Re:Balance -- Jim Peterson

RIP Paul Volcker (1927-2019) – There Was One Wreck He Couldn’t Salvage

The out-pouring of encomia for Paul Volcker, who has died at age 92, would tower over even his own formidable 6 ft. 7 in. (e.g., samples in the Financial Times and the New York Times).

His credits over more than forty years include the taming of the rampant inflation of the 1980s as Federal Reserve chairman and, post the 2007-2008 financial crisis, the articulation of an eponymous “rule” aimed at the proprietary trading excesses of the investment bankers.

One effort for which he will be little remembered was his ill-fated aspiration to forestall the Enron-driven collapse in 2002 of the Arthur Andersen accounting firm. His proposed “rescue” – floated for three months in the winter of 2002 but effectively dead in the water from the moment of its launch – would have included a cleansing replacement of its leaders with management selected by a new outside board, shrinkage of the firm to “audit only” scope, and negotiations led by his own virtuous self to resolve the Damoclean legal exposures brought by the government and civil litigants.

The Andersen drama included hubris enough to fill a Greek theater: its leaders’ cries of innocence even amid the rubble of its reputation, voracious law enforcement agents displaying their punitive prosecutorial DNA, the plaintiff’s lawyers ratcheting upward their own demands.    

And Volcker himself – boldly taking the stage to reprise a familiar role, only to discover that the script made demands beyond his repertoire.

Volcker’s quixotic effort was doomed from the outset, by a trifecta of insurmountable barriers:

• The fragility of Andersen’s organization, as a global network of national partnerships which, lacking the cohesion of a corporate structure supported by shareholder capital, was hostage to the rapid and fatal erosion of individual partner trust, confidence, and mutual commitment.
• The unwillingness of Andersen’s senior leaders to surrender their positions of stature, remuneration and accountability, to be displaced by an outsider from a different profession, however grise his éminence.  
• Above all, the unsustainable impact of the multi-billion dollar litigation exposure inflicted on Andersen’s limited capital resources – a mortal blow the instant it fell, that made futile any rescue attempt as too little and too late to stop the disintegration already begun.

One legacy of Volcker’s failed mis-adventure is worth recalling today, in the currently fraught environment in which the structure and business model of the surviving Big Four firms are under existential threat from politicians and regulators, particularly in the UK.[1] That is, Volcker’s ambitious but benighted initiative was incorporated into the report issued on April 1, 2008, by the US Treasury Department’s Advisory Committee on the Auditing Profession – inspiring the report’s straight-faced suggestion that the audit firms’ governance should include a mandatory management-replacement program in the event of a disintegration threat.

That the Committee’s entire body of deliberations and pronouncements promptly faded without a trace – its risible Volckeresque proposal included – suffices to capture the inadequacies that inhered in the failed attempt at Andersen.

Meanwhile in its aftermath, fresh outbreaks of financial malfeasance mark the passage of the years since the disruptions of the financial crisis of 2007-2008, with intense public criticism rather than the introduction of sustainable “solutions” dominating the debate around the fitness of the current Big Audit model.

Paul Volcker himself was never heard to admit that he lacked sufficient appreciation of the issues to comprehend the futility of his efforts. A dose of that humility would have spared him a conspicuous failure. If true for a figure of his considerable stature, the same would be prudent today for those critics tempted to prescribe impracticalities far beyond their own vision and competence.

 

[1] For which, please see my book of this May, “DOA: Can Big Audit Survive the UK Regulators?” (Amazon 2019).

 

Thanks for joining this dialog. Please share with friends and colleagues. Comments are invited and welcome, and subscription sign-up is easy and free – both at the Main page.

              

“The Chickenshit Club,” Jesse Eisinger (Simon & Schuster 2017)

Jesse Eisinger having conclusively nailed the award for best book title of the year, for his detailed polemical history of the US Department of Justice’s timorous post-Enron retreat from the pursuit of corporate malefactors, it may seem churlish to quibble.

Nor to take away from his dispiriting story’s call for renewed vigor in the prosecution of financial criminality. But from the perspective of fifteen years of scrutinizing Big Audit and the challenges facing the large accounting firms,[1] there are issues at both ends of Eisinger’s narrative – subtle, to be sure -- on which the vigor of his arguments can stand for clarification.

Background, for those who have not yet done the reading (emphasis deliberate): after the convictions of the principals of Enron, WorldCom, Tyco and Adelphia,

“Today’s Department of Justice has lost the will and indeed the ability to go after the highest-ranking corporate wrongdoers…. Prosecutors don’t simply struggle to put executives for “Too Big to Fail” banks in prison. They also cannot hold accountable wrongdoing executives from a gamut of large corporations: from pharmaceuticals, to technology, to large industrial operations, to retail giants” (p. xvii).

His argument bases heavily on the disintegration of Arthur Andersen, Enron’s auditor and the target of the DOJ's wrath for document shredding in the fall of 2001, while the company was collapsing and law enforcement forces were gathering.[2]

Eisinger spins out the 2002 time line of Andersen’s indictment, jury trial and conviction, and cessation of business; the Supreme Court’s 2005 reversal; and the public relations campaign by which Andersen posed itself as the aggrieved victim of government over-reach. As he concludes, Andersen’s “too big/too consequential” arguments failed, but also had no observable collateral consequences:

“The Andersen case ushered in an era of prosecutorial timidity when it came to taking on the largest corporations in America. The response to the financial crisis of 2008, which took down the nation’s largest banks and put the global financial system at risk, stands in contrast to the post-NASDAQ-bubble accounting-fraud emergency…. (F)ear for the fragility of the system dominated the political discourse and tormented Department of Justice officials” (pp. 57-8).

Here’s the first problem. Eisinger is correct, but for the wrong reason, saying that, “The notion that the indictment was solely responsible for putting Andersen out of business is a myth” (p. 54).

In fact, the indictment was irrelevant. Andersen was mortally wounded by Enron, beyond salvation or recovery, simply because it lacked the financial strength and organizational cohesion to withstand the litigation shock.

Enron’s collapse was to be the first case to extract a billion dollars as the responsible auditor’s litigation exit cost. Andersen had that capacity, with its 2001 revenue of $ 9.3 billion -- but barely. It would have teetered on the brink, still facing a crushing load of claims relating to the catalog of scandals that caused Justice to view it as an unrepentant serial recidivist – the sum of which would have swiftly driven it into insolvency.

So -- arguments on both sides of the Enron indictment impact miss the misplaced nature of their premise: Andersen was dead anyway, no matter the policy decisions at Main Justice in Washington. Andersen was like a terminal patient on late-stage life support -- its death was imminent and inevitable; the tortured decision to indict only pulled the respirator plug.

Having strung so much dirty laundry on this fragile line, Eisinger works himself into a righteous froth over the government’s retreat to its pattern of settlements and corporate fines -- all to be absorbed as business costs by the corporate treasuries and shareholders’ equity of the large public corporations -- rather than devoting the time and taking the risks of seeking the higher but less certain rewards of pursuing prosecutions through to trial.

His proposition raises two concerns. The first is narrow, based on the post-Enron structure of the Big Audit model, totally dominated as it is by the surviving Big Four. Here, Eisinger’s bland observation (p. 56) about the absence of effect from Andersen’s collapse – that its “prosecution did not lead to any economic or financial crisis…. Markets didn’t crash (and) corporations just found other auditors” -- fails to meet today’s reality. Which is, loss of another of the surviving quartet would not just reduce the field to a Big Three, but would trip the entire Big Audit franchise into failure.

That’s because the four-firm model is down to a critical minimum. Unlike with the Big Four, there is no supply shortage elsewhere in the professional services sector. The clients of the recently-failed public relations firm Bell Pottinger are relocating without issue, as did those of failed law firm Dewey LeBouef. But as is currently playing out in Japan in the dysfunctional relations between Toshiba and PwC, the range of large-company auditor replacement choices is now too severely constrained to allow any margin for reduction.

So much for the sector. Closing views on Eisinger’s basic premise on criminal accountability start here: outbreaks of financial malfeasance well enough evoke spasms of cathartic retribution. Society calls for the guilty to be punished.

Any longer-term deterrent impact, however, is another matter. That is, cyclical outbreaks of financial excesses inhere in the system and are inevitable,[3] with their attendant criminality, for reasons ranging from the post-event focus of regulators and legislators on fighting the last war, to simple human credulity, greed and rapacity -- embodied in the observation of a legendary New York judge, that “from the time to which the memory of man runneth not to the contrary, the human animal has been filled with cunning and guile.”

It is simply fanciful to think that the next generation of as-yet-undiscovered white-collar successors to the current Martin Shkreli of Turing, Elizabeth Holmes of Theranos or Kweku Adoboldi of UBS will be deterred in the least by the successful but now ancient and forgotten prosecutions of Ken Lay or Jeff Skilling or Andy Fastow – any more than they would by a return to public flogging or transport to Tasmania.

In the rural countryside of my youth, it was considered a measure of perception and good judgment whether a man “had the common sense to tell gravel from chickenshit.”

At the level of fundamental law enforcement policy, that question hangs over Eisinger’s otherwise noble and illuminating work.  

 

[1] Please see my book, “Count Down: The Past, Present and Uncertain Future of the Big Four Accounting Firms” – here at Amazon, where the “Look Inside” link gives free access to the Contents and Introduction.

[2] Disclosure: after 19 years as a senior member of Andersen’s in-house legal group, I had just left in June 2001, months ahead of the Enron debacle; intensely unpleasant events were to come, but as put by the eponymous ogre in that year’s “Shrek” -- “Better out than in, I always say!”

[3] See, for example, Benoit Mandelbrot’s brilliant “Misbehavior of Markets” (Basic Books 2004, paperback 2006).

 

Thanks for joining this dialog. Please share with friends and colleagues. Comments are invited and welcome, and subscription sign-up is easy and free – both at the Main page.

 

 

 

Book Announcement: "Count Down -- The Past, Present and Uncertain Future of the Big Four Accounting Firms"

For those who may have wondered -- my reduced schedule here in recent months had a reason: completion and readying for publication of my book, "Count Down -- The Past, Present and Uncertain Future of the Big Four Accounting Firms".

I am pleased and proud that the book is next in the Emerald Publishing Group's series, "Studies in the Development of Accounting Thought," edited by Gary Previts, E. Mandell de Windt Professor of Accountancy at Case Western Reserve University, member of the Accounting Hall of Fame and past president of the American Accounting Association.

Its scope -- bringing together themes long explored here and going back to my column in the International Herald Tribune -- is summarized in this from Emerald:

The post-Enron disintegration of Arthur Andersen in 2002 reduced to the surviving Big Four the number of international accounting firms that audit nearly all of the world’s largest public companies -- Deloitte, EY, KPMG and PwC.

 Despite their strengths -- market dominance, double-digit annual growth in non-audit services and continued revenue expansion to a global total above $ 120 billion in 2014 – the viability of the Big Four and their business model faces serious threats:

• Widespread dissatisfaction with the standard form and language of their core product -- the traditional “pass-fail” auditor’s report.

• The persistent “expectations gap” between their perceived performance quality and the stated desires of information users.

• Difficult relations with regulators and oversight agencies.

• And especially, the questionable ability of the Big Four and their partners to survive a “black swan” financial shock – a litigation judgment or law enforcement sanction on the scale that destroyed Arthur Andersen.

"Count Down" looks at the complex challenges facing the Big Four, questions the feasibility and achievability of the various proffered “solutions,” and proposes an evolved model for Big Audit that would be both sustainable for the large firms and fit to serve the capital markets of the 21^st century.

“ This book lifts the lid on the story behind the financial statements of the world’s major companies. If you want to understand the system that is allegedly validating the reported data - and why the system is a clone of the Maginot Line - expensive, obsolete and irrelevant - read on. Weak as the present system is, there is a solution. It will take a major change in regulatory attitude and a fresh approach, unfettered by history. The section on the imaginative use of Big Data is worth study by itself. “

     -- Duane R. Kullberg, Arthur Andersen & Co., S.C. Chief Executive Officer, 1980-1989

“Illusions of safety in size doomed allosaurus, empires, and auto makers. In his Count Down, Jim Peterson examines the fragility of the ineffectual audit regime, and the imminent threats to its survival. Peterson combines the insider’s knowledge with an outsider’s critical but sympathetic perspective and suggestions in this fascinating and insightful volume—a must-read for accountants and students of accounting.”

     -- Shyam Sunder, James L. Frank Professor of Accounting, Economics, and Finance, Yale School of Management

Scheduled release date is October 15. For information, and to order:

     From Emerald Books

     From Amazon

Please share with your friends and colleagues. For questions and other inquiries -- and for Emerald's pre-publication discount -- please write me: [email protected]

Should the Big Four Have Audited Financial Statements? Should the Cobbler’s Children Have Shoes?

The Public Company Accounting Oversight Board’s member Steven Harris proposed on March 20 “that the large accounting firms make their audited financial statements available to the public.”

Harris observes that “many find it ironic that auditing firms in the United States…resist providing their own financial statements,” and sees no reason “that the auditing firms that act as gatekeepers to our securities markets should not be as transparent to investors as the companies they audit.”

“Irony spotting” not being a trait of Washington functionaries, Harris did not observe this coincidence – that he was two weeks ahead of the PCAOB’s two days of public meetings to further address its 2011 proposal for reconsideration of the manifest inadequacy of today’s auditor reporting, about which Harris himself said in September 2011:

“Investors clearly do not believe the current three paragraph, largely boilerplate, binary audit report, is either sufficiently informative or serves their needs.”

Suppose -- instead of his agency’s dreary record of spotty inspection coverage, confusing metrics and failed initiatives – that the Harris proposal to impose on the Big Four an obsolete and ineffectual assurance model were actually taken up and debated seriously.

The foxes would be truly set among the chickens.

First of all, it can be done. Some local firms of the large networks already publish IFRS-based financial statements, audited and reported on by their colleagues (in the UK, see Deloitte, EY, KPMG and PwC).

Problems of scale and substance raise immediate questions, but it’s to be noted right here – and on which more anon – that back in the late 1970’s, Arthur Andersen’s global financial statements were audited and reported on by Haskins & Sells – as the Deloitte firm in the US was then branded.

Should the Big Four voluntarily offer such disclosures and assurance? Or should they be required to do so? The cross-currents and antagonisms in those discussions would be worth the admission price.

Over the profession’s long-standing resistance, there could be considerable public education, both from the information to be disclosed, and from that not furnished.

Consider an extension to the US of the Big Four’s UK audited disclosures: for 2013, country-level revenue ranging (in millions) from £ 1,721 to £ 2,689, with UK firm profits from £ 455 to £ 740.

Those UK data mainly serve to reinforce a point urged here for years – that the Big Four’s business model, running on client receivables and egg-shell-thin capital, is not designed or robust to withstand the ten-figure financial shock that would be inflicted by a truly bad-case litigation or law enforcement outcome.

As to information that similarly-designed US disclosure would not make available – two gaping holes:

The first is that, just like the world’s other large enterprises – and noting that the Big Four’s reported aggregate global revenues for 2013 exceed $ 113 billion -- their UK statements are opaque on the extent and quantification of litigation claims and contingency exposures.

The same would be true in the US – where the modus vivendi between the accounting standards-setters and the litigation defense lawyers has forever permitted a shroud of confidentiality over the uncertainties of publicly predicted litigation outcomes.

And second, the UK experience makes clear the limited amount of world-wide information to be gleaned from country-level reporting – which offers only the most passing reference, in either words or numbers, to the local firms’ membership or participation in the business and funding of their global networks.

The Big Four continue to work the two sides of this structural issue, of course, as they are both obliged and permitted to do under the parochial nature of the profession’s organization, regulation and oversight. They proclaim both their revenues and their commitments to seamless service on a global scale, but they pull back to local-country descriptions for purposes of risk acceptance and cross-border liability.

So this point requires public acknowledgement: although Arthur Andersen was alone in ever submitting its statements to independent audit, its global network fell in 2002 like a house of cards, under the unwillingness of its ex-US firms to support the US firm in its time of Enron-based travail.

Which calls for one final and irony-tinged observation. Those urging the extension of Big Four reporting transparency would no doubt press Harris and the PCAOB to require the Big Four to follow the initiative of Andersen’s global reporting from a generation ago, as could be done, under the PCAOB’s authority over non-US audit firms participating in the audits of public companies filing in the US.

But whereas the Big Four’s UK firms are audited by firms in the next smaller tiers – who have no significant share of the market for audit services to the world’s largest global companies – the only auditors having the geographic scope and scale to report on the Big Four’s global networks would be those very four networks themselves.

If put in place, that round-robin of mutual examination and reporting would not find favor, it could be surmised, among the unremitting critics of the accounting profession who see malign cartel behavior at every turn.

So – bravo for the Steve Harris initiative. Let both the hand-wringing and the stone-throwing begin at once. And see who comes out on the other side.

 

Thanks for joining this dialog. Please share with friends and colleagues. Comments are welcome, and subscription sign-up is easy and free – both at the Main page.  

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.   

 

Thanks for sharing this dialog. Please share with friends and colleagues. Comments are welcome, and subscription is easy and free, both at the Main page.

 

---

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

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

 

The SEC Strikes Goldman Sachs -- Now Will Goldman Strike Out?

As the great baseball umpire Bill Klem said, about whether a pitch was a ball or a strike:

“It ain’t nothin’ ‘til I call it.”

Which, as a lesson in political science, is being taken to heart by only some of those holding forth on the April 16 charges of fraud lodged by the Securities and Exchange Commission against Goldman Sachs and one of its employees (here), alleging misstatements and omissions in the structure and marketing of a synthetic collateralized debt obligation tied to residential mortgage-backed securities.

The SEC’s enforcement director, Robert Khuzami, dealt a high fastball -- avoiding complexity in packaging his advocacy for public soundbite-scaled consumption (here):

“The product was new and complex but the deception and conflicts are old and simple.”

Goldman itself played its defensive position the same way, but to different effect (here). Its terse one-liner fouled off the pitch: “We are disappointed that the SEC would bring this action related to a single transaction in the face of an extensive record which establishes that the accusations are unfounded in law and fact.”

Give Goldman points for a sense of reality, recognizing both that the judicial process will be unaffected by public posturing, and that the court of public opinion itself will not be in a mood for hand-wringing.

For it remains a mystery what inspires any claim to credibility by the typical spinners of over-played corporate protestations, when initial impassioned pleas of innocence give their inevitable way to plea bargains and outsized settlements to “put it all behind.” 

Meanwhile, the purple clouds of “I told you so” commentary from the bloggerati are as noxious as the volcanic spews from Iceland, and should only be dispersed as rapidly into inconsequence. 

Not least, the self-righteous are – as customary – conflating an initial law enforcement complaint with an adjudicated conclusion. Consider:

• ·      Much as public opinion had convicted O.J. Simpson of his wife’s murder, before his trial, the jury found otherwise – and he remained at large until the outbreak of his predictable recidivism.
• ·      It was financial and structural weakness that felled Arthur Andersen, not its indictment – remembering that procedural flaws in its conviction led to the Supreme Court’s reversal, but with no element of vindication or rehabilitation.
• ·      Even the now-jailed Bernie Madoff was presumed innocent (although charged) until the entry of his guilty plea, and entitled to bail and at least a measure of his liberty.

Respect for due process requires a measured recognition that the SEC case is at the top of the first inning – though there may well be further cases, additional claimants and private claims as well (see Kevin LaCroix’s always helpful D&O Diary). 

But Charlie Green also has it right, at Trust Matters. That is, if as Charlie suggests, the SEC’s case “resonates easily with Main Street as also being unethical,” and as corrosive to credibility, motives and trust, then the capital markets community will hold Goldman accountable for the state of its franchise in ways that the judicial process can never address.

A final constituency is yet to be heard from, about we should worry. Eight years ago, when the collapse of Enron was trailed by WorldCom, a stampeded Congress inflicted Sarbanes/Oxley and its massive demonstration of the law of unintended consequences.

Given its head, a legislature bent on retribution against the financial services sector is capable of twinning up the bankruptcy examiner’s report on Lehman Brothers (see here) with the SEC’s complaint against Goldman.

In which case, anxiety should run very high.

Because the result, in Bill Klem’s terms, will most likely be a wild pitch.

 

Thanks for sharing this dialog. Please share with friends and colleagues. And if not a subscriber, you are invited to sign on at the Main page.  

 

 

On the Midwestern Calendar for March: Two Events Addressing the Audit Profession

An alert for those in the Midwest looking to warm up the chill of late winter: I am looking forward with enthusiasm to joining Duane Kullberg, retired managing partner of Arthur Andersen, who will be the Chapman Executive-in-Residence at Carthage College in Kenosha, Wisconsin, on March 2 and 3.

 On Tuesday evening the 2^nd, Duane and I will be on a panel on the “Future of the Audit Profession,” joined by Bill Goodman, CPA and president of Schenck Business Solutions and chaired by Dennis Tomorsky, CEO of the Wisconsin Institute of CPAs. At the college’s Todd Wehr Center, 7.30 pm.

 On Wednesday the 3^rd, the Kenosha/Racine area Business and Professional Coalition’s regular luncheon will feature Duane’s presentation and our taking questions on the “Rise and Fall of Arthur Andersen.”  Noon, also at the Todd Wehr Center.

 Any further details will be forthcoming, so drop me a line to be advised, or are available through David Brunn, Carthage’s Rogers Palmer Professor of Business Administration (tel: 847-256-2287 or e-mail: [email protected]).

Measuring Corporate Stewardship by the Century -- A Lesson from the Oak Groves

"I know a bank where the wild thymes blow" --

    Oberon, Shakespeare's "Midsummer Night's Dream," II,i

A few words further (after these of November 10th and 17th), on corporate stewardship, and the ability to assess management's commitment to long-term sustainability.

The context is the measure of dysfunctionality in the dialog, with Lloyd Blankfein’s year-end bonus at Goldman Sachs expected to establish a compensation benchmark for the entire financial services sector.

Despite his vilification for both Goldman’s off-message diversion of $500 million to the aid of small businesses, and his own tone-deaf joke about “doing God’s work,” there is no other banking CEO being publicly fitted for a halo. And his company’s record is compelling, even though unless poor Blankfein suddenly develops the political savvy to foreswear all pay for this year, he is going to catch media hell no matter what take-home figure he tries to justify.

To take a long step back in history, consider the vision, commitment and behavior of the great canal-building companies of Victorian England.

These innovators not only joined with the newly-constructed railroads in making possible the Industrial Age, by achieving the first inland transport break-throughs in human history – re-writing the limits of bulk and speed that had been constrained by the capacity of an ox-cart and the pace of a horse and rider.

Knowing that the great oaken beams and timbers in the intricate gates of their lock systems would eventually require replacement, the canal developers had the foresight to plant groves of oak saplings around the huts of the lock-keepers – not for the shade and the aesthetics, but to assure a ready supply of mature trees when needed, many decades into the future.

That their legacy is now picturesque rather than practical owes only to the unforeseeable over-taking of technologies based on electricity, internal combustion, silicon and rocketry.

But sadly, it is no less unthinkable that their modern successors – the chief executives of the large airlines or trucking companies – or their counter-parts in banking, industry and professional services -- should invest and manage for their future based on such long-range planning.

Instead, there is a disconnection between managements’ incentives and long-term sustainability strategies -- as laid out by the guru of game theory, Bruce Buena de Mesquita, in his provocative and challenging new book, “The Predictioneer’s Game.” (For reviews, see the book's website. For the lite version, see his September 28 appearance on John Stewart’s Daily Show.)

His chilling example is the loss of vision of the Arthur Andersen leadership in the period leading up to the Enron debacle:

As he puts it -- under the grim caption, “Incentivizing Ignorance” (pages 116 et seq.) -- Andersen’s senior management “helped foster their own demise by not erecting a good monitoring system to protect their business from the misbehavior of their audit clients,” chiefly because ”Andersen’s most senior management genuinely did not seem to understand the risks they were taking.”

And why? Because as he puts it, “costly litigation … would not be settled until ten or so years after the initial prediction of risk.” But by that time “the engagement partner who brought in the business in his early to mid-fifties was retired and enjoying the benefits of his pension.”

Which creates the disconnection: by then, “the money for the defense was coming out of the pockets of future partners,” so “the financial incentive to know was weak indeed.” 

Recent years have shown the pervasively destructive influence of short-term incentives – from the exploding volumes of unsustainable subprime mortgages, to the proliferation of incomprehensibly risky financial instruments, to the current stripping of seasoned employees for the sake of expense reductions -- putting at risk the retention of expertise and capacity as the economic cycle turns.

It’s a sorry statement on leadership that Lloyd Blankfein is one of the few left standing, when so many short-visioned leaders have been shown unwilling to show the kind of commitment to maintenance and stewardship of the 19^th century canal builders.   

 

Thanks for joining this dialog. Please share with friends and colleagues. And if not a subscriber, you are invited to sign up at the Main page – easy, free and non-commercial.

Congress Looks at the Fall of Lehman Brothers: Was it a Sequel to Arthur Andersen?

For low-grade political theater, Monday in Washington was sadly typical: Richard Fuld, ex-CEO of the bankrupt Lehman Brothers, spent two hours under ritual excoriation by a panel of self-righteous legislators.

The play ran in several predictable acts:

•    The outlandish and unseemly “fairness” of Fuld’s nine-figure compensation history, in context of the firm’s disintegration and the erasure of equity value for public shareholders and trapped employees alike.
•    The absence of timely leadership responsibility and Fuld’s finger-pointing at exterior forces -- the rumor-mongers and the short sellers.
•    The whining over Lehman’s solitary fate, while the government supported “rescues” – if such they can be called – of such fallen institutions as Bear Stearns, Fannie Mae, Merrill Lynch and AIG.

Melodramatic scenes of tearfully innocent ex-employees hauling off boxes of personal effects and the pathetic invocation of antagonistic government treatment invite comparison of Lehman’s downfall with Arthur Andersen’s speedy demise in 2002.

They’re equally unfortunate, especially in the personal and systemic disruptions caused by the disintegration of once-noble institutions, but neither fits well the classic model of tragic definition.

Just as with the failure of Fuld’s leadership to admit the mounting evidence of compelling weakness in Lehman’s business model, the belated calls for stabilizing steps at Andersen came too late to escape its death spiral of departing personnel, fleeing clients and global structural break-up.

Likewise, Fuld’s invocation of the influence of darker forces corresponds with the self-inflicted aspects of Andersen’s demise, despite the clinging among members of Andersen’s alumni and sympathizers to a sinister plot line driven by vengeful prosecutors.

That is, while Fuld is chargeable with denial and delayed recognition of reality and a lack of credibility in his case for last-minute rescue, Andersen was reportedly perceived by the government prosecutors as a firm of arrogant and unrepentant recidivists and repeat offenders – not a tactful attitude conducive to amiable treatment by agents holding the power of indictment.

Finally, while the enterprise value of Lehman and Andersen alike rested critically on the continued repose of trust and confidence by both clients and personnel alike, neither management saw on a timely basis the fraying of the fragile fabric of reputation which -- once torn -- was damaged beyond repair.

The Lehman / Andersen comparison should not be pushed too far – Lehman became its own house of cards, for one thing, while Enron as a business fiction served that role for Andersen.

More to the point are differences as to the treatment of successor institutions. Last week’s US bail-out legislation and the programs emerging daily from other governments around the world amply demonstrate that “too big to fail” has broad resonance for the world’s trading and financial systems – for the benefit of troubled enterprises trailing in the wreckage of Lehman.

But for the surviving large accounting firms, confidence in their assured future viability remains a goal that has eluded the limits of their political and lobbying skills.

And in any event, the break-up and migration of the bankers’ brands, corporate structures and business teams – whether Lehman or any of the others – has no correspondence in the ability to preserve the Big Four’s private partnership organizations or their requirement for global presence to serve their large-company clients. 

Richard Fuld may be the least appealing villain of that name since Shakespeare’s king – who at his end at least had the consistency of character to go down in battle, crying, “My kingdom for a horse!” rather than “I’ll keep my millions – now where was my bail-out?”

But he was not redeemed either by the windy pontifications of the likes of Congressmen Henry Waxman or Dennis Kucinich – whose own troubled constituents might well have watched Monday’s posturings while wondering about their public guardians soundly asleep at the switches.

Meanwhile, the fates of both Lehman and Andersen make clear that vitality based on trust and loyalty will not survive the evaporation of either – in which case, it’s curtains.

Special thanks on this one for the advice and support of Charlie Green – whose general wisdom on these matters is at Trust Matters.

Thanks to readers for joining this dialog; your comments are welcome, and if not a subscriber you are invited to sign on at the Home page – easy, free and non-commercial.