ON Facebook’s Folly
Published in the Globe and Mail October 11, 2021
Facebook’s Folly
Bank of America’s Record Settlement: The tsunami of wrongdoing and excess that caused barely a ripple of inconvenience at the top.
The indisputable economic (and moral) fact of our time is that America’s most wealthy, from whom capitalism’s CEOs, directors, guardians and gatekeepers are drawn, not only allowed this torrent of financial chicanery and deception to occur, they profited handsomely from it.
These pages have voiced strong doubts over the years about the leadership and compensation practices that prevail at many of America’s corporations. Chief among the criticisms were that these plans provided incentives and rewards that caused companies to take improper risks which allowed CEOs to rack up huge gains in the short run while investors — and, ultimately, society — were left holding the costly bag of empty promises when reality came crashing down.
Take Bank of America, for example, which recently settled with the U.S. Justice Department by agreeing to pay a record $17 billion in penalties and restitution. In the long history of American business, there has never been anything approaching this outsized penalty. It stems from improprieties at Countrywide Financial, which B of A bought in another fit of misguided thinking, just before the onset of the Great Recession. There were also irregularities involving disclosures about its takeover of Merrill Lynch as well as with Bank of America’s own mortgage practices.
You might think that CEOs and boards are paid well for keeping companies out of trouble and avoiding these kinds of disasters. Half of that observation is certainly true. In the five years leading up to the crash of 2008 and the beginning of the worst recession since the Great Depression, B of A’s CEO Ken Lewis was paid more than $200 million. Each of the bank’s directors awarded themselves a minimum of $1.5 million in the same period. Many collected more.
When he retired in 2009, Mr. Lewis walked away with a further $83 million in retirement benefits. Others connected with B of A, such as former Merrill Lynch CEO John Thain and Countrywide Financial’s former CEO Angelo Mozilo, also made off with huge fortunes as a result of deals made with the bank under Mr. Lewis.
And for all that, one of America’s most prominent financial institutions did not walk — it ran — into the giant propeller of U.S. government in a predictable and avoidable financial collision that resulted in this staggering record payout.
Bank of America was, as we documented over the course of several years, far from alone in practicing financial acrobatics that were more suited to a travelling carnival than an iconic institution of capitalism. Yet in this mighty tsunami of boardroom wrongdoing and excess that nearly upended Main Street, barely a ripple of bother was felt among the first-class decks of Wall Street and America’s financial elites. No CEO has been sent off to jail. No director or chief executive has been forced to return any pay. As we noted in The Fallacy of Giants, in most cases when these kinds of eye-popping settlements are announced, the company’s stock shoots up. Government fines, no matter how staggering, and accusations of abuse and betrayal by top management and boards, no matter how shameful, are regarded by many business insiders and much of the market as just another cost of doing business.
The indisputable economic (and moral) fact of our time is that America’s most wealthy, from whom capitalism’s CEOs, directors, guardians and gatekeepers are drawn, not only allowed this torrent of financial chicanery and deception to occur, they profited handsomely from it. The result is that those same elites in the period between 2007 and now managed to gain an even larger choke hold on the wealth and income of America than at any time since the 1920s. This, despite the fact that were it not for the bailout provided by America’s taxpayers who largely live on Main Street, not only would this expansion of wealth not have occurred, but capitalism itself might not have survived. On that point, is it not interesting that the same voices that are generally quick to rail against government excess and demand fiscal discipline when it comes to the public purse are uncharacteristically silent when it comes to the $5 trillion the U.S. Fed paid to finance the bailout? Does that have any connection with reality, or is it just another case, like CEO compensation, for instance, where there is one set of ever accommodating rules for those at the top and another for everyone else?
What happened with Bank of America, and other prominent institutions like it, and the ease with which moral and legal improprieties can be sloughed off with little consequence for those in charge, is at the heart of the current record level of public disaffection with capitalism and those who lead it. Having spent nearly half a century working with and around capitalism and its leaders, it is hard for me to imagine that one day it may cease to exist. But the too often overlooked reality is that the fundamental currency that sustains modern capitalism is not capital at all — it is the consent of the public.
If present trends in income equality and corporate immorality continue, and its leaders fail to ensure that capitalism is governed by a set of values that is consistent with the needs and dreams of Main Street, it is hard to imagine how it will survive.
The Fallacy of Giants | Part Two
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.
The Fallacy of Giants | Part One
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.
BOTCHED APPOINTMENT SHOWS SERIOUS FLAWS IN HOW CANADA’S SUPREME COURT JUDGES ARE CHOSEN
It has been nearly 30 years since I proposed a more open process for selecting and confirming nominees to the Supreme Court of Canada in the op-ed pages of the Globe and Mail. I was among the first voices to do so. But the Frankenstein-like creation followed recently by the Harper government in the botched nomination of Marc Nadon is not the solution. It’s a big part of the problem.
Every aspect of the lives of Canadians is influenced by the nine-member top court. This past year alone saw landmark decisions involving the right of physicians to end the life of a patient over the objections of a family and extended free expression rights to reporters and bloggers. How someone is appointed to that court, and who is actually appointed, are matters that should command the attention of much more than the usual suspects in the legal community.
Until the early part of the 21st century, appointments were made purely on the whim of the prime minister of the day. But the Nadon appointment followed a model established with the naming of Justice Marshall Rothstein to the Supreme Court in 2006. And it is here the process descends into byzantine complexity and opaqueness worthy of the great Machiavelli himself.
This is how the scheme works. In an entirely closed process, the minister of justice puts forward a list of names to a group of legal elites, including the chief justice of the Supreme Court of Canada, the Quebec minister of justice and the Canadian Bar Association. Their job is to advise on the suitability of the candidates presented — the legal equivalent of pre-qualifying for a mortgage application. The criteria for selection, and how the list is arrived at, are never made public. The names on the list are secret, and so is the actual number considered. The Department of Justice claims that the minister also “consults” with the prime minister in coming up with the list, but we know who is really running the show here.
Next, a special committee, known as the Supreme Court of Canada Selection Panel, is formed. This group consists of five members of parliament. In the Nadon nomination, it was comprised of three Conservative members and one each from the Liberal and NDP benches. The committee meets, also in secret, to review the list of pre-qualified candidates provided by the minister of justice. After its closed-door deliberations the committee presents a list of three candidates it deems acceptable. But whether this was arrived at by a majority vote or was unanimous is never disclosed. The only name that is ever revealed publicly is the one chosen and announced by the prime minister. This peculiar process does not end here, however.
After the prime minister makes his decision known, an ad-hoc committee of MPs is formed. Their job is to ask questions of the candidate during a televised session. But they don’t get to make recommendations or to vote on the prime minister’s choice. In fact, their role seems to be relegated to that of mere stage props for one leading part: the prime minister’s choice for the top court, whose performance is usually distinguished by smiles, sports anecdotes and stories of triumph over various childhood adversities.
With the Nadon nomination, the committee had less than three days to get up to speed on the candidate’s background and legal history and to prepare discerning questions. In the United States, it can take three months for the Senate judiciary committee to prepare for its hearings on Supreme Court nominees. Nor was the time adequate to engage Canadians in the process. But then this was never intended to be a real vetting of a nominee of the kind that might reveal important aspects of the candidate’s judicial philosophy.
After all, there is nothing significant hanging on this committee’s actions when the outcome is pre-determined and no actual confirmation vote is ever taken. Mr. Harper has virtually unchecked power in the choice he makes. He determines everything from who gets on the initial list to which of the three names is selected for the nomination. If, for example, all the names presented in the process are male, how exactly does a woman get appointed to a court already heavily male-dominated? Had Mr. Nadon’s nomination not been blocked in a most ironic twist by the Supreme Court itself, he would have completed a court comprised of 7 men and two women.
That last sentence about the decision of the Supreme Court of Canada, which amounted to the Court’s saying a resounding “non” to Mr. Harper’s choice, is the biggest kicker of all in this flawed system. Apparently, through all of this contorted process, it never occurred to anyone that, for at least one name on the list, there was a serious chance his qualifications were not in compliance with the Constitution of Canada in respect of Quebec’s enshrined right to representation on the top bench — not a small point when dealing with a Supreme Court appointment. And the rejection of Mr. Harper’s nominee was not exactly a squeaker. Six of the seven voting justices called the Nadon nomination unconstitutional.
As this experience shows, it’s time to go back to the drawing board. A cloak of secrecy continues to obscure how Canada’s top court is chosen. What is still missing is a genuinely transparent process that fully engages and informs Canadians while demonstrating that democratic values are followed in filling these critical positions. That’s unlikely to happen, however, since in Canada a prime minister simply has too much power — another case I attempted to make in the op-ed pages of the Globe and Mail some 14 years ago.
Unfettered power, which is what any majority prime minister for the most part enjoys, is an unwise exercise in tempting fate, as Mr. Harper — and his nominee — have now discovered.