To see the facts clearly, put on your political goggles -- San Francisco Chronicle

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To see the facts clearly, put on your political goggles

Lee Drutman

Monday, April 16, 2007

Full Disclosure

The Perils and Promise

of Transparency

By Archon Fung, Mary Graham and David Weil

CAMBRIDGE UNIVERSITY PRESS; 282 Pages; $28
Maybe Louis Brandeis only had it partially right. Sure, sunlight can be the best disinfectant. But it depends. Is it direct sunlight? Or is it filtered? If so, by what? And what are we trying to disinfect, anyway? As it turns out, things get complicated quickly when you start questioning this bit of conventional wisdom. According to Archon Fung, Mary Graham and David Weil, sunlight has its dark side, and "simply placing information in the public domain does not guarantee that it will be used or used wisely."

The authors (a political scientist, a lawyer and an economist, all based at the Kennedy School's Taubman Center for State and Local Government at Harvard University) got interested in what they call "targeted" transparency policies about five years ago, when they noticed these kinds of policies popping up all over the place (by "targeted," they mean focused on a particular area, such as automobile defects or hazardous materials exposure, with specific, previously agreed-on metrics as opposed to more general, "right-to-know" disclosure).

The political appeal was easy to get: Respond to a crisis quickly without getting mixed up in thorny regulation. Harness the power of technology and the market at a time when people don't trust their government anyway. But there seemed to be less understanding of whether the faddish approach actually worked to produce "significant, long-term behavior changes by users and disclosers in the direction intended by policymakers." True, there were some successes. But there were also some costly failures. And many policies didn't seem to be making much of a meaningful difference. The authors wanted to know why.

In one sense, "Full Disclosure" is aguide for policymakers, complete with the requisite "10 principles for an effective transparency policy" guide. Their basic advice is that for transparency policy to be effective, the information must be both easy to understand and easy to act upon. Users must be able to register their choices clearly, and disclosers must have the ability and incentive to respond meaningfully. As an example of a relatively successful policy, the authors offer up Los Angeles restaurant hygiene. Every restaurant in that city must post a health inspection score (A, B or C) in its window: easy to interpret, easy to act upon and every restaurant owner knows what happens when the score drops from A to B.

Problem is, such effective policies are hard to come by. That's because they are, after all, a product of politics, and politics is a nasty business. Targeted groups fight tooth and nail to make sure that disclosures are weak and confusing, and, therefore, largely ineffectual: What, exactly, will be disclosed? How will it be measured? How often will it be disclosed? And who has to disclose it? It all depends on who is at the political table. "Targeted transparency policies are often born in crisis," the authors write, "usually as political compromises reflecting the relative power of organized representatives of potential disclosers and weak coalitions of potential users."

A disclosure policy written to favor the disclosers tends to result in atrophy. Only when users (or as is more often the case, groups working on behalf of users) gain some political power can disclosure become sustainable and effective. Good transparency policies can do this, essentially changing the "political terrain." Good policies empower users. They also ultimately make it so disclosers have no incentive to undermine transparency.

Consider financial disclosures for publicly traded companies. First introduced in the early 1930s in response to the stock market crash of 1929, financial disclosure has generally worked well (though, there have been some recent, err, hiccups). That's because investors as a class have been politically powerful. But it's also because they've made use of financial information to send signals to corporations that they value disclosure. Equally important, companies came to value transparency because it made raising capital easier (investors are less skittish when they have faith in the numbers). In short, incentives were well aligned all around; everybody was better off with a system of transparency. But, "significant incentives for disclosers to support transparency do not materialize until a viable system is in place or seems inevitable."

At best, "Full Disclosure" ought to make citizens wise to the tricks that commonly turn transparency policies into little more than symbolism. At worst, the book is just one more piece of information, interesting but difficult to act on, because though there is plenty of sunlight shining into our political process, there's little the average reader (or even the average policymaker) can do when powerful interests dig in their heels. If James Madison once warned that "a popular government without popular information or the means of acquiring it, is but a Prologue to Farce or a Tragedy or perhaps both," then Fung, Graham and Weil seem to be warning that even with popular information and the means of acquiring it, farce and tragedy remain acute dangers absent a meaningful way to act on that information.

Lee Drutman is the co-author of "The People's Business: Controlling Corporations and Restoring Democracy."

http://sfgate.com/cgi-bin/article.cgi?f=/c/a/2007/04/16/DDGR5P8IOH1.DTL

Whither corporate accountability? - Providence Journal

Whither corporate accountability?

01:00 AM EDT on Monday, April 9, 2007

Lee drutman

BERKELEY, Calif.

LATE LAST MONTH, as the U.S. Supreme Court heard oral arguments in a pair of cases regarding the rights of investors to hold corporations and banks accountable for fraud, I was once again reminded of the puzzling (though, sadly, not shocking) fact that the very groups that benefit most from our current capital-formation system still don’t seem to understand that accountability matters. A lot.

In one case, Credit Suisse First Boston Ltd. v. Billing, 16 Wall Street banks (joined by the solicitor general of the United States, which filed an amicus brief) argued that they are immune from antitrust lawsuits when it comes to initial public offerings (IPOs). They claim that they are already capably regulated by the Securities and Exchange Commission (SEC), and to allow an investor antitrust suit to go forward would illegally undermine the SEC.

There is less doubt that the named banks successfully conspired to artificially drive up the price of about 900 IPOs during the 1990s technology bubble, engaging in a practice called “laddering” — essentially requiring that certain customers purchase the shares at steadily escalating prices to create the trompe l’oeil of a seductively rising stock. Banks also awarded hot IPO offerings to select clients in exchange for underwriting business. While the banks and their favored clients all made out quite well in all this, the resultant market bubble had real consequences. In expanding, it misallocated capital into firms that probably should have never been taken public in the first place. In bursting, it left less in-the-loop investors (i.e. you and me) holding the bag at a cost of billions of dollars (to us!). Wonder where that capable SEC was . . .

Now the banks and their attendant cheerleaders assert that to let investors hold banks accountable under antitrust law would undermine capital formation by increasing its costs. Funny, for all their great love of free markets, they don’t actually trust leaving IPO prices up to an open market. No, better to let investment banks conspire to self-servingly cheerlead investment dollars into worthless technology companies. After all, think of the lucrative underwriting business to be gained!

The second case, Tellabs Inc. v. Makor Issues & Rights Ltd., is about the proper threshold for investors to bring class-action lawsuits when a CEO makes false statements about company finances, as optical networking and broadband equipment firm Tellabs’s chief executive allegedly did in 2001. Tellabs (with supporting briefs from both the Securities and Exchange Commission and the U.S. Department of Justice) argues that under the proper interpretation of a 1995 law regarding such suits (The Private Securities Litigation Reform Act) it should be very difficult indeed for investors to bring such suits — that investors need to show that there was, in fact, a “high likelihood” that the executive was intending to deceive investors. But investors (with support from 32 states) argue that such a threshold is unnecessarily high. After all, how can investors ever gather enough evidence to show intention to deceive if they can’t even undertake legal discovery?

Again, the issue of accountability. One common explanation for the recent wave of corporate frauds was the 1995 law in question, which significantly limited the ability of investors to file suit when companies committed fraud. In doing so, it emboldened executives to be less than forthright about their company’s finances. Arguing for the strictest interpretation of the law is in essence an invitation for more fraud, telling companies: Go ahead, make it up as you go — ain’t nobody gonna be able to touch you on that one.

In all likelihood, the Supreme Court will resolve these legal ambiguities on behalf of the corporations, banks, and fellow travelers in the current administration who, ever since Sarbanes-Oxley, have been complaining loudly that all this accountability stuff does nothing but gum up the market by making everything more expensive.

They ought to be careful what they wish for. Free markets not only require rules, but also confidence that those rules will be followed and that those who don’t follow them will be punished. This confidence is the main reason that the U.S. has been the world’s preeminent stock market. And yet, piece by piece, the very groups that seem to benefit most from this system seem to stubbornly insist on undermining it. If this is what they mean by lowering the costs of capital formation, it’s worth remembering the old adage that you get what you pay for.

Lee Drutman, a frequent contributor, is the co-author of The People’s Business: Controlling Corporations and Restoring Democracy.

http://www.projo.com/opinion/contributors/content/CT_drut9_04-09-07_GD52JQQ.1d61b2e.html