Re:Balance -- Jim Peterson

Business Strategy for the New Year -- A Non-Review of Pierre Bayard

How to Talk About Books You Haven’t Read, by Pierre Bayard, translated from the French, “Comment Parler des Livres Que l’on n’a pas Lu?,” by Jeffrey Mehlman, Bloomsbury, 185 pages

It being the time of year for suggestions and resolutions, this bit of strategy is from the syllabus for my January class of MBA students, by way of a jewel of an essay from French literature professor Pierre Bayard.

Early in my prior life writing for the Paris-based newspaper, I adopted a personal principle – that I would not review a book I was not prepared to recommend.

I had been sharply negative about a book that fell well below my perhaps too-generous expectations. To fend off the author’s immediate and self-righteous unhappiness – directed loudly to both my editor and to me – outweighed the satisfaction of warning potential readers away from an unworthy piece of work.

But that is not the reason why these comments should not be seen as a “review.” Rather, the suggestion that you need not read this book – indeed, ought not – is driven by the exposition of M. Bayard himself. 

Which is that, in a literate society, we are all obliged – academics and critics perhaps more than others – to speak knowledgeably about books we have not read. The context may be as intimate and embarrassing as a chance encounter with the author, or as professionally risky and demanding as a themed symposium. Involved in any case are high degrees of anxiety and the likelihood of career-threatening exposure and humiliation.

Drawing upon sources from Montaigne, Proust and Oscar Wilde, to Bill Murray’s character in the movie “Ground Hog Day,” Bayard proceeds – with his glib Gallic tongue lodged firmly in his cheek – to deconstruct the very concept of “reading”: an activity seen to embrace no more than a glance at a title and table of contents, skimming, sampling pages at random, absorption of commentary, and familiarity with the author’s other works as well as those of others in the genre.

Conversely, to allay the concerns of the insecure and the indolent, Bayard extends the ambiguous concept of “non-reading” not only to books both unknown and deliberately ignored, but those once read but long ago forgotten.

Once established that to “read” is to know a book by any of the identified means, and not necessarily by turning the pages, Bayard provides a structure and gives permission to hold forth on a book not ever actually held in hand – using techniques such as talking only about the author, discoursing on the subject in general, avoiding or changing the topic, or speaking instead of entirely other works. 

So here is the pedagogic follow-up: just as Bayard clarifies that the choice to read a book necessarily implies a choice not to read an infinity of others, so too the limits of time and energy put constraints on the ability to absorb business advice and guidance – there’s just too much out there. 

Academic theory is here supported by the empirical observation of workplace rules of thumb: 20% of customers generate 80% of profits; one-quarter of employees cause three-fourths of the human resource problems, etc.

From which emerges this guidance for priority setting: spend time where the pay-off lies, and stop sweating the small stuff.

And from that comes specific implementation: Most books of strategy, advice and social theorizing consist of a succinct hypothesis, an explanatory outline of modest length, and the blown-out and over-long expansion to book length that seeks to justify a price of $29.95. But since their real value – if any -- lies in the preface and the first chapter, the available wisdom can be extracted while standing in the bookshop aisle or resting in its café, whence the book can be re-shelved with a savings of both time and purchase price.

It would violate my reviewer’s principles to give here my choice of recent books that deserve this treatment – although in response to readers’ queries I will be happy to do so privately. But as a hint, I would point to anything in the Business section written by a retired CEO or with a single word for a title.

Bayard himself would not only endorse the suggestion that readership of his book is expandable to include all those who never crack its covers. He would also credit my confession to launching these observations although I had left the last fifty pages of his book untouched.

This will thank you for your interest and comments during a difficult and challenging year. I wish to all a safe and joyous holiday season, and a peaceful and healthy New Year.

   

Sadly Predicted -- A Madoff Investor is an Apparent Suicide

Last Tuesday, December 16, I wrote that one of the "safe predictions as the Madoff story brings a sorry year to its welcome close" was this:

"(T)he safe but unfortunate bet, at this still-early writing, that at least one remorse-driven suicide will further color an already tawdry tale" -- here.

Today's news announced in New York -- here quoting the Associated Press -- is that Rene-Thierry Magon de la Villehuchet, "the founder of an investment fund that lost millions with Bernard Madoff was found dead at his Madison Avenue office of a possible suicide...."

There are aspects of this work that bring no satisfaction. Being right in this prediction is one of them.

With much more to come, it is enough today to say that my condolences go out to M. de la Villehuchet's family and his colleagues. 

Sheep on the Prowl -- Madoff's Victims Go After the Auditors

There’s an ominous if predictable new chapter this week in the saga of Bernard Madoff’s alleged $50 billion escapade: the inclusion of the auditors as recovery targets. As the front page of the normally sensible Financial Times put it on Wednesday, “lawyers say the asset-rich firms are likely to be targeted for legal action.”

The Seidman firm has been sued along with its client Ascot Partners, and threats are percolating against three of the Big Four who audit funds that had fed some $20 billion into the Madoff operation.

The large firms were already on the bubble of survival, awaiting only the return of critical political and regulatory scrutiny later this winter – here. Now, for two reasons, what might once just have been Madoff’s epic re-scaling of the familiar story of a glib and well-connected scamster and his credulous circle of ready victims takes on the potential to rock the already shaky foundations of global financial statement assurance.

The first is that, much as Madoff’s victims might hope for deep pockets to pick, characterization of the large accounting firms as “asset-rich” is thoroughly wrong.

The principal “assets” of the firms appear nowhere on their balance sheets – comprising only their fragile measure of gate-keeper trust, and the professional skills of the partners and their staff that deploy by the tens of thousands. But these structures are highly brittle under stress and threat, as proved by the speed of Arthur Andersen’s post-indictment disintegration in 2002, and they have no monetizable value – to pay lawsuits or otherwise – as shown by their lack of appeal to the world’s investment bankers – here.

On the contrary, under a model developed two years ago in London for the European Commission, the limited capacity of the thinly-capitalized Big Four to withstand a litigation death-blow can be calculated as ranging between $500 million and $2 billion – here -- small fractions of the amounts Madoff apparently sluiced away.

Impelled by fee-motivated lawyers, the blame-seeking Madoff investors are unlikely to be deterred by the absence of a pay-off, of course, which exposes the other reason the auditors should be very worried:

Namely, “failure to detect” cases are easily started, but they are hell’s difficult for the auditors to defend, much less to win.

On the jurisprudence, cases are brought by audit clients in the often accommodating state courts, under garden-variety common law theories of malpractice, negligence and breach of contract, rather than under the stricter standards of fraud required by the federal securities laws.

In addition, defendant auditors face three huge hurdles in the courtroom:

First, human nature cannot resist applying the crystal clarity of hindsight, so juries presented with the inescapable reality of a catastrophe are inexorably drawn to the allocation of blame, rather than a reasoned consideration of ex ante discoverability or prevention.

Second, the very nature of audit execution involves judgment and choice about sampling and the depth and extent of work to be done. After the fact, even for a job perfectly executed, plaintiffs are well armed to second-guess any audit procedures omitted or disregarded – and are abetted in their advocacy by forensic experts hired to focus the jurors’ attention on the hostile arguments of fault.

And third, if the past is future, the nightmarish likelihood is that down deep in the audit papers on the feeder funds, waiting to be unearthed by the plaintiffs’ subpoenas, lurk the worrisome memoranda of alert staff personnel, questioning the legitimacy of Madoff’s operations or fingering its weaknesses – the very smoking guns with which the firms will have to play survival roulette.

Despite the large firms’ formulaic protests that they conformed to applicable standards, and their professed readiness to defend themselves, the future of the Madoff cases can be foretold.

That is, the record already presented by the firms themselves to the US Treasury Department’s Advisory Committee on the Audit Profession – here – is that the large firms cannot afford to go to trial in life-threatening cases – as reinforced by the Seidman firm’s survival on life support as it appeals its $521 million Bankest verdict in Miami -- here.

So, facing a deeply insulted and well-heeled set of investor adversaries, the large firms would be brought to the brink of survival if obliged to take up any share of Madoff’s predations of $50 billion that even approached ten percent.

That thought alone -- passing the gruesome ignominy that a noble profession delivering highly complex and technical service to the world’s capital markets could be brought down by the prosaic activities of a single if grandiose con artist – is enough to mute the level of cheer and festivity at the large firms’ annual holiday parties.

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Bernard Madoff -- Voyeurs Around the Investor Pool

There’s a rich new context for the aphorism forever linked to Warren Buffett, that “when the tide goes out, you learn who’s been swimming naked.” And it’s not a pretty sight.

In the social cliques of the Hamptons and around the pools of Palm Beach, there’s agony aplenty among those pink-cheeked with embarrassment at being fleeced by Bernard Madoff. It’s not just that he was one of their own, but that the credulous actually paid for the chance to be invited into the privileged circle of his victims.

As with so many of this decade’s scandals, the Madoff scheme differs only in scale from predecessors dating to time immemorial. The accounting shenanigans at Enron and Parmalat hark back decades to those of Penn Square and Equity Funding, and the subprime mortgage meltdown echoes the savings and loan debacle of the 1980’s. The methods of the schemers don’t change – only the number of zeroes.

Scam artists have forever used the same four techniques to skin their constituents, starting with the suppression of intelligence that goes with membership in a shared and exclusive community. The investment advisers who work over a church roster or an Elks lodge or a society of county dentists are no different from Madoff – and more’s fool the over-eager who suspend belief in favor of the comfortable but dangerously irrelevant rituals of insider familiarity.

The second tool is the “admission threshold” – the bogus entry ticket by which the victim is lulled into feeling special. As proved lately by the hedge fund stampede of the medium-rich, the enticement of “I’ll take your $5 million, although my usual minimum is $10” can be remarkably seductive.

Third, recall the 1989 tax evasion trial of the late Leona Helmsley, hotel queen and über-bitch that she was – an event defined by her pronouncement that “Only the little people pay taxes” – her cluelessly insulated attitude now revealed as extending to disregard and disrespect for the basics of skepticism and due diligence as well.   

Fourth and most pernicious, accountability and transparency are quashed by the enticement of secrecy: Returns may seem inexplicable, and strategies opaque –- but ask too many questions, or break the code of silence, and risk expulsion from the circle of initiates.

That model has ugly antecedents – the same coercive rules have enabled pedophile clergy, corrupt police rings and gangster clans.

If this late-arriving exposé of another “story too good to be true” does not exactly elicit outcries of sympathy for the lambs willingly prepared to be sheared by Madoff, some hostile reaction might well be directed at the banks and hedge funds who ran “feeder” funds, taking a fee rake-off with a compliant lack of curiosity at Madoff’s apparent lack of technology infrastructure, oversight or a comprehensible investment strategy.

The very concept of “funds of funds” has always suggested a structure designed primarily for the enrichment of the fee-collectors, especially for those with memories extending to the Geneva-based wheeler-dealer Bernard Cornfeld, whose 1960’s Fund of Funds had a Ponzi-like flame-out that differed from Madoff’s only in the size of his elaborate sales force.

Lastly, as for the notion of regulatory alertness or prevention of Madoff’s eye-popping piracy, it’s been clear for two years now that Washington’s bureaucrats would not recognize a crisis unless a Black Swan flew up and kissed SEC Chairman Christopher Cox on the ear. And in any event, with the Congress on the eve of adjournment and the Bush administration in its final exhausted weeks, its place-holders will be able to slink out of town before the forces of blame can assemble.

If past is prelude, there are two safe predictions as the Madoff story brings a sorry year to its welcome close.

The first is the safe but unfortunate bet, at this still-early writing, that at least one remorse-driven suicide will further color an already tawdry tale.

The second is that before the books are closed on the reporting of dismal corporate results for 2008, an entirely new multi-billion dollar operational and accounting scandal will erupt somewhere in the world – outside the investment scams and the already battered financial services sector.

That’s because with the tide already fallen so far, and still receding, the exposure means that the gauzy swimsuits peddled by the Emperor’s clothier are still in the process of dissolving.

Credit Rating Agencies and Tourist Traps -- Can You Get What You Pay For?

What chance is there that the restrictions on the credit rating agencies, announced by the US Securities and Exchange Commission on December 3 – here --will actually be for the better? There is plenty of reason for doubt.

Although vital players in the credit market implosion that has triggered recession on a global scale – here – the rating agencies are receiving only wrist-taps: a bunch of additional disclosure about their processes and results, plus a vague scolding about the conflicts presented by their advisory involvement in the structure of their clients’ rated financial products.

An exercise for another day will be to compare the limpness of the SEC’s approach with the equally lackluster attitude of the Treasury Department’s Advisory Committee toward the accounting profession – see here. For now, two observations suffice:  

• First, neither the basic business model nor the inherent performance issues of the rating agencies are about to be disturbed.

• Second, it is therefore not cynical to note that Moody’s, S&P and Fitch all support the SEC’s moves -- an indicator of how little effect they will have.

An apt comparison struck me earlier this week. I was loitering in a sidewalk café in the Muristan neighborhood of the old city of Jerusalem, when one of my fellow tourists emerged from Shadi’s souvenir emporium, waxing expansive.

Earlier in the trip, the shops in Bethlehem had offered her a mere discount of 15%. She was enticed that while Shadi was posting his “usual” 25% rebate, as a holiday gesture for the Christmas season, he would go all the way to 50%.

To reinforce his probity and to open her wallet, Shadi backed his eloquent pitch by invoking his government-issued certificate as an approved dealer in antiquities, along with his personal assurance that the silver was all sterling, the coins were all Roman and the stones were the finest local malachite.  

I felt almost grinch-like in suggesting to my friend that certain rules of trade applied to amateur shoppers and one-time visitors:

•    Foreign tourists had no information at all about the store’s underlying costs or concealed profit margins. 

•    Each shop around the square was hawking precisely the same goods as were on offer in all the others.

•    The souvenir sellers were not charities, and most unlikely to do any transaction on a money-losing basis.

•    Buyers had no practical recourse whatever, once they and their purchases left the store and headed back home across the ocean.

As made starkly clear in the catastrophic collapse of exotic financial instruments despite their investment-grade ratings, investors put themselves no less at the mercy of the promises made by the touts of stellar reputations and superior expertise.

Nor is that condition subject to change at the hands of the bureaucrats. Regulation can at best only guide, but cannot promise, scrupulous normative conduct – whether the honesty of a souvenir peddler or the reliability of a rating agency. It’s not the stop sign that saves the lives of pedestrians, after all – it’s the socially-agreed convention that cars will actually stop in front of the red octagon. Or, sometimes not.

A tidal wave of litigation is building that will sweep over all the players in the credit market debacle – a trend admirably tracked and explicated by Kevin LaCroix at the D&O Diary.

It remains to be tested whether the defense of an “unprecedented business crisis,” advanced by the rating agencies along with the other lawsuit targets, will ultimately prevail. And when at the global economies do emerge from the current environment of disaster, only time and the next inevitable cycle of white-collar rapacity will test the SEC’s attempt at the imposition of virtue – noting only that this outcome has never been accomplished in any prior cycle of regulatory reaction.

Either way, even ostensibly sophisticated investors placed undue credulity on the rating agencies and their role.

In serving a function of some utility, not unlike the souvenir sellers in the old city market, the rating agencies operate under well-known conditions, including engagement by their clients and involvement in the deals being rated.

So long as those conditions obtain, changes at the margin -- to make the rating agencies buy their own basketball tickets and re-label the scope of their engagements -- will leave users to their own due diligence, where they should be anyway.

In both cases, a serious degree of caution is indicated, lest the trusting and the naïve be left holding empty bags and empty promises.

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