Governance
New Benchmarks of Fiduciary Practice
July 27, 2011
By John Bloom
Much has been made recently of Trustees’ and Directors’ fiduciary responsibilities. Governance is demanding, sometimes elusive, and often shifting in a world that seems in constant change. Almost all boards generally know they are fiduciaries even if they are confused by the duties of care and loyalty, and are sometimes challenged to create and sustain the distinction between governance and management. However, most boards understand and practice their fiduciary responsibility through the limited view of legal and financial matters. Though I am hesitant to over-generalize, boards tend to treat this construction of fiduciary responsibility as a matter of protection or preservation—and thus operate from a gesture of fear. Of course, there are important and non-negotiable legal and compliance issues under the board’s purview. In addition, boards are held to a standard of prudent management of fiscal resources delimited in terms of risk management. Both the legal and financial responsibilities lend themselves to this constrictive interpretation, especially when acted on as separate from, or without full consideration of, the broader umbrella of an organization’s mission, purpose, and espoused values. The purpose of this essay is to recast the fiduciary function in the context of this broad umbrella and reframe how an organization practices its values in all its decisions and actions.
The origin of the word fiduciary resides in trust, faithfulness, and reliance. These are three deeply human conditions that cannot truly be defined in a court of law or through Internal Revenue Service code. These governmental agencies treat them, instead, as normative processes or what a reasonable person might be expected to do in a similar situation. The reality is that each of us determines the terms of how we place trust in another person or an organization, how we practice faith, and on whom we will rely. What matters most are the following: on whose behalf do the fiduciaries function, from where does the authority come that is placed in the hands of the governing body, and with what intention does the governing fulfill its service? Right now, in the for-profit sector, the directors of a C-corporation, for example, serve the fiduciary interests of the shareholders, and thus operate in a rather unilateral alignment of decisions and governance. The new B-corporation is an attempt to remedy this one-sidedness in favor of a more triple-bottom line approach. In the non-profit and charitable sector, fiduciary authority is granted to the board of trustees to fulfill the stated charitable purpose by the office of attorney general of the state of incorporation, and is further conditioned by charitable code of the Internal Revenue Service that holds public benefit as the organization’s outcome.
There is another important element to the fiduciary role. That is, to serve as fiduciary means that one does not do so for private gain. This avoidance of gain means the individual and the group of trustees as a whole can make decisions free of self-interest and in line with the needs of the organization and its purpose. In this light, I would like to make the case that a true fiduciary is deeply committed to stewardship on all levels—this reaches beyond the conventional legal and financial to a more mission-based, values-based, spirit-based complexion. This could mean for example, that trustees taking a loan consider not only the interest rate, but also the nature of the community of investors and borrowers they would be joining, and whether the debt service is really mission aligned. This is a degree of consideration that reaches past taking the best deal based on organizational self-interest, to one that looks at the potential transaction in the full interdependent economic context, while considering how the organization’s values as practiced in its programs can also be practiced in financial dealings. I point to this example among many because the disconnection between mission and money is prevalent in the non-profit world. The for-profit world is not immune from this issue either, it just manifests differently.
From a certain perspective, trustees and directors stand in for or represent the whole ownership of the corporation. The sense of fiduciary stewardship I am speaking of actually redefines the concept of ownership from a materialistic perspective to a more spirit or values- based one. Private ownership is never really separated from moral and ethical responsibilities that connect the private to the public. The natural world and the transformative capacities we bring to it through economic activity are in many ways gifts themselves, but we have lost this sense in our over-commoditized world. In this context, ownership and the fiduciary responsibilities that come with it are more an extended right of use, both time bound and transferable. How we manage that right of use, in service to what, with what awareness of the affects on the whole, with what integrity or values, and at what cost—these become the new systemic benchmarks of fiduciary practice.
This is a lot to ask of trustees and directors. Yet many of the social issues that we face in the economy today could be remedied by governing bodies applying these benchmarks, not out of fear, but rather out of affirming the missions they serve and their social value. Imagine how positive and transformative it would be if, regardless of the corporate form, fiduciary responsibility and governance were practiced in a way that recognizes the capacities of each individual in a framework of rights and agreements while meeting true economic needs. This would be a fiduciary practice for the public good that embodies and engenders trust, faithfulness, and reliance.
John Bloom is the Director of Organizational Culture at RSF Social Finance. If you enjoyed this post, look for John’s book, The Genius of Money, at steinerbooks.org.
Social Enterprise, Exits, and Liquidity Events
September 7, 2009
By Elizabeth Ü
True Confession: while studying toward my MBA in Sustainable Management, I was baffled by the concept of an “exit plan.” I just couldn’t understand why a social entrepreneur – especially one who poured her heart and soul into building a mission-driven business – would ever want to leave that business in the hands of others… others who probably did not share her passion, commitment or values. Wouldn’t the founder’s exit lead to a dilution of those values?
Since then, I’ve gained a better understanding of the need for exit plans. Of course there are several reasons why a social entrepreneur might want to move on from a company she birthed and nourished: she might be ready to retire or turn her energy toward other projects. She may be called to take care of herself (or family) in the event of illness. Or perhaps the founder is truly an entrepreneur at heart, and navigating the waters of a mature business just isn’t as exciting to her as starting up a brand new social enterprise.
In order for there to be enough cash on hand to repay the exiting founder for her investment in the business, a succession plan requires some kind of liquidity event. If there are outside equity investors involved, the liquidity event is when they would see their return as well. (See Terri Spath’s recent blog post: rsfsocialfinance.org/2009/08/revenue-participation-notes, which outlines the benefits and drawbacks of traditional loans and equity financing, and what RSF is doing to offer alternatives.)
Historically, a social entrepreneur has had two choices with regard to liquidity events: 1) Offer up the business for sale to another business (in this transaction, known as an acquisition, the purchaser provides the liquidity), or 2) raise cash through a public offering (also known as the IPO, or Initial Public Offering).
Both of these events can be problematic when it comes to maintaining the values of a mission-driven business. There’s no guarantee that the acquiring company will honor the environmental or social practices of the original social enterprise; there’s also the possibility that the smaller company’s offices may be shut down altogether, with any remaining jobs moving to the acquirer’s headquarters. In the case of taking the company public… well, suddenly there are quite a few shareholders who can exert their voting power in whichever direction they please.
Whether you believe that the sale of Odwalla, Ben & Jerry’s, Stonyfield, Tom’s of Maine, or Burt’s Bees to much, much larger — and in some cases, multi-national — corporations has had a positive or negative effect on the social responsibility of the acquired (or acquiring!) companies, we consider it part of our mission at RSF to champion new and meaningful options for community ownership, wealth creation, and social impact. Here are a few examples for social entrepreneurs seeking alternatives to the usual exit or liquidity events:
One option is to transfer ownership of the social enterprise to its employees, rather than to another company or to the public. When employees have played key roles in developing and implementing the company’s social mission, they can be well-positioned to steward that mission over time; there are also tax benefits to this plan. (For more information about employee stock ownership, read this article by Esther Park, RSF’s Director of Lending: rsfsocialfinance.org/2009/06/employee-ownership-for-social-enterprise.)
Another promising model is that of Upstream 21, which is essentially a holding company for small, independently owned companies with products or services designed to benefit their employees, communities and environment. Upstream 21 does more than just talk about values; its founders have written them directly into its corporate charter, mandating that the “best interests” of the company include consideration of employees, the environment, and both the short- and long-term interest of customers, suppliers, and the communities in which the company and all subsidiaries operate. In other words, the risk of mission dilution usually associated with acquisition is extremely low! Focusing within the Pacific Northwest, this is an example of a truly place-based approach.
If you’d like to learn more about the truly innovative work of Upstream 21, visit their website (www.upstream21.com) and watch this video featuring Upstream 21’s chair (and member of RSF’s investment advisory committee) Leslie Christian, from last year’s Summit on the Future of the Corporation.
Finally, it should come as no surprise that Judy Wicks, chair and co-founder of the Business Alliance for Local Living Economies and inspiration to countless social entrepreneurs, blazed a new path when she decided to transition leadership of her iconic White Dog Café in Philadelphia. Rather than sell the business outright, she drafted a detailed social contract for the new owner. She also retained ownership of the name White Dog Café, which she licenses to the new owner. If the social contract (which details operational standards such as the procurement of local ingredients and equitable pay scales, and requires ongoing leadership in socially responsible business practices) is breached, she can revoke the license. A passionate advocate for all things local, Wicks of course drafted the contract to stipulate local ownership of the Café. (Read more in this GreenBiz.com article, written after Judy spoke at the Investors’ Circle conference last spring.)
If you have experience with either traditional exit plans and liquidity events or their alternatives, we’d love to hear your stories in the comments section below.
Elizabeth Ü is Manager of Strategic Development at RSF Social Finance.
RSF’s Lending Process As Inspired By Rudolf Steiner
July 6, 2009
By Esther Park
At a recent RSF board meeting, I was asked to provide some detail on how our lending process is inspired by the work of Rudolf Steiner. In RSF’s early days, board members were often intricately involved in our lending process, so they never had to wonder how we imbued our values into our work. But today we operate under policy governance, which means that the board is less involved in our day-to-day operations. While we strive to wear our values on our sleeves, I thought readers would benefit from a glimpse into how we operate differently than other lenders.
1. Because we seek two levels of impact – direct impact of our borrowers and our own impact – educating prospective borrowers about the structure of our loan fund is an important part of our work. There is a unique and distinct story behind our pricing (it’s based on the return we provide to our 900+ individual investors) and our loan products (some specific products are meant to intentionally build community behind a project) that we like to share with potential clients.
2. With regard to our borrowers’ social impact, we believe we hold a high bar for what qualifies as a “social enterprise.” For example, it’s not enough for us if a company gives away a percentage of their revenues or profits to charity. While we consider this activity to be admirable, we insist on seeing social values embedded in all areas of the operation, from what is publicly seen, to what happens behind the scenes. This is the first hurdle for us, before we even go down the path of financial analysis.
3. Further to the previous point, we find that mission alignment is an important part of our discussion in credit committee, and sometimes we spend more time on that than on the financial feasibility of a project (though the latter is always given rigorous review).
4. We have adopted a “work-through” policy for when loans become troubled. For many traditional lenders, this is otherwise known as a “work-out” policy. We named our policy thus in order to better reflect our intention of working through problems with borrowers instead of just trying to find the fastest way out.
There are also a number of other unique practices that are close on the horizon. Some examples include:
1. Pricing – Our medium term goal is to convert to a “community-based” pricing model that would be driven collectively by our investors and borrowers.
2. Social Covenants – Just like financial covenants, social covenants would be hard-baked into loans, which means that non-compliance could trigger a default. A handful of our loans currently have these, but as we progress on the social impact work, we hope to institute these covenants broadly across the portfolio. These are not meant to be aspirational, but would be intended to act as minimum thresholds.
3. Peer-driven social impact goals – We hope to address the aspirational part of improving an organization’s social impact by offering our borrowers a carrot rather than a stick toward achieving greater social impact over time. In the future, this will likely be done collaboratively through a peer-review process, and outstanding work may be financially rewarded via a borrower’s interest rate.
4. Creating more community among our borrowers – Some recent ideas that have surfaced include a peer learning network, online bartering/advantageous sale platform, a closed listserv.
Although it may not always be explicit, each of the above ideas and practices is directly influenced by Rudolf Steiner’s insights and teachings on economics – many of which are rooted in the theory that money and finance are ultimately meant to connect people in relationships of service. As a result, we seek to carefully assess the impact that we and our borrowers are having at every step of the lending process, and to create opportunities for partnership and collaboration with our borrowers. We also place great importance on Steiner’s core belief that economic processes should be transparent, and hope that our actions in lending reflect these values on a daily basis. In that spirit, I invite your questions and comments, and look forward to continuing this dialogue.
To find out more about how RSF is inspired by Rudolf Steiner, visit: rsfsocialfinance.org/values/inspiration/
Esther Park is the Director of Lending at RSF Social Finance.
Dialogue on the Banking Crisis Continued
June 15, 2009
By Ted Levinson
It’s ironic that one contingent of society rails against big government and that another camp curses big business, and few people recognize that each is a threat since with extreme size comes extreme power, and extreme power leads to ruin.
E.F Schumacher warned of the “almost universal idolatry of gigantism” and we are now paying a dear price for our devotion to General Motors, AIG and Chrysler. There is certainly cruel justice in the fact that our punishment for letting these companies grow so big is to become unwitting taxpayer-owners of these businesses as they shrink.
I’ve read James K. Galbraith’s statement that Don recommends in his recent blog post, but my attention was drawn to different parts of Galbraith’s testimony. The first was the simple statement that “credit is a contract,” and the second was his view that the world “trusted the transparency, efficiency and accountability of the U.S. financial system…” Both are historically true, but our response to this financial crisis has cast doubt on both claims and this is what worries me the most.
Rudolf Steiner advocated a threefold social order where the economic sphere was separated from the state. He would have likely rejected the political influence of lobbyists, government subsidies, and tax breaks as vehemently as he would have rejected our response to propping up businesses defined as “too big to fail.” We have addressed the current financial crisis by forgetting that credit is, indeed, a contract. We have also threatened the transparency, efficiency and accountability of our financial system by abrogating the laws that permit credit to flourish and by creating artificial and perverse incentives for lenders to withhold the very credit that could extricate us from our situation.
Credit is built on trust. Our willingness to trade our money today for a piece of paper promising repayment later is undermined when the rules of the game can change for the most powerful. Without consistent laws regarding private property and bankruptcy, and without confidence in the stability of money, credit cannot exist. This is why credit cards work in California and farmers in Nigeria are unable to borrow to finance a tractor.
In the past year, we have responded to the outrage of outsized bonuses, inflated ratings on murky credit derivatives, and corporate collapse by altering the rules by which the largest companies play. We have bailed out big banks by using taxpayer money to buy preferred shares at inflated prices while simultaneously discouraging them from using that capital to make new loans. We have trampled on secured lenders’ rights in our rush to shepherd Chrysler through bankruptcy with concessions that are not afforded to most.
As the line between big business and big government becomes more blurred, the conflicts of interest and self-dealing multiply. Shouldn’t AIG become the preferred insurer for HUD homes? Shouldn’t GM become the sole provider of cars to the government? Governments owning businesses is as unwise and unfair as businesses running governments.
Steiner’s countryman, economist Joseph Schumpeter remarked that, “Rational as distinguished from vindictive regulation by authority turns out to be an extremely delicate problem which not every government agency, particularly when in full cry against big business, can be trusted to solve.” How then can we solve the challenge of consolidated power in our largest banks and corporations? At RSF we aim to do so by working with small businesses and nonprofits that measure their impact in more meaningful ways than sheer size. We also aim to restore humanity to lending – it’s not an abstract transaction, but a meaningful relationship built on understanding the contributions, needs, and long-term intentions of all parties. By bringing together investors and borrowers in a culture of spirited inquiry and dialogue, RSF is creating a community too invested in one another to fail.
Ted Levinson is Senior Lending Manager at RSF Social Finance.
A Dialogue on the Banking Crisis
May 25, 2009
By Don Shaffer
Public debate over the banking crisis in the past few months has been a fascinating examination of a system I have been studying for years. So, I have closely followed the range of opinions flooding from the pens, keyboards, and voices of economists, journalists, politicians, and others. Assessing the scale of banks and their impact on society is a topic that I see as a crucial piece of the puzzle in changing and reforming our broken financial system.
Recently I read some stimulating pieces that I’d like to share with you, the first of which was written by economist James K. Galbraith as a statement before the U.S. House of Representatives’ Committee on Financial Services. (To download and read the full statement, click here.) I believe Mr. Galbraith really hits his stride in section number three, titled: “The bank plan will not work.” As he points out, “If we are in a true collapse of finance, our models will not serve and our big banks will not serve either. You will have to replace them both. Since several very big banks are deeply troubled, there is in my view no viable alternative to placing them in receivership, insuring their deposits, replacing their management, doing a clean audit, isolating the bad assets. Since these banks were clearly too large, in my view they should be broken up, and either sold in parts or relaunched as multiple mid-sized institutions with fresh capitalization and leadership.” I would encourage you to read section three of his statement, at least, and consider his arguments with a critical mind.
Another essay I would recommend is “The Quiet Coup,” by a former chief economist of the International Monetary Fund, Simon Johnson, in the May issue of The Atlantic. (To read the essay, click here.) Please pay particular attention to the final section of the article, entitled “The Way Out.” Here, Mr. Johnson lays out a case very similar to Mr. Galbraith’s. I am particularly struck by his discussion about the inherent problems of gigantic-scale mega-banks:
“Oversize institutions disproportionately influence public policy; the major banks we have today draw much of their power from being too big to fail. Nationalization and re-privatization would not change that; while the replacement of the bank executives who got us into this crisis would be just and sensible, ultimately, the swapping-out of one set of powerful managers for another would change only the names of the oligarchs.
“Ideally, big banks should be sold in medium-size pieces, divided regionally or by type of business. Where this proves impractical—since we’ll want to sell the banks quickly—they could be sold whole, but with the requirement of being broken up within a short time. Banks that remain in private hands should also be subject to size limitations.
“This may seem like a crude and arbitrary step, but it is the best way to limit the power of individual institutions in a sector that is essential to the economy as a whole. Of course, some people will complain about the “efficiency costs” of a more fragmented banking system, and these costs are real. But so are the costs when a bank that is too big to fail explodes. Anything that is too big to fail is too big to exist.”
Lastly, I would encourage you to read the recent interview of President Obama in the New York Times magazine. (To read the full interview, click here.) The first part of the interview is entitled “The Future of Finance.” The President has some encouraging things to say, but I can’t help feeling disappointed in the overall tone and substance of his responses… in which he says, in essence, “We’ll be fine with a bit more regulation.” He seems convinced that we should just duct-tape our financial/monetary system back together, and re-acquaint ourselves with a strong and powerful Wall Street (oligarchy?) as a foregone conclusion. Mr. Obama’s choices for key leadership positions in the administration reflect these views; in particular, Mary Schapiro as Chair of the Securities and Exchange Commission has functioned as a steadfast and loyal proponent of Wall Street – most recently as head of FINRA, the financial industry trade association. Schapiro is one example, but Obama has also put into place many others with direct ties to the big commercial and investment banks.
All this said, I urge you to draw your own conclusions. Certainly no one has a crystal ball, and no one can claim to know the best path to pursue at this point. For 15 years, I have read The Wall Street Journal (nearly every day) and The Economist in an effort to understand how the financial system works.
The biggest issue for me is scale, and its relationship to power. Mostly based on my study of American history, I’m a fan of small, entrepreneurial, decentralized marketplaces—in other words, networks of people and companies trading with relatively little financial intermediation.
In short, I don’t think a $2 trillion bank (e.g., JP Morgan Chase) is much good at innovation anyway. And personally, I think services like online bill pay and convenient ATM’s are insufficient reasons for not switching to a community bank or credit union if you really think it through. With a giant transnational bank, you have no idea what loans your money is being used for, or where your funds reside at any given time. Plus, how can you trust “collateralized debt obligations” or other “structured” financial vehicles that are designed only to help the bank become a larger and larger pile of money?
Public equity markets suffer from the same issues as the banks. There is absolutely no reason why the world needs over 8,000 different mutual funds, most charging fees well in excess of the value they create. Merrill Lynch and other brokers have been exposed as hopelessly riddled with conflicts-of-interest and incentive/compensation problems.
But, Wall Street will live on. Capital markets will exist, for good reason, for companies and industries that require large-scale R&D, manufacturing, and distribution, such as airplane engines, pharmaceuticals, semi-conductors, etc. Hopefully, investors will reward only the most transparent and honest of the remaining players.
Most important, I think we will also see the growth of diversified, regional capital markets – not dependent at all on Wall Street – designed to support small-and-medium-sized, triple-bottom-line companies in sectors like food, energy, clothing, building materials, and a whole range of household products (furniture, toys, etc). The goal here is that people save more, spend a higher percentage of their overall income on basic needs, keep their investment strategies simple, and their money closer to home.
To return to the issue of scale and power, these regional capital markets will ensure a healthy democracy in the U.S. Every business student of the post-World War II era has learned about “efficient” flows of capital and how a “fragmented” market will invariably consolidate. But, I don’t think this is true anymore. The 21st century will have many fragmented markets, because investors and consumers will demand authenticity and real innovation from the companies they support. This fragmentation or diversification will only be accelerated as a result of the current financial/economic crisis. This is how nature works, too. An ecosystem rich in biodiversity is the most resilient.
At RSF Social Finance, we are excited to play a leadership role in the transformation to a more decentralized financial system:
• in the “what” (our financial and advisory support for companies and non-profits that create tremendous positive social impact), and
• in the “how” (our approach to working with investors and borrowers, and donors and grantees in each transaction that acknowledges the interconnected nature of life).
I hope we have a spirited discussion on the issues presented here and in the articles cited, both amongst the RSF staff and Board, as well as with you: our clients, partners, and friends.
Don Shaffer is President & CEO of RSF Social Finance.
Governance
