Many Americans are surprised to learn that some publicly traded U.S. companies are conducting business with nations defined as State Sponsors of Terror. Even as U.S. is engaged in a war on terror these companies provide funding and resources that may assist the opposition. Terror-free investing, however, is a growing investment movement that is intended to limit this type of corporate behavior. By choosing to invest terror-free, an investor prohibits their funds from being invested in any company doing business in State Sponsors of Terror, such as Iran and Syria.
In addition to the many compelling moral reasons to divest from terror, there are also a number of reasons to consider it from a portfolio risk perspective. The SEC performs a thorough due diligence review of all known terror related investment activity. Starting in 2005, the office of Global Security Risk provides investors with detailed information of known organizations that have performed investment activity with State Sponsors of Terror. Global security risk is broadly defined as the risk to share value stemming from a company’s international business activities and security related concerns, such as terrorism. Despite the growing problem and institutional acceptance, investment options for individual investors demanding divestment have been very limited.
When global crises arise, the average citizen may be left feeling helpless. Most cannot pick up a weapon and join the physical fight against terror. However, terror-free investing may be a powerful tool in the fight against terrorism, genocide, racism, fascism and all kinds of injustices. It is not only an investment in the future of an individual, but perhaps an investment in the future of humanity itself.
Investing involves risk. Every prospectus, management brochure, television commercial and piece of media that has anything to do with the investment industry must have a disclaimer. These disclosures are required to ensure individuals who are choosing to invest are fully aware that something unforeseen could occur and the strategy could not go as planned.
While this was a significant blow to the company’s bottom line, it hurt investors as well. SCBFF, the common stock symbol for Standard Chartered Bank, dropped from $25 per share to $19—a 24% decline within the trading day—within 24 hours on the day the allegations came to light.2 This dramatic decline is an example of how an unforeseen event can sometimes occur when choosing to invest.
For investors, it must have come as somewhat of a shock that a company they had placed their money and faith in—one of the largest banks in the world—had been dealing with a country deemed a State Sponsor of Terrorism. The bank’s illicit dealings cost itself and it’s investors billions, not to mention the reputational damaged that was incurred.
SCB investors fell victim to what is known as “global security risk,” or GSR. Understanding what it is, how it affects the investor and how it can be avoided is critical in the pursuit of mitigating risk, making morally sound investments and seeking a stable investment portfolio.
WHAT IS GLOBAL SECURITY RISK?
Global Security Risk (GSR) is any risk for investors that may arise from a company conducting business in or with a country deemed a State Sponsor of Terrorism.3 The U.S. State Department sets the designations for State Sponsors of Terrorism and defines them as “Countries determined by the Secretary of State to have repeatedly provided support for acts of international terrorism.”
Three countries are currently designated as State Sponsors of Terrorism: Iran, Syria and Sudan.4 North Korea is no longer on the list, although it is still considered an at-risk country by many.
The Securities and Exchange Commission (SEC) has determined that if a publicly-traded company does ‘material business’ inside of or with one of these sanctioned countries, it is of significant importance to an investor. This is because it may ultimately affect an investor’s potential returns. Material business may include but is not limited to:
• a company that controls property or assets located in these countries
• has employees, offices or facilities located in these countries
• provides or obtains goods and services from entities or individuals in said countries
• provides credits or loans to entities/individuals in these countries
• invests in a project or company in these countries
• has equity ties with companies that have employees or facilities physically in these countries
• has non-equity ties with companies with activities in said countries that involve the sales of products or services in the country or a distribution agreement with another party for the company’s products in said countries
• companies with other ties to the country that do not fit the definitions of equity or non-equity
It is quite clear, given the finite definition of material business dealings, the SEC requires disclosure that may impact a shareholder if there are any potential dealings with State Sponsors of Terrorism.5 For example, Schlumberger Ltd., a Houston, TX based energy company with a market cap of nearly $100 billion, disclosed on their annual 10-K statement: “If any of the risks described above materialize, or if any governmental investigation results in criminal or civil penalties or other remedial measures, it could reduce our earnings and our cash available for operations.” This disclaimer highlights a company’s Global Security Risk – the risk to a company’s bottom line and ultimately shareholder value due to operating or doing business in potentially volatile, terror-sponsoring nations.
Three Fold Risk
Global security risk carries a three-fold hazard. First, the company may suffer reputational damage when it is shown to do business with a State Sponsor of Terrorism. Countries carrying such a designation from the State Department are often associated with crimes against humanity and, as a result, are viewed extremely negative. This reputation can easily rub off on businesses that maintain close relationships with these states, resulting in a type of guilt by association.
Additionally, investors face a moral quandary when investing in companies that do business with a State Sponsor of Terrorism. When such a state carries out an act of terror and individuals are harmed or killed, a business—such as a bank—could be reasonably believed to have aided the state in committing the act. By handling transactions, storing wealth or providing credit, banks can be seen to be indirectly complicit. In such a case, a plea of ignorance will likely not be well received. Upon learning of the consequences of a company’s relationship with such entities, as in the case of Standard Chartered Bank, shareholders are at risk of suffering significant losses. Furthermore, companies doing business with a State Sponsor of Terrorism run the risk of opening themselves up to legal repercussions.
Since the attacks on the World Trade Center in September of 2001, Americans have become acutely aware of terrorist activity. Any business that becomes associated with a State Sponsor of Terrorism— even in periphery—may suffer harsh judgement from the public at large. When made public, this relationship could result in mass divestment, leaving shareholders with a greatly devalued or even worthless holding.
Social Structure Risk
In many cases, the social and political infrastructure of countries labeled State Sponsors of Terrorism are unstable. Currently, two of the three countries carrying this designation—Syria and Sudan—are embroiled in civil war. The risk is apparent. If the social structure within a country suffers total collapse due to war, insurgency, coup or general discord, any business operating within its borders is subject to loss of product, infrastructure and even the lives of its employees. These material losses harm the business from a financial perspective and serve to devalue its share price in the marketplace.
Manifestation of this risk can be seen experienced by Citigroup Inc.’s fine in 2014 for dealing with State Sponsors of Terrorism. Such punitive payments can undoubtedly hurt a company’s bottom line, as well as harm a firm’s reputation.
AVOIDING GLOBAL SECURITY RISK
As previous risk has shown, proper risk management is key for managing portfolios. It has become so important, that as of 2014, institutional investors are expected to spend 73% percent more time on investment risk issues.6 Certainly, global security risk must be given a share of this attention. Terror-free investing presents a sound solution to GSR.
In short, terror-free investing is a strategy in which assets are divested from all entities that do business with State Sponsors of Terror.7
Terror-free investing is useful beyond just pragmatic purposes. The case of Standard Chartered Bank and Citibank’s unexpectedly plummeting share prices is the nightmare of every investor. Terror-free investing also carries an emotional component. Most investors likely do not wish to see their investment—through the transitive property—support terrorism. Many are not aware that their investment may be doing just that.
It is entirely possible that one or more holdings in many mutual funds may be an entity that does business with a State Sponsor of Terrorism. For both individuals and institutions, the case for investing terror-free is compelling. These remarks by Mathew Potter, former Chairman of the Investment Committee of the Wyoming Public Pension System raised an interesting point in an interview with Pensions and Investments entitled “Fiduciary Duty Calls for Divestment.” Mr. Potter noted:
“One would have to question the business acumen of a company that makes the decision to do business with such a regime in light of all the opposition to that regime. It makes no sense to hold the shares of such a company when it would appear that those shares will likely come under a great deal of selling pressure, causing their price to drop. It seems to me that continuing to hold these shares, with the knowledge that the pressure is forthcoming, truly is a violation of one’s fiduciary duty.”
As investors, it is widely understood we may take a measured amount of risk to potentially gain reward, as all risk is not bad. However, what type of risk to take is an individual portfolio decision. Not all risk is created equal and by default, are not easily understood. With the right risk framework in place, not only can portfolios experience better downside protection, but investors can potentially see higher returns and enhance portfolio diversification.
A terror-free investing strategy may attract investors who are concerned about mitigating overall risk within their investments portfolios. Aside from the potential return on investment, investors may find comfort in knowing that they contributed to the divestment of harsh and terroristic regimes. Protesting divestment, an investment strategy intended to elicit some form of change, has proven effective before.
From 1985 to 1990, South Africa lost approximately $1 billion in American investments due to protest divestment over the country’s apartheid regime. South African currency, the Rand, was severely devalued, inflation soared and the economic system nearly collapsed under the crushing weight of investor flight.11 Of course, many other factors contributed to the fall of apartheid, but the protest divestment by global investors is recognized as a contributing factor in the destruction of a racist, unjust regime.
Today, the same efforts can help bring about change in the current State Sponsors of Terrorism: Iran, Syria and Sudan, all while providing an umbrella of risk management to an investment portfolio.
1 Rappaport, Liz. “Bank Settles Iran Money Case.” The Wall Street Journal. August 15, 2012. http://www.wsj.com/articles/SB10000872396390444318104577589380427559426 2 “Historical Prices - Google Finance.” Standard Chart PLC ORD USD0.50: OTCMKTS:SCBFF Historical Prices - Google Finance. Accessed August 22, 2016. https://www.google.com/finance/historical?cid=14946598
3 “Concept Release on Mechanism to Access Disclosures Relating to Business Activities in or with Countries Designated as State Sponsors of Terrorism.” Securities and Exchange Commission. November 16, 2007. https://www.sec.gov/rules/concept/2007/33-8860.pdf 4 “State Sponsors of Terrorism.” U.S. Department of State. Accessed August 30, 2016. http://www.state.gov/j/ct/list/c14151.htm 5 “SEC Seeks Comments on Disclosures of Business Activities in Cuba, Iran, North Korea, Sudan and Syria.” Gibson Dunn. November 27, 2007. http://www.gibsondunn.com/publications/pages/SECSeeksCommentsonDisclosuresOfBusinessActivities.aspx IRAN SYRIA SUDAN NORTH KOREA
6 McGuinness, Kevin. “Importance of Risk Management for Institutional Investors.” PlanSponsor. February 18, 2014. http://www.plansponsor.com/Importance-of-Risk-Management-for-Institutional-Investors/ 7 Writer, Elizabeth Lazarowitzdaily News Business. “Investors Take a Stand.” NY Daily News. October 8, 2007. http://www.nydailynews.com/news/money/investors-avoid-stocks-connections-rogue-nations-article-1.228238#ixzz0V7rqOAGo “One would have to question the business acumen of a company that makes the decision to do business with such a regime in light of all the opposition to that regime. It makes no sense to hold the shares of such a company when it would appear that those shares will likely come under a great deal of selling pressure, causing their price to drop. It seems to me that continuing to hold these shares, with the knowledge that the pressure is forthcoming, truly is a violation of one’s fiduciary duty.”
SUMMARY 11 Gethard, Gregory. “Protest Divestment And The End Of Apartheid | Investopedia.” Investopedia. http://www.investopedia.com/articles/economics/08/protest-divestment-south-africa.asp
The material provided herein has been provided by Ascendant Advisors, LLC and is for informational purposes only. Ascendant Advisors, LLC is the adviser to one or more mutual funds distributed through Northern Lights Distributors, LLC member FINRA/SIPC. Northern Lights Distributors, LLC and Ascendant Advisors, LLC are not affiliated entities. Definitions: MSCI ACWI (All Country World Index) - A market capitalization weighted index designed to provide a broad measure of equity-market performance throughout the world. The MSCI ACWI is maintained by Morgan Stanley Capital International, and is comprised of stocks from both developed and emerging markets. FTSE CSAG Terror-Free Ex US Index - FTSE Csag Terror-Free Developed Ex US (London Stock Exchange [LSE]) or otherwise known as FTFD. 7724-NLD-8/30/2016