Cost Effective Strategy to Accomplish Responsible Ownership Goals

A Manhattan federal judge recently dismissed a shareholder lawsuit accusing current and former American International Group Inc executives and directors of ignoring “red flags,” leading to the insurer’s near collapse and need for more than $180 billion in cash and loans it received from taxpayers.

Shareholders led by the Louisiana Municipal Police Employees’ Retirement System pension fund failed to show enough facts creating a reasonable doubt that the directors were disinterested and independent, or failed to properly exercise their business judgment.

In a written response to the lawsuit filed by shareholders in a New York federal court, AIG conceded that its executives were, at times, too optimistic, but denied any intent to deceive investors, “Being wrong or even unwise, in hindsight, is not the same as violating the securities laws.”

In defending itself against the shareholders’ lawsuit, AIG contended, “Statements of optimism about the future…that turn out to be wrong are simply not actionable. Even in times of market turmoil, the company need not presume the worst about its market prospects.”

To federal prosecutors, investment professionals and shareholders, how do you know where delusion ends and dishonesty begins; how do you distinguish the difference between incompetence and ill intent?

The Securities Act of 1933 requires that information provided to investors is accurate – Investors who purchase securities and suffer losses have important recovery rights if they can prove that there was incomplete or inaccurate disclosure of important information.

With this Act, Congress created the Securities and Exchange Commission. The Act empowers the SEC to require periodic reporting of information by companies with publicly traded securities.  The Act empowers the SEC to enact regulation to ensure transparency.

“The point of regulation is to increase transparency. You can call it regulation, but you’re just shining a light on a murky opaque process that, most recently, brought this economy down”

(Michael Oxley, Sarbanes-Oxley Act of 2002).

“If you read any of the books that have come out, from Hank Paulson’s book [On the Brink] to Too Big to Fail, the common thread is an incredible lack of transparency and no accountability.”

According to Richard Lochridge (Board Member, PetSmart, Lowes), “the board is a slow vehicle for figuring out when there is a problem and taking appropriate action. Management is hesitant to tell the whole truth; the board doesn’t know nearly what management knows; and, board members don’t always pay attention to all that’s going on.”

The burden to find out what really goes on inside a company rests solely with investors. Investors must do their due diligence to ensure that a company discloses the real state of the business.

Companies with more than $10 million in assets whose securities are held by more than 500 owners must file annual and other periodic reports. Public companies use these financial statements to communicate with investors.  Financial statements give investors a clear picture of the past – a look in the rear view mirror. 

But investors are also interested in where the company is going – a look out the windshield. Companies also use press and earnings releases to communicate with investors and the public. Unfortunately, earnings releases are currently unaudited and not subject to internal controls.

Today, transparency into publicly traded companies is amorphous.  Information is often incomplete, irrelevant or outright incomprehensible.

Investors need assurance that the companies within their portfolio will not be the next highly publicized failure. To give them that assurance, investors must have the ability to identify the potential causes of such failures.

Investors become very upset and pay attention to corporate governance only when they’re losing money. After a bull market has been underway for some time investors become confident and complacent, until once again they are blind-sided by corruption, fraud and poor management.

After a second financial crisis in a decade, some shareholder advocates are now pressuring Corporate America to rein in hazardous pay practices, hold directors of corporate boards more accountable, and improve oversight of risk.

“It’s time for lawmakers to hold the line and do what’s right for investors. . . . Reform should not be what is in Wall Street’s best interests,” said Amy Borrus, deputy director of the Council of Institutional Investors. “It’s not just enough to overhaul the regulatory architecture. We need market-based discipline. Investors need the tools to hold the directors’ feet to the fire.”

The key to their success will depend largely on improved internal transparency, preferably via an independent third party.

Employees have the highest success rate for uncovering fraud and find more corporate fraud than regulators, according to the latest research by Alexander Dyck, Adair Morse, & Luigi Zingales (September, 2009).

The Investor Protection Act making its way through Congress intends to expand the authority of the US Securities and Exchange Commission, in any action in which it levies sanctions in excess of $1 million, to compensate employees with up to 30% of the amount of the sanctions; i.e., employees share in awards up to $300,000 for every $1 million the SEC levies in sanctions. 

A group of finance and accounting professionals have created an online forum,, where employees can submit information anonymously about the business practices of the company and its executives to share in these awards.

This online forum aims to demonstrate that transparency can work.  When information is relevant, standardized and public, it fosters intelligent decision-making.

To investors, information is knowledge, and knowledge is power.  Improved internal transparency from an independent third party arms investors with comprehensive information about the quality of the business and strength of the management team.  This information source serves as a check and balance against the information provided by management as well as auditors and outside consultants. 

Pension fund managers can now gain access to accurate and comprehensive information about the companies within their investment portfolio online at to formulate and execute a cost effective strategy to accomplish responsible ownership goals.

Armed with a valid information source, pension fund managers now have a “tool to hold the directors’ feet to the fire.” Investors who purchase securities and suffer losses now have the ability to prove when there is incomplete or inaccurate disclosure of important information.

After a second financial crisis in a decade, it’s more important than ever to position investment portfolios for enhanced performance while safeguarding investments against corruption, fraud and poor management.  Providing employees a structured process to disclose information about a company’s fundamental strengths and weaknesses is an internal audit best practice, and provides a unique opportunity to accomplish responsible ownership goals at a lower cost.

zEthics, Inc. is a participating member of the Business Integrity Alliance™.  The mission of this alliance is to influence positive and sustainable change to the governance and risk management principles and practices, which are so vital to organizations, their stakeholders, and the communities in which they operate. 

A sample report from the online service provider is available at


About zethics
CEO and founder of zEthics, Inc. Thirty years of experience with finance and accounting background in public private sectors.

One Response to Cost Effective Strategy to Accomplish Responsible Ownership Goals

  1. thank you 4 share this

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