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from Breakingviews:

One reason for Facebook IPO mess: Zuck didn’t care

By Rob Cox The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Facebook has reminded investors of a simple lesson: Avoid companies whose bosses don’t care about you. From the get-go, Mark Zuckerberg, the social network’s not very sociable founder, made clear he had little interest in welcoming public shareholders. That indifference set a tone for his executives, venture capitalists and bankers that arguably contributed to the glaring flaws in Facebook’s initial public offering last week.

True, the company’s earlier backers, who were able to unload more than $10 billion of stock at the highest possible price, may consider the deal worthy of high-fives and Cristal. But the combination of a stock already trading well below its offer price, annoyed retail investors - many of them Facebook users - and regulatory probes constitutes a botched deal. And that’s without mentioning trading glitches, which were presumably beyond the company’s control.

There’s also the impact on Facebook’s reputation and morale. Where the Silicon Valley titan was once viewed as a benign force connecting people, albeit with occasional privacy concerns, it now risks being synonymous with Wall Street money-grubbing. That’s bad for a product dependent on consumers. It’s also harmful for morale internally and, along with a listless stock price, for recruitment.

The irony is that these issues - along with the lawsuits now piling up on Hacker Way - may be exactly what Zuckerberg hoped to avoid by keeping his company private for so long. As he made plain in his letter to prospective investors, “we’re going public for our employees and our investors.”

Contrast his hands-off approach with the attitude of Microsoft’s Bill Gates back in 1986. Gates insisted the company’s IPO underwriters set a lower price range than they thought achievable, according to a Fortune story on the process, settling on $21 a share. That helped make the IPO an easy hit for incoming investors, even in the early days of trading.

By all accounts, Zuckerberg is Steve Jobsian in his attention to detail when it comes to coding for his internet creation. But the vacuum created by his distance from the IPO allowed underlings to make decisions - for instance in pricing and allowing early VC investors to ratchet up their sales - that may have damaged Facebook. In this respect, Zuckerberg has failed an early test as the CEO of a public company.

from Breakingviews:

Did Chesapeake miss Enron lessons?

By Christopher Swann and Robert Cyran The authors are Reuters Breakingviews columnists. The opinions expressed are their own. Chesapeake Energy, the embattled U.S. natural gas producer, seems to have missed some of the lessons of Enron’s demise. There have been no allegations of fraud. But the U.S. gas firm’s vast trading operation, fondness for complicated holdings and relationships, and corporate generosity are among the traits that, in hindsight, should have invited greater scrutiny of Enron’s edifice.

Chesapeake is a force in the U.S. gas market. It owns real assets, and it is the second-largest producer in the United States, accounting for about 9 percent of gross domestic gas supply according to a recent company presentation. It is the most active driller of new U.S. wells, and has substantial proven and unproven reserves. Meanwhile, joint-venture partners including Total of France and Norway’s Statoil attest to the substance of the projects they are involved in.

By contrast, while Enron’s byzantine structure and other questionable features may have developed to support aggressive expansion, they ultimately helped conceal essentially fake trading activities and fraudulent accounting. There is no suggestion that is the case, or might ever be the case, at Chesapeake. And other companies are complex or, for instance, offer generous perks without running into trouble. Yet it’s notable that Chesapeake, a self-described “bold” competitor in a sector close to Enron’s, has seemingly failed to avoid some of the defunct energy giant’s well documented flaws.

Corporate complexity Some Wall Street analysts admitted that they didn’t really know how Enron made money. The company had evolved into a labyrinthine organization that combined real energy assets, a black box trading operation and a web of off-balance sheet structures.

For its part, in conjunction with its energy properties and trading business, Chesapeake had seven joint ventures as of March 31, according to its first-quarter filing with financial regulators. U.S. gas sector rivals typically have only one or two such partnerships - Devon Energy, whose market value is more than twice that of Chesapeake, has only one. Chesapeake also had 10 so-called volumetric production payment agreements (deals to sell future production of gas or oil in return for up-front payments) and four separate holdings classified for reporting purposes as variable interest entities, including a controlling stake in a separately listed master limited partnership.

“The company is impossible to fully understand,” says Phil Weiss, an analyst who covers Chesapeake at Argus Research. “It’s what I can’t see that worries me.”

Oversized trading businesses Chesapeake has reported realized cash gains on hedging of $8.5 billion for the period from January 2006 to March 2012. That’s more than four times its cumulative $1.8 billion of net income over the same period. That makes the company look more like a hedge fund than a gas producer, even though it still holds plenty of gas assets.

from Breakingviews:

JPMorgan loss kicks succession race into high gear

By Rob Cox This column appeared in the May 21 edition of Newsweek magazine. The author is a Reuters Breakingviews columnist. The opinions expressed are his own. A time-honored tradition for handling executive succession on Wall Street is the practice of putting two ferrets in a sack, figuratively speaking. That’s when a bank takes two promising managers and makes them co-heads of the same business. The expectation is that, like two feral mammals clawing each other in the darkness, one will emerge victorious. He will become CEO. The other is named deputy vice chairman of Bolivian equities. JPMorgan has yet to officially haul out the burlap sack, but the $2 billion trading loss it disclosed two weeks ago has accelerated the contest to succeed Jamie Dimon at the top of America’s biggest financial institution.

Not that Dimon is leaving anytime soon. His hair may be silver, but he’s only 56 and has every intention of running the place into his 60s. Moreover, the losses from bets on funky derivatives incurred by the chief investment office in London look manageable for a bank that minted a $5.4 billion profit in the first quarter and boasts nearly $200 billion in capital. But as Dimon readily admits, the trades were dumb. They certainly undermined many of his public arguments for resisting additional regulation of the banking industry. As a consequence, the question of who will one day fill Dimon’s wingtips has become a money-industry parlor game.

For clues, look no further than the cleanup crew for the trading snafu. Two of Dimon’s most capable lieutenants, Michael Cavanagh and Matt Zames, have been handed high-profile roles that will help determine their suitability in the eyes of the board, investors, and regulators to eventually run the $2.32 trillion bank. Zames, 41, is taking over the unit that made the crummy trades. Cavanagh, 46, is leading a team of senior officers to “oversee and coordinate” the bank’s response to the affair.

Both are important tasks. Zames must unwind the problem trades while minimizing losses. Given the size and public nature of JPMorgan’s wagers, that won’t be simple. Having run JPMorgan’s bond trading desk, he should be well-suited to the challenge, though it may be his stint at Long-Term Capital Management, the hedge fund that collapsed in 1998, that’s more applicable to the current situation.

But it’s Cavanagh’s job that has far larger ramifications for the bank as a whole. As Dimon says, “Mike will ensure that best practices and lessons learned are carried across the firm.” Read between the lines, and that means the former chief financial officer’s recommendations may include changes to governance, risk management and corporate controls that implicate flaws in Dimon’s stewardship. How successfully Cavanagh can constructively criticize his boss for the greater good of the institution may determine whether he emerges from the sack as bloodied ferret or CEO.

from Financial Regulatory Forum:

Investor group seeks JPMorgan governance changes

By Emmanuel Olaoye

NEW YORK, May 18 (Thomson Reuters Accelus) - A labor-backed investor group critical of JPMorgan Chase & Co's corporate governance said the bank has failed to address concerns over its risk oversight and it will try to rally other shareholders for changes after a $2 billion trading loss.

CtW Investment Group, which advises labor pension funds holding what it said are 6 million shares in JPMorgan, has advocated for risk governance changes there for more than a year. The risk policy committee of the bank's board lacks the expertise to understand risks the bank is taking, such as the complex "London Whale" transactions that led to last week's loss disclosure, a CtW official said.

"It's exactly the kind of bet that is very difficult for board directors to understand. It reinforces concerns we have that a major financial institution doesn't seem to have learned the right lessons from the financial crisis," said Richard Clayton, research director at CtW.

CtW will work with pension funds in the Council of Institutional Investors and the International Corporate Governance Network to get more answers from JPMorgan, Clayton said. He said the timing of the multibillion dollar loss had left it too late to gather support in time for JPMorgan's annual meeting this week.

The failed hedging strategy by its JPMorgan's Chief Investment Office in London was designed to hedge the risks to the bank's bond portfolio. The bank has acknowledged $2 billion in losses, and the total could grow by another $1 billion or more. The trades were based on an index that is essentially a portfolio of credit default swaps - contracts that protect against default by a borrower.

It remains unclear how much JPMorgan's risk committee knew about the trades that led to the massive loss, and whether a chief risk officer was reporting to the committee, Clayton said.

from Lucy P. Marcus:

Facebook versus the Shareholder Spring

The corporate world is emerging from several weeks of boardroom turbulence dubbed the “Shareholder Spring.” In annual meeting after annual meeting around the world, boards have been taken to task by investors and other stakeholders on a wide range of issues: remuneration, board composition, competence, diversity, voting control, dual stock, and more. In the meantime, we have also witnessed the soap opera of Yahoo’s boardroom, the rebuke to newly public Groupon’s board for its lack of oversight of accounting practices, and the public condemnation of News International’s chair – and, by extension, its board – questioning his competence to lead the organization. No sector has been immune; no director has been untouchable.

Now Facebook is about to enter the public markets. Its defiant position regarding its old-style governance is in stark contrast with the temper of the Shareholder Spring. Facebook swims against the tide of a global movement toward transparency, engagement, and checks and balances. It feels as if we’ve all stepped into a time machine and none of the past couple of years of governance lessons – including the failures of boards in the banking-sector crisis – ever happened.

Several troubling issues call into question how this company can consider itself groundbreaking, innovative or new: the concentration of power in the hands of one man, the stranglehold on voting rights, the lack of diversity in the boardroom (which in a way is inconsequential, as the Facebook board does not have much bite anyway), and above all else the flagrant disregard of the lessons of the past several years about engaged, active and independent boards contributing to strong companies. Were Facebook striving to be an innovative company built to last, it would encourage healthy dialogue and diversity in the boardroom, and equal shareholder voting rights. It would not need to lock in power, but rather earn authority through excellent performance and results. The leadership would trust that a democratic boardroom would foster greater strength and stability than dictatorship, which brings a false sense of security. That's a lesson we can take from the Arab Spring, where dictators thought that they held real control.

Today there is euphoria, anticipation and excitement among investors. A lot of people will make money in the short term, but short-term investing is not what builds strong businesses and strong economies. The world needs durable companies that are innovative in the products and services they sell, but also distinguish themselves through responsive and responsible conduct in their corporate governance structures and business practices.

Over the years Facebook will need to grapple with many issues that affect the development of the company and the lives of its users, from growth to innovating ahead of the curve, and from privacy to social responsibility. My hope is that Mark Zuckerberg begins to see the value of ceding some of the control he holds by rule and is able to trust that he will be able to earn that control through deed. If that doesn’t happen, all eyes will be on the investors to see if at least they have learned the lessons of bad governance and the value of good.

PHOTO: The Facebook profile of founder Mark Zuckerberg on a mobile phone is seen in this photo illustration, May 16, 2012. REUTERS/Valentin Flauraud

from Financial Regulatory Forum:

JPMorgan AGM punctured by thorny hedge issues

By Christopher Elias

LONDON/NEW YORK, May 17 (Business Law Currents) - JPMorgan’s disastrous $2 billion hedge loss has raised some thorny issues on management oversight, corporate governance and the effectiveness of the Volcker Rule, as division at the banking giant’s annual general meeting highlight a growing tension between its shareholders and management.

Little more than a week ago, prior to Tuesday’s annual general meeting (AGM), JPMorgan announced that it had incurred a $2 billion loss as a result of a hedge gone wrong from its London offices with the possibility of $1 billion in additional losses to follow.The exact nature of JPMorgan’s derivative betting and what went wrong remain remarkably vague, despite JPMorgan’s numerous public statements. While the prevalent theory being made by financial analysts is that this was a “flattener” bet or a directional bet on credit default indices, the consensus that for the hedge to have generated $2 billion in losses, its unwinding was likely as disastrous, if not more so, than the “hedge” itself.

The fallout from this baneful bet became a comedy of errors after JPMorgan CEO Jamie Dimon described the matter as a “tempest in a teapot”. Dimon was later forced to admit at a hastily convened conference call that the “new strategy was flawed, complex, poorly reviewed, poorly executed, and poorly monitored.”

With management desperately trying to plug a hole in the balance sheet, questions are being raised about the competency of JPMorgan’s management and how corporate governance and risk procedures could have allowed such a volatile and ultimately disastrous investment to have manifested itself.

Age-old shareholder concerns over the dangers of one person holding the combined role of CEO and Chairman, and of the effectiveness of management oversight, surfaced and made for a tense AGM. Despite the discord, JPMorgan’s executive team remained largely intact, with the exception of chief investment officer Ina Drew, the lone casualty – having retired shortly before the start of meeting.

The matter has highlighted persistent corporate governance issues at large banks that look increasingly “too big to manage” as well as “too big to fail”.

from Financial Regulatory Forum:

JPMorgan repeats basic mistakes managing traders, say officials

By Rachel Wolcott

LONDON/NEW YORK, May 15 (Thomson Reuters Accelus) - JPMorgan's Chief Investment Office, which last week was responsible for more than $2 billion in mark-to-market losses, appears to have made some classic mistakes in the risk management of trading desks and the monitoring of traders. Although the CIO losses have not been blamed on a rogue trader, they do have much in common with the incidents at UBS and Société Générale, where single traders lost billions seemingly overnight. At the time the losses were announced, Jamie Dimon, chief executive at JPMorgan, said that the strategy responsible was "flawed, complex, poorly reviewed, poorly executed and poorly monitored".

Dimon's candid comments say plenty about the state of trading-desk risk management at JPMorgan and other Wall Street firms. In the cases of MF Global, UBS and SG sloppiness and plain incompetence in the institutions' risk management of trading operations were cited as important contributing factors.

There are other contributing factors, however. Risky and complex positions such as the ones alleged to have been taken by the CIO are notoriously difficult to risk manage, due to a lack of data and because they do not fit neatly into firms' risk management software and systems. Usually, positions such as these are monitored on spreadsheets or somehow shoe-horned into a system. This ad hoc approach makes it tough for risk managers to get a genuine picture of what is going on.

PJ Di Giammarino chief executive of JWG, a regulatory think-tank said: "JPMorgan's problem, like many large firms’, is that they couldn't detect and mitigate the risk in their aggregated view of the portfolios. Part of the reason that's a problem is the multiple, disconnected trading and risk management silos that are managed by pressed and laminated reports at best, or at worst, controlled via a spread sheet. Without any standard risk data definitions, use case rule book or common reference data to be able to link it all back together in a better, faster and safer way large firms will continue to have problems defining and interpreting risks for some time to come."

Moreover these losses often occur around a single trader or a small team who have done well for the firm in the past. In the JPMorgan case, that trader is Bruno Iskil, a City veteran. That points to what experts say is usually the main reason trading desks are so lightly risk-managed — if a trader is doing well, the tendency is for their managers to let them get on with making money, not to call time because they've breached their position limits.

"Was risk management checking the trades? I believe they did, but assessing the risk of some complex transactions is not easy. Probably these trades were approved at the top level, but because it has become more difficult to make money prop trading, some people are taking big risks to collect pennies in front of a steamroller," said Giorgio Questa, a former senior banker and now a professor in the faculty of finance at Cass Business School in London.

from Breakingviews:

Pricey Chesapeake medicine highlights its sickness

By Christopher Swann and Robert Cyran

The authors are Reuters Breakingviews columnists. The opinions expressed are their own.

Pricey medicine can help. But in Chesapeake Energy’s case, it shows how sick the company is. The embattled energy firm is borrowing $3 billion at 8.5 percent to repay a loan whose terms might otherwise prevent asset sales. This buys time. But it makes even more obvious Chesapeake’s unsustainable reliance on selling assets to fund its persistent cash drain.

Chesapeake, America’s second-largest natural gas producer, has been cash-flow negative for a decade. Fitch Ratings reckons it faces a $10 billion shortfall this year. Aubrey McClendon, the chief executive now beset by questions over financial conflicts of interest, recently sounded characteristically confident that the gap could be bridged by asset sales. The company is targeting up to $14 billion of them this year.

But the firm’s quarterly filing with regulators on Friday - curiously delayed - painted a less optimistic picture. Chesapeake said it might have to delay and rejig asset sales to avoid flogging off assets needed as collateral or cutting cash flow below the level required by its debt covenants. The shares slumped 14 percent, and have lost about half their value in the past year.

The main stumbling block appeared to be the firm’s $4 billion revolving credit facility. The new, much more expensive loan from Goldman Sachs and Jefferies unveiled later on Friday will repay that, easing concerns that a cash flow squeeze could force more asset sales only to have lenders demand repayment, creating a fresh cash deficit.

But it’s a temporary reprieve. Chesapeake still needs to reduce its debt and wring more dollars from its wells. Selling choice oil assets while gas properties suffer with ultra-low prices only whittles away further at the company’s long-term earning power.

from Breakingviews:

Boardroom botches call for checklist fix

By Jeffrey Goldfarb

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

If checklists can save lives, surely they can help shareholders. The scandals at Yahoo, Green Mountain Coffee, Chesapeake Energy and other U.S. companies suggest boards of directors could do with some simple reminders to prevent them from making stupid mistakes. Breakingviews has drawn up a starter set.

The pressure on companies to find competent leadership has grown in tandem with their complexity. And in their quest for chief executives and directors who can deliver on a range of diversified financial and strategic initiatives, the basics are too often being forgotten and leading to avoidable failings. Just as surgeon Atul Gawande showed, in his recent bestseller “The Checklist Manifesto,” how a 90-second checklist reduced deaths in the complicated world of intensive care, boards could preserve shareholder value with a Post-it note of sorts.

College, degree, work history and military service confirmed? At Yahoo, a straightforward bit of due diligence, like the kind conducted by activist investor Dan Loeb, would have uncovered Chief Executive Scott Thompson’s misrepresented scholastic credentials.

Doing any moonlighting we should know about? Among his many undisclosed and still-unexplained activities, Chesapeake boss Aubrey McClendon was running a hedge fund on the side.

Do you have a close personal relationship with any of the senior management here? The designated stewards of Rupert Murdoch’s media empire are limited in their ability to restrain the mogul and his whims. But having the godfather to one of his grandchildren - whose father is also a director - officially designated as an independent should be a stark reminder to others.

from Financial Regulatory Forum:

Corporate governance watch: vote failures signal investor dissatisfaction with executive pay

NEW YORK, May 10 (Business Law Currents) - Stockholders are making their discontent heard through say-on-pay votes that have not been flattering to executives. So far this year, multiple companies have outright failed these votes and even more have not been able to reach the 70 percent approval threshold. In light of Institutional Shareholder Services’ (ISS) 2012 Corporate Governance Policy Updates, evaluations of company pay policies are in line for even greater scrutiny.

According to ISS, a majority vote that does not reach at least a 70 percent approval rate is considered as a failure. A simple majority alone is no longer deemed a mandate of a board’s policies, and any approval level below 70 percent is now perceived as a serious exhibition of shareholder dissatisfaction.

Recently, in a less than glowing endorsement of executive pay levels, only 56.7 percent of stockholders voted in favor of approving compensation at NYSE Euronext. A significant 42.8 percent of stockholders voted against approval of executive pay. The annual meeting results highlight the growing unease with which stockholders are viewing NYSE Euronext’s executive pay policies.

There may be larger structural issues at play for NYSE Euronext, as not only did they say-on-pay vote go poorly but Ricardo Salgado, a member of the company’s board, resigned after not receiving a majority of the votes cast. He was only able to obtain 46 percent of the votes and, per the company’s bylaws, tendered his resignation to the board. There may have been strong sentiment that Mr. Salgado had relegated his NYSE Euronext board duties in favor of increasing his concentration on efforts to help stabilize Portugal’s banking sector.

The pain has been spread throughout the markets with companies in a myriad of industries with differing sizes falling by the wayside. In a massive exhibition of disapproval for a financial institution behemoth, Citigroup failed to reach the desired 70 percent level by a wide margin, managing only a lowly 45 percent approval rate.

KB Home was another casualty of stockholder disapproval of executive compensation. KB Home crossed the finish line with a mere 45.6 percent approval level. This level of shareholder dissatisfaction is a likely reflection of the relatively poor financial performance of the company leading up to the vote. In the current environment, where shareholder value maximization is king, voters may show even less patience than in previous years.

According to GovernanceMetrics International, 38 Russell 3000 companies failed say-on-pay votes through October 2011. So far this year, there have already been five failures. It is interesting to note that voters appear to be showing signs of actively wanting to engage say-on-pay issues. In the case of NYSE Euronext, abstentions only accounted for 0.5 percent of votes.