An Essay by J. Richard Finlay
on corporate integrity in the post-bailout era
Recent multi-billion dollar settlements involving Bank of America and JPMorgan Chase show the staggering costs of ethical folly and the culture of moral hazard that places too many companies, and capitalism itself, at risk.
It is the curse of giants to believe in their own invincibility. It is also the curse of their acolytes, as the White Star Line discovered with its “unsinkable” Titanic and the Philistines learned with the defeat of their champion Goliath at the hands of a young shepherd boy. Yet these lessons, and countless others, over millennia have not dispelled such illusions in the world of business, where size is seen as an insulator against all manner of misadventures and the too-big-to-fail mentality shows few signs of abating. Indeed, the extent to which America’s major banks and Wall Street icons were on the wrong track when it came to compliance with the law and standards of ethics during the great financial meltdown and even afterwards is becoming even more striking. Recent reports involving Bank of America, Citigroup and JPMorgan Chase vividly make the point.
On these pages in the years and months leading up to the worst financial crisis since the Great Depression, and in numerous op-ed columns before that, I wrote about the dangers of relying on the myths of giants. Until they were categorized as being too big to fail, corporate monoliths like Bank of America, Citigroup and JPMorgan Chase were viewed as being too smart to fail. Trophy directors and fantastically compensated CEOs, with the assistance of huge PR departments that never seemed to sleep, worked overtime to present an image where success was virtually guaranteed. The reality, however, was that too many boards were recklessly disengaged from what was happening around them. Seeds of folly were being sewn by undersupervised employees more interested in creating clever short-term financial devices than sustainable building blocks of long-term business. And too many investors and journalists had become prisoners of what I call cheerleader capture. First cousin to the condition of regulatory capture, this refers to the state where it is virtually impossible for any dissenting voices to penetrate the thundering chorus of cheers by insiders and their loud choir of supporters.
There were warning signs of the unwise effects of that mindset, to be sure. Scandals involving security analysts, for instance, for which Henry Blodget became the poster-boy, revealed the dangers of a culture of cheerleader capture. In too many cases, the analysts who were supposed to be delivering objective assessments of the financial health of companies enjoyed personal and career incentives that caused them to paint a more glowing picture than justified by the facts. Citigroup was touched in several ways by that scandal.
There were the accounting frauds at Nortel, Enron and Worldcom that were so stunning they resulted in landmark legislation known as the Sarbanes-Oxley Act being passed. The collapse of Hollinger and Livent provided an interesting coda to those scandals. If these events of just a few years earlier had been taken seriously, they would have produced a higher standard of boardroom oversight that might have prevented the blunders and financial chicanery that brought the world to the brink of the financial abyss in the first decade of the 21st century.
But even before the gales of that crisis rose to full force, this space questioned the governance practices of companies like JPMorgan Chase, Citigroup, Bank of America, as well as Countrywide and Merrill Lynch, two institutions which BofA bought. We took frequent issue with the sweetheart boardroom deals that propelled their CEOs into the super-compensation stratosphere. We felt that the excessive deference accorded many CEOs reflected a perilous level of disengagement on the part of boards which in turn were failing to exercise the independent judgment needed to fully protect investors and the public franchise of capitalism itself.
Many of the decisions these companies made were fraught with ethical failures, violations of the law and just bad business thinking. Their consequences are coming home to roost even years later. Bank of America recently agreed to pay $9.5 billion in fines to settle civil lawsuits with U.S. federal housing authorities. Ken Lewis, the company’s former CEO, settled with regulators by paying $10 million personally. All told, it has cost BofA some $50 billion to resolve a variety of claims stemming from the subprime era, including the fraudulent actions of Countrywide Financial and misleading statements made in connection with the bank’s purchase of Merrill Lynch.
Improprieties at JPMorgan Chase resulted in an astonishing $20 billion being handed over to various regulatory authorities. The amount barely caused a ripple on Wall Street, where reaction to the announcement registered nothing untoward in respect of JPMorgan’s stock or the reputation of its CEO, Jamie Dimon.
Citigroup, which has also paid out huge amounts to settle regulatory claims, recently failed the Fed’s financial stress test — for the second time in two years. Its stock languishes at the unconsolidated 1-for-10 equivalent of the same $5 range it was at during the bailout crisis. Were its recent history of losses, bailouts and scandals not sufficient, there are new regulatory and legal issues arising from a potential fraud involving Banamex, a Mexican subsidiary. In one day early this April, Citigroup’s shareholders were hit with a double whammy. The company said that it was unlikely to meet a key profit expectation it had set and then announced it was paying $1.12 billion to certain investors to settle claims stemming from mortgage securities sold before the financial crisis.
Yet the level of shareholder outrage one might think would be directed at Citigroup’s board for this Job-like litany of woes has, for the most part, failed to surface, just as tolerance of years of poor boardroom practices and bad decisions earlier led to a cascade of scandals and financial losses culminating in the bank’s liquidity crisis that prompted the U.S. government bailout in 2008.
In no case has any banking or Wall Street executive faced jail time as a result of the misdeeds that resulted in these record massive payouts or those of other companies. By contrast, in any given day on Main Street, courts routinely hand out jail sentences to elderly seniors convicted of shoplifting and single mothers who pass bad cheques for even small amounts.
Like the notion of billions and billions of stars in the cosmos often attributed to the late Carl Sagan (with the help of Johnny Carson), it is hard to get the mind around the scale of these fines, payouts and penalties. And in the case of Bank of America and JPMorgan Chase, and numerous other companies from drug makers to car manufacturers along the way, it seems nobody is even trying.
What seems to be happening instead is that the wrong-headed mindset that gave birth to excessive CEO pay has infected other fields of business responsibility and decision-making. We explore this further in Part II.
One of the most disaster-plagued boards in corporate America has done it again. Right after the results of a third quarter that offered the first glimpse of a turnaround, it announces the departure of its CEO and COO the next day. It is a classic case of how not to handle a seminal change, if that’s what it is. No responsible board would permit a situation where the CEO is gone by noon after a sudden announcement in the morning, unless there is something terribly wrong. An orderly period of transition to help investors become acclimatized to the new faces typically occurs. The number one and number two executives never leave at the same time, unless the board is oblivious to the effects of harmful conjecture and divisive speculation, which is what the market will always resort to in the absence of credible and timely information. That’s been happening all day with Citigroup.
These pages have offered much criticism of Citigroup’s governance and leadership for many years. It has been a rolling disaster since the demise of Sandy Weill. Its stock still bears no relationship to what it once was, and is down some 90 percent under Vikram Pandit. The bank lags the performance of its peers. Its board has constantly misread red flags and warning signs has had a tin ear when it comes to how it is being perceived by regulators, investors and retail customers. Admittedly, there are new faces in Citigroup’s boardroom, but this latest event does not contribute to investor confidence and there is much speculation that lurks behind the departures, to say the least.
What is happening at Citigroup may be totally above board. But it is a clumsy way to handle it. And in that regard, nothing has really changed at Citigroup.
Recent changes only confirm that the company remains in denial
We are quoted in this week’s cover story of Maclean’s on the RIM fiasco. Regular readers will know that Finlay ON Governance has been on this story for several years and has long predicted the kind of stock meltdown and leadership turmoil that has rocked the company. The co-founders’ decision to step aside from the co-CEO slot, but not out of the boardroom, and the appointment of an insider to CEO with an old-guard director moving up as chair of the board, do not change our views.
The Maclean’s piece presents a good overview of some of the failures but is a little short on the root cause, which we have long contended is RIM’s dysfunctional system of corporate governance. Here are some further thoughts on that subject and why the recent management changes are unlikely to produce the results investors would like.
The fact that RIM’s top management and board could take so long to come up with so little just shows how far out of touch they remain. It’s obvious that Balsillie and Lazaridis wanted their guy in the top spot and do not grasp why shareholders were looking for more than a marionette whose strings they can pull any time.
What is really alarming is that independent directors think this will work, when a clean break with a strong new CEO at the helm, plus a fresh outsider as board chair — unaccompanied by RIM’s bulging baggage of failures — should have been brought in. Of course, any new CEO worthy of the title would have insisted that Balsillie and Lazaridis depart the board, as was the case at Yahoo recently. It will take a few more tries, and several new shocks, before the company actually gets it right — if it ever does.
Separation complexes are unfortunate in dogs. They are a disaster in company founders who can no longer read the market or the wishes of their investors. The new insider CEO is not the solution. Nor is the appointment of Barbara Stymiest as the so-called “independent” board chair. We were among the first — and long before it became fashionable — to openly call for this kind of change. But putting a long-time enabler of RIM’s governance problems in charge of the board is a little like promoting a sleeping sentry to captain of the guards.
RIM’s boardroom is located in Waterloo, Ontario, but as far as investors are concerned, these changes only confirm that it remains firmly footed in denial.
Another costly blunder from corporate America’s most dysfunctional, discredited and disdained board
HP’s board took another gigantic jump backward today. It’s not so much that it fired one CEO and hired another. People have come to expect that on a regular basis from what has become corporate America’s most dysfunctional, discredited and disdained board.
It is the shell game involving HP’s chairman that should prompt eyebrows to be raised even higher. Ray Lane was the board’s non-executive chairman and played the largest role in the appointment of Meg Whitman as new CEO. Now, he’s jumped inside, this time to become executive chairman of the board, with a much bigger payday as part of the deal. We are unaware of any comparable situation where two outside directors suddenly have become insiders, one as CEO and one as head of the board she reports to. Is this marriage of convenience the main reason why there was no full search for a new CEO? Is it just one more sign of a cozy club mentality at work in a boardroom where accountability has been the missing voice? We think so.
We also believe it is a further step in the wrong direction for the board to think that a lead director, yet to be appointed, will be able to provide the necessary focus for checks and balances that is so important to its fiduciary responsibility. No lead director has ever prevented disaster from occurring in any major company. It is bad corporate governance, pure and simple. For a company whose most costly product has been disaster, with billions in shareholder value wiped out over the past year alone, HP’s board obviously still does not get the fundamentals of how to execute on its significant responsibilities.
HP’s formula for a turnaround must include the highest standards of corporate governance, not the lowest. The rather large shell game it engaged in by turning a so-called non-executive chairman into an insider as part of the package that brought its newest CEO into the room shows that it does not even know where the switch is to turn that process on.
The game has changed. RIM’s management has not. Neither has its board.
Today’s latest (20 percent) plunge in the stock of Canadian based Research In Motion, this time because the company missed about every expected metric for the quarter, re-confirms that RIM needs a new operating system for its boardroom. It is the board, with a its succession of lame directors, that has permitted a culture of smugness, distraction and disconnection to cloud the judgment and performance of top management, and has too long tolerated a disingenuous streak in the way the co-founders deal with adversity. This is what has led to RIM’s fall from glory and the devastation of its stock. Management was playing its own game and setting its own rules. It thought success would continue indefinitely and the market would defer endlessly to its much-trumpeted wisdom.
The game has changed. RIM’s management has not. BlackBerrys are out. Apples are in. The kids decide what’s hip and everybody wants to be cool. Holding up a new Playbook is the definition of uncool. Launching it in the summer is the definition of stupidity. Only grandiose egos, too used to everyone genuflecting to their brilliance, could come up with this foolishness.
Long before it became popular, in the wake of the billions of dollars in company value that have been obliterated, we lamented the weaknesses of RIM’s governance practices . We predicted further casualties from a board mentality where management is effectively accountable to itself and still allows a regime involving co-this and co-that at the top that would not be tolerated in any mature, self-respecting company, let alone one that is experiencing something of a freefall in its shares. The stock is down more than 60 percent this year. No significant change in management, or the board for that matter, has been forthcoming.
RIM’s problems will not end until the board steps up, key management actors are forced to step down and a new culture of accountability is rebooted in RIM’s boardroom.