Something has gone fantastically awry in the risk management and oversight of some of the world’s most renowned investment bankers and financial institutions. The shortcomings in their controls and governance systems that permitted multi-billion dollar losses at Citigroup, Merrill Lynch, Bear Stearns, UBS and Swiss Re, and the overall failure of top management and boards to comprehend the risks of the subprime related investment vehicles they were packaging and selling, has been a recurring theme at Finlay ON Governance in recent months. We were taken aback, as we noted last week, when new Merrill Lynch CEO John Thain told the Wall Street Journal “Merrill had a risk committee. It just didn’t function.”
But nothing has been as breathtaking as the loss of more than $7 billion by Société Générale, apparently the result of a rogue trader acting on his own. (more…)
Merck pays out nearly $5 billion to settle Vioxx claims, Yahoo incurs the wrath of legislators, and another poisoned child’s toy made in China is recalled. The growing credit market implosion threatens recession. These are the predictable consequences of the subprime leadership and ethics in our boardrooms and in our institutions of government over the past number of years.
The Outrage generally prefers to focus on a single event. This week, however, there was a common theme among several events. There was the Merck $4.85 billion settlement over its Vioxx debacle. Next, there was the appearance of Yahoo CEO Jerry Yang before the U.S. House Foreign Affairs Committee to answer questions about his company’s turning over information that led to the arrest and imprisonment of Shi Tao, a Chinese journalist and political activist.
The week ended with revelations that yet another toy made in China contained toxic chemicals and with officials ordering that Aqua Dots, distributed in North America by Toronto-based Spin Master, recall more than four million units.
What these incidents share is a betrayal on the part of the companies and leaders who could have done better, but failed miserably in their ethical performance. Merck is one of the world’s leading drug companies, yet it continued to market this highly profitable product even after company officials were warned by their own medical researchers of serious problems.
The company pulled Vioxx off the market in 2004, citing increased cardiac risk. But, as the Wall Street Journal reported at the time, Merck had earlier indications of serious problems. A March 2000 internal email shows company research chief Edward Scolnick warning that cardiovascular events “are clearly there.” Still, Merck continued to deny any link between heart attacks and Vioxx.
Yahoo is a company founded and headed by a brilliant billionaire who one might have thought had enough money and youth to still have a social conscience. But doing business in a multi-billion consumer market headed by a corrupt authoritarian regime was too tempting to resist, it seems. And so it was that Yahoo became an adjunct of the Chinese secret police –spying and snitching on its customers and thereby poisoning a name and a brand that had become known world-wide for its sense of innovation and exploration of the limitless knowledge held in cyberspace.
We don’t know who is really behind this latest toxic threat to our children. And maybe that’s the real problem here. Distant manufacturers operating under opaque regulations and dubious enforcement, vague distributors, off-shore companies and the lure of huge profits all conspire to put health and safety way down the line and out of the mind of any responsible entity. These kinds of incidents have happened too often in recent months to be a mistake. They reflect a cultural and ethical deficit endemic to the way global business is being done with despotic regimes.
Among the factors that are causing a crumbling of the pillars of confidence, the subprime mortgage scandal also figures prominently. Here, once again, the too-clever-by-half characters who concocted these elaborate schemes and got paid a sultan’s treasure for their efforts have turned out to be not quite as clever as they wanted us to think. It is unlikely they will have to repay any of the stratospheric bonuses they were receiving while creating these artifices that, like the dot.com bubble and the Enron-era accounting shenanigans, foolishly attempted to defy the rules of basic economics and common sense as only those infused with the curse of hubris will do.
And the figures touted for their wisdom and vigilance who are supposed to be monitoring the actions of these other bright fellows whom history has shown to have gotten carried away with themselves on more than a few occasions, seem not to have been as wise and as vigilant as advertised. Having underestimated the effects of these toxic credit toys before with assurances that the subprime mortgage defaults would not intrude into the broader economy, one wonders if they are any better prepared for the wider economic crisis that seems to be looming.
There will be many casualties before the full extent of the great unfolding 21st century credit debacle is over. There have already been a few CEOs who are taking a very well paid early retirement. More will follow. Some companies will not survive. The stock market will continue to experience unsettling jolts, like its more than 600 point drop this week. But, unfortunately, it will be the ordinary consumer —not the central bankers or the treasury luminaries or the credit agency raters or the boardroom directors who permitted this fiasco and were blind to its early signs— who will suffer most from the turmoil and set backs that lie ahead. So too will the idea that we can look to the icons at the top to do the right thing because their wealth and privilege bestow on them a higher level of accountability to do the right thing. That moral touchstone seems to have vanished, along with the primacy of the common stakeholder —something that has been a recurring theme at Finlay ON Governance.
These events have been the predictable consequence of what has amounted to decidedly subprime leadership and ethics in our boardrooms and in our institutions of government over the past number of years. They are a harbinger of the further crumbling of the pillars of public confidence and trust, which make them our choice for the Outrage of the Week.
First, the company apologized to its American consumers and laid the problem of defective children’s toys squarely on China’s doorstep. “Our standards were ignored, and our rules were broken” at Chinese plants, said Mattel CEO Robert A. Eckert in testimony under oath before Congress this week. Next, Thomas A. Debrowski, Mattel’s executive vice president for world-wide operations, issued an apology to Chinese officials and the Chinese people, saying
Mattel takes full responsibility for these recalls” and that “the vast majority of those products that we recalled were the result of a design flaw in Mattel’s design, not through a manufacturing flaw in Chinese manufacturers.
To confuse the issue even further the toy maker is beginning to backtrack from that apology with a statement about its Chinese statement. One fact that cannot be disputed is that Mattel clearly doesn’t know what it is doing. Not only did the company drop the ball in failing to ensure quality standards on the part of its Chinese manufacturers, it also failed in its own designs. It took too long to recognize that fact. It has frightened parents, placed children at risk and ill-served its own shareholders. With more than 20 million toys recalled, its reputation is in shambles. Yet, with all of this, the company’s board of directors has been basically invisible. There are no reports of resignations of top management. There is no indication that anyone in the company has been held accountable for what has occurred or that there have been any consequences as a result. Disappointing, too, is the apparent absence of any whistleblower within the company who might have alerted top management to problems either off shore or with its own design process. Is this a culture that discourages such action? The company thwarted efforts by Congressional committee staff to visit the plants in China that Mattel deals with, according to members of the House Subcommittee on Commerce, Trade and Consumer Protection. At the very least, the board needs to conduct a review of ethics standards and practices. It also needs to set up an independent committee of directors to investigate all the circumstances of what have brought the company to the brink of disaster.
Mattel is a classic case of what can happen when a company takes for granted the trust it holds and thinks it can coast on its good name. It is also an instructive lesson in what can occur with a country that is governed by a fundamentally corrupt dictatorship that hides most of what it does behind closed doors and secret police. One cannot imagine that Barbie or Ken would approve.
You have to wonder whether this company has really become anything more than a subsidiary of China Inc. and whether as a result of its plan to produce the lowest cost products from what turned out to be questionable sources of quality and regulation, it has created a situation where it now faces the prospect of going out of business altogether.
There are few things that outrage the consuming public more than that which endangers its children. For doing so, and making such a botch of how it handled those problems, Mattel is our choice for the Outrage of the Week.
The Outrage of the Week has returned to its regular Friday slot at Finlay ON Governance.
Seventy–six years ago, the business world was rocked by another sensational trial involving corporate fraud and the scamming of investors with a prominent baron at the centre of the scandal. It did not end well for Lord Kylsant of Carmarthen. The uncanny similarities are not encouraging for Lord Black of Crossharbour.
A Finlay ON Governance Exclusive
Copyright (c) 2007 Finlay ON Governance
Considerable speculation is gathering about what will become of Conrad Black in light of his four-count felony conviction earlier this month. In that regard, the past provides a useful and rather unexpected guide. Corporate governance, which I think factored significantly in the outcome of the case against Mr. Black and his colleagues and set the stage for their eventual downfall (I will have a further posting on this in light of the verdict) actually has a history, though most of its champions don’t bother to study it.
Two decades ago, I came across a case involving boardroom misfeasance by another British baron. I found it interesting when I first learned about it, but thought it was from a different and by-gone era. I had no idea it would someday spring from my archives and take on a totally modern face. Today, in the wake of recent developments in U.S. federal court in Chicago, it is truly fascinating for its uncanny similarities to Hollinger’s demise and for its instructive value as to what might lie ahead for Mr. Black. It is not a pretty picture.
Owen Philipps, who became Lord Kylsant of Carmarthen in 1923, was born to great wealth and a prominent family, like Lord Black of Crossharbour. His ancestry could be traced back to the nobility of post-Roman Wales. And like Lord Black, Lord Kylsant attracted early praise for his business acumen. He commanded enormous respect in commercial and political circles and was then, as his baronial counterpart is today, viewed as a larger-than-life figure. At six feet seven inches, he was straight out of central casting for that role. Like Lord Black, Lord Kylsant began to assemble an empire, not of newspapers, but of ships. An admirer of Bonaparte like Lord Black, Lord Kylsant became known as the Napoleon of the seas for his tenacity in making deals and expanding his empire and for an almost single-handed domination of his company. You have to wonder what this fascination of ill-fated business tycoons with the likewise ill-fated emperor, who was given to such monumental lapses in judgment, is really about. Perhaps they should have studied more Wellington and less his conquered opponent.
Lord Kyslant and Lord Black received their titles largely because of their business successes. Some good connections no doubt helped in both cases. Lord Kylsant’s huge ego —he, too, did not suffer mere mortals gladly— was illustrated by the equally oversized “K” which he scrawled on memos and company orders to signify his approval. Lord Black is known for signing his name to emails in all capital letters. And the two men held rare honors: Lord Kylsant was a Knight of the Order of St. John of Jerusalem; Lord Black is a Knight of the Order of St. Gregory the Great.
In 1926, the Royal Mail Steam Packet Company, which was publicly traded on the London Exchange and headed by Lord Kylsant, bought the White Star Line, which also owned the Titanic prior to its catastrophe-destined maiden voyage. The Royal Mail was essentially a holding company for various shipping entities, which continued to operate under their own corporate flag. Like Hollinger, the Royal Mail financed many of its acquisitions by taking on enormous amounts of debt, which later proved difficult to service. By the early 1930s, the company began to fall behind in its payments to the White Star’s former owners. Soon, investors were publicly questioning the Royal Mail’s accounting practices and whether the true state of its financial health was being disclosed. Lord Kylsant, like Lord Black, initially bristled at any suggestion of irregularities in his stewardship. But under mounting pressure, and in a move that presaged Lord Black’s own actions some seventy years later, the baron responded by agreeing to the creation of a special committee to investigate the company’s affairs. The highly respected Sir Josiah Stamp —the Richard Breeden of his time— eventually submitted a devastating report that showed the alarming extent of the company’s financial deterioration and found that investors had been misled.
Lord Kylsant soon took a leave of absence from daily management of the company. Still, a criminal investigation followed and, in a move that rocked both Britain’s financial community and aristocratic society, he was arrested and charged with two counts of fraud. The mirrors of history form an uncanny reflection of the proceedings in U.S. federal court against Conrad Black. In June of 1931 a trial began in London’s historic Guildhall. The country was spellbound. The courtroom was packed. The press from around the world followed every word, along with the comings and goings of Lord Kylsant and his family in their limousines. The best —and certainly most expensive— legal minds in England, perhaps even rivaling Lord Black’s fabled team of the Two Eddies (fabled, that is, before his four-count conviction), were retained by Lord Kylsant to marshal his defense. Hundreds of boxes of documents were introduced into evidence. Prominent directors testified —as they so often do in such cases— that they were not aware of what was really happening in the company. Lord Kylsant’s lawyers mocked their testimony and asserted the board was fully informed and approved of all financial transactions and disclosures. Sounds familiar, doesn’t it? A jury of ten men and two women (Lord’s Black’s was composed of nine women and three men) did not buy that line. The central issue was that Lord Kylsant deliberately hid the true state of the company’s finances from his board of directors and the shareholders. The verdict acquitted Lord Kylsant on one count of fraud and convicted him on the other. A sentence of one year in prison was imposed.
There was great speculation at the time, as there is today with Lord Black’s conviction, about the success of an appeal, which was launched immediately. Many assumed a prominent titled member of the aristocracy would do well before similarly privileged appeal court judges and that what were asserted by the baron’s supporters to be relatively minor infractions would not be deserving of incarceration. They were wrong.
When her husband’s appeal failed, Lady Kylsant, a much remarked about figure at the proceedings, broke down and embraced the emotional baron in his last moments of freedom. The sentence was upheld and ordered to commence immediately. And so it was that this lord of the oceans who commanded one of the largest fleets of British commercial ships to sail the seven seas was dispatched into the company of petty thieves, small-time criminals and household robbers. He never set foot in the House of Lords again. He was never entrusted with other people’s money again. All of Lord Kylsant’s significant honors, including the previously noted Order of St. John of Jerusalem, were rescinded in the months following his conviction. Struggling with public disgrace and social ridicule, not just because of his crime but also the legacy he squandered, he died a broken man in 1937. The Royal Mail sailed into virtual extinction, and the financially troubled White Star Line, which even the greatest calamity of the sea could not sink, was brought down by a scheming boardroom baron who plotted his misdeeds among mahogany tables, leather chairs and every privilege his country could bestow upon him.
The shareholders of Hollinger Inc. and Hollinger International may themselves be struck by the parallels in the demise of Lord Kylsant’s empire and the hollowed-out remains of what not long ago was the world’s third largest newspaper owner.
If, on a Christmas Eve in the late 1990s, before the twin vices of greed and miscreance had settled on Lord Black’s mind, the ghost of Lord Kylsant had been able to visit him, as Marley appeared to Scrooge in the Dickens tale, one wonders what he would have said. Would he have warned his modern equivalent to change his ways? Would he have counseled him that it profit a man nothing to gain a few dollars more only to lose his priceless freedom and precious reputation? Could anyone have persuaded an uncommonly determined man who rose from The Bridle Path to a British peerage to take a less ignoble path? Is it always the curse of larger-than-life men to surround themselves with smaller figures of little courage and a never-ending sense of obliging service? Or are there just so few men and women who will stand up to hold back the destructive tide of hubris and unquenched ego? Looking at the examples from as far back as the Royal Mail and as recent as Hollinger, a long series of rather remarkably ineffectual boardroom players, distinguished more by the outcome of their carelessness than by the product of their diligence, seems to lead to that conclusion.
It is perhaps not just Conrad Black who needs to reflect upon the events that have taken him to this regrettable point in his life. The experience carries valuable lessons for how we all deal with such titanic figures in the future, whether they be noble barons or just common variety CEOs who think they should be paid a king’s ransom.
Conrad Black is the only member of the House of Lords to be convicted of criminal charges involving a publicly traded company since 1931. It did not end well for Lord Kylsant of Carmarthen. One wonders what history will finally record in the case of Lord Black of Crossharbour.
A Finlay ON Governance Exclusive
Copyright (c) 2007. All Rights Reserved.
There can be few more heart wrenching moments than seeing a loved one racked with pain and being desperate to find them relief —except, perhaps, if you are the person in pain yourself.
In the search for something that would help, millions turned to a new drug called OxyContin, which promised relief without the curse of addiction. My mother was one. Yet it soon became apparent that the medication was not quite the miracle its makers purported it to be. By the mid-1990s, press reports began to raise the possibility that the drug was far more addictive than originally claimed. The death toll from the drug’s overuse began to mount. A whole new class of addicts was created. Court records now show that the drug’s maker, Purdue Pharma L.P., repeatedly and willfully ignored those concerns.
This past week, the company pleaded guilty in U.S. federal court to criminal charges in connection with the deceptive claims it made about the drug. Three of its officers, including its CEO, top lawyer and former chief medical officer, pleaded guilty to less serious misdemeanors. Purdue will pay a fine of $470 million and its current and former executives will pay some $35 million. A further $130 million will be set aside to settle civil claims resulting from injuries and deaths. Nobody is going to prison.
Even in the face of warnings from health-care professionals, the media and members of its own sales force . . . Purdue continued to push a fraudulent marketing campaign,” U.S. Attorney John L. Brownlee said in a justice department press release.
Now, here’s a question: Why is Purdue CEO Michael Friedman, one of the three who pleaded guilty to misdemeanor charges involving “misbranding,” still on the job? The answer lies in the difference —too little considered by advocates of private equity— between a publicly traded company and a private corporation. Purdue is in the latter category. Its web site does not even disclose the names of its executive officers. Its sales are not reported. Its board of directors is not easy to identify. It is, in most respects, a closed, secretive and opaque company. It is also a corporate felon. But because it is a private entity, it is much less influenced by public opinion and the résumés of those in control.
Fortunately, my mother saw the troubling reports about this drug early on and insisted that her doctor take her off the medication. Not all patients were as alert as my mother; many had become too addicted to do anything about it. The company knew it was deceiving medical professionals and vulnerable patients. It did so solely to enhance the profit and wealth of its already well-heeled private owners —names, by the way, the public does not get to see. Billions poured into the company from the sale of this drug, according to court papers.
Like many companies, Purdue boasts on its web site that “Honesty, integrity, and respect for the individual are at the core of our culture.” Its conduct makes a mockery of such values and the company should probably be prosecuted for lying about that, as well.
But there is a larger issue at work here, and it involves the actions of the government itself. When corporate heavyweights have engaged in wrongdoing, such as what Martha Stewart did in obstructing justice or Alfred Taubman did in price fixing at Sotheby’s, they were sent to prison. Nobody died or even got sick because of their actions. In contrast, Purdue not only orchestrated a plan of deliberate deception, but when it became aware of the drug’s damage, it turned a blind eye and continued the scam —over and over again.
Companies are eager to write a check when confronted with their misdeeds. Many insiders see it as a cost of doing business. When executives are sent to prison, however, it tends to elicit a different appreciation for the consequences of wrongdoing.
Individual officers and employees at Purdue made the decisions that took the company down this criminal path —their evil transgressions were not forced upon them. Yet everyone connected with this criminal conduct is free today. Ms. Stewart and Mr. Taubman, on the other hand, will be considered ex-felons for the rest of their lives. There is something terribly wrong when fiddling with the price of antiques can send a man to prison and peddling a drug that is branded in deceit and causes enormous pain and suffering does not even result in a jail door opening, which is why the actions of the U.S. Justice Department in failing to demand prison time for those responsible for the criminal actions at Purdue Pharma is our choice for the Outrage of the Week.
The New York Times reports that the committee of World Bank directors which was set up to review the actions of Bank head Paul D. Wolfowitz in connection with the compensation and promotion of his girlfriend, has found that he violated Bank ethics rules. This follows the resignation earlier today of top aide Kevin Kellems. It is inconceivable that Mr. Wolfowitz can, or would wish to, cling to his position in these circumstances.
We predict he will be gone within 24 hours.
