How this 85-year-old icon of Wall Street was governed was also a clue as to how it might fail.
When rumors were circling the company and threatening its survival, it responded by issuing a strong statement denying liquidity problems. The board agreed. But astonishingly, the company disintegrated less than 48 hours later and was quickly valued at only $2 per share in a fire sale to JPMorgan. The board agreed with that number. Then, in yet another stunning twist, just a few days later the company was suddenly valued five times higher by the same suitor and a new price of $10 per share was set. The board agreed with that number, too. In the dust and rubble that cover the collapse of Bear Stearns, much is still unknown and unexplained. But one thing is clear: the fifth largest investment bank in America has been governed by one of the most incurious and acquiescent boards in history. On the other hand, perhaps it has had no real board at all.
On paper it appears that Bear’s board complies with NYSE rules and Sarbanes-Oxley legislation. Dig deeper though and you will find a dysfunctional board, overstretched independent directors and an executive chairman whose approach to his duties is novel, to say the least.The first thing that hits you about this Wall Street icon is that it is governed by men. Only men. It was like that at its inception in 1923; it remains a men’s club in 2008. Three of its 12-member board are insiders, as is the executive chairman, James Cayne. (There were actually four insiders until Warren J. Spector, the firm’s president and co-chief operating officer, resigned last fall over the collapse of Bear’s hedge funds.) Best corporate governance practices generally prefer management limited to one or two seats at most. The insider problem in Bear’s boardroom is even more pronounced where all the heavy lifting is done: the company’s executive committee. Composed entirely of the top insiders of the investment bank, company filings confirm that in 2006 (the most recent figures available) the executive committee met on 115 occasions. By contrast, the full board met only six times.
When the board of a sizeable and complex institution such as Bear Stearns believes it has so little need to meet, it is generally a sign that the company’s corporate governance culture has not evolved to the level that shareholders and the global capital markets require in the 21st century. Another red flag is the existence of a committee of insiders that performs much of the board’s work to the exclusion of any independent director involvement.One of the hallmarks of boards today is the role of independent directors and the extent to which they are actually informed and empowered. When they are left out of the equation, accountability and sound decision-making can be severely compromised. There was an executive committee composed solely of insiders at Hollinger International, for instance. It was headed by Conrad M. Black, who also held a jaded view of modern corporate governance practices. Lord Black of Crossharbour, as he prefers to be called, is now presiding over a small cubicle cell at the Coleman U.S. prison complex in Florida.
It’s not that Bear’s independent directors are underworked, however. They are busy –serving on the boards of other publicly traded corporations. On the all-important seven-member audit committee, three directors hold among them 18 board seats on listed companies. Vincent Tese, the audit committee chairman, serves on the boards of five listed companies in addition to Bear Stearns. Two members of the audit committee, Michael Goldstein and Frederick Salerno, serve on the audit committees of 11 public companies between them. In the Sarbanes-Oxley era which tightened up the role and duties of audit committees, it is rare, and more than a little troubling, to see boards tolerating that level of concurrent responsibility on the part of audit committee members.
Bear Stearns was among the most aggressive risk takers of the top investment banks. Its demise today reflects how poorly that risk was managed. Yet the firm never took a formal approach to its risk oversight responsibilities until a year ago when, on March 22, 2007, the board approved the charter for a finance and risk committee. Prudent directors would have known, given the nature of Bear’s business lines and how intricate its products had become, that a risk committee was called for much earlier. The choice of how Bearn Stearns was governed and how its board was structured to discharge its duties were clearly a decision of its directors and, especially, of James Cayne, who became CEO of the firm in 1993 and has been chairman of the board since 2001.
In my 30 years or so of following, working with and commenting on boards, I have come to learn that the chair of the board sets the tone for how it performs. In searching for clues as to where the board was when the seeds of Bear’s destruction were being sewn, one need look no further than Mr. Cayne. It has often been asserted, in the aftermath of boardroom debacles, that directors were asleep at the wheel. In Mr. Cayne’s case, there is compelling evidence that he was not even on the ship.
When Bear’s mortgage-based hedge funds were collapsing last summer –and there were strong adumbrations of a gathering storm of subprime credit before this– Mr. Cayne was off enjoying a golf and bridge vacation. As we noted previously:
Of course, it is harder to excuse a CEO who is making stupid mistakes or issuing comments that are so at odds with reality that it becomes impossible to have confidence in his sense of vision and judgment. This was the case with Mr. O’Neal’s previous pronouncements that things were looking OK with the subprime situation at Merrill Lynch. And we expect it will also be the case with Bear Stearns’s Jimmy Cayne, who rode out that company’s summer hedge fund storm in the calm of a golfing and bridge tournament vacation and who may yet learn that, in the department of CEO appearance, a corporate crisis always trumps a card game. Others will surely fall before the latest turmoil is quelled and the surprise-o-meter is likely to get quite a workout when all is said and done.
The first losses in Bear’s history soon followed Mr. Cayne’s summer shenanigans. A few months later he gave up the CEO slot while remaining executive chairman of the board. They were not the only hits the above noted surprise-o-meter took, as predicted.
But in an astonishing encore of his now infamous disappearing act, Mr. Cayne was at a bridge tournament in Detroit while the investment bank was facing its deepest crisis ever. This he chose to do even while rumors about the company’s liquidity problems were so rampant that it had to put out a press release denying them. So bizarre were Mr. Cayne’s actions that the only equivalent that comes to mind is Nero’s reported fiddling while Rome burned. It is no doubt an approach to a director’s duty of care that has not escaped notice by the shareholders’ bar. There is no record of any independent director having been troubled by Mr. Cayne’s frolics during the past six-month fall of the company. There is no evidence available that the corporate governance committee, whose charter includes “the evaluation of the Board and management,” or the lead director, took any action to replace Mr. Cayne when it was first apparent that he had other priorities besides leading the board during this decisive period.
With a board that seldom meets and has a habit of giving over so much of its authority to an insider-dominated executive committee, and an absentee leader at the helm like James Cayne, one wonders precisely how much due diligence directors did before they signed off on the sale. They sizably undersold the company’s assets, as the recent $10 per share price –five times what the board accepted last week- confirms. Such a dramatic shift over a period of just a few days in what the directors think the company is worth suggests a board that is either being poorly advised or is not entirely focused on its duties. It was an approach to corporate governance in Bear’s boardroom that was consistent with the pattern of shortcomings that brought the firm to the point of crisis and collapse in the first place.
Much of what happened and how it could have been permitted remains a mystery. There were, after all, many lessons from the past that showed the painful consequences of disengaged boards which the chairman and directors of Bear should have committed to memory. But this much is certain: When such an important financial institution begins to crumble so quickly, leaving the capital markets in turmoil and requiring the intervention of the highest echelons of the federal government, Congress needs to ask some pointed questions.
It should start with the Bear Stearns board.
If Bear Stearns had no chairman and no board at all, would the results have been any worse?