Minding the New York Fed

07/09/09 - 08:59 AM EDT

BAC , MS , GS , AIG , PEP , C , GE

Eric Jackson

We were all riveted last fall by the economic meltdown, which pulled down Lehman (now absorbed into Barclays (BCS Quote)) and Merrill (now part of Bank of America (BAC Quote) and forced many of us to consider the previously inconceivable outcome of a total collapse of the capital markets.

Through it all, then-Treasury Secretary Henry Paulson, Federal Reserve Chairman Ben Bernanke, and then-head of the New York Fed Tiimothy Geithner, tried to orchestrate an acceptable soft landing for all market participants. Many of the most pivotal planning sessions during that dark time happened at the offices of the New York Fed.

Yet, who was watching over the New York Fed at the time? As it turns out, many of the market actors were central in the drama playing out, including Lehman head Dick Fuld, who was a New York Fed director then.

Did Dick Fuld really deserve to have a say on whether BofA should buy Merrill, or on the fates of AIG(AIG Quote), Morgan Stanley (MS Quote) and Goldman Sachs (GS Quote)?

The board of directors of the New York Fed was poorly composed then, and it remains highly problematic today. Changes need to be made.

The New York Fed is basically the on-the-ground interface between Wall Street's biggest banks and the Federal Reserve. It plays part policy adviser, part diplomat and part message-runner between the two sometimes very different worlds. The bank plays a critical role in how policy is set and implemented.

During several critical moments last year (with the downfall of Bear and Lehman, the shotgun marriage between Merrill and BofA and later the pressuring of BofA to follow through with the merger) and no doubt in the future, the New York Fed has and will play a critical role in real-time decisions that can have ramifications on our markets and the broader economy for years.

It's reasonable to better understand who ultimately was responsible for directing and judging if Geithner was doing his job effectively last year. That responsibility falls on the New York Fed's board of directors.

That group is divided into three classes of directors three Class A directors who are from member banks and who are elected by member banks; three Class B directors who are elected by member banks to represent the interests of the public, and three Class C directors who are elected by the New York Fed's board of governors (who are all appointed by the president) to represent the interests of the public.

The Class A directors have been problematic in the last eight months. First, Fuld was one of them last fall when his firm became the focal point of concern for the entire U.S. financial system. Later, Stephen Freidman, then-chairman of the New York Fed and formerly with Goldman Sachs(GS Quote), was forced to resign amid revelations that he had purchased stock in his old firm -- raising questions about his impartiality overseeing the entire financial system.

There's no evidence that either Fuld or Friedman took any actions that benefitted either of those firms in their New York Fed roles, but, in matters of corporate governance, appearances count.
Currently, three of the nine seats on the New York Fed's board are vacant. It's not clear when they will be filled. Of the current directors, all three Class A directors are in place representing the interests of the member banks.

Jeff Immelt of General Electric(GE Quote) is the only Class B director. His job is to represent the public in that role. However, it's clear that his day job of overseeing GE Finance also makes him sympathetic to the needs of the member banks. Only two of the three Class C seats are filled (Lee Bollinger, the president of Columbia University, and Denis Hughes, the president of the New York State AFL-CIO).

Based on this composition, you could fairly make the case that the current board of the New York Fed is more weighted to look out for the interests of the bankers than the interests of the taxpayers and the broader economy. That needs to be immediately corrected. That means getting more experienced business executives like Pepsi(PEP Quote) CEO Indra Nooyi back on the board as Class B directors and replacing Jeff Immelt with another business executive who runs a company not as financially dependent as GE Finance.

Additionally, the open Class C position should be quickly filled with a director who is business savvy but will represent taxpayers first and foremost. Ideally, the Class C director should be someone who knows something about corporate governance and can bring that perspective to the New York Fed's board. Ira Millstein of the law firm Weil Gotshal & Manges would be fit the bill nicely.

There have been other bothersome governance issues cropping up at the New York Fed recently. It was recently reported that former New York Fed President Geithner advised the current board members to select his former lieutenant, William Dudley, as his replacement.

Although this happens a lot in companies (think Citigroup's(C Quote), Sandy Weill telling his board to replace him with then general counsel Chuck Prince), it is always a bad idea. Former CEOs and presidents can have cloudy judgment on these kinds of issues, affected by legacy or loyalty.

It's also been reported that it was due to Geithner's strong advice about hiring Dudley that former Class B director Nooyi recently stepped down from the board entirely. Take all these incidents together and you can't blame her.

The New York Fed plays a critical role in the healthy functioning of our capital markets. In my view, member danks deserve to have a seat at the table of the board of directors, but the majority of views should be separate from Wall Street and ensure that Wall Street's actions are serving the interests of the entire economy. The Federal Reserve and the U.S. government should immediately take steps to ensure that this organization's governance matches the standards they wish to see implemented in the big Wall Street banks they oversee.

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How to Fix Corporate Boards

From TheStreet.com

By Eric Jackson

02/24/09 - 12:01 AM EST

C , BAC , GE (Cramer's Pick) , HD

A couple of weeks ago, I co-authored an op-ed on Forbes.com about the problem of bad corporate boards in America.

In it, Sydney Finkelstein and I laid the primary blame for the wheels coming off our economy in the past year at the feet of our corporate boards. There is no question that others, like politicians, CEOs, banks and consumers all had a hand in this mess.

We don't absolve anyone of their justifiable blame. But ultimately, it was the corporate boards of Citigroup(C Quote - Cramer on C - Stock Picks) , Lehman Brothers, Bank of America(BAC Quote - Cramer on BAC - Stock Picks) and others who gave the green light for excessive risk-taking based on assumptions that housing prices would always rise.

Boards are usually an afterthought for most in the media and public. When asked to explain the problems of the past year, there has been a lot of focus on CEO pay and "Wall Street greed." Most people view boards as nothing more than "window dressing" for a company. They are seen as a group of mostly retired execs, bankers, lawyers and accountants who get together once a quarter and rubber-stamp the desired corporate actions of the CEO.

It's certainly true that these groups have been too friendly over the years in allowing CEOs to run businesses as they saw fit. Quite often, directors feel beholden to the CEOs who appoint them and are well paid for serving as a director, so they do not push back on issues when the CEO is a firm believer. Of course, there's also always a friendly consultant that a CEO can trot out to give some third-party support for whatever the initiative is.

Yet it doesn't have to be this way. Boards are responsible at every company for hiring and firing the CEO. They are also the only interface the shareholders have with the running of a business. Every year (except in the case of staggered boards), shareholders have the ability to vote "for" or "against" each director being re-elected to the job. Sadly, many shareholders don't even bother to vote during these elections. For those who do, they overwhelmingly support the incumbent board, as re-election percentages are usually on the order of 90% to 95%.

If shareholders truly were to become engaged with the voting process, the result would be a much more responsive board of directors on their toes to represent their constituents and not just be in the back pocket of the CEO who appointed them.

Tougher questions would be asked at board meetings, and potential excessive risk-taking would be challenged earlier on. If only boards had been doing their jobs over the last six years instead of cheerleading and rubber-stamping, our economy wouldn't be facing such dire circumstances.
Sarbanes-Oxley Not the Answer

After the last bubble, when formerly billion dollar entities such as Enron, World Com, and Adelphi were shown to be shams, the U.S. government swooped in to improve corporate governance and overall financial and operational fiduciary oversight. The result was the Sarbanes-Oxley law, which required CEOs and CFOs to personally attest to the veracity of financial statements, prevented auditors from also consulting with businesses and supposedly improved the quality of boards of directors.

To have better boards, SarbOx suggested that the roles of chairman and CEO be split, that there be more "independent" directors on every board, and that boards avoid becoming too large so that meetings resembled something more like a United Nations get-together. Of course, none of those changes, even if they were followed (which wasn't required), seemingly did anything to make Lehman's board any better.

Let's consider the Lehman board in detail. About half of the 11-member board had an average age of 77. Seven of the 11 had been on the Lehman board an average of 15 years -- not exactly fresh eyes. Nine of the 11 directors were effectively retired -- many for several years. One director (Roger Berlind) was a former Broadway producer. Another director (Marsha Johnson Evans) was the former head of the American Red Cross and, before that, Girl Scouts of the USA.

There are many types of backgrounds, tenures and ages that make for an effective director. Yet, in looking at this makeup of the Lehman board, you have to ask yourself: Were these people who were going to (or even had the knowledge and experience to) challenge Dick Fuld about the firm's aggressive risk-taking and scenario-planning in the event of a major housing slowdown?

Of course, CEOs, pro-business leaders and their lobbying groups, such as the Business Roundtable and Conference Board, have complained that SarbOx did nothing to stop the breakdown of 2008. Just last week, Ken Langone, supreme capitalist and compensation committee member of the NYSE for Grasso, Home Depot(HD Quote - Cramer on HD - Stock Picks) for Nardelli, and GE(GE Quote - Cramer on GE - Stock Picks) for Welch, made the case on CNBC that the breakdown proved that CEOs should be less fettered by legislation like SarbOx rather than more.

I would agree with critics that SarbOx and other laws that seek to improve the quality of boards and board governance are ineffective. If you switch over a board so that it is 100% independent, how is it going to be knowledgeable enough about the business to challenge the CEO? So, if things like SarbOx aren't the answer, what is a solution for better boards?

The Solution for Better Boards

There are two ways to improve the quality of boards in corporate America today. The first is self-improvement: Boards need to fix themselves. The Securities and Exchange Commission or members of Congress can't be a fly on the wall to all boards to tell them whether they are debating issues enough. Therefore, boards must do it themselves. The massive value destruction in real capital and reputational capital that we've witnessed in the last year in firms like Citi, Bank of America and Lehman should send shivers up the spine of every public company director.

We hope that this spurs them to action and to seek out advice from other directors or consultants who have seen these changes successfully put in practice.

It would be nice if boards actually did take it on themselves to improve the quality of their governance. However, I am cynical enough not to expect that Vikram Pandit and Ken Lewis are putting such an effort at the top of their corporate to-do list. This brings us to a second solution, which does have some teeth to it.

The second solution is called "proxy access." The SEC has kicked the can on doing something on this for mor than a decade now. After 2008, there's no excuse for Mary Schapiro not moving ahead on it now.

Today, if any public company shareholder wants to nominate any one or more candidates to be elected by all shareholders to a company's board of directors, that shareholder must foot the bill and jump over an extraordinary number of hurdles to do so. The out-of-pocket costs are at minimum a million dollars (for lawyers, mailing, and proxy solicitors). They must run against an incumbent board's campaign paid for entirely by shareholders.

"Proxy access" would allow shareholders, if they were able to demonstrate that they held shares in a company for a certain period of time, to nominate one or more individuals to be elected to the board on the company's own proxy (so the challengers wouldn't have to pay the freight costs of mailing out the proxies). If the challengers make their case on why they should get a seat at the table as opposed to an incumbent, they should have a seat at the table. May the best directors -- not only the friends of the CEO -- serve.

Shareholder activist Carl Icahn supports this initiative but wants to limit the right to nominate a director to shareholders holding a 5% stake in the company. That's not a problem for him of course, but it defeats the whole notion of "proxy access," which is that if you hold one share in a company, you have a right to air your views and suggest a legitimate candidate to run.

Opponents of proxy access basically make the case that shareholders aren't smart enough as management to nominate people to serve on the board. They say groups such as the AFL-CIO and Teamsters will "hijack" the process and seek to use it to further their "extremist" views. They also like to criticize shareholders calling for change as not having the "long-term interests" of other shareholders in mind.

Citi was criticized for having an obfuscated corporate structure and lack of corporate strategy years ago. The company responded by saying critics were being short-sighted when the stock was in the $50s. "Let our vision for a financial supermarket play out," they said. They repeated the same thing when the stock was in the $40s, $30s, and $20s. Last Friday, the stock dipped below $2. Are shareholders supposed to still shut up and sit on their hands waiting patiently for the all-seeing and all-knowing Citi managers to dig themselves out of this mess? Of course not.

These criticisms have no merit. Any potential director up for re-election to a board of directors -- incumbent or challenger -- should make his or her case on why they deserve the seat. Shareholders can judge for themselves. Large shareholders like Capital Research, Legg Mason(LM Quote - Cramer on LM - Stock Picks) and Vanguard regularly spend a lot of time and effort studying how to vote. Other large shareholders aren't as fastidious, but hopefully that will improve over time. Shareholders can tell if a potential director is a crackpot, an extremist or simply a pawn of the CEO who will do nothing more than rubber-stamp decisions.

When the SEC allows "proxy access," my prediction is that it won't result in a huge number of shareholders rushing to use the power they've been given. Inevitably, some will, and they'll be successful. These few litmus-case examples will do more for improving corporate governance in America than any SarbOx-like legislation could.

There are other changes the SEC could make to improve corporate governance. For example, any director on a board for a company that goes bankrupt or sees its stock price drop by more than 90% in 12 months (like the aforementioned Lehman directors) should have to resign any other corporate boards he/she sits on and not be able to take any future directorships on a public company for the next 10 years.

The risk of being fired by shareholders through proxy access will always be in the back of the minds of corporate directors. This will indirectly lead to incumbent directors asking tougher questions and better corporate governance. And that will benefit all shareholders in the long-term.

At the time of publication, Jackson had no positions in stocks mentioned.

Eric Jackson is founder and president of Ironfire Capital and the general partner and investment manager of Ironfire Capital US Fund LP and Ironfire Capital International Fund, Ltd.

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TheStreet.com: The Activist Investor: Lehman's Fuld Under Fire

From TheStreet.com
by Eric Jackson
06/12/08 - 12:59 PM EDT

CFO Erin Callan has been the public face for Lehman Brothers (LEH - Cramer's Take - Stockpickr) over the past six months, trying to convince shareholders that all is well with the smallest of the big investment banks. She failed, and that's why she got sent back to the firm's Investment Banking group this morning and why COO Joseph Gregory got ousted.

CEO Richard Fuld has a sterling reputation on Wall Street, and he has seen trouble before and navigated through it. The Long-Term Capital Management imbroglio from 1998 has been often cited as the last example of Lehman fighting off predictions of its demise. Fuld was there then and is firmly in command now. However, after what he allowed to transpire, particularly between Callan and hedge-fund manager David Einhorn over the past several weeks, he needs to be put under the spotlight now.

It was only in December that investors were congratulating Lehman for side-stepping the credit crunch that had hit their competitors between the eyes. That good fortune vanished when the ball dropped in Times Square to herald in 2008. Lehman has been under fire ever since, because of a number of poor decisions which began to show themselves.

Fuld yielded the spotlight to the CFO, who only took the position last November, and that's been a mistake. You might have thought he was playing bridge with Jimmy Cayne this whole time, based on how little we've seen or heard from him.

For the Icarus-like Callan, her brief CFO stint has seen lavish media praise and now a harsh fall from grace in the most public way. Four months after her promotion to CFO, Portolio magazine called her "Wall Street's most powerful woman". (Zoe Cruz relinquished that title when she left Morgan Stanley (MS - Cramer's Take - Stockpickr) amid large losses from her group last year.) Fellow women execs from the financial world voiced support for Callan. 85 Broads, a Web site for women in the financial industry, declared Callan a "rock star" CEO who is "drop-dead gorgeous with a brain to match."

The public attention that comes with the label of "most powerful woman on Wall Street" is a double-edged sword; ask Cruz or Citi's (C - Cramer's Take - Stockpickr) Sallie Krawcheck, who also was moved out of the CFO post at that firm. The press often praises women on the way up with glossy profiles, only to pounce immediately when trouble comes.

Callan's big undoing in these last six months has been her penchant for bravado-laden predictions, which she has had to continually back-track.

Here's a recap:

Earlier this year, Lehman bought up $2 billion in Alt-A loans (i.e., riskier mortgages). "We saw a great opportunity," said Callan in March. The current quarter has had more than $2.8 billion in losses of these loan types.

In January, she predicted that Lehman's return on equity would average in the mid- to high-teens this year. It's around 9%.

In February, Lehman raised $1.9 billion. Callan said at the time that it "took care of our full year needs." In late March, it raised an additional $4 billion and then another $6 billion earlier this week.

Additionally, for several days in March, many worried that Lehman was the next Bear Stearns, further adding to the market's turmoil. Its stock price plummeted from $45.99 on March 13 to $31.75 on March 17, the day before the release of its first-quarter earnings.

After Lehman exceeded expectations with those results, its stock snapped back 46% and the Callan swagger returned. She walked down to the trading desk following the call and, according to The Wall Street Journal, "high-fived" her colleagues. It seemed as though the storm clouds would pass.

The Einhorn Factor

David Einhorn, founder of the $6 billion Greenlight Capital, became Callan's nemesis.
Einhorn is the anti-Callan. He hasn't been perfect in his calls (being on the board of New Century, which was one of subprime's first big casualties), but he knows how to make money with average annual net returns of 25% since 1996. Einhorn puts substance before style.

Einhorn began questioning Lehman three weeks ago, after Greenlight's analysis showed that the firm had booked an unusually large number of unrealized gains in the first quarter -- 10 times the average from previous quarters -- which marked up equity positions that were not publicly traded.

Activist investing is typically practiced by long-only hedge funds. They use their "ownership" in the company as justification for calling for improvements that will increase shareholder value. Although companies can respond by trying to paint such investors as "short-termists," it's hard to disparage a fellow owner of the company. Activists will typically encourage the company to take actions meant to benefit all stock holders (including management).

With his Lehman investment, Einhorn might have created a template for a new type of activist investor: the activist shorter. Einhorn made his case for why Lehman would drop through a series of speeches and media appearances. With a good argument and his own track record as credibility, people listened.

Shorts are unfairly vilified in the press for not being true owners and for wanting to drive down the stock. Yet, as Einhorn and another prominent shorter, RealMoney.com contributor Doug Kass, have pointed out: Are management, stock analysts or stockholders of a company who talk up a stock not guilty of the same bias that a short has when talking down a stock?

All long and short holders of stock deserve to make money if they can articulate a point of view before the fact and see it borne out. Einhorn simply had a better argument than Callan and the market sided with him. Lehman's stock dropped 16% between the time when Einhorn first made his public remarks on the bank's problems on May 22 and last Friday.

Lehman Shows Its Hand

Callan was forced into damage control. She immediately questioned Einhorn's credibility, reminding investors that he was a short-seller. "Mr. Einhorn cherry-picks certain specific items from our quarterly filing and takes them out of context and distorts them to relay a false impression of the firm's financial condition which suits him because of his short position in our stock. He also makes allegations that have no basis in fact with the same hope of achieving personal gain," said Lehman in a statement.

Yet, days later, by its actions, Lehman demonstrated that it was in exactly the position Einhorn said it was. On Monday, Lehman raised $6 billion -- higher than what market observers expected. The stock has dropped another 17% this week and is down 64% year to date.

Said Einhorn succinctly, "They just raised $6 billion that they said they didn't need to cover losses they said they didn't have."

Who was picking cherries?

Market observers didn't necessarily blame Callan for Lehman's poor investment decisions, but she lost all credibility for her serial back-tracking.

Callan still didn't lack confidence in announcing the capital raise on Monday, sold at 20% off the firm's book value. She jawboned, saying: "The discussions at this point aren't about our viability or the fact that we will be here or the fact that we have sufficient liquidity. I think we put that to bed on a number of different levels through our own actions."

Her words simply did not match up to the reality Lehman is facing and that's why she deserved to be removed. She committed the cardinal sin of overpromising and under-delivering -- repeatedly. Einhorn, by contrast, has walked softly and carried big returns for his investors.

Yet, neither Callan nor Gregory is completely responsible for the mess Lehman finds itself in. Where was Dick Fuld?

Why Should Fuld Get a Pass?

It's inconceivable that if such problems were facing Citi or Goldman (GS - Cramer's Take - Stockpickr) that Vikram Pandit or Lloyd Blankfein wouldn't be held to account. Why have analysts, investors and the press given Fuld a pass? Callan alone didn't sign off on those Alt-A loans earlier this year.

Dick Fuld clearly needs to step out of the shadows and demonstrate there is a path forward that Lehman investors can believe in. Most expect that Lehman will have to sell itself in whole or part in the coming months.

Fuld's greatest asset through this mess has been his mystique that he's been here before and can help the firm get through this again. You don't lead through abstention though.

Lehman shareholders need Fuld to step up -- or sell out.

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