Re:Balance -- Jim Peterson

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.

 

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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Accounting Standards: Rules or Principles? Lessons From the UBS Dress Code

Goldman Sachs has snatched from its US clients the windfall chance to front-run Facebook's IPO, by limiting access to the potential of its $1.5 billion special-purpose fund to foreigners -- while professing no influence from the fuss-budgets at the SEC (here). So it seems a good time to ask:

Should regulatory compliance and accounting standards be expressed as detailed codes of precisely-drawn rules? Or as broadly-articulated principles?

There are lessons to be taken from the 43-page dress code issued by Swiss bank UBS in December (here).

The debate needs help: endless, pointless and fruitless, it feeds the conclusion that much-touted but never progressed “convergence” between international accounting standards and country-level codes in Europe, the UK and the US is as distant, elusive and unlikely as ever.

Popular reaction is that only a Swiss mentality could perpetrate the obsession at UBS, with its meticulous prescriptions on suit fabrics, cosmetic colors, collar points and hair care both facial and cranial.

Although, a dress code did appear late in my own corporate life – no less ridiculous but also raising non-trivial dissonant issues about the boundaries and effectiveness of guidance.

I was the senior member and titular head of a team based in Paris – an expatriate American amongst colleagues from the major European countries. To a man and woman, all were immensely talented and hard-working. They were also urbane, stylish and beautifully attired.

Global headquarters in the US published its requirements for the new “business casual.” It was only six single-spaced pages, compared to the fulsome 43 pages of UBS – but who’d have expected better from the sartorially challenged Americans?

It went into gruesome detail on necklines and sleeve styles and degrees of elasticity; it proscribed denim and gym gear and athletic branding; and it forbade flip-flops and open toes and footwear of any aerobic provenance.

On a given day, probably one-third of our Paris team would have been out of compliance. But, making their own individual decisions about skirt lengths, or pantyhose in July, or whether to match an Armani T-shirt with a differently-branded suit, my young charges were always impeccably turned out and appropriate for client premises and boardrooms anywhere.

For the purpose, they were capable of proper judgments under the lightest of guidance. At our annual group party our solicitor from Edinburgh was elegant in his formal tartan kilt, dirk and sporn – but for court he was always in proper dark grey suit. On warm spring days the length of limb on display among our lanky cadre of legal assistants was a substantial percentage of their average 1.8 meters – but they all donned decorous trouser suits when the visiting firemen arrived from America.

Which has what to do with the challenge of setting international accounting standards? The answer starts with the extent of mutual trust and confidence shared by a community seeking for mutually-acceptable guidance and limits.

Our Europeans rightly expressed derision and ridicule for the US code, just as most of the world feels for the pathetic efforts of UBS, because of our expectations for what was important: discipline, dedication and execution of first-quality work. Under broad principles of professionalism and good taste, their public face was virtually one of self-regulation.

Whereas if constrained by punctilious trivialities, they would have wasted both their morale and my goodwill, along with countless hours of productive time, on manipulation of the rules in rebellious search for boundaries and exceptions.

It’s no different with financial reporting standards and regulations. History teaches that bright-line limits are pushed to excess by the creative and the aggressive: the depreciation lives of mainframe computers in the 1970’s, the elastic retained ownership requirements for special-purpose entities exploited by Enron in the 1990’s, the investor limits skirted by Facebook under the counsel of Goldman Sachs.

It is the human condition that some deviance from codes of behavior is inevitable – society decides the amount, by voting its willingness to allocate resources to law enforcement and sanctions.

The range across cultures can be vast – from the de facto legalization of recreational drugs in urban America at one end, to the use of flogging in Singapore to punish the consumption of fast food on the public streets.

At the extreme, drunken driving among teen-agers could be eliminated: raise the driving age to 25 and impose capital punishment on first offenders. No less, accounting manipulations could be wiped out – by outlawing commercial transactions in more than one currency or that fail to settle for cash within 48 hours.

But the compromises required of society would never go so far. Instead, the certainty of occasional lapses and excesses is accepted. Limits are broadly defined, and enforcement mechanisms are calibrated -- for both better andworse -- in both the capital market’s use of financial information and the fashion decisions of a business office.

Judged by my experience in the latter, a global environment is far more seemly and operates with more success without the heavy hand of excess regulation.

That will soon be learned, I wager, in the halls of UBS. Whether the new leaders of the Financial Accounting Standards Board and the International Accounting Standards Board will agree is a matter of greater doubt.

 

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Book Review: Tony Judt Has a Few Last Words

Ill Fares the Land, by Tony Judt, Penguin Press, 237 pages

“Ill fares the land, to hastening ills a prey,

Where wealth accumulates, and men decay."

-- Oliver Goldsmith, The Deserted Village, 1770

Although I had devoured Tony Judt’s sweeping prize-winner, “Postwar: A History of Europe Since 1945” (2006), I had missed the April release of “Ill Fares the Land,” for which I am obliged to a regular reader.

If there is reason to celebrate Judt’s ability to bring forth his extended essay under the terrible burden of his terminal battle with ALS – and there is – it is no less lamentable that his premature death in August removed him as promoter and advocate on its behalf.

Even if some months late to the task, I am impelled by the strong suspicion, much as I would love otherwise, that this space shares few enough readers with Judt’s regular platform, “The New York Review of Books.” 

Judt paints with eloquence the debased world of “conspicuous consumption of redundant consumer goods” – enabled by the retreat from the postwar achievements of interventionist governments in areas of security, prosperity and social services. Instead are the unprecedented wealth disparities of the last thirty years, especially in the United States and the United Kingdom but throughout advanced economies globally, with all the attendant costs and consequences falling disproportionately on the increasingly disadvantaged: social alienation and depression, failed education and mental and physical dysfunction.

Judt points to the confusion sown by self-interest pursued and based only on maximized individual economic advantage, with “minimal reference to extraneous criteria such as altruism, self-denial, taste, cultural habit or collective purpose” – even while the advocates of unregulated free markets drove into the abyss of the credit crisis of the last three years under the “false precision” that because “they didn’t know everything, as a result it turns out that they didn’t really know anything.” 

As Judt sees it, the reduction in trust and cooperation on which the social cohesion of the modern state critically depends, has given way to policies driven by fear, selfishness and bigotry – manifest in communities segregated and gated-off both physically and culturally. The ominously frightening consequence, when government cannot function on trust, is that it will move to do so by intrusion and repression, and ultimately by violence.

In the way of polemicists since Jeremiah, Judt in his outcry for a new form of social discourse does stop short – or so it could be charged, by those for whom words of inspiration only come alive in action. For his rhetoric flags, both on the particulars of a process for a new form of engagement across the spectrum of political principles, and even more on the blueprint by which the headline topics of a just and caring society might be realized.

Which takes nothing away. Voices on Judt’s behalf need to be raised, post mortem. His legacy is one of those small works that emerges from time to time, well ahead of the readiness of even sympathetic audiences to grasp its ultimate impact.

To punch its weight, however, would not have meant stints on the Oprah show or Comedy Central. Even writing for an American audience, Judt has a style, exemplified by his use of both diacritical marks in the word “dèbâcle,” that must have prepared him for an underwhelming reception in the popular audiences.

Which is fine. “Ill Fares the Land” was never destined for wide readership. The population of conservatives genuinely qualified and inspired to engage a substantive conversation with its content could probably convene in a closet; other pretenders on the Right would fall among Judt’s targets as having prospered personally – he would say, selfishly – from the subsidies and support of the active operations of government through the course of “the American century.”

Meanwhile, know-nothings at both ends of the political spectrum will not appreciate a work demanding more cerebral engagement than Fox or MSNBC, nor will they stick with the task of reading to chapter two without their lips getting tired.

For myself, I happily leave to the professional ideologues the debates over the relative analytic purity of Judt’s vision for a renascent substantive form of civic engagement.

Here’s the thought: take an evening off from the cacophony of the electronic media, and invest the time and mental effort to wrestle with these messages. When a sufficiently receptive audience has done that, the process will be well begun of extending the foundations for a sustainably re-envisioned global society of both compassion and decency.

 

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Hailing a Driver: Not Just a Ride to the Airport

 

Reminders of the petty scale of our daily problems come often as a subtle tap on the shoulder – but sometimes as a blow to the head, or the heart.

The only attractive reason to anticipate my pre-dawn business trip this week was the chance to spend an hour with Adam, our family’s friend and driver for the last dozen years.

It was much more than his immaculate town car, with the daily papers and the ready stash of chilled drinks and its soft and capacious seating – all in contrast to our city’s rattle-box taxis with their cramp-inducing lack of legroom and pervasive odors mixed of dirty laundry and spicy roast goat.

It was the spirit of Adam himself -- always turned out in tie and cap, with his broadly-smiling reminder on the outbound legs to count the luggage and confirm the tickets, and his cheery “Welcome home” at the arrivals terminal on the other end.

He was a Coptic Egyptian. He had lived in the minority all over the world, acquiring along the way a quiet and pacific tolerance that was always calming as we would sit in traffic and review the world’s issues from one trip to the next.

I never met his wife, but I learned through his affection the model of two well-differentiated personalities, who bring complementary skills and strengths to the sustaining of a long, caring and devoted partnership.

And we shared the joys and challenges of older fatherhood. We supported each other on the evolving problems of “little kids” and “big kids.” As he drove us to family holidays and college visits, he always asked about our daughter’s well being.

Adam moved into semi-retirement, but loyally kept us in his client book. As ever, he was always ten minutes early rather than five minutes late. So when he was not at our door at 6:30 am, just before the morning rush hour would begin to build, I called his number on the speed dial, out of concern that I had given him a wrong date or time.

What I was not prepared for was the stranger’s voice: “This is Adam’s son. Adam passed away suddenly, last Thursday. The funeral was yesterday.”

The world is changed. It’s no more a matter of his help in finding the passports and loading the ski bags and making the adjustments of cancelled flights and re-arranged pick-ups. It’s that a wise and gentle man will no longer be there to bring tolerance and perspective to the nuisance and disruptions of a traveler’s life.

Our family loved you, Adam Bisher, and we will miss you. You drove us faithfully in comfort and safety. Flights of angels now drive thee to thy rest.    

 

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The Big Four's UK Firms Pick Up Non-Executive Directors -- And Then ...?

All the girls get prettier at closin’ time –

                    Mickey Gilley, 1976

A recent discussion with Re: The Auditors about the governance of the large global accounting firms was triggered by the UK news that the Big Four were appointing non-executive directors (here), as contemplated under the Audit Firm Governance Code published in January by the Financial Reporting Council (here).

Francine McKenna’s blog post (here) included my own skeptical two cents worth, on the unlikely effect on the culture of global-scale private partnerships, and the limited impact of single-country endeavors. It also led to these further pessimistic reflections on the reasons why the FRC’s efforts – however noble and well-intentioned – will create no traction in favor of the firms.

A starting point is with the process itself: a task force was assembled under the auspices of the auditors’ own trade group, the Institute of Chartered Accountants in England and Wales, comprising four members from the accounting firms, seven from large clients and a single academic. So as to the question of “regulatory capture”:

Would you expect roast goose for Christmas dinner, if the flock got to vote on the menu?

More important is a proper apprehension of the role of codes of conduct and ethical charters and all the accompanying high-toned rhetoric. It’s the common confusion of cause and effect, to view these as drivers of responsible corporate governance.

The contrary is readily observed. Governance-challenged enterprises from Siemens to AIG to BP could claim the vigor and piety of their pre-lapse structures, and Enron was lauded for years as an American model of behavior.

The FRC’s code (here) rightly identifies the importance of executive “tone at the top” – but its induction runs the wrong way. In truth, when company leadership really does “walk the talk,” its employees are infused and its community is served in praise-worthy fashion -- codes and charters follow with credibility.  

Not only can good governance not be inflicted or imposed, in other words, because resistant leaders will find ways to disturb or subvert the purpose, but a virtuous culture will display its legitimacy without the need for pietistic overlays.

So the FRC is on the back foot in at least these ways:

First, the Code makes persistent reference to the non-executives’ presumed “independence,” but recitation and reality do not engage. As contemplated, newly-engaged worthies will be compensated under employment contracts, provided with staff and resources by the clients, and insured and indemnified for their conduct – putting them under far closer relationships than the large audit firms are permitted themselves.

Second, the FRC proposes that non-executives might facilitate communications and reduce exposures when the large firms face existential threats from litigation, regulation or prosecution. As floated briefly at the US Treasury Committee on the Audit Profession in 2008, the suggestion of stand-by management replacement under similar conditions displayed a Panglossian naïveté that thoroughly deserved its criticisms (here). But rebuttal need not go so far. If “tone at the top” is to be successful in a crisis, it has to be engaged first-hand – not insulated or protected by proxies, delegates or intermediaries.   

Finally, the Big Four firms already have an agenda of opportunities to address the credibility gap with their critics, none of which involve the cost or distraction of bloating their boardrooms with outsiders drawn from the available ranks of the great and the good:

• Arguments about the safety and soundness of the Big Four are going nowhere without their publication of audited world-wide financial statements. Single-country information, of the type now available in the UK, leaves unaddressed the implications of strategic directions, personnel deployment and risk and quality exposures that span the globe.
  
• No progress is possible toward a sustainable business model resistant to deadly litigation exposure, so long as the large firms limit their advocacy to summary data and hand-wringing by their messengers -- as witness the sterile paralysis of the Paulson Committee (here). If inflicted on a Big Four firm, the $ 3 billion cost-to-date of BP’s exposure to Deepwater Horizon would already have been fatal (here) – a message supportable only by an available public acknowledgement of the specifics of the large-firms’ list of death-threats.
• Relatedly, it is past time to recognize that the energy devoted to narrow-focused “liability reform” and “damage caps” is a wasted effort – not only as a political non-starter in every major legislative venue, but as unsatisfactory to achieve sustainability. Legitimate structures for investor protection cannot in the long run be built on the narrow base of the accounting firms’ partner capital – the resources are simply not there – but require instead the presence of government as a resource of last resort.
  

To the extent any of these require more fundamental re-engineering than that offered by the FRC and the ICAEW – and they do – so be it. 

 

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Trust Matters: Charlie Green and I on Ethics Training, Corporate Standards and Society's Limited Expectations from Government

I talk often with Charlie Green -- author, speaker and consultant, and expert on the theme of trust in business relationships. His blog, Trust Matters, is a ready and regular source of wisdom.

We spoke at length this week, on a broad range of related subjects. Charlie has posted the interview as the latest in his series of Trust Quotes. Here are several excerpts:

CHG: What concerns do you have about the effectiveness of teaching about trust, ethics and governance in the business schools and universities?

JP: It’s my belief that much of the teaching is at best ineffective and at worst a misleading waste of time – although I am sensitive to the way this is received among my colleagues in academia. Jeff Skilling and Andy Fastow were celebrated as executives to be admired, and either one would have scored an A+ on any university-level course in ethics or governance.

****

CHG: Both “doing good” and “doing well” are byproducts of a cultural devotion to doing business from a certain set of principles? Care to say something about what those principles look like?

JP: One of the finest defense lawyers I ever knew, the late Peter Fleming, had nothing but scorn for elaborate codes of behavior – governance, accounting principles, whatever. His guidance required one page: “Can you credibly defend this decision in front of a jury?”

****

CHG: What can we reasonably expect from government by way of contribution to good corporate behavior?

JP: I’m a deep skeptic on the ability of regulators to either detect or to deter bad behavior. Not that oversight and enforcement are not necessary. But it seems to me pretty clear that the post-Enron imposition of Sarbanes/Oxley did not lead to an outbreak of virtue.

Look at the many examples over the last three years....Law enforcement is by nature always going to be reactive, behind the curve of the inevitable misbehavior of those who would burst the limits...It goes back in part to why societies evolve their laws and codes of behavior. People don’t become law-abiding because more laws are passed.

I invite you to the interview in its entirety. And Charlie and I would both welcome your reactions and comments.

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Goldman Sachs and the Fabulous Future of Fabrice Tourre

Is there a future at Goldman Sachs for Fabrice Tourre? The self-styled “fabulous Fab” was the only individual clipped as co-defendant in the suit by the Securities and Exchange Commission over Goldman’s late 2006 flogging of the exotic financial derivative Abacus, a credit default obligation based on a portfolio of toxic subprime mortgages.

Tourre is now safe-housed in London -- Goldman having evidently taken the strategic decision to keep their erstwhile wonder-boy clasped in close embrace for the duration of its legal exposures. 

For which, by contrast, compare the unpleasant consequential exposures for Société Générale, whose rogue ex-trader Jérôme Kerviel’s just published tell-all, “L’Engrenage, Mémoire d’un Trader”, re-ignites the early 2008 agony of his multi-billion euro infliction; or Arthur Andersen’s ready disavowal and jettison of Enron engagement partner David Duncan, before its own flame-out in 2002.

It would be inductively flawed for Tourre to assume continued enjoyment of his employer’s long-term hospitality. Thanksgiving turkeys, fattening in luxury through the autumn, learn to their dismay of the radical adjustment in their life-style when the farmer’s late-November strategy brings down the axe. Equally, Tourre’s useful life at Goldman is tied entirely to the resolution of its concerns with law enforcement.

So, being well-advised, he should expect to become chum for the sharks either as part of a settlement or directly thereafter.

Unless of course he can prove his present value by re-programming the energy with which he hawked the Abacus product to Goldman’s ready market of credulous believers. 

And how? The British bookmakers have already captured the odds-making on the survival prospects of the Tory/Lib Dem coalition. This year’s action on the NCAA basketball tournament is over. And the consequences of BP’s blown well in the Gulf of Mexico are priced into existing petroleum futures.

Other exotic alternatives? Given the volatility of emerging information about the organized church, arising from Chile to Germany, what about “clerical futures,” tied to the predicted tenure and turn-over of a portfolio of Catholic bishops, or the likelihood of Episcopal schism based on gay ordinations?

Or perhaps a wager on the total first-year sales volume of Apple’s iPad – directly tied to the roll-out of the device itself rather than the prosaic proxy of AAPL’s stock price?

Or here: our cultures now encourage wagers on the duration of life itself, through life insurance, viatical settlements and reverse mortgages -- and pre-nuptial agreements are increasingly used to manage the business side of romantic associations. Do the investment bankers’ innovators not see an unexploited niche market for financial products tied to the durability of marital contracts?

A full range of investment opportunities should be available. A customized wager on the likelihood of the neighbors’ break-up would require frequent re-pricing, depending on the level of loud arguments and broken crockery. By contrast, standardized trades could be tied to the five-year intervals celebrated in the etiquette books – call them “anniversary futures,” denominated wood, tin, pearl, silver, and golden, and priced accordingly.

The records of the domestic courts would also make historical data available to underpin trading opportunities in “marriage pools” -- say, by parish or profession or income level -- with divisions into tranches and risk ratings differentially assigned and priced. 

Consider the risk-disclosure language in the offering documents: triple-AAA ratings for the likely fidelity of a group of unadventurous stay-at-home actuaries – or junk-level assessment for the ten-year prospects of wander-lustful professional golfers or soccer players or elected officials.

These ideas might generate a certain reticence among portions of the investor community. Betting against the probity of the local clergy might infringe some sensitivities. Hard-core adherents to the sanctity of life-long vows might be uncomfortable taking bear positions. But no more so than the occasional unease with the role of short-sellers in the equities markets – recalling that nobody actually forced Goldman’s clients to buy those doubtful-looking CDO’s.

A host of small details would remain to be worked through – whether insider status would extend to clergy or divorce lawyers, for example.

But these are small concerns, and “the Fab” has time on his hands. 

Unless, being smarter than a turkey, he is already busy trading the over/under on his departure date.

 

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Sheep Dogs and Stewardship -- Why Groom the Next Generation?

Reader reaction indicates that I touched a sensitive subject, when I suggested on November 10 – here – that there was a mis-alignment in the compensation models of the large accounting firms, who distribute immediate profits to their current partners while the potentially devastating impact of related litigation takes years to befall the succeeding generations.

Which suggests the broader personnel picture and the range of attitudes and strategies involved in obtaining, maintaining and retaining the staff necessary for an enterprise to thrive and survive.

Among the large accounting firms, the topic of cut-backs, lay-offs and treatment of subordinates is under-reported but acutely felt – scrutinized by the bloggers and their exploding audiences (see Re:TheAuditors and Going Concern), if mainly ignored by the mainstream media.  

As a way to measure corporate management’s behavior in the areas of governance, incentives and sustainability, consider a couple I know well, who in their “retirement“ are ranchers in southwestern Oregon. They tend the largest flock of Soay sheep in America – one of the oldest domesticated breeds known to human history – for which they have the indispensable aid of one spry border collie and a quartet of massive Anatolian sheep dogs.

This fall, as they do every other year, they made a two-day round trip to fetch a new puppy from their specialized breeder – bringing home an already formidable bundle of energy, who will quickly grow to 125 pounds and demand enormous quantities of both food and training. 

With a quarter-ton of canine appetites already deployed around their pastures, why do they add this burden to their back-bending task of hauling dog food by the truckload of hundred-weight sacks?

Because eagles and coyotes find special allure in the scent of baby lambs, and predators are kept at bay only by the imposing presence of a four-footed guard force on 24/7 postings at their fences.

The demands on the recruiting directors of the banks and law firms and accountants are not different. They manage their personnel pipelines because, as a senior Big Four partner put it in a moment of candor, “the only reason we hire new staff is so we can re-stock our need for managers.”

There is a crucial difference. An Anatolian has an average ten-year life span. And when the inevitabilities of age or accident claim one of their veterans, the ranchers cannot just drop into the nearest Pups-R-Us and charge a replacement to their Amex card. “Staff maintenance” is not just a slogan, when safe-guarding the inventory is quite literally a matter of life and death. 

But whereas it takes about the same length of time to train a sheep dog as it does to convert a university graduate into a decent staff accountant or associate lawyer, there are a whole lot more of the latter on supply, and the sources are numerous and diverse.

I’ve largely been of the view that the world’s anxious regulators should resist intrusion into corporate hiring and compensation structures – there being almost nothing in fragile and volatile business environments that cannot be further distorted or broken by the tinkering of an over-eager bureaucrat.

But all interested parties – employees and shareholders and, yes, the public overseers of taxpayers’ bail-out funds – should at least evaluate whether a company’s bonus arrangements and staffing strategies extend over the length of a business cycle or are focused only on this year or this quarter.

How else could anyone assess the credibility of pious recitals about the importance of preserving and maintaining morale, tenure and talent? 

So it is not a cynical observation that – unlike the coddled shepherd puppy whose specialization makes him uniquely difficult to replace – rookies in the professional services firms should both sign up and stay on with the open-eyed expectation that their tenure is likely to be limited.

A strategic suggestion for the realistic perspective of both new hires and young partners at the large firms, then, is that all concerned should investigate and share a common understanding -- whether promotion and retention prospects and decisions will be made over time spans of the length used by a careful shepherd.

Well and good, if so.

And if not, there are always greener pastures.

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What To Read: Catch 22 -- The Ultimate Management Manual

Always stimulating, Francine McKenna last week posted at Re:The Auditors her advice to young professionals, "Recommendations: Great Books to Read at Any Stage of Your Career."
Her list being of recent vintage, my own preferences tend to sources that have withstood tests of time -- Niccolo Macchiavelli's "The Prince," published in 1532, for example, or perhaps Sun Tzu's "The Art of War" (c.400 BCE) -- and for pedagogic purposes, I also favor the wisdom available from sources outside the field under scrutiny.
So -- slightly updated from the original as it ran in the International Herald Tribune for January 24, 2004 -- if you had only one guide on corporate behavior and management strategy:

“It's a Catch-22 situation.” Those words, spoken by a French banker at a conference for European business leaders and received with understanding all around, reminded me how deeply Joseph Heller's 1961 novel has penetrated the global business environment.

I have long relied on Heller, and his vision of a military comprising equal parts corrupt self-interest and naïve idealism, as an extended guide to life in any complex system, including business. Periodic re-readings have had more value for me than any of the so-called team-building exercises and mission statements that pass for motivational management these days.

For those unfamiliar with the story of Yossarian the bombardier and his World War II comrades on the Italian island of Pianosa, Catch-22 goes like this: Only a crazy man would fly the murderous late-war missions demanded of the pilots, and flight surgeons had to ground anyone who was crazy. But asking to be grounded showed proof of sanity, which required denial of the request and continued flying.

Caught in an endless loop of twisted logic and bloated bureaucracy, Heller's characters cope as best they can. A testimony to the universality of their experience is that to this day, the same characters can be found at business enterprises, university faculties and professional partnerships the world over:

•    Major Major, the persistent but hopelessly mediocre administrator, promoted by those eager to be rid of him. Once made squadron commander, he loses access to his mess hall and basketball buddies, and then makes his isolation complete by ruling that visitors wait outside his office while he is in and be allowed in only when he is out.

•    Doc Daneeka, the flight surgeon who refuses to ground anyone who is sane enough to ask for it and who keeps up his combat pay by forging entries in flight logs. After being listed erroneously as a casualty of a plane crash, he lurks unacknowledged outside his own medical tent, losing his pay, his PX privileges and his wife, whose grief at his untimely loss is tempered by full collection of his GI death benefits.

•    Colonel Cathcart, pumped with aggressive insecurity and conceited ambition. He indulges his taste for power by continually raising the number of missions that must be flown - often just before a pilot has attained them.

•    General Peckem, the noncombatant expert at turf expansion, whose successful ambition to bring bombing operations within his purview at Special Services turns to ashes when command changes to the sycophantic General Scheisskopf, who was promoted from lieutenant on the sole strength of his meaningless memos announcing the postponement of Sunday parades.

Even more than Heller's personalities, the bizarre interactions replay endlessly in corporate corridors and boardrooms - and find eerie echoes in recent events:

The questionable Cayman bank balances of Parmalat or the non-existent securities of a Madoff or the kerfuffle of "mark-to-market" would have been child's play to Milo Minderbinder, the entrepreneurial mess officer who could make a profit on fresh eggs bought in Malta for 7 cents each and sold to the mess halls for 5 cents. (Message to Bob Herz at the Financial Accounting Standards Board: the lowdown on how he did it can be found in Chapter 22.)

The debacles at AIG or Bear Stearns or Long-Term Credit Management could easily have been Milo's operations. The demise of the latter was a hedge fund set up by its Nobel Prize-winning managers, running their highly touted models into the ground with a wrong-way bet on Russian debt. That tracks the universal acclaim the military heaps on Milo's business acumen - until he corners the market in Egyptian cotton that nobody wants, bringing his black-market syndicate to the brink of ruin.

The antics of the equities analysts through the bubble years of the 1990's or the sub-prime mortgage originators of this decade are echoed in the treatment of Chief White Halfoat and his Oklahoma tribe, who have such an affinity for petroleum products that everywhere they seek to settle, the oil companies hit oil, requiring the forced relocation of the tribe. At some point geologists and engineers begin to guess where they will settle next and drill before they arrive, kicking them off the land before they can unroll their blankets.

Heller's characters, at least some of them, survive the insanity by finding ways to stay alive until the end of the war. Corporate managers seeking to cope with a dysfunctional organization may not be so fortunate. But they can at least save the huge fees inflicted by outside gurus and facilitators just by going away for a weekend, each having read "Catch-22" as a homework assignment, and recasting the novel's plot and characters out of the people and events well known to all.

I've done it. It works. As a way of placing the absurdity of the workplace in perspective - and as a starting point for finding solutions - "Catch-22" is an indispensable tool. Or, in the words of Doc Daneeka, "It's the best there is."

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Independence Day: On The Freedoms to Choose, Use and Abuse Great Personal Wealth

The national celebration this weekend in the United States, and the coming Bastille Day celebration in France, serve as platforms for scrutiny of issues of public policy and private conduct.

Two recent personal experiences provide the context for this question: As a society how should we judge, concerning the balance between private wealth accumulation for personal consumption and its deployment for the public good?

The issues are emotion-laden and politically divisive, not least around the regulation of executive compensation. There, a pigs’ breakfast of policy choices includes salary limitations, bonus caps, use of bail-out funds, and director and shareholder responsibility – and the loftier themes of norm setting and coercive codes of conduct.

(For helpful background on the current state of play in Washington, the always-informative Edith Orenstein had this post last week on her FEI blog.)

Last Saturday I was curbside in search of a taxi when accosted by a waif-like beggar. The dollar I peeled off generated a persistent plea from the wrinkled crone, that she needed eight dollars for a bed in the shelter that night.

Influenced by reasons shortly to be told, I handed over a fistful of small bills – and was rewarded by a rainbow smile and effusive thanks when she realized that her daily quota was made. For the price of a stop at the nearest Starbucks, I had enabled a poor woman to spend a night in the safety and security that her life otherwise lacked.

The stimulus to my altruism was the party we had just left: the conclusion of what had been the most elaborate and costly family ritual ever to cross my vision. We had declined and not attended the main events -- a week of feasting and partying in a far distant venue -- said by guests to have set back the patriarch on the order of $ 8 to $ 10 million.

Recalling all the weddings and bar mitzvahs and sweet sixteen parties that at the time seemed over the top -- on the scale of this extended festival, they reduce in comparison to tea at the Ritz.

To transport the guests, private jets had filled the trans-oceanic skies. Public buildings had been closed – private castles had been opened – platoons of hostelers and caterers and entertainers had exceeded their annual revenue goals. Couturiers and florists and photographers and heavy-weight security guards had all worked overtime. Even on the pale evidence of the slideshow and videos, the maligned notion of “trickle-down” had been a frothy and multi-colored cascade. 

Thinking of the number of homeless shelters that could be supported by the cost of this extravaganza, it would be tempting to point the bony finger of self-righteous indignation – to turn up a censorious bluenose at the questionable morality of such an ostentatious display of personal consumption. 

All the more, since the paterfamilias ranks in the low digits on the Forbes scale of his country’s self-made wealthy. Only exceptional naïveté could believe that he had moved in one generation from pushcart and sweatshop to chateau and polo grounds, unless with the considerable application of both grease and muscle.

And yet: he is a reverent and devout practitioner of his religious faith, generous and philanthropic at a level beyond common contemplation. His annual benefactions are many multiples of the one-time cost of this family celebration, even at its lavish scale. As a percentage of his wealth, the outlay for this week-long party was several orders smaller than the impositions willingly incurred for a typical middle-class wedding or baby shower or graduation ceremony.

And in the end, the entrepreneurship by which he achieved the status to stage such a display of largesse would be untouchable by the debatable constraints of “say-on-pay” or narrow bonus limits – exercises in small-bore legislative vision that are of doubtful effectiveness but only stimulate hypocrisy, evasion and misdirected incentives.

The evidence of society’s broad range of behavior is far too complex and ambiguous to support facile condemnations – that the ownership classes are unexceptionally venal and corrupt, or that every bonus payment is an incentive to greed and over-reaching. Neither, symmetrically, is there any necessary correlation of virtue or magnanimity with the poverty of the ghetto or the favela.

More importantly in the quest for guidance, skepticism is certainly indicated about the potential for leadership from the politicians. In the degraded atmosphere that extends from the tawdry antics of a Berlusconi or the soap opera of a Palin to the expense fiddles of the British parliamentarians and the parade of Republican “affairs of state,” restraint is indicated in expectations for legislated morality.

Does a tithe for the poor excuse the gaudy display of the other ninety percent? Must the owner of two coats yield one to the unclothed? And is it the business of the state to compel the answers? Or if not, then whose?

Those wrapped in the luxury of this extraordinary celebration enjoyed hospitality at an unmatched level. How well they’d have slept in their silks and linens, if mindful of the beggar scratching out the price of a bare cot, is more ambiguous.

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Michael Jackson: Please Get Off the Stage

A diversion from the usual topics -- because Saturday we had the privilege again to hear the exquisite Diana Krall in live performance – maturing and better with each tour.

Unannounced, in the middle of the set, came a sonorous and dirge-like instrumental of “I’ll Be There” – a touching tribute to the late Michael Jackson, and a rare example of taste and restraint in this post-death period of media-driven frenzy.  

It may be churlish to suggest – in a time when the world’s adult challenges include on-going violence and epochal turmoil in the Middle East, financial dislocation around the globe, and political opportunities not seen for a generation in America – that the editors and producers of the channels of news should get over and beyond their voyeuristic fixation with Jackson, and get back to serious business.

All this is for what? The Neverland comparison does a disservice to Peter Pan – who exercised leadership and earned loyalty from his band of boys without drugs, inducements or molestation charges – and who faced pirates as adversaries rather than hiring them as a squad of goons and hangers-on.

The better comparison is with Benjamin Button, the eponymous, reverse-aging hero in Scott Fitzgerald’s story: Brad Pitt in the movie – manifest by Jackson in life, first as the boychild performing grown-up choreography and adult lyrics, who then did not mature but aged instead into adolescent behavior and infantile judgments.

And if there were virtue or ennobling in the pitiable story's end, wrought by physical and emotional family violence and indulgently enabled substance abuse, it would be no more for a talented escapee from the underclass shacks of Gary, Indiana, than for the less fortunate multitudes who suffer and die of the same causes without escaping those oppressive venues.

As for the career. Somewhere at least, there was surely business genius in securing control over the Beatles’ songbook. Less clear is the weight of all that against decades of profligacy and waste.

I plead a generational gap that impedes my “getting it” on Jackson’s music. Under the blazing arc at the end of the ‘60’s that extended from the Beatles and the Rolling Stones across the Atlantic to the post-Woodstock generation, the Jackson Five looked to be a bubble-gum machine, engineered to prop up Berry Gordy’s Motown after the best years of Smokey Robinson, Diana Ross, Stevie Wonder and Marvin Gaye.

In that context, even “Thriller” had its weirder side, foreshadowing – but who knew – the Wacko Jacko to come.

Members of a news-deprived minority who would plead “enough” will have their own candidates for the moments of gag-me excess in this week’s saturation coverage. My own -- so far -- is the self-promoting sycophancy of Larry King’s photo op with Jackson – reminiscent of Richard Nixon’s nausea-inducing drape over the slight but accommodating shoulders of Sammy Davis, Jr.

Relief, for God’s sake! There are serious and real subjects to address. This is, not least, the week we are to learn the sentence to be given to Bernie Madoff. Let’s keep things in perspective.

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Teed Off at Bernard Madoff? His Character was Provable on the Golf Course

Bernard Madoff was observably crooked, and his long-running swindle could easily have been stopped, early on. Except that those in the know either didn’t care, or had their own interests to be served.

Calling a halt to his scheming did not require a wake-up call at the soporific SEC, so thoroughly outed after the fact by whistle-blower Harry Markopolis, or performance of the due diligence that the feeder funds promised their customers, for which they and their gatekeepers will now pay the litigation cost.

Instead, it was as simple as the questionable honesty of Madoff’s golf game – and the mutually corrupted readiness of his country-club set of investors to subvert the integrity of that ancient sport.

Deep in “Madoff’s World,” Mark Seal’s delicious piece in the April edition of Vanity Fair, Seal observes that in the catalog of Madoff’s obsessive-compulsive mannerisms, his golf game was as tightly managed as the rest of his life. He quotes Donald Trump: “Out of hundreds and hundreds of rounds, he never shot lower than 80 or more than 89.”

Although the Donald may not top everyone’s list of character witnesses, there’s an unmistakable clue to Madoff in his throwaway line, “Experts say he’s either the most consistent golfer in the world or he’s cheating.”

In golf as in most other endeavors, whether recreational or professional, there is simply no way to avoid the occasional bad day. A weekend duffer with no hope of approaching par will still have the rare round where the gods smile, drives are straight and every putt drops. Still, there are two tails to every bell curve. Symmetry teaches that there are days when the sand traps eat up approach shots and the cup seems to have a lid – and an honest scorecard shows it.

So the only way Madoff could have shown his reputed consistency would have been through all the available manipulative devices: improved lies, do-over shots and disregard of the whiffs and the penalties for landings in the water.

Golf being an activity where integrity relies crucially on self-reporting, that brings up the role of Madoff’s interested enablers -- the playing partners who would have seen his doubtful conduct in the bunkers and on the greens – but who if they called him, stood to lose their privileged access as early beneficiaries of his Ponzi scheme.   

Regular readers know that I have neither aptitude nor appetite for golf (here), choosing instead to keep the game safer for everyone by staying in the clubhouse. For its culture and protocols I rely on my friend Joe, who played scratch in college and still posts a handicap in the single digits.

He tells of a now-retired professional athlete of epic dimensions, who receives a guest's celebrity welcome on courses worldwide, but who will never be invited into serious club membership – because he is known to fiddle his scores, stiff his caddies and welsh on his bets.

That measure of the seriousness with which the game’s code is taken, and the apt phrase from the fractured Latin of the law schools – falsus in unum, falsus in omnibus – point the finger of accountability at Madoff’s companions. Facing the disrepute of Madoff’s violations, they evidently elected to accommodate their source, lest the promised stream of their investment returns be closed off.

Joe taught me that the dour Scots who invented the game called it “golf” because the more pungent four-letter words were already taken – “hell” or “damn” or the stronger alternatives, muttered or shouted in exasperation at the shanked drive or the malignly placed tree branch.

Would that Madoff’s blind-eyed followers had had the honesty to call “foul.”

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Happy Thanksgiving -- and Thank You

A brief note to advise that until mid-December it will be quiet around here -- if nowhere else in the financial and accountancy world -- while I will be traveling, largely beyond the reach of e-mail and daily news.

Thanksgiving is a special holiday in the United States, and with the arrival of Advent as well, this is an excellent time:

     To pause in grateful reflection -- in the midst of widespread turmoil, need and strife -- on many reasons to be thankful.

    To translate a spirit of gratitude into actions by which energy, commitment and compassion can better a troubled world.

So reach out. We can bring some peace -- do some good -- share some loving -- with family, friends and communities.

My thanks for your interest and support -- I'll be back with you soon.