in your career prospects. Men seldom mentor women (and when they do, it’s often perceived to be for the wrong reasons, undercutting the benefits of the tutelage) and women are also typically cut out of the informal information networks in large organizations. Indeed, just as “pink collar” professions are (or at least were until this downturn) worse paid than comparable or even lower-skilled work performed by men, so to did women in finance wind up being shunted to the less well paid areas like muni finance and (ironically) structured credit (but not higher paid CDOs, that was macho).

So give the inherent and large obstacles that minority groups face, having companies be scrupulous in their hiring and pay practices in the areas they control has social value (and I don’t just mean fairness; my own experience has been that I could get much better talent by hiring outside the white male spec; this gap was persistent even with budget-constrained employers like me leaning against the wind, so it strongly suggests that even with laws encouraging minority hiring, we are well away from an optimal outcome in terms of efficiency).

How does the Supreme Court ruling weaken this effort? Again from the Times:

In its majority opinion, the court essentially said that if lawyers brought a nationwide class action against an employer, they would have to offer strong evidence of a nationwide practice or policy that hurt the class. In the Wal-Mart case, the court wrote that the plaintiffs had not demonstrated that Wal-Mart had any nationwide policies or practices that discriminated against women.

Now anyone with an operating brain cell can see the problem with this logic. At most companies, there is a not-inconsiderable gap between formal policy, enshrined in CYA documents that pretty much no one reads, and all of the formal and informal signals as to what is acceptable, the biggest being the behavior of the people who get promoted. For instance, back in the stone ages when Goldman actually was a pretty well behaved firm by Wall Street standards, people who were seen as being “political” or too risk oriented got promoted less quickly than nose to the grindstone types (no joke, a fondness for fast cars was not seen as a plus). By contrast, most companies suffer from a “big producer syndrome” in which a certain amount of rule breaking is forgiven for managers who are seen as particularly valuable.

So in other words, if you assume discrimination is normal human behavior, you need to have policies in place to mitigate it that are enforced adequately, and looking for “proof is in the pudding” widespread patterns of, say, pervasive pay gaps, should be considered to be strong evidence that something is amiss (and the company should have reason to engage in prompt corrective action rather than wait to have lawsuits dropped on it).

But the Court’s top sophist Judge Scalia turned that sort of reasoning on its head:
“In a company of Wal-Mart’s size and geographical scope, it is quite unbelievable that all managers would exercise their discretion in a common way without some common direction.” Huh? What about “people prefer to hire people just like them” don’t you understand? In other words, the company has to have active policies in place that encourage discrimination for it to be liable, when the standard more logically when the data looks sus is that companies need to prove they did an adequate job in making sure that managers did not overindulge the strong propensity that many have to discriminate.

Consider the implication of Scalia’s stance. It’s pretty well known on Wall Street that strip clubs and prostitutes are a mainstay of entertainment on the trading side. The fact is that this practice works to the disadvantage of women. No firm admits to having a pro-strip club/hooker policy, yet the expense chits get processed and manager level types all know this happens all the time. But because there was no “common direction”, it would seem that a group of women could not argue an accepted and well established practice was an impediment (and it could well be due to it being perceived to be an impediment, that that sort of entertainment was actually less important to winning business than everyone professed, but since the manager like oogling naked pretty women, they would be the last to question whether this sort of expenditure was really all that productive. Paying for hookers is different, that’s more of an out and out bribe, but that also skirts legality….).

Now admittedly that sort of abuse could still be fought on a more local level, most likely the business manager or business unit. But as the strip club example suggests, some practices are hostile to certain groups, widely practices across major firms, yet this ruling would seem to give management an easy escape for appropriately broad-based legal actions.

If we take this out of the employment realm, it might be easier for some readers to see what is wrong. Notice the Scalia emphasis upon manager discretion. This gives Big Cos a liability shield they can drive a truck through. Just be silent or issue apple pie and motherhood statements on key issues, and let managers be your liability shield. This ruling encourages large corporations to have lax controls as way for them to engage in misconduct and escape the more costly repercussions (if nothing else, it will be harder for less well heeled litigants to get someone to take up their cause).

I’m every bit as unhappy with the other recent heinous Supreme Court ruling, Janus Capital Group, Inc. v. First Derivative Traders, but since this ruling came out last week and I somehow managed to miss it. other able commentators have already expressed their considerable dismay.

But what is disconcerting and even scary about the Janus ruling is that it guts a key section of well settled securities law, the one that was the best (and in some cases the only) grounds for wronged investors in mutual funds or special purpose vehicles to sue. And it provides a road map for other fund operators to escape from liability.

The basis of the fraud claim against Janus was that the Janus fund prospectuses stated clearly that market timing was prohibited, yet the manager allowed it to occur. Hedge funds would rapidly trade in and out, arbing the mutual funds’ stale prices. Janus allowed that to occur because it also enhance its profits. The suit was brought by public shareholders in Janus but the logic of the ruling would apply to fund investors as well.

Steve Waldman, who has an excellent post on this ruling, explains how barmy and damaging it is:

When an ordinary firm issues securities, the firm itself is the “person” who makes the statements that appear in prospectuses and other disclosures. But with dedicated investment vehicles, things are more complicated. Investment vehicles — mutual funds and ETFs, but also securitizations like RMBS and CDOs — segregate the management and operation of the fund from the legal entity whose securities investors hold. If you “own” a Janus mutual fund, the securities you hold are likely claims against an entity called Janus Investment Fund. But Janus Investment Fund exists mostly on paper. Another company, Janus Capital Management, actually does everything. The human beings who make day-to-day investment decisions, as well as the offices they work in and the equipment they work on, are provided by Janus Capital Management. Communications and legal formalities, including prospectuses, are drafted by employees of Janus Capital Management.

The Supreme Court held is that, even though employees of Janus Capital Management company actually wrote any misleading statements, even though they managed nearly every substantive aspect of the operation of the fund, they cannot be held responsible because they did not “make” the statements. The “person” under law who made the statements was the entity on whose behalf the offending prospectus was issued, the investment fund, which has no capital other than the money it invests for shareholders. Under Janus, the management company is beyond the reach of aggrieved investors.

CBS MoneyWatch (hat tip Michael F) was equally derisive:

Now you, I, and anyone who’s spent two minutes thinking about it know that the notion that a mutual fund is independent of its advisor is laughable…..those funds are staffed, managed, and operated by the management firm. Further, the fund’s board of directors is almost invariably chaired by the CEO of the management firm. And where does the board get the information they need in order to provide their oversight? Well, from the management company, of course…

The relationship between management company and mutual fund is so entrenched that I can recall only one — one single instance — in which the mutual fund board of directors told the management company to take a hike because they weren’t performing well…

The clearest proof of control that fund managers have over the funds they manage is the enormous amounts of money that mutual fund advisors reap on the sale of their firms. If the underlying funds are beyond the control of the manager and likely to be pulled at any given moment, it’s difficult to explain why those managers are being paid hundreds of millions of dollars to transfer those funds to another manager.

But in Janus Capital Group v. First Derivative Traders, the Supreme Court ignored reality, along with decades of history, in favor of a breathtakingly narrow reading of the law. In writing for the majority, Justice Clarence Thomas wrote that despite Janus Capital Management’s inarguable role in preparing those prospectuses, the statements therein were “made” by the Janus funds. As such, according to the Court, the funds are responsible for those statements, not Janus Capital Group

For those who like more nitty gritty, Michael F also passed along this analysis from Clearly Gottlieb. Reading between the lines of their dry prose, you can tell they are also gobsmacked:

Cleary Gottlieb – Supreme Court Limits Liability for False Statements Under Rule 10b-5

Most Federal regulators, Congress, and the Supreme Court seem altogether happy to indulge the black hole of desire, the ravenous Id that Corporate America has become. They’ve become an indulgent parent that continues to give their spoiled child whatever he wants, even when they know their checks are being used to feed a drug habit that will destroy his health. By contrast, although Paul Volcker’s anti-labor stance is reason to have reservations about his record, he knew it was important to rein the banks in for their own good, and Wall Street applauded even while it was suffering meager profits from taking his tough medicine.

As Amar Bhide stressed in a 1994 Harvard Business Review article, and it really was true back then, the US had the deepest capital markets in the world, and one of the biggest reasons was they were seen as the cleanest and fairest. As the US is losing its dominant economic role, you would think it would be incumbent upon us to preserve our other bases for competitive advantage, such as well functioning and policed markets. Why should foreign or even domestic investors be wiling to put money in funds or other pooled vehicles when the Supreme Court has just removed the best avenue for seeking recourse in the case of abuses? The corporate enablers are the worst enemies not just of average citizens, but of even of the long term interests of the interest groups they think they are aiding. But who needs to worry about the future if you have stacked the deck so you can grab enough today?