Leonard Lance, (R.NJ): Mr. Cruikshank, to follow up in your remarks. Do you believe there were corporate governance failures at Lehman?
Thomas Cruikshank, Chairman, Lehman board auit committee: No, I don’t. I think our governance procedures were really very, very good.
House Committee on Financial Services, April 20, 2010
A number of revealing facts emerged from testimony before Congress this week on the Lehman Brothers bankruptcy. The Securities and Exchange Commission said that, despite being aware of red flags, it did not believe it could press for any changes at the company where staff members were embedded for several months. It appears some SEC staff had other things on their minds, however.
CEO Richard S. Fuld Jr. claimed he had no idea about the problems that were brewing and had never heard of any Repo 150 transactions. And Thomas H. Cruikshank, chairman of the defunct investment banker’s audit committee and a Lehman director since 1996, pronounced that “(Lehman’s) governance procedures were really, very, very good.”
His statement came in response to a question from Rep. Leonard Lance (R-NJ), who accepted Mr. Cruikshank’s assurance without further question. And that was all that was asked about board practices at Lehman. The committee could have probed into some of the concerns we first raised on these pages nearly two years ago. It might have inquired whether it was really a good idea to concentrate so much power in Mr. Fuld, who was CEO, chairman and of the board and chairman of the board’s executive committee, or for half of Mr. Fuld’s handpicked board members to be in their seventies and eighties. It could have looked at the executive committee, which had just two members — Mr. Fuld and John D. Macombre, who was in his eighties at the time the Lehman crisis was unfolding. It might have cast its eyes on the risk committee of the board, which met on only two occasions in 2007, or considered whether several of the directors had been overloaded with responsibilities on other boards. Was being an actress sufficient qualification to be a board member,or was a poor performance something that was common to all of Lehman’s directors? The committee did not pursue any of these lines of inquiry.
In his voluminous report, Anton Valukas, the court appointed examiner for Lehman’s bankruptcy, gave the board a clean bill of health and said it did not know what was going on. He could not point to anywhere management had actually informed the board of the extent of the risks that were being incurred or the undisclosed use of accounting tricks like Repo 150. But he also does not cite a single case where directors asked discerning questions and where they were misled by management’s response.
However, in a scathing criticism of the SEC, Mr. Valukas told the committee:
The SEC did not ask the right questions. It’s failure to ask about off-balance sheet transactions in the post Enron-era is hard to understand.
But it is also hard to understand why Mr. Valukas did not apply the same thinking to Lehman’s board, which he seems to exonerate because it was not told about wrong doing or alerted to red flags. This, too, raises the ghost of the Enron board whose specter the examiner invoked.
On that point, it is unfortunate that neither Lehman investors nor legislators have had the benefit of an investigation such as the one the Enron board itself commissioned (much to its later dismay). In an extensive and courageous probe conducted under the chairmanship of William Powers Jr., the report concluded that:
Enron’s “Board of Directors failed … in its oversight duties” with “serious consequences for Enron, its employees, and its shareholders.” With respect to Enron’s questionable accounting practices, the Report found that “[w]hile the primary responsibility for the financial reporting abuses … lies with Management, … those abuses could and should have been prevented or detected at an earlier time had the Board been more aggressive and vigilant.
One wonders what at Lehman Brothers would have made the actions of its board so different or less deserving of scrutiny and condemnation than Enron’s. Would not a prudent board, faced with a crisis of unprecedented proportions in the capital markets, have made diligent inquiries of management that could have produced the answers needed to grasp the real extent of the company’s exposure? What questions might it have asked of its auditors and management that would have enabled the firm to detect the unfolding disaster at an earlier time? What steps could it have taken in its structure and composition as a board that would have made it more pro-active and less an array of Christmas lights that only work when the CEO turns them on? Mr. Valukas’s report was unenlightening in this regard, as were Mr. Fuld and Mr. Cruikshank at the committee’s hearing.
Mr. Fuld was paid nearly half a billion dollars in salary, stock options and bonuses between 2000 and 2007. In the same period, independent directors were paid approximately $20 million in fees and stock awards. For that sum, shareholders saw the fabled firm that had been a Wall Street landmark for more than 150 years sink into the ground and the value of their stock plunge with it.
They can be grateful, however, that Lehman’s governance procedures were “very, very good.” Had they not been as long-time director Thomas Cruikshank warranted and the Congressional committee accepted without challenge, instead of being faced with a calamitous outcome of historic proportions, investors would have had to deal merely with a catastrophe of unprecedented magnitude.
Such is the fantasy world that has long come to define corporate governance in America and the legislative and regulatory apparatus that permits it.
The court-appointed Examiner chose to continue the same lackadaisical approach to directorial performance and accountability in his search for answers as the directors themselves evidenced in their drowsy drift toward disaster.
A little noted statement in the report of the court-appointed Examiner in the Lehman Brothers bankruptcy reveals the extent of the deference displayed to the company’s former directors.
The Examiner admits in his report that he provided witnesses “advance notice” of the topics he intended to cover and that he allowed them to make use of notes and written statements before the interviews in order to “refresh recollection.” No doubt these were prepared with the assistance of legal counsel, whom the Examiner confirms represented interviewees in the “vast majority” of cases. Significantly, the Examiner chose not to conduct his examinations under oath, and, if that’s not astonishing enough, no transcripts were ever recorded. The Examiner preferred an “informal” approach over the formal depositions available to him.
This is how the largest bankruptcy in history conducted its search for information and how Lehman’s directors, who presided over the downfall, were allowed to take part in what amounted to a quest for the truth with all the rigor and intensity of a marshmallow roast – – without the fire.
We have long maintained that directors are among the most pampered class in the business world, accorded by society, the media, investors and the courts a level of deference and respect that has few parallels. Time and again, it is this approach that has permitted directors to take shelter in the harbor of the disengaged and uninformed, giving rise to the appearance of men and women who, having been lauded in press reports and company statements just days or hours before as experienced and exceptionally accomplished, suddenly adopt the demeanor of amiable dunces in their hapless efforts to explain what happened and why. This is what occurred in Enron’s collapse and before the fall of the Penn Central Railroad. The spectacle of Hollinger’s confused directors at Conrad Black’s criminal fraud trial in 2007, where board members appeared challenged even in reading important documents, will also be recalled among astute boardroom watchers.
As we noted well before the company’s demise, and repeated here, Lehman’s feeble approach to corporate governance was well established by its board and the structure and membership it adopted. It was, in our view, a significant and inevitable contributor to that downfall. It is an outrage that the Examiner chose to continue the same lackadaisical approach to directorial performance and accountability in his search for answers as the directors themselves evidenced in their drowsy drift toward disaster.
Once again, an inept board escapes culpability through a Houdini-like contrivance called the business judgment rule, one of the most anti-shareholder and destructive of legal principles ever to emerge in modern times.
Lehman Brothers made a brief return in the news today, just long enough to fall into another abyss of folly and misjudgment that will leave its former shareholders and the investing public shaking their disbelieving heads. The appearance of the once-fabled but now bankrupt firm comes in the form of a report by the court-appointed examiner. As The New York Times notes today:
The directors of Lehman did not breach their fiduciary duties in overseeing the firm as it acquired toxic mortgage assets that eventually sank the firm, a court-appointed examiner wrote in a lengthy report published Thursday.
The report, by Anton R. Valukas of the law firm Jenner & Block, found that while Lehman’s directors should have exercised greater caution, they did not cross the line into “gross negligence.” He instead writes: “Lehman was more the consequence than the cause of a deteriorating economic climate.”
Here’s what Mr. Valukas wrote on the Lehman board’s conduct:
The examiner concludes that the conduct of Lehman’s officers, while subject to question in retrospect, falls within the business judgment rule and does not give rise to colorable claims. The examiner concludes that Lehman’s directors did not breach their duty to monitor Lehman’s risks.
We rather strongly disagree. As we pointed out months before the collapse of the company, Lehman Brothers was a poster child for how not to run a board. On the Lehman boardroom stage there was but one speaking part, that of CEO Richard Fuld. He also served as board chairman, as well as chairman of the powerful two-man executive committee. The only other member was 81-year-old John D. Macomber. The executive committee met 16 times in 2007, more often than the board itself or any other committee. Lehman’s finance and risk committee was headed by 80-year-old Henry Kaufman. It met on only two occasions during 2007 — the very time that Lehman’s destructive risk, debt and CDO time bomb was ticking away.
Five of Lehman’s directors were over 70. Most were hand-picked by Mr. Fuld. Many had no previous connection at all with Wall Street. The 83-year-old actress Dina Merrill was a member of Lehman’s board and its compensation committee for 18 years until 2007. And we know that Mr. Fuld was compensated exceedingly well, to the tune of some $354 million between 2002 and 2007 alone. Somehow it seems poetically symbolic for the kind of board Lehman was that Ms. Merrill (about whose acting career we were early young fans) should have appeared on What’s My Line? and starred in such movies as A Nice Little Bank that Should Be Robbed and, a perennial favourite of many corporate directors, Catch Me if You Can (original 1959 version).
You can read more about Lehman’s antiquated and dysfunctional board here.
Once again, an inept board escapes culpability through a Houdini-like contrivance called the business judgment rule. In our view, this doctrine has been shown time and again to be one of the most anti-shareholder and destructive of legal principles ever to emerge in modern times. Talk about the need to stand up for capitalism. There is no greater form of boardroom socialism than the business judgment rule. Time and again, those who otherwise claim to have the intelligence and experience to govern giant corporations, and are paid handsomely for the privilege, suddenly appear to have been deaf, dumb and blind in the face of the disaster that was approaching. They say they should not be held to account. They claim they didn’t know what was really happening. They stress that they tried their best. Sorry things didn’t work out. Could they have a note from the court now so the besieged directors could go home early?
Lehman’s directors even managed to get away with this spiel at a time when the world was reeling from the unraveling of credit markets, when subprime mortgages and derivatives were sending off toxic alarms everywhere and when generally accepted standards of sound governance strongly signalled that the Lehman board was a train wreck just waiting to happen.
Fortunately, the judgment rule has few parallels that protect other professionals in a similar fashion, or society would be in an even more frantic state than it is today. Unsurprisingly, this rule takes its origins from a time when the courts felt it only proper to defer to men of means and that nothing too arduous should be permitted to interfere with their avocational diversions.
Under this doctrine, you have to wonder, if Clarabell the Clown and the Marx Brothers had been kibitzing about while serving on the board of Lehman Brothers in the years before its collapse, would the examiner’s report have been any different?
On second thought, you don’t have to wonder. You have your answer.
The settlement was not crafted to act as a deterrent to future wrongdoing or to give the investing public confidence that the SEC is looking out for their interests in this post-Madoff era.
U.S. District Court Judge Jed S. Rakoff had finally approved the settlement between the Securities and Exchange Commission and Bank of America. Our concerns seemed at least to have made an appearance in the courtroom, though they clearly did not carry the day.
As we set out here before the judgment, our greatest misgiving in the proposed settlement was the inherent unfairness surrounding the $150 million penalty, which effectively involved the transfer, without their consent, of money from one shareholder pocket to another. The main players in the abuse, which included key officers and directors, got a pass on making any payment proportionate to their responsibility. To us, the settlement could easily have been concocted by Groucho Marx. It was not crafted to act as a deterrent to future wrongdoing or to give the investing public confidence that the SEC is actually looking out for their interests in this post-Madoff era.
Judge Rakoff correctly focused on this shortcoming in his combined opinion and order:
An even more fundamental problem, however, is that a fine assessed against the Bank, taken by itself, penalizes the shareholders for what was, in effect if not in intent, a fraud by management on the shareholders.
Unfortunately, the specter of judicial deference to tribunals like the SEC was also looking over his shoulder and he was unable to do more than register his chagrin. That does not do a lot for investors who were victimized by the shell game Bank of America engaged in, but it may serve as further evidence that the SEC needs to seriously rethink what precisely it is seeking in such settlements. Too often, they seem cleverly designed to create the illusion that justice is being served, rather than fostering policies that promote investor confidence in the capital markets and stand the test of garden-variety common sense on Main Street.
Judge Rakoff gave his verdict on that score, calling the settlement “half-baked justice, at best.” We see it more like a pie in the face of shareholders, despite the efforts of a plain-speaking judge to do his best to prevent it.
Regulators and the investing public need to demand that boards of directors be placed on the front line of accountability and not be allowed to slip away from scrutiny like some escape artist in a circus act.
The SEC’s settlement with Bank of America, still to be approved by the court, raises another question beyond the shell game contrived to give the impression – entirely misleading in our view – of a fair financial settlement for shareholders. Our thoughts on the $150 million “penalty” were set out here.
The boards of both Bank of America and Merrill Lynch appeared to escape the scrutiny of regulators, as well. While some 25 management personnel and in-house lawyers were deposed by the SEC, no independent director of either company underwent such questioning. Though a great deal of attention was focused on emails to and from legal counsel and management, there is no evidence of any effort to look into what the board was thinking when it came to its role in the merger or in related compensation and disclosure issues.
The settlement makes reference to some rather cosmetic changes in respect of the compensation committee. One bars members from accepting “consulting, advisory or other compensatory fees from the Bank…other than routine compensation for serving as a Board member.” But the Commission has offered no evidence that any compensation committee director at Bank of America was receiving anything beyond normal compensation. In any event, the idea that such ancillary compensation might have played a role in compromising the independent judgment of compensation committee members has no antecedent in any of the SEC’s supporting documentation. It has, instead, the appearance of being included as a part of the settlement to make it look like something meaningful was done.
Finally, the settlement requires the Bank’s CEO and CFO to certify proxy statements along the lines set out under the Sarbanes-Oxley Act for quarterly and annual financial statements. But there is no requirement that any independent director, like the chairman of the board or the chairman of the audit committee, has to certify anything along SOX standards. This has always been a flaw in the existing SOX legislation from our perspective. It is one that could have been addressed in the settlement, as the certification process is intended to concentrate the mind of key shareholder guardians in a way that ensures that they have done their due diligence.
It is astounding that in the recent succession of corporate disasters of Depression-era proportions – which many feared would lead to a return of Depression-era misery – the SEC has not been moved to conduct a sweeping review of the generic failings of the board of directors. The often expressed discovery that it was the last to know of the problems, and that it had no idea what was really happening around it, is a common refrain on such occasions, as we remarked some years ago to the U.S. Senate Banking Committee when it was considering legislation in response to the Enron et al. debacle, and as we repeated in an appearance before Canada’s Senate equivalent later. It does not assist in investor confidence or society’s faith in its giant institutions of capitalism that boards either view themselves, or are viewed by regulators, as the junior partners in corporate performance and outcomes, as if they were some 1950s suburban housewife who by custom and design tended to be sheltered from having any knowledge of or responsibility for the business affairs of the household.
Time and again, in one corporate calamity after another, the question has been posed: Where was the board? If the world’s top securities regulator is not prepared to dig deeper to find out the answer, if it is unwilling to hold directors’ feet to the fire during major enforcement investigations like the one involving Bank of America, that question will persist like a great mystery. But as the world has been painfully reminded on too many occasions, boards have a role beyond being viewed as a riddle or the perennial focus of ridicule.
They are the governing authority elected by company owners to operate in their interests and according to the customs and standards of society. They are generally paid handsomely to perform their tasks, and when they fail, the consequences, in personal and financial terms, have been devastating. The only option, therefore, is for regulators and the investing public to demand that boards be placed on the front line of accountability and not be allowed to slip away from scrutiny like some escape artist in a circus act.
The czars and kings of Europe could not grasp why the people revolted against the high taxes, low wages, and hunger inflicted upon them by those who knew only opulence and self-aggrandizement. The Davos mentality still cannot fully understand the resentment of a public saddled with massive unemployment and a bill for bailouts and social costs that soars into the trillions.
The annual winter parade of the puffed-up peacocks of privilege has come and gone at Davos. The dire state of the world once again showed the courtesy not to intrude upon the gathering of major élites from business and government, permitting them to descend in their private jets and frolic at the best-catered parties in Europe. Reality, as it generally does at the World Economic Forum each January, seemed to pass by, as well.
Last year, they missed the extent of the global financial meltdown – a big miss given that it is widely seen as the worst crisis in 70 years. This year, they had trouble seeing what reforms are necessary to prevent such calamities in the future – or even that any are necessary. In 2000, Enron CEO Ken Lay declared to his fellow Davos participants that his company was the “21st century corporation.” In 2003, the gathering was abuzz over U.S. Secretary of State Colin Powell’s rock solid assertions that Saddam Hussein controlled “hidden weapons of mass destruction meant to intimidate Iraq’s neighbors.” In 2008, former Treasury Secretary John Snow announced at Davos that any U.S. recession would be ”short and shallow.”
Reality, to those inclined to view it from the cloud-fringed temples of great heights or beyond the attended gates of deference and privilege, often appears fuzzy and ill-defined.
As it was with the monarchs of early 20th century Europe who presided over one calamity after another, those responsible for the failures and excesses that led up to the great financial crisis of the 21st century lack the vision to figure out the solution. The czars and kings of that earlier era could not grasp why the people revolted against the high taxes, low wages, and hunger inflicted upon them by those who knew only opulence and self-aggrandizement. The Davos mentality cannot fully understand the resentment of a public saddled with massive unemployment and a bill for bailouts and social costs that soars into the trillions that stems directly from the abuses, failures and negligence of those in charge of the world’s financial ship. Like myopic despots who seldom bothered to read history, and inevitably stumbled into catastrophe over its unheeded lessons, these modern misguided princes of finance have already forgotten the events of the past year and seem headed for further anticipated collisions with the future.
Instead of striking an uplifting tone that shows the titans of Wall Street and its counterparts (or, perhaps, counterparties) actually “get it,” the spirit of Davos produced the grating sound of ingratitude and obliviousness. Josef Ackermann, CEO of Deutsche Bank AG, talked about the “noble role” of banks and announced that the world should “stop the bank bashing, the blame game.” Mr. Ackermann was chairman of this year’s forum at Davos. Billionaire Stephen Schwarzman, a regular attendee at Davos, warned there could be costs to the public’s jaundiced attitude toward the banking system. “My biggest concern is that, as a result of either proposals or tone, that financial institutions are going to feel under siege and their [sic] going to retreat with their extension of credit,” he told CNBC. Lord Peter Levene, chairman of Lloyd’s of London, mocked government’s role in bailing out the financial system: “I’m from the government — I’m here to help. You guys in the industry don’t know what to do, so we’re going to fix it for you.”
How quickly they forget. Citigroup, Bank of America, Wells Fargo, Bear Stearns, Lehman Brothers, Merrill Lynch, UBS, RBS, Lloyds, Fannie Mae, Freddy Mac, AIG and so many more, were all crumbling under the massive weight of writedowns and losses and a withering credit market that only government was able to repair.
Change, especially for those in the Davos world, often comes not in the reform that reality demands, but in the fantasy that overly indulged egos command. Not surprisingly, there is a resistance in the world of high finance to adopting or supporting widespread financial reforms. A reliance upon extended methods of liquidity and a zero Fed funds rate seems ingrained in business plans. And in a culture where obsession with bulging bonuses still prevails, you have to wonder what kind of screwy financial Frankensteins are being assembled that may once again place institutions, and the public, at risk. Paul Volcker, please take center stage.
Perhaps the irony is not entirely lost on the world that while many of its citizens shell out for the misjudgments of these Alpine participants, they also pay, as taxpayers, shareholders and customers, for this annual march into the snow drifts of élite folly.
When it comes right down to it, there are few thoughts the big players mount at Davos that could not be distilled into a simple Tweet. Their use of technology and methods of transportation have changed, but in most other ways they are little different than the princes and grand dukes who trotted themselves out every so often to remind the people that they still existed, confusing – as receding fragments of supremacy so often do – vanity with relevance.
The World Economic Forum may have found its way onto YouTube. But in most respects it is still a silent movie involving people whose attire might seem modern but whose sense of originality and connection with much of the world is as unfashionable and out of date as the Hapsburg dynasty. One might have thought that the most costly financial crisis since the 1930s and the highest unemployment rates in decades would have produced a paradigm shift at Davos, too. Instead, the world was treated to an encore performance of over-hyped élites desperately struggling to cling to any vestige of credibility and respect. They have forgotten even the most recent past. They have shown little vision for of the future. This is not leadership. It is an outrage.
As in previous years, we have included a YouTube film that gives an uncanny portrayal of the Davos mindset of another era.
