When investors lose trust, they can put stocks in the 'penalty box'

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A new client recently told us that he didn’t want to own Boeing.

He did not cite the two planes that crashed or Boeing’s enormous consumption of fossil fuels. His primary concern was the integrity of its management. We mentioned that a new management has taken over the company, but he responded that that there is not enough evidence that Boeing’s values had changed across the organization to alter his opinion. We might call this approach “penalty box” investing.

Since our inception, we have complied with both individual and institutional client requests to avoid certain stocks and industries, commonly fossil-fuel related. We chose not to purchase tobacco and gun stocks, because of our personal beliefs and because we heard frequent client objections to them.

A couple of years ago, the tone changed entirely with Facebook. What had previously been an aversion to owning shares of a company selling cigarettes, assault rifles, or even gambling experiences, shifted to a rejection of the way in which a company, about whose products or services you might have no objection, conducts itself.

If Boeing is now in the penalty box for its management behavior surrounding the 737-MAX, how long might that last, and how will they make their way back onto the ice? The answer, of course, is that it depends. Factors include how egregious investors view the infraction, the length of time in which new pieces of negative news emerge, the complexity of the solution, and the way in which the “guilty” management handles the crisis and changes its practices.

In recent years, we have, a range of examples, including Wells Fargo, Facebook and Equifax. All three failed to protect their customers’ privacy or capitalized on their access to client accounts without approval from them.

Wells Fargo engaged in a widespread fraud, opening millions of fee paying accounts without consent from its customers. While The Wall Street Journal and the Los Angeles Times had unearthed the relentless cross-selling strategy years earlier, the scandal broke widely in September of 2016 when the Consumer Financial Protection Bureau announced $100 million of fines on Wells.

Despite management changes, repeated apologies in recent years, and restructuring of all the misguided sales incentives, the stock is still 12% below its level when the story emerged publicly. What good is a bank if you can’t trust it with your money? Wells Fargo stock has attempted to recover, but strong competitors and low interest rates have depressed earnings.

The Facebook scandal, which hit the headlines in March, 2018, exposed how the social network had allowed the UK data mining firm, Cambridge Analytica, to access private information on over 87 million users without their knowledge. The stock fell 14% on the news, more than recovered to hit a high of $209 in July, but tumbled again when investors learned how much it would cost to monitor the website and improve security.

Since the end of 2018, the stock has climbed over 60%, as investors have forgiven Facebook, or, at least, overlooked its transgressions. Unlike Wells Fargo, which violated an original bank commandment — to keep depositors’ money safe — Facebook’s raison d’etre is sharing, not privacy, and its platforms still dominate this market. Also, despite media outcry, the currency of privacy may have a lower value than real money.

Equifax, the credit agency, was involved with a data breach in 2017, when personal information on close to 147 million Americans was hacked. The company paid a $650 million fine, apologized profusely, agreed to spend $1 billion on enhanced cybersecurity, and offered compensation to affected parties. Investors appear to have forgiven them; the stock is now at an all-time high.

Boeing, down almost 30% from its high last March, still has its highest hurdle to overcome — the re-certification of the 737 Max by the Federal Aviation Administration. The investing public probably trusts the FAA, which feels the heat of this decision, and that seal of approval could prompt the company’s release from the penalty box.

Like Facebook, Boeing is the dominant U.S. player in its field. Once investors feel a higher authority has sanctioned the aircraft, they will likely look forward rather than back.

Meanwhile, how should investors address their concerns about corporate behavior? Since most individuals hold equities via index or mutual funds, their allocations are tied to the index constituents without other considerations. Several fund complexes, such as Fidelity, Blackrock and, Schwab, now offer customers funds that are focused on environmental, social, and governance factors, which measure sustainability. Presumably, these ESG funds eliminate equities with poor rankings. Those investors who work with financial advisors should articulate their concerns about corporate behavior.

ESG rating systems offered by S&P, Morningstar, MSCI, and others are expensive for individuals, often costing more than $5,000 for comprehensive data. They can also vary widely between ranking systems for the same name, because each organization creates its own standards. Over time, customer demand will require the major firms offering ESG, socially responsible investing, or SRI, aligned products to provide more user-friendly and comprehensive analysis of company rankings.

Even without standardized metrics of public corporate behavior or easy accessibility to the highest quality ratings systems, the public has numerous news sources on which to make its own judgments. The market concern for accountability and trust of all public companies is growing, and managements need character strength and awareness to avoid the “penalty box.”

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