Investors of the world, unite! The Motley Fool declares "mayday" on the U.S. stock markets, the most powerful capitalist force on the planet. Individual investors are increasingly important to the vitality of the stock market, yet, in terms of policy and regulation, our voices are a mere whisper compared to the organized lobbying efforts of the business, exchange, and institutional investor constituencies. Events over the last year have highlighted some significant flaws in the way that the U.S. markets are run. This is a direct threat to our economic well-being, for honest markets are certainly part of the reason that the U.S. is the destination of choice for so much capital from overseas.
Well, guess what? The markets need us, individual investors, to help keep it vital. It is our responsibility to demand that they be run in a way that is equitable, transparent, and benevolent, not just for us, but for all constituencies. We are willing to take risks that companies will succeed or fail as businesses; we should not be willing to risk that we are being deceived, or that the information we are provided is not an accurate representation of a company's economic condition.
From May 1 to May 8, The Motley Fool will present its ideas for best practices in the marketplace. We hope that these ideas will stir debate among individual investors. We have set up a discussion board for just that purpose. We will release a new Declaration each day at noon.
Declaration #4:
We, as individual investors, demand greater accountability of individual managers and directors in instances of corporate fraud.
Problem: In 2000, there were 233 cases of public companies having to restate their earnings, at a cost of billions to shareholders. In such cases it is often difficult to prove fraud on behalf of individuals. It is much simpler, however, to prove that many top executives and board members with fiduciary responsibility to shareholders profited mightily as a result of fraud that happened on their watch. These ill-gotten profits should be at risk.
Although Enron may be the most spectacular corporate flameout in our history, it is by no means the first, nor will it be the last. What is intriguing, though, is that there seem to be little repercussions to the executives who have defrauded investors or the directors who allowed it to happen either by conspiring or failing to oversee and protect the interests of outside shareholders. We do not expect that individual shareholders will have much additional recourse for recovery of their losses. However, we find it deeply troubling that those who seek to game the U.S. markets are not consistently and vigorously prosecuted. Where the cost of getting caught is minimal, those who lack the moral conviction to do that which is right have all the more reason to break the law and shareholders' trust.
It is and will remain the ken of enforcement officials at the SEC and elsewhere to be the watchdog guarding shareholders against fraud. But we find it disheartening to know that those who booked nonexistent revenue at Cendant, to name an example, have never been faced with real risk of prosecution. They got to keep their ill-gotten money, while outside investors lost billions. It is just as disheartening to talk with an enforcement official at the Justice Department who concedes that he has delivered several management fraud cases to prosecutors only to have them ignored or dismissed as insufficient. The truth may be more mundane: Such crimes are kind of boring and hard to prove.
The trouble lies in the fact that it is extremely difficult to prove cases of securities fraud on the part of insiders. The standard American legal protection of requiring the prosecutorial burden be "beyond a reasonable doubt" and the need to show fraudulent intent for securities fraud provide a significant barrier to making insiders and boards more culpable for misdeeds. After all, the Supreme Court has found that there is no "aiding and abetting" liability for securities fraud. In other words, just because something happened on your watch doesn't mean that you are complicit by virtue of "being there." The most accessible outlet has thus become civil actions, shareholder suits against companies and insiders.
Company executives and boards of directors have a fiduciary responsibility to their shareholders. Each year, they sign off on the company's financial statements, thus attesting their accuracy. However, it is possible for certain individuals to have committed fraud without the board having violated its duties. While this may not be the most exciting crime of all time, we outside investors demand that there be some consequence to those who do approve fraudulent financial statements and those who oversee the executives. We do not believe that company directors or management should be held culpable for business failures; we do believe that they should have responsibility for the process should it become fraudulent.
Our participation in the stock market depends upon our ability to trust the statements that companies release to the public. This trust will be significantly enhanced with the knowledge that a person who does flout the law and his fiduciary responsibilities does so at significant risk to himself. We, therefore, suggest that it is in the best interest of every participant in the public markets that prosecution of securities fraud be extremely aggressive, that prosecutors should risk bringing cases to trial even if they are not optimistic about their chances of winning. We would also suggest that it is in the best interest of all market participants that legislation be enacted making securities prosecution easier, including that of uninvolved directors or accomplices. We believe that the responsibility of directors for management's bad acts be increased. This may discourage people to serve as corporate directors, but it should also be noted that directors, whose job it is to protect outside shareholders' interests, would be much less likely to be disinterested, or to be pliant to the wishes of management in regard to actions that might rise to the level of fraud.
What to do now
The SEC has significant power to sanction companies for fraudulent activities. If you suspect that a company's management is violating its fiduciary responsibility to you as a shareholder, contact the SEC at [email protected].
Feel free to voice your displeasure to individual companies if you believe that it is not operating with the best interests of shareholders in mind. In many cases, management efforts to confuse or defraud investors include efforts to prop up share prices. Should investor relations not be able to give you sufficient answers for your questions as to why the company has chosen to act in certain ways, your best interest may be to protest their actions by selling.
Watch boards closely. Even though their exposure to prosecution may be limited, corporate board members do face the risk of civil judgments for corporate misdeeds. Should you see several corporate board members resigning at once or in quick succession, this might be a sign that the company is doing something that puts the board at risk. Write your congressional representatives and senators and ask them to support legislation that increases personal responsibility of boards and managers to management's bad acts.
This is a call to action. We intend to make the opinions of individual investors heard about issues that directly affect their ability to participate in the public markets. Please take a moment to comment on this and subsequent Manifesto points that will be released over the next few market days, even if just to say, "Hear, hear!" or "I agree and would further say..." or "I disagree because...." We will deliver these comments to the SEC, members of Congress, and the exchanges prior to the SEC Investor Summit scheduled for May 10, in which our own Bill Mann will be a panelist.
