On Your Behalf - April Report

Shareholder Resolutions: A Powerful Advocacy Tool

An important socially responsible investing tool is the filing of shareholder resolutions. A resolution allows a shareholder, as part owner of a company, to submit an issue for consideration by all shareholders at the company's annual meeting of shareholders. Just as citizens assume responsibility for their governments through voting, shareholders assume responsibility for the companies in which they invest when they file and vote on shareholder resolutions. However, resolutions provide more than the opportunity to exercise ownership rights. Among socially responsible investors, shareholder resolutions are frequently the starting point for important dialogue and negotiations with a company.

The General Board of Pension and Health Benefits of The United Methodist Church (General Board) takes its shareholder rights very seriously and files or co-files approximately 20 resolutions each year. These resolutions may not always appear on a company's proxy ballot and when they do, may not receive a majority of the shareholder vote, but they frequently open doors to productive dialogue with the company. A resolution recently filed with Bank of America is a case in point.

Last November, in cooperation with Catholic Healthcare West and other faith-based investors, the General Board filed a shareholder resolution requesting that Bank of America "develop higher standards for the securitization of subprime loans to preclude the securitization of loans involving predatory practices."

What is subprime and predatory lending?

Subprime lending is directed primarily to borrowers who do not qualify for conventional loans. Such borrowers may be low-income or they may have a bad credit history. Because subprime loans are more risky than conventional loans, they usually have higher interest rates and fees. But they also play an important role in the home lending market where they can increase home ownership, improve the financial resources of the borrower and contribute to safer, more stable communities.

Predatory lending is a form of subprime lending characterized by unscrupulous or unethical lending practices. These practices can include the application of excessively high fees and interest rates, the use of balloon payments, flipping (successive refinancing of the original loan at increasingly higher rates), packing (linking the issuance of the loan to the purchase of some form of insurance) and steering (directing otherwise credit-worthy borrowers into high-priced subprime loans). Predatory lending tends to target certain segments of society, most often the elderly, the poor and minorities. The United Methodist Church has directed all general agencies to invest in banks that have "policies and practices that preclude predatory or harmful lending practices." (Resolution 213, Investment Ethics).

The securitization of loans is a process whereby one financial institution buys the loans of another, repackages them and then sells them to investors. Securitization provides lenders with new capital, thus allowing them to make additional loans. Loan securitization is now a trillion-dollar business. Bank of America has been actively involved in the securitization of subprime mortgage loans for many years.

Subprime lending is not, by its nature, predatory and many banks have substantial subprime portfolios. Financial institutions may be implicated in predatory lending, however, if they have not sufficiently evaluated the loans they are securitizing to ensure predatory loans are not present. In 2003, for example, a federal court held Lehman Brothers partly liable for securitizing the predatory loans of subprime lender First Alliance Corporation.

The General Board files a shareholder resolution

To safeguard against such potential liability, socially responsible investors, including the General Board, approached Bank of America last fall with a request that it improve its processes for detecting the presence of predatory loans in its securitized portfolios. Because Bank of America said that it was unwilling to make the requested improvements, investors filed a shareholder resolution to encourage the adoption of more stringent subprime loan securitization standards.

Perceiving that a shareholder resolution might negatively affect its reputation, company management often will meet with shareholders to negotiate the withdrawal of the resolution. Another option that companies may take is to challenge the resolution at the Securities and Exchange Commission (SEC). If the SEC rules in the company's favor, the company may omit the resolution from the proxy ballot without penalty.

Last December, Bank of America sent a letter to the SEC challenging the resolution filed by investors. The bank argued, in part, that the resolution dealt with matters relating to the ordinary business of the corporation (and therefore not under the purview of shareholder resolutions) and that the resolution's request already had been substantially implemented. Shareholders responded with their own letter to the SEC countering the company's arguments.

Negotiations conclude successfully

In late February, the SEC notified Bank of America that it would deny its request to exclude the resolution from the annual meeting proxy ballot. As a result, Bank of America entered into another round of negotiations with investors. In return for withdrawing the resolution, bank officials agreed to:

• enhance the review of lenders' broker approval and monitoring processes,
• review Federal Trade Commission complaints filed against originating lenders in order to detect problematic or questionable lending practices,
• review complaints received by the originating lending companies to determine how complaints are handled,
• review significant settlements in order to improve lender scrutiny, and
• meet with shareholders within six to nine months to review the progress of implementation.

So, filing a resolution (even though it was not voted on at the annual meeting) resulted in important additions to Bank of America's securitization procedures. With more safeguards in place, fewer, if any, predatory loans will appear in the bank's loan portfolio. Shareholders are more confident now that those most vulnerable to unscrupulous lenders are better protected.