Bank Missteps? Review the Board!/Andrea Psoras
And other Risks and Vicissitudes Shareholders Face/May 2003
Not to disparage Marilyn Seymann’s observations, board quality only recently has become a matter of concern in the financial sector. “Making Sure Your Board Has Proper Chemistry, Skill Base” (American Banker-5/16/03) she suggests some reasonably good ideas: “To assess whether your board has the appropriate mix of skills and experience, chart each director’s knowledge in various areas, such as finance, HR, credit, technology, mergers and acquisitions, regulatory issues, and marketing. You may find – particularly if your bank has grown by acquisitions – that you have high degrees of skill duplication on your boards but still have holes in the skill base, despite a large number of directors…” The number of women and minorities serving on boards has been steadily increasing as corporations recognize the importance, and the benefits, of bringing in new perspectives. Not only does a diverse board sometimes bring together different perspectives, but it also tends to enhance the bank’s community relationships, reputation, and often its customer service. A consultant on board/governance matters, the author adds some advice for improving board communication and creating an environment of trust, comfort, and non-confrontation.
Although I may disagree on the ‘diversity’ emphasis, eliminating ambition and conceit at the board level in order to deter this at the management level will come with finding and engaging superior board candidates, and perhaps they are women and minorities. On addressing and remedying the aforementioned as well as following complexities, however, I support comfort with friction and ‘confrontation’ as “Steel sharpens steel” according the Proverb. Hubris displayed by conceit and greed produce and has produced recombinant/ decombinant banking such as many bank mergers. Steps to lance such ‘character’ flaws at the Board and senior management levels will facilitate a better bank, and a better sector overall. Moreover, quality does not mean a larger bank, or a higher share price, or paying the largest bonus and proposing fat ‘comp’ schemes to lure ‘superior’ management. High quality management candidates exist without requiring the most lucrative comp packages. And optimal operating decisions need effective board involvement. The status quo and what’s maintained and paying ‘up’ for status quo at the board and senior management levels can not drive optimal, judicious operating decisions.
While in M&A and strategic advisory work for bank/thrifts, we practiced board and management reviews as a matter of course. The markets and some analysts are slow to embrace analyzing the most important parts of the company, or perhaps the markets were easily defrauded by boards that appeared and do appear to have substance, using Enron as the example.
Many of the larger banks and larger companies like Enron appear to have ‘well-qualified’ boards. On careful inspection, however, more boards are falling short of high marks. Using the Sarbanes-Oxley legislation and new board and corporate mandates, one should filter observations of management’s operating decisions and what those decisions produce. The financial press has indicated numerous examples of (management) failures in operating and financial reporting producing corporate scandals and even bankruptcies. Bank regulators and supervisors closely review for criminal backgrounds and conflicts of proposed board candidates of bank/thrifts Directors’, although that’s all for which those parties are reviewed, not if they’re effective selections for Board and Management. If having selected inferior candidates, infrequently will these cause ‘bankruptcy’ or cause the bank to be seized, however inferior Board and senior management over time cause problems in the enterprise. And an inferior board at a large bank, this also will cause problems in the sector. Notwithstanding, current flawed operating and other decisions at the management level indicate board weakness warranting review for meaningful improvement. And given this time of economic adversity, negligence and carelessness at the board level perhaps could produce ‘failure’. Combined with reckless oversight, failures will occur. In the past this mix along with flawed legislation produced grand scale failures as we saw in 2 thrift crises and one of those which also coincided with a large number of bank failures in the late 1980’s and early 1990’s with the failure of Bank of New England. This era produced legislation including “Prompt Corrective Action” in the 1991 Federal Deposit Insurance Corporation Improvement Act.
Hopefully the American Bankers’ Association’s new handbook on Corporate Governance will encourage its members to recruit optimal Board candidates. “This handbook focuses on the questions bank directors will have regarding new corporate governance changes,” says Don Ogilvie, ABA’s president and CEO. “While some of the changes are very significant, they are also manageable. We believe this guidebook will minimize any implementation issues.” The handbook, titled Bank Director’s Advisory: New Directions in Corporate Governance, was written by ABA’s accounting and securities experts and the law firm Covington & Burling. It details: scope of new laws and regulation; changes in board composition, roles, and responsibilities; changes in audit committee composition and responsibilities; and changes in public company disclosures. A careful read of the new handbook will reveal if the ABA exhorts its members to find and secure superior candidates for their boards.
An eagle’s-eye view of this matter among the big financials produces these assessments. In carefully examining PNC’s status as an example, I recalled its recent reporting problems and regulatory reprimands. Observing in its proxy the board’s composition, one could conclude it needed to shuffle its board to include more of the protean ‘banking’ financial expert types to improve the management decision process to produce optional, prudent operating performance.
PNC’s board has six standing committees: an Audit Committee; a Nominating and Governance Committee (formerly the Committee on Corporate Governance); a Credit Committee; an Executive Committee; a Finance Committee; and a Personnel and Compensation Committee. The Board has also established an Operations and Technology Committee and a Special Regulatory Affairs and Oversight Committee and is authorized under the By-laws to establish other committees from time to time as stated in its proxy.
Regulators recently reprimanded PNC for poor internal controls and poor reporting judgment. They forced PNC to restate its earnings (back several years? I recall). And although core banking still represents most of the motor for earnings/operations at the bank, it appears some forays into other lines of business may lack Board understanding. Its current Board reflects its former branch banking profile. It made some key operating and board/governance improvements, although adding some quality board members able to handle PNC’s non commercial/retail banking lines of business will improve oversight on management decisions in those more complex, more recent businesses added to the bank.
Not only at PNC, but pervasively throughout the banking sector and corporate America, the occurrences of poor reporting and/or poor internal controls indicate management feeling pressured to goose earnings. They use questionable reporting conventions failing on transparency and being in a ‘winning sector’, both keys to the health of the banking sector and in turn, for bank stocks and bank stock investors. Although the ‘new economy’ propaganda presumes and attempts to force choosing ‘winning’ and ‘loosing’ sectors, investors have tired of the fraud, and will hunt for ‘quality’, which banks should have stayed the course to practice in every way. The Board is to oversee and commit to this, while management effectuates this in the bank. It is in all this PNC (as well as other peers have) have failed, although Michael Mayo had observed its problems, which along with issues such as Too-Big-to-Fail have contributed to keeping PNC independent in this market.
PNC has a weak Board of Directors. The lack of substance situation had eroded the quality of the franchise and deleteriously affected its financial situation. A cursory review of PNC’s Board led me to believe it needs more financial experts on all of its committees. Most likely, the lack of strength on the Board for those qualities for that reason PNC has had reporting/restatement and other problems indicating both management and board distraction. Include in that, the management and Board loosing grasp of the internal control situation.
Its Credit Committee has its women, whose backgrounds seem a little light – IBM sales/marketing, horticulture – perhaps these directors are OK, but as the bank’s condition has deteriorated, these women perhaps are part of the problem. Perhaps there’s a board culture that hinders their input, even if it is very good. Likewise, the current CFO of Alcoa, a former chairman of JP Morgan’s Risk Management Committee sit on the “Audit Committee” as its financial expert according to PNC’s proxy, “as that term is defined in SEC rules”. Neither are CPAs? Both are CPAs? If neither are CPAs preferably with bank audit experience, in lacking meaningful financial expertise on the Audit Committee, the bank is rudderless on some key financial matters.
Further, the bank needs to alter the “Audit Committee” into the “Reporting-Audit & Control Committee”. That committee should include the Operations and Tech committee tasks and oversight of the responsibilities of the newly combined committee. Isn’t most of the IT the ‘tech’, and related to the control/reporting systems?
Perhaps the Board should replace Rohr on the Executive Committee. Because the Executive Committee’s oversight provides an efficient means of considering such management matters and taking such actions as may require the Board’s attention or exercising Board’s powers or authority in the intervals between meetings of the Board, then it errs to have Rohr in that committee. The Board risks Rohr will interfere when some insightful Board decisions to improve the franchise will rock the boat and Rohr is reluctant to make the necessary changes.
Perhaps rename or combine the Finance Committee with the “Risk Management (“RM”) Committee”. In turn, remove to a comp-benefits committee the activities of the Pension Plan Committee, the Group Benefit Trust Committee, and the Incentive Savings Plan Committee along with the fiduciary activities of the Corporation’s subsidiaries, including its principal banking subsidiary. Meanwhile, in the RM Committee it would keep the activities more related to the bank’s risk management architecture and character. These activities are among the risk management process and internal control structure relating to the interest rate and liquidity risks of the Corporation, the trading activities, the capital management activities, the equity and subordinated debt investments, risks associated with valuation adjustments of such investments in the financial markets, and such other matters relating to the financial management of the Corporation as the Committee may deem appropriate or necessary from time to time.
This Board must watch for management passive or covert ‘neglect’ and or inferior practices that attempt to position this company for a sale. Often the senior management gains the most with or without a place in the combined management. Conceit should pay the highest price, rather than that in the business world which often costs the most to the non-management shareholders over the short and long run.
Other recent examples of board ‘negligence’ with relation to management operating decisions include: J. P. Morgan Chase, Citigroup, Bank of New York, Fifth Third.
J. P. Morgan Chase & Co. JP Morgan Chase & Co, after its choppy ‘merger’, “is facing immense pressure to raise its stock price and profits. Its third-quarter earnings fell 91%, to $40 million, from a year earlier on mounting losses” according to the press, although I mention, losses due to flawed operating decisions that made poor choices in corporate and wholesale lending and private equity investments, not including significant merger related expenses all wasting shareholder money. “But the consumer banking has been a bright spot. In the first three quarters the retail bank generated net income of $2 billion, up 63% from a year earlier”. Although the bank reshuffled management, it should have reshuffled the Board; the Board remains the same although that perhaps due to some legacy of management power on the Rockefeller (Morgan?) ‘plantation’ where owners were also top management who cultivated and inculcated their heirs apparent at the board and senior management levels.
In any event, “Mr. Layton took over as retail chief in May as part of a reshuffling of top executives at Morgan Chase, trading roles with David A. Coulter to spur more growth from the retail bank. At the same time, Geoffrey T. Boisi, who had co-headed investment banking with Mr. Layton, left the company.” Perhaps they needed to keep Boisi or even better outside candidates, to help breathe some life to counter any disintegration into ‘six-fingered’- hidebound vestigial thinking. The bank also has announced that it will acquire local financial institutions to ‘fill-in’ and spur its market presence. As long as the local economy improves, the bank will have made a prudent operating decision.
Citigroup. This company’s complications exist at its Board level. Its Board in its chairman and some of his board selections, historically has preferred expedience, which eventually has produced – scandals, over more deliberate, non conflicted business practices. Most of Wall Street and the money-center banks have failed in choosing more judicious, prudent and domestic enterprise. Citi’s board needs review and an effective shuffle. Personally disliking how the US taxpayer has subsidized globalism and the ‘build-out’ entailed in that, while the non-management shareholders have born the cost of loses at home as well as abroad, where they are often more common, from the Board I would eliminate the ‘globalists’, who are quick to waste non-management shareholder and taxpayer money using the guise of gaining ‘global market share’. I have listened to the best and their pipe-dreams, and remain unconvinced their interests mean the best for their enterprises and their shareholders, as well as the US economy. I would give the same advice to every other Wall Street Bank~Investment bank, as well as to the US S&P1500.
The Bank of New York/Mellon. This other local regional bank is hoping to find profitable niche businesses that substitute for being a financial institution that lacks critical mass against Citigroup, JP Morgan Chase, Bank America, Wells and many local thrifts in the retail market. It will face the same credit problems that its peers face, however, in the current recession combined with the equity/investment market volume problems in the current environment, the degree of profits from which some of its fee business strategy is predicated. Michael Mayo recently downgraded the recommendation on this bank’s stock, I am assuming because of 1) Credit quality problems that have yet to end; 2) low market trading volumes diminishing investment management and related fees for BK.
Fifth Third Bancorp. In Ohio court, shareholder plaintiffs have filed a class action lawsuit against Fifth Third Bancorp directors and officers indicated as defendants: George A. Schaefer Jr., Neal E. Arnold, and David J. Debrunner. “Specifically, the Complaint alleges that throughout the Class Period, Fifth Third issued press releases and filed financial reports with the SEC which represented that the Company had successfully and seamlessly integrated Old Kent Financial Corp (“Old Kent”) into FITB’s operations and was already experiencing meaningful growth from the acquisition.
“These statements were materially false and misleading, as they failed to disclose that the Old Kent merger seriously strained the Company’s infrastructure, causing deficiencies in its internal controls and other business-critical systems, which was having a material and negative impact on Fifth Third’s ability to operate and even to keep track of its business. Rather than disclose these facts to the public, Defendants continued to tout the Company’s effective integration of acquisitions, which had been the driving force behind its stellar growth, in order to artificially inflate its stock price to be used as currency for new acquisitions.” The Company had outgrown its infrastructure and internal controls, but continued to keep this fact from investors, falsely presenting its business as stronger than ever and promising continued growth with “investment-safety” according to the financial news wires. No doubt it deserved the slap, and as the non management shareholders were defrauded, perhaps the company should settle, and then replace the Board as well as some senior management.
Are we going to have a new normal when the financial sector and its companies are encountering the globalists and the other ‘visionaries’ of the ‘New World Order’ and the ‘New Economy’ which disfavored the financial sector? Although the ‘New economy’ began as a colonialistic “New World Order” business strategy, and a ‘propaganda’ that favors some sectors while rejecting often unionized and manufacturing related sectors, those among the “favored” companies win as those stocks are promoted, regardless of earnings. Until the prevalent thinking/memes as well as operating strategies change to prefer the development of the domestic economy, banks often were among the ‘rejected’, even while they had earnings and dividends. Again, unless the mindset changes and respects and emphasizes the large and very broad domestic economy, that will hinder earnings and stock prices of the entire sector will continue to suffer.
Meanwhile, strategies to enliven the domestic economy should include using excise taxes, duties, and tariffs also known as indirect taxation on the people by taxing imported goods and services. Indirect taxes are included in our Constitution’s Article 1 Section 8 as fiscal revenue tools, rather than wage and salary taxes, also known as direct taxation. Trade ‘liberalization’/‘free’ trade by way of the multilateral Agreements such as the G20 Agreements have our policy makers supporting anti-Constitutional policies over those of the Constitution and voting, property owning Americans, many of whom are non management shareholders of stock in financial institutions. This sector is deleteriously affected by the ‘free’ trade which resulted from US policy makers supporting G20 Transatlantic Agreements.
The trade associations of these sectors, the ABA, ICBA, SIA (SIFMA) all had paid significant, copious amounts of soft money into political campaigns and the political parties. Often they and senior management and directors at many of these companies have the ear of some legislator or well-placed bureaucrat that can encourage maintaining the Constitution and more responsible policies on imported-produced goods and services as a matter of what’s better for the US Economy in which they operate. That also is solid Board activism for good Corporate Governance/Stakeholder Rights. Using the Constitution’s rules of fiscal revenues for the federal government likewise will restore the domestic economy better than any ‘tax cut’ or WTO, ‘free-trade’ etc, deal. Individually, any single bank may have some difficulty lobbying Congress or the Executive branch to begin keeping excise taxes, duties, etc on imported goods and services, however, as a sector for their future health, this is the vision they need to embrace and promote in Washington as well as in their business practices.
By way of the 1% the bankers de facto control the world, but will make every excuse to pretend they don’t. And on the Board, the directors need to shoulder more responsibility for management actions and lance agency ambitions and self-dealings detrimental to the bank, its markets and trade areas, and in the long run its non-management shareholders.