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Green Mountain Margin Call Latest Sign Market Is Stuck in 1929

Oftentimes, margin accounts are created so executives can use their stock for personal investments or loans without having to sell shares, which could be viewed negatively by investors and lead to capital gains tax. However, violations of company bylaws by Green Mountain's Stiller, the liquidation of McClendon's stock, and the prospect of a share liquidation by Goldman executives all stand as a clear indication that forced selling can impact investors.

"It's okay for CEOs to leverage their stock if it's used to invest in more shares. But if it's used for personal consumption, then it's probably a problem," adds David Yermack, a professor at NYU's Stern School of Business.

In the event of a share slump or overall market turmoil, though, the distressed sale of those shares can create the potential for insider trading, conflicts of interest and even put boards in the awkward position of bailing out top company officials.

"I don't think there is anything fundamentally wrong with this as long as it's disclosed and the board approves it," says David Larcker, an accounting professor at the Stanford Graduate School of Business and director of its Corporate Governance Research Program. "I think it is very controversial where the board would step up and bail out [an executive]. Is that in shareholder interests?"

While the Dodd-Frank Act seeks to instill regulation that will prevent a repeat of the Great Depression, little attention has been paid to questionable share liquidations by top corporate officials. Other provisions, such as "Say on Pay," are more widely known and recently led to the shareholder rejection of Citigroup (C ) CEO Vikram Pandit's pay package.

Prominent proxy voting advisory firm Institutional Shareholder Services recommends to shareholders that they vote to remove the ability for top corporate executives to use their stock based compensation as collateral for margin accounts or personal loans.

"Generally vote FOR proposals seeking a policy that prohibits named executive officers from engaging in derivative or speculative transactions involving company stock, including hedging, holding stock in a margin account, or pledging stock as collateral for a loan," the ISS has advised shareholders.

ISS isn't overreacting in sounding alarm bells about this accepted practice. There aren't standard disclosures for such policies, which vary in the way they are reported from company to company. And even if a company states to its shareholders that margin accounts are prohibited and that stock sales during earnings season violate insider trading policies, a corporate board may still give hardship exceptions to an executive facing a margin call.

Meanwhile, a failure to comply with publicly stated corporate rules isn't necessarily a violation of securities laws. It means that companies may be marketing policies to investors that can be bent during a board vote and may not be enforceable under existing securities law.
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