The New York Times has an odd piece today, “Where Did the Buck Stop at Merrill?” which seeks to determine whether the unexpectedly $8.4 billion third-quarter writeoff was not just former CEO Stanley O”Neal’s failing, but also one of Merrill’s board. Another shoe may be about to drop, since the Wall Street Journal claimed that Merrill may have engaged in transactions with hedge funds designed to hide losses (note that the Financial Times says that the transactions could be kosher).
The piece doesn’t give a clear picture of what the board’s role should be (in fairness, there are differences of opinion here), and therefore can’t answer the question posed in its headline.
Now, generally speaking, the board’s responsibilities include hiring the CEO, reviewing his performance, and making sure there is a succession plan and overall organizational planning; helping set broad policies; providing for fiscal accountability and assuring that there are adequate resources and funding.
Although the article is loath to reach a conclusion, it appears the board wasn’t on top of things. My sources tell me O’Neal was nearly forced out in 2004 over the turnover in the top ranks and the lack of any internal replacement. The New York Times also indicates that continuity within the board was an issue:
Nell Minow, editor of the Corporate Library, an independent research firm that rates company boards, said her company had expressed strong concern about the Merrill board for several years, citing, among other things, high turnover and the possibility that newcomers were not asking tough questions. In addition, she said that there was very low share ownership among directors, and “that’s a big red flag about motivation.”
But the far bigger failing was in the risk management area. Unlike most other Wall Street firms, until September, Merrill did not have a head of risk management. And the New York Times has some crucial info but failed to connect the dots:
The particular responsibility for risk oversight and control at Merrill lay with its finance committee — a four-member group headed by Charles O. Rossotti, former chairman and chief executive of American Management Systems, and a senior adviser to the Carlyle Group, the private investment firm. Other members of the committee include Ann N. Reese, a former chief financial officer at the ITT Corporation; John D. Finnegan, chief executive of the Chubb Corporation; and Alberto Cribiore, an executive at a private equity firm….
Merrill’s proxy statement says that its finance committee among other things, “reviews, recommends, and approves policies and procedures regarding financial commitments and investments.” It also “reviews our policies and procedures for managing exposure to market and credit risk, and when appropriate, reviews significant risk exposure.”
But while the finance committee has the main responsibility for risk oversight, another group, Merrill’s four-member audit committee, also shares some responsibility for overseeing risk policies.
Ms. Reese and Mr. Rossotti serve on the audit committee, along with Joseph W. Prueher, a former United States ambassador to China, and Judith Mayhew Jonas, a New Zealand academic who has experience running London’s financial district.
None of these board members had any experience in trading businesses. The closest was John Finnegan of Chubb, since insurers have sizable investment operations, but their time horizons, frequency of trading, and risk appetite are very different from that of a securities firm.
If I were in the board’s shoes, I would have engaged a risk management guru, or maybe even two, to bring them to a common understanding of modern practice and key issues. And it’s also an accepted practice among boards to do “probes,” that is, interview people in the organization up and down the line, on key issues (and note that savvy boards get an org chart and pick their own interviewees, rather than have the executives make the choice).
Hindsight is always 20/20, but it still appears Merrill’s board ought to have been more proactive, particularly as the credit contraction progressed.