Halakhot of Investing in the Stock Market (1)
[Note: This is an updated and expanded version of a shiur which was sent out in 5756.]
The extent to which stock ownership is considered active partnership in a corporation is a critical question in numerous areas of halakha. Conceivably, by buying a single share of stock a person could find himself committing transgressions from all four sections of the Shulchan Arukh! Some examples include:
* from Orach Chaim - Shabbat prohibitions such as profiting from one's business, employing Jews and working animals; possessing leaven during Passover;
* from Yoreh De'a - benefiting from a mixture of milk and meat, from avoda zara, and from orla; lending and borrowing at interest; doing business in forbidden foodstuffs; cross-breeding animals;
* from Even Ha-Ezer - being a partner in licentious activities; mutilating animals;
* from Choshen Mishpat - being a partner in robbery, withholding of wages; commission of damages.
This article will not discuss all the halakhic issues relevant to the limited liability corporation, but only possible problems in the actual ownership of stock. Due to its length, the article will be presented in several installments.
A. WHAT IS A CORPORATION?
In order to study the rules governing the corporation, we must have a clear idea of what a corporation is. There are three main characteristics of a modern corporation:
1. Limited liability: Any debts of the corporation are collectable only from the assets of the corporation itself, and not from the assets of the individual shareholders. This is in contrast to a normal partnership, where even private assets of all partners are subject to collection by the partnership's creditors.
2. Separation of ownership and control: The shareholders per se do not have any control over the corporation. All they can do is appoint directors and managers who will exercise day-to-day control.
3. Legal personality: A corporation can sue and be sued, and survives until it is dissolved without any dependence on the lives of its owners and managers. In every way it is considered to be an independent legal actor.
These properties are all geared to helping create very large economic entities which can benefit from economies of scale. In order to raise huge amounts of capital, many partners are needed. It is impossible for many partners to take part in management, so separation of ownership and control is vital. Likewise, if there are many partners the body of shareholders will naturally be ever-changing, so it is necessary to provide the business with an identity independent to that of its owners (unlike a partnership which is automatically dissolved when any partner dies). People will be reluctant to invest in a business in which they have no say unless their liability is limited.
Even so, these properties, while related, are not technically interdependent. They are not even legally dependent, and have independent expression in the secular law. Consider the following instances: In a limited partnership, the limited partner enjoys limited liability without the firm having a legal personality; in some states, an ordinary partnership can be a legal person, but there is still unlimited liability; a trust exhibits separation of ownership and control, but is not a legal person nor is it limited in its liability.
A proper understanding of the distinctions between these properties is essential, because different properties are relevant to different areas of the law. Regarding forbidden interest, according to many authorities the critical criterion is ownership, whereas by Shabbat operations control is extremely important. Legal personality may not constitute a leniency in any particular prohibition, and yet may be successful in preventing "mar'it ayin" - the appearance of wrongdoing.
It is intriguing to note that each legal tradition emphasizes one of these three aspects. In the US a corporation designates itself "Inc." emphasizing that it is a "corpus" - a legal person. In the UK the designation is "Ltd." emphasizing limited liability. And in the Latin countries the usual designation is "SA" which indicates that the company is an "Anonymous Society," highlighting the separation of ownership and control which makes the shareholders invisible.
B. CORPORATE-LIKE PROPERTIES IN JEWISH LAW
All three of these properties exist in Jewish law as well: Limited liability exists on a contractual basis in agreements such us a designated lien (apotiki mefurash). Separation of ownership and control is found in a trust or "apotropsut." And communities such as towns and labor guilds (also considered a "city" in halakha), as well as charitable organizations (which are considered "hekdesh" or devoted property) have a distinct legal identity which remains even as the community members or charity trustees are replaced over time.
Furthermore, a widespread HALAKHIC form of business ownership displays ALL THREE characteristics. This is none other than the well-known silent partnership or "iska" (Bava Metzia 104b-105a). In this form of business organization, the silent partner provides capital, the working partner acts as entrepreneur, and the profits and losses are equally split. The silent partner in an "iska" experiences:
1. Limited liability. The most he can lose is his stake in the business, and the active partner does not have the power to obligate him. This is in contrast to an ordinary partnership in which the usual condition is that each partner has the power to create obligations of the partnership as a whole (SA CM 176:20). Furthermore, unlike a designated lien in which the debt is collectible from one specific asset, the claim of the silent partner is a FLOATING lien, like that of a corporate creditor or a shareholder - collection is only made from the assets of the business at the time of collection.
2. Separation of ownership and control: In the usual case where a specified period of dealing is agreed upon in advance, the silent partner of an iska has no ability to demand that the partnership be dissolved before this period and as a result has no say in how the business is run (BM 105a, SA YD 177:36).
3. Legal personality: Just as the assets of a corporation are registered in the name of the corporation, and not in the name of the shareholders, in the usual case of an iska the assets are listed in the name of the active partner, while the silent partner who is often unknown. In this case the titular ownership is not in the name of a legal personality but in the name of something even better - an actual human personality!
C. WHAT IS THE STATUS OF THE SHAREHOLDER IN JEWISH LAW?
Two main approaches to stock ownership are discussed in halakhic literature: CREDITOR and PARTNER. Some view the stockholder as a mere lender or financier, and the assets of the corporation as a kind of collateral against the company's obligation to return profits to the shareholders. Others view the stockholder as a partner and the corporation as an ordinary partnership, with particular conditions made among the partners themselves.
1. CREDITOR APPROACH
Already in the middle of the last century we find a leading authority who asserted that the owners of shares are not thereby owners of the lendable funds of the company, nor of the chametz of the company (Responsa Mahari [Yitzchak Izak] HaLevi [Ittinga], II:54 and II:124 respectively).
Of course this approach raises an obvious question: if the shareholders are not the owners - the ones who bear responsibility - then who is? Several answers are given to this question:
A few authorities take the secular-law concept of a legal person at face value: the corporation itself is the owner. The halakhic justification for this is sought in legal-person-like entities such as the "tzibbur" (community) or "hekdesh" (Temple-owned property); in the authority of the secular law in monetary matters; or in the power vested in halakhic authorities to innovate new forms of ownership just as secular legislators do (R. Dichovsky, Piskei Din Rabani'im Vol. X p. 273).
Alternatively, the management of the company may be considered to be the "real" owners, who owe the shareholders a share of the profits. Or, if there is a controlling interest, then the controlling shareholders may be considered the "real" owners, leaving minority shareholders as run-of-the-mill creditors. R. Moshe Feinstein (Igrot Moshe, EH Vol. I, 7) inclines toward this alternative lenient view in the specific case of a small shareholder who is not interested in influencing company policy.
While this approach gives due recognition to the impotence of an individual shareholder - a lack of power characteristic of a creditor, not an owner - how can it be reconciled with the decisive power wielded by the shareholders COLLECTIVELY? After all, if the shareholders get together they can do anything they please with the company and its assets!
Perhaps we can find a parallel in the legal right that creditors have to pressure the court to create a receivership when a debtor is mismanaging his assets (SA OC 73:10; according to the Rema we are particularly lenient). After all, it is very unusual for the shareholders to take an activist role UNLESS they in fact feel the company is being conspicuously mismanaged.
2. PARTNER APPROACH
Many modern-day halakhic authorities have not taken the "legal-person" view of the corporation. The refusal to infer any leniencies from the corporation's secular legal-person status can stem from any of three assumptions:
i. Some have based themselves on a doctrinal principle, that the halakha does not give us the power to create new forms of ownership, so the question of whether we may adopt the secular-law approach is not even entertained (Moadim U-Zemanim III 269 note 1).
ii. Alternatively, one may even leave open the question of whether we have the power to recognize such an entity, but still maintain that even in the secular law this legal-person status serves to complement, and not to efface, the ownership status of shareholders. R. Yitzchak Weiss (Minchat Yitzchak Vol. III, 1) cogently points out that even the secular law does not view the corporation's legal personality as entirely independent of its owners. We can give examples of this principle: The law views the managers and directors as trustees of the shareholders; they have a fiduciary responsibility to the shareholders as owners of the corporation. Some rights of shareholders are manifestly rights of ownership: the right to examine the books of the company, to sue the management on behalf of the shareholders, and to propose resolutions to be voted on by all shareholders.
iii. Finally, we may even grant that the corporation has the status of a legal person in the halakha but maintain that this status does not create any leniencies. As Rav Weiss (MY III:1) again points out, the congregation (kahal), which is certainly a legal person and is mentioned by the lenient authorities as a possible source of halakhic legitimacy for the legal-person status of commercial companies, is NOT exempt from halakhic strictures. As examples, we may point out that the community may not build on Shabbat (MB 244:13), must nullify and destroy its chametz (SA OC 433:10), and may not lend at interest (SA YD 160:22 in Rema).
There is some evidence that the influence of the small shareholder has grown, a phenomenon known as the growth of "corporate democracy." Corporate democracy has made its mark in both the commercial and moral sphere. Commercially, we have seen the appearance of the corporate raider who is often able to wrest control of an entire company from a relatively small ownership position - perhaps less than ten percent. His influence on management is related to the fact that every single share is a potential ally of the raider. Morally, we have seen the growth of corporate chaperones (my term) who acquire only enough shares to make a voting proposal at the annual meeting ballots, suggesting for instance that the firm stop strip-mining or desist from using slave labor. The letters sent out by management relating to these proposals testify to the fact that the management takes seriously the influence of these ballots as they are distributed to millions of shareholders, each one a prospective saint who will be willing to give up a few dollars to save the rainforest. Perhaps this may affect the way we view the applicability of some earlier leniencies to our current situation.
R. Weiss does exempt the shareholder if he has no voting rights (e.g., preferred stock). R. Moshe Sternbuch is stringent even in this case as long as the stock represents a defined percentage of the company's assets (Mo'adim U-zemanim Vol. III, 269, note 1). However, R. Sternbuch suggests a leniency in the case of a non-Jewish company due to a technical flaw in the shareholder's kinyan (acquisition). Though he is unwilling to rely upon this leniency fully, he is prepared to combine with other lenient considerations.
To summarize, it seems that the most common view among major authorities (R. Moshe Feinstein, R. Yitzchak Weiss, R. Moshe Sternbuch, R. Menashe Klein, R. Shlomo Zalman Auerbach) is to view the corporation as an ordinary partnership, while accepting its limited liability to its creditors (though not to injured third parties). Although each authority mentions leniencies which apply to special cases, these are not due to the special legal status of the corporation. Rather, they are a function of specific aspects of the stockholding which could apply just as well to an ordinary partnership.
D. A CORPORATION BY ANY OTHER NAME ...
While it is interesting and important to define the halakhic status of stock ownership, we must remember that in the final analysis, the halakhic rules we are interested in applying will depend on the specific PROPERTIES of the corporation, and not on the NAMES which we give these properties. We may give a very instructive example from the case of "iska" which is, as we pointed out, a good model of corporate structure.
There can be no doubt as to the formal halakhic status of iska, which is explicitly given in the gemara and in the SA as "half loan, half deposit." Yet, the "loan" of the iska is a little more than an ordinary loan, insofar as it is not subject to the complete discretion of the "borrower" but rather must be invested in the business (BM 104b, SA UD 177:30). Conversely, the "deposit" of the iska is a bit less than an ordinary deposit, since the "bailee" - that is, the active partner - has an absolute and irrevocable right to use this "deposit" in the business until the agreed-upon period is over.
As a result, there are cases where we view the "loan" as if it were a deposit, and other cases where we view the "deposit" as if it were a loan.
For instance, the SA (CM 67:3) rules that the release of debts in the Sabbatical year releases half of an iska - the half which is defined as a debt. This seems to be the most logical view. Yet, if we examine the commentary of Ketzot Ha-choshen on this siman, we learn that according to many Rishonim the Sabbatical year does not release ANY of the iska - the "loan" half is treated like a deposit since it is subordinated to the business.
Conversely, the Ridbaz (Beit Ridbaz Shvi'it) rules that in the case of a "heter iska" - a special iska arrangement made to permit an interest-like transaction - the Sabbatical year releases ALL of the iska. In this case, the rights of the lender in the deposit half are so weak that the deposit is treated as if it were a mere loan!
In the following installments, we will start examining the various halakhic problems that we could encounter by investing in public corporations. We will keep in mind the lesson we just demonstrated with "iska:" the name we give to a particular form of ownership does not answer all of our halakhic questions. In order to decide the issues, we will have to make a close examination of the laws of forbidden interest, the laws of Pesach, the laws of Shabbat and so on, and then determine how these laws apply to the unique form of ownership known as the public corporation.