A quest for clean hands

Values-based fund managers delve deeply into the moral character of companies

Ever since Enron's collapse two years ago, and the wave of corporate scandals, Julie Gorte's job hasn't been the same. As director of social research at Calvert Funds, she uses new criteria to decide if a company is "socially responsible." She's asking previously unasked questions. (Examples: Are executives getting personal loans from the company? Are board members indebted to anyone at the firm?) The point: to plumb not just a company's business practices but the morality of its management.

"It's a puzzle," Ms. Gorte says. "I'm just trying to deduce things from clues."

For more than two decades, socially responsible investment funds have been refining their tools for evaluating corporate character. Social screening criteria have expanded through the years to weed out not just flagrant polluters, sweatshops, and enemies of public health, but also "green washers," a term for companies whose sophisticated public relations strategy masks a pattern of serious infractions.

In the wake of recent scandals, however, the search for solid moral character in corporations has turned the spotlight inward to management itself. As the shift unfolds, companies getting the highest marks for trustworthiness and devotion to social responsibility are those with strongest safeguards against human weakness, especially greed.

"If you cut corners in one place, you're likely to cut them somewhere else," says Sophia Colliers, president of Citizens Advisers, a socially responsible network of funds with about $1 billion invested. "We really are focusing more [than before the scandals] on how a company is being run. We now ask what kind of environment is this for management? Is it given to cronyism and back-scratching?"

To find out, Citizens now investigates relationships among board members. Do any benefit from contracts or philanthropic gifts from the company? If so, their voice is compromised, Ms. Colliers says, because they might hesitate before taking issue with the CEO. Disney, for instance, gets demerits in Citizens' eyes for affording a seat on its board of directors to the head of a school where CEO Michael Eisner has children enrolled.

"Our concern with boards [before the scandals] was for diversity in gender, race, and ideology," Colliers says. "We never before asked what relationship do all these people have."

Morality tests

Though analysts across the industry are testing management in new ways to discern corporate moral character, the tools they use vary from fund to fund. Domini Social Investments, for instance, has begun investigating whether companies are involved in tax disputes. Those said to owe more than $1 million in taxes are ranked as problematic.

Similarly, although the fund has long frowned on companies that pay hefty fines to regulators, Domini now places double the significance on fines than they had in analytical reports three years ago. Companies owing more than $100,000 to state governments or $1 million in federal fines may as well be carrying a bright red flag that reads "trouble."

"The fines they pay are an indication of a lack of concern for authority," says president Amy Domini, who is also author of "Socially Responsible Investing: Making a Difference and Making Money."

Pay to CEOs in excess of $10 million per year, like board member pay beyond $100,000 per year, also raises more concern at Domini than in the past: "The theory is that after a certain point, if you make too much money as a CEO or board member, you become more concerned with continued employment than with vigilance," Ms. Domini says.

Industry watchers say corporate governance is not an entirely new consideration for socially responsible funds, since some have for years looked at the independence of board members and executive compensation when evaluating companies.

But today, these concerns have not only become universal, but they have come to seem indispensable to the task of judging a company's true character, according to Mark Thomsen, research director at SRI World Group, a Brattleboro, Vt., consulting firm for socially responsible investors.

"The number of fund [managers] looking at corporate governance before the scandals was few," Mr. Thomsen says. "But all of them have now expanded the criteria they use" to evaluate corporate character.

Pax World approach

At certain funds, recent scandals seemingly vindicated long-established screening processes used to judge character. Pax World Funds, for instance, has not changed its official criteria, which kept the company from investing in Enron and other environmental polluters who turned out later to be guilty of more than green washing.

Yet even at Pax World Funds, those in charge of social research fear that a corporate portrait might be misleadingly incomplete without a keen sense for a company's leadership and willingness to abide by restraining principles. One sign of trouble - an auditor who receives more than 25 percent of pay for nonauditing activity, such as consulting - gets even more attention than it did before recent scandals began.

There are "other things [beyond basic social criteria] you will note about a company in a screening report, things that just give you a feel for how worthy they are," says Anita Green, vice president for social research at Pax World Funds. "If we see these corporate governance factors painting a picture, then they'll make it into the report, whereas five years ago they might not have."

Calvert's lesson

Where prior screens proved inadequate for detecting crooks, a fresh interest in tools for ranking management has taken off, perhaps as a glimmer of hope for the possibility of truly understanding a company's moral mettle.

Calvert Funds, for instance, has been burned more than once. Analysts saw Enron making progress on the environmental front and approved it for investment in March 2001, months before the energy giant's collapse. The Fund also owned HealthSouth Corp. and ImClone Corp., both devastated by ethical improprieties among executives.

Having been bruised by deceptive information more than once, Calvert now processes three times as much corporate governance data as before the scandals began. And the new techniques are leading to swift action. Calvert has dropped Computer Associates for exaggerating revenue figures and bagged Oracle for a series of ethics violations, including an alleged payoff to a California legislator. Neither move would have been possible without the arsenal of new questions in place to provide new insights, according to Gorte.

"One of the things you can't see, no matter how you look at it, is fraud - because it's concealed by nature," Gorte says. "What we're trying to see is good management because you, as shareholders, basically hire management to create value that isn't a house of cards."

And to see good management, according to Domini, is to see leaders willing to abide by restrictive policies to rein in the darker side of human nature.

"We do all this to stay alert to how vigilantly management is looking out for themselves," Domini says. "With a piece here and a piece there, you're eventually able to get a picture of the mosaic. Then you hope you know - as well as possible, at least - what kind of company you have."

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