The S.E.C. Rule That Destroyed The Universe

How the coronavirus is creating a political opportunity to overturn one of the worst practices of the kleptocracy era

The Covid-19 crisis has revealed gruesome core dysfunction.

  • Drug companies have to be bribed to make needed medicines,
  • state governments improvise harebrained plans for emergency elections, and
  • industrial capacity has been offshored to the point where making enough masks seems beyond the greatest country in the world.

But the biggest shock involves the economy. How were we this vulnerable to disruption? Why do industries like airlines that just minutes ago were bragging about limitless profitability – American CEO Doug Parker a few years back insisted, “My personal view is that you won’t see losses in the industry at all” – suddenly need billions? Where the hell did the money go?

In Washington, everyone from Donald Trump to Joe Biden to Alexandria Ocasio-Cortez is suddenly pointing the finger at stock buybacks, a term many Americans are hearing for the first time.

This breaks a taboo of nearly forty years, during which politicians in both parties mostly kept silent about a form of legalized embezzlement and stock manipulation, greased by an obscure 1982 rule implemented by Ronald Reagan’s S.E.C., that devoured trillions of national wealth.

The mechanics of buybacks are simple. Companies buy their own stock and retire the shares, increasing the value of shares remaining in circulation. This translates into instant windfalls for shareholders and executives that approve the purchases. That this should be proscribed as market manipulation, and additionally offers a clear path to insider trading – former SEC chief Rob Jackson found corporate insiders were five times as likely to sell stock after a share repurchase was announced – is just one problem.

The worse problem comes when companies not only spend all of their available resources on stock distributions, but borrow to fund even more distributions. This leaves companies with razor-thin margins of error, quickly exposed in a crisis like the current one.

“When companies spend billions on buybacks, they’re not spending it on research and development, on plant expansion, on employee benefits,” says Dennis Kelleher of Better Markets. “Corporations are loaded up with debt they wouldn’t otherwise have. They’re intentionally deciding to live on the very edge of calamity to benefit the richest Americans.”

It’s hard to overstate how much money has vanished. S&P 500 companies overall spent the size of the recent bailout – $2 trillion – on buybacks just in the last three years!

Banks spent $155 billion on buybacks and dividends across a 12-month period in 2019-2020. As former FDIC chief Sheila Bair pointed out last month, “as a rule of thumb $1 of capital supports $16 of lending.” So, $155 billion in buybacks and dividends translates into roughly $2.4 trillion in lending that didn’t happen.

Most all of the sectors receiving aid through the new CARES Act programs moved huge amounts to shareholders in recent years. The big four airlines – Delta, United, American, and Southwest – spent $43.7 billion on buybacks just since 2012. If that sum sounds familiar, it’s because it equals almost exactly the size of the $50 billion bailout airlines are being given as part of the CARES Act relief package.

The two major federal financial rescues, in 2008-2009 and now, have become an important part of a cover story shifting attention from all this looting: the public has been trained to think companies have been crippled by investment losses, when the biggest drain has really come via a relentless program of intentional extractions.

Corporate officers treat their own companies like mob-owned restaurants or strip mines, to be systematically pillaged for value using buybacks as the main extraction tool. During this period corporations laid off masses of workers they could afford to keep, begged for bailouts and federal subsidies they didn’t need, and issued mountains of unnecessary debt, essentially to pay for accelerated shareholder distributions. 

All this was done in service of a lunatic religion of “maximizing shareholder value.” “MSV” by now has been proven a moronic canard – even onetime shareholder icon Jack Welch said ten years ago it wasthe dumbest idea in the world – and it’s had the result of promoting a generation of corporate leaders who are

  • skilled at firing people,
  • hustling public subsidies, and
  • borrowing money to fund stock awards for themselves, but
  • apparently know jack about anything else.

During a Covid-19 crisis where we need corporations to innovate and deliver life-saving goods and services, this is suddenly a major problem. “We’re seeing, these people don’t have the slightest idea of how to run their own companies,” says Harvard economist William Lazonick.

Wall Street analysts spent the last weeks mulling over the grim news that society is wondering if it can afford to keep sending most of its wealth to a handful of tax-avoidant executives and corporate raiders (known euphemistically in the 21stcentury as activist investors). The Sanford Bernstein research firm sent a note to clients Monday warning buybacks would be “severely curtailed” in coming years, for the “intriguing” reason that they were becoming “socially unacceptable” in this crisis period. 

Goldman, Sachs chimed in with a similar observation. “Buyback activity will slow dramatically, both for political and practical reasons,” the bank told clients.

The political furor on the Hill in the last weeks has mostly been limited to grandstanding demands that recipients of aid in the $2 trillion CARES Act not be spent on stock distributions. “I’ll take it, but most of them don’t know what the hell they’re talking about,” is how one economist described these complains.

If politicians did understand the buyback issue more fully, they either wouldn’t have voted for this unanimously-approved bailout, or would have insisted on permanent bans, given the central role such extraction schemes played in necessitating the current crisis to begin with. The history is ridiculous enough.

***

The newspaper record of November 17, 1982 shows an ordinary day from the go-go Reagan years. Republicans boosted tax cuts and military budget hikes. An NFL player strike ended after 57 days. Soviet and Chinese foreign ministers met, and 80 complete skeletons were found in a dig at Mount Vesuvius in what one scientist called a “masterpiece of pathos.”

There was little news of a rule passed by the Securities and Exchange Commission and implemented with almost no documentary footprint. “It’s not written about in histories of the S.E.C.,” says Lazonick. “It’s barely mentioned even in retrospect.”

Yet rule 10b-18, which created a “safe harbor” for stock repurchases, had a radical impact. For decades before Reagan came into office and stuck E.F. Hutton executive John Shad in charge of the S.E.C. – the first time since inaugural chief Joseph Kennedy’s tenure in the thirties that a Wall Street creature had been made America’s top financial regulator – officials had tried numerous times to define insider purchases of stock as illegal market manipulation.

Again, when companies buy up their own stock, they’re artificially boosting the value of the remaining shares. The rule passed by Shad’s S.E.C. in 1982 not only didn’t define this as illegal, it laid out a series of easily-met conditions under which companies that engaged in such buybacks were free of liability. Specifically, if buybacks constituted less than 25% of average daily trading volume, they fell within the “safe harbor.”

The S.E.C. in adopting the rule emphasized the need for the government to get out of the way of such a good thing:

The Commission has recognized that issuer repurchase programs are seldom undertaken with improper intent… any rule in this area must not be overly intrusive.

The rule added that companies may be justified in “stepping out” of safe harbor guidelines, and said that there would be no presumption of misconduct if purchases were not made in compliance with 10b-18. Thirty-three years later, in 2015, S.E.C. Chief Mary Jo White would double down on this extraordinary take on “regulation,” saying that “because Rule 10b-18 is a voluntary safe harbor, issuers cannot violate the rule.”

10b-18 was a victory for a movement popularized in the late sixties by Milton Friedman and furthered in the mid-seventies by academics like Michael Jensen and Dean William Meckling. The aim was to change the core function of the American corporation. If corporate officers previously had to build value for a variety of stakeholders – customers, employees, the firm itself, society – the new idea was to narrow focus to a single variable, i.e. “maximizing shareholder value.”

Like objectivism and other greed-based religions that helped birth the modern version of corporate capitalism, “MSV” was anchored on hyper-rosy assumptions tying efficiency to self-interest. It was said CEOs paid in stock would become owners, which would lead to reductions in spending on private jets and other waste.

Shareholders previously were paid via dividends, or by waiting for share prices to appreciate and selling them. Now there was a shortcut: board members chosen by shareholders could raid their own companies’ assets to buy stock and to goose share prices. 

Employees, customers, and society were suddenly in direct competition for resources with executives and shareholders. Should a company invest in a new factory, or should it just deliver instant millions to shareholders and executives paid in options?

By 1997, MSV became orthodoxy, as the Business Roundtable declared that the “paramount duty of management and of boards of directors is to the corporation’s stockholders.” This was understood to mean that the sole purpose of the corporation was to create value for shareholders.

In the 2008 financial crisis, many firms poured resources into buybacks even as they hurtled toward bankruptcy. Some kept shifting money to stock buys practically until the day of their deaths. Lehman Brothers, for instance, announced a 13% dividend increase and a $100 million share repurchase in January 2008, when the firm was already circling the drain. Many of the TARP bailout recipients kept up buybacks even during the bleakest days of the financial crisis.

“If you added up the capital distributions of the banks in just the few years before the crash,” says Kelleher, “it adds up to half the TARP. They wouldn’t have needed a bailout if they’d [curbed] distributions.”

Before and after 2008, American companies repeatedly begged to be subsidized by taxpayers even as they systematically liquidated revenues via buybacks.

For instance, as Lazonick pointed out in a 2012 paper, Intel in 2005 lobbied the U.S. government to invest in nanotechnology, warning “U.S. leadership in the nanoelectronics era is not guaranteed” and would be lost absent a “massive, coordinated research effort” that included state and federal investment. That year, Intel spent $10.5 billion on buybacks, and spent $48.3 billion on them in 2001-2010 overall, four times what the federal government ended up spending on the National Nanotechnology Initiative

The classic extraction trifecta was to ask for public investment, take on huge debts, and enact mass layoffs as a firm spent billions on distributions.

Microsoft in 2009 laid off 5,000 workers (its first mass layoff) and did a $3.75 billion bond issue (its first long-term bond) despite earning $19 billion. That same year, the company spent $9.4 billion on buybacks and $4.5 billion on dividends. Lazonick argues such cash-rich companies borrowed money in order to avoid having to repatriate overseas profits, which would have forced them to pay taxes before blowing cash on buybacks.

Buyback waste is breathtaking. Exxon-Mobil, apparently disinterested in researching alternative energy sources, did $174 billion in buybacks between 2001-2010. The nation’s 18 largest pharmaceutical companies, who feed off NIH grants for free research and have relentlessly lobbied to be protected from generics, reimportation, the use of Medicare’s bargaining power to lower prices, spent $388 billion on buybacks in the last decade.

Apple, upon whose board sits relentless seeker-of-green-technology-seed-capital Al Gore, did $45 billion in buybacks in one year (2014) and $239 billion over a six year period between 2012 and 2018. Gore also owned over 79,000 shares of Apple as of last January, and sold nearly $40 million worth of Apple stock in February of 2017. So he’s probably not too upset that Apple is spending sums equivalent to major bailout programs on stock repurchases, rather than investing in new technologies.

In March of 2018, Wisconsin Senator Tammy Baldwin finally introduced legislation to halt the practice, called the Reward Work Act, which would:

Ban open-market stock buybacks that overwhelmingly benefit executives and activist hedge funds at the expense of workers and retirement savers. It would also empower workers by requiring public companies to allow workers to directly elect one-third of their company’s board of directors.

In summer of 2019, the Business Roundtable shook corporate America by abandoning “shareholder value” as the animating principle of American business. This led to a spate of breathless news reports: “Shareholder Value Is No Longer Everything” (New York Times), “Group of US corporate leaders ditches shareholder-first mantra” (Financial Times) and, “Maximizing Shareholder Value is Finally Dying” (Forbes).

This was all going on against the backdrop of a Democratic presidential election campaign that in the campaigns of Bernie Sanders and Elizabeth Warren especially saw the rise of furious anti-corporate sentiment. The Roundtable response might have been P.R. designed to dull the pitchforks somewhat, but it’s notable that there was enough worry about the optics of shareholder piggery to even do that much.

As Forbes put it:

Maximizing shareholder value has come to be seen as leading to a toxic mix of soaring short-term corporate profits, astronomic executive pay, along with stagnant median incomes, growing inequality, periodic massive financial crashes, declining corporate life expectancy, slowing productivity, declining rates of return on assets and overall, a widening distrust in business…

Economist Lenore Palladino, who has worked on these issues for years, hopes Covid-19 and other looming crises will force politicians and the public to see fundamental changes to corporate structure as inevitable.

“I believe there will be a political mandate to ensure business resiliency in the 2020s, not only to survive coronavirus, but so that the American workforce can thrive in the era of climate change,” she says. Banning buybacks, she says, would (among other reforms) comprise “one step towards rebalancing power inside corporations.”

However, unless the public puts more pressure on politicians to keep the issue alive during the coronavirus crisis, the $2 trillion rescue and the near-daily barrage of radical new bailout facilities being introduced – the Fed as of this writing is introducing yet another amazing “bazooka” program to hoover up junk bonds – could just end up subsidizing the last decade of buybacks.

If political focus on repurchases becomes a purely temporary policy fixation, a la Joe Biden’s “CEOS should wait a year before gouging their own firms again” proposal, this bailout will be massively counterproductive, enshrining buybacks in non-emergency times as a legitimate practice. If we can’t fix a glitch as obvious as 10b-18, what can we change?

How Buybacks Have Warped the Stock Market & Boeing (w/ Dr. William Lazonick)

Dr. William Lazonick, co-founder and president of The Academic-Industry Research Network, sits down with Real Vision’s Max Wiethe to dissect the evolution of the stock market and the modern American economic system. Citing Boeing as an example, he contends that the stock market is being used to loot previously innovative corporations as insiders and outsiders alike are incentivized to push stock prices higher. He also argues that American competitiveness is being sapped as companies prioritize stock buybacks over investing in research and development, building new infrastructure, and paying off debt. Lazonick explains how this focus on short-term profits has led to unstable employment, sagging productivity growth and a loss of international competitiveness. Filmed on December 6, 2019 in New York.

Exponent: Episode 001 – THE GARBAGE TRUCK SONG

In this, the first episode of the Exponent podcast, we talk about our background, Microsoft and disruption, and the meaning of culture. We also explore our goals for this podcast, and just a bit about Taiwanese garbage trucks.

Show Notes:

  • If Steve Ballmer Ran Apple link
  • The Halo Effect:…and Eight Other Business Delusions that Deceive Managers link
  • Skating Towards the Goal link
  • Bill Gates’ Steve Jobs Moment link
  • Friction link
  • Note: The Internet Explorer rendering engine is called Trident, not Triton

Comment:

  • Companies get disrupted when they focus on maximizing profit and less on building the best product.
  • Steve Balmer was a sucessful CEO from the standpoint of maximizing shareholder value for a ~10 year period.
  • But what about in the long run: 30 or 50 or 100 years
  • What is the purpose of corporations?
  • Should companies milk their core business over a lifecycle and not try to maintain themselves after that.
  • Would it be better for Microsoft to generate billions for shareholders and have them reinvest in a bunch of startups.

William Dalrymple on the ruthless rise of the British East India Company

The outrageous story of a group of financiers from a poor and damp island on the outer rim of Europe, who created a private company that became the biggest military and political power in all of India
17

Move Over, Shareholders: Top CEOs Say Companies Have Obligations to Society

The leaders of some of America’s biggest companies are chipping away at the long-held notion that corporate decision-making should revolve around what is best for shareholders.

The Business Roundtable said Monday that it is changing its statement of “the purpose of a corporation.” No longer should decisions be based solely on whether they will yield higher profits for shareholders, the group said. Rather, corporate leaders should take into account “all stakeholders”—that is, employees, customers and society writ large.

It is a major philosophical shift for the association, which counts the chief executives of dozens of the biggest U.S. companies as its members. The group, led by JPMorgan Chase & Co. CEO James Dimon, is a powerful voice in Washington for U.S. business interests.

The Business Roundtable’s old statement of purpose espoused economist Milton Friedman’s decades-old theory that companies’ only obligation is to maximize value for shareholders.

“Each of our stakeholders is essential,” the new statement says. “We commit to deliver value to all of them, for the future success of our companies, our communities and our country.”

A company’s position on the question of corporate purpose can influence issues as diverse as worker pay and environmental impact. It plays a central role in discussions about stock buybacks, corporate spending and how companies respond to activist investors agitating for moves meant to boost returns.

Seven Fixes for American Capitalism

Ideas from the Right, the Left, and across the Atlantic to mend what’s broken in our economy.

Antitrust Pivot

Many of the U.S.’s biggest economic ills—rising inequality, stagnant wages, low productivity growth—stem in large measure from corporate consolidation and monopoly power run amok. That’s the message from a new breed of policy wonk urging a return to the trustbusting days of the early 20th century.

The movement—labeled the New Brandeis School by its proponents and derided as Hipster Antitrust by its critics—is looking to ditch the Chicago School approach that’s dominated antitrust enforcement since the late 1970s. The Chicago School hews to what’s known as the consumer-welfare standard, which finds mergers anticompetitive only if they raise prices.

The new model takes its inspiration from Supreme Court Justice Louis Brandeis, who emphasized the need to restrain big companies and the concentration of economic power. Lina Khan helped galvanize the movement with a 2017 paper she wrote as a law student at Yale that made the case that Amazon.com Inc. is a threat to competition, even though it’s lowered some prices for consumers.

Any ambitious government-led project to reshape the U.S. economy usually runs into the same objection: We can’t afford it. One school of economic thought says that’s all wrong.

Modern Monetary Theory, a once-fringe set of ideas now getting some mainstream attention, says governments borrowing in their own currency have more room to spend than they think. The U.S., for example, can run deficits without having to worry about going bust, because it creates the dollars in the first place. The real constraint only kicks in when there’s too much spending relative to a limited supply of goods and services—in other words, when inflation spikes. And there’s been little sign of that in America for decades.

MMTers argue that their system isn’t so radical; it’s the way things already work, at least some of the time. Presidents, including the current one, haven’t balked at measures to boost the military or cut taxes, even when the resulting deficits run into the hundreds of billions. And emergencies, such as the 2008 financial meltdown, typically push concerns about balanced budgets deep into the background.

Now there’s a different sort of emergency on the horizon: climate change. Since the threat is arguably greater than economic depression or even war, it requires action on a suitably vast scale, argue Democrats who’ve picked up on the issue.

And MMT offers a key to unlock the financing. That’s why freshman Representative Alexandria Ocasio-Cortez, one of the first U.S. politicians to talk publicly about MMT, is also at the forefront of the drive for a Green New Deal. The maximal version of that program includes shifting the U.S. to 100 percent renewable energy within 10 years. If that wasn’t ambitious enough, the plan also calls for the government to guarantee a job for everyone who wants one—an MMT favorite that’s also a throwback to Franklin D. Roosevelt’s New Deal.

“Clearly, the environment matters more than entries on balance sheets,” says Randall Wray, a senior scholar at the Levy Economics Institute of Bard College and one of MMT’s most prominent proponents. “The environmental thing is real. It’s not financial.”

MMT’s detractors say government spending on that scale could trigger the kind of inflation that would wreck the whole economy. America’s national debt has already ballooned since the Great Recession, they warn, and adding more will erode the country’s creditworthiness and undermine the dollar’s role in global finance.

While those warnings are still frequently heard, there are signs that they’re losing their impact as the debate leans left. Several renowned economists who aren’t MMTers have recently tried to downplay the risks attached to deficits and debt. They include Olivier Blanchard, former chief economist at the International Monetary Fund, and Obama administration heavyweights Larry Summers and Jason Furman. Bank of England chief Mark Carney has made the case that action on climate change represents an economic opportunity, not a burden.

Ocasio-Cortez didn’t manage to garner enough Democratic support for her first attempt at actual legislation, a proposal to set up a Green New Deal committee. But there’s broad sympathy for the idea in principle, including among several of the party’s presidential candidates, and many of them have also endorsed a jobs guarantee. —Katia Dmitrieva

Tech to the Rescue

Amazon.com Inc. Chairman and Chief Executive Officer Jeff Bezos wishes there were a trillion human beings in the solar system. With room for that many people, there would be “a thousand Einsteins and a thousand Mozarts,” he told the Economic Club of Washington, D.C., in September. The world’s richest man is funneling $1 billion or more a year into a company, Blue Origin, that he hopes will help make extraterrestrial settlement a reality, creating places to live for all those Einsteins and Mozarts.

Bezos and others argue that innovation is the essential ingredient in human betterment. They have a point. Life would be pretty awful without the advances made by past generations, such as indoor plumbing, vaccines, refrigeration, and telephones. Bezos even asserts that freedom itself, not just material well-being, depends on technological progress: “I don’t even think stasis is compatible with liberty,” he told the Washington audience.

In the view of the tech-to-the-rescue crowd, innovation can solve just about every problem humanity faces. Global warming can be fixed with better electric cars, solar cells, wind turbines, and batteries. Income inequality can be solved by educating or retraining workers for the high-tech jobs of the future.

The Information Technology & Innovation Foundation, a Washington think tank founded in 2006 to propagate this philosophy, argues that using antitrust law to break up or discipline the big technology companies can backfire, discouraging innovation and harming consumers. Robert Atkinson, president and founder of the ITIF, co-wrote a 2018 book with Michael Lind called Big Is Beautiful: Debunking the Myth of Small Business.

The techies welcome a prominent role for government in paying for education and conducting or supporting research and development. But the movement is split on trade. The nationalists want to keep the U.S. in the tech vanguard and are willing to resort to tariffs and subsidies to preserve its dominance. The globalists, including some heads of multinational companies that earn lots of their profits abroad, are happy to see other countries advance technologically, figuring that the benefits of breakthroughs—say, a cure for cancer—will be shared by all of humanity regardless of their origin.

The common theme is that prosperity depends on a robust tech sector. “We’re in a 10-year productivity depression” that’s hurting living standards, says Atkinson. “Tech is really the only way we’re going to raise productivity growth.” —Peter Coy

Tariff Truthers

If there’s one thing most economists around the world today can agree on, it’s that tariffs are bad. Protect one domestic industry with an import tax, and you hurt a swath of others. Tariffs reduce choices for consumers and push up prices for goods. They stifle competition and deter innovation. And they invite other countries to retaliate, leading to the sort of tit-for-tat behavior that’s left U.S. soybean farmers watching crops once destined for China rot in their fields.

Libertarianism

Devotees of small government were stirred by candidate Trump’s vow to “drain the swamp” and pull U.S. troops out of foreign quagmires. But President Trump, with his tariffs and deficits, has proved to be “the opposite of a libertarian,” the Libertarian Party declared in March.

Still, the free-market purists aren’t giving up the fight. One of their bugbears is the Federal Reserve and its cheap money—a distortion of the market’s natural efficiency, according to Austrian economist and libertarian idol Friedrich Hayek. When Ron Paul, America’s highest-profile libertarian, ran for president in 2012, he pushed for the Fed’s abolition and a return to the gold standard. “If you want to restrain government, you restrain the power to create money,” he said. “That’s what gold does.”

The Fed can probably rest easy. Americans aren’t exactly clamoring for a return to gold, while hyperinflation and other disasters predicted by libertarians in the easy-money decade since 2008 haven’t come to pass.

Some libertarian ideas are finding a larger audience. Among them are the call for stripping back zoning rules, because they limit the construction of affordable housing, and their criticism of patents that lock in profits for Big Tech or Pharma and licensing requirements that insulate professionals like doctors from competition. A common theme of such critiques—that the economy is rigged in favor of big and established actors—commands growing support among mainstream economists.

And beyond the realms of U.S. policy, the world is evolving in ways that give libertarians hope. Those who deplore the “tyranny” of central banks are rejoicing at the explosion of cryptocurrencies. (The Libertarian Party accepts donations in Bitcoin.) Recreational marijuana use is already legal in 10 states and backed by more than 6 in 10 Americans, according to a poll by the Pew Research Center.

Paul, who outperformed most expectations during his own tilt at the presidency, says a popular Libertarian candidate could well emerge in 2020. It’s a stretch to say he’s cheerful about the wider outlook, though. “It’s a bubble economy in many, many different ways, and it’s going to come unglued,” he told the Washington Examiner. —Andrew Mayeda