Re:Balance -- Jim Peterson

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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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.     

 

DSK - A Fallen Politician on What the Market Will Bare

“Clothes make the man. Naked people have little or no influence on society.”

-- Mark Twain (attrib.)

Today’s meditation – extending a series that examines clichés and maxims of importance – concerns Dominique Strauss-Kahn, who lost both his position as head of the International Monetary Fund and his presumptive inside track to the French presidency, over a much-disputed sexual encounter with a New York hotel housekeeper on May 15, 2011. 

That day’s events – combed microscopically in a trans-Atlantic media frenzy and forever irreconcilable for the inconsistencies and diminished credibility on all sides – supported competing claims and theories of criminal assault, opportunistic maneuvering and politically-motivated conspiracy.

What was not at issue, in the background, was DSK’s propensity to pursue the pleasures of the flesh down unconventional paths -- a personal history behind his two recent days in the custody of French authorities (here), giving evidence regarding a ring of highly-sponsored sex parties in the northern city of Lille.

On the sensitive question of the negotiable virtue of the participating ladies, prostitution not being illegal in France, DSK’s lawyer offered the piquant challenge, “to distinguish a naked prostitute from any other naked woman."

Here’s a theme worth considering for application in the business, professional and political worlds, where states of dress convey broad symbolic meaning.

For context, consider the metaphoric richness of the vocabulary of corporate governance and finance: “full disclosure” and “transparency,” and “covered options,” and the beguilingly oxymoronic “naked shorts.”

Or more broadly, consider:

• The continued influence and prosperity of Savile Row’s bespoke tailoring, its nuances of fabrics and buttonholes signifying the structure and power of hierarchy among London’s masters of the universe.

• The overwhelming rejection by the young professionals in my company in Paris of the chance to go “business casual” – retaining instead the formal-looking black “costume” – and the status-conferring ability to distinguish themselves on the Metro from lower-level clerks and functionaries.

• The dynamic effects of political dress codes, from Republican aspirant Rick Santorum’s sweater vests to Secretary of State Hillary Clinton’s recent failure to get the “white shirt” memo at the G-20 finance ministers’ meeting (here).  

Did DSK have a duty of inquiry? To, as it were, “look beneath the covers”? And if so, does it extend to other situations, where an interest worn on a sleeve may be difficult to discern if there are no sleeves covering all that exposed skin? 

The commercialization of the parties in Lille may, in other words, have been explicit, or more subtle.

But no less so than, say, the financial escort services provided to the board of scandal-ridden Olympus by its on-call roster of Tokyo banks.

Or the client-readiness of Moody’s and S&P to answer the come-hither whistles of the peddlers of toxic mortgage debt, looking to tart up their products in tassels and ribbons so as to transmute “X” ratings to “AAA.”

Or, come to it, the corporate executives aggressively cashing ethically challenged compensation packages that would in DSK’s model give alternative meaning to the illicitly pleasurable restraints of “golden handcuffs.”

While other comparisons no doubt occur, across scenes from bedroom to boardroom, the salient observation may be the one variously attributed to either Winston Churchill or George Bernard Shaw, answering the equivocal rejection of his proposition of a one-night stand for either a million or a mere five pounds:

“Madam, we’ve established what you are. Now we are merely haggling about the price.”

 

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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.

 

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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