Obscenity

The Supreme Court has struggled mightily with the concept of obscenity. What is it, legally speaking?

In order to figure that out, the justices had to look at about 200 porno films and read every filthy magazine ever published.

For example, deciding if this scene pictured below is obscene or not is the kind of thing the Supremes had to wrestle with for weeks in their dark oak paneled chambers.

Finally, after all that exhausting research in private, one justice concluded that obscenity could not really be defined but “I know it when I see it.” [1]  Seems like he wanted to see a lot more of it in the future after his extensive introduction.

Judges may know it when they see it, but for a long time, corporate boards have not been able to recognize what was obscene and what was just a little bit naughty. The have continued to rubber-stamp mammoth paychecks for CEOs even while those same CEOs were busy driving their companies off the cliff, simultaneously trucking their own personal compensation home in gigantic armored vehicles.

The boards of directors of American companies may not know what is obscene and what is not, but some shareholders are starting to recognize it. The new definition of “obscene” is Vikram Pandit, the CEO of Citigroup.  Citigroup's shareholders voted down a $15-million pay package for Vikram, with one investment group saying “there is good pay and there is obscene pay.”[2]

This vote has been called “historic,”[3] “a milestone for corporate America” and “a wake-up call.”[4]


Corporate boards have been AWOL on the issue of corporate misbehavior, including excessive salaries for several decades. Arianna Huffington wrote about it in her book, "Pigs at the Trough" in 2003. Since then, the situation has only become more extreme. The Washington Post reported last week that Jamie Dimon was awarded compensation of $23,000,000 for managing J.P. Morgan Chase, 67 times the earnings of an average employee of the company.

The Bank of America awards millions to its CEO while the company is engaged in so much corrupt activity that it took Rolling Stone 6 pages of small print just to list crimes the company has been engaged in before and after the taxpayers bailed it out.

One of the most curious things about the Citigroup event is that—for the first time ever--some money managers took the side of investors instead of backing up Citigroup’s board. This is totally unheard of and unprecedented.

Money managers, especially the managers of mutual funds, have stayed away from the issue of corporate executive largesse, silently allowing those executives to pillage their companies-- even though those funds have a fiduciary obligation to their customers to protect the customers’ interests. As Vanguard founder John Bogle remarked, “The funds should demand with all their voting power that the companies they own are putting the interests of their shareholders first." (See the link to this study.)

Mutual fund silence on the issues of corporate malfeasance and bad governance, at shareholder expense, could come back to haunt them some day.  Being complicit in corporate greed and short-changing of shareholders on the part of companies they select to invest their customers’ money in destroys investor trust.  It shows zero integrity.

Mutual funds, with 21% of the shareholder votes, can block the door to shareholder efforts to fix the problem of obscene corporate executive pay and other corporate malfeasance. Or they can push that door open. Most funds have declined to use that power.  If 21% of the votes are going to either be silent or vote to rubber stamp bad corporate board decisions, shareholders have no hope of reforming corporate rip offs and misbehavior.

For a big list of the funds and ranking of how they vote on corporate governance, click here. Some of the biggest refuse to limit excessive executive compensation (the worst is Vanguard-ranked 26 out of 26 despite what its founder said, as quoted above). Some do try to limit excessive pay (like American Century, rank-1 and Dreyfus-rank 2), and some help once in a while, but not always (like T.Rowe Price-rank 9, and Fidelity-rank 15)

Why have so many mutual funds been so silent, letting their customers be taken to the cleaners by the executives of the companies the funds invest in? Who knows?  They won’t say, and speculation is rife.

The Harvard Business School has a technical explanation.  So does CBS News. And the University of Iowa has an explanation as well. The most plausible explanation appeared on Salon.

Mutual funds may be saying “What, me worry?”--but some other big investors are not playing dumb.  The CEO of the large retirement fund, Calpers (Phil Angelides,) has been voting against obscene corporate salaries. He said, “What we’ve tried to do is ask the question: How can we use our power to send a clear message to the market about the importance of corporate responsibility and conduct?” 

And Bill Gross, manager of Pimco, the world’s largest holder of corporate bonds takes another route. He outright dumps the bonds of corrupt companies who have crooked compensation committees and  pay their CEOs too much.

Mutual Fund Ties to Corporate Boards

The incentives on this issue are bass ackwards for mutual funds. (See the Note at the bottom of this blog.)  The big money made by mutual funds is in managing fat retirement accounts for the largest companies in America. There is far more money to be made managing those huge corporate retirement accounts than in managing puny IRAs and other small-time money for little grunts who only have small change invested with the funds.

So, mutual fund managers must ask themselves, “Why alienate the highly paid executives of the companies whose huge retirement funds we manage? If we do, they might take their retirement fund elsewhere, maybe to a more compliant mutual fund, one that will keep its mouth shut when the company CEO runs off with a few billion bucks in compensation, leaving the shareholders with nothing but the dregs.”

So in this bed of rattlesnakes, where can you feel safe hiding your puny little bag of shekels?

Beats me.

The Happy Blogger at Play 

"What if everything is an illusion and nothing exists? In that case, I definitely overpaid for my carpet."--Woody Allen.

To comment on this blog, click on the hyperlink at the bottom that reads “Post a Comment.”

---

[1] This is how Justice Potter Stewart described his threshold test for pornography in Jacobellis v. Ohio (1964). See Paul Gewirtz, "On 'I Know It When I See It'", Yale Law Journal, Vol. 105, pp. 1023–1047 (1996).

[2] Silver-Greenberg and Nelson Schwartz in “Citicorp’s Chief Rebuffed on Pay by Shareholders,” DealB%k, April 17, 2012, NY Times, quoting an investment advisory officer of a large Philadelphia money management company.

[3] Donal Griffin, “Investors Reject Citigroup’s Plan for Executive Pay,” Washington Post, April 17, 2012, p.A15.

[4] Silver-Greenberg and Schwartz, Ibid. The only reason this vote could ever happen is that Citigroup was a big benefactor of the bank bailout, and as a condition of being bailed out, they had to agree to allow a shareholder vote on executive compensation. More may be coming, however, because the Dodd-Frank legislation requires a much wider group of corporations to allow shareholders a say in executive compensation. Lobbyists are, of course, hard at work trying to get that onerous regulation repealed before it takes effect--or at least to riddle it with loopholes.

More Information: For more detail on mutual funds and executive compensation, click on this extensive study. For more on why mutual funds kowtow to excessive pay for executives in badly managed companies, see Gretchen Morgenson, “A Door Opens. The View is Ugly.” The New York Times, Sept. 12, 2004, and Gerald F. Davis & E. Han Kim, “Would Mutual Funds Bite the Hand that Feeds Them? Business Ties and Proxy Voting,” at 25(working paper 2005) (available at www.ssrn.com). Also see Gretchen Morgenson's expose in the NY Times.

For information on how a single executive pay consultant, Frederic W. Cook (whose company was named "Ratchet, Ratchet, and Bingo by Warren Buffet), has driven up corporate salaries, click on the link to this article.

For more information on whether the highly paid CEOs are really earning their huge salaries, see the new book "Pay Check" by David Bolchover.

The short answer is: "No."