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Tuesday, May 21, 2013

Jamie Dimon Wins Stockholder Vote: Exploiting Conflicts of Interest Undercuts Fairness

Chairman of JPMorgan since 2006 and CEO a year longer, Jamie Dimon faced down a daunting stockholder vote on May 21, 2013 on whether he should be allowed to retain both roles. Despite the bank’s $6.2 billion trading loss, deeply flawed risk-management oversight, and “credibility issues” with regulators, only about 32% of the votes cast were in favor of the nonbinding resolution that the chair and CEO jobs be separated. Interestingly, not only does the chair/CEO duality have an inherent conflict of interest because part of what a board (including its chair) does is hold management (including the CE) accountable, the means by which the pro-duality side campaigned also included conflicts of interest. I cannot help but wonder whether Jamie Dimon, his immediate subordinates, the bank’s board directors and even the stockholders who altogether voted a supermajority of shares in support of Dimon’s two roles were negligent ethically in failing to even recognize the institutional conflicts of interest involving Dimon and the board. To the extent that recognition existed, permitting the conflicts to exist and in some cases knowingly exploiting more than one at a time are even more squalid than merely being oblivious to them. To the extent that structural conflicts of interest were enabled through the campaign and in the election results, JPMorgan Chase can be likened to a house of cards. This does not bode well for the financial system and broader economy to the extent that the largest American bank holds systemic risk (i.e., “too big to fail”). I look at the campaigning first, as doing so will lead us directly to the main conflict of interest that is at issue here.


The directors and/or Dimon may have exploited a conflict of interest had either been behind the decision to keep the running vote tally from the stockholders supporting the proposal to split Dimon’s two roles. According to the New York Times, “the ability to get real-time voting information is crucial for both Wall Street firms and the shareholders sponsoring proposals. A losing side may decide to pour more resources into its campaign, making additional calls or send additional correspondence to shareholders.” For years, Broadridge, a firm paid by corporations to tally their shareholder votes, gave the same information to both the managements and the proposal sponsors. Nearly two weeks before the end of the vote at JPMorgan, Lyell Dampeer of Broadridge was called by an employee of the Securities Industry and Financial Markets Association, Wall Street’s lobby group, requesting that Broadridge cut off the access of stockholders sponsoring proposals to the information. Executives at “some banks” were concerned, according to the New York Times, “that shareholder groups were leaking early vote tabulations.” Never mind that a CEO might ever have an incentive to do likewise. SIFMA and Broadridge are hired by the banks rather than their stockholders. “We act at the behest of our clients,” Dampeer said, so if JPMorgan’s CEO does not want his opposition to have vital information on the voting, he can cut them off using the financial sector’s lobbyist as a messenger. Put another way, the election was not fair. It was like one in Belarus, Iran, or Cuba rather than the E.U. or U.S.

“If they aren’t providing results to one side, they shouldn’t give it to the company,” said Brandon Rees, acting director of the A.F.L.-C.I.O. Office of Investment. William Patterson, the executive director of the CtW Investment Group, which represents union pension funds and owns six million shares in JPMorgan, said that when deprived of the initial tallies, shareholders were at the whim of management. “If you go in blind,” Mr. Patterson said, “you can’t really make an informed case to management” at the annual meeting about voting results “and hold them accountable.” But that is precisely the point; a CEO who chairs the board charged with holding him or her accountable will naturally resist accountability even from the owners of the company.

In terms of conflicts of interest, Broadridge was in one due to its roles as running the election and being a client of one of the two parties. If Dimon or any of his directors was involved in getting Broadridge to cut off the opposition from the tallies, this too would be yet another conflict of interest. In fact, for the bank itself to take the side of its management on a decision to be made by the bank’s owners involves the bank itself in a conflict of interest. The New York Times reported that “(b)ehind the scenes, JPMorgan has been working to persuade shareholders to support having [Dimon] keep both the chairman and chief executive titles.” In yet another conflict of interest, Dimon’s management cadre and directors on the bank’s board campaigned for each other directly in what can be characterized as a cozy relationship. Because a board is accountable to the stockholders rather than the management that it hires, colluding with the incumbent management when such collusion is itself at issue before the stockholders could mean that directors are working against the stockholders or at least manipulating or obstructing their choice.

After two shareholder advisory firms issued statements recommending the split due to questions about the independence and qualifications of several board members, directors and executives went into overdrive contacting major stockholders. The board put out a statement strongly urging stockholders to retain its chair even though he would still be the bank’s CEO. Two directors, Lee Raymond and William Weldon, went as far as to write a seven-page letter urging the stockholders to oppose the split. The “most effective structure” for the bank is to have Dimon “serving as CEO and chair. . . . It would be a mistake to change it now.” Dimon’s directors were acting as though they were looking out for the bank (and thus the stockholders) rather than simply doing Dimon’s bidding. Not only would it be a mistake, the two directors assert in the letter, a vote to permanently bar the same person from serving concurrently in both capacities “could be disruptive to the company and is not in shareholders’ best interests.” Stockholders reading the letter could have caved into the manipulation in utter panic unless they recognized the directors’ more immediate incentive to manufacture a doomsday scenario. Because of that incentive and the directors’ fiduciary duty to the stockholders, the directors’ two roles put them in a conflict of interest.

Whether he realized it or not, Dimon had his own conflict of interest in campaigning for himself and even for the incumbent directors. Perhaps in a quid pro quo, he told an audience of technology investors toward the end of his campaign that the board “should be applauded." He also said he didn't think any changes were necessary to the bank's board or its current structure. In other words, he didn’t think he needed to give up the chairmanship. The week before, he had already “upped the ante” by letting it be known that of the downsides to a vote relieving him of the chairmanship, “one thing would be I might leave.” He might as well have said he would take all his marbles and stomp away mad. Such is the attitude in having to have it all. Besides holding himself ransom to manipulate the stockholders rather than respect their independent decision, he was implying that if he couldn’t control the board whose main function is to hold the management (including the CEO!) accountable, he couldn’t do his job. It is as if he were saying, “Don’t be concerned about any conflict of interest in me being both chair and CEO because other things, such as me retaining both roles or even staying at the bank, are more important.”

               Jamie Dimon, CEO and Chair of JPMorgan Chase.  The duality of roles can benefit him both personally and institutionally. NYT

It is common for joint CEO/Chairs to maintain that it is necessary for the CEO to have all the reins, lest there be a power-struggle. Years ago, I asked Mike Armstrong, CEO and chairman of ATT before his broadband strategy failed, why he opposed having someone else as chair of the board. He replied that he needed all of the authority for his broadband strategy to be implemented. “The buck has to stop with me for me to complete the broadband strategy.” Similarly, appearing before the U.S. Senate in June 2013, Dimon said the "buck stops with me." That expression comes from President Truman even though he shared power with, and was restrained by Congress and the U.S. Supreme Court. In contrast, Armstrong and Dimon were assuming that complete control is requisite to accountability being possible.  “With a separate chair,” Armstrong told me, “the resulting strategy might not be all mine, so it would not be clear who is responsible should the strategy not succeed.” The fallacy invalidating this statement is that a chair and CEO occupy the same turf.

Commenting on Dimon’s dual roles at JPMorgan, Robert Benmosche, CEO of the infamous bailed-out AIG, said on CNBC in May 2013 that having another person chairing the board would make power-struggles more likely. “People in the organization would naturally go to mom or dad.” Benmosche was assuming that a chair and CEO occupy the same turf—that both come up with the strategy and therefore compete with each other.

The relation between a chair and CEO is vertical, not horizontal. Rather than being “mom and dad,” the chair of the board that holds the CEO accountable is like a parent and the CEO is like the child. It follows that the two roles are fundamentally (i.e., qualitatively) different, rather than overlapping a lot. Even though a CEO can propose a broad strategy to the board, the top manager is in charge of implementing, or managing, the broad direction set by the board. Put another way, the board sets the general direction and the CEO sets about setting the course in terms of business strategy. Just as the CEO is not rightfully to be held responsible for the general direction, the board can rightfully hold the CEO accountable for implementing the broad strategy within the general direction set by the board. A CEO being held accountable by a board chaired by another person is vested with sufficient authority to implement strategy and thus can be held accountable by the board (including its chair) for it. Similarly, the stockholders can hold their board’s directors accountable for the effectiveness of the general direction even though the chair is not also the CEO and thus does not implement the strategy.

Whether from a bloated or arrogant sense of entitlement or a fear of not being able to perform well enough or be fairly evaluated otherwise, insisting on being both CEO and chair of the board that holds the management accountable involves a conflict of interest, which, if exploited, is not in the interest of stockholders. “There’s a fundamental conflict in combining the roles of chairman and C.E.O.,” Anne Simpson, director of corporate governance at Calpers, said. One of the main tasks of a corporate board is to oversee the corporation’s management. If the CEO, who heads the management, is also heading the board tasked with overseeing management, the CEO is institutionally and personally tempted to influence the board to go easy on the management. Re-nominating and actively campaigning for the directors could be the quid pro quo that completes the tight, cozy circle of the dominant board-management coalition.

From the standpoint of systemic risk, a board easing up in holding the management of a bank too big to fail accountable or even looking the other way represents a danger to the entire financial system and even the global economy. “It’s all thrown into stark relief when you’re dealing with a company that’s too big to fail,” the New York Times observes. Lest this assertion seem like fear-mongering, JPMorgan had lost $6.2 billion the year before on a risky trade mislabeled as a “hedge” against risk. In its report, Institutional Shareholder Services (ISS) cites “material failures of stewardship and risk oversight” by the board and upper management. Glass, Lewis points its criticism at the directors on the board’s risk policy and audit committees. “We believe that shareholders may justifiably expect that the audit committee of one of the nation’s largest banks, and one of the largest participants in the global capital and derivative markets, should act to ensure that the bank’s traders cannot obfuscate the values of their positions with as much ease as evidently occurred in the London Whale matter.”  The report raises questions about the independence of several board members. Accordingly, the reduction in Dimon’s compensation should not be regarded as a sufficient remedy and safeguard.

The Wall Street Journal reports that the board of JP Morgan Chase reduced the compensation of James Dimon by 50% for 2012 because of the “London Whale” trading loss. In its decision, the board stressed that he bore “ultimate responsibility” for the trading failure. Dimon himself referred to the trading loss as “one huge embarrassing mistake.” Accordingly, the board set Dimon’s pay for 2012 at $11.5 million, down from $23.1 million in 2011. This decline was in spite of the bank’s record profit in 2012 of $21.3 billion. For the 4th quarter, the bank reported net income of $5.69 billion, up from $3.73 billion in the last quarter of 2011. The rationale for the reduced compensation lies in the fact that 2012’s profit would have been even more had the $6.2 billion loss not occurred.

Moreover, oversight, which failed in regard to the trade, is closer to the CEO’s function than is the change in profit. For example, a CEO should not receive a bonus for profit due to circumstances behind the firm’s control. Additionally, the board also delayed the vesting on 2 million stock options that had been awarded to Dimon in January 2008, pending “remediation relating to the CIO matter.” An internal investigation had found that the CIO unit’s judgment and handling of risk management were poor in regard to the trading loss. Dimon bore oversight responsibility on that unit. It is unlikely, however, that delaying vesting would matter at all to an already-rich person.

It is difficult to see how receiving $11 million represents a hardship. Were an American CEO’s compensation ten or eleven times that of the average worker, rather than over three hundred times, perhaps reductions in compensation would have greater impact on an executive’s subsequent performance. Moreover, the linkage between cutting the CEO’s compensation and achieving systemic improvement in the CIO unit is indirect at best. To have more confidence that such wholesale change will be accomplished, changes in the corporation’s governance are also necessary. The magnitude of the turnaround in terms of the culture, policies, processes and personnel dwarf what a compensation committee can do.

JPMorgan’s stockholders can ill-afford a compromised board protecting an entrenched management rather than the stockholders’ interests. Because part of the question before the stockholders is whether their board is independent of the management, allowing that board to serve as the ultimate decider on the split is problematic due to the conflict-of-interest. The bank’s corporate governance “basic law” is flawed, therefore, in that the shareholder vote on the split (and even on specific directors!) is nonbinding. Although the Wall Street Journal notes that directors “could face pressure to act if more than half of all shareholders want the positions divided,” relying on pressure—particularly if the board has been contaminated—is naïve and woefully unfair to the stockholders’ property rights. Whether on a plurality or majority basis, stockholder votes should be binding on the board and management—both of which are the agents of the stockholders (e.g., fiduciary duty).

It is astonishing (and telling), therefore, that Dimon said that whether or not to split his two roles is “a policy decision” that should be made by the board rather than the stockholders. His stance assumes that the board would be acting in the stockholders’ interest rather than that of the management. With Dimon serving as chair of that board, the board’s decision would likely be made in his interest rather than that of the stockholders or even the bank itself.

Whereas Dimon was likely contending that the “policy decision” should be made by the board looking after the stockholders’ interest rather than by the stockholders themselves because the directors have more business or banking expertise, I contend that managerial expertise is not requisite to evaluating proposed changes to a system of corporate governance. That is to say, the business judgment rule should not trump property rights on corporate governance proposals. Governance is not management. Political theory and judgment are more salient in governance, hence business or managerial expertise does not enjoy the prerogative.

In the sphere of public governance, constitutions (i.e., basic law) are not written as statutes. Therefore, citizens need not be lawyers in order to make a judgment on a proposed constitutional amendment. When amendments are written in legalize, as was the case in Florida’s 2012 election, the fault lies with the legislators who wrote the amendments rather than the voters who could not understand it. That is, the use of technical writing does not give lawyers the prerogative in the matter of adoption.  The voters would rightfully object were lawyers to demand that they should vote on the electorate’s behalf, for the good of the electorate. The right to vote trumps a lawyer’s expertise even if legalize is erroneously used on questions put on the ballot.

In terms of corporate governance, writing a proposal to be put before the stockholders in technical business language does not justify having the directors or executives rather than the stockholders make the decision. Being of “basic law,” governance proposals are not so esoteric. Even if they were, the increased role of institutional investors as activist stockholders deflates Dimon’s self-serving argument that the board knows best how to decide a “policy” on corporate governance. The fact that ISS recommended voting against three of the bank’s eleven directors while Glass, Lewis urged stockholders not to vote for six of the directors suggests that the two firms had analyzed particular directors from the standpoint of independence rather than merely saying making a broad statement, such as that the board lacks sufficient independence to act on behalf of stockholders rather than the management.

Even with a board composed of corporate governance experts, decisions on a corporation’s system of governance are rightfully the prerogative of the owners rather than their agents, even if those agents would make better choices on behalf of the stockholders. To subvert a principal-agent relationship because an agent has expertise puts effectiveness above rights. Add in the conflict of interest and upholding the rights becomes even more important. Until these principles are grasped by investors and business managers, the practitioners will continue to have an unwarranted advantage over the owners.

 

Sources:

Susanne Craig and Jessica Silver-Greenberg, “Small Firm Could Turn the Vote on Dimon,” The New York Times, May 7, 2013.

Dan Fitzpartrick and Kirsten Grind, “Amid Vote, Dimon Has Considered Departure,” The Wall Street Journal, May 11, 2013.

Susanne Craig and Jessica Silver-Greenberg, “Shareholders Denied Access to JPMorgan Vote Results,” The New York Times, May 15, 2013.

Dan Fitzpatrick, Robin Sidel, and Kirsten Grind, “Dimon Makes His Case,” The Wall Street Journal, May 17, 2013.

Dan Fitzpatrick, Julie Steinberg, and Joann Lublin, “Dimon Strengthens Grip at J.P. Morgan,” The Wall Street Journal, May 21, 2013.