The long-running Livent legal drama shows that what passes for Canadian justice among white-collar offenders remains something of a mystery, like a glacier that moves imperceptibly.
You have to wonder what Livent’s former investors are thinking, or what others might be learning, about Canadian justice. First of all, there were four convicted criminals on Livent’s board, which we were the first to note here. That would be a record if it were not for Hollinger’s boardroom, which boasted a grand total of six felons.
Next, they have had to contend with the iceberg that is Canadian justice. Garth Drabinksy and Myron Gottlieb were both charged with fraud in U.S. federal court in 1999. It wasn’t until 2002 that they were charged in Canada. Six years later the trial began, and last March a conviction was handed down. In a much shorter span of time, Martha Stewart, Jeffrey Skilling, Sanjay Kumar, Dennis Kozlowski and Conrad Black, to name a few, were all charged, convicted and put behind bars. Some are still there. Livent’s duo were convicted in March of this year. They will not be sentenced until mid-August, seven years after the Canadian charges were filed. There will be appeals that will keep the crafty pair out of jail for many years. Along with an appointed senate and a system where the prime minister selects judges for the supreme court and all other top courts without any constitutional checks or balances whatever, what passes for Canadian justice as it pertains to the errant white- collar community remains something of a mystery. Nortel’s former CEO has yet to see the inside of a courtroom. The Ontario Securities Commission seems to have forgotten about Hollinger and dropped an appeal in a high profile case it lost. No one was ever convicted in the Bre-X fraud, the largest crime of its kind in mining history. None of this, including the lethargic handling of the current Livent case, is likely to change the image that Canada is soft on white-collar crime.
If that playbook is followed, Livent’s founders will spend a relatively short time in prison. A sentence of between two-and-a-half and three-and-a-half years would not be surprising given the leniency Canadian judges have shown toward miscreants in the boardroom. These courts have little trouble expressing outrage over a single mother who passes bad cheques. When it comes to rich tycoons or theater impresarios, their disdain appears more muted, almost apologetic, for having to find someone guilty. Livent’s founders will regain some measure of freedom within months of beginning their sentences. Some of Judge Mary Lou Benotto’s decision reads in places like a publicity brochure for one of Livent’s productions and in others could pass for the citation during the awarding of an Order of Canada medal (which Mr. Drabinsky holds).
As to the proposal put forward by Mr. Drabinsky’s lawyer that his sentence include no prison time but rather a speaking tour on the topic of ethics in business: In this fictional portrayal worthy of the stage, Mr. Drabinsky would find himself in the company of an interesting cast. Ken Lay used to give such speeches before his conviction in the Enron case. Bernard Madoff, when he chaired NASDAQ’s board, was seen as a strong advocate of robust industry regulation on Wall Street. Michael Edwards, a former chairman of the Toronto Stock Exchange, was also considered a proponent of ethical and governance reforms, until he was penalized by the Ontario Securities Commission for his failures in the RT Capital (then a division of the Royal Bank of Canada) scandal some years ago. He was also a member of the committee that brought forward the Exchange’s 1994 landmark corporate governance guidelines. It was later discovered that he chaired a board at RT Capital that never actually met. Ethics, it seems, is the last available refuge for the corporate scoundrel.
Having looked at the subject over several decades and given more than my share of speeches and media interviews on it, as well as advice to several governments and major corporations, I have found that it is a good idea for one to know something about the subject of ethics before claiming to extol it. It requires a commitment to ethics as a core value, not as a convenient tool to avoid prison or promote good public relations. Ethics might also entail some knowledge of right and wrong. As far as Mr. Drabinsky is concerned, there has been no demonstration of remorse or appreciation for the wrong he committed and the injury he caused.
Canadian justice has moved at its customary glacial pace since the fraud at Livent was alleged in the Manhattan Office of the U.S. Attorney. Perhaps all investors and advocates of a higher standard of justice in the boardroom and enforcement by Canadian regulators and the courts have left is the hope that by the time the sentence is handed down next month, it will not have melted into a puddle of meaningless platitudes where the offenders pay with empty words instead of a significant measure of their freedom.
More than two years ago, we asked the question “How long can Nortel go on being Nortel?” The final answer came this weekend, when it was announced that the remains of the company would be broken up and sold off, leaving not much except a once- respected, but long since discredited, name.
You might wonder what happened to Canada’s most valued corporate prize–this bastion of innovation that put Canadian technology on the map around the world. The answer is a failure of corporate governance, pure and simple.
Nortel had a series of boards that drew their cultural inspiration from the old Bell Canada monopoly model which gave the company its life many years ago. Many of Nortel’s directors in the 80s and 90s, and even in the 21st century, were also directors of Bell Canada. The former CEO of BCE (or Bell Canada now), Jean Monty, took two turns at being Nortel’s CEO and then going back to head BCE.
That model was about a never-ending deference to management and the assumption that large size would always translate into continued success. Nortel’s boards missed red flag after red flag and took the wrong turn in the market, like General Motors, on almost every occasion. They continued to put their fate in the hands of managers who were not up to it, and pay them absurd levels of compensation. They thought they could give lessons to the world on corporate governance. Several of Nortel’s directors, including one-time CEO John Roth, were on a committee appointed to reform Canada’s corporate governance practices. They fell embarrassingly short of that mark but did manage in one respect to provide an unexpected lesson: how to take a giant company with an astonishing pool of innovative workers and enormous shareholder support and turn it into a basket case of accounting scandals, self-serving management and stunningly complacent directors.
Rest in peace, Nortel. You deserved better.
Had there been no board at all at AIG, Bear Stearns, Merrill Lynch, Lehman Brothers, General Motors and so many others, it is hard to imagine how the outcome could have been any worse for those institutions and their investors. This is a stunning indictment of a vital and much relied upon function of modern business that creates real systemic risk. It should not have been overlooked as major focus for reform.
Take any defunct company or failed enterprise of major note in recent years -Enron, Hollinger, Nortel, Bear Stearns and Lehman Brothers jump to mind- and you will see the faint outline of the ghosts of its board desperately seeking to attain meaning in death which it failed to achieve in life. In many cases, the difference between the productivity of a sleeping board and one no longer breathing at all is barely perceptible in any event. These boardroom apparitions have likely tried to make contact with the administration of U.S. President Barack Obama as it prepared its sweeping agenda for reform of the financial system. They have apparently been without success in that endeavor as well.
Whenever there has been a collapse or serious threat to the survival of a company, a first slumbering-and then startled-board of directors has been discovered cowering close by. The inability of directors to properly direct and exercise the informed, independent judgment that is required of their positions was a defining feature of the 20th century’s two great financial upheavals. It is a distinguishing factor in the worst economic crisis of the 21st century, where board after board claimed to be unaware of the true depths to which their companies had fallen and most professed surprise at the extent to which management had run amok with risk and debt.
As we have observed many times in public forums and before legislative committees, no other institution in modern business has so persistently failed to perform its intended mission or brought discredit to otherwise illustrious names of accomplishment and virtue as the board of directors of the publicly traded company. At a time when their size and power have expanded to the point where companies have become too big to fail or require billions in taxpayer support to prevent their total collapse, it is unacceptable-indeed, it is an affront to any concept of sound risk management-that the board of directors is the weakest and most unreliable link in the corporate governance chain.
In the run-up to the subprime debacle that brought the world to the brink of financial collapse, boards at some of America’s oldest and most respected financial institutions were seemingly oblivious to the risks that their companies were incurring or the mortal threats that were gathering on the horizon. Many, like Bear Stearns and Lehman Brothers, seemed to have no effective oversight at all. Citigroup’s directors appeared to be in a constant state of suspended animation, acting always too slow and too late on the few occasions when they actually did anything. When AIG’s directors received warnings about the Financial Products division, whose out-of-control derivatives business eventually brought the company to the edge of ruin, they remained in denial. At Hollinger, big name directors seemed to have all the requisite skills, except the ability to read and ask discerning questions of a constantly scheming management. Even in non-financial companies, like General Motors, the board seemed indifferent to management’s repeated failure and disconnected from the changes that were reshaping the consumer market. (See these companies under categories section for more analysis).
And in virtually every case where the existence of a company has been imperiled, or it has disappeared altogether, the specter of wildly excessive CEO compensation loomed large. Rather than acting as watchful guardians of shareholders’ assets, directors too often seemed to be little more than obliging ushers, happy to facilitate the greatest transfer of wealth of its kind in history to the CEO class of management. It is the failure of boards to properly bring discipline to the compensation file that permitted a situation whereby CEOs were encouraged by oversized bonuses to take the unjustified risks that later led to a cascade of unprecedented failure and stock market calamity.
It is not a matter that accountability and director engagement have had an insufficient presence in the American boardroom. In many cases, they didn’t even make it into the company’s main floor elevator. Had there been no board at all at Enron, AIG, Bear Stearns, Merrill Lynch, Lehman Brothers, Hollinger, Nortel, Livent, General Motors and so many others, it is hard to imagine how the outcome could have been any worse for those institutions and their investors. This is a stunning indictment of a vital and much relied upon function of modern business.
So it is with astonishment that we find the issue of corporate governance and the need to make boards work as intended are nowhere to be found in the Obama administration’s comprehensive agenda for financial regulatory reform. Nor does it appear that the Securities and Exchange Commission is undertaking any significant overview of what has gone wrong at so many boards, as we recommended on these pages some months ago. Indeed, in the executive branch’s proposals for reform, the term “board of directors” as it applies to the publicly traded company appears only once-in passing-in all the report’s 88 pages.
The issue is hardly insignificant. As we said last April:
Here’s something else the SEC is missing: What exactly was the role of boards of directors in the credit and financial meltdowns of the past 18 months, and to what extent did a failure of structure or culture among directors contribute to a global crisis affecting hundreds of millions of individuals, costing trillions of dollars and eventually leading to the collapse of banks around the world?
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What boards did and did not do, and how they were organized, in recent years and months when calamity has been such a frequent guest are lessons that are too important to ignore. We suspect that what will be found is a weak and compliant boardroom culture where the most taxing job for most directors was lifting the rubber stamp marked “yes.” That, in our view, is the real definition of systemic risk.
Boards exist as stewards of other people’s money. The wise use of that trust is central to the principle of capitalism. Without it, capitalism would cease to exist. Either the board of directors occupies an important place in the functioning of the modern, publicly traded, corporation, or it does not. Either there is the need to ensure that management is held accountable and that directors answer for their stewardship to investors, or that charade should come to an end. Either the system of corporate governance that has evolved over the past 100 years and which views the board as the lynchpin of that regime should be accorded its rightful prominence, or an entirely new system needs to be created.
One thing is clear: Oversight of the operation of a company, including its management of risk, the supervision of its ethical standards, the quality of supplier, employee and customer relations and the accuracy of its financial reporting, cannot be left to outside regulators alone. Capitalism and its stakeholders cannot rely on government for every aspect of their survival. That is for other systems of economics and government, not for one that values freedom, individual choice and personal initiative. What capitalism must do is to first look within its own system to ensure that the tenets of fairness and integrity that are essential to its existence are being upheld. Companies need to self -regulate if they are to fulfill the promise of a system that is said to thrive in a climate of least involvement by government. It is the job of the board of directors to perform this self-regulating task, though, sadly, many boards betray discomfort when called upon to protect their own shareholders’ interests, much less serve as guardians of capitalism. Free market advocates and champions of limited government someday need to address this glaring gap in leadership.
Public policy periodically, and generally after some scandal or disaster, has tended to recognize the vital role that boards hold and has attempted to raise their standards of performance and accountability. This happened notably in the 1930s and again after the Enron-era accounting scandals. There is no reason to think that, in the aftermath of the most costly abuses and betrayals on the part of Wall Street and the financial sector since the 1930s, the importance of the board has suddenly been diminished or its need for reform has been averted.
If restoration of confidence in the system of capital markets is the goal of the Obama reforms-if there is a genuine desire to minimize the chances of disaster in the future-the role of the board of directors, and what needs to be done to make it more effective, cannot be overlooked. It was disappointing that the administration, which is otherwise rather astute in its comprehension of economic forces, chose to do so. We look at some ideas to bridge the gap between what boards are supposed to do, and what they have actually done, in Part 2.
It is not just an American icon that has foundered, but an age that has too long emphasized the wrong values, and sometimes no values at all.
And so the unthinkable has finally happened. The company that was once the marvel of the world, its largest industrial corporation and the first stock listed on the NYSE, has become the biggest industrial bankruptcy in history. Its shares, long the most coveted among blue chip portfolios, have seen their value slide into the pennies and are about to be removed from the fabled Dow 30 index. It is a business equivalent both as dramatic and unthinkable as the sacking of ancient Rome (by the Vandal King Geiseric in 455 AD) or the sinking of the Titanic (1912). Perhaps things will someday turn around for the once mighty automaker. But, for now, General Motors is just another company making its way through the court of losing enterprises. Whatever happens, the symbol GM will never mean the same when measured by industrial size, labor force or customer trust. (more…)
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 agency that bills itself as “the investor’s advocate” needs to go well beyond asking boards to chime in on what’s behind their structure. It needs to focus on the bigger picture of the role of the board in the worst financial crisis since the 1930s and the persistent folly of directors who do not direct. That, in our view, is the real definition of systemic risk.
There is a common factor in nearly every major corporate governance failure and virtually all of the enforcement actions taken by the Securities and Exchange Commission since the 1960s. In almost every instance, including the bankruptcy of Penn Central Railroad, the bribery scandals of the 1970s involving Gulf Oil, Lockheed and many others, the criminal misconduct at Enron, WorldCom, Tyco, Qwest, Livent, and Hollinger, and, more recently, the stock options backdating scandal at Research In Motion, these companies preferred to vest the powers of the board chair in the hands of the CEO. In all these situations, there was a troubling degree of boardroom deference to the CEO while improprieties were occurring.
So it is that the announcement by the SEC’s new chair, Mary L. Shapiro, that the agency is thinking of requiring listed firms to disclose their reasons for adopting their particular leadership structure, and whether that structure includes an independent chair, struck us as somewhat anticlimactic and underwhelming.
The case for separating the roles of CEO and board head, with the board chair being filled by an outside director, has been supported by a formidable consensus of independent corporate governance experts since the 1940s. It was a prominent part of the groundbreaking research by the late Myles L. Mace of Harvard in the 1970s and has continued to be embraced by leading authorities since that time. The rationale for separating these positions is simple: it defies both human nature and precepts of modern organization for a CEO to be held properly accountable to a board which he or she heads and leads. To instill a true culture of accountability, a CEO needs to see an independent counterpoint to his power sitting at the other end of the boardroom table, and not just a mirror image of himself.
I made that case in 1994 when I was invited to testify before Canada’s Senate banking committee (and in several subsequent appearances), as well as in submissions to committees of the U.S. House and Senate during hearings leading to the passage of the Sarbanes-Oxley Act of 2002. An argument can be made, as I did, that separating these top positions is as important to the effective running of a major publicly traded company as the requirement to have an audit committee composed of independent directors.
Given the undeniable weight of history in tow on this subject, the SEC should be doing more than trying to send up a trial balloon and looking rather feeble in the process. What is required is for the agency to be far more aggressive about fostering a climate of accountability in American boardrooms. That it has taken this long to recognize a reality that has stood the test of time for decades, and that it is only now thinking about asking boards where they stand on the issue, illustrates how far behind the curve the SEC is when it comes to modern corporate governance practices.
The agency that bills itself as “the investor’s advocate” needs to go well beyond asking boards to chime in on what’s behind their structure. It needs to set out principles of sound corporate governance in language as hard as cannonballs, to borrow from Emerson. And it should insist on narrative from boards that is extensive and sets out in clear language in circumstances where a company has departed from those practices, including the appointment of an independent board chair. Naturally, separating the top positions and requiring an independent director as chair of the board is no guarantee of success. Having a ball team of nine players is no winning formula either, as any Mets or Cubs fan will admit. But not having the right number means that you don’t even get to play the game. Boardrooms have also reached the point where some basic structural rules are too important to overlook.
It was as a result of the financial excesses and failures of the 1930s that the SEC was born. There has been nothing even remotely approaching that level of reform coming out of the SEC in what has been the worst financial crisis since that time.
Here’s something else the SEC is missing: What exactly was the role of boards of directors in the credit and financial meltdowns of the past 18 months, and to what extent did a failure of structure or culture among directors contribute to a global crisis affecting hundreds of millions of individuals, costing trillions of dollars and eventually leading to the collapse of banks around the world? We have already pointed out on these pages the colossal shortcomings of the boards of Bear Stearns, Lehman Brothers, Merrill Lynch, Citigroup and Countrywide Financial, to name a few. All of these troubled institutions, by the way, followed the unified CEO/board chair model, although at Bear Stearns, James Cayne gave up the CEO slot and became an executive board chair a few months before the company’s collapse.
What boards did and did not do, and how they were organized, in recent years and months when calamity has been such a frequent guest are lessons that are too important to ignore. We suspect that what will be found is a weak and compliant boardroom culture where the most taxing job for most directors was lifting the rubber stamp marked “yes.” That, in our view, is the real definition of systemic risk.
During a disaster of a much more limited scale -the collapse of Penn Central Railroad- the SEC ordered its staff to conduct a through review of what the directors knew and when they knew it. Staff also examined the structure and culture of the board and its interactions with management. The result was illuminating and became a template for the disengaged board. As the staff report concluded:
Directors of Penn Central were accustomed to a generally inactive role in the affairs of the company. They never changed their view of their role.
The SEC has no trouble spending what seem like endless time and resources looking at the uptick rule and the allegedly detrimental role of short-selling, for instance. A case can be made that it is focusing too much on the individual trees and not on the health of the boardroom forest. Much more has been lost by shareholders, and by society more recently, as a result of boards that simply did not direct, did not hold management sufficiently accountable for its actions and were not adequately engaged with the affairs of the company in order to monitor risk and foresee the disasters that were looming on the horizon. The corporate board, with all the power and responsibility it entails, is an institution that requires considerably more focus on its limitations, its deficiencies and on its need for reform if it is to play its necessary role as a steward of investors’ interests and a guardian of the integrity of capitalism itself.
We will have more discussion about the past and future role of boards, and where they fit into the post-subprime recession era, in the days ahead.
