The Ethical Barometer

The Wall Street Journal published a letter to the editor from the Barometer on Monday, January 10, 2011.  The letter was in response to a December 31, 2010 op-ed piece on what boards need.  The letter was, of course, edited for length, but it is reproduced below. 

Mr. Pozen, as so many others before him who have tried to address corporate governance weaknesses, misses the big picture on boards.  Indeed, the big picture is precisely what weak boards fail to provide.  For decades, consultants, academics, and activist groups have tried to create artificial numbers gauges and apply facile criteria for what an effective board looks like.  For example, Enron was once hailed for its “strong” board.  Corporate governance dashboards on directors’ ages, limits on years of service, size of the board, and now professional directors are all easily measurable but contraindicated when we look at failed companies and their boards.

 The latest research indicates that the boards of failed companies are those that are comprised of directors who, while independent in the statutory sense, are conflicted by their philanthropic or personal interconnections. Mr. Pozen is correct with his advice on compensation — excessive compensation compromises director independence. However, Mr. Pozen’s proposal will lead us down another path of weakness.

 You don’t need an expert in financial services (as Mr. Pozen suggested Citi lacked) to pick up the Wall Street Journal circa 2004-2006 and read up on Fannie, Freddie, and a looming crisis.  A person who follows business, as opposed to managers who are immersed in details, will be an effective sage. Likewise, you don’t need an expert in toys to sit on the board of Hasbro in order to understand that loading-dock shenanigans are being used to inflate sales.  If you have business experience in any sector, you know to where and how to look for that flurry of activity at the end of the month, quarter, and year that points to declining sales and a nonsustainable attempt by management to keep the numbers up until the news is better.  

 What companies need in board members are a curious mind and a backbone:  the ability to spot emerging micro and macro issues that affect the company and the guts to raise the questions about them at the board meeting.  Superficial measures for these two qualities do not exist.  Happily, competent executives of all ages and who hail from all industries do indeed exist.  They can provide the pairs of outside eyes and the big picture management needs to steady the course — therein is the secret to effective governance.

Facebook wanted to remain a privately held company and it was getting too close to the 500-shareholder limit.  Actually, it was over that size limit, but the SEC gave it an exemption in 2008 to allow the company to exclude its restricted stock units from the 500-shareholder limit. So, Goldman stepped in as a single investor with its special-purpose vehicle (SPV) and paid Facebook for its shares. Investors then pay Goldman and own a piece of Facebook, rather indirectly.  Goldman pools investors’ money into what counts as a single investor.  Goldman’s SPV can sell, sell, sell, and what you have is a public company without regulation.  Facebook employees and former employees can now sell their shares even though Facebook shares are not publicly traded. 

Other formerly privately held companies have trod this path.  Google went public in 2004 because it could no longer manager the 500-shareholder ceiling. “Oh, but we can retain talent this way!”  Does that mean that there are no good employment options in privately held companies?  One lawyer noted that these types of firms are “betwixt and between: not quite private and not quite public.”[1]  Ah, but they are more public than private now because those shares are being sold.    

The letter of the law vs. the spirit of the law.  The loophole that lets you get what you want, sans the constraints other growing companies face.  How many times must we trot in gray areas before we learn the lesson that a loophole exploited results in exploitation? Goldman’s recent settlement for its activities related to the subprime investment vehicles, CDOs, tranches, etc. has not changed the investment banker’s views on trust and transparency.

 

For the first time in decades an airline has been kicked off a National Transportation Safety Board (NTSB) investigation process.  The NTSB has bumped American Airlines for its breach of protocol in the investigation of its jet sliding 600 feet past the runway at the Jackson Hole, Wyoming airport.  AA removed the infamous “black boxes” from the jet and downloaded data before turning them over to the NTSB.  The data were not compromised, and AA assures that it was not attempting to circumvent the investigation.  AA can talk itself blue with a “Trust us” message and perception will move nary an inch. This breach of protocol, a violation of the rules put in place to ensure the integrity of airline incident investigations, is more than just an internal snafu.  The lesson for companies here is to be sure employees understand that they are to follow the rules and help them to do so by explaining WHY we follow seemingly innocuous rules.  AA employees who did the downloading are probably wondering, “How could anyone think that I would ever tamper with the data where safety is involved?” 

WE will give the employees that level of integrity, but the issue is not their integrity.  The issue is simply following the rules. Hindsight bias kicks in when you are the center of an investigation and you depart from a decades-old step-by-step policy for that investigation. Violate the rules and you scramble to explain yourself even if you didn’t do what folks assume you did.  Procedural rules in this situation protect the chain of custody:  that the information came off the planes and went to the federal agency without a pit stop in the airline’s computers. No matter how AA explains or how many internal investigations it conducts, perception trumps reality.  And AA lost its seat at the investigation table.