Re:Balance -- Jim Peterson

Congratulations to a New Chicago Cop! Now -- How Do We Support You?

 My nephew Rory Oliver was sworn in this morning as a new police officer for the City of Chicago. So the usual topics are put aside, so I can say “congratulations,” and offer my respect and admiration.

Marine veteran, number one for fitness in his academy class, ridiculously fit – he’s worked for this goal with focus and intensity, both physical and mental. Loving father of a handsome son and a daughter on the way this winter -- devoted husband with the caring support of his marvelous wife -- parents and brothers and grand-parents and in-laws pulling for him – he exemplifies all we can hope from the first responders of whom society asks so much.

So how will we respond, to Rory and his class of fellow rookies -- ready to answer the call, and to put on the line for us all that they love and value?

Surely it’s time in our national discourse to act on these core truths:

• That there is no place in civilian life for weapons designed only for warfare, for armor-piercing bullets or for high-capacity magazines.

• That if we can license and regulate and restrict access to the rights to drive a car or give a haircut, we can design reasonable safeguards around the constitutional right to bear arms. 

• That while access to mental health care should be part of our commitment to care for those in our midst least able to care for themselves, there is no discernible difference between the deeply disturbed in America and those in other countries where the ability to wreak homicidal violence is impeded by effective limits on gun access.

• That the same liability system that puts responsibility on the sellers and distributors of other dangerous means of harm and injury can work effectively to constrain the supply chain of gun-related death and destruction.

As a matter of priority we must start there, because suicidal “outliers” will always slip through any cracks, undetected and unpredictable – no system for deterrence or counsel will stop those crazed enough to act. But it makes the wrong point, looking at the foreign killer with a knife, to say, “See, it happens there too.” The right question is, “What do we learn, of how many were spared, because he could not get a gun?”

Or, for that matter, the deadly feedstock of ammunition. For a gun without bullets is no more than household décor, unusable to inflict deadly harm on spouse or sibling or self. As a weapon, an unloaded firearm is only a club, and an ineffective one at that. So cutting off the means to damage, especially large clips and belts, must be one of the many fruitful ways to start rendering more safe our schools and theaters and homes and public places.

I was raised in rural America, where gun ownership and the safe, respectful use of firearms was part of every household, including mine. Skill with a gun determined whether there was meat on the table, and bragging rights accrued to skill on the target range. I need no persuasion on the diverse scope of our national culture.

But the accommodation to hunting and sport and the rights contemplated by our nation’s fathers should not extend to the failure to assure the freedom from wanton slaughter of our first-graders.   

So we salute you, Rory Oliver. We are proud of your calling and your ambition to serve. We will rely on your strength and your dedication. We will pray daily for your safety and that of your brethren in uniform. And we are dedicated to help you, in the quest to free our land from its course of senseless mayhem and to make it instead a place of peace and safety for all. 

 

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Mitt Romney Contributes to Bigger Government -- A Self-Imposed Personal Tax Increase

”Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.

  -- Court of Appeals Judge Learned Hand, Helvering v. Gregory (1934) 

By far the stalest of the few tired jokes about accountants, in its tax code version:

            Client: How much is my taxable income this year?

            Accountant: How much do you want it to be?

 How should we feel, the fraternity concerned for the essential integrity of publicly-reported financial information, about presidential candidate Mitt Romney’s 2011 taxes? 

In particular, what about his choice to under-declare $ 1.75 million in charitable donations, to avoid reducing his overall income tax rate below a previously-announced target of 13 percent?

The US Treasury is no doubt happy to accept Mitt and Ann’s resulting over-payment, and their gratuitous contribution to be mingled with the trillions extracted from the rest of the tax-compliant population. But under Judge Hand’s formulation, no added virtue accrues to their extra-generous support of the federal government’s activities.

The context for Judge Hand’s famous pronouncement was a controversy in which the substance of a tax avoidance scheme was held to prevail over the tax-payer’s argument that its form was strictly legal.  

Substance over form: What is the reason? And the question follows: Does that reason pass a test for credibility?

The first anomaly arises because there is not a single number on a balance sheet or a tax return that is not subject to some degree of judgment – not to say, flexible up to and past the point of manipulation. The choices are never neutral – some interest is always served.

• An entire career ago, my very first securities fraud investigation involved a life insurance company that for years invented fictitious clients, thus falsely over-stating its liability to pay death benefits – a “fool-the-auditors” technique that appeared counter-intuitive, until exposed as a Ponzi scheme made possible through cash-generating fakery in its dealings with re-insurers.

• Similar motives explain the padding of employee rosters with ghost employees (e.g., ZZZZ Best, decades ago, and Satyam in India). Over-stating expenses for payroll, office space and supplies would be perverse, except to off-set the criminally systematic booking of fabricated contract revenue.

So is this a Romney head-fake? A smoke-screen of piety and beneficence behind which, like the Wizard behind the curtain, are concealed the off-shore accounts and the sheltered capital gains? Transparency and answers are both lacking, unrelieved by purported “summaries.”

But, giving benefit of the doubt to a vacuum of hard information, assume tax legitimacy. If the motivation lies elsewhere than in the Romney family’s taxes themselves, is there a political constituency to whom this tactic appeals? 

• For the bulk of tax-payers at the population base, whose income tax obligations are withheld by employers at the source and whose deductions are standard, the entire Romney approach is incomprehensible noblesse oblige.  

• For those a level higher on the income pyramid, enjoying some measure of return on their modestly accumulated capital savings, Romney’s ability to maneuver his tax rate between 11 % and 14 % is an advantageous opportunity only accessible to the Bain-enabled.

• For the one-percenters at the top, to whom tax minimization is an article of faith having theological dimensions, natural affinity for Romney’s otherwise sympathetic policies must be off-set by the appearance that, on his taxes at least, he is acting like a fool.

• And for Grover Norquist and those ideologically committed to opposing both growth in government and taxes on the wealthy – Romney himself having taken the pledge years ago – the foregone charitable deductions confirm Romney’s two separate acts of anathema: He has inflicted a tax increase directly on himself, and his resulting inflated payments only serve to grow the malign resources of a bigger federal government. 

If tax policy, like charity, truly does begin at home, then those concerned about Romney’s consistency and true conservative colors had best be placing defensive calls to their own tax advisers. 

Or – if I am missing something and there is anyone persuaded by his reasoning – please advise.

 

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Preserving and Re-Building Trust -- An Event Preview

On October 2, the Consortium for Trustworthy Organizations at Fordham University in New York sponsors “The Summit on Restoring Trust in Business,” on West 60^th Street in Manhattan. 

An A-list of participants from major companies and consultancies will be there. Those with professional or academic interest are invited – program details and enrolment information are here.

I have the pleasure of bringing my perspectives on risk management, litigation and disputes to a great panel, “Effective Trust Repair,” led by Charlie Green (for whom, see Trusted Advisor Associates and his blog, Trust Matters).

With the quality of gathered credentials and experience, the discussions will be seriously substantive – with more nuance and value than the sometime platitudinous slide-decks of the typical Trust-Building 101 curricula.  

Because a forum of this sophistication can dig far beyond the “easy stuff,” we expect to probe some of the conventional attitudes. Three such topics are sketched below -- in no more than the possible appetizer-sized portions.

“Trust Survival” May Be the Best There Is

Run-of-the-mill literature on trust in business strongly features its preservation and maintenance. But take note: when corporate times are rosy, the language of trust gets subsumed within the overall anodyne vocabulary of feel-good success. 

And after the fact of a disaster, it’s too late.

At the only time it truly matters – when an enterprise faces existential crisis –– continuity of trust is at best a problem of second-order importance. And the small circle making life-and-death decisions -- those directly reporting to the chairman or the CEO –- are the only people with real influence.

Examples:

• As Arthur Andersen spiraled into disintegration in 2002, it was the peeling away of partners, clients and its non-US firms – trust was implicated, to be sure, but at stake was the immediate impact on the firm’s very viability.

• At MF Global last fall, Jon Corzine would have cared less for the preservation of customer or counter-party trust, when what really mattered was a Hail Mary scramble for survival that turned into $ 1.6 billion in missing customer funds.

• And at Knight Capital over the weekend of last August 4-5, virtuous concerns for trustworthiness, following the $ 440 million loss inflicted by a trading software glitch the week before, would have been subordinated to the search for friendly rescuers – surrendering ownership to investors prepared to salvage the firm’s ability to open for business that Monday. 

Only if the enterprise survives, in other words, do the re-builders of trust have a chance at an invitation to the table.

And even then, trust-related advisors in a post-breakdown environment risk relegation to the same role as the medieval camp-followers after battle – executing the wounded and looting the corpses.     

“Trust Building” May Not Always Really Matter 

The constraints of a cartel or the impositions of regulation affect whether trust in business is relevant at all.

Nobody loves the indifferent service of the local cable company or the lock-step piracy of the neighborhood filling stations. But subscription and consumption continue.

As Michael Corleone was reminded by Frankie, the disaffected mob soldier in The Godfather II (1974), “Your father did business with Hyman Roth. Your father respected Hyman Roth. But your father never trusted Hyman Roth.”

Bond offerings require ratings, despite the agencies’ consistent behind-the-curve performance during times of crisis, from the savings-and-loans of the 1980’s to the subprime mortgage and sovereign debt calamities of this decade. Audit reports are required by law on the financial statements of public companies, despite manifest dissatisfaction with their content or their usefulness to readers.

The result in these contexts is narrowed relationships and skeptical doubts about value. Notions of “trust” are conspicuously absent from the dialog.    

“Trust Repair” May Be Non-Strategic 

Finally, when business trust is broken, and a supplicant comes around to plead for another chance, symmetry requires a response by those asked to re-affirm their faith. What conditions should apply? 

In other words, “fool me once…” – and then what?

Consider the frequency with which a large-scale fraudster gives early signals of his corruption – Bernie Madoff’s unbelievable golf scores evidenced his flim-flam. Or even confirms, like the recently re-jailed Barry Minkow of ZZZZ Best, the overwhelming rate of recidivism among white-collar criminals.

What combination of sentiment and compassion, or venality and credulity, blinds the risk processes of those charged as fiduciaries for their stakeholders, such that the victimizations continue?

Salience does enter in, of course. A single disappointing meal at a favorite restaurant should not kill its reputation, nor an explicable one-time lapse in service by a supplier or payment by a customer. Some tolerance is required, for the inevitable breakdowns that inhere in complex systems of human design.

But while repentance and forgiveness have their place in a caring society, prudent risk management counsels against re-admitting a known fox for a return visit to the henhouse.

These are among the complex issues, and they have no simple answers. Reactions here are invited and encouraged. And those able to extend the discussion in New York on October 2 are most welcome.

 

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A Personal Note: Mother Takes Her Leave -- Teaching Us All the Way

Our 92-year-old mother’s family gathered, to say good-by, and to honor and celebrate a life well lived.

Each such loss is grievous in its own way. We count ourselves fortunate that, because her malign intruder had not yet reached its tipping point, we had the special benefit of her lucid presence and participation.

With integrity, discipline and personal and family responsibility – amply leavened with humor and curiosity – she raised a family, inspired her students, re-invented herself in comunity service through both retirement and widowhood, and re-married in wonder and delight at age 85. The same principles have now been on full display. Her medical instructions were terse and precise -- "no intrusive measures" -- and her affairs and estate are in meticulous order.

That this should be so is no surprise. In February 2006, my letter recognizing the inspiration and character with which she embarked on her magnificent new marriage became one of my most-read columns in the International Herald Tribune.

That testimonial to the guidance of her life’s inspiring example is worth sharing here. It also serves to alert Saint Peter and the other gate-keepers – Michael and Gabriel and the whole team of angels: Elizabeth is coming – so be on your toes:       

A TOAST FR0M THE KIDS
February 3, 2006 -- the International Herald Tribune

                "Oh, Momma, get married today!
                    - "Gypsy," lyrics by Stephen Sondheim, 1959


Over Christmas dinner, my mother, 85 and widowed 15 years ago, shared with her assembled family the news that she and Don - until then known only as her "very good friend" - were engaged to be married.

Mom is fortunate: She is in good shape, given the vicissitudes of age and their toll on health and energy. Despite limited means, she kept us all fed and clothed and sheltered, yet was disciplined to do the planning and saving that now keep her in modest comfort. And she is grateful. She has found a companion her own age, and her four children were unreservedly delighted.

She and Don have insisted that there be no gifts. So instead I make this tribute, both as a wedding present and to pass along some of the inspiring good sense I was privileged to grow up around.


Dear Mother,

On behalf of all the children and grandchildren, congratulations on your wedding! We applaud and endorse your plans. We especially appreciate the grace and style with which you and Don are dealing with the many decisions involved in this grand venture.

For starters, you remind us of the importance of direct control of critical choices. When I jokingly suggested that Don should have asked me, the eldest male, for your hand, your reply - "Forget it, kid!" - made clear that you retain authority over your own business.

We offspring have always been grateful for the explicit and active role you have taken in the management of your financial affairs:

By doing the research and planning for your recent move into an extended-care facility, you have given us the confidence that your daily needs are well and professionally looked after.

Because you have kept up to date your estate plan, living will and medical-care instructions, we need never go through the uncertainty or undignified family disagreements over the intentions of a loved one.

And though, of course, you consulted with lawyers and financial planners, you and Don have kept in your own hands the hard and diligent work of writing your prenuptial agreement.

Hammering out that 40-page document can't have been easy, but you are entitled to some good form of celebration for documenting the undertakings and obligations the two of you are exchanging, and fitting them into the management of your financial resources. The details of the agreement are none of our business, except to have the comforting assurance that you have each other's interests both at heart and in view.

In all these areas, those much younger and more spry will put off or deny the value of the kind of work you have done. But having clarity for yourselves also means that none of us will ever have to worry about your well-being or about the dispositions you are entitled to make.

During recent years as an expatriate, I was separated from you physically over extended periods and thousands of miles. I have all too often seen our overseas friends forced under stress and panic, and for lack of your kind of planning, to make choices and take responsibility for the condition of their elderly parents.

As my middle-aged generation knows, those parent-care challenges are tough enough in close proximity; at a very great distance, they can be overwhelming. So for your investment of energy in meticulous self-care, we thank you.

We know, too, that you have deftly handled myriad nonfinancial details, especially in areas where sentiment intersects with good sense.

You have the same lively task as any newlyweds, to combine your households: furniture, accessories and, in your case, two separate nine-decade accumulations of memorabilia. The demands of selection and dumping surely vindicate your robust injunction, "No gifts."

And it was a creative touch to publicize the event by posting a wedding announcement on the bulletin board of your residence. You may have set tongues wagging in the cafeteria line, but you also saved lots of postage.

In closing, let me say how very classy it was of Don to celebrate your engagement over a bottle of Dom Pérignon. Although the vintage doesn't quite approach your own, any Champagne that retails in the high three figures a bottle makes an elegant reminder of the many experiences that remain vital and pleasurable at any age - including the well-timed splurge.

Again, congratulations, Mom, and Godspeed.

Your loving and respectful son,

Jim

 

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RIP Daniel Pirron -- Deloittes Mourns the Loss of a Partner -- And We Should Too

What internal demons impel a suicide?

No reaction but sorrow seems appropriate, for the self-inflicted gunshot death on August 13 of New York-based Deloitte partner Daniel Pirron.

Limited attention has been paid in the accountancy media (here and here). Of which, some comments are tracking his family’s suggested linkage to Deloitte’s UK client Standard Chartered Plc, and the Iran-related money-laundering scandal in which, the week before, the bank had agreed with the New York Department of Financial Services to a $ 340 million fine.

That speculation is unfortunate, for reasons only starting with Pirron’s scope of work itself, in the office of Deloitte’s general counsel, and the firm’s statement that “he was not involved in any way” with its work for Standard Chartered.

Focus here on suicides proximate to financial and corporate wrong-doing – an area of my concern long-predating my unhappily accurate prediction on December 16, 2008, that it was a "safe but unfortunate bet…that at least one remorse-driven suicide will further color the already tawdry (Madoff) tale” – coming only too true a week later with the suicide in his Madison Avenue office of Rene-Thierry Magon de la Villehuchet, the founder of a fund whose investors lost millions with Bernard Madoff. 

That context is difficult enough – initially because the sample size is miniscule, making attempts at meaningful generalizations intensely hazardous. The conditions are, however, readily distinguishable from the impulsive acts of the emotionally immature – fortunately most often not effective – or the reasoned acts of the gravely ill – movie director Tony Scott’s recent fatal leap being perhaps explicable by a report (since disputed) of his terminal brain cancer.

A non-comprehensive survey of scandal-related suicides starts with one point of interest – that with the exception of the recent failed attempt by Peregrine CEO Russell Wasendorf Sr, those driven to act are not the principal perpetrators.

Which should be no surprise. The necessary level of introspective regret and remorse would not be in the DNA of the typical white-collar criminal. Think of the egos both of those actually brought to book – a sample including Bernie Cornfeld, Bernie Ebbers and Bernie Madoff – and those of tattered moral fabric although escaping the formalities of prosecution – “Chainsaw Al” Dunlap and Donald Trump and Angelo Mozilo and Dick Fuld.

Instead it’s the secondary players – the lower-level executives and the gate-keepers – Frank Shuch, the least of the accused triumvirate at Connecticut’s Colonial Realty (1992); Cliff Baxter at Enron (2002); Bernie Madoff’s son Mark (2008); or the reported attempt by Satyam CFO Srinivas Vadlamani (2009).

Even so noted, extreme personal acts are not in character for those choosing careers in professional services, particularly accountancy – there being perhaps some dignifying comfort behind the tradition of ill-founded ridicule of the bean-counters’ brown shoes and green eye shades.

True enough that accountants are neither saints nor angels. As with any fallible system of human design, the firms’ best-tuned screens for personal quality will let slip the rare exceptions – those challenged by intelligence or discipline, the addict or the abuser, the venal or the pliable. And while public accounting is not a vehicle for great wealth accumulation, those shifting to entrepreneurship or the executive suite are on occasion seduced or suborned.

But in the four decades of my broad experience across the profession, only a handful have met the defined standards of the criminal mind. Practitioners of independent assurance -- first delivered to Victorian-era public companies starting in 1850 with the report by William Welch Deloitte himself on the accounts of the Great Western Railway -- have overwhelmingly been people of stability, intelligence, good faith and honorable intentions.

The best scholarship on human behavior and choice-making counsels us to resist the instinctive impulse to construct simplistic stories in a futile search to comprehend the irrational.

So – rather than press an inexplicable coincidence, genuine mourning by the profession is in order – joining with his family, friends and colleagues – for the sad death of troubled Dan Pirron.

 

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Of Crimes and Punishments -- And Where Shall Justice Be Found?

 A quiet summer holiday in a mountain village – time to ponder last month’s note from an always-thoughtful reader, on the news that Msgr. William Lynn, then secretary for clergy in the Catholic archdiocese of Philadelphia, had been convicted of child endangerment for allowing priests accused of child molestation to be moved from parish to parish. He asked:

“How is it that the Catholic Church and its senior hierarchy have not also been indicted?”

The question resonated for two reasons. The first was poignant, because the questioner is a retired partner of the Arthur Andersen accounting firm[1] – perhaps the single global institution in the last decade to have paid with its own life for individual wrongdoing at its senior levels. 

The second is the still-unfolding question of sanctions for the global banks, starting with the multi-year conspiracy to rig the London interbank offered rate, which so far has include the defenestration of Barclay’s chairman Marcus Agius, CEO Robert Diamond and COO Jerry del Missier.

The three departed took hidings from the British Parliament’s Treasury Select Committee on July 4^th, 10^th  and 16^th, after the bank in late June had agreed to pay fines totaling some $450 million to the British Financial Services Authority and the US CFTC.

By settling, the bank avoided criminal charges – eliciting speculation as to whether the Libor-fixing scandal will lead to actual indictments of other banks, and querulous criticism from James Stewart of the New York Times – who is also upset about the serial mis-behavior of UBS (here).

Unlikely. With the singular exception of Andersen, the prosecutorial pattern is to allow the institutions to settle:

• Goldman Sachs threw its trader Fabrice Tourre under the government bus in 2010, over its design of a tradable hedging product designed with the input of a favored customer, escaping itself with the fine of an inconsequential $ 550 million (here).   

• The fine of $ 456 million paid by KPMG in 2005, to settle criminal charges by the IRS over its long-running tax-shelter activities, was said by those knowledgeable to have approached the firm’s survival tolerance – but an outside monitor’s supervision and a deferred prosecution agreement allowed the firm to survive and carry on. 

• The revelation of Jerry Sandusky’s decades-long abuse of young boys, under the knowingly tolerant eyes of the authorities at Penn State, cost the jobs of the president and athletic director, plus that of the theretofore sanctifiable coach Joe Paterno – as detailed in the damning report of ex-FBI director Louis Freeh – and now removal of JoePa’s on-campus statue and agreement to accept NCAA sanctions including a fine equal to a year’s football revenue, four years of post-season suspension and the bizarre “vacating” of its football victories since 1998. Thus briefly hobbled by a national sports administration arguably more influential than official law enforcement, the Penn State football program survives, and there is not a whisper of existential threat to the school itself.   

So what does it say about the societal enforcement of the responsibilities of large institutions, that they are normally spared from the ultimate penalty?

Whatever one’s belief about the proper scope of government, my reader presents a profound challenge: how can and should agencies of government act for the public good, with appropriate recognition of the limitations on their competence?

Societies decide on their behavioral norms, their tolerable limits for deviation, and their enforcement expectations from agencies of regulation and governance.

The Andersen experience may prove a rule, that the powers of law enforcement are fundamentally reluctant to threaten the life of an enterprise or institution, no matter how egregious the behavior of its principals.

The weight of anecdotal evidence would appear so.[2] And society has and uses other tools:

• As one effective sanction, the rules of the private marketplace are inexorable. Fallen leaders have taken down entire institutions, from Bear Stearns and Lehman Brothers to Merrill Lynch and MF Global. But the history is uneven: doubtful actors also survive, sometimes with government assistance but also due to the vagaries of bankruptcy and reorganization – recent examples being GM, AIG and Fannie Mae.

• Further, the lottery of civil litigation – with all its flaws, costs and uneven application – provides some reimbursement to some of the wronged – although with the slow grinding of the wheels of the courts, these will impose mainly not on the wrong-doers but on current and generations – Barclay’s current shareholders, and future Penn State students seeing larger tuitions and smaller course selections.

• Thirdly, the fragility of reputation takes its toll: Penn State will fail to attract some future students, and the Church will lose some members. Companies will change auditors, and bank clients will shift their loyalties. 

The conflicts and ambiguities in the punishment of institutions mean that “justice” is not easy to define in practice and even harder to locate and apply case-by-case. 

With that, I can only hope to hear whether this meditation nourishes the reader whose note, with my appreciation, set it in motion.   

 

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---

[1] Where, by way of reminder/disclosure of a chapter long closed but not forgotten, I also spent a considerable time, although ended before the firm’s death spiral that was Enron.

[2] Not least, because Andersen’s fatal indictment and disintegration can be explained, with the simplicity of Occam’s Razor, as owing to its leadership’s arrogant refusal to face its record as an unrepentant recidivist.     

 

The French and the Americans Both Go to the Polls: Et Voilà … Plus Ça Change….

This spring’s teaching assignment at a Paris law school has provided the benefit of an extended stay in France, and a chance to observe its presidential campaign at close range. 

It’s the long May Day holiday. And this coming Sunday, May 6, brings the runoff between incumbent president Nicolas Sarkosy and his Socialist opponent, François Hollande – two weeks after initial voting winnowed a field of ten candidates who covered the lunacy spectrum from right-to-left.

Partisans of the integrated, two-stage French method extol its benefits over the seemingly endless American system of separate party primaries and conventions. Meanwhile, readers having asked for my observations, I mainly keep to the process – being by nature hesitant about predictions, most especially this far off my usual turf.

Briefly, there is widespread “Sarko fatigue” at the limited accomplishments of his erratic bursts of official energy, reflected in low overall voter turnout and flight from the center parties – especially in the record-setting numbers for the far right’s third-place finisher, Marine Le Pen – whose traditional unifying endorsement for Sarkosy has not been forthcoming at this writing, and could well be a poisoned chalice in any event.

It is also the case, however, that Hollande has all the sparkle and charisma of a small-town insurance agent, with a lukewarm brand of leftist policies unlikely to resonate either on the global stage or with the anemic French economy itself.

Compared to the excruciating tedium of the Republicans primary in America, displaying its parade of the unqualified, the inconsequential and the comedic – and who can recall without cringing the embarrassments of Michele Bachmann, Herman Cain and Rick Perry – it is hard not to be attracted to a system by which all the marginal wackos were stripped off the ballot in a single day.

And compared to the obscene amounts of American cash, time and energy dissipated across its political landscape, the tightly focused timetable in France is refreshing: monitors by law keep stopwatches on the media’s coverage of the candidates, television advertising is confined to limited blocks of evenly accessible time, and there will be one single debate between the finalists.

The campaigns do share two common and equally dispiriting characteristics – the degraded level of civility among opponents and -- probably a symmetrical consequence – the candidates’ aversion to matters of serious consequence for their respective economies and societies.

While both countries confront fragile economies, excess government spending, unsatisfactory levels of unemployment and the necessity of fundamental reforms to their revenue raising, Americans are subjected to dog-whistle appeals to scarcely concealed issues of race, class and religion – “he’s really a Muslim”… “a Mormon is not a real Christian”– while in France, the trigger phrases are equated with Vichy collaborators and anti-immigrant isolationism.

In pessimistic moments I despair of the future Franco-American conversation. Should Hollande reach office, with his proposed 75% marginal tax rate and revival of the fantasy of a 35-hour workweek, only to face Romney and his promised dismantling of government involvement in everything from medical care to college financial aid, the two will have less in common than creatures from politically different planets.

Meanwhile I did get a valuable reminder this weekend of the universal nature of the political process, at the annual meeting of our apartment building’s co-proprietaires – where we revalidated the political maxim – also abundantly on display in the two presidential campaigns -- that energy expended in debate is inverse to the gravity of the issue.

In characteristic French fashion, with ten owners represented there were usually more than a dozen views being argued, loudly and at length. And while we passed both the building’s annual budget and a huge capital investment within minutes, we wasted four hours of heated discussion over such matters of inconsequence as the shape of new lights in the foyer and the relocation of the dumpsters.

In the end, political science being scalable across democratic constituencies from apartment boards to national parties, the gaps are consistent between the fictive purity and ambition of campaign promises and the actual accomplishments in office.

So the outcome in both the United States and France will be similar – as they are in my modest Paris building – that voters will put candidates into office who will actually do the least that they must, and far less than they might.

 

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Lessons from Football: Strategic Risk, Reward and Uncertainty

If the essence of strategic decision-making lies in the assessment of potential rewards under uncertain conditions, whole seminars can be taken from the last minute of this year’s Super Bowl between the New York Giants and the Boston Patriots. 

For extra flavor and pedagogic potential, both coaches in this 46^th edition of America’s great sporting spectacle had to make choices that ran against their deepest, aggressive go-for-broke instincts.

Trailing by two points on the Boston six-yard line, Giants coach Tom Coughlin could come from behind and win with a chip-shot field goal – a high-odds likelihood but never a certainty. So to keep the ball out of the hands of dangerous Boston quarterback Tom Brady, his interest was not an attempted touchdown – but to stay out of the end zone and run the clock near zero before what would be the winning kick.

Whereas, having no chance to win without his offense on the field, Boston coach Bill Belichick’s defense had to allow the Giants a quick touchdown to have any last-minute hope.  

The play itself was surreal. Giants running back Ahmad Bradshaw, offered a clear path by the Boston defense, drove for the end zone with all the DNA of his entire playing history – realized his error and tried to stop short – but failed to halt his momentum, stumbling awkwardly for a bizarre and unintended score. 

At that point, the decision-theory exercise was complete. The game’s final outcome was then only interesting from the perspective of one of the largest-ever audiences of actual football fans.

As frequently the case, the ultimate outcome did not undercut the validity of either strategy – to which it was equally irrelevant that Boston was unable to score in their last remaining drive, or that the Giants snatched a victory despite Bradshaw’s gaffe.

In other words: Coughlin had the right idea, but his player failed to execute – and he still won the game. Belichick was no less canny, and got precisely his desired result – only to see Brady’s final drive fall short.

As my students in Risk Management come to grasp, it is not just the balance of success or failure of competing alternatives, but the magnitude of the consequences in either direction: a multi-dimensional decision calculus weighs both a huge potential benefit against a modest chance of loss, but also a likely but small upside against an unlikely but possible catastrophe.  

Examples run from the deeply personal, through all aspects of commercial and professional behavior, to the highest levels of governmental policy-setting: 

• To the feckless Francesco Schettino, captain of the stricken Costa Concordia, the frisson of a near-shore detour overcame his judgment as to the hazard that his ship would land on the rocks.

• To MF Global’s Jon Corzine, now-fallen former master of the universe, the desperate gamble to save his enterprise made it worth raiding the accounts of his customers.

• To central bankers confronting the potential collapse of, say, a General Motors or an AIG or the sovereign debt of a Greece or an Ireland, the ability to quantify and evaluate the “success” of a bailout must include complex and uncertain consequences, economy-wide, of both action and inaction.

The choice-making architecture in all of these – from the football field to the captain’s bridge to the bankers’ boardrooms – traces back to the proposition posed by the 17^th century French mathematician and philosopher Blaise Pascal, on how the rational man should wager on the existence of a benevolent god:

There is no downside to affirmative belief, which if ultimately correct gains an eternity of heavenly reward – whereas to doubt has no immediate benefit but if proved wrong carries the punishment of eternal damnation by an angry diety.

It’s getting the downsides properly evaluated that is often the hardest, as I have written elsewhere. Belichick was challenged, because to allow an opponent’s unimpeded score went against the competitive grain – unappealing, but less consequential than the likely prospect of a Giants winning field goal.

Fortunately for Coughlin, on the other hand, his choice had an inbuilt hedge – the undesirable touchdown gave him a four-point margin, putting back on Boston the higher burden of driving the field, within an NFL minute, to answer in kind.

As for Captain Schettino or Mr. Corzine or the world’s purported financial wizards – however sincere their various professions of hindsight regret might be – only the bright sunshine of prosecutions or public inquiry will shed light on the extent to which they were remotely conscious of the potentially catastrophic results of their choices.

 

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The Airbus A380 as a Risk Assessment Case: Cracked Ribs Do Not Signal Good Health

Cause for concern are reports that European air safety officials have ordered inspections of cracks in the mounting brackets that attach the wings of the Airbus A380 – already a plane with a long history of delays, design issues and cost over-runs.

And if the bland assurances being spun by the manufacturer’s publicists – that “the cracking problem … is not a safety risk in the short- to medium-term” – reflect the company’s risk assessment attitude, then a suppressed but potential catastrophe is a matter of time – a mid-air disintegration with massive casualties and the subsequent grounding of an entire discredited fleet.

I am just winding up a month-long Risk Management teaching engagement, migrating an MBA-level curriculum to a class of undergraduates.[1]

Some recalibration has been involved. At the graduate level of business and law students, our focus is on the broken models and ineffective risk processes that have characterized the worlds of finance and banking, insurance, accountancy and professional services, over the years of the credit crisis. These run through the period -- from the collapse of Bear Stearns to that of MF Global; from rogue trader Jérôme Kerviel at Société Générale to his UBS counterpart, Kweku Adoboli; from the corruption of the American subprime mortgage market to that of Japanese corporate governance at Olympus.

Younger students stay with the basics – the human behaviors by which incentives are skewed, failures are rationalized away, and incipient disasters are hidden under the mistaken illogic that safety and soundness can be inferred, only because a breakdown “hasn’t happened yet.”

The discovery of cracks in the “rib feet” of the A380s presents a long-familiar challenge: what response is proper to the emergent symptoms of a potentially devastating event?

It is all too natural to put up an optimistic face – to admire success and to wish away the language of bad news. But the consequences can be dire:

• The late Steve Jobs may well have paid with his life for his denial-based postponement in treating his pancreatic cancer.

• The Italian liner Costa Concordia would most likely be cruising in comfort, rather than lying as a hulking wreck, had the supervisors tracking its earlier near-shore wanderings acted on the ready GPS data revealing the captain’s record of reckless behavior.

• And the signs of corruption in Bernie Madoff’s Ponzi operation were well within view, both to the SEC and to his investors, had they not chosen to turn blind eyes to the readily apparent.

Historical memory is hard to hold, especially where corporate budgets and profits and bonus payments depend on the wishful avoidance of delays, repairs and caution-based slow-downs.

But for learning directly applicable to the A380 and its cracks, my students have just scrutinized the 1986 case of the space shuttle Challenger – launched to its fatal explosion, before they were born, over the engineers’ objections that cold weather would threaten the flexibility of the eroded O-ring seals on its rocket booster.

The logical flaw in the shuttle case extends: The fact that prior launches had succeeded, despite O-ring erosion, did not provide comfort for future launches under other conditions. No more, that the A380s may have flown so far without incident despite wing bracket cracks – when such potential stresses as severe weather, hard landings or simple future wear-and-tear fatigue would change the failure calculations and render invalid the assumptions underlying margins of safety. 

In other words, paraphrasing with emphasis physicist Richard Feynman on the shuttle, “the A380 rib feet were not designed to crack. Cracking was a clue that something was wrong. Cracking was not something from which safety can be inferred.”  

In the Challenger case, seven astronauts and a space vehicle were lost to the deficiencies in NASA’s risk management. As for the A380, has any learning occurred?

As soon as my final grading is done, I will be uplifting for Paris and a spring-semester teaching gig with law students there.

But not on an A380. In its wounded state, I will be happy to book on the robust aircraft of an American airline.

 

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[1] My thanks and gratitude to the congenial community of Carthage College – faculty, administration, support and especially the students in my seminar – for a welcome and an experience as warm as this unseasonable winter in Kenosha, Wisconsin.

 

Review -- Book of the Year: Daniel Kahneman, "Thinking, Fast and Slow"

One of my students in Risk Management at the University of Chicago beat me to a reading of Daniel Kahneman’s recently-released “Thinking, Fast and Slow” (Farrar, Straus and Giroux, 2011, 418 pp.). 

A young man of few words but crystalline insights, he brought to class this terse review of Kahneman’s reprise of four decades of ground-breaking research into the flaws and fallacies embedded in judgments and choice-making:

“Too long” – he was typically pithy. “But brilliant.”

Right, on both counts. Start with the second: 

Modern English literature would have been impossible without the works of Shakespeare, if few others. The same, going back to the 1970’s: Kahneman and his late collaborator, Amos Tversky, opened whole new fields of inquiry and perception into human behavior.

Thanks to their pioneering work, we have the means to be both entertained and informed by the lessons in “Moneyball” (both the movie and Michael Lewis’s book), such as the stubborn clinging to soon-to-obsolesce folk verities by the talent scouts gathered in Billy Beane’s baseball clubhouse in Oakland.

And we can appreciate being rightly agog at the singular slogan of the credit crisis, the feckless pronouncement of Citigroup’s Chuck Prince in the summer of 2007, that “as long as the music is playing, you’ve got to get up and dance. We’re still dancing.”   

More broadly, Kahneman and Tversky gave us the means to identify – and desirably to comprehend, although that is subject to much doubting skepticism – whole categories of sub-optimal decision-making. Consider such influences as:

• Herd behavior – and the entire population of mutual fund advisors, unable to distinguish the dubious quantity of talent in their performance from the simple effects of random luck.

• The compulsion to construct compelling if entirely unreliable stories based on tiny bodies of data – and the daily flood of the commentators’ vacuous “explanations” for insignificant price moves in the securities markets. 

• The whole industry of prediction models that are blind to their in-built exposures to rare but catastrophically destructive events – thinking, with sorrow and anger, of the graveyard population of financial structures, from Bear Stearns and Lehman Brothers to the Icelandic banks and the Irish real estate market, right on down to the “repo-to-disaster” at MF Global.

As for my student’s first words – Kahneman’s editor falls into the genre’s too-familiar pattern of over-stuffing between the covers. To be sure, the book is worth its price for its two appendices alone – Kahneman and Tversky’s landmark papers on the irresistible reliance on heuristics and biases, and the assessments of risk appetite and aversion in decision-making under conditions of uncertainty.

But it fails to distill and sharpen, for just one example, the unappreciated significance of regression to the mean in cases where hindsight attribution of causation is a cause of systemically erroneous decision analysis. 

That’s by way of quibble, for Kahneman has brought about a worthwhile trade-off: in exchange for any loss of readers deterred by an over-weight hundred pages, he has gained the achievement of a career-spanning reference work, to become dog-eared on the desks of those of us who will hope in small ways to pass his genius on to the next generation of the students of risk.  

  

This will be by way of valedictory to a difficult and challenging year -- to wish all readers a healthy and peaceful 2012 – even if the new year bids fair to be no less volatile and unpredictable than the old.

January marks this blog’s fourth birthday – celebrated in anticipation that inevitable new eruptions of corporate malfeasance, the capacities of regulators for continued mischief-making, and their continuing and frustratingly ineffective inter-actions with issuers and auditors, will all continue to provide material worth addressing. 

   

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Lessons in Risk Management: A Broken Clock is Never Right -- It's Just Broken

The national recalibration caused by this weekend's fall-back to standard time is a reminder of the cliché recently repeated by a friend, that: 

“Even a broken clock is right twice a day ….”

Or so it is supposed, for the proposition that some information is better than none at all.

I will spare my friend's identity, since this is not personal. But as studied by my students in Risk Management, it is vitally important to scrutinize both what you know and what you don’t – and not be misled into missing the difference by the invocation of familiar but unexamined verities.

I surveyed my students – who with their PC’s and iPads and smartphones are carrying around an average of 2.5 devices providing them with the hour – of which only a fraction are readable by way of little hands pointing at a circular array of twelve numbers on a dial.

It’s the same in today’s public life: the handsome golden landmark clock in Grand Central Station is an anachronism, superseded by the blinking digital screens of the airport flight announcements, the pulsing scoreboard lights of the sports arenas and the obnoxious talking panels of the typical office elevator.

Even in the classroom for my MBA course, a sleek modern rectangular digital time screen hangs above the door.

Here’s the point: when broken, the ubiquitous digital clocks simply go blank. There is no sense in which, when non-functioning, a dark and empty display can ever be “right.”

So the claim is incomprehensible to anyone raised in a world of digital time-pieces. Baby-boomers are likely the last at risk of being led astray, having grown up with (and still using) analog time-keeping machinery.

At no time in the diurnal cycle is any meaningful time guidance offered by a crashed computer or an uncharged cell phone – or, for that matter, a dead microwave or DVD player or any of the myriad of appliances now equipped with digital clocks on which generations younger than the fogies rely.

The “right twice a day” assertion also suffers a more subtle flaw: How do you know? The question of “right-ness” is only testable by reference to an outside source. Looking at the hands of a broken clocked stopped at the classic “ten-to-two,” you may suspect being late for lunch.  But you can’t know without a working alternative. Whatever its format, no informational value is added by viewing the face of a dysfunctional clock.

The inquiry really needs to go down another layer, though, to the reason for calling on the cliché in the first place.

Examples abound where a little information is actually worse than none, especially where users are lulled into a false sense of security and over-confidence.

Unmarked and narrow country roads suffer a lower rate of fatal vehicle accidents, for example, than high-speed expressways, even if the latter are fitted with lane markers and rumble strips and crash barriers, precisely because the rural lanes demand high degrees of focus and attention, prudence and speed discretion.

Equally, day traders seduced by computer-generated graphs and charts of stock price activities are lured into the misapprehension that the flood of data is a reliable measure for predictability, only to crash and fail at the rate of amateur punters in a casino.

And on a global scale since 2007, the road to financial ruin has been littered with the reputational corpses of those who mistakenly believed that the quants’ “value-at-risk” models and their off-spring sufficed to support their portfolios of exotic financial products – among them, Jimmy Cayne of Bear Stearns, Chuck Prince of Citi, Dick Fuld of Lehman Brothers and most lately, Jon Corzine at MF Global.

Which is not to say that there is nothing at all to learn from a clear-eyed acknowledgement of the limits on the knowable. But more likely than an unexamined repetition of a maxim that is both conventional and therefore probably wrong, let the inquiry seek wisdom from the more humble perspective of the counsels of caution. 

PS: An invitation: send me your suggestions for other clichés worthy of attention and deflation. Thanks.

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Racing to Avoid a Crash: On the Track -- On the Street

There’s a stack of final papers in my Risk Management course – and an apero on the sunny terrace of the neighborhood café, to ease the grading process.

And a fond wish for one more class session, to dissect last weekend’s lesson in the disastrous consequences of bad risk assessment and choice-making under high-stress competitive conditions.

It happened at Sunday’s Indianapolis 500. Rookie driver JR Hildebrand had a comfortable lead going into the final lap. But instead of riding easily to victory, he attempted a high pass of a slower car on the very last corner, crashed into the wall, and slid his wreck to a second-place finish – passed by the doubtless astounded Dan Wheldon, on whom Hildebrand’s error of judgment and the fickle gods of fate bestowed a gift beyond imagination.

Aggressive, brave or foolish – the high cost of immature enthusiasm under “win or crash” analysis is not rare. Recall the Olympic gold medal that snowboarder Lindsey Jacobellis threw away on her final run at Turin in 2006, with her ill-advised showboating stunt attempt on the last bump.

My class of MBA and Finance students focuses on lessons from highly-consequential decisions, especially in failure situations – drawn from many fields into the worlds of commerce and professional services, where most will eventually work, and where senior leaders charged with risk responsibility have performed so poorly over the last four years.

From Hildebrand’s split-second choice – now part of racing lore and a life-long mark on his career record, they would take at least these two:

First, the skills and energy of the young are to be recognized and respected; a new hot-shot does command attention and can achieve greatness, whether in sport or government or a trading room. But as events at Indy showed, the converse is no less valid. Beginner’s luck is no substitute for seasoned strategy, and those surviving to accumulate the scars of experience bring wisdom that tempers rash choices.

Provided Hildebrand does learn his risk/reward lesson, in other words, he is not likely to repeat it.

Therein lies learning for business and financial disciplines, still struggling past the recent crisis. The tragically short time horizon of the designers of exotic derivatives, and the exclusion from the quants’ risk models of events beyond their recollection, created the conditions for the crushing impact of events erroneously thought to be unforeseeable.

The second lesson from Hildebrand’s choice-making looks at the structure of his decision matrix: a binary choice -- “try to pass” or “lay off” -- but with alternative and different benefits and detriments for each.

The consequences of playing safe and cautious were in his favor: there was no downside, as he was at no risk of being overtaken, and to cruise safely meant a checkered flag.

In choosing to charge the corner, on the other hand, he had negligible upside – he was already holding a dominant lead – while, as events proved, the downside of being unsuccessful was catastrophic.

(Take note, of course, that the calculation could alter dramatically – if, for one case, he was trailing and needed a last-minute pass to advance, or if he was tightly shadowed and at risk of losing his lead.)

The metaphor extends, readily enough:

Should an investment manager double down on a losing strategy, which unless reversed will bankrupt his fund? Or should the size of his positions be controlled along the way, so that no single exposure could threaten his entire firm’s survival?

Should an entrepreneur put all his capital at risk to start a new venture? To a retiree in reasonable comfort, the upside is limited, but the hazard of a failed and penurious old age is real; while to a new graduate with a long view, fortune favors seizing the greatest number of jackpot opportunities.

The under-appreciated risk-assessment obligation, all of this should suggest, lies in deliberate attention, usually overlooked, to the alternative choice: the action foregone, the rejected Plan B, the road not taken, the decision not to charge ahead.

To a rookie Indy driver with his hair on fire and his foot to the floor, this would all seem abstract, bloodless and pedantic. But it should feel otherwise to a risk officer whose strategic control over a floor of stoked-up traders is his bank’s best hope for survival through the next bubble.

Because my students are more likely, post-graduation, to steer companies and to run portfolios, than to drive turbocharged racing cars, the sorry case of JR Hildebrand’s impetuous mis-chance will keep a place in my curriculum.

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Risk Management: Where Shall Learning Be Found?

Here comes summer.

School is out - oh happy day.

     --    Jerry Keller, 1959

Classes finished last weekend for the students in my MBA-level course in Risk Management. They are even now beavering away on their final papers: assessments of the flaws and defects in risk handling among the many catastrophic business failures of the last four years.

While awaiting their efforts and the task of year-end grading, I have two summer projects – both involving the re-calibration of our syllabus, which explores the lengthy catalog of executive and governmental bias, errors, misapprehension and general group-based follies that have defined the recent era of unprecedented excess and turmoil. The differences will be interesting.  

For one, I am asked by a professor at a near-by college whether this curriculum on the diagnostics of fallibility would deploy for a classroom of capable undergraduates. My cautious “yes” rests on the continuity and commonality of the themes:

To take only one of our subjects of study --  the group-think, dissent suppression and publicity-oriented overrides of technical competence that led to the break-up and loss of the Challenger space shuttle in 1986 were replicated in the blow-out of the Deepwater Horizon oil-well in April 2010. Are we learning anything yet?

Or – it does not require a degree in finance to appreciate that the unlearned lessons of the failed financial models that took down Long Term Capital Management in 1998 recurred in the model-driven rush to disaster that spun out of the subprime mortgage derivatives sector starting with the implosion of the Bear Stearns real estate funds in 2007.

The lessons may have evaded the decision-makers at the time, but they are well within the aptitude of a collection of above-average undergraduates.

I am less confident of my second mission – a call from the leadership of a world-class professional services organization. There, job-by-job client delivery is impeccable, but the prevailing attitude toward risk is that “we’ve always done it this way, and it works” – a view that leaves the firm hostage to an inability to distinguish skill from dumb luck.

The challenge to offering advice in the commercial world – an environment be-set by the logically flawed belief that if a problem has not arisen in the past, it will not in the future – is the lack of appetite for the same kind of time and effort that my students put into the scrutiny of multi-disciplinary learning opportunities. “Manage what you measure” is an unfortunately blinkered approach, when it is precisely what you don’t know that blows up and kills you – whether it is among the dinosaurs unable to conceive or adapt to the emergence of the faster, smarter mammals, or Bernie Madoff’s investors with their addictive blindness to the reality behind monthly account statements simply too good to be true. 

It is sensitive, to find diplomatic language in which to convey risk process deficiencies to a senior executive team, where as one commentator bluntly puts it, “They’re not good, and they don’t know it.”

One alternative, in an only slightly more nuanced articulation, is put as a question: “How can you design a strategy to get better, if you lack the skills to evaluate how good you really are?”

Studying past failures is a good place to start. That’s where my students focus their attention – working toward their own personal pay-off in superior skills in analysis and application once they are launched into the workplace.

But that’s not an approach that goes down well in the business and professional world. The humility of accepted limits comes hard to a latter-day Ozymandias such as Dick Fuld or Chuck Prince or Angelo Mozilo – their reputations along with their visages now lying shattered and half-sunk. 

So even as I search for the ways to press for improved perceptions and performance among my clients, it’s a certainty that a renewed cycle of mis-behavior, failures and collapses is brewing and will continue to feed the academic appetite for new material.

Readers having good examples under any of these headings are cordially invited to contribute to the searching.

 

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Recidivism and Risk Management: Barry Minkow Goes Back to the Slammer

Son, always remember: some day, somewhere, a guy is going to come to you and show you a nice brand-new deck of cards, and this guy is going to offer to bet you that the jack of spades will jump out of this deck and squirt cider in your ears. But son, do not bet him, for as sure as you do, you are going to get an ear full of cider.

-- Damon Runyon, “The Idyll of Miss Sarah Brown” (1933)

 A question for those charged with risk management and fraud prevention:

 What’s your company policy on employing or doing business with ostensibly reformed white-collar criminals?

 And is a re-think indicated by the news that Barry Minkow, wunderkind among securities swindlers for the scam at ZZZZ Best in the 1980’s, for which he served seven years of a double-digit sentence on 57 counts, is negotiating a securities-fraud plea bargain under which he now faces fives fresh years of jail time (here).

My concern is a prosaic one – not Hollywood’s question whether his return to federal housing means that the pending Minkow bio-pic requires re-shooting of a new ending (here), or whether the February burglary of $50,000 at the Community Bible Church where he recently resigned as pastor (here) bears any of his felonious fingerprints (here).

It’s only this: Given the rate of relapse among those described by English essayist Charles Lamb as “so crooked that if they’d swallow a spike, they’d void out a corkscrew,” should a company concerned for its reputation and fiscal soundness ever yield to sentiment and invite such a fox back into its henhouse?

Experience over the years counsels against it. Examples in my own catalog include the large-company CEO convict, who finagled a reduced sentence via a convenient medical excuse, and was no sooner paroled to a halfway house than he took over its single pay-phone to peddle the rosy promises of new oil deals. Or the youthful CFO applicant who persuaded an employer of his time-served maturation, following bucket-shop charges; the naïve advice of the audit firm partner was to “keep the kid away from the cash” – unavailing to prevent a scandalous and catastrophic collapse and a portfolio of lengthy prison sentences for the entire executive team.

And it was surely foreseeable, following O.J.Simpson’s circus-trial acquittal, that his temporarily dampened symptoms of renewed personal violence would re-erupt – the only question being the period of his volcanic latency.

For a risk manager the decision-making process is a two-by-two matrix – evaluating the rewards and benefits of a yes/no choice whether to chance re-attachment to someone’s checkered past.

A successful result could yield good and honest performance – non-trivial, but likely not different from that available with many other candidates – whereas the negative – a relapse into criminality – would at minimum be seriously costly and disruptive.

On the other hand the cautious choice to forego the relationship would mean sacrificing the potential contribution of an ex-felon – again, a modest upside – although avoiding the destruction that a recidivist’s presence might cause.

The analytic process has its formulation in the 17^th-century French mathematician and philosopher Blaise Pascal’s wager on the existence of God:

Betting against the proposition, with no particular reward for being right, could – if proved wrong -- suffer the punishment of an eternally vengeful deity. Rather, the wager in favor of His existence carries no hazard if incorrect, but offers the upside of an eternity of bliss.

Minkow’s own now-former church is no doubt a repository of repentance, atonement, forgiveness and charity. Admirable qualities, all. But they should not overwhelm what is learnable from logic and experience.

Namely: the percentage of white-collar wrongdoers in the executive suites is small to begin with. But once the “contingent possibility” is established – that is, an already existing proclivity to misbehave – the risk calculus is fundamentally changed.

There is a cottage industry of ex-cons and their acolytes, working the book-and-lecture circuit and flogging scripts of penitence and redemption pitched to the credulous.

It is one thing to read their stories and even to consider the quondam relevance of their experiences. But the case is not made that they should be entrusted with access to the balance sheets of any enterprise involving other people’s money.

 

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Coincidence, Causation and Apple's Stock Price: Further Lessons from the UBS Dress Code

My MBA students in Risk Management study closely the hazards of conflating coincidence and causation – at best mis-leading, and at worst, acutely dangerous.

But sometimes it’s so delicious, we could only wish it so.

Last Monday, with a focus on the never-ending debate over international accounting standards based on general principles or detailed rules, I made sport of the 43-page employee dress code published in December by Swiss bank UBS (here), believing that professional guidance based on the former is definitely preferred.

And the very next day – mirabile dictu – UBS stood down (here), with a sheepish retreat to “what is important” – evidently still, the modest requirement to dress in the bank’s official colors of black, white and red (here).

This was not the grand capitulation to public opinion shown by The Gap, when it hastily withdrew its misbegotten new logo last October (here). But it makes the important point that normative behavior can be modified by non-coercive societal influence – rather than under the heavier hands of legislatures or law enforcement.

I dare not claim a causal relationship between my digs at UBS and its hasty retrenchment – no more, for that matter, did my criticism of PwC’s loopy new logo (here) stimulate a re-think on its part.

A far better case for the caution not to over-weigh coincidence lay in last week’s storm of activity around the stock price of Apple Inc. On consecutive days, January 17 and 18, CEO Steve Jobs announced an indeterminate medical leave, and the company released estimate-smashing results for 2010 – revenues up 71% and net income up 78%.

The pundits’ cacophony went in all directions, following Apple’s closing the prior Friday at an all-time high of 348. Monday’s US market holiday gave a whole extra day for the uncertainty-mongers to stir the pot.

As they did. The ride began with Tuesday’s early trading down at 326, driving back up to close the day at 340 – if only temporarily. Punters in options saw short-dated 320 puts that had closed Friday at 54 cents explode briefly to $ 5, while those betting on a quick recovery could “buy the dip.”

Then during the week, while the major indices were basically flat, both those positions were trashed; Apple peaked back above 348 on Wednesday, doing for any skittish bears, and then slumped to close at 326 on Friday the 21^st, doing the same to itchy-fingered optimists. 

It took the week for events to shake out. Apple’s roller coaster fell out of the technology news, supplanted by the board shake-up at HP (here) and Google co-founder Larry Page’s emergence to sole leadership out of the triumvirate with Sergey Brin and Eric Schmidt (here).

On Monday the 24^th the stock was back to 337, and as things stand on Tuesday it has cheerily closed above 341, looking again at its pre-tumult high.

From the perspective of long-term Apple investors (a group to which I belong, by the way), viewing a price chart over a year or even a month, the price moves over the week are an inconsequential hiccup. But to those caught in a flurry of zero-sum trades, there were real effects.

How would they have divined the reasons and the lessons?

Just as primitive peoples lit bonfires and beseeched the gods of the solstices to return the sun, mistakenly believing themselves both responsible and successful, athletes maintain their winning streaks through locker-room rituals and lucky amulets. Investors too invoke their models and their charts as if to be convinced that their decisions are guided by design and intelligence rather than the randomness of fortune.

Both those shorting Apple on Jobs’s health news and those who bought the company’s future in the narrow trough are congratulating themselves on their insightfulness and perspicacity. While those taking the opposite (and losing) positions – in both directions – are equally wringing their hands that some undetectable malign external forces – surely not their own fault – conspired to sabotage their investment strategies.

All of which goes to confirm yet again, that a hubristic over-confidence unable to differentiate skill from random luck is a dangerous substitute for the humility to appreciate that the market, like life itself, is too complex to be predictable.

Still, it would be nice if someone from UBS would call up and say, “thank you.”

 

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