Corporate Governance Failures: Malice in Wonderland?

1. Corporate Governance Failures: Malice in Wonderland? Simon Gray, Head of Business Development and Marketing, BVI Finance 20th June 2019 – ACO Conference Tortola

2. Perspective • “If I had a word of my own, everything would be nonsense. Nothing would be what it is because everything would be what is isn’t. And contrary-wise; what it is wouldn’t be, and what it wouldn’t be, it would. You see?” • - Alice • “Fraud and deceit abound in these days more than in former times!” • - Sir Edward Cole (1602)

3. What’s on the menu..!

4. Definition

5. Context • Corporate governance has been practiced for as long as there have been corporate entities • Yet study of subject is < half a century old • Phrase “corporate governance” scarcely used until 1980s • Adam Smith – Wealth of Nations • Shakespeare’s Merchant of Venice

6. History • 4th Century BC – Arthasastra– ancient Indian book of political realism. Comprised of 15 books with book 11 entitled The Conduct of Corporations. Sadly the tome then goes on to recommend the use of spies, destruction of enemies & world domination. • 10th Century AD - “Governance” is an ancient word, used since the time of Chaucer. But the phrase “corporate governance” is new!! • 16th Century - Shakespeare – Merchant of Venice • 19th Century– laid foundations for modern corporations / century of entrepreneurs • 20th Century – the century of management – vast growth in management theories, consultants, gurus and management teaching • 1983 – it appeared as the title of a paper in Perspectives on Management • 1984 – it appeared as the title of a report in the American Law Institute on the Principles of Corporate Governance and also as the title of a book Corporate Governance – practices, procedures and powers in British companies and their board of directors. • 21st Century – promises to be the century of governance – as the focus swings to the legitimacy and effectiveness of the wielding of power over corporate entities world wide

7. Code breaking..! • 1992 – Cadbury Committee • Code of Practice on Corporate Governance • importance of independent non-executive directors • independence defined a “independent of management and free from any business or other relationship which could materially interfere with the exercise of independent judgment, apart from their fees and share-holding.” • Audit Committees • Cadbury represented a significant breakthrough in corporate governance thinking • Replicated elsewhere

8. Remuneration

9. Remuneration

10. Key change in corporate governance • dynamic flexible new corporate structures, often global, replaced the stable, often regional, corporate groups of the post war years • massively complex networks of subsidiary companies and strategic alliances with cross-shareholdings of shares, cross-directorships, chains of leveraged (and often public) funding, dynamic and ever changing operational and financial linkages throughout the added-value chain The naughty 90’s

11. Key change in corporate governance • conflicts with accountancy firms taking on more consulting roles • “client focused” – euphemism for increased attempts to sell clients a significant bundle of non-auditing services • political indifference – laissez-faire • shareholder indifference • record number of new offerings to capital markets The naughty 90’s

12. Rapid growth spawns greed Bad behaviour not new but world changed in 1990s • From 1990 – 2001 • worker pay increased 42%; corporate profits increased 88%, S&P 500 index increased 248%; and CEO pay rose a whopping 463% • Earnings restatements, a serious step taken to correct inconsistencies, increased dramatically • 1997, 116 firms restated their earnings • 2001, 270 firms restated their earnings • “managements growing incentive, willingness, and ability to manipulate earnings” – McNichols (Stanford University)

13. Dominant CEO • Queen of Hearts: Now then, are you ready for your sentence? Alice: But there has to be a verdict first. Queen of Hearts: Sentence first! Verdict afterwards. Alice: But that just isn't the way. Queen of Hearts: [shouting] All ways are...! Alice: ...your ways, your Majesty. • Cheshire Cat: All ways here, you see, are the Queen’s ways!

14. Lehman Brothers

15. Merrill Lynch

16. Bear Stearns • 9 non-executive Directors • 2 Equity investors • Priest • Toy Executive • Oil Executive • Mobile Phone Executive • Professional Board Member • Lawyer • Academic • Age from 59 – 80 • Absent CEO and non delegation policy • No business strategy • No capital planning • Absence of effective supervisor demands a sterling Board

17. AIG • Did not understand risk of credit default swaps • Outsized position • No reserves • Skirted regulatory controls • Dominant CEO who micro-managed and was force to leave – no management succession

18. Northern Rock

19. Sir Allen Stanford

20. The Sticky Wicket “Surely only a fraudster with a supreme sense of invulnerability – or a shaky grasp of cricket slang – would have the nerve to call his restaurant the Sticky Wicket….Sir Allen is at the crease and facing some very tricky balls.” Tom Leonard – 20th Feb 2009 – How Sir Allen Stanford bowled Antigua over https://www.telegraph.co.uk/finance/financetopics/sir-allen-stanford/4736739/How-Sir-Allen-Stanford-bowled-Antigua-over.html

21. Post mortem “It is only in the rinse cycle that you see just how dirty the washing was. We are in the rinse cycle.” Warren Buffet

22. The Fix

23. Finally – faith and the future…! (1) • Corporate Governance Policy for Financial Institutions should be covered by regulatory requirements • Should apply to all banks • Fitness and Propriety of Directors • Clear delegations of authority and responsibility at senior management level and through the organisation • Strong framework of operational controls

24. Finally – faith and the future…! (2) • Financial supervisors need to undertake a robust assessment of governance and have the power to intervene as necessary • All violations of safe and sound practices must be brought to Board’s and management’s attention with clear time frame for resolution • There should be a clear separation of duties and authority between Chair and CEO or President

25. Finally – faith and the future…! (3) • Non-executive directors must have a mix of relevant skills compatible with the bank’s business lines • The Board clearly understands the risks undertaken by the organisation and seeks professional outside guidance periodically • There is a clear strategy for the bank and definitive risk parameters for executives and staff to follow • Operational controls and policies, practices and procedures are in line with the strategy and risk tolerance of the institution

26. Finally – faith and the future…! (4) • The Board should be using all the tools at its disposal to maintain rigorous oversight over the institution including audit, supervisory authorities and outside counsel • Supervisors should have experts dedicated to assessing proper governance • Supervisory authorities should keep the industry informed of emerging good practice

27. But….!

28. Positives • Let us not forget the many positive elements the financial innovation has brought: • liquidity • job creation (direct and indirect); and • massive increase in invisible earnings.

29. Going in the right direction? • “Would you tell me, please, which way I ought to go from here?” • “That depends a good deal on where you want to get to,” said the Cat. • I don’t much care where…” said Alice • “then it doesn’t matter which way you go,” said the Cat. • “…so long as I get somewhere,” Alice added as an explanation. • “Oh you’re sure to do that, said the Cat, “if you only walk long enough.”

30. THANK YOU FOR LISTENING!