There is much discussion about whether anything has changed in the culture of Wall Street in this period. Maybe it has, or maybe it hasn’t. But at least in Judge Jed Rakoff’s Manhattan courtroom today, something undeniably did.
Common sense received a well-deserved nod today in a landmark ruling from U.S. District Judge Jed S. Rakoff. The judge rejected the overly cozy settlement struck between the Securities and Exchange Commission and Bank of America. In making his ruling, he expressed skepticism that a public agency should allow shareholder money to be used to shield B of A’s management from more rigorous investigation over the Bank’s takeover of Merrill Lynch. The move was stunning in its departure from the way the courts normally handle SEC settlements.
As the judge astutely noted:
The S.E.C. gets to claim that it is exposing wrongdoing on the part of the Bank of America in a high-profile merger, and the Bank’s management gets to claim that they have been coerced into an onerous settlement by overzealous regulators…. It is quite something else for the very management that is accused of having lied to its shareholders to determine how much of those victims’ money should be used to make the case against the management go away.
As we said about this case here:
The settlement process between the SEC and securities issuers is part of the old way of doing business involving weak oversight and overly permissive regulation that helped to create the recent market debacle. Far from spurring accountability and transparency, which is generally regarded as a necessary part of financial reform, it allows companies to pay money out of shareholders’ pockets and evade any larger sense of responsibility for what they have done. In this charade, management knows it can try to get away with as much as possible and, if caught, has only to come up with a few million, which becomes another business expense. It is an easy way of creating the impression that the SEC is making progress toward reform and enforcement when it is nothing more than a mere slap on the wrist that perpetuates the culture of always skating close to the edge of the law. That is a culture that needs to change dramatically if the lessons from the market’s meltdown and credit collapse mean anything.
The decision is a poetic present as Wall Street and a still-reeling, bailout-fatigued economy celebrate the first-year anniversary of the collapse of Lehman Brothers and the dramatic weekend that saw the forced Bank of America – Merrill Lynch deal.
There is much discussion about whether anything has changed in the culture of Wall Street in this period. Maybe it has, or maybe it hasn’t. But at least in a federal building in Manhattan today, something undeniably did. Common sense was a rare witness in the courtroom. Judge Rakoff preferred her testimony.
An investing public who should more than ever be interested in the truth and in the morality of how business is run should feel grateful and a little more relieved today.
Bank of America’s settlement shows that it’s time to look at the way the SEC allows companies just to pay when they break the rules. It is part of the culture that created the financial crisis of recent months.
An interesting development is occurring in a federal courtroom in Manhattan. U.S. District Judge Jed Rakoff is departing from what most judges do when it comes to SEC settlements: he is actually asking questions about the deal struck between the SEC and Bank of America. The case involved the Bank’s failure to disclose material information to shareholders about the Merrill Lynch bonuses and expected losses. The Bank knew more than it previously admitted, according to the SEC. For its part, BofA does not admit any wrongdoing, but it will pay the SEC some $33 million to settle the regulator’s charges. Would that be $33 million in TARP funds, aka public money?
The fact is that Bank of America’s deceit here was a disgrace. It was very expensive to investors, to taxpayers and to public confidence in the marketplace at a time when it is already in short supply. The size of the settlement falls insultingly short of the magnitude of the offense. And how exactly did the SEC conclude that BofA’s investors, whom it contends were misled in the first place and suffered huge losses at the hands of its management, should now have the privilege of paying millions more on top because of management’s deception?
Perhaps these are some of the factors prompting the judge’s heightened scrutiny. As he told lawyers for both the SEC and BofA:
I would be less than candid if I didn’t express my continued misgivings about this settlement at this stage. When this settlement first came to me, it seemed to me to be lacking, for lack of a better word, in transparency. I did not know much about the facts from the complaint. I did not know much, or really anything, about the basis for the settlement.
The settlement process between the SEC and securities issuers is part of the old way of doing business involving weak oversight and overly permissive regulation that helped to create the recent market debacle. Far from spurring accountability and transparency, which is generally regarded as a necessary part of financial reform, it allows companies to pay money out of shareholders’ pockets and evade any larger sense of responsibility for what they have done. In this charade, management knows it can try to get away with as much as possible and, if caught, has only to come up with a few million, which becomes another business expense. It is an easy way of creating the impression that the SEC is making progress toward reform and enforcement when it is nothing more than a mere slap on the wrist that perpetuates the culture of always skating close to the edge of the law. That is a culture that needs to change dramatically if the lessons from the market’s meltdown and credit collapse mean anything.
If any greater reminder were needed, another recent SEC settlement involved one of the most storied names in American capitalism: General Electric. That company paid $50 million to settle an SEC civil suit over alleged improprieties in GE’s accounting. GE says it did nothing wrong but apparently just had an extra $50 million in shareholder funds kicking around and decided to throw it at the SEC to keep them happy.
One might ask the SEC where the so-called renewed commitment to principles of financial responsibility is in all of this? The approach to enforcement seen in these examples does a disservice to investors and to taxpayers, both of whom deserve more than what amounts to a pantomime of regulatory gestures and corporate nods. When you have some of America’s most capitalized and prominent institutions falling short and misleading even in the wake of the most costly financial breakdowns in generations, more than just the formalities need to be observed. Thankfully, there is a judge who appreciates that notion and is, at least for now, standing up for both taxpayers and shareholders when no once else bothered to do so.
The decision of a majority of shareholders at Bank of America to oppose the board and separate the positions of CEO and chair, appointing an independent director to the latter position, is one for the books. This is the biggest institution in the history of business where shareholders have brought about such a dramatic change in corporate governance practices and actually removed a top title from a sitting CEO.
The move from yesterday’s annual general meeting comes in answer to the staggering losses and a shocking stock value decline that have roiled the company in recent months, as well as in response to a number of unresolved questions regarding the Merrill Lynch acquisition and who in the B of A boardroom knew what and when. It is the investors’ version of Newton’s third law of physics, (as modified by Finlay ON Governance) which holds that when shareholders are pushed too far, there can sometimes be an equal and opposite reaction.
Whether the replacement of Ken Lewis by new board chair Dr. Walter Massey will make a difference in a way that empowers independent thinking in the bank’s boardroom, and improves management performance through enhanced accountability, is yet to be seen. Some might think a physicist to be an unlikely candidate for such a key position in a bank. But given recent events on Wall Street and in the credit markets where there seemed to be little grasp of the laws of gravity, but rather, a misplaced view that debt and risk could expand into infinity -taking earnings and share prices along for the ride- perhaps Dr. Massey could give his board colleagues some useful lectures on Sir Isaac’s other discoveries a few centuries ago. So far, not even the biggest names in banking have managed to escape their universal application.
The sudden fascination on the part of the former CEO of Merrill Lynch with expensive antiques paid for by beleaguered shareholders illustrates once again that sound judgment is the most underrated and unevenly dispensed attribute among modern leaders today.
A year ago, at the beginning of 2008, investors in U.S. financial stocks had already begun to see their fortunes dwindle. Major icons of American capitalism, including Merrill Lynch, had already lost or written down billions. Layoffs had already begun in the financial sector, including at Merrill Lynch. And families were losing their homes to foreclosures in record numbers. At Merrill Lynch, a new CEO was called in to clean up the mess that the misjudgments of his predecessor, Stanley O’Neal, had caused. Bringing in John Thain was considered a real coup for Merrill, and they paid handsomely for that privilege -to the tune of nearly $80 million. It was, a year ago, a sobering time for Wall Street, where confidence was evaporating faster than an Irishman’s bottle of whiskey. Many had begun to glimpse a gathering financial storm like no other imagined.
In the peculiar world of John Thain, however, it was just the right time for something else: a spending spree of more than a million dollars to redecorate his personal office. Evidently, investors at Merrill Lynch, who had already lost big-time, had not paid enough. They needed to fork over more than a million dollars for things like a George IV chair at $18,000, a carpet for $85,000 and four pairs of draperies for $28,000. (The complete list is available here.)
Keeping Mr. Thain happy became a very expensive proposition. And the amazing thing is, he thought he could really get away with it at a time when the world was so distracted by the implosion of Wall Street and the credit markets. Had he been a passenger on the Titanic, he no doubt would have pulled a Bruce Ismay. (He was the head of the White Star company, owner of the Titanic, who took one of the last lifeboats off the ill-fated ship while more than 1,500 crew members and pa
ssengers were left to perish onboard.)
It has become increasingly common in recent months to discover a certain disquieting reality about America’s CEO class. When times were good, it seemed to many that they could do no wrong. They were lauded as superheroes and garnered celebrity status on a level with rock stars and sports giants. But now that the economy is not proceeding ever upward with the obliging assistance of absurd levels of leverage and a blind eye to any notion of risk, the pressure is on. Many CEOs in this environment simply don’t cut it. They don’t seem to possess the sea changing abilities they once did. Problems appear more intractable. Many have decided to pack it in rather than keep up the pretense that they really know what they are doing.
Then there are the John Thains, who rake in tens of millions just for showing up, demand a $10 million bonus even at the lowest ebb of the company’s fortunes when thousands have been sent packing, and need a more impressive office from which to preside over the company’s shrinking fortunes, its dwindling share value and, ultimately, its disappearance as a standalone entity.
This kind of conduct, in addition to his decision to award $4 billion in bonuses company-wide just days before the deal with Bank of America closed and further losses of $15 billion were reported, shows the extent to which Mr. Thain did not grasp the radically changed landscape on Wall Street. There are many CEOs, unfortunately, whose actions also illustrate a nearly complete disconnection from reality.
As we have said before, sound judgment is the most underrated and unevenly dispensed attribute among modern leaders today, in politics and in business. Without it, even the brightest stars eventually sputter out, usually in some kind of stupid scandal quickly captured under the category “What were they thinking?” Astrological awareness is something few leaders possess. Believing their own press clippings and the unfailing deference of the media, politicians and boards of directors to their every action, many begin to think that the earth and all the other planets really do revolve around them. Clever public relations people can do many things, but they cannot forever defy the laws of physics. Sooner or later, there is a stumble involving conduct that is, at best, unacceptable and, at worst, one hundred percent weird (see Admiral Bobby Ray Inman). Many cannot adjust to the sudden reality that a different set of laws governs the universe and that they are not the center of it. It is generally an episode that causes others to question how these people actually got as far as they did, or whether they were just among the luckiest people in the world -for a while.
Mr. Thain’s actions, including his shameful attempt to claw back a $10 million bonus just after the company’s forced sale to Bank of America, also fall into the bizarre category. But this is about more than the spectacle of the patently over-praised engaging in the unmistakably despicable. Mr. Thain has brought discredit to the company he once headed, the industry of which he has been a life-long part, and Wall Street itself at a time when what they all need is genuine leadership that can regenerate lasting confidence. He is a deserving choice for our Outrage of the Week.
On one side, there are the quiet heroes who perform deeds of courage and generosity every day, often saving their fellow citizens from disaster. On the other, there are the overpaid CEOs at Citigroup and Bank of America who cannot even save their own companies from their misguided schemes and have made them financial wards of the state.
It was one of those weeks where one’s neck got quite a workout from all the surprises happening around it. On a cold afternoon in New York, an Airbus A320 was forced to make an emergency landing on the Hudson River, gliding like a gigantic bird onto the frigid water with 155 passengers and crew on board. Earlier that day, investors woke up to learn that giant Bank of America would, like its ailing competitor Citigroup, need billions more in government handouts to keep it afloat. By the end of the week, both institutions would post billions more in losses and write-downs.
Thanks to the skills of pilot Capt. Chesley B. Sullenberger, and one of the most remarkable feats of airmanship of its kind ever, the engineless US Airways Flight 1549 made an emergency landing in the busy lower Manhattan harbor and awaited the rescue that came fast. The stock of Citigroup and Bank of America was not so lucky. Both crashed to near record lows, leaving shocked shareholders wondering where their help will come from. They are still wondering. (more…)
With yet more losses and its recent credit downgrade to junk status following stunning statements by Bank of America regarding Countrywide’s debt, the question is how many icebergs will this Titanic of subprime lending need to hit before the inevitable occurs?
In a posting on Tuesday this week, we suggested that Countrywide’s sinking financial state might be a worrisome signal to Bank of America, and that the sudden 990 percent increase in bad loan provisions ($158 million for Q1 2007 vs. $1.5 billion for Q1 2008) might be something of an unanticipated iceberg for the deal. More and more, Countrywide is beginning to resemble the Titanic of modern subprime lenders: an enterprise that was based on flawed principles, that had become too large for its own good and was steered by overpaid egos who never contemplated the prospect of disaster. The question is: Will it meet a similar fate?
The record is not encouraging. Somehow Countrywide managed to strike another iceberg in a matter of days. On Friday, Standard and Poor’s cut Countrywide’s credit rating to junk status. It based its downgrade on a filing by Bank of America on May 1st that discloses it might not be taking on some $38 billion in Countywide debt. As a statement from the rating agency noted:
Until this filing it was our understanding that [B of A] would acquire all of Countrywide as stated in the January 2008 merger agreement. This new filing raises the possibility that this assumption is no longer true.
The downgrade could trigger a host of draconian actions on the part of lenders and insurers of Countrywide’s obligations that will prove very costly to that company and much more expensive and complicated for Bank of America to complete the transaction.
We have previously conjectured that in its acquisition of Countrywide, Bank of America may be trying to follow the JP Morgan Chase model for the Bear Stearns takeover. In that case, JPMorgan was able to get rid of nearly $30 billion in riskier Bear securities through a Fed-led bailout. B of A’s announcement this week that it might not be backing such a huge chunk of Countrywide’s bonds and notes was considered something of a surprise among analysts. We have been predicting for some time that the element of surprise will be Countrywide’s constant companion. So far, we’re batting 1000. The biggest surprise, however, will be if this deal actually goes through before the Countrywide ship has gone down and top managers and directors have decided to jump into the lifeboats.
A couple of weeks ago, I was interviewed by Barron’s on B of A’s plans for Countrywide. I suppose my comments were too trenchant for the folks at that magazine, since they did not run them. What I said, however, seems to have been fairly close to the mark, given recent events. Here’s part of the interview:
Bank of America may not be as smart in seeing the potential downside of this acquisition as it claims. What is at the heart of many fears about the deal is a concern that we may be witnessing the creation of another Frankenstein-like Bear Stearns monster that just causes a whole new set of problems for everybody. You have to wonder if Bank of America has a plan to get some of the poorer Countrywide assets off its books, as JPMorgan Chase did with Bear Stearns, leaving others on the hook.
Stay tuned for more surprises.
