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.
It is hard to imagine how the bank could have done any worse if Bernie Madoff had been on its board.
There was sound and fury, but in the end it appeared to signify nothing. At Citigroup’s annual meeting last week, not a single shareholder proposal for reform was adopted. Every board/management nominee was returned. Over the past year, the company’s losses soared to $28 billion and its market capitalization has dwindled from $260 billion at the beginning of 2007 to $16 billion now. With its shares having fallen below the one-dollar range and still languishing around $3.00, many see Citigroup as basically a penny stock. Since the last AGM, the bank has become a ward of the state and could not have survived without the $45 billion it received in public funds. This is the shape of once-mighty Citigroup today. It is hard to imagine how the bank could have done any worse if Bernie Madoff had been on its board all this time.
Yet all of this was not enough to galvanize Citigroup’s institutional investors into making any changes whatever -or seeing that a new approach to corporate governance is desperately needed at this institution, beginning with the ouster of Richard Parsons, the long-serving director who became board chairman earlier this year.
If a company’s management and board can preside over the obliteration of shareholder value while losing billions, and the outcome at the annual meeting is the same as if it had the best year ever, you have to wonder about the health of shareholder democracy in America. Let’s hope that Citigroup’s investor flu does not spread.
Shareholders everywhere, dawn your masks!
Our long held view, as the New York Post noted, is that much of what comes out of the Citigroup boardroom is too slow and too late. Something of another installment in that department occurred today when CEO Vikram Pandit issued a memo to employees in which he said Citi has been profitable for the past two months.
As he outlined in the memo:
I am most encouraged with the strength of our business so far in 2009. In fact, we are profitable through the first two months of 2009 and are having our best quarter-to-date performance since the third quarter of 2007. In January and February alone, our revenues excluding externally disclosed marks were $19 billion.
That is most encouraging, no doubt, especially if the optimism holds. But here is a question for you, Mr. Pandit: Why did you wait until the stock crashed through the dollar mark and was trading for pennies before you brought out any good news? Last week, you seemed to go radio silent while thousands sold the shares they had left…for pennies. It might have meant more to have heard from you when the stock was hovering around $4 in early February. As it is, it may be good news, but it still comes in pennies.
Smart plays in banking, as in football, work best when the ball is still in your hands. Not after the game is over.
C itigroup’s common stock dropped below $1.00 this morning. A share of one of the most storied financial institutions in America, with a Dow Index moniker that straddles the globe, now trades in pennies. We have consistently predicted more surprises and greater mishaps as a result of a governance system that has failed to function for years, if it ever did, and a board of directors that long ago lost any shred of credibility. But not even a modern Nostradamus could have foretold a descent of this depth. (more…)
To say that one of the most storied banking names in the world has become a ward of the state is to diminish the extent of the reliance. Citigroup has taken on the likeness of a crippled orphan in a Dickens classic, unable to stand on its own and unlikely to survive against the bitter winds of Darwinian, or in this case, free market, vicissitudes.
There is a scene in the movie Nicholas and Alexandra where, in the days leading to the outbreak of the First World War, the Czar finally orders a general mobilization of the Russian troops. Among his war council, only a single advisor -played masterfully by Laurence Olivier- voices dissent. Sensing the catastrophe that will soon befall his country, and the fate of the Romanov dynasty, he calls the decision “madness.”
It is a sentiment that quickly springs to mind over the latest tortured survival plan involving Citigroup and the American taxpayer, which, after pumping $45 billion into the institution, now becomes the largest single shareholder. Expectations are that still billions more will be required. To say that one of the most storied banking names in the world has become a ward of the state is to diminish the extent of the reliance. Citigroup has taken on the likeness of a crippled orphan in a Dickens classic, unable to stand on its own and unlikely to survive against the bitter winds of Darwinian, or in this case, free market, vicissitudes.
We have offered our comments and predictions about the unraveling of this institution, and the shortcomings of its board, for a number of months. It began with the overblown, ego-driven monstrosity created by Sandy Weill, who capped his career with a series of costly scandals. It continued with his hand-picked protégé, Charles Prince, who, after boasting that he had his arms around the challenges to the company, displayed a striking lack of judgment and experience in handling those twin vials of financial mercury known as risk and leverage. It then turned to a hedge fund manager, Vikram Pandit, for the bank’s salvation, which was more like the Titanic turning to the iceberg. Sound governance has been the missing voice in the room at every step along the way.
“Too big to fail”? Sandy Weill, Charles Prince and Robert Rubin invented the concept long before the current crisis made government the hesitant partner. There has never been a sense of mortality in the modern incarnation of this company. Personal hubris, the illusion of invincibility that comes when reality is viewed by distance, and a belief in the inevitability of never-ending success have been the chief prerequisites for entry into the executive suite. Accountability never even made its way into the elevator, much less into the boardroom, at Citigroup.
It may well be that weaknesses and failures in government oversight, especially in the previous administration that favored less regulation and soon became fixated on blunting the effects of Sarbanes-Oxley shortly after it was passed (as former Treasury Secretary Paulson betrayed in his first year on the job), played a role in bringing Citi to this sorry state. So, too, did the long vacation from reality that Wall Street and much of business took when they saw an endless horizon of people willing to pay any number of transaction fees, max out their credit cards and refinance their homes multiple times, and a banking system eager to make ever grander sacrifices to the god of high leverage. Citi pursued this path with unbridled enthusiasm.
What needs to be remembered is that Citigroup’s directors are the ones who were in the room -or were supposed to be- when the key decisions were being made and the big questions needed to be asked. They failed on both counts. As the New York Post quoted us on the subject some weeks ago,
Citigroup’s board of directors increasingly resembles a first-class sleeping car on a train wreck that just keeps happening,” said J. Richard Finlay, head of the Centre for Corporate & Public Governance.
“Almost whatever it does, it is too slow and too late.
It can take months for Citigroup’s directors to clue into what others in the real world have known for some time”.
Public rescues and bailouts, including the most recent effort with Citigroup to twist itself into a pretzel by turning the government’s previous cash injections into the largest ownership stake in the bank, only give tacit approval to the governance disasters and shortcomings that have taken place. It is a bad model for the financial world in the best of times. But the worst financial crisis since the Great Depression makes this far from the best of times.
We remain skeptical, as we have from the outset of the TARP bailout, that the infusions of public investment are either wise or that they will work as intended. One of the reasons is that essentially the same players remain in the boardroom in most situations. This is especially true at Citigroup. A measure such as the unprecedented and costly type announced today should have been accompanied by an announcement of immediate changes in the boardroom and in the CEO spot. That it should be left to long-time director and current board chairman, Richard D. Parsons, to say that there is no time frame for making any changes at the top shows that he, the board and the administration still do not get it.
Much more than Citigroup’s stock has plunged 94 percent over the past year. Respect for capitalism, and the timeless covenant that the use of other people’s money must be accompanied by the most rigorous accountability at all levels, have been casualties on a grand scale.
The failures that have led to today’s most recent rescue, much of which can be traced to arrogance and lack of accountability at the top, are the doubtless outrage here. But when a government continues to buy into the notion that such institutions are too big to fail, by throwing billions after upon billions into propping up such a discredited model even after bailout after bailout fails, it is beyond folly. One cannot repeat the same actions in response to the same mistakes, which produce the same outcomes time and again, as now two separate administrations have done with their banking and insurance rescue plans, without the specter of madness being raised. The madness can be counted in the trillions now. More will surely follow with the horrific $60 billion forth-quarter loss anticipated for AIG, another showcase model of discredited corporate governance and risk management. With three bailouts totaling $150 million, the company has become a significant drain on the U.S. taxpayer – now the insurance giant’s largest single investor. What toll this and all the other apparently bottomless handouts and bailouts of former bastions of free market principles who, not long ago, wanted to be left alone by government, will take on other virtues, such as the credibility of a young administration and the confidence of an exhausted and battered American public in it business leadership, is yet to be written.
We can hope that the fate of the financial system and the trust that is indispensible to the institutions of both capitalism and government do not suffer anything like the fate of that other institution where indifference to the rising dissatisfaction of constituents had a very bad ending. It, too, proceeded on the mistaken belief that it was too great to fail and that the world could not possibly survive without it, until its financial excesses and arrogant missteps mounted so high that they toppled over even the gilded gates of the unthinkable and the unprecedented.
