When the market is going up, much of the world treats CEOs like superheroes who are worth every penny of the extraordinary sums they command. But when fate and fortune retreat and reverse direction, these CEOs suddenly claim only to be human, an attribute with which they had previously never shown much familiarity.
It was, in many ways, a script that has become all too familiar in recent months. The well-dressed CEO appears before a committee of the U.S. Congress, says he takes full responsibility for the collapse of the company he headed, and then goes on to blame short-sellers, the housing market and a run on the bank. He says there was no need for more capital, but now, as a result of that decision, there is no company either. And yes, he, too, was worth the fortune he was paid. The problem was that, although its CEO received close to half a billion dollars since 2000, the company that prevailed for 158 years through a civil war, financial panics, economic depressions and two world wars could not survive the leadership of Richard S. Fuld Jr. So Lehman Brothers is no more.
There is a way that the spotlight of Congressional investigations and live television reveal dimensions to CEOs like nothing else can. Yesterday, it was Mr. Fuld’s turn before the U.S. House Committee on Oversight and Government Reform. A familiar pattern emerged from the hearing.
When the market is going up, much of the world treats CEOs like superheroes who are worth every penny of the extraordinary sums they command. A company’s success is seen pretty much as a one-man show. This was especially true for Lehman’s Mr. Fuld, who apparently was so crucial to the bank that they needed to replicate him as chairman of the board of directors, CEO of the company and chairman of its executive committee all at the same time. No private jet is too luxurious, no pay package is too extravagant, no amount of directorial slumber too deep that otherwise might challenge the modern boardroom Caesar. As noted on these pages last month, the CEOs of Merrill Lynch, Citigroup, AIG, Bear Stearns and Lehman Brothers’ Richard Fuld received an aggregate compensation in excess of one billion dollars over the past five years.
But when fate and fortune retreat and reverse direction, these CEOs suddenly turn humble and claim only to be human, an attribute with which they had previously never shown much familiarity. They speak plaintively about the vicissitudes of life, look for empathy and understanding –and a lot of scapegoats.So much of the world they once ruled is, they admit, really beyond their control. As Mr. Fuld testified before the Committee:
In the end, despite all our efforts, we were overwhelmed… A litany of destabilizing factors: rumors, widening credit default swap spreads, naked short attacks, credit agency downgrades, a loss of confidence by clients and counterparties, and strategic buyers sitting on the sidelines waiting for an assisted deal were not only part of Lehman’s story, but an all too familiar tale for many financial institutions.
It’s a far cry from the tone struck before by executives like Mr. Fuld. In the good times, success pretty much has only one father and that’s the CEO, according to many board compensation committee reports. Failure’s paternity has many culprits, including always short-sellers and the occasional abrupt change in the weather.
We’ve heard this song before. Conrad Black when he headed Hollinger; Enron’s Jeffrey Skilling; James Cayne, who ran the board and management of Bear Stearns for many years; and Angelo Mozilo, the subprime czar of mortgage giant Countrywide Financial all cut a swath of media adulation and investor diffidence during their reigns. But the perverse gods of markets and boardrooms insist on having their laughs. The CEOs whom they raise up to such rarified heights that they actually begin to think they are god-like themselves soon have a harsh reconnection with human frailty and imperfection when they fall back to earth with a hard thud. For some, like Conrad Black and Jeff Skilling, that sudden descent to a decidedly undeferential world comes in the form of prison time for corporate crime. For others, like Cayne, Mozilo and Fuld, a different kind of prison locks them into a sentence of personal failure and public disgrace from which there is seldom any escape, no matter how impressive their mansions and luxury condos.
If you did not know that Mr. Fuld had run one of the largest and oldest investment banking institutions in the world and that he was compensated in sums that defy human comprehension, there would be nothing in his performance yesterday to suggest that he had ever occupied such lofty office. His speech was halting, his manner often disingenuous, his memory selective, his words unevocative, his judgment unimpressive. There was no hint of insight or foresight that was any greater than that of a million middle managers, let alone a five hundred million-dollar man. Mr. Fuld, who claimed the company was in good shape one week apparently could not see even into the next, showing his vision lacked something of the reputed prescience of the Davos clan. (Mr. Fuld is a long-time attendee at the World Economic Forum, another puffed-up institution of over-hyped CEOs and hangers-on that has become an annual fashion show for the emperor without clothes.)
One more thing that might give reason to pause and reflect about the man who presided over the largest collapse of any corporation in American history: Until a few weeks ago, Mr. Fuld was a director of the Federal Reserve Bank of New York. He was elected by other member banks –and hold onto your hats for this one– to represent the general public.
The besieged state of the world’s economy seems to be in the process of separating models of genuine leadership, which emphasize value and character, from their long-reigning impostors. It has taken the worst threat since the Great Depression for Wall Street and Main Street to comprehend the depth of the scam that has been occurring under their beguiled eyes over the past number of years. Assurance of value was taken for granted; the skill and accomplishment (and need) of grandly compensated egos was not even to be questioned. Their word was gold, so we were told. What we have discovered in recent months after trillions in losses and government interventions, however, is, to paraphrase Gertrude Stein, there was no there, there.
Perhaps when this unseemly procession of failed and discredited CEOs, whose arrogance, greed and misjudgments have brought Depression era fears to Main Street and necessitated the largest private sector bailout in history, is over and the extent to which the world was taken in by the myth of their excessively compensated abilities becomes inviolably clear, we can return to a time of real leaders whose attributes include some of the most paramount and uncommon abilities of all:good judgment, common sense and two feet planted squarely on the ground.
The public rarely likes to be hoodwinked or dismissed; their ire is almost certain to be raised when they believe their pockets are being picked in the process.
Somewhere at the intersection of Wall Street greed and tone deaf political acumen you will find the shattered remains of the $700 billion Bush-Paulson bailout plan. It collided on Monday with outrage on Main Street. Whatever else the proposal -which was narrowly rejected by the House of Representatives- was intended to do, its first priority was clearly one of bailing out the banks and players who caused much of the current economic crisis. The value to Wall Street of the vaguely crafted plan to buy back securities would have been immediate and clearly defined. The benefit to Main Street would have been longer in coming and more circumspect in specifics.
Wall Street’s reaction was a predictable plunge in the Dow. It closed with the largest single point drop in its history. The NASDAQ lost more than nine percent of its value. The Canadian TSX plunged by an unheard of 840 points. Unnoticed in all of this mayhem was the fact that the U.S. dollar actually rose as the bill faltered. The next day, more than half the losses were gained back.
The legislation as drafted, even altered from its original sparse and accountability-challenged state, gave too much discretion to the administration and offered too little assurance that its provisions are what the stalled credit system actually needs. The so-called oversight board for the bailout included the same actors who presided over the explosion of the crisis, denied the obvious storm clouds that were brewing and brought to the American people the draft that wanted no accountability whatever. The architects of the plan, and the ones running it, effectively would have been overseeing themselves. The Treasury secretary, the chairman of the Fed and the head of the Securities and Exchange Commission were named to the board in the plan rejected by the House. Monthly meetings were all the legislation required of the board overseeing some $700 billion in taxpayer funds. This is governance, Wall Street style. It’s one of the reasons why calamity has struck so many institutions and befallen so many investors.
Rarely has such an important and costly public policy initiative been as bungled, or its authors and sponsors so tone deaf to an already disbelieving and angry public. It is as if ordinary citizens were not even in the picture for all the heed paid to their concerns or to crafting a plan that would appeal to their sense of fairness and prudence. Not a good approach when 435 lawmakers have to face the voters in 35 days.
Maybe if a few Wall Street CEOs apologized to the public for the excesses and misjudgments of recent headlines and gave back a good portion of last year’s multibillion-dollar bonuses, people would have some faith that there are real leaders in charge. They might also be more predisposed to a bailout. Maybe if the plan did not start off trying to turn Henry M. Paulson Jr. into a modern King George III, with powers that could not be reviewed by any court or authority, initial reaction to the rescue plan would have been more positive. A reasonable mind might even question whether Secretary Paulson -a former Wall Street titan himself, who for some time has been in denial as to the depth of the problem- is really the best person to be hovering over the financial sector in a helicopter shoving billions out the window to his friends and colleagues.
Speaking about pushing money out the window: Since the beginning of the year, more than a trillion dollars has been pumped into the banking system by the U.S. Federal Reserve. On Sunday, the Fed boosted its currency-swap facility with foreign central banks to a total of $620 billion. Hundreds of billions more have already been paid out or committed for the Bear Stearns takeover, the seizure of AIG, the nationalization of Fannie Mae and Freddie Mac and the housing rescue plan passed in July. If these trillion-dollar-plus steps have failed to smash the ice jam in the flow of credit, what assurance is there that another $700 billion will? Does anyone really have a handle on the problem and what needs to be done to fix it, or are policy makers and regulators just hoping that if they keep throwing money at the problem it will get solved? At least 228 Congressional districts appear to be asking the same questions.
No doubt there are serious problems in the financial system.But little certainty has been offered that buying up structured investment vehicles and bad car loans from distressed banks will achieve stabilization in the housing market, which is the controlling declining asset base that is central to the whole problem.
Funneling $700 billion into the hands of the very actors that caused the financial crisis without any hearings or public consultation, and against the advice of some of the top economic minds in the nation -including several Nobel laureates, was a clumsy way of achieving the consent of the governed. The public rarely likes to be hoodwinked or dismissed; their ire is almost certain to be raised when they believe their pockets are being picked in the process. I seem to recall that the relationship between citizens and those who tax them featured rather prominently in America’s founding.
A sensitive and prudent plan would not have started off with targeting $700 billion at Wall Street. This only magnified the public perception of the wealth and privilege gap that is consuming America and fueling its indignation, which rather notably has reached a point not seen since 1929. It would not have attempted to secure a blank check with little oversight and absolute unreviewable powers. That was too reminiscent of other costly bungles by the Bush administration that did not unfold as promised. The lack of vision that has hobbled policy makers and regulators in the past, which saw them proclaiming the subprime fallout would be contained and where each bailout along the way has been portrayed as what was necessary to prevent a wider meltdown, did not bode well for their ability to get it right this time. The outcome seems unsurprising when you really think about it.
Investors would not lay out $700 billion for an ill-defined and uncertain plan run by people with this kind of track record. It is not surprising that American taxpayers are no different.
A brief essay on the subprime credit consequences when CEOs fail to lead, directors fail to direct and regulators fail to regulate
It began as a term that few had even heard of barely 18 months ago and most experts dismissed as an insignificant blip in a fundamentally robust economy. But yesterday, George W. Bush signed into law the most extensive -and expensive- free market repair bill since the Great Depression, thanks to what we have come to know as the subprime mortgage meltdown. The legislation marks another ironic milestone for this Republican, MBA-trained apostle of the private enterprise system. In 2002, he put his signature to the Sarbanes-Oxley Act, which, in the wake of Enron and numerous more accounting-related corporate frauds, also brought the power of the federal government closer to the boardroom than at any time since the 1930s.
The Housing and Economic Recovery Act of 2008, which also serves as a bailout for Fannie Mae and Freddie Mac, addresses precisely the flaws and failures which successive business leaders and government officials said would never occur in the modern era. Depression-time failures, runs on banks, and the collapse of huge financial institutions that were typical of the 1930s, they said, were a thing of the past. But just as those events were a product of human shortcomings and unbridled greed, so too is the present day crisis the result of CEOs whose bonus-obsessed lack of vision made them unsuited to lead, directors whose risk-oblivious nature made them incapable of directing and regulators whose focus on the battles of the past made them incapable of regulating. Exhibit One in this regard is the more than $30 million in compensation the CEOs of Fannie Mae and Freddie Mac, the struggling mortgage giants that prompted the recent government bailout, were awarded by the boards of those companies during the past year when the seeds of their horrific losses were being sewn.
Only a few months ago, the priority of the new treasury secretary, Henry M. Paulson Jr., and the Bush administration was to roll back enforcement under Sarbanes-Oxley, which many in the business community claimed was hampering American competitiveness. Blue ribbon committees composed of impressive and accomplished corporate men and women were formed to look at ways of blunting the regulation of business. All the time they were focused on this objective, the time bomb of the subprime credit disaster was ticking away. But the business world, and Wall Street in particular, disposed typically to hearing only the siren song of great bonuses and increased fees, did not heed the tick, tick, tick of impending calamity that was of their own making. No alarm bells sounded, at least on Wall Street, about the overly complex financial instruments that were being created, or the possibility that the ever- faster moving gravy train would meet with an abrupt generational derailment. So much has the landscape shifted that the man from Wall Street who was brought in to loosen the reins of corporate regulation has now become the architect of the most sweeping government intervention since FDR. And his boss, the first MBA graduate in presidential history, will have presided over the most staggering run up of the national debt in U.S. history.
Republicans and other traditional advocates of government restraint have fallen so far from their Milton Friedman, laissez-faire pedestals that they have given Secretary Paulson what amounts to a blank check for unlimited backing of these government-sponsored enterprises whose names sound like something out of a 1920s Gershwin musical. It is a hard swing from earlier days, when Fed chairman Ben S. Bernanke testified before Congress that he didn’t expect the credit crisis would spread to other parts of the economy. Just days before the meltdown at Fannie and Freddie, Henry Paulson was predicting “we are closer to the end of this problem than we are to the beginning.”
Much of the litter prompting the actions of the Bush clean-up crew came about through Wall Street’s obsession with bigger bonuses and more fees, and insufficient attention as to how they were achieved. A good part of the world, though happily we did not count ourselves among this group, really believed for a while that some of these fellows actually deserved and earned their bonuses, which, in many cases, amounted to $40 million, $50 million or even more than $100 million in a single year. We have long contended on the subject of excessive CEO pay that it is well to remember that its recipients are endowed with no superhuman traits.
Unfortunately, too many in the boardroom and on the stock exchange floor seemed to think the more a CEO received, the more he was able to jump over tall buildings in a single bound. But as Merrill Lynch’s Stanley O’Neal and Citigroup’s Charles O. Prince schlepped out of their offices for the last time after presiding over record multi-billion-dollar losses, they seemed remarkably fallible -even with the millions in bonuses and severance they carted away in the process. Also gone with the toppling of CEO after CEO who failed to live up to their Marvel Action Comics billing is the idea that their compensation is the business just of shareholders. Look at the casualties of home ownership and the record foreclosures that are sweeping America, a trend that can be traced to the creation of flimsy investment vehicles designed only for their quick fee and bonus producing content for Wall Street and mortgage lenders, and you see how much Main Street America has at stake in the compensation inducements that crony boards hand out to their country club CEO buddies.
It was a nice party while it lasted. Shareholders did well. Directors commanded ever higher fees for their slumbering counsel in what was an impressive reprise of their roles during the Enron era scandals and long before, during another time of Wall Street excess culminating in the market crash of 1929. Top management became elevated to god-like status with remuneration packages commensurate with that standing.
The shell game continues. Just this week, Merrill Lynch announced that it was selling off $6.7 billion in what many regard as toxic mortgage investments. The problem is, only two weeks ago those assets were valued by the company at $11.1 billion. The company’s write-downs -so far- we are told exceed some $40 billion. But to be honest, whenever numbers climb over the $25 billion mark we generally have to reach for the oxygen mask and lose track of the details in the process. Another problem: Merrill has to loan the buyer most of the money to take over the sludge. It’s a little like the Fed buying up $29 billion in feeble Bear Stearns assets to help out with the JPMorgan Chase deal. Except they called it a loan at the time. Nobody is calling it that now. Thinking about Fannie Mae, one is reminded of the scandal there when government investigators found top management fiddled with the books in order to prop up their bonuses. In 2006, U.S. regulators filed more than 100 civil charges against former CEO Franklin Raines and other officials of the company, accusing them of manipulating earnings to maximize their bonuses. It was among many ethical lapses that will be uncovered during the heady times of recent years.
Now the party is over. And, as they had to in the 1930s, it is the taxpayer who must pick up the tab for the broken furniture and all the other casualties of the splurge of over-indulgence that marked what we have called before the Modern Gilded Era. When incomes in America begin to approach the level of disparity which existed in the 1920s, as they did in the past couple of years, perhaps it is a warning sign that reason and judgment have reached a dangerous state of undersupply in the economy, and in society as well.
With the stroke of a pen this week, America’s debt will have been increased by nearly a trillion dollars; its deficit now the greatest in the country’s history. Many of the owners of the corporations who gambled and lost on these ill-conceived schemes will be bailed out. Some homeowners may benefit from the legislation, and a higher standard of regulation -which should not have required a Titanic-like catastrophe before its need became obvious, will prove beneficial in the future. But the greatest beneficiary is Wall Street, which has consistently held the view that there is no better system than modern free market capitalism, except, of course, modern government enterprise when it shows up with its purse open. For there is no more beautiful sight to the errant Wall Streeter than when Mr. and Mrs. America come to junior’s rescue after he wraps the BMW of self-aggrandizement around the lamppost of ever looming, but never fully contemplated, reality.
The point of all of this is not to disparage capitalism, especially the idea of responsible capitalism -a principle we have long advocated and believe is fundamental to the innovation, creativity and advancement of a free and prosperous society. But it is to further illustrate that capitalism is merely an engine, not an Adam Smith-invented autopilot. How well it operates, what value it creates, what havoc it wreaks are dependent upon the skills, vision and integrity of the men and women to whom it is entrusted.
Many of the wrong people were entrusted with it this time. The price has been steep. The damage to the reputation of this unique economic system has been considerable. The consequences of insatiable greed, and of governance and regulatory systems that failed to check it, have been historic.
It might be hoped that for the hundreds of billions of dollars American taxpayers are shelling out for the economic debacle which in some respects rivals the Great Depression, they also will have paid for the education of future actors on Wall Street, in the boardroom and in the regulatory halls of government, who will have learned something of the vice of unrestrained excess, something of the virtue of a financial system more grounded in both value and values and something of the sacred trust that is bestowed when society loans power and opportunity to those whom it allows to lead, direct and regulate.
The absence of any discussion concerning all the roles held by these important Wall Street figures, including in the governance of the Fed itself, does a disservice to the stakeholders who are entitled to all the facts.
It is widely held, even by Fed Chairman Ben S. Bernanke, that the Federal Reserve System helped to bail out Wall Street when it agreed to “loan” $29 billion to facilitate JPMorgan’s purchase of distressed investment bank Bear Stearns. We will have more on the subject of that so-called loan in an upcoming posting. What has gone unnoticed and uncommented upon by the press, analysts and members of the U.S. Senate banking committee during its hearing last week, however, is the fact that key Wall Street figures, including Jamie Dimon, chairman and CEO of JPMorgan Chase, Richard S. Fuld, Jr., chairman and CEO of Lehman Brothers and Jeffery R. Immelt, chairman and CEO of GE, are directors of the Federal Reserve Bank of New York, the institution that is putting up the money.
Mr. Dimon is a “Class A” director of the New York Fed, elected by member banks to represent member banks (i.e., Wall Street). Mr. Fuld and Mr. Immelt are elected by member banks to represent the public. One might take the view that foxes are generally elected to guard the henhouse, too. The New York Fed’s governance brings to mind the crony-stocked, self-serving boardroom of the New York Stock Exchange under Richard Grasso before it was forced to make major changes to ensure higher standards of independence and accountability. It is clearly time to look at to whom and how the New York Federal Reserve is held accountable.
We know that JPMorgan benefited handsomely from the Fed’s dramatic measures. Lehman Brothers, widely rumored a few weeks ago as the next possible Bear Stearns, got a boost from the Fed’s market soothing actions. And GE, who just today jolted the market by announcing a 5.8 per cent decline in first quarter net income, was also having problems with its financial services division. Mr. Immelt told CNBC (a unit of GE) that he began to be aware in March of a weakening company outlook. (In an interview earlier that month, he indicated the company was still on target to meet its previous positive guidance.) A less volatile capital market temperament was no doubt helpful to him as well.
More and more, the picture is emerging that this was a bailout of Wall Street, prompted by Wall Street, over problems caused by Wall Street, with terms dictated by Wall Street. The Fed’s agreement constitutes the single most significant market intervention in generations. Such a decision, which places substantial taxpayer dollars on the line and the concept of moral hazard in jeopardy, should be arrived at in a manner that is beyond reproach not only in fact but also in appearance.
The absence of any discussion by the media, the Federal Reserve or legislators concerning all the roles held by these important Wall Street figures, including in the governance of the Fed itself, does a disservice to the stakeholders who are entitled to all the facts in order to properly hold government and its agencies to account. It is our call for the Outrage of the Week.
Bear Stearns’s collapse confirms that excessive CEO pay, along with the feeble corporate governance that permits it, continues to be one of the most corrosive forces in modern business. It offers further evidence that, far from aligning pay with performance, oversized compensation induces risks that lead to disaster. It comes at a price that is too costly to society.
One of the striking features of corporate governance scholarship is that it reveals the same shortcomings and the same calamitous results occurring time and again throughout history.
“The sad case of Penn Central,” Dun’s magazine wrote about the giant corporate collapse in 1970, “is worth mentioning, not because it is unique, but because it is not. Many another US corporation has gotten into trouble because its directors did not do what they were supposed to do, that is, keep a warily inquiring eye on management and ask the right questions at the right time.”
A similar refrain was expressed about the boardroom before and after the Penn Central debacle. As we detailed in Part 1 of this series, Bear Stearns’s weak, distracted and ineptly led board was a contributor to its collapse as well.
Bear was not alone in displaying obvious signs of corporate governance weaknesses, however. Boardroom-wide, directors have permitted the complete discrediting -some would argue hijacking- of the executive compensation system. They have legitimized the creation of payment schemes that have induced CEOs to take on excessive risk in the hope of bringing in fees and deals that push up share values in the short-term and trigger unprecedented awards of stock and bonuses, while at the same time insulating them from the consequences of their actions by guaranteeing golden separation packages in the event of failure.
Excessive CEO pay, as I suggested in a submission to the Senate Banking committee during its Enron-related hearings in 2002, is the most corrosive force in modern business. It is fast eroding respect for the leadership of American capitalism among both shareholders and society. It was a contributing factor in the demise of Enron and Hollinger and in the scandals involving WorldCom, Tyco and many others. Its cancer is also evident in the current economic crisis. Over the past five years, when the foundation for the subprime disaster was being laid, the CEOs of Citigroup, Merrill Lynch, Countrywide Financial and Bear Stearns were paid more than half a billion dollars -$556 million- among them.
Like the toxic effects of the credit catastrophe that spread into the housing market, then to the balance sheets of major financial institutions, and finally into the wider economy, the debilitating repercussions of excessive CEO pay and the subprime misjudgments they spawned have long since moved past the shareholder annual meeting and into the recession dampened lives of ordinary people. In the last year of reported filings, James Cayne (then chairman and CEO of the company) and Alan Schwartz (then president and co-chief operating officer) were paid more than $73 million between them. Did the prospect of such huge compensation distort their judgment and tempt them to accept unwise risks and ignore red flags? It is a line of inquiry policy makers ought to pursue with Bear Stearns and throughout the financial industry.
For every year of the past five, while management misjudgments and miscalculations were laying the course for the credit crisis that eventually claimed the investment bank, the compensation committee of Bear’s board declared that it was happy with the performance of the company and that management fully deserved the compensation it was awarded. So blind was the committee to any notion of excessive risk that was being taken, it simply copied and pasted many of its statements of praise and satisfaction from one proxy statement to the next. “Therefore, the compensation paid to the Company’s executive officers reflects the Company’s strong absolute and relative performance” was how the compensation committee was fond of putting it -so fond, in fact, that it used exactly the same phrase year after year.
Close ties and over familiarity may also have been a problem with Bear’s compensation committee. The board’s pay panel was headed by 81-year-old Carl D. Glickman. While securities filings by the company claim that he has been a Bear director since 1985, biographical information provided by Cleveland State University, where Mr. Glickman is also a trustee, claims he has served on Bear’s board since 1978.
At the very least, the compensation committee’s culture, structure and decisions raise unsettling questions about whether its products are more the reflection of a cozy club mentality of close connections than the result of vigorous market forces and heavy negotiation.
As we noted earlier, long-time chairman and former Bear CEO James Cayne recently sold all his holdings in the firm to net $61 million, according to formal declarations. By some standards, that sum is far below what his holdings were worth a few months ago. On the other hand, he has long been chief officer of the Bear Stearns ship. Having set its ill-fated course, it is remarkable that he came out with anything at all. The ship is going down, but Captain Cayne managed to jump into the Fed-sponsored lifeboat before anyone else. It is not often that any single person, much less one who has been such an outspoken advocate for free market capitalism as Mr. Cayne, can trace his added wealth to the entire apparatus of the federal government coming to his rescue, and to the Federal Reserve taking actions not seen since the depths of the Great Depression.
The subprime scandal also exposed holes in the governance of other investment banks. Merrill Lynch, as incoming CEO John Thain observed, had a risk committee that didn’t function. And Countrywide Financial, which likes to think of itself as a bank, has another all-male boardroom that seldom formally meets and where the compensation committee writes with a hyperactive pen that seems unable to stop putting zeros at the end the CEO’s paycheck. How it permitted a situation where the CEO was allowed to sell a substantial chunk of his own shares at a time when the company was engaged in a share repurchase plan which pushed the price up constitutes an unbecoming stretch for even the most compliant board.
But Bear Stearns is the first institution of its kind to collapse so dramatically with the fingerprints of questionable corporate governance practices found throughout the ruins. There was a disconnect between what the board was supposed to be doing and what it actually did. In that respect, it is reminiscent of the approach taken by another board: Enron’s. It did not end well for that company, either.
The directors of Bear Stearns were paid well for their duties -at least $200,000 each. Management directors were paid in the tens of millions every year. For that sum, and under the board’s unhurried watch, shareholders and employees were treated to the privilege of witnessing the unthinkable: an 85-year-old institution that survived the Great Depression and two world wars only to slide under the turbulent sea of subprime folly, leaving a token reminder in its decimated share price that it once existed at all.
“Where was the board?” is a question governance scholars and others have increasingly come to inquire during times of corporate calamity. It has been asked of many large failures over much of the past 100 years. But for this most recent boardroom mishap an even more probing question needs to be posed: “If Bear Stearns had no chairman and no board at all, would the results have been any worse?”
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.
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If Bear Stearns had no chairman and no board at all, would the results have been any worse?
Read part 2 of this series.
