When Countrywide Financial’s Angelo Mozilo told a Congressional committee in 2007 that there was a lot of fraud in the subprime business, we thought at the time it might be a prophetic statement. The Securities and Exchange Commission apparently agrees, as this week it laid civil charges of securities fraud against the company’s former CEO. What we sometime ago dubbed as Mr. Mozilo’s miraculously timed stock sales, the SEC thinks could be insider trading.
In 2006, Mr. Mozilo was among America’s ten highest paid CEOs, with a paycheck that topped $142 million. Between 1999 and 2008, he pocketed some $400 million in total compensation. It will be interesting to see whether this was one of those cases where the compensation was fully justified–as Countrywide’s board always maintained during this period–and an example of aligning the interests of CEOs with those of investors, or whether it was, instead, nothing more than reward founded on sands of subprime fraud and another example of CEO pay being aligned with CEO greed.
The decision of a majority of shareholders at Bank of America to oppose the board and separate the positions of CEO and chair, appointing an independent director to the latter position, is one for the books. This is the biggest institution in the history of business where shareholders have brought about such a dramatic change in corporate governance practices and actually removed a top title from a sitting CEO.
The move from yesterday’s annual general meeting comes in answer to the staggering losses and a shocking stock value decline that have roiled the company in recent months, as well as in response to a number of unresolved questions regarding the Merrill Lynch acquisition and who in the B of A boardroom knew what and when. It is the investors’ version of Newton’s third law of physics, (as modified by Finlay ON Governance) which holds that when shareholders are pushed too far, there can sometimes be an equal and opposite reaction.
Whether the replacement of Ken Lewis by new board chair Dr. Walter Massey will make a difference in a way that empowers independent thinking in the bank’s boardroom, and improves management performance through enhanced accountability, is yet to be seen. Some might think a physicist to be an unlikely candidate for such a key position in a bank. But given recent events on Wall Street and in the credit markets where there seemed to be little grasp of the laws of gravity, but rather, a misplaced view that debt and risk could expand into infinity -taking earnings and share prices along for the ride- perhaps Dr. Massey could give his board colleagues some useful lectures on Sir Isaac’s other discoveries a few centuries ago. So far, not even the biggest names in banking have managed to escape their universal application.
It is hard to imagine how the bank could have done any worse if Bernie Madoff had been on its board.
There was sound and fury, but in the end it appeared to signify nothing. At Citigroup’s annual meeting last week, not a single shareholder proposal for reform was adopted. Every board/management nominee was returned. Over the past year, the company’s losses soared to $28 billion and its market capitalization has dwindled from $260 billion at the beginning of 2007 to $16 billion now. With its shares having fallen below the one-dollar range and still languishing around $3.00, many see Citigroup as basically a penny stock. Since the last AGM, the bank has become a ward of the state and could not have survived without the $45 billion it received in public funds. This is the shape of once-mighty Citigroup today. It is hard to imagine how the bank could have done any worse if Bernie Madoff had been on its board all this time.
Yet all of this was not enough to galvanize Citigroup’s institutional investors into making any changes whatever -or seeing that a new approach to corporate governance is desperately needed at this institution, beginning with the ouster of Richard Parsons, the long-serving director who became board chairman earlier this year.
If a company’s management and board can preside over the obliteration of shareholder value while losing billions, and the outcome at the annual meeting is the same as if it had the best year ever, you have to wonder about the health of shareholder democracy in America. Let’s hope that Citigroup’s investor flu does not spread.
Shareholders everywhere, dawn your masks!
The calamity of the ship which was thought too big to sink did not capsize the company that owned it. But the White Star Line, which had roamed the seas through wars, depressions and revolutions since the mid-1800s, was unable to survive the greed, hubris and deceit of one man. It is an experience that carries some valuable lessons for today’s financial empires and Wall Street titans as well.
On a crystal-clear, star-filled April evening in 1912, what had been to that point an astonishing triumph of human imagination and engineering suddenly changed into a tragedy on a horrific and incomprehensible scale. It was 11:30 pm on the night of April 14th when the ship’s lookout called down to the bridge. What took millions of words in plans, designs, work orders, contracts and printed material was about to be undone by a mere three: “Iceberg right ahead.” The second officer then made the fateful, and, by most later accounts, calamitous, decision to stop and reverse propellers. Less than three hours later, in the early morning of April 15th, RMS Titanic descended to the bottom of the Atlantic Ocean, taking 1,517 souls with her.
One who did not perish that night was the chairman of the Titanic’s owner, White Star Lines. J. Bruce Ismay’s survival was not exactly miraculous. Fulfilling Montaigne’s aphorism, Ismay did not enjoy the reputation of a hero because of his escape that night, either to the general public, who tended to vilify him as coward, or to his valet, Richard Fry, who was not as fortunate as his master in avoiding the cold clutch of the cruel sea. William Henry Harrison, Ismay’s secretary, also went down with the other 1,516 men, women and children.
The disaster, and all the morbid press it generated, along with hundreds of lawsuits, did not end the White Star Line, however. It steamed on for some years, until it was bought up in 1927 by Lord Kylsant of Carmarthen, becoming a part of the Royal Mail Steam Packet Company, the largest shipping empire of the time.
Lord Kyslant had a well-deserved reputation as something of the “Napoleon of the seas” for his ability to conquer his competitors and impress investors. Like Conrad Black -or Lord Black of Crossharbour, as he prefers to be known even while residing at the Coleman Correctional Facility in Florida- he steered a course of deference-producing success until it was halted by an encounter with prison-confining deceitfulness.
He was a larger-than-life figure in London’s business and social circles, acquiring many honors along the way. He financed his empire through massive amounts of debt and the generous use of other people’s money. The Royal Mail was a darling of the stock market at the time and both its fortunes and Kylsant’s own lavish life style required that the shares of the company be kept high. Like others before and after him, Kylsant made a decision at some point that if his business could not be made to look good on its own merits, a little fudging with the figures might help. So it was in 1931 that Kylsant found himself charged with accounting fraud and was later sent to prison for a year. Lord Kylsant’s long fall from grace shocked the world and led to the disintegration of the company, including the fabled White Star Line. There was a British government-forced merger with Cunard, but White Star never sailed again or operated under under its own flag.
In an irony as large as the name Titanic itself, the calamity of the ship which was thought too big to sink did not capsize the company that owned it. But the White Star Line, which had roamed the seas through wars, depressions and revolutions since the mid-1800s, was unable to survive the greed, hubris and deceit of one man.
Somewhere in all of this, even without the benefit of the binoculars that the Titanic’s lookouts did not have (they were locked in a cabinet and the key was misplaced during the ship’s test runs), one might discover a lesson about the recent financial disaster that has been unleashed upon the stock market and the global economy. Its cause was not natural or celestial; it was not preordained or the result of an asteroid hitting the earth. It was brought on by more common suspects: everyday greed, a giddy sense of intoxication induced by fast money that made a whole crew of business decision-makers and investors laugh at the unfashionable attire of of risk, an obliviousness to duty (and even common sense) on the part of directors and regulators, and an epidemic of self-delusion afflicting too many CEOs and Wall Street titans that they, also, were too big to fail and too smart to ever encounter the sudden reversal of the propellers of fortune.
Editor’s Note:
My father, Jack, was a keen student of the Titanic’s history and misfortune, and believed that it held many useful lessons for the lives of leaders, institutions and their followers. He would have been 85 today. This posting is dedicated to his memory.
The agency that bills itself as “the investor’s advocate” needs to go well beyond asking boards to chime in on what’s behind their structure. It needs to focus on the bigger picture of the role of the board in the worst financial crisis since the 1930s and the persistent folly of directors who do not direct. That, in our view, is the real definition of systemic risk.
There is a common factor in nearly every major corporate governance failure and virtually all of the enforcement actions taken by the Securities and Exchange Commission since the 1960s. In almost every instance, including the bankruptcy of Penn Central Railroad, the bribery scandals of the 1970s involving Gulf Oil, Lockheed and many others, the criminal misconduct at Enron, WorldCom, Tyco, Qwest, Livent, and Hollinger, and, more recently, the stock options backdating scandal at Research In Motion, these companies preferred to vest the powers of the board chair in the hands of the CEO. In all these situations, there was a troubling degree of boardroom deference to the CEO while improprieties were occurring.
So it is that the announcement by the SEC’s new chair, Mary L. Shapiro, that the agency is thinking of requiring listed firms to disclose their reasons for adopting their particular leadership structure, and whether that structure includes an independent chair, struck us as somewhat anticlimactic and underwhelming.
The case for separating the roles of CEO and board head, with the board chair being filled by an outside director, has been supported by a formidable consensus of independent corporate governance experts since the 1940s. It was a prominent part of the groundbreaking research by the late Myles L. Mace of Harvard in the 1970s and has continued to be embraced by leading authorities since that time. The rationale for separating these positions is simple: it defies both human nature and precepts of modern organization for a CEO to be held properly accountable to a board which he or she heads and leads. To instill a true culture of accountability, a CEO needs to see an independent counterpoint to his power sitting at the other end of the boardroom table, and not just a mirror image of himself.
I made that case in 1994 when I was invited to testify before Canada’s Senate banking committee (and in several subsequent appearances), as well as in submissions to committees of the U.S. House and Senate during hearings leading to the passage of the Sarbanes-Oxley Act of 2002. An argument can be made, as I did, that separating these top positions is as important to the effective running of a major publicly traded company as the requirement to have an audit committee composed of independent directors.
Given the undeniable weight of history in tow on this subject, the SEC should be doing more than trying to send up a trial balloon and looking rather feeble in the process. What is required is for the agency to be far more aggressive about fostering a climate of accountability in American boardrooms. That it has taken this long to recognize a reality that has stood the test of time for decades, and that it is only now thinking about asking boards where they stand on the issue, illustrates how far behind the curve the SEC is when it comes to modern corporate governance practices.
The agency that bills itself as “the investor’s advocate” needs to go well beyond asking boards to chime in on what’s behind their structure. It needs to set out principles of sound corporate governance in language as hard as cannonballs, to borrow from Emerson. And it should insist on narrative from boards that is extensive and sets out in clear language in circumstances where a company has departed from those practices, including the appointment of an independent board chair. Naturally, separating the top positions and requiring an independent director as chair of the board is no guarantee of success. Having a ball team of nine players is no winning formula either, as any Mets or Cubs fan will admit. But not having the right number means that you don’t even get to play the game. Boardrooms have also reached the point where some basic structural rules are too important to overlook.
It was as a result of the financial excesses and failures of the 1930s that the SEC was born. There has been nothing even remotely approaching that level of reform coming out of the SEC in what has been the worst financial crisis since that time.
Here’s something else the SEC is missing: What exactly was the role of boards of directors in the credit and financial meltdowns of the past 18 months, and to what extent did a failure of structure or culture among directors contribute to a global crisis affecting hundreds of millions of individuals, costing trillions of dollars and eventually leading to the collapse of banks around the world? We have already pointed out on these pages the colossal shortcomings of the boards of Bear Stearns, Lehman Brothers, Merrill Lynch, Citigroup and Countrywide Financial, to name a few. All of these troubled institutions, by the way, followed the unified CEO/board chair model, although at Bear Stearns, James Cayne gave up the CEO slot and became an executive board chair a few months before the company’s collapse.
What boards did and did not do, and how they were organized, in recent years and months when calamity has been such a frequent guest are lessons that are too important to ignore. We suspect that what will be found is a weak and compliant boardroom culture where the most taxing job for most directors was lifting the rubber stamp marked “yes.” That, in our view, is the real definition of systemic risk.
During a disaster of a much more limited scale -the collapse of Penn Central Railroad- the SEC ordered its staff to conduct a through review of what the directors knew and when they knew it. Staff also examined the structure and culture of the board and its interactions with management. The result was illuminating and became a template for the disengaged board. As the staff report concluded:
Directors of Penn Central were accustomed to a generally inactive role in the affairs of the company. They never changed their view of their role.
The SEC has no trouble spending what seem like endless time and resources looking at the uptick rule and the allegedly detrimental role of short-selling, for instance. A case can be made that it is focusing too much on the individual trees and not on the health of the boardroom forest. Much more has been lost by shareholders, and by society more recently, as a result of boards that simply did not direct, did not hold management sufficiently accountable for its actions and were not adequately engaged with the affairs of the company in order to monitor risk and foresee the disasters that were looming on the horizon. The corporate board, with all the power and responsibility it entails, is an institution that requires considerably more focus on its limitations, its deficiencies and on its need for reform if it is to play its necessary role as a steward of investors’ interests and a guardian of the integrity of capitalism itself.
We will have more discussion about the past and future role of boards, and where they fit into the post-subprime recession era, in the days ahead.
Does FASB’s change in accounting standards improve investor confidence or detract from it? Is it a move consistent with a renewed commitment to transparency, or is it that famous political game of dressing up disaster like putting lipstick on a pig?
If you looked at all the causes of the great recession of 2008-2009 -which would doubtless include unbridled greed, an unconscionable obliviousness to risk, complacent regulators and sleeping boards- lack of transparency would figure high on the list. The extent of credit default swaps, for instance, which, in the case of Bear Stearns, Citigroup and AIG, appears to soar into the trillions, was a ticking toxic time bomb hidden from investors. They were nowhere on the radar of regulators, either. At some point, the silent ticking stopped and the world was abruptly awakened to the costs when risk and reality are allowed to be covered by a convenient curtain of concealment, if not outright deception.
It is, therefore, with some dismay that we greet the recent announcement by the Financial Accounting Standards Board (known as FASB, and another institution that does not exactly go to Herculean lengths to make itself clear and understandable to the average person affected by its decisions) to permit a retreat from current mark-to-market rules. These are the accounting principles that have required banks to place a current market value on their assets. Many of these assets have been categorized as “toxic” because they are based largely on mortgages that have plunged in value with the residential real estate market. Beginning with the collapse of Bear Stearns a year ago and all through the turmoil that has shaken the credit and capital markets, toxic assets have prompted trillions of dollars in bank losses, write-downs and interventions from the Fed and U.S. Treasury.
The accounting changes announced this week will allow banks to take a variety of approaches to valuing the assets under stress, and many will no doubt go into an impressive series of contortions to convince investors that they know better than the market their real value. If only somebody would pay that price, they could get back to the days when Ken Lewis of Bank of America was making $100 million, as he was in 2007, and bankers would be heroes again. But markets don’t always co-operate in the self-idolization aims of men, and it is not entirely clear that some banker’s valuation that supposedly trumps the market’s view is going to have any credibility at all. FASB’s move may be favorable for some banks in the short run. But will it accurately portray their state of affairs in a way that investors will trust when uncertainty has on more than one occasion given confidence quite a beating and knocked it down for the count? The New York Times’s Floyd Norris, long a follower of accounting standards and practices, has a number of insights on his blog into how this change came about.
What is most feared is that the gatekeepers are allowing another dimension of uncertainty to be introduced into the economy’s precarious equation just when it is widely agreed that what is needed is transparency with all the klieg lights it can marshal.
This is part of a disturbing trend that seems to favor the opaque over the undisguised. It is still unclear how all the original TARP funds (the program which, even before it was finally enacted, we dubbed the biggest boondoggle in the history of government) have been spent. The Congressional Oversight Panel, the body charged with monitoring the TARP, has been troubled by its lack of adequate controls and transparency. The watchdog’s head, Elizabeth Warren, has described the bailout as “an opaque process at best.” The TARP’s special inspector general, Neil Barofsky, recently reported that not all recipients of the government’s funds are willing or able to account for how the money was spent. “The most significant failing from a transparency standpoint: understanding the process and criteria Treasury used to decide who would receive TARP funds and what the recipients have done with the hundreds of billions of dollars that have been invested,” Mr. Barofsky told the Senate Banking Committee. The $175 billion funneled into AIG has not been fully documented, and only recently has it come to light that a large portion of it went to U.S. banks and financial institutions, like Goldman Sachs, which have already received TARP funds, as well as to foreign banks. Then there is the issue of compensation and bonuses, where awards have been made behind closed doors only to prompt public disbelief when they are finally brought to light. Trillions of dollars in Fed commitments and loans remain clouded by a veil of secrecy. The struggle to achieve transparency appears to be as challenging and arduous as the battle to restart the economy. It is not coincidental that the two are linked.
The lessons of the financial abuses and failures that came to light in the 1930s, like the excesses and deceptions of Enron and WorldCom some decades later, all point to the imperative of doing business in an open and accountable fashion. That applies especially to honest and accurate financial statements that reflect reality, not the pipe dream of a CEO who wants to put a happier face on the company’s situation -at least until he can cash in his stock options and retire in regal style. We have already seen too many companies shock their investors and the world by having carried on with a degree of leverage and risk that no sane person would have condoned. The solution, or at least a significant part of it, is to move accounting practices and everything else that determines the worth of a company out from behind the heavy curtains that for too long permitted bankers and other players to pull the strings for their own aggrandizement and into the sunlight of greater transparency that is essential to truth and confidence.
Does the recent change in accounting standards, during a time of the most profound unease in the economy and among investors since the Great Depression, improve investor confidence or detract from it? Is it a move consistent with a renewed commitment to transparency, or is it that famous political game of dressing up disaster like putting lipstick on a pig?
We see FASB’s decision as a regressive and very large step in precisely the wrong direction, which is why we chose it as our Outrage of the Week.
