Does Last Place Really Deserve a Participation Prize?

Capitol Hill is getting quite a bit of action lately.

Last week, U.S. credit bureau Equifax admitted to a security breach impacting nearly half of the entire United States population. The breach had leaked the personal information of 143 million people (44% of the U.S. population), inclusive of social security numbers, driver’s licenses, birth dates, you name it. In typical fashion, those with the lowest financial literacy and resources will be hit the hardest.

Equifax is the oldest of the three main U.S. credit bureaus, aggregating information on over 800 million people for insurance and credit reports.

“The Equifax data breach poses serious problems for consumers of all socio-economic levels, but in particular, those consumers who are less educated on the repercussions associated with data theft and identity theft. We are deeply concerned that Equifax – and all credit reporting companies – are not doing enough in a timely manner to protect under-served consumers who have been victimized by this data breach and stand to suffer the most.” – Thomas Hinton, CEO, American Consumer Council

Companies make mistakes. The implications of some mistakes larger than others, but the response to the mistake is always imperative. Equifax asked its customers to give up their right to sue the company in exchange for credit monitoring services. The company retreated from this stance shortly after, but the response has not yet been forgotten. Also not forgotten is the fact that Equifax let six weeks go by before announcing the breach. It should be noted, however, that the company’s interim CEO Mr. Paulino de Rego Barros Jr. wrote a nice apology in the WSJ and other media outlets, and the company is also developing free services to let consumers lock and unlock credit card file access. Not entirely consolation for having your identity stolen, but its a step in the right direction.

Behavior, Repeated 

As reported on CNN Money, “Scandal 101: Equifax repeated Wells Fargo’s mistakes”, we are witnessing an unfortunate repetition of bad behavior.

You might recall hearing about a certain $185 million scandal involving fake accounts last year.

What happened? Well, the story is that employees inside Wells Fargo created millions of fake accounts and credit card applications. Associated with these accounts were fees for customers which helped augment sales figures for Wells  Fargo employees. As result, 5,300 employees were fired and the company forced to pay a $185 million fine. Also as a result, Wells Fargo has lost over 550 financial advisors overseeing assets northward of $20 billion.

Adding insult to injury, just one month ago Wells Fargo admitted it had found an additional 1.4 million fake accounts, totaling to approximately 3.5 million fake accounts. What does this mean? About a year after its first congressional hearing, Wells Fargo is back in the hot seat and just yesterday, both Wells Fargo and Equifax testified at Congressional hearings. A simple Google search will lead you to a plethora of opinions and quotes from yesterday’s events.

Hindsight is 2020…and so is the MSCI ESG Index

Interestingly, if one had been following the MSCI ESG Index, one might have had a bit of foresight into both the Equifax and Wells Fargo Scandal (and Volkswagen, but who’s counting).

In fact, prior to scandal, Equifax had already been rated as an extreme underperformer according to both MSCI ESG Research and Sustainalytics, ranking in the lowest decile out of 93 firms. In August, MSCI ESG Research downgraded Equifax to its lowest rating “CCC”. Months prior to the scandal, the April MSCI ESG Rating Report stated:

“Equifax is vulnerable to data theft and security breaches, as is evident from the 2016 breach of 431,000 employees’ salary and tax data of one of its largest customers, Kroger grocery chain. The company’s data and privacy policies are limited in scope and Equifax shows no evidence of data breach plans or regular audits of its information security policies and systems…Equifax faces high exposure to regulatory and reputational risks associated with privacy and data security issues, primarily because of the company’s involvement in credit reporting…”

MSCI ESG Rating of Equifax
MSCI ESG Rating of Equifax

One might conclude that because two renowned predictors shared similar opinions about Equifax and Wells Fargo, the companies would surely be missing from ESG portfolios, right? Wrong. Somehow, both Equifax and Wells Fargo were included in top portfolios.wellsequifaxMSCIIt seems reasonable to conclude that there is an apparent disconnect between ESG investment research and actual investments, despite the fact that ESG research is proving to be quite predictive. Let this be a call to action for investors to fully embed ESG research into portfolios.

Investors as Stewards of the Commons?

Increasing social inequality and environmental deterioration, coupled with the failure of government to provide regulatory interventions to mitigate negative externalities, has led many to look to the private sector to alleviate environmental and social deficiencies. Such was recognized in the Sustainable Development Goals (SDGs).

In his working paper, Investors as Stewards of the CommonsHarvard Professor George Serafeim urges for the mobilization of investor voices towards positive social and environmental change.

“While companies are increasingly addressing environmental and social issues that also improve their economic value, for some of these issues individual company action is costly. At the same time, for a further subset of those issues, company action coupled with collaboration between companies is value enhancing, However, collaboration between companies is notoriously difficult and fragile requiring commitment mechanisms.

I suggest that a small set of large institutional investors, importantly, but not exclusively, index and quasi-index investors, could provide this commitment mechanism. Common ownership of competitors within industries and long-time horizons in ownership of shares are key characteristics for investors that could act as stewards of the commons. Social pressure fueled by socially responsible investment funds and non-profit organizations and customer pressure from individual investors are critical in mitigating free-rider problems among asset managers and sustaining engagement practices.”

Serafeim’s theory of change suggests that investors have a tremendous power to serve as the mechanisms by which corporations can collaborate for meaningful change.

Serafeim argues that pre-competitive collaboration would allow for an equal playing field when competition eventually occurs. For example, consider the effect of the big wigs in the fashion industry collectively managing resources to reduce water pollution caused by their manufacturing and supply chains. Such collaboration is not to be mistaken with collusion. Rather, as noted by Serafeim: “Similar to airlines cooperating by purchasing jets together in order to lower costs collectively, collaborations are mutually beneficial but do not affect the fundamental relationships of competitors.”

While we must not diminish the fact that business and government action has resulted in incredible commitments and actions on behalf of many companies and pockets of environmentally-positive legislation, the fact of the matter is that there is still much work to be done. The way forward is presumably a combination of investor action, conscious consumption, policy regulation, innovation, and private sector leadership.

One thing is for certain – the train heading towards protecting the planet’s resources for future generations has collaboration written all over it. Hop on board.

2 thoughts on “Does Last Place Really Deserve a Participation Prize?

  1. Your article is excellent and motivated me to look at some of the other holdings of of these socially responsible funds such as Vanguard. One of Vanguard’s holdings in their socially responsible index fund is EOG Resources, a fracking company and Conoco Phillips, also fracking…..Shame on them!

    Liked by 1 person

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