The global banking industry faces its biggest challenge in decades. Hundreds of billions of dollars have been written down and wiped off its market value in the space of just six months. But shareholders looking to independent directors to shore up their interests and make sure the same mistakes do not happen again are likely to be disappointed. The make-up of many banks’ boards of directors means they simply aren’t qualified for the task.
ROGER BERLIND IS a theatrical producer. During the septuagenarian’s glittering career on Broadway, his shows have garnered an amazing 62 Tony awards. He has put on definitive productions of such classics as Guys and Dolls, Kiss Me Kate, Hamlet and Amadeus.
Marsha Johnson Evans, known commonly as Marty, has lived an impeccable life in public service. She is a retired rear admiral in the US Navy, a former national executive director of the Girl Scouts of the USA, and is president of the American Red Cross.
It is no wonder that such successful people are much in demand in corporate America. Indeed Dick Fuld, the chairman and chief executive of Lehman Brothers, asked both to sit on the board of the investment bank he has run so successfully for close on 20 years. As independent, non-executive directors, they no doubt bring that experience and wise counsel to bear in board meetings.
But it might come as a surprise to many Lehman observers that both Berlind and Evans also serve on the firm’s finance and risk committee. Such committees always have non-executive board representation to offer an independent voice to their important work. As Lehman only has one independent board director with any direct experience of the banking industry, it has no choice but to appoint apparently poorly qualified individuals to a role in which, one can assume, they would have needed to consider such complex positions as Lehman’s exposure to sub-prime, CDOs, SIVs and the like.
Lehman is far from alone in this. But its case is symptomatic of a worrying situation that faces a global banking industry already under huge scrutiny, extreme pressure, and with a compelling need for people to advise on and take tough and often complex measures – many of the world’s leading financial institutions suffer from a chronic lack of bankers on their boards of directors.
At a time when it has been shown that even senior executive financiers struggled, and often failed, to understand the risks associated with many of the products that have led to the sub-prime crash, many shareholders will now be asking how their interests could have been best served by the collection of industrialists, business executives, academics and public policy officials that populate the boards of the world’s biggest banks.
Boards without bankers
Research carried out by Euromoney in January of this year looked at 17 of the world’s biggest banks and investment banks. These financial institutions, according to their websites, had a total of 248 board directors between them. We analysed the biographies and CVs of these board members posted on each website to see how many mentioned any direct, relevant experience of working in the banking industry. We did not include those that have indirect experience through positions in other areas of the financial service industry such as private equity, asset management or insurance.
The results, published on the following pages, make for some surprising analysis. Fewer than one in three directors of these 17 banks has any direct experience of the banking industry. Most worrying for shareholders, only one in 10 directors are former bankers in a non-executive role – which is principally to represent investors’ interests on the board.
And the situation is worst at many of the US banks that have suffered most in the credit crunch. In fact our earlier analysis probably does a disservice to Berlind and Evans. At the time of going to press, Lehman’s finance and risk committee, which is chaired by non-executive director and former Salomon Brothers managing director Henry Kaufman, had apparently done a much better job than many of its Wall Street counterparts. Berlind’s career, it should be noted, includes a stint as one of the founders of Carter, Berlind, Potoma & Weill in 1960, a company that would later through Sandy Weill become Shearson Loeb Rhoades, which was eventually sold to American Express in 1981 for approximately $930 million in stock.
But what of the board of Merrill Lynch, which has written off well over $20 billion, seen its market value halved and lost its chairman and chief executive over the past six months? The only banker on its board is new chairman and chief executive John Thain. If you want diversity and years in the service of business and government, then Merrill’s board has it covered. Its non-executive directors include Judith Mayhew Jonas, a member of the UK government’s commission for equality and human rights; and Ann Reese, the co-founder and co-executive director of the Center for Adoption Policy. But where are the board members who could have questioned whether 2006 was a good time to try to smash into the sub-prime mortgage business with the acquisition of First Franklin?
Citigroup is another global financial institution to have lost many billions as well as its head. Some 15 people sit on its board. Again, not a single one is a non-executive, independent director with direct experience of banking according to its website – although the chairman of its Mexican subsidiary, Banamex, Roberto Hernández, does also sit on Citi’s main board. Therefore it is no shock that the four-strong committee appointed to find successors to Chuck Prince contained only one banker – the chairman of the executive committee, Robert Rubin. And could it be that the many current and former CEOs that sit on Citi’s board took so long to unseat Prince because they were loth to get rid of one of their own?
The list goes on. JPMorgan Chase’s board of directors has only one banker on it – chairman Jamie Dimon, who is also the chief executive. Bank of America’s only non-executive with a career in banking behind him is Charles Gifford, its former chairman. Goldman Sachs has also persuaded one of its former chiefs, Stephen Friedman, to sit on its board – but he’s the only one, despite the huge and admired ranks of Goldman alumni.
Many non-US banks aren’t much better. For example, HSBC’s only non-executive director with a banking background is Simon Robertson, a former Goldman managing director and senior executive at Dresdner Kleinwort Benson.
As shareholders look beyond the losses they have suffered and question why they occurred and what can prevent such catastrophic reverses being suffered again, they might begin to turn their scrutiny to people who are there to represent their interests on banks’ boards.
"As a shareholder we would always hope and expect a bank board to be made up of a variety of different people, bringing relevant expertise to the table," says Charlie Metcalfe, chief executive of First State Investments and former deputy CEO of Hermes, a UK-based investment manager that is seen as a leader in the area of corporate governance. "Banking experience could constitute many different things including financial, wholesale & capital markets, consumer products, corporate lending and advisory, trading, regulatory/compliance/legal and governmental affairs, marketing, HR and overall management – to name some."
But what happens if a board fails to meet Metcalfe’s criteria? "If individuals at a board seeking to oversee management, set strategy and the appropriate allocation of shareholder capital have no relevant experience, shareholders should challenge their role. We do have rights which we must exercise appropriately," he adds.
Already some senior executives within banking are, in private of course, admitting the current composition of boards is not serving the industry’s best interests. "Sinecures for sycophants" is the phrase used, perhaps uncharitably, by one senior official at a US bank that has suffered severe losses.
Bank CEOs know it is an issue and those who have populated their boards with bankers are quick to make a play of it.
"We strongly believe that a board of directors in a bank should, first and foremost, know banking. That means a good number of directors should have backgrounds in financial services," says Alfredo Sáenz, chief executive of Santander, which in just 20 years has grown to be one of the world’s 10 biggest banking groups. "We also believe in a balance among executive, outside and independent directors and those representing an ownership interest."
Sáenz adds: "Santander’s board of directors reflects this. Its membership is balanced – with five executives, nine independents, two outside and two representing ownership stakes. Furthermore, among them, six of the members have been chief executives of national or international banks." Two of these are non-executives: Guillermo de la Dehesa, the former CEO of Banco Pastor; and Rodrigo Echenique, former chief executive of Santander.
If only it were that simple. Take the contrasting fortunes of the two leading French banks and the two leading Swiss financial institutions.
UBS, which has lost a chief executive and written off over €10 billion in the credit crunch, has no supervisory board members with banking experience other than its chairman and executive vice-chairman, according to its website. Rather, its board is a collection of present and former senior executives of leading global enterprises such as Fiat, Ciba, BMW and Royal Dutch Shell.
Credit Suisse’s writedowns had, as of late January 2008, been much less significant. And the make-up of its supervisory board is rather different to that of its local rival.
Seven out of 13 board members at Credit Suisse are non-executive directors with banking experience, in addition to board chairman Walter Kielholz and vice-chairman Hans-Ulrich Doerig.
"The overall success depends on a good mix of industry expertise, global perspective, management and marketing experience and external insights from a client and government perspective," says a Credit Suisse spokesman. "Board committees require qualified members."
Doerig, a former chief risk officer of the Credit Suisse group, chairs its risk committee. Its board also include Dick Thornburgh, the former CFO of Credit Suisse First Boston, Anton van Rossum, a former CEO at Fortis, and Robert Benmosche, once an executive vice-president at PaineWebber and ultimately chairman and CEO of MetLife.
BNP Paribas has eight out of 12 of its board made up of independent directors, well in advance of French guidelines of 50%. But none of them is a banker.
The bank’s CEO, Baudouin Prot, is however well aware of the unique challenges that the boards of global financial institutions face.
"I don’t think there is, and even could exist, an ideal standard set of backgrounds and experiences for directors of any public company, but it’s important board members can speak out individually, and board decisions are facilitated by efficient working processes, high quality and timely documentation, as well as transparent and objective information," he says. "Boards should also organise relevant committees according to the kind of business the company is conducting. In the banking industry for instance, risk management and internal control lie at the heart of the profession, and we recognized this by setting up our internal control and risk management committee just after the bank went public in 1993."
It’s those controls that appeared to have failed dramatically at Société Générale – albeit seemingly as the result of a highly complex fraud instigated by a rogue trader – in late January, when the French bank revealed a loss in its equity trading book of about €5 billion, almost wiping out its profits for the year.
Unlike BNP, SocGen has three non-executives with banking experience: Robert Day, chairman of the TCW group and once of White Weld; Antoine Jeancourt Galignani, former CEO of Banque Indosuez; and Gianemilio Osculati, chairman of McKinsey’s Mediterranean office and a former general manager of Banca d’America e d’Italia, a subsidiary of Deutsche Bank.
When Euromoney asked Bouton to describe the ideal make-up of a board of directors at the beginning of January, he said the following: "There is probably no one ideal structure. A successful board of directors stems from a well-balanced mixture of experience in business, markets and management of large companies; the ability to work as a team; the capacity to anticipate; as well as certain psychological qualities, not least the courage to defend positions that may go against the tide.
"Beyond these aspects, there are also a number of organizational principles: a mix of financial and banking specialists on the one hand, and experts in general corporate management on the other; an international vision, made possible by a board membership welcoming people from different countries (four out of Société Générale’s 15 board members come from outside France); a significant proportion of independent directors (50% of Société Générale directors are independent); and, especially, a smooth committee organization.
"In particular, the audit committee, which also handles risk, must be fully informed on an ongoing basis, vigilant regarding market trends and with a membership whose expertise matches the issues at stake. At Société Générale, we ensure that the committee receives regular training, as our businesses and the regulations governing them are subject to rapid evolution. The committee must have a global vision of risk, as well as a concrete approach."
Perhaps it is because it knows Bouton takes this approach to risk that his board of directors chose not to accept his resignation offer in the wake of the bank’s trading losses.
One issue for shareholders is that there are a number of different models for bank boards, as of course in other industries: but banking is perhaps the most globalized and complex industry of them all.
The US model places huge executive power in the hands of a combined chairman and chief executive, who is often the only full-time executive on the board.
The European/UK model sees a mix of executives and independents mingling. It is only in the UK model that the CFO tends to sit on the main board of directors.
The German model splits the executive and non-executive functions straight down the line, with the management board reporting to a supervisory board of independents.
This leaves the unusual situation of the person running the bank – the CEO – not actually belonging to the group that is ultimately responsible to shareholders.
But proponents of the supervisory model say that in the modern world of corporate governance, this traditional Germanic organization offers the best bet for shareholders.
"The two-tier management board model offers specific advantages in terms of corporate governance – especially when it comes to the separation of powers," says Walter Rothensteiner, chief executive of Austrian Bank RZB. "Whatever the formal structure, a culture must exist that ensures independent consideration of market and risk issues at board level."
But whatever the model, is it unrealistic to expect non-executives, far removed from the centre of operations, to be able to properly oversee the business of a modern financial institution?
"Banking is a very specialist field. We’ve seen the problems that banks have had internally with their risk management recently, so what chance does a non-executive – even one that is fully briefed – have to understand the more complex products?" asks Michelle Edkins, managing director of Governance for Owners, a UK-based organization founded in 2004 that both invests and advises on corporate governance issues. "Are we confusing oversight of risk management with actual risk management? If the non-executive directors’ role is more than keeping management teams focused and representing shareholder interests, then perhaps we have unrealistic expectations of them."
USS is the second largest pension fund in the UK and the principal pension scheme for UK universities, acting for 378 universities and academic institutions. It has more than £30 billion in assets.
Its co-head of responsible investments, Dan Summerfield, says that while the banking industry might need to look more closely at who sits on its boards, investors need to take more responsibility themselves.
"We like to see a collection of skill sets but do expect to see people with experience of the relevant industry," he says. "In some cases, form sometimes takes precedence over substance in terms of finding the right candidates for board positions."
Summerfield thinks that might change now investors begin to become more active in monitoring financial institutions. "In the good times, when economies were performing well and banks were posting record profits, these issues didn’t come up. But there are clearly potential flaws in the system. It may be time for a reappraisal."
Board or beach?
The problem is: even if banks wanted more of their own kind on their boards, who is going to take the job? In an industry the size of banking, there’s a lot of senior former executives who could play an important role.
That so few choose to do so comes as no big surprise. The banking industry lives up to its stereotype of competing egos and rivalries – both internal and external. Would Morgan Stanley, for example, appoint a former Merrill Lynch senior executive to its board? It’s almost as unlikely that an investment bank CEO would appoint a recent predecessor to an oversight role. Even if they remained close, increasingly rare these days, would the new chief want a former mentor looking over his shoulder? Would competitors see it, and exploit it, as a sign of weakness?
Then there are the huge rewards that senior executives will have accumulated over the years. Being a non-executive director brings a lot of responsibility for relatively little reward. As one senior investment bank executive, whose firm has announced large write-downs in recent months, says: "Our board members have been through hell over the past few months. If we get litigation from investors, they’ll be named in it. Who needs all that for about $150,000 a year?"
It’s no wonder that most bankers who stay in the industry opt for a role of senior adviser: you get to see the clients, do the business, earn great money but have neither the executive nor the non-executive responsibility.
Even bankers who profess great affection for their institutions are unlikely to be tempted on to the board. "When I finish my career here, no way am I going to take a board position," says a senior investment banker. "The beach is much more appealing."
Of course many bankers who have had hugely successful careers do pour themselves into good works for little reward once they remove themselves from the daily grind. Charities and universities would happily vouch for this.
With the reputation of the industry that made them wealthy, and the banks that gave them the chance to become so, under fire, could it be time for some of these people to put something back into banking by giving banks’ boards of directors at least a chance of understanding the risks the industry faces?
Don’t hold your breath.
|Only one in three bank board directors has any direct banking experience|
|Board representation of selected financial institutions, January 2008|
|Bank||Board members||Bankers||Non-exec bankers||Chair & CEO||CFO||Non-exec bankers|
|Bank of America||17||2||1||Y||N||Charles Gifford, ex chairman, Bank of America|
|Barclays||18||9||3||N||Y||David Booth, ex management committee, Morgan Stanley, Richard Broadbent, ex group executive committee, Schroders, Danie Cronje, ex CEO Absa|
|Bear Stearns||12||3||1||N||N||Alan Greenberg, ex CEO Bear Stearns|
|Credit Suisse||13||9||7||N||N||Robert Benmosche, ex EVP, PaineWebber, Noreen Doyle, ex MD, Bankers Trust, Anton von Rossum, ex CEO, Fortis, David Syz, ex UBS, Jean Lanier, ex Paribas, Richard Thornburgh, ex CFO CS First Boston, Peter Weibel, ex UBS|
|Goldman Sachs||12||5||1||Y||N||Stephen Friedman, ex senior partner, Goldman Sachs|
|HSBC||16||5||1||N||Y||Simon Robertson, ex MD, Goldman Sachs|
|Lehman Brothers||10||2||1||Y||N||Henry Kaufman, ex MD Salomon Brothers|
|Morgan Stanley||12||3||2||Y||N||Charles Philips, ex MD, Morgan Stanley, Griffith Sexton, ex Morgan Stanley executive|
|RBS||17||12||4||N||Y||Colin Buchan, ex head of equities, UBS, Bud Koch, ex CEO, Charter One Financial, Joe MacHale, ex CEO EMEA, JPMorgan, Peter Sutherland, Chairman Goldman Sachs International|
|Santander||19||6||2||N||N||Guillermo de la Dehesa, Ex CEO Banco Pastor, Rodrigo Echenique, ex CEO, Santander|
|Société Générale**||15||6||3||Y**||N||Robert Day, ex White Weld, Antoine Jeancourt Galignani, ex CEO Banque Indosuez, Gianemilio Osculati, ex general manager, Banca d’America e d’Italia|
|Column A: Number of board directors according to the banks’ websites on January 16, 2008|
|Column B: Number of board directors who currently work as bankers or have worked as bankers in the past, according to information made available on the banks’ websites|
|Column C: Number of non-executive directors who have previous banking experience|
|Column D: Is the chairman of the board also the CEO of the bank?|
|Column E: Does the CFO sit on the main board?|
|Column F: Names and former senior positions of non-executive directors with banking experience|
|*Deutsche Bank numbers include both four-strong management board and supervisory board|
|**SocGen chairman Daniel Bouton is co-CEO with Philippe Citerne|
|Source: Euromoney, bank websites|