Subject: File No. S7-33-10
From: John B Kosecoff

December 18, 2010

A Vision of Shared Responsibility in Financial Reform

John Brian Kosecoff
December 17, 2010

Failure of the investment industry has now been laid at the feet of every participant: from the Federal Reserve, to the S.E.C., FDIC, FINRA, Congress, Wall Street, and even Main Street. Care should be taken so that reform is implemented in a manner that does not cripple free markets, cause significant market distortions, or add undue cost to transacting in the markets.

As a thirty-year veteran of the financial services industry, I still have faith in a market economy and believe that reform will be most ideal if it is implemented in a market-centric manner. That is, rather than trusting corporate management, their captive boards, industry lobbyists, or self-serving plaintiff litigators (e.g., such as William Lerach), I think that the public should have a direct seat at the table and that restitution of abuses to the public trust be made in a manner than most directly benefits the common good.

One might suppose that this is the purpose of government. I might favor that view except that the government has shown itself to be anything but neutral in allocating market resources. By way of example, well-intended legislation in the early 1990s to reform excessive cash compensation for entrenched corporate management resulted in excessively allocating stock option incentives to executive management throughout an extended bull market. The result of this was an increase in management ownership of the SP 500 from 2% at the beginning of the 1990s to more than 7% by the decades end. This wealth transfer was disproportionate to the contribution and permanence of corporate management, and came at a cost of depriving retirees, foundations and endowments of their stake in Americas capital.

In an ideal construct, the remediation of corporate abuses would be the restitution of capital to the public from which it had been raised. Accordingly, if whistle blowing were pre-emptive, then a percentage of the lost averted should accrue to the agent (the whistle blower) that prevented such a loss in market value. If the going rate for raising capital is the investment bankers 7%, then the whistle blower should be rewarded a proportionate 7% for the capital saved. In this construct, the incentive is to be anticipatory and proactive.

For example, if a banks trust department were liable for breaching its fiduciary trust by, say, taking undue risk or by applying a blanket investment policy to all accounts, or loading trust portfolios with inferior proprietary in-house mutual funds, the cost to compensate clients for loses might be $2 billion and the cost to rectify the operational cause of the problem might be an additional $100 million. I would favor setting aside 7% of the $2 billion to fund a consumer or fiduciary advocacy agency, and an amount equal to 7% of the $100 million paid to those individuals who brought the abusive practices to light and aided in its correction.

This model, I think allocates capital back to serve the class of society who are most vulnerable to corporate malfeasance: fixed income retirees. If over time, the pooled funds of such restitution exceeds the amount necessary to effectively administer improved corporate governance, then the excess amount should fund direct ownership in companies reallocated by publicly trusted portfolio managers to those companies that demonstrate prudent financial controls and profitable allocation of capital resources.

A fair arbiter might judge that a 7% reward based on the cost of correction constitutes a substantial windfall. The fairness of this amount, however is supported by three factors:

1) Like the investment banking underwriters 7% fee, this is risk capital, since the whistle blowers career is fully at risk.
2) The amount represents taxable income.
3) Recognition of the whistle blowers claim must be supported by corroboration, documentation and evidence, and by the following of clear and timely procedures for intervention.

To truly institute a culture of corporate responsibility, publicly traded companies should be incentivized to make their employees financially literate about the economy, the corporate business model, the operating unit fundamentals, and the individual employees contribution to the enterprise. More modest rewards should be encouraged and facilitated so that even relatively modest suggestions are articulated with an awareness of the magnitude of impact.

It might be anachronistic to think in terms of long-term loyalty to an employer, a reciprocal social contract, and pride in owning ones work. However, a culture of mutual interest in producing globally competitive products and services must be developed at all levels of all enterprises, with the implicit value that Americas well-being is built by entrepreneurial initiative and that American companies can more sustainably thrive by embracing a participatory workforce: what I might coin as intrepreneurship.

I wish to include a final note about public interest in a more just allocation of national wealth. There is more than just recognition that there have been abuses, that concentration of wealth is unhealthy to the fabric of America, and an implicit view that New Deal remedies to economic distress must be enacted by Federally imposed socialistic reallocation of wealth. America, by its nature, is a diverse society that is dynamic in its constant change, its uncommon mobility, and the underlying aspiration that work and measured risk can result in improved life.

Based on these principles, corrective consideration should be given to holding executive stock incentives until the sustainability of financial results is proven over a normal business cycle (i.e., seven years). Stock options should be accorded to executives whose contribution can be gauged by more than just the near-term relative performance of a stock price versus a peer group in a time when all stocks are rising. Rather, risk adjustments need to be incorporated to measure the quality of accounting, the avoidance of contingent liabilities (i.e., environmental impact, retraining of displaced labor), the creation of domestic employment opportunities, and the rejuvenation of tired and decaying systems of transportation, housing, education, health, and local enterprise.

To complement that end, the workforce, corporate leadership, and global capital markets must be convinced and trust that America is worthy of investment for long-term stable returns and mutual benefit.