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Warren Buffett and Managing Through Trust

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On March 30, Warren Buffett’s Berkshire Hathaway announced David Sokol’s resignation. Buffett’s reputation quickly took a bit of a hit from the likes of Joe Nocera.

Nocera suggests it wasn’t the first time Buffett had tap-danced his way out of a tight spot; he cites the Salomon Brothers’ bond scandal in the 1990s, and the General Re dustup in the mid-2000s.

What’s Nocera’s point? He later elaborated that Berkshire Hathaway is run by “rules that are extraordinarily lax by the standards of good corporate governance…Standards and practices have to change.”

Do Trust Violations Invalidate Trust?

Nocera’s examples amount to once per decade over the last 30 years. Buffett’s reputation is probably pretty safe, because a great truism about trust isn’t true at all: you know, that bit about how trust is hard to gain, but can be lost in an instant? Not true: trust takes roughly as long to dissipate as it took to create (see Toyota, J&J, Madoff).

But Nocera’s reaction is the norm. Ethical problems? Time to double up on compliance, standards and practices, procedures.

Nocera is speaking for business when he sees violations of trust as prima facie evidence of the failure of trust as a strategy.

In this regard, he could not be more wrong.

Charlie Munger and Wisdom of Managing through Trust

Charlie Munger is Buffett’s much-less-in-the-press partner. Buffett credits Munger with at least half the wisdom of the two, and quotes him often.

Munger lives up to his reputation in a trenchant article[1] by Darden Professors Brian Moriarty and Edward Freeman:

In response to a question about whether Berkshire needs more compliance controls Munger said:

…the greatest institutions in the world…select very trustworthy people and then trust them a lot.” He added, “I think your best compliance cultures are the ones which have this attitude of trust, and some of the worst with the biggest compliance departments, like Wall Street, have the most scandals.”

To Munger’s comment: Amen.

The violation of trust by someone who was trusted does not justify giving up on a strategy of trusting. In fact, if you never have a violation, one has to wonder how real your trusting is.

If all of Wall Street ran themselves like Berkshire Hathaway, and had one scandal per decade, we’d all be vastly better off.

Instead, we have an institutionalized belief system that the solution to ethical problems is a set of adversarial business processes. Dealing with ethical issues solely via compliance departments is the best way to take the trust and ethics out of management.

And if the bar is set at once per decade by famous journalists thinking they are acting in service to greater trust in business–well, heaven help us.

[1] The article was in the Washington Post, though the Post will make you jump through hoops to get it. I’ve linked to the hoops.

Carnival of Trust for July, 2010

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Welcome to the July edition of the Carnival of Trust.

This month we are graciously hosted by the hardest working man in the compliance business, Doug Cornelius. Doug resides at compliancebuilding.com. He’s a Boston lawyer, with serious experience in real estate, private equity, knowledge management, and–of course–compliance and corporate ethics. He’s Chief Compliance Officer at Beacon Capital Partners, a real estate private equity firm, though the views expressed in his blog are his alone. Trust is a central subject matter for those in the compliance business, many of whom read Trust Matters. Doug is a consistently thoughtful observer of things trust-related, and I’m delighted to have him as host. The Carnival of Trust is a highly subjective listing of key blogposts related to trust. The choices are made by rotating hosts–Doug, in this case. They make the choices and write the commentary. This way you get a seasoned voice, other than mine, on the key subject of trust. Click on over to Doug Cornelius’ Compliancebuilding.com, and give a read of his selections and commentary this month. I assure you, you won’t be disappointed.

Bank Credit Cards: Not-Illegal Does Not Equal Ethical

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The bloated pig...This past May, the US Congress passed, and Obama signed into law the credit Card Accountability Responsibility and Disclosure act (CARD, of course, for short).

It provides for significant consumer-friendly reforms, due to take effect in February 2010.

These regulations are going to cost bank card issuers some significant chunks of change, as they’ll no longer be able to do things like apply your payments to the lowest-interest part of your debt, charge rates like 29.99% and hit you with large fees for slight transgressions. 

That is, when the law takes effect.

A Funny Thing Happened on the Way to the CARD Act Effective Date

Something happened between May and now–something that has caused many bank card issuers to raise their rates, accelerate their payment terms, and increase fees for those who can’t comply.

Now, why would that be happening?

The obvious deduction is that the banks just couldn’t resist getting in a last feast on their already burdened consumers by jacking up rates until they are forced to behave in a way society, through its duly elected government, has dictated they must.

Oh, what to do?  Bend to the will of the people?

Nah.  How about one last feeding at the trough, while it’s still legal.

That’s how Christopher Dodd, chairman of the Senate Banking Committee, sees it, and he’s not alone. Last week, the committee passed legislation to move up the CARD implementation to December 1.   And yesterday, he proposed freezing rates in the interim.

Sometimes, the obvious conclusion is the right conclusion. But that doesn’t stop some banks, and their industry spokespeople, from trying to argue the opposite.

Says Scott Talbott, SVP for Government Affairs at the Financial Services Roundtable:

…the bill was based on the faulty premise that credit card interest rates were going up because of legislation.
Instead, he said, interest rates were rising because of risks posed by the unsteady economy and by card holders themselves, who are defaulting on their payments or paying late more often.

In other words, we’re raising your rates because interest rates are going up in this recession, and because you greedy customers are abusing us poor folks at CitiBank and BankAmerica by withholding your money from us.

(Just to be clear: these actions are being taken by the banks who issue the cards, not by the MasterCard and Visa folks who create and brand them).

This is not a function of US culture only–it seems to be endemic in the business.  Over in the UK, where they’re presently considering US-like regulation, we get a similar argument from the banks:

One senior credit card executive pointed to the United States, where the supply of credit is already shrinking and its cost rising as a result of similar reforms, which are to come into force in February 2010.

In other words, if you restrict our profits, we’ll yell and pout and gouge you and generally behave badly; consider yourself warned, you’re responsible for our bad behavior.   

Responsible Business Behavior? Or Merely Not Illegal?

Most people can intuitively understand the difference between ethical and legal, and between unethical and illegal. Most of us want to live in a society where laws are ultimately derived from a sense of ethics—not the other way around. Just because something is not illegal hardly implies it is ethical.

But it seems increasingly that business is becoming deaf and blind to this simple distinction. Consider the Congressional testimony by several health care executives this past summer.

When asked whether they would voluntarily forego rescission (cancelling policies in effect) except in cases of intentional fraud, the executives one after another said they would not. Why?

Because, they said, what they were doing wasn’t illegal.

You have to ask the question, are these people stupid? Or venal?

In favor of the argument for stupidity, one can point to a modern penchant to substitute process for judgment. How else to explain a school principal suspending a 6-year old child for eating with a cub scout knife’s spoon? Or mechanical SEC procedures that Madoff and his whistle-blower Markopolis both called stultifying? 

While I think stupidity is the more usual culprit, in this case I vote for venal.  How arrogant do you have to be to insist that raising rates is the fault of economically challenged customers?   To tell your PR people to stand down?  And to argue that not being a crook entitles you to a seat at the table of responsible businesspeople?

I was privileged to share a platform this Monday morning with an entirely different kind of leader. I wish the heads of credit card operations in some of our major banks would take a look at this CEO, Aaron Feuerstein, in a 60 Minutes video.  And to hear him on Monday describe in the simplest terms why good corporate citizenship must be rooted in a sense of personal values. 

Not being illegal is nowhere near close enough.

 

 

The Ethical and Regulatory Morass of the Stanford Scandal

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I didn’t start out looking for trouble.

But like the camera shots in a Sergio Leone western, every time the camera pulls back for perspective in the Stanford Investment Bank story, the plot changes.

But let’s begin at the beginning. You of course know Madoff–the man with the minus touch.

Now we have "Sir" Allen Stanford–let’s call him mini-Madoff. He’s head of the Stanford International Bank (SIB), now accused by the SEC of bilking about $1.8 billion through, what else, a Ponzi scheme. Based in Antigua, operated out of Mississippi and Texas, a very private management team.

SIB had an outside lawyer from the prestigious firm Proskauer, Rose. His name is Thomas Sjoblum. On February 10, in the SEC offices in Fort Worth, Texas, Mr. Sjoblum accompanied his client, SIB’s Chief Investment Officer Laura Pendergest-Holt, to a 4-hour deposition by her.

The next day, Mr. Sjoblum told the SIB folks he was resigning from the case.

Musta been one helluva testimony Ms. Pendergest-Holt gave, eh? So it would sound.

In a blackberry email to an SEC lawyer two days later, Sjoblum clarified:

"I disaffirm all prior oral and written representations made by me and my associates … to the SEC staff regarding Stanford Financial Group and its affiliates.”

For me, it all started with that funny word–“disaffirm.” In a blogpost on February 20 I said “disaffirm” was a tortured linguistic construct aimed at putting distance between telling the truth and technically not lying.

But then the real fun started. Pull the camera back a few feet.

I then separately heard from two lawyers for whom I have very high regard, suggesting I had been too hard on Sjoblom. They suggested Sjoblom was a whistle blower whose actions were principled, difficult and courageous.

They were not alone. The blog AmLaw Daily had written the day before:

…Sjoblom…sniffed out the fraud, withdrew his representation, and told federal investigators he essentially took back everything he had told to them in recent weeks…

Am Law Daily contacted a number of legal ethics experts to discuss Sjoblom’s decision to come clean about a client’s alleged frauds–especially given the possibility that in doing so, he disclosed confidential client information to the government…

Experts said Sjoblom did precisely the right thing–and, more importantly, that the federal Sarbanes-Oxley Act likely made his decision much easier than it otherwise might have been.

"He [Sjoblom] did the right thing here," says Stephen Gillers, a legal ethics expert at New York University School of Law.

I started looking for crow to eat. Until, that is, I read the Memphis Daily News account of what actually happened at that February 10 SEC deposition.

By the SEC’s own notes, Sjoblom came out swinging—asking if the SEC had yet referred the case to Justice, arguing that the SEC didn’t have geographic jurisdiction, arguing that the (allegedly) bogus CDs Stanford sold were not “securities” under the relevant legal definition.

Huh?

Suddenly the aspiring Hollywood screenwriter in my head switched stereotypes: this was not the plot for the courageous whistle blower movie. This was the script for the B "mob lawyer" movie. Could he really have had a Saul on the road to Damascus conversion in one afternoon?

So–what happened in that room? Did Ms. Pendergest-Holt really drop a bombshell that blindsided Sjoblom? Or did Sjoblom do a Claude Raines (“I am shocked, shocked! to discover my client has lied to me for years about billions of dollars!”)? Incidentally, Ms. Pendergest-Holt was arrested by the FBI a few days later.

Let’s pull the camera way back.

Attorney Sjoblom is an ex-assistant chief litigation counsel in the SEC’s Division of Enforcement. On February 10 he aggressively explores defenses for SIB just before Pendergest-Holt comes on and says things that get her arrested. The next day he resigns.

The obvious question becomes, ‘What did Sjoblom know, and when did he know it?’ Of course I don’t know, but let’s consider what Sjoblom might have known:

  1. In 2003, a whistle blower case against Stanford was brought in front of the NASD (FINRA’s predecessor).
  2. In fact, according to Henry Blodget, "at least five former Stanford employees told the SEC they thought Stanford was running a Ponzi scheme, from 2003 on."
  3. A January 2008 lawsuit was filed against Stanford alleging endemic lack of compliance.
  4. A Venezuelan analyst wrote a report called Duck Tales in January 2009 which did for Stanford what Markopolis did for Madoff–blew the conceptual lid off.
  5. But the nail in the "shocked, shocked!" coffin is in the FBI arrest claim for Stanford’s Pendergest-Holt:

..the complaint alleges there were stormy preparation sessions for Pendergest-Holt in January and February “during which the bank’s shaky asset base became apparent to a wider circle of officials and to the lawyer — ‘Attorney A’ — who later quit.”

Um, who might ‘Attorney A’ be? Whoever it was, he knew something was up back in January.

So–just when did Sjoblom "sniff out the fraud?" The day after he heard testimony in Dallas? Or way before?

If he knew anything in advance–then why the aggressive denial-of-jurisdiction rant at the outset of the hearing? How much charade does a lawyer have to go through before he can speak some truth? I know legal ethics is much concerned with maintaining client confidences. But how much pretzel-twisting is required to serve that particular god?

The legal experts said Sjoblom did “exactly the right thing.” They also say that Sarbanes-Oxley made it far easier for lawyers to reveal confidences in certain situations. Let’s assume both statements are true. How horrible it must have been pre-Sarbanes–how many would-be whistle-blowing lawyers went to the grave mute?

How much in-your-face evidence of massive fraud does it take before a lawyer can say "my client is a crook and a liar" in a legally acceptable manner?

May I suggest the right answer should be–"less than this."

If this was a praiseworthy, ethical act consistent with the highest standards of the law, then something is very wrong–either with a lawyer, with legal ethics, or with the law itself. The law owes society more than citing last-minute tortured "disaffirmations" in the face of egregious criminal wrongdoing as examples of ethical behavior.

Note: It’s possible that Professor Gillers was not aware of all this background when he called Sjoblom’s actions "exactly the right thing." For all I know, given the background, he might even agree with me. I’d welcome his perspective here, and I’d welcome any correction from anyone about matters of law or fact.