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.
What a contrast is the deathwatch that now grips many RIM analysts. Years ago, they were bedazzled cheerleaders. We had some thoughts on the folly of that short sighted thinking at the time. Today, they seem more like jilted fanboys in the face of the company’s announcement of record losses, shrinking sales and shipments and other setbacks in its new product launch.
What is happening at RIM is sad for the company, its employees and investors. What is sadder, still, is that, just like what happened at three other now vanished Canadian icons — Nortel, Livent and Hollinger — it was avoidable, and almost entirely the product of management arrogance that was unstopped because of bad corporate governance.
We wrote about these same issues in these same companies long before anyone else because they foreshadowed the crisis that history predicted was coming. In RIM’s case, it was a lesson that even major shareholders who claim a strong commitment to good corporate governance, like the Ontario Teacher’s Pension Plan, were too blinded by the prospects of giddy returns to see. So they and others gave a pass to the weak board structure and the mesmerized cast of directors who bought into a loopy management style.
These are not popular positions to take, as we often discover. When we raised issues about RIM’s boardroom culture and ethically challenged top management — and we were the first on record to do so — a barrage of nasty, vindictive and occasionally threatening emails and telephone calls followed. RIM, it seemed, could do no wrong even when it did (remember the stock option backdating fiasco?), and absolutely no one was interested in hearing a critical word because of the company’s success at the time. “Who needs a board when you have Jim and Mike?” seemed to be how most saw it. No one considered for a moment that RIM’s success might be fleeting, least of all entranced directors on its board. But being a director, investor or analyst is about more than being a captive of a shiny object, whether it is a glittering gold watch or a spellbinding (co-) CEO.
Next on the agenda will be a succession of directors who start to bail out, not wanting their reputations to be tarnished when the Chapter 11 filing is made and not admitting that they, too, took too long to use their mentality to wake up to reality, as Frank liked to urge on Cole Porter’s behalf.
Early clues to RIM’s fast approaching demise, which is clearly underway as the stock hurtles toward the five-dollar mark, were there for all to see, as they were, and are, for many other companies. They always begin with how the boardroom culture dictates the exercise of power and accountability or whether it plays any meaningful role in that process at all. But that is a view that too many inside and outside the boardroom, often caught in a hypnotic state of denial on the one hand and over-deference to the beguiling CEO on the other, remain unwilling to see. A change in fortune can always happen to the beneficiaries of great success and especially to those who make the mistake of assuming previous success is a guarantee for future wins, as JPMorgan’s board is in the process of discovering today in its widening scandal of losses, and as GM’s, Nortel’s, Lehman’s and Penn Central Railroad’s directors before them learned the hard way. It seldom announces its impending arrival in a corporate wide email.
For those interested in learning more about the missed boardroom clues that brought RIM to the brink, our full series of 25 posts over the past six years can be found here.
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Happy Birthday, Canada. Having survived the theatrics of Conrad Black’s renunciation, the vanishing of the Canadians icons he once headed like Hollinger, Dominion Stores, Massey Ferguson and Argus, and now his coming back to your forgiving embrace after being a guest of the U.S. penal system, you can survive anything. More significant, however, and worthy of recognition and praise on such a day, is the sacrifice and courage shown by the men and women of Canada’s armed forces who serve to protect freedom and democracy here and in far off lands, along with their families who give so much. A different kind of war is fought daily at home as well by those who battle poverty, injustice and the tyranny that is often inflicted by power on the part of governments, corporations and the media when that becomes untethered from moral values and human decency. They seldom receive plaques or medals, unlike Mr. Black who continues to hold his Canadian distinctions despite disgracing them (it was on Canadian soil in Toronto that Mr. Black engaged in his obstruction of justice for which he was convicted in the U.S.). These foot soldiers of a civilized society represent in their often unremunerated and unsung work the best of what Canada stands for in the world.
And other overdue thoughts on Conrad Black’s return to Canada, Obama’s fall, RIM’s folly, Canadian healthcare death panels and the changeless universe of Wall Street
The Centre for Corporate & Public Governance was interviewed last week about the frequent behind-the-scenes efforts of the privately financed Washington-based Committee on Capital Market Regulation to turn back regulatory reforms the group thinks get in its way. The piece is by Emmy Award-winning writer Justin Rohrlich and presents a timely and detailed analysis of a too-overlooked aspect of American business. It can be read here.
Once again, Wall Street’s memory makes an amnesiac’s recall look positively eidetic. We had a few thoughts on the CCMR’s earlier efforts to weaken Sarbanes-Oxley legislation just months before the near collapse of the banking system. Nobody in this group had the slightest concern at the time about excessive leverage, off-the-book transactions, credit default swaps that potentially ran into the trillions, or excessive boardroom pay scams that encouraged too many CEOs to take on too much risk. Many boards had no idea what was happening around them. Jimmy Cayne of Bear Stearns and Dick Fuld of Lehman Brothers were thought of as Wall Street heroes. Citigroup and AIG were proud supporters of the group’s efforts, then and now.
To our dismay at the time, then-treasury secretary Henry M. Paulson Jr. was known to support the early efforts of the CCMR to roll back the regulatory clock. A few months later, he was bailing out the very companies that had been squawking about too much government in their boardrooms.
That alone should have been enough to discredit the CCMR and anything it has to say now about the so-called excesses of Dodd-Frank and the Volcker Rule. As we said in the article this week: “The idea that the CCMR has anything credible to say about what is necessary to protect capitalism has got to be one of the greatest scams ever foisted on the American public.”
But in a world where memories are considered non-performing assets and rarely accorded any importance at all, the CCMR and its likes appear to have no difficulty in raising money in order to blunt the regulatory reforms of the government that saved capitalism from itself. The spirit of E. Merrick Dodd Jr., who made a similar observation after the economic collapse that followed the Great Depression, would not be surprised.
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We have been less than regular in our comments and reporting of events that shape the accountability of leaders, the responsibilities of capitalism and the madness that continues to infect the boardroom on the subject of CEO compensation. Life- changing events have a tendency to rudely interrupt even the most important of debates, and I must confess there have been a few in my family to deal with over the past 18 months. We may fool ourselves that we sit in the saddle able to command our direction and destination, but it is the horses of fate that are often in control of where we wind up, as any family suddenly faced with a medical trauma surely knows. Such events tend to concentrate the mind on the preciousness of life. Unfortunately, that appreciation is not as universally held in the health care system as one might think. For while they were a concoction of anti-Obama forces during the great health care reform debate in the United States a few years ago, the shocking reality is that in Canada’s often praised but entirely unaccountable medical system, the specter of death panels, and a bias against what are seen as too costly efforts to prolong the life of the elderly, even for those with a chance of recovering, has now arrived. Extricating an elderly parent from the jaws of certain hospital death, whether from neglect or a predisposition by medical professionals to end that life, can be just as traumatic and debilitating to a family as the injury that put them there.
Further thoughts on this third rail of the Canadian health care system will ensue.
* * *
For all the pain felt mostly on Main Street and in the dire state of the U.S. deficit, but apparently long since forgotten on Wall Street, the aftermath of the worst economic calamity since the Great Depression has changed very little in American business. Wall Street and big bankers have conveniently forgotten about the missteps that brought the financial system to the brink of collapse. Boards continue to be out of touch with what is happening around them and still show up with the water hose long after the fire has erupted, as recent events at companies like Chesapeake Energy, CP, and Yahoo confirm. Citigroup remains an under-five-dollar-stock, when you strip away its reverse one-for-ten split. Bank of America seems headed in that direction, too. Lobbyists still make millions in their insidious attempts to skirt reforms and undercut measures to save the middle class. CEO pay soars without any connection to performance or to the independent thinking of fully engaged directors. And in the White House, the greatest hope for change in the way Washington works since FDR has permitted a sequence of blunders and mishandled events (support for an extension of the Bush-era tax cuts while failing to champion Simpson-Bowles, to cite just two) to tarnish that promise to the point where the presidential podium seems destined once again to become an institution of, by and for the billionaire class. Barack Obama’s uncertain future in the face of a querulous electorate is all the more bewildering given that Republican contenders for their party’s presidential nomination have unleashed the most divisive assault against good judgment and common sense since the short- lived Know-Nothing party of the mid-19th century. Not even the most recent Republican circus-like spectacle was sufficient to give the White House an edge, so bad has been its handling of major issues and how it has allowed them to be misperceived in a regressive sea of billionaire-supported super PACs.
Elsewhere, investors, along with once starry-eyed analysts who were too long prepared to give a pass to the governance failures and shortcomings of Canadian- headquartered Research In Motion, have at last been jolted by the carnage we predicted. Company co-founder and long-time co-CEO and co-board chair (the titles alone reflected the dysfunctionality of the boardroom) Jim Balsillie, is gone. The devastation wrought by years of board neglect will take much longer to fade away, if it ever does. There is hope, however, in what Bill Ackman managed to pull off in awakening investors at CP and prompting them to replace a dozy, imperious board with a strategy that might add value, which is precisely what most boards should do but don’t. There is little to take hope from in the Facebook IPO fiasco or the ceremonial (and that’s all it is) board that Mark Zuckerberg put together.
Also in Canada, the dark prince of the Canadian establishment, Conrad M. Black, has returned. His reentry to the country whose citizenship he renounced to accept a British peerage (evocative of Sir Thomas More’s plaintive inquiry to a chief witness in his prosecution, “but for Wales?”, in Robert Bolt’s A Man for All Seasons), only hours after his release from the U.S. penal system, stunned many observers and immigration lawyers who claimed that such a deal would not be available to anyone else. I do not begrudge Mr. Black’s return to Don Mills, a childhood haunt we both shared. What I do take issue with is the special treatment hatched behind closed doors that has all the earmarks of Canada’s elite, including at least two former prime ministers and a string of A-list partygoers, going to bat for Mr. Black by influencing the Harper government to pull strings that are invisible, and most definitely unreachable, to anyone else.
But then special treatment and a lifetime of doors opened expressly for him have been the recurring landmarks of Mr. Black’s public and business life. He still holds the various national honors bestowed upon him which were revoked for other (actual) Canadian citizens when they fell into the criminal abyss. Special parking spaces in the often busy nearby York Mills Shopping Centre surely cannot be far behind for his lordship. In fact, Canadian novelist Margaret Atwood, one of Mr. Black’s newly recruited fans, might put her own talents to good use by inveigling, through poetry or other literate means, the City of Toronto to establish a special lordship-only lane that would permit Mr. Black to motor briskly without undue delay along Bayview Avenue for those quick shopping errands he missed doing for the past few years. Once the special express train of privileges and exemptions gets rolling in Canada, where half of the legislative branch of the federal government is still appointed by the imperial wave of a prime ministerial hand with not a whit of public input, there is no stopping it.
Still, my 90-year-old mother, who always had a corner on the family’s supply of sympathy for Mr. Black (fortunately for him she did not see Mr. Black’s recent performance with the CBC’s Peter Mansbridge), and whose survival from an incredible array of medical blunders and the arrogance of an astonishing assemblage of unaccountable actors in the Canadian health care system could only have been produced by Divine intervention, is heartened to know that Mr. Black will finally get to enjoy his August by a Don Mills ravine. At this point, that’s good enough for me. Like the Canadian author Barbara Gowdy who made it famous, and Mr. Black, I, too, participated in its wonders and delights for many years with friends sadly lost to the mists of the retreating years and still not recoverable by the famous Facebook time machine.
Mr. Black has paid his formal debt to U.S. society. Civil servants often easily manipulated at the behest of their political masters, along with the rich and powerful, may have skirted the rules to allow a preferred outcome in Mr. Black’s case. And further explanations and inquiries are surely appropriate in a land where the rule of law, and not the power of individuals, is supposed to be the defining principle of its civil society. But at least for this summer, Mr. Black should have his chance to gaze upon the woods from his baronial mansion and to ponder the freedom of the foxes at dusk and how their survival still depends, as it forever has, upon the cunning of their instincts and the swiftness of their mind.
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Our rambling journey from the White House and Wall Street to Don Mills and Canadian health care death panels barely scratches the surface of thoughts unvoiced on these pages over the past many months. No mention has been made of Irish Setters (a rescue joined our family not long ago); the Titanic; Davos and the G8 (two modern day hubris-afflicted and overrated Titanics of another kind), the Great Pyramids of Giza, which can never be overrated; Jazz and the unique vocal stylings of Stacey Kent; Oliver Jones, who somehow manages to put more piano notes in a song than even another favorite, Oscar Peterson; the magical clarinet tones of the great Artie Shaw; Muskoka sunsets; the 1960 World Series; Clare Island salmon; the Susan Hampshire rose; and any movie written by Robert Bolt and directed by David Lean.
These and other favorite topics will have to await another day.
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.
