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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Best in Class: America's Top Boards

07/07/09 - 09:11 AM EDT

AMZN , JNJ , BRK-A , C , GE , IBM , GIS

Eric Jackson

It seemed an easy-enough question last week when someone asked me: What's the company in America with the best corporate governance? Yet, in trying to answer it, I was sent on a frustrating journey and a disappointing conclusion that there's no obvious winner. However, I'll name three good companies and look to address why it's so tough to answer the question.

In preparing this article, I reached out to some of the people I most respect in the world of corporate governance today: consultants, writers, bloggers, corporate secretaries and academics. Most of them were stumped by the question of what company is the best when it comes to corporate governance. It's certainly much easier to list 20 companies with bad governance for every company with good governance, which says a lot.

But three really good ones are Berkshire Hathaway(BRK.A Quote), Amazon.com (AMZN Quote) and Johnson & Johnson(JNJ Quote).

I'll revisit them later after I explain how I arrived at my conclusion.

To help spark my thinking, I searched the Web for recent corporate rankings of the best boards in corporate America. I came across a list from BusinessWeek from 2000. The top board on the list was General Electric (GE Quote), which unseated Campbell Soup(CPB Quote). Others near the top were IBM(IBM Quote), Home Depot(HD Quote), Intel (INTC Quote) and Cisco(CSCO Quote).

Since this ranking was issued, the combined stock returns of this group has been down 60% vs. negative 37% for the S&P 500. Three of the worst boards in 2000 in the rankings -- Walt Disney(DIS Quote), Rite Aid (RAD Quote) and Waste Management (WMI Quote) -- actually have slightly outperformed the best boards in the nine years since, but still returning on average negative 54% .

Ten years ago, GE's board was lauded for having a high number of outside directors who owned large amounts of stock in the company, which is worth 77% less today than it was back then. The board's largest move since 2000 was appointing Jeff Immelt as Jack Welch's successor rather than Bob Nardelli. It's hard to fault the board for that pick, given Nardelli's travails since then, but GE's shareholder base was frustrated with the stock's flat performance for the majority of this decade -- and that was before the wheels fell off last year with the concerns about GE Finance and its commercial real estate holdings.

Campbell Soup, the No. 1 corporate board of 1999 according to BusinessWeek, has lagged its peers like General Mills (GIS Quote) and Heinz(HNZ Quote) for a decade and barely treaded water with the S&P 500 over that time. Its stock is down 30% from 1999.

Finding the link between governance and performance has often vexed academics researching the link. At larger firms, with so many moving parts, it's often difficult to find the long-term performance effects of, say, separating the chairman and CEO roles.

''You are never going to be guaranteed total success,'' says Charles Elson, head of the Weinberg Governance Center at the University of Delaware. ''But good governance gives you protection when things go wrong. In the long run, that will play out.''

I spoke to Elson last week about the problem which many governance ratings have had in subsequently predicting company performance. He told me, in his view, that there were two critical governance factors which clearly showed a relationship to performance: (1) equity ownership of directors and (2) independence of directors.

I think he's right. Back in 2000, I was involved in a major research project which sought to link governance-related factors to subsequent company performance. The one factor which stood head-and-shoulders above any other was director stock ownership. And, by the way, owning stock through stock options or stock grants (the equivalent of "found money") didn't predict future company performance compared to when directors actually dug into their own pockets and purchased stock.

Board "independence" has been talked about often since the Enron and Worldcom scandals. We take it for granted that having a board stacked with family members or lawyers, accountants, and consultants who are paid by the company as directors is likely to produce more rubber-stamping boards than ones with more independent-minded people. However, there's still a lot of work to do in linking specific types of independent directors and company performance.

For example, I strongly believe having an independent director with industry experience is going to be more valuable in the long run compared with an independent director without that experience who doesn't want to speak up for fear of looking like a fool in front of the group. I also think too many boards lack diversity, in terms or ages, backgrounds or tenure on the board, which makes them collectively less independent thinkers than boards with such diversity. (However, adding a director for diversity's sake, without required business or industry experience, won't result in any new benefits for the group because such directors, again, will likely be too afraid to speak up.)

There's one more dimension I would add to the mix as being critical to finding a clear link between board governance and future company performance, and that's time to serve. If you go back and review the boards of the big failures from last year -- Lehman, AIG(AIG Quote) and Citigroup(C Quote) - all had a large number of directors who were too busy with other commitments to effectively serve as directors.

You had people like Anne Mulcahy and Andrew Liveris (CEOs of Xerox(XRX Quote) and Dow Chemical(DOW Quote), respectively) on Citi's board, who also served on Citi's audit committee, which is the most time-intensive of any board committee). When their own companies were seeing their stocks drop like stones last year, both Mulcahy and Liveris participated in 25 Citi board meetings and 12 audit committee meetings. In my view, they were stretched too thin from their day jobs to flag Citi's problems early enough.

Directors also can serve on too many other boards. Roland Hernandez who, in addition to serving on the board of Lehman and its "risk" committee (which failed if ever a board committee did), also served on the boards of MGM Mirage(MGM Quote), Ryland(RYL Quote), Vail Resorts (MTN Quote)and Wal-Mart(WMT Quote). Maybe if Hernandez hadn't been so over-committed he might have asked more questions about Dick Fuld's assumptions about Lehman's real estate

So, if equity ownership, independence, and time are the criteria for "good governance," along with evidence of sustained outperformance relative to peers, what are America's best boards? Like I mentioned earlier, the standouts are Berkshire Hathaway, Amazon.com and Johnson & Johnson.

Even as Berkshire Hathaway has taken its hits from the fall in financials and insurance companies, the stock still has beaten the S&P 500 in the last one, five and 10 years by a greater margin as you go back further in time. Investments made in Goldman Sachs(GS Quote), GE, and Harley-Davidson (HOG Quote) in the dark days of six months ago, look shrewd today. From a governance perspective, Berkshire is the gold standard for shareholder openness through its two to three-hour question-and-answer sessions at the annual stockholders' meeting and in its annual letter to shareholders. In terms of stock ownership, with the exception of Sue Decker who joined the board last year, each director owns at least $6 million in stock, with the median holding being $106 million. I also smile every year when I read how much Berkshire directors are paid to serve on the board. The majority of them get $2,700 a year, with a couple of special folks taking home $6,700, which is far less than the $300,000 to $400,000 a year some bank and tech directors take home.

The biggest problem I have with the Berkshire board is its average age. A third of the board is above the age of 80. These directors will have to face board succession issues, as well as CEO succession issues, over the next few years. They seem to recognize that they could benefit from some new perspectives on the board, judging from the most recent appointment of Sue Decker, formerly president of Yahoo!(YHOO Quote) and in her 40s.

Amazon.com also has been a standout performer for the last one, five and 10 years. Although consistently criticized by some for its sky-high valuation, it continues to succeed operationally and in its moves into new categories (most recently with the introduction of the Kindle electronic book reader). CEO Jeff Bezos gets the lion's share of the credit, but the company's board also is deserving. The stock ownership among the directors is high, with the median around $4 million.
But what I love most about this board is that every director has relevant tech or consumer experience which they bring to the group. Bezos didn't waste a seat around the table with the former ambassador to Ireland, buddies from the Seattle business community with no consumer background, former bosses, or the general manager of the Oakland A's baseball team. There's also a good range of ages and length of time served on the board across its eight members. A couple of the directors serve on two other boards besides Amazon's, and three have been on the board more than 13 years, which is getting a little long in the tooth, but these are very minor infractions when compared with most boards.

Johnson & Johnson's long-term corporate performance also has stood out compared with other "Big Pharma" players, and its governance has stood out as well. Unlike many New York-area boards of S&P 500-listed companies, J&J doesn't boast a board replete with active CEOs. In fact, it doesn't have any current CEOs (although disgraced former Citi CEO Chuck Prince was appointed to the board before he was ousted).

The board is a blend of retired CEOs and people from academia or with a specific health care background. The median stockholdings of directors is good at just under $900,000. My concerns with this board are that a few of the ex-CEO directors hold several other directorships -- including chair of JNJ's audit committee, James Cullen, who serves on four other boards. It's also odd that the finance committee didn't hold any meetings in 2008.

If I had to pick one of these as the best corporate board, I would say it's the board of Amazon.com. It's done things right on the most important governance factors of equity ownership, independence and time. Given this, I expect the company's positive stock performance to continue in the next 10 years. More importantly, Amazon's good governance means it's far less likely to suffer a Lehman-like shock that could destabilize or kill the company.

At the time of publication, Jackson had no positions in the companies 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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Was Bob Nardelli Ever Any Good?

Doug Kass wondered aloud in these pages last week about why anyone would care about what Bob Nardelli thinks, after he went on CNBC to debrief us on the Chrysler bankruptcy.

After this poor outcome, on the back of his disastrous six-year run at Home Depot (HD), it's fair to ask the question: Was Bob Nardelli ever a good manager?

Is it the case that he landed in two situations where the odds were stacked against him and anyone would have failed, or is he responsible for those two poor outcomes? If he was responsible, why was he so highly regarded coming out of General Electric (GE)? Was that high regard misplaced?

Although Chrysler dealt Nardelli a tough hand due to its size and market position, Alan Mulalley -- another outsider to the industry like Nardelli -- appears to be steering Ford (F) effectively through it.

Nardelli presided over Home Depot during the biggest housing market boom of the last century, yet it dramatically underperformed against Lowe's (LOW) over that period.

Favoritism no doubt played a role in Nardelli getting the Home Depot top job in the first place -- as Ken Langone (Home Depot cofounder and chair at the time) was also on the GE board and was very close to Jack Welch. They offered him this consolation prize days after he was passed over for Immelt. But what got Nardelli near the top rung of the ladder at GE in the first place?

Was Nardelli any good at GE and did he simply go into industries (retail and autos) in which lacked the experience to be successful, or was Jack Welch a poor judge of talent in letting him rise as far as he did at GE?

Nardelli's stumbles obviously hurt his own career prospects, but they also mar the reputations of Langone and Welch, as well as the mystique of GE's leadership funnel.

Position: None.

Originally published in RealMoney.com on 5/5/2009 9:49 AM EDT

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Good CEO/Bad CEO

RealMoney.com: Investing

By Eric Jackson

1/28/2009 11:45 AM EST

The bestselling author of Why Smart Executives Fail, Sydney Finkelstein is Steven Roth Professor of Management at the Tuck School at Dartmouth College. His upcoming book,Think Again: Why Good Leaders Make Decisions, coauthored by Jo Whitehead and Andrew Campbell and published by Harvard Business Press, expands on why companies run by sharp executives run off the rails.

After discussing the main themes of his new book and how they relate to the current market environment, we moved on to translating his research on executive and board decision-making into tangible investment ideas.

Jackson: What are examples of corporate leaders who make smart decisions and whose companies would make good long bets?

Finkelstein: I'll start with Jeff Bezos of Amazon (AMZN - commentary - Cramer's Take). That's a company that keeps on going even though no one gave it much of a chance in 2001. Remember that he had the foresight -- or good luck -- to tap the debt markets for $1 billion. This helped Amazon weather the storm after the Internet bubble burst. He's made his strategy work and he's innovative in ways that are complementary to the core business.

This is anecdotal, but I've had so many people ask me if my new book is coming out on Kindle. (Editor's Note: It is.) They've told me they wouldn't read it unless it did. Bezos has had a strong vision for what he wanted the company to be and stuck with it. He experimented with offshoots to the core business without getting too far afield. He also surrounded himself with good team members who appear to have been unafraid to challenge him.

Jackson: People worry about Amazon's high valuation.

Finkelstein: I'm not a valuation expert, I'm a leadership expert. However, I do know that good leaders do the necessary things to keep growing their businesses in sustainable ways. For that reason, I think Amazon is a good pick.

Another great corporate leader is Sandy Cutler at Eaton (ETN - commentary - Cramer's Take)(ETN). He's a Tuck grad, so I've had the chance to meet him several times at the school and he's always impressed me.

I haven't met anyone more knowledgeable about M&A. He knows how to integrate a company, how not to overpay. He's built a very strong organization around him. He always demands a good debate from the executive team. He also wouldn't be comfortable with me singling him out alone; he would always credit the team. Eaton's stock is down by half in the last year, but it's ahead of many peers in the market.

Google (GOOG - commentary - Cramer's Take) has also done a good job. It has one business that makes money and 29 that don't. A bunch of these that don't make sense have been jettisoned. Google is growing up. It was fine to experiment when times were flush, and you want to keep talented people around. Now it's being serious and cutting and not hiring.

New CFO Patrick Pichette seems to have done a good job here. No one could believe how well Google put the brakes on costs in the last earnings call. Capital spending dropped by half of what was spent a year ago and only 99 people were hired last quarter, down from thousands in past quarters. The company appears to have an excellent management team: It's not just Eric Schmidt, Sergey Brin and Larry Page. Shona Brown is also very strong.

Lastly, I'll mention General Electric (GE - commentary - Cramer's Take) and Jeff Immelt, even though the stock has been savaged. He was dealt the toughest hand you could possibly be dealt for an incoming CEO: following the most famous CEO ever, as well as dealing with Sept. 11 and the general stock market decline that followed. He's focused on some important themes: globalizing, going green and continuing to develop talent. He's controlled what he can control.

Jackson: Let's shift to examples of CEOs doing the opposite of what you advise and which companies, as a result, would make good short candidates.

Finkelstein: I'll start with Ken Lewis at Bank of America (BAC - commentary - Cramer's Take). It's amazing to me that he still has a job. Lewis cut his teeth as a credit analyst under Hugh McColl at North Carolina National Bank, later overseeing the bank's aggressive acquisition strategy. He got the top job in 2001 -- most people thought Lewis would be less acquisitive than McColl, but it has been just the opposite.

This is going to sound a little like armchair psychology,but for Lewis to be a major success at BofA, he knew he'd have to surpass McColl, already a legend in Charlotte for growing the bank into such a global powerhouse. How do you do that? You've got to make acquisitions and grow this bank even bigger. In 2003, he bough FleetBoston Bank for $48 billion. He bought MBNA in 2005 for $34 billion. And in April 2007, he bought LaSalle Bank for $21 billion.

He followed the Citigroup (C - commentary - Cramer's Take) failed "financial supermarket" strategy. Then BofA took on Countrywide for $4 billion and Merrill for $50 billion this year, with all the ticking time bombs in their portfolios. You're looking at another Citi. Lewis has been overly attached to his image of needing to be better than McColl.

There's another aspect to Lewis that relates to what we discuss in the book: He based his decision-making in 2008on misleading past experiences. BofA was built on many small bank acquisitions. McColl would cut costs and look for revenue enhancements, which gives you greater market power and heft. It's a great model, on such a different scale than Fleet, MBNA, Countrywide and Merrill.

Lewis thought -- based on Fleet and MBNA -- that he knew how to do these big acquisitions. He didn't. The due diligence was shockingly short on Merrill. This was a trophy acquisition. Reports are that Lewis wanted this jewel for a while. If the stock goes up, I would look to short it. I would bet there are more skeletons in their book.

Staying with financials, when you think of what Citi was and what it could have been, it's a tragedy. Citi has been incredibly slow to face up to problems. It took far too long to replace former Chair Sir Win Bischoff. There were rumors that he was on his way out for months. Dick Parsons appeared to be the de facto chair anyways, so what was holding Citi up?
It's also obvious that Citi moved too slow to break up the company. It's only been done begrudgingly and probably at the insistence of the new owners -- the U.S. government.

Vikram Pandit is a disastrous CEO. It's a tossup if he's worse than Charles Prince. You really wonder where was the board in all this? Why are most of the directors still there after making two terrible picks? When you think of the job of a board of directors, its most important job is hiring the CEO. Citi's board has failed twice now in this most basic function.

How they picked Pandit is a story in itself. He ran a hedge fund that seemed to be successful, but a year later Old Lane proved to have made many terrible bets. The performance plummeted, redemptions were through the roof and Citi needed to inject it with capital to keep it going. It has since been shut down.

Pandit was picked because basically any other senior talent in the company had been driven away months and years earlier. Pandit's been in way over his head from the start.
The lesson from Citi is: you've got to face reality immediately and move on. And for the board, the lesson is: you can't be attached to the CEO you pick. Your attachment can blind you to what's going on. Until there are major CEO and board changes, Citi is a short.

Finally, Jerry Yang at Yahoo! (YHOO - commentary - Cramer's Take) clearly made a number of poor decisions as CEO. First of all, he had an inappropriate attachment to Yahoo! from the beginning as a cofounder. From the outside, it also appears that he (and others on the management team) were very much against the idea of selling to the "evil empire" of Microsoft. As a result, he left $30 billion on the table for his shareholders.

Even now with Carol Bartz, about whom I've heard a lot of very positive things, I wonder whether Yang would approve a deal if it came along.

The other major problem with Yahoo! -- even more important, in fact -- is the tired board. It didn't pay any attention to Terry Semel, except when it came to approving his monster pay packages; let Yang be CEO when he wanted to instead of doing a thorough search; and let the company go through countless reorganizations with no results and no accountability.

How can you expect the rest of the organization to be accountable when no one on this board has been accountable? Even if Bartz is exactly the right CEO, she's going to be saddled with one of the worst boards in corporate America. What shocks me the most is that Yahoo!'s largest shareholders sit back and except this. They are gluttons for punishment.

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