Essay by J. Richard Finlay
The blind eye which shareholders and analysts too long cast upon the abuse of excessive CEO pay is now being turned to the recent trend of monetizing ethical abuse. Who knows when the tipping point might come in the ever-widening wealth gap where capitalism is finally seen to cross the river of moral conscience and moves from being trumpeted as a source of social progress and individual incentive to one of middle class tyranny and public opprobrium.
Continuing from Part I
One of the defining features of today’s world of big business is that, too often, shareholders have been willing to turn a blind eye to any amount of pay to a CEO, no matter how disproportionate, as long as they were getting impressive returns each quarter. Never mind how many times poorly crafted compensation devices gave incentives to CEOs to artificially push up the stock when such growth could never be sustained in the long run. As I suggested to the U.S. Senate Banking Committee long before the financial meltdown that traced its roots in part to unsound compensation schemes:
The most corrosive force in modern business today is excessive CEO compensation. Such lofty sums tempt CEOs to take actions that artificially push up the price of the stock in ways that cannot be sustained, and to cash out before the inevitable fall.
Our comments on these pages and elsewhere over the years have also attempted to rebut the most common justifications frequently advanced by boards as to why CEO pay needs to be at the level to which it has skyrocketed.
But the inescapable lesson of history appears to be that no boardroom scandal or financial meltdown is so great, no gap in wealth or income is so wide, that it will deter CEO pay from its self-appointed destiny of creating the wealthiest professional class in the history of the world.
Now a view is emerging in many boardrooms and on Wall Street that appears to regard ethical and legal transgressions, even the kind that result in multi-billion dollar fines, penalties and settlements, as mere transactions. This is the case with JPMorgan Chase, whose profitability is so vast its shareholders are prepared to accept a record settlement with the U.S. justice department for $13 billion (among other penalties) as just another cost of doing business. The stock has risen 28 percent in the past 12 months. Other examples abound, including Bank of America’s $9.5 billion to settle government actions involving federally insured mortgages, $1.2 billion paid out by Toyota and $7 billion in penalties by drug makers GlaxoSmithKline, Pfizer and Abbot.
It is not as if the ethical and legal dimension of business has suddenly dropped onto the corporate landscape unexpectedly. There are more compliance officers and university think tanks on ethics than at any time in the history of business. Every publicly traded corporation has a code of ethical conduct. Company websites all make reference to being committed to the highest standards of ethics and honesty. Most CEOs will give an annual keynote speech somewhere showcasing the social responsibilities of their business. I’ve written many of them over the years myself. Enron had a stellar reputation for commitment to high ethical standards. Its CEO, Ken Lay, liked to be known as “Mr. Business Ethics.” But between the words and the actions of too many companies there falls an ethical shadow. It is much easier to simply assume a standard of ethical performance than it is to subject it to the scrutiny and testing it actually requires.
History is littered with the bleached remains of fallen giants, even of the corporate species. Nortel and BlackBerry not long ago led their industries. Today, one has vanished and the other is quickly disappearing. Some years ago another Canadian institution, Royal Trust, collapsed under the slumbering eyes of inattentive directors and stunned regulators. Livent was North America’s largest publicly traded theatrical entertainment company. But its most artistic accomplishment came in the form of the highly creative, but decidedly unlawful, accounting engaged in by its Toronto-based founders Garth Drabinsky and Myron Gottlieb, who both swapped the company’s swank Manhattan condo for sentences in a Canadian prison.
General Motors had a hammerlock on the North American auto market that was thought to be unbreakable, until it limped pathetically to the wicket of government assistance and declared bankruptcy. The “new” GM is today being rocked by the lingering effects of a culture that dismissed the risk of customer deaths from defective ignition switches as an acceptable business cost. Microsoft, once the dominant force in consumer software to the point where it actually fixed prices, has been reduced to selling software for competing Apple iPads on the rival iTunes store as consumers abandon its signature Windows software in droves. And to the pantheon of vanished business icons, Bear Stearns and Lehman Brothers are now fully inducted, as are their former leaders, Jimmy Cayne and Dick Fuld.
Like many other companies, they were lost to the all-too-common, but entirely avoidable, affliction of hyper-ego and deficient common sense. Before the crisis that claimed them, we often asked here if some of these companies actually had a real board of directors, since it seemed there was little evidence of them when they were most needed.
In situations like these, and in many others, when disaster strikes the board of directors typically professes surprise and claims to have no idea what could have caused it. Memo to board secretaries everywhere: Have a full-length mirror installed in the boardroom.
The idea that there are few outcomes that are not insurmountable when a company skates over ethical and legal boundaries, that a board can throw money at any type of egregious conduct to get past it, is fundamentally subversive to the well-being of both capitalism and society. It feeds the delusion, commonly held by many who enjoy great wealth and power, that certain companies are endowed with a financial shield so impenetrable it makes them invincible to the consequences of their actions. This same view creates a culture of moral hazard where the scale of the transgressions, and the costs necessary to remedy them, inevitably keep getting bigger and bigger until the unthinkable calamity occurs. As the lessons of the great financial crisis of recent years demonstrate, when the unthinkable does happen, the CEOs whose misjudgments caused it have long fled with their trove of stock options profitably cashed out, while ordinary shareholders, and occasionally taxpayers, are left to pick up the pieces.
Far more important than the loss of any one giant, however, is the integrity of the system of capitalism itself. Capitalism cannot survive if its leaders, guardians and gatekeepers remain willing to tolerate such costly misbehavior. Nor will society, whose support it requires, endlessly abide a system that does not convincingly demonstrate that it recognizes a sacred obligation to the public for upholding a standard of ethical conduct that goes well beyond what has been evidenced by many firms in recent years. Lest there be any doubt, twice in the past 100 years, capitalism has effectively turned to government for its very survival in what amounted to a public bailout from the epidemic of excess and misjudgments that led to massive job losses and social dislocation.
It would be the height of folly for the titans of Wall Street and elsewhere to conclude, as a result of these recent multi-billion dollar settlements, that they can simply write a cheque and continue on with business as usual whenever moral impediments stand in the way of increased profitability and outsized compensation.
Business has misjudged the reaction of society to a number of major issues over the years, from the dangers to food safety and the exploitation of child labor to threats to the environment and the need for safer cars. The results were not particularly welcomed by business nor were they predicted by it. And the business world did not exactly distinguish itself by the silence of its leaders in the early phases of the subprime meltdown or for presiding over an inadequately governed system that let America down to the point where corporate welfare through the generosity of government became capitalism’s only hope. When high profile tycoons like former GE CEO Jack Welsh and Home Depot’s billionaire co-founder Ken Langone bemoan the expressions of antipathy toward Wall Street and big business, voicing puzzlement over its cause, as they regularly do on CNBC, for instance, they betray a larger disengagement from the forces that shape the social and political dimensions of modern capitalism.
Who knows when the tipping point might come in the ever-widening wealth gap where capitalism is finally seen to cross the river of moral conscience and moves from being trumpeted as a source of social progress and individual incentive to one of middle class tyranny and public opprobrium. A firestorm of outrage may be in the waiting.
In that context, it is not unreasonable, and certainly not imprudent, to suggest that if a more fair and honest culture consistent with the core values with which America has always approached its concentrations of power, is not soon embraced, if the idea that ethical abuse can be monetized is not quickly dispelled starting with capitalism’s most valued icons, the costs to investors and to society will be measured in more than the Sagan-like billions and billions tallied thus far.
Seven years for a high profile corporate fraud may not seem like much compared with the sentences handed out in the United States (see Jeffrey Skilling, Bernie Madoff et al.), but it is an eternity for Canada. The country that produced Conrad Black and Garth Drabinsky has become notorious for its light touch when it comes to dealing with boardroom felons. But something, perhaps that very fact, appeared to prompt Judge Mary Lou Benotto to take a different approach and hand out a sentence today that was toward the higher end of what was expected – including on these pages. It is even more than the 76 months Conrad Black, Mr. Drabinsky’s good friend and former Livent board member, got for his corporate fraud adventure.
The seven years that elapsed between charges being laid against Mr. Drabinsky (2002) and his sentencing (2009) shows that Canadian justice can move painfully slowly. But today also demonstrates that, in the end, reasonable justice – not the Bernie Madoff-type American overkill or the wet noodle approach so often handed out by Canada’s top securities regulator – can prevail and the time can be set to fit the crime. Even for the rich and famous.
We had some harsh things to say about some of the wording in the judge’s verdict and the slow approach taken in the sentencing process. But now it appears that Madame Justice Benotto has discharged her duties with fairness and with firmness. The security of Canada’s capital markets at home and their reputation abroad are better for her efforts.
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.
We have received a number of emails from readers who were shocked at the revelation, first brought to light on these pages, that, between them, the boards of Livent and Hollinger had seven directors who became convicted felons. Here’s another gem: three of them were trained as lawyers. The number of felon directors on these boards sets a record for modern publicly traded corporations. For those interested, here’s how the total was calculated:
A. Alfred Taubman, Director (convicted of price fixing, 2001)
Conrad M. Black, Director (convicted of mail fraud, etc., 2007)
Garth H. Drabinsky, Director (convicted of fraud, etc., 2009)
Myron I. Gottlieb, Director (convicted of fraud, etc., 2009)
A. Alfred Taubman, Director (convicted of price fixing, 2001)
Conrad M. Black, Director (convicted of mail fraud, etc., 2007)
F. David Radler, Director (convicted of mail fraud, 2007)
Peter Y. Atkinson, Director (convicted of mail fraud, 2007)
John A. Boultbee, Director (convicted of mail fraud, 2007)
Black, Drabinsky and Atkinson were trained as lawyers.
Gottlieb and Boultbee were trained as professional accountants.
Both Black and Drabinsky, during the time of the crimes for which they have been convicted, were members in good standing of the Order of Canada, the country’s highest civilian honor. They remain so today. There is no indication if or when they will be stripped of that prized decoration, which, as we have long maintained, is a sad commentary on the distinction, on the men and women or who hold it and, especially, on those who are entrusted with maintaining the integrity of the award.
The descent to criminal status of Livent’s founder, like that of his friend and former board member Conrad Black, was stunning but not entirely surprising, given the contempt both men showed for modern corporate governance practices. Between the boards of these now defunct stock market icons, Livent and Hollinger, there stands a roster of seven directors who became convicted felons.
They shared a taste for the finer things and reveled in the image of being larger-than-life figures. They were also good friends. One served on the other’s board. Both were members of the esteemed Order of Canada and held numerous honorary degrees and other accolades. And when they fell into legal difficulties, they were represented by one of Canada’s most respected criminal lawyers, Edward Greenspan. Now they share another label: convicted felon. Soon Garth Drabinsky will follow his friend Conrad Black, now serving a 78-month sentence in a Florida federal prison, to a new address with a very tall fence and rather drab clothing. Earlier this week, Mr. Drabinsky and his long- time colleague, Myron Gottlieb, were convicted in a Toronto court on all charges of fraud and forgery in connection with their management of Livent, a once- thriving theatrical production company.
Like Mr. Black, Mr. Drabinsky travelled in a rarified circle of the rich and famous, occasionally bumping into more common mortals. There was a rather eerie period a few years ago when Mr. Drabinksy and I frequently found ourselves standing just behind or in front of each other at some pleasant dining establishments in New York and Toronto. At one point, a maître d’ at the Four Seasons asked if we were together. The New York coincidences ended when Mr. Drabinsky was charged with securities fraud by the Manhattan U.S. Attorney and became a fugitive from justice when he failed to surrender himself. For a while, we shared the same tailor. Mr. Drabinksy had an understandable preference for Italian Brioni custom-made suits. His appearances were always considered something of a theatrical production themselves by my tailor, who would boast frequently that the impresario had just picked up four or five new suits. Helping me pick out an on-sale, off-the-rack Brioni must have seemed like a real off-Broadway production to this impressionable fellow.
More than once I have found myself standing in front of the pastry counter at what some think to be a chichi grocery store when Mr. Drabinsky has popped up to inquire about the freshness of a chocolate layer cake.
A couple of summers ago, we wound up on the same road in the middle of nowhere in Ontario’s cottage country. But there was Garth, in his black Porsche Cayenne Turbo, dawdling and weaving on the road in front of me, looking like something of the Phantom of the Highway. I think he may have been looking for property on which to build his new $5 million cottage, which I thought at the time was quite a display of chutzpah, given that a number of friends had just put together a legal defense fund for him after Canadian authorities charged with fraud and forgery.
I gave a short blast of my horn as I moved around him, fearing that he might wander into the passing lane. He managed a pleasant smile and a wave, not realizing once again that it was the fellow who was the first to raise red flags in a major publication about Livent’s corporate governance.
Therein lies another interesting trait Mr. Drabinksy and his corporate empire shared with Conrad Black and Hollinger: a board of directors where management dominates and controls. Mr. Black was CEO, chairman and president, as well as chairman of the executive committee, of Hollinger. Mr. Drabinsky held the same posts at Livent. Perhaps he took his cue from Hollinger’s structure and confirmed it by placing Conrad Black on his board. When Mr. Drabinksy fell into legal difficulty, Mr. Black was part of a group who came to his rescue. Order of Canada members stick together, it seems, inside and outside the law. (There is still no indication that Canadian officials seek to strip Mr. Black of that country’s highest honors or of the membership he holds in Canada’s Queen’s Privy Council).
What boggles the mind is the stellar board of directors that Livent boasted. The names follow below in my original op-ed piece published in the Financial Post in 1998. One name, in addition to Mr. Black’s, stands out in Technicolor: A. Alfred Taubman. Mr. Taubman, who was also a director of Hollinger, served on Livent’s audit committee. In 2002, he served one year in federal prison for criminal violation of antitrust laws.
Thus the following fact is now revealed for the first time in the context of the criminal convictions this week in Toronto. At Livent, five individuals who held the post of director have at one point or other been convicted of criminal conduct. At Hollinger, five directors in the company were also found guilty of white-collar crimes. Two -Black and Taubman- sat on the boards of both Hollinger and Livent. Between the boards of these now defunct stock market icons, Livent and Hollinger, there now stands a roster of seven directors who became convicted felons. Odd, too, is the shared training both Mr. Drabinsky and Mr. Black had as lawyers. Both earned a well-established reputation for their inclination toward litigation. It is in the most serious kind of litigation, the fight for one’s freedom, that both lost their reputations.
When I used to make observations about the risks posed by so many insiders on the boards of Livent and Hollinger, many in the business press and market analysts would often skoff at my concerns and point to the stellar performance of the companies and the trophy names on their boards. Now it seems that this structure was a convenient cover for the perpetration of accounting frauds in two orgnizations where the CEO had little trouble mesmerizing even big name directors, who ultimately showed little knowledge of, or sympathy for, modern corporate governance practices. One wonders if the board thought it was viewing a theatrical event rather than governing a publicly-traded corporation. At Livent, directors gave Mr. Drabinsky and Mr. Gottlieb bonuses even when the company was losing money, and allowed Mr. Gottlieb to sit on the board’s audit committee. Even the recurring statement in Livent’s proxy circular that the board was viewed by management as something of an advisory group did not seem to bother these directors. One phrase especially caught my attention a decade ago when the company claimed that the board preferred to rely on the “specialized expertise” of Drabinsky and Gottlieb. We learned the meaning of “specialized expertise” this week.
How loud the thud when oversized egos come crashing to the earth, which they otherwise rarely touched before. No matter how often the sound is heard -Conrad Black, Bernard Madoff, R. Allen Stanford and, recently, Peter Pocklington, one-time owner of the Edmonton Oilers who gave Wayne Gretzky his first NHL season, come to mind- it is impossible not to wonder what might have been if they had been imbued with a lesser ego and a larger sense of integrity and perspective that might have kept their feet more firmly planted on the ground.
One of my articles on Livent did manage to make its way into the Financial Post some years ago. I have reprised it below. Incidentally, this was my final contribution to the Post, which had been running my Op-Eds since the 1970s and on a number of occasions called on me to help write editorials in the newspaper. Shortly after the article was published, Mr. Black bought the paper. I was told later by editors that he did not appreciate the article about Livent. My by-line did not appear in the Post again. Mr. Black’s successors -who continue to cheerlead for him and run the occasional columns produced from his prison cell, and have expressed the view that his crime was of a minor nature- prefer to keep it that way. The Financial Post ran a retrospective of the key articles it had published about the Livent saga going back to 1998. It did not include the article below, which ran in August of 1998.
Saturday, August 15, 1998
Livent shakeout raises issues about how boards work
By J. RICHARD FINLAY
The Financial Post
The guns of August are booming again. Four summers ago, the blue-chip board of Confederation Life Insurance Co. came under fire for its failure to prevent that company’s collapse. This time, the target is Livent Inc., where assertions of financial irregularities have led to the suspension of company founders Garth Drabinsky and Myron Gottlieb. On their face, the accusations seem implausible. If true, they would mean there had been a systematic juggling of the books under the noses of some of the most prominent figures in Canadian business. Once again, troubling questions would be raised about whether boards really work, or whether they are just relics of the past.
It will likely be some time before all the facts come to light, but the recorded corporate governance practices of Livent give important insights into the nature of board supervision in the company.
For the period in which the irregularities allegedly occurred, Livent had a board that varied between 13 and 14 directors. Toronto Stock Exchange guidelines, as well as best governance practices elsewhere, recognize that there should be no more than two insiders on the board — usually the chief executive and chief operating officer. In Livent’s case, three senior company officers were also directors in addition to Drabinsky and Gottlieb. Five insiders on a board of 14 is a rarity in Canadian business these days, and not an admirable one at that.
Interesting, too, is the fact that Drabinsky held the dual positions of chief executive and board chairman up to June. It is widely believed that having a non-executive director as board chairman provides for better accountability and board oversight of management.
The most notable feature of Livent’s board, however, is the fact that it is composed of such high-profile names. Conrad Black has been a director since 1993. Joseph Rotman has been on the board since 1995. Jim Pattison joined the board in 1997. Indeed, in some ways it would be difficult to find a more distinguished board. Black, Rotman, Pattison and Drabinsky are all members of the Order of Canada.
Could such respected and experienced business leaders have been duped? Did the audit committee of the board, which included Rothschild Canada chief executive Garfield Emerson, Sotheby’s chairman and shopping centre king Alfred Taubman and polling guru Martin Goldfarb, fail in one of the director’s most solemn duties: to, as Harvard board scholar Myles L. Mace observed, “ask the right questions”? Or were they given the wrong answers? Livent also claims outside directors on the board’s audit committee have a procedure for meeting independently with the auditors, if they so choose. It will be interesting to learn in the weeks and months ahead if they ever did.
The company has declined to follow TSE recommendations and form a nominating committee composed of outside directors for the selection of new board members. Instead, company documents as recent as May state it prefers to rely upon the “specialized expertise” of Drabinsky and Gottlieb, who, along with unnamed outside directors, look for board members who will “supplement” management. That concept alone, where directors are viewed as some kind of appendage of management, ought to have set off alarm bells among professional investors.
The same philosophy might explain why the board felt no need to follow TSE guidelines in forming a corporate governance committee to examine ways of ensuring board effectiveness. Perhaps now they might wish they had.
Much is resting on the outcome of what happened here, not the least of which is Canada’s already tarnished reputation in global investment circles over the Bre-X Minerals Ltd. and YBM Magnex International Inc. scandals.
If financial irregularities did occur, it may be hard for the investing public and policy makers to resist concluding high-profile boards are little more than ornaments on management’s Christmas tree, and sweeping change is needed.
A Canadian court found Livent founders Garth Drabinsky and Myron Gottleib guilty (on all counts) of fraud and forgery in one of the most high profile white collar criminal cases in recent Canadian history. We will have more on this stunning development in an upcoming posting.