Examining Recent U.S. Corporate Board Failures at Banks and Wall Street Firms

With the news of the latest financial institution to fall - Washington Mutual, I was curious to know why at this point no one has thought to ask what are the Corporate Boards of Directors of these companies have been doing?

For example, how could an institution like WAMU with over $300Bil in assets go from a share price in the latest 52 weeks of over $36.00 per share to $0 in that short of an amount of time? We all know at this point about the mortgage mess, but my real question is to the board of directors. If I'm a shareholder in WAMU isn't it part of your job to be looking out for my best interest and the long term viability of the organization? The next logical question that I came up with along those same lines is, how did some of these financial firms like JP Morgan Chase come out of this whole mess ahead?

As a shareholder it looks to me like the board and management team did a great job for JP Morgan Chase and others. In fact, some financial institutions have not only weathered this economic storm but have now grown to sizes they couldn't have imagined before. Why couldn't it have been the reverse? Was it all luck or a strategy that these boards and management teams executed on?

These questions would be hard to answer unless you were in those board meetings however, part of ABA's corporate board consulting expertise and evaluation process is determining the human capital expertise that is on a particular board.

ABA has found very insightful information about how strong the board, and thus the organization is based on the backgrounds and experiences of its Directors. We look at the stewards of these companies being the Officers on the Board of Directors as in the end it is their responsibility to increase shareholder value and maintain the long term viability of these companies. It is an interesting exercise when you analyze the people and the makeup of these boards. We analyzed the Directors on the Boards of Washington Mutual, Lehman Brothers both now gone, to those at JP Morgan Chase, who just acquired the assets of the now defunct WAMU, and Goldman Sachs, one of the most successful firms on Wall Street.

Let's be clear that we are not analyzing whether the Directors of the now defunct company boards are not smart business people nor accomplished individuals. As a matter of fact, they all have impressive resumes and backgrounds. I am not even implying that these individuals did not know what was going on or that they were not having conversations about how to protect the shareholders. Although our board evaluation process has over 30 different areas that we evaluate, we analyzed these boards (with the small amount of information from their Board bios) from two main perspectives that we find very critical in corporate boards today.

1. How many board members have industry experience? Our process has proven that this is helpful in getting a company to execute on the RIGHT business model (not just a business model). ABA does not believe that our clients need a group of people with all the same background and experiences who all think the same way. But having some percentage (as high as 50%) for what we would call a "pilot" board that not only understands where the company is going but can help the CEO avoid missteps because they know the industry is ideal. It is also helpful for more debate between the board and CEO. By having industry experience the board process does not allow for the CEO to come in and give the Directors the information they see fit and thus rubber stamping the CEO's wishes without some debate from Directors with experience in the industry.
2. How many other boards are the Directors on? Our research has found this to be a problem much too often. To be on a corporate board we would expect a minimum (conservatively) of 80 to 100 hours of time per year not including travel. If you are a committee chair you can double that. Being a Director with multiple companies we often question an individual's level of engagement on strategic issues with so many other opportunities to think about as well. We don't find too many of our own clients thinking about this issue, but our research indicates this to be a large part of the reasons behind board disengagement.

We found some interesting information given these two basic parameters.

Makeup of Boards

We first analyzed how many officers of these companies had experience in the industry that the company they were serving was in? We think it's great to have a diverse group of experiences from different backgrounds and industries. We also believe that to get a company to the next level a CEO and management team can only be so knowledgeable about their industry. When we build boards, our premise is that at least half of the directors should have industry expertise (for advisory boards we would expect this to be even higher) to highlight some unknown specifics about the industry.

Given that these companies were dealing in CDO's, high risk mortgages or other complex financial instruments and so much of the profits generated by these companies were based on these investments over the last few years, we thought it would be prudent to analyze who might have financial experience that might translate into understanding the downside risk associated with these types of financial instruments. Although these instruments were highly speculative and unknown to many, we feel that having Directors (or even an Advisory Board) who had experience in other complex financial instruments or industries in ensuring that the downside risk was adequately covered might have been a good idea from a shareholders perspective. We also feel that if an organization is trying to grow it would make sense to have expertise on the board that understood from past experience how to do that. When it came to Banking or Investment Banking we found the following when it came to that expertise:

Defunct Companies:

• Washington Mutual - HAD 13 people on its board 3 of which they claim to be financial experts which we found to mean they were former CFO's of large organizations. Based on their backgrounds we found 3 that had direct financial industry experience. 1 individual (who is now Mayor of Dallas, TX) was head of the Bank of Hawaii in the early 90's, 1 individual who had Private Equity Experience and 1 individual who seems to be the most qualified, Alan Fishman, came to the board in September of 2008 (yes this month) to take over as CEO. Up until 2007 he was President and COO of Sovereign Bank and other banks as well. So up until recently they had only 2 individuals with any sort of banking or mortgage experience. They did have some former Chairmen and CEO's of construction and energy companies and even the former CEO of Starbucks.
• Lehman Brothers - HAD 10 people on its board 3 of which have banking or investment banking backgrounds; the former Chairmen and CEO of U.S. Bancorp, a Founder of an investment management and economic and financial consulting firm, and a Director that is a principal of a private investment firm. They also had 3 directors that they termed "private investors" (none of which had the name Buffett or Soros), a theatrical producer and the former CEO of the Red Cross who is also a retired Rear Admiral in the United States Navy. Again not that these other individuals do not have impressive backgrounds and accomplishments (especially an Admiral in the US Navy) but someone would have to convince me that a theatrical producer has the background and experience required to be a Director of one of the oldest and most respected investment banking firms on Wall Street.

Successful Companies:

• JP Morgan Chase - 11 current Directors 4 of which have financial industry backgrounds from banking, diversified investments, insurance and real estate. They also have a former Congressman and the Chairs and CEO's of Johnson and Johnson, Honeywell and Yum! Brands.
• Goldman Sachs - 9 current Directors 4 of which of financial industry backgrounds including an investment company, private equity firm, merchant banking, mortgages and banking. They also have a current Chairman of the Federal Reserve Bank of New York, the former Chairman of the Executive Committee of Fannie Mae (when it was successful) and a former Assistant to the President for Economic Policy and Director of the National Economic Council.

As you can see from the basic information here if you took the names of the organizations out and just gave these backgrounds for Directors of an organization in the Banking or Financial Services industries I think as a shareholder most people would choose the successful company boards makeup every time.

Number of Other Boards

We also analyzed how many other boards the Directors of these companies are on. We simply do not understand how an individual can provide all of the time, energy and commitment needed at this high level being a Director for so many companies. As a shareholder or CEO at some point it would concern me that my company would not get the attention needed because a Directors focus was on other boards. Additionally, the numbers we illustrate below are only company boards, not including the advisory or non-profit boards or community activities which most seem to be involved in as well.

Defunct Companies:

• Washington Mutual - the former Directors are on 31 other boards. By far this was the most of all the companies that we have ever analyzed. These were not small company boards either it is companies like Nike, Disney, Northrop Grumman, and Continental Airlines. They have one board member who is on 10 OTHER boards, one who is on 5 and 3 members who are on 4.
• Lehman Brothers - the former Directors are on 13 other boards and companies like MGM Mirage, Sony, Vail Resorts, Ferrari, Office Depot, W.R. Grace. They have two members that are on 4 boards.

Successful Companies:

• JP Morgan Chase - The current directors are on 17 other boards. This may also seem like a lot but when you consider that 5 of the 11 board members are currently Chairs of and CEO's of their current company and of those for 3 of them JP Morgan's board is their only outside Directorship. In addition only one member is on more than 2 boards.
• Goldman Sachs - The current Directors are on 12 other boards. Again, this may seem like a lot but given the level of the Directors they have we were surprised it was not more. They also do not have one member who is on more than 3 boards.

The ABA methodology has been designed to eliminate some of the guesswork that is associated with adding board members. Our proprietary ranking system numerically values potential board members before they would ever be considered for a board position and both of these parameters along with many others would be part of our scoring matrix.

These are just a couple of evaluation steps that are involved in our process and there would be many more that might not show JP Morgan's or Goldman Sachs board as the most optimal. In addition we would need to analyze their specific processes as well to come up with a total evaluation. We also realize that there is a bit of luck where these two organizations are concerned. For example analysts expect Goldman to report a record net annual income of $11 billion in one of the worst market environments in its history, due in large part to small group of traders who bet AGAINST the CDO market (even though Goldman was making a market and selling these securities to its clients) earlier in the year. It has also been reported that JP Morgan was trying to buy WAMU late last year for a substantial amount more than it just paid for the company last week. Being an ex Wall Street trader myself we always used to say it is better to be lucky than smart sometimes.

That all being said these two companies have come out of one of the worst economic environments their industries (or this country) have ever seen and are more powerful than before this whole mess began. At the same time two very large and well-respected financial institutions are no longer and we feel it is impossible not to tie an organization's success and failures at some level back to the Corporate Board of Directors. We find it surprising that no one is talking about this yet especially when there are discussions about not bailing out the executives with these companies in the financial bailout plan. As a matter of fact Mr. Fishman was hired as CEO of WAMU earlier this month was paid more than $13m for 18 days worth of work. When talking about these crazy comp plans and golden parachutes, who do you think developed those comp plans - the Compensation Committees of the Board of Directors.

Bob Arciniaga

Managing Partner

Advisory Board Architects