It has not been a good month for the financial industry: JPM's ever growing CDS trading (and apparently mismarking) loss; PFG Best's appreciation for Adobe Photoshop; HSBC's AML deficiencies; and pretty much eveyone's LIBOR manipulation, although only Barclays have - so far - turned up the "thanks for that - let's have some Bolly" emails.
PFG Best displays some key red flags - the CEO was a controlling personality and the only one who could access bank statements. Moreover, the firm was audited by a no name, apparent one person auditor. Thankfully, in a hedge fund context, a normal adminstrator would complete a full, tri partite reconciliation - taking trade information from the manager, booking it into their systems, and then reconciling, daily, to the prime broker. Moreover, technology is the hedge fund investor's friend - the days of daily rec administrators relying on paper PB statements are, thankfully, long gone.
JPM appears to present a different pattern where, once more, traders were in charge of - or at least had undue influence over - pricing of complex securities, despite the fact that their multi million dollar bonuses depended on those very prices. This is not a JPM problem, but is "best practice" throughout the investment banking industry (and, unfortunately, is too frequently used as a justification by hedge funds who have elected to put the front office in charge of the pricing process). We continue to have extreme skepticism that putting traders in charge of marking portfolios, and then paying them large sums of money based on those marks, will lead to a reliable pricing process. We have yet to encounter a trader who was not supremely confident that their marks were correct - especially when they knew they were wrong.
The issue of conflicts of interest, alignment of interest and compensation brings us to an editorial published in the National Post, the more right wing of Canada's two national newspapers. We have included the text in full, as this is one of the best summaries of the state of leadership of the global finance industry we have seen to date.
Dishonesty is the new greed on Wall Street
A high-level executive at Europe’s biggest bank quit on Tuesday. It was big news: a senior corporate leader actually accepting some blame for his actions, while his bank is engulfed in scandal.
In this case the bank is HSBC Holdings PLC and the allegations are just another day at the office for the modern-day finance industry: terrorism, money-laundering, drug-running, sanctions-busting. Not that your local HSBC has been staffing up with drug lords. No, the crimes are at higher levels, up where HSBC corporate bosses make thereally big bucks, and where they acknowledged that, when the opportunities arose, they didn’t do all they could have to avoid dealings with killers, bombers or organized crime in places like Mexico, Saudi Arabia and Iran. Instead the bank offered “a gateway for terrorists to gain access to U.S. dollars and the U.S. financial system,” according to a U.S. Senate report.
Ho hum. “I recognize that there have been some significant areas of failure,” acknowledged David Bagley, who was head of HSBC’s group compliance. “HSBC has fallen short of our own expectations, and the expectations of our regulators.”
Well gee David, no need to get all worked up about it. “Some significant areas of failure” — Is that what they call involvement with international crime bosses these days? Oh well, at least Mr. Bagley is stepping down. Most other corporate titans wouldn’t bother. Anyone know what happened to Jamie Dimon since he admitted J.P. Morgan vaporized somewhere between $5-billion and $8-billion? Oh yeah — he’s still in charge. Like most of the lords of international finance who have been embarrassed by massive cock-ups involving billions or trillions of dollars, he’s clinging to their jobs for all its worth, which as usual is quite a lot.
Sorry if I’m sounding a bit cynical, but really: If you decided to enjoy the summer and skip the business pages, you’re missing a humdinger of a crime story. Just four years after they helped send the global economy into a chasm it has yet to escape, the world’s corporate and financial leaders are back with a sequel. There’s greed on a monumental scale. Cheating and lying. Dishonesty, incompetence and theft. Hubris like you’ve rarely seen. Arrogance, lots of arrogance. Plus fraud, embezzlement, conspiracies and money-grubbing on a monumental scale, by a host of breathtakingly high-paid bankers, financiers and corporate kingpins. There’s even a moral to be learned: no matter how well-educated, well-dressed or well-paid, when an ambitious executive is put in the vicinity of billions of dollars and given an opportunity to pilfer it, all sense of honesty goes out the window.
There’s been so much malfeasance the Wall Street Journal can barely make room for its ritual editorials denouncing government interference in corporate affairs. The Journal views corporate governance much like China treats foreign intrusion in its domestic matters: We don’t care how high the bodies are stacked, that’s our business, not yours. But so abundant is the current supply of kleptocracy that it couldn’t resist. Even a capsule summary can barely contain the main points of all the wrongdoing that’s been going on:
* Russell Wasendorf Sr., a U.S. “business kingpin and philanthropist”, tried(unsuccessfully) to take his own life, after writing a suicide note revealing he’d spent 20 years systematically defrauding customers of Peregrine Financial Group, which he founded 22 years ago and almost immediately began looting. Peregrine is missing $215-million. Mr. Wasendorf’s explanation was straightforward: When his company ran into trouble he decided he could admit the truth, or start stealing. And he was too embarrassed to admit the truth.
* Mr. Dimon, CEO of J.P. Morgan and Chase, dismissed concerns over “trading problems” at the bank as a “complete tempest in a teapot” in April, but now admits it’s a bit worse than that. No, Morgan didn’t blow a measly $250-million as he thought at the time, or even $2-billion like he suggested in May, but more like $5.8-billion. Or maybe it’s $7-billion or $8-billion — who knows, it’s early yet. Numerous agencies are investigating the losses, and there’s talk of criminal inquiries, though there’s plenty of precedence for banks blowing that kind of money with no one ever being held to blame.
* J.P. Morgan’s losses pale next to the big Libor scandal, which involves a group of the world’s top banks deliberately manipulating interest rates to avoid admitting how bad their finances had become during the financial meltdown of 2008 (which was caused, in case you’ve forgotten, by many of these same banks and financiers trying to scam investors with third-rate, high-risk products dressed up to look like safe investment opportunities.) It’s unlikely anyone will ever know how much money Libor involves. The money flow is simply too big and complex, and involved too many organizations in too many countries. The New York Times notes that “up to $800-trillion in financial products are pegged to Libor”, meaning all the bankers in all the world could use all their fingers and all their toes and still never produce a clear idea of how much they scammed from various economies.
But that’s what we’ve come to expect, isn’t it? We already know from the 2008 meltdown that we can’t trust Wall Street as far as we can throw it. We can’t trust ratings agencies, which certified all those high-risk derivatives as completely safe and sound. We can’t trust the regulators, who either can’t spot, or can’t stop, abuses of the financial system. U.S. regulators evidently knew of the Libor problem four years ago, but couldn’t figure out a way to let their British counterparts in on the secret. Mervyn King, head of the Bank of England, claims he only learned what was going on a few weeks ago, even though there have been reports in the papers since at least 2007. The quality of policing when it comes to corporate crime is so hilariously low that Mr. Wasendorf managed to outwit authorities for two decades with the simplest of tricks: He used Photoshop and Excel to forge bank statements, gave auditors a phony address so he could intercept their communications and wouldn’t let anyone else open his mail. Now the same geniuses who missed his criminal activity say Mr. Wasendorf is obviously such a skilled liar they can’t decide whether to believe his confessions
Most of all, we know we can’t trust the men (and a few women) who reign at the top of the financial heap, tasked with making money for shareholders, protecting the investments of clients and staying within the law. Other than Mr. Wasendorf, you’ll have a hard time finding a CEO willing to take the blame for anything untoward, not withstanding the evaporated billions. Forbes magazine is bedazzled by Mr. Dimon, noting, “He hasn’t even stepped down as chairman of the Morgan board of directors or even as a ‘Class A director’ of the Federal Reserve Bank of New York.”
“If Jamie Dimon had been on the Titanic, he’d have jumped in a lifeboat … and then issued a press release describing his heroism,” Forbes notes.
Slightly less adept is Robert Diamond Jr., the high-octane head of Barclay’s Bank, who has been front and centre in the Libor mess but is so unrepentant he had to be driven from his job by the combined forces of the British government. As with other bosses, he’s willing to admit mistakes were made – just not by him. Diamond blames U.K. regulators, and says he only stepped down because of “external pressure.” The point of the gargantuan rewards people like Mr. Dimon and Mr. Diamond pay themselves is purportedly to compensate them for the enormous responsibility they carry in overseeing large and complex organizations that handle huge amounts of money. Yet when deceit, fraud, criminal activity or mammoth losses occur, somehow the buck never quite stops at their desk. Barclays put it about that Mr. Diamond had agreed to give up a $32-million sweetener when he resigned, though a later report suggested he wasn’t due the bonus in any event. It was considered a big deal last week when Ina Drew, J.P. Morgan’s chief investment officer, voluntarily agreed to return two years’ salary – about $30 million – over her involvement in the bank’s losses. And three other traders involved in the losses had part of their pay cheques seized. But is their boss’s neck on the line? Could Mr. Dimon actually be held to account? Fat chance. AsForbes marvels, “He’s unsinkable!”
Because, you see, when these huge losses occur, it’s always other people’s money. Other people’s mortgages are bundled up and sold to unsuspecting suckers. Other people’s investments are pilfered while the regulators are on coffee break. Other people have to cope with the effects of the global downturn while the banks protect themselves by manipulating interest rates and lying to federal authorities. Other people watch their investments shrivel up because some London Whale wants to make a name for himself by launching fantastically risky bets. And other people are supposed to accept that these self-serving egomaniacs deserve to be paid tens, or hundreds, of millions of dollars a year due to their unsurpassed financial acumen and the value they bring to international markets.
So what’s a business prof supposed to tell his class when it comes time to discuss ethics and corporate accountability? Ethics? Honesty? Responsibility? Integrity? What makes you think you’d need to be familiar with those concepts, just because you might find yourself running a public company in which millions of small investors have put their savings, and trust?
Judging by recent history, the key to corporate success is an unshakeable belief in your own superiority, combined with a total lack of responsibility and an overwhelming disregard for the impact of your actions. The goal is to get a job in which you’re able to enrich yourself so mightily that, even when disaster strikes, you’ll still have millions stashed away with which to comfort yourself. Avoid risking your own money, because if you own a private company and it goes belly up, you’re the one on the hook for the losses. Much better to lead a public company where you can help yourself to more than your share of the profits during good times, and wriggle out of blame when things go south. And never question that you deserve every penny.
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