Felix Salmon

Splitting the roles of chairman and CEO at a public company is nearly always a good idea. It makes sense at Goldman Sachs, which is reportedly considering it, but if it were to happen, the decision would be a fraught one.

For one thing, it would look panicked and defensive, rather than a long-term strategic move. But the main reason not to do this, from Goldman’s view, is simpler: it’s incredibly difficult to find a suitable candidate. Just think of all the qualifications which are needed:

• The ability to set the strategic direction for what is still the world’s foremost investment bank and broker-dealer. How big should Goldman be? What kind of balance between banking and trading should it have? How much should it pay?
• The ability to be the risk manager of last resort, keeping an eye on the balance sheet and making sure that nothing is getting out of hand. With David Viniar as CFO, this part of the job is maybe less important right now. But it’s still hugely important.
• The ability to communicate effectively with shareholders, regulators, and politicians — in a way that Lloyd Blankfein is not so great at.
• The ability to represent Goldman’s shareholders, who are to a large degree its partners.
• The ability to restore the credibility of the rest of the board, which has been something of an embarrassment of late.

Is there anybody who can do all this? The WSJ article barely even brings up the names of Hank Paulson and Arthur Levitt before throwing cold water on them. My feeling is that if the job is going to be real, and not a figurehead, it really needs to be a Goldman person of some description doing it: maybe Bob Hormats or Byron Trott? Or bring back Jon Corzine? I wonder whether he’d take the job, since it comes with so much downside and so little obvious upside.

It’s pretty clear now why Rajat Gupta stepped down from Goldman’s board of directors last month — the only question is why it took him so long. Galleon’s Raj Rajaratnam was charged back in October, along with McKinsey director Anil Kumar; Gupta was not only the former head of McKinsey but was and is a close friend and business associate of Rajaratnam:

Messrs. Rajaratnam and Gupta spoke frequently, and Mr. Gupta was invited to attend parties hosted by Galleon, an individual close to the situation says.

In 2006, Mr. Rajaratnam, Mr. Gupta and Mark Schwartz, a former Goldman executive, formed Taj Capital, a hedge-fund and private-equity firm focused on South Asia. The firm, since renamed New Silk Route, manages $1.4 billion in private-equity investments.

All of that alone places Gupta far too close to Rajaratnam for Goldman to be happy with Gupta on its board. But today it gets much worse: the WSJ’s Susan Pulliam reports that Gupta is being investigated for examined with respect to insider trading in Goldman shares, via his friend Raj.

What is it with Goldman and these unfortunate events surrounding its board? First there was the scandalous secret meeting with Hank Paulson in Moscow. Then there were the dubious stock transactions by Stephen Friedman. Then there was the embarrassing interview with Ruth Simmons, which was swiftly followed by her departure from the board. And now this. What can it all mean?

Update: souhaite, in the comments, reminds me of the Meg Whitman affair in 2002. And a friendly PR person emails to tell me that there’s “an important distinction” between being investigated and being examined. Gupta’s being examined, according to the WSJ, he’s not being investigated.

On Tuesday, Brown president Ruth Simmons explained that the decision as to whether she should continue to sit on the board of Goldman Sachs was a complex one which would not be taken lightly:

If Simmons were to leave Goldman’s board, she said, she does not think she would join another board…

One reason Simmons cited not to seek out new positions was that the seniority she now enjoys on Goldman’s board allows her to advocate for programs to help women and minorities.

Simmons said that, as with her retirement from Pfizer’s board three years ago, when to call it quits with Goldman will not be a decision she makes by herself, but rather in cooperation with the Corporation, the University’s highest governing body, with which she meets regularly to evaluate her actions.

“I feel very strongly that I don’t know enough as an individual — a sole individual — to make that decision alone,” she said.

On the other hand, it seems that complex decisions on such matters can still be taken quickly. Goldman put out a press release on Friday afternoon, just as the long weekend was starting, saying that Simmons was leaving the board, and citing “increasing time requirements associated with her position as President of Brown University”.

Happily, Simmons leaves with Goldman stock resurgent: her 27,386 restricted stock units are worth $4.2 million right now, and can be sold the year after she retires from the board; she also has another 10,000 options on top of that. Goldman Sachs board members, it seems — who are all members of the compensation committee — are compensated as well as you might expect from the company which invented the $68.5 million CEO bonus.

I said after Tuesday’s interview with Simmons was published that she seemed to think about her membership on Goldman’s board much more in terms of what it could do for her and her pet causes than in terms of being a shareholder representative tasked with overseeing senior management, and I called for a revamp of the board. Friday’s news is exactly the step in that direction that I was looking for: maybe Simmons took my comments to heart!

In all the bellyaching about the governance of the biggest banks, and the fact that their boards were spectacularly unqualified to provide any kind of oversight of what they were doing, Goldman Sachs has gone largely unmentioned. But what’s true of Merrill Lynch and Bank of America is true of Goldman too: its executives need some kind of adult supervision, seeing as how they work for their shareholders, rather than just for themselves.

Yet this interview with one Goldman board member, Ruth Simmons, hardly instills in me the confidence that she can or will understand what Goldman is doing, stop them from acting in a reckless manner, or keep a close eye on compensation as she wears her hat as a member of the compensation committee:

Simmons said she originally joined Goldman’s board at the recommendation of Smith’s Board of Trustees around the time that she started a center for financial literacy on campus.

“We had a big push to think about how we could improve the knowledge and ability of women to manage their financial affairs,” she said. “At the same time, there was a good deal of interest in the fact that women have not done so well in the financial sector and on Wall Street.”

Simmons has moved on from Smith, and is now the president of Brown University. But of all the reasons to join the Goldman Sachs board of directors, improving the ability of women to manage their financial affairs has got to be one of the worst: that’s simply not something that Goldman board members do. Instead, they’re meant to represent Goldman’s shareholders and oversee Goldman’s management.

But rather than bring any kind of financial or economic expertise to bear on her job, it seems that Simmons was happy to simply sit back and receive the gift of wisdom in such matters from the Squid:

Simmons said her service on Goldman’s board gave her the economic savvy to take certain risks that she might not have taken otherwise, such as the introduction of need-blind admissions.

This seems to me to be both an admission that she was lacking in economic savvy when she joined the board, and an admission that being on the Goldman board made her more prone to taking financial and economic risks than she was before. Is this really the kind of person that Goldman’s shareholders want representing their interests as an overseer of management?

There’s no indication in the interview that Simmons takes her fiduciary responsibilities to Goldman’s shareholders particularly seriously; instead, there’s a great deal of talk about the effect of the directorship on her and on Brown, not to mention a fair amount of standard-issue ass-covering:

“There are lots of things in a complex institution that go on,” she said. “You’re not in charge of everything that your friends do and every policy that organizations that you’re affiliated with issue.”

It seems to me that the days when Goldman Sachs could fill its board with these standard corporate board types — the college president, the management consultant, the business-school professor, even the long-time chairman and CEO of Fannie Mae — have surely come to an end. It’s made a stab at beginning to reform its compensation practices, and I’m quite sure that’s entirely a decision of management rather than of the compensation committee. Next up, it should get to work on the board, appointing people who will look hard at managerial business decisions, and won’t allow themselves to be snowed by Lloyd. Indeed, he should welcome the extra set of eyes and a few tough questions: it’s good, in his position, to be forced to know what you’re doing and be on your toes.

Paul Smalera asks — but, sadly, doesn’t answer — the big question surrounding AIG’s bonus compensation: why on earth are the company’s executives specifically asking for it to be paid in worthless AIG stock, when they already got permission from the special paymaster to pay bonuses with a special “basket” of stock that reflected the value of four profitable AIG divisions?

It’s certainly true that AIG executives know something we don’t: they know, for instance, the contents of the SEC filing which won’t be made public until 2018. But AIG is saddled with enormous obligations to the government, which have already been restructured at least once, and no one has ever indicated that they can be repaid in full. So long as the government ends up incurring a loss on its AIG bailout — and everybody expects there to be some kind of a loss on the deal — AIG stock should be worthless, no?

I understand that there’s some tiny possibility that AIG will be able to pay the government back in full, and that therefore AIG stock has a small amount of option value. But I don’t think that explains the desire of AIG executives to be paid in stock with a high probability of being worthless and only a small probability of ending up in the money. It certainly seems as though here’s something very fishy going on here. Smalera has one theory:

If AIG does end up spinning off its profitable units, it might be able to construct the IPOs in such a way as to grant executives valuable stock in the new companies in exchange for their worthless AIG shares.

I don’t buy it: the probability of such a scheme working out is, again, too low. But I have to admit I don’t have a better idea.

John Deutch, one of the many grandees with no financial experience who populated bank boards in the run-up to the financial crisis, is finally stepping down from his sinecure at Citigroup:

“Directors that served on Citi’s board during this financial crisis should rotate off in an orderly fashion,” Mr. Deutch, a chemistry professor at Massachusetts Institute of Technology in Cambridge, Mass., said in an interview Thursday. “My view is that there should be a complete turnover. Now is the time that’s appropriate for me.”

Which sounds very noble, until you realize that Deutch, who lasted 19 months as CIA director in the mid-90s, is actually rather late to this game. As Aaron Elstein writes:

Mr. Deutch, 71, is one of the last to leave from the old regime of Citi directors who apparently snoozed as the bank piled up more than $25 billion in losses in 2008. Five of those directors left the board last year, including former Treasury Secretary Robert Rubin. Mr. Deutch was replaced as chairman of the audit and risk committee last July by Jerry Grundhofer, a former chief executive of U.S. Bancorp.

Interestingly, Deutch waited until he was nominated to the high-level Defense Science Board before he announced his departure from Citigroup. Good to know that helping destroy a systemically-important part of the US economy didn’t disqualify him from that.

We all love independent board members of public companies. But can they be too independent?

Townsend expressed concern that Massey has been ineffective at building consensus among directors who have proven themselves to be fiercely independent. “That has been an unintended consequence” of April’s shareholder actions, he said.

The problem, of course, is that of who will replace Ken Lewis as BofA CEO. Lewis had no coherent succession plan, and the board can’t seem to come to an agreement either.

Ultimately the important thing is not that board members are independent of each other but rather that they are independent of management. There are definitely many advantages to have the board broadly pulling in the same direction, and then hiring and firing the CEO accordingly. And I think we’re beginning to see, at BofA, the disadvantages of having an ineffectual chairman who has less money, power, relevant experience, or charisma than just about anybody else on the board: it’s a recipe for sclerosis and infighting.

We got a hint of it when the government ousted Ken Lewis as chairman of Bank of America; it became more obvious with the decisions of pay czar Kenneth Feinberg. And then of course there’s the revolving door into the corner office at AIG. But the defenestration of Fritz Henderson makes it clear if there was any doubt: Barack Obama is the most powerful and effective activist shareholder that this country has seen in a very long time.

Needless to say, this is not common when it comes to state-owned companies, which often amble aimlessly in random directions for decades. The Obama administration, by contrast, has clearly made a decision to err on the side of action and decisiveness, and to fire any CEO who isn’t showing (as opposed to promising) results. Good for them: would that America’s institutional investors followed suit.

That said, it’s easier for the government to behave like this than it is for most shareholders. If Ed Whiteacre wants to know what GM’s majority shareholder would like him to do, all he needs to do is pick up the phone and ask. At most companies, by contrast, the communication between the board and the shareholders they work for is distant and strained and largely filtered by management. Maybe the trick, when it comes to improving corporate governance, is to improve communication between shareholders and directors. Any bright ideas on that front?

At the same time, this development proves that the dream of the bank-nationalization crowd — the idea that the government could take ownership but have little if any control over management — was never going to happen. When this government takes over a company it does so with both hands: there’s nothing arm’s-length about it. And I’m happy about that: owners should take responsibility for maintaining their property.

Good news on the corporate-bully front: Hertz, which was behaving abominably towards Audit Integrity, has utterly caved, dropping its libel suit on the grounds that it was “not worth pursuing now”. Or, one assumes, ever again. A small but important victory for freedom of speech in the financial markets.

Kevin Connor has found something rather interesting with respect to the Wells Fargo-Wachovia merger: Donald Rice, who was Wells Fargo’s chairman until 2007, sits on the board of a company called Vulcan Materials. Also on the Vulcan board are Donald James and John Baker, who sat on the Wachovia board.

When Wachovia was incorporated into Wells Fargo, a dozen of its directors found themselves with no seat on the new board. But Donald James and John Baker — the men who had sat with Rice on the board of Vulcan — were whisked over painlessly to the Wells Fargo board.

Connor concludes:

The data can be interpreted a few different ways, but it strongly suggests that the Vulcan Three were at the center of this deal — that Rice, James, and Baker played key behind-the-scenes roles in the Wells-Wachovia merger.

There’s no smoking gun here, of course. But it’s certainly an intriguing hypothesis.

Good on Audit Integrity for fighting back against the blatant bullying being perpetrated on it by Hertz.

A brief history is in order: on September 16, Audit Integrity released a report, based on new and proprietary analysis, listing 20 large public companies with the highest probability of declaring bankruptcy in the next twelve months. One of those companies was Hertz, which, in its latest 10-K, has a 23 pages of risk factors, including these:

We have substantial debt and may incur substantial additional debt, which could adversely affect our financial condition, our ability to obtain financing in the future and our ability to react to changes in our business…

Despite our current indebtedness levels, we and our subsidiaries may be able to incur substantially more debt…

Our reliance on asset-backed financing to purchase cars subjects us to a number of risks, many of which are beyond our control…

We may not be able to generate sufficient cash to service all of our debt or refinance our obligations and may be forced to take other actions to satisfy our obligations under such indebtedness, which may not be successful…

A significant portion of our outstanding indebtedness is secured by substantially all of our consolidated assets. As a result of these security interests, such assets would only be available to satisfy claims of our general creditors or to holders of our equity securities if we were to become insolvent to the extent the value of such assets exceeded the amount of our indebtedness and other obligations.

Hertz wasn’t happy with the Audit Integrity report, and sent the company a rather silly letter on September 22, which included lines like this:

Several analysts follow Hertz and its competitors closely, and all of them have significantly increased their estimates of the per-share price of Hertz’s common stock from where their price targets were 6 months ago. In addition, had your staff taken the time to review what the analyst community is saying about the rental car industry in general and Hertz in particular, you would have learned the favorable macro economic factors working in favor of the industry into the foreseeable future.

Heaven forfend that an independent research house should do something other than just “review what the analyst community is saying” and look at “macro economic factors”!

The really nasty bit of the letter, however, was where Hertz’s general counsel not only threatened to sue Audit Integrity over the report, but also copied the general counsels of all the other companies on Audit Integrity’s list, encouraging them to do likewise.

The lawsuit arrived on September 25. It’s pretty weak stuff, but Hertz is clearly hoping that it can embroil Audit Integrity in a large number of annoying and expensive lawsuits, brought not only by itself but by any other company that Audit Integrity singles out as being at risk.

So Audit Integrity’s chairman, James Kaplan, has decided to take this to the SEC:

Hertz is entitled to protest Audit Integrity’s findings. It also has the right – in fact, we believe the obligation — to address the areas of risk which we identified, and take steps to correct them. Such actions would benefit Hertz’s shareholders and would show that fact-based research was being used to improve the transparency and financial health of the company. Instead, the company has chosen to defame our methods – which are published on our website, but which the company’s management apparently has not read – and to invite unrelated companies to file action against us.

Frivolous attempts to crush independent research do not benefit investors. Publicly dismissing our model as “misinformation and untruths” also is a materially misleading statement about Hertz’s current financial condition…

As you have stated that you plan to step up the SEC’s enforcement efforts and better protect investors, it is my hope you will investigate this matter. It is possible Hertz will yet prove to be one of America’s great corporate success stories, but there is a disturbing trend of financially precarious companies aggressively trying to silence or tarnish their critics in the months immediately prior to their demise (Enron, Tyco, and Lehman immediately come to mind). If Hertz is allowed to mask serious financial risk by attempting to discredit quantitative research, Hertz’s shareholders may follow in the footsteps of others who suffered from a lack of warning.

It would be great if the SEC took this letter very seriously. Not all independent research is accurate, but the way for companies to deal with inaccurate research is to engage it on the merits and the substance, rather than to launch bullying lawsuits which have the aim of shutting down the research house in question. I haven’t spent any time looking in detail at the Audit Integrity report, but I do know that Hertz’s response is extremely worrying, and in and of itself raises serious questions about the company’s commitment to transparency and openness.

Jack Welch likes to cultivate an image as a straight-talking kinda guy who would never say something to an enclave of CEOs that he wouldn’t be happy putting his name to in one of his books or columns.

Except, according to the Economist (a/k/a Matthew Bishop):

This columnist once heard Mr Welch tell a chief executives’ boot-camp that the key was to have the compensation committee chaired by someone older and richer than you, who would not be threatened by the idea of your getting rich too. Under no circumstances, he said (the very thought clearly evoking feelings of disgust), should the committee be chaired by “anyone from the public sector or a professor”.

Maybe that’s the reason he finally retired from GE: there was no one left who was richer than he was.

Update: Bishop went into more detail on this here.

David Reilly reckons we should have bankers overseeing banks:

Only about 15 percent of directors have banking experience at the 10 largest U.S. commercial banks by assets, according to my own analysis. Include directors with investing, accounting, insurance or real estate backgrounds and the rate creeps up to only 33 percent…

Bank directors also include academics, politicians, retired military officers and heads of nonprofit groups such as the Pennsylvania Horticultural Society. There are more of these folks than non-executive directors with banking experience at the banks I examined.

This is startling, and I’d be inclined to agree with him — if he did a bit more empirical work. Looking at the percentage of directors with banking experience is just step one; the second step is to see if there’s any correlation between the number of directors with banking experience, on the one hand, and the performance of the bank, on the other. Reilly writes:

To understand what might sink a bank, directors needed a grasp of instruments like collateralized debt obligations and off- balance-sheet entities like conduits or structured investment vehicles…

Boards with more investing, finance and accounting experience may be better positioned to deal with today’s quickly evolving financial industry.

Or, they may not: bankers have proven themselves, over the past couple of years, to be just as oblivious as everybody else when it comes to complex products and systemic risks.

So let’s do a bit of homework here, and see whether banks with boards with lots of financial experience are less likely to lose money, or less likely to blow up, than banks with few such board members. Then we can start pushing them to make changes, starting with the chairman of BofA.

Ben Bernanke, Tim Geithner, and Sheila Bair have put out a statement which says that the stress tests aren’t just about capital:

Over the next 30 days, any BHC needing to augment its capital buffer will develop a detailed capital plan to be approved by its primary supervisor, in consultation with the FDIC, and will have six months to implement that plan…

In addition, as part of the 30-day planning process, firms will need to review their existing management and Board in order to assure that the leadership of the firm has sufficient expertise and ability to manage the risks presented by the current economic environment and maintain balance sheet capacity sufficient to continue prudent lending to meet the credit needs of the economy.

I’d love to know what this means. Who’s going to review the management and boards of these companies, if not the management and boards themselves? And what are the chances that any such entity will come to the conclusion that the leadership of the firm does not have “sufficient expertise and ability to manage the risks presented by the current economic environment”?

I suspect that this requirement is basically a way to allow Treasury to make any changes it wants at the top of the banks’ org charts. Obviously Ken and Vikram are at the top of most pundits’ hit lists, but there’s a good chance that Treasury has overly-complaisant boards in its sights too. I’m sure that Walter Massey is a first-rate physicist, but he has no financial experience whatsoever: is he really the best possible person to be chairman of the largest bank in America? I suspect that Treasury might have its doubts.