Author: Ben W. Heineman, Jr.

One of the dumbest corporate governance issues is whether to split the roles of Board Chair and CEO. That debate is now playing out on the front pages of business sections (print and online) as shareholders will decide next week in a nonbinding vote whether to take the chairman of the board title away from JP Morgan CEO Jamie Dimon.

This is a reprise, for the zillionth time, of the pointless push by governance types to call the senior director “chairman of the board” rather than “lead” or “presiding” director and to deny the CEO the chairman of the board title. (Dimon, of course, is today Chairman of the Board and CEO of JP Morgan; Lee Raymond is JPM’s “lead” director.)

What is lost in virtually all stories and commentary hyping the Dimon election is an answer to the basic question: what is the function of the lead director? It is this issue of function, not form (i.e., what title that senior director carries), which is crucial.

It has been a governance verity, if not always a reality, that a strong board should provide oversight and constructive criticism to the CEO and other company leaders.

Since Enron, this basic principle has been implemented in most companies by designating one director to be first among equals, whatever her title. That director performs at least the following core roles (as I have discussed in detail elsewhere):

• Chairs the meetings of the directors, now regularly held without the CEO being present (either before or after the regular board meetings). As chair, that director elicits from the other directors any and all issues of concern that do not emerge when the CEO is present. That director, with the advice of the other directors, then determines how best to communicate those concerns to the CEO — and follow up.
• Leads the board in setting the agenda of the highest risks and opportunities facing the company, which the board should understand in detail — and the key systems and processes for mitigating or exploiting those risks and opportunities. A best practice: that director should work with the board and the CEO in the fall of Year 1 to identify the top 15 risks and opportunities that should be covered in-depth at board meetings in Year 2 (with the obvious flexibility to add issues as events warrant).
• Ensures that the materials presented to the board — or the discussions at the board meetings — fairly and honestly present the hard issues and the credible options and trade-offs that are at the core of the priority risks and opportunities. This allows directors to make real, substantive comments, rather than trying to fight through management obfuscation and obscurantism.
• Leads the board in setting meaningful operating objectives for the CEO and top business and staff leaders in the broad areas of commercial performance, integrity promotion and risk management.
• Leads the board in translating those operating objectives into meaningful cash and equity present and deferred compensation structures for near, medium and longer term results in all three dimensions — and that provides for hold-backs or claw-backs if the CEO or senior officers seriously underperform or are guilty of bad acts.
• Ensures that board oversight during any particular year focuses rigorously both on the highest priority risks and opportunities and on the secondary, but important operating objectives outside those priorities.

If these are the core functions of the director as first among equals, then whether that director is called “Chairman of the Board” or “Lead Director” or “Presiding Director” doesn’t matter. This is a critical internal position, not an external one. And if the top director needs to speak or meet in public on rare occasions, the role of senior director, not the title, provides foundational credibility. Function, not form, is what matters.

What also matters, of course, is who the director is in that lead role. Does she have the respect of the board? Does she have the respect of the CEO and top business leaders? Does he have the skills to carry out the functions to provide proper oversight and guidance without micro-managing? The wrong director as “chairman of the board” won’t carry out the key functions properly. The right person as “lead director” (who actually leads) will discharge the functions effectively. The personal qualities of that senior director, not her title, are everything.

Any substantive issues with CEO Dimon or current JPM lead director Lee Raymond aren’t going to be fixed by changing Raymond’s title to Chairman of the Board, and taking that title away from Dimon. The vote on the shareholder proposal to strip Dimon of the Chairman tile may be an indirect way of chastising him for past mistakes (most prominently the losses due to the trades of the “London Whale”), but it has nothing to do with the proper functions of the senior director in the future. Indeed, this dust-up symbolizes one of the failings of the governance movement: a tendency to focus on formalism rather than substance.

In President Obama’s second term, the United States has an ambitious and challenging Atlantic and Pacific trade agenda which could significantly alter the architecture of the global economy.

But the President has yet to designate someone to fill the crucial Cabinet level position of U.S. Trade Representative (USTR). The stakes, both internationally and domestically, are extremely high and Mr. Obama should immediately send to the Senate for confirmation a nominee of prominence and stature.

Doing so would show that he places the highest priority on both the Trans-Pacific Partnership (TPP) negotiations — started in 2011 and slated to end this year — and the newly launched free trade negotiations between the US and EU which are scheduled (optimistically) to be completed before the 2016 election. He should simultaneously push hard for Congressional renewal of Trade Promotion Authority (TPA) which gives the Executive the power to negotiate trade agreements subject only to a prompt up or down vote in the House and Senate with no amendments. This authority expired in 2007.

The Trans-Pacific talks have involved 11 developed and developing Pacific Rim nations with a combined GDP of $40 trillion,and which recently got a jolt of energy and complexity when Japan (GDP=$6 trillion) joined the negotiations. The US-EU talks involve the two largest economies in the world (EU $17 trillion, US $15 trillion, China $12 trillion) which account for about one-third of world trade annually ($2 billion per day).

Both negotiations aim to reduce tariff and non-tariff barriers in goods, services, investment and procurement. Importantly, this means harmonization or mutual recognition of national regulatory regimes, which can lead to global standards and greater ease and efficiency in cross border economic activity. The US-EU talks, for example, can not only have economic benefits (reduced costs/higher GDP in both regions without stimulus spending) but also geopolitical ones (refreshing the transatlantic alliance and rule of law market economies). The TPP hopes for similar effects.

Both negotiations are driven by a desire to spark a sluggish world economy and by an unstated but clear desire to provide powerful counterweights to China. This China strategy can occur through greater growth in developed and developing democracies; through regulatory and product standards which become world norms and to which China may have to conform; and through new rules, as yet undefined, to address the trade distortions of Chinese “state capitalism.” This last point, explicitly mentioned in the terms of reference of both negotiations, is aimed at the licit and illicit subsidies, preferences and advantages which China’s government provides to its national “corporate” champions, especially those owned by the state.

But, while the broad goals and general impact of both the Atlantic and Pacific trade talks are thematically compelling, the actual negotiations are exceedingly detailed and difficult. In each nation or region, special interests have to give up sacred cows, regulatory agencies have to modify their behavior and certain segments of the economy will suffer from increased competition while others will prosper. A Trade Representative of real stature and skill is needed to bring a broad national and global (not parochial) perspective to the talks, and to negotiate, compromise and close the deal with international counterparties on a package of contentious issues. Such a trade leader must simultaneously keep a fractured Congress informed and supportive while getting Trade Promotion Authority enacted and also carrying out the negotiating goals which Congress writes into the legislation.

Surviving, even thriving, in the domestic and international crossfire on such fractious issues as autos, drugs, aviation, financial services or agriculture requires that the President make these trade negotiations a top priority. This means he needs a strong leader who can remain not only above specialized interest group, regulatory and Congressional interests, but who is also outside the West Wing and can effectively direct the effort and package the issues in internal processes, until the President’s direct public involvement is needed.

Past USTRs were people of remarkable ability who came to the job with strong track records, or who developed a reputation for leadership once appointed, such as: Bob Strauss (Carter), Bill Brock (Reagan), Carla Hills (Bush 41), Mickey Kantor (Clinton), Charlene Barshefsky (Clinton), Bob Zoellick (Bush 43), Rob Portman (Bush 43).

Although top Administration officials, like National Security Advisor Tom Donilon, talk about the strategic importance of the Atlantic and Pacific trade negotiations, unfortunately the President himself has never shown much public interest in trade. Obama announced the US-EU trade negotiations in a single sentence buried deep in the State of the Union address. And he is the only recent president not to immediately propose renewal of Trade Promotion Authority upon assuming office. Instead, we have seen only an administration announcement, in an anodyne and faceless trade agenda paper, that it planned to work with the Congress on new TPA legislation. And thus far, leadership on the US-EU talks has come from the White House staff (per Michael Froman on the National Security and National Economic staffs), and TPP negotiations have been led by an assistant USTR, with neither the talks nor the point person receiving much national attention.

There is, in short, genuine doubt about whether President Obama really cares about these critical global initiatives, given all the other priorities with which he must deal. The obvious symbol of Presidential commitment is the United States Trade Representative. That is why it is so odd that no nomination has been announced, with TPA facing a tough fight in Congress; with the Pacific talks made infinitely more complicated by Japan’s entrance; and with the US-EU talks requiring firmer, clearer negotiating plans and some quick victories to develop momentum. Although strong support is needed from the President himself, Mr. Obama needs a potent national figure outside the West Wing who can take fire prior to his personal involvement in negotiations.

Reaching meaningful agreements with real impact in the Atlantic and Pacific trade talks would be a long-shot under the best of circustances. If the President does not make this a key priority which commands his attention, and on which he will spend leadership capital, these talks will not succeed, and may not even happen given the degree of political difficulty here and abroad. The economic costs would be very high for the US and the world.

Obama’s task is clear. Appoint the USTR now, Mr. President.

The current front-page sub-contractor controversies surrounding BP’s liability for the gulf explosion and Boeing’s grounding of its 787 Dreamliner should not obscure an ultimate take-away for corporate leaders: companies must take operational responsibility for ensuring that products and services provided to them by third party suppliers are safe, effective and of high quality.

In this era of complex supply chains and the hiring of expert sub-contractors, taking such responsibility is crucial for preventing events with the potential to adversely affect the corporation and its reputation. Business leaders must establish robust processes not just for qualifying third party vendors, but for making sure that there is integration of those suppliers in a strong safety culture with close company oversight of safety management and processes. This fundamental lesson may be lost on business leaders amidst the high profile excavation of past supplier controversies currently besetting BP and Boeing.

BP is, of course, currently in the eye of a media and legal hurricane as the Justice Department and other plaintiffs begin the trial on penalties under the Clean Water Act. These penalties can be as high as $17-$18 billion if BP is found grossly negligent (legally defined as egregious conduct beyond reasonable care with foreseeable adverse consequences) or to have engaged in willful misconduct (defined as intentional acts with adverse consequences). There are myriad legal issues in the BP case as it seeks to show that it was merely negligent and that its key contractors, Transocean (rig owner) and Haliburton (well cementer), were also responsible.

Boeing has been a huge business story this year due to the grounding of its new 787 Dreamliner for fires in ion-lithium batteries made by the Japanese company, GS Yuasa. For Boeing, the questions at the moment are urgent but primarily technical: what caused the fires and how (and how soon) can the new plane become airworthy again. Backed up orders, lost revenue, angry customers, reputational injury and the success of the innovative 787 all turn on resolution of this dramatic problem.

In structuring relationships with third party suppliers, there can often be complex negotiations, and complexly worded documents, apportioning legal and economic risk. BP, for example, has itself sued Transocean and Haliburton seeking to spread the huge costs of the explosion at the Deepwater Horizon rig and the oil spill in the Gulf. But the judge in the current case last year ruled that BP had agreed to a clause indemnifying both sub-contractors for compensatory damages, while leaving open whether BP could collect from Transocean or Haliburton for fines, penalties or punitive damages imposed on BP.

But for all the effort to structure legal and economic issues after a disaster occurs, it is far, far better to address critical operational issues — relating to safety culture, process and management — to prevent one. BP, or any other primary operator, must treat subs as if they were virtually part of the parent company and must take operational responsibility. Doing this right helps to avoid the endless, expensive, time-consuming and debilitating after-the-fact fights about who was at fault.

BP has admitted as much in its now long-forgotten report on the Gulf explosion. As to events and causes, the report was, of course, one sided, admitting some fault but spreading the blame to others. In a little-noticed section on recommendations, BP effectively admitted, however, that it had not supervised key contractors properly. In this section (at p.181), BP said it should be responsible for:

• Developing better, clearer standards and processes for a range of activities in deep-sea drilling from cementing, to testing for leakages, to well control and general risk management.
• Significantly improving education and training of BP personnel to enhance capability and competency.
• Implementing much greater oversight of contractors’ current practices relating to cementing, well control, rig process safety and blow-out preventer design and safety.
• Requiring contractors to develop and implement audit-able safety processes, including identification of key indicators — processes which BP can review.

This point was underscored by Exxon Mobile CEO Rex Tillerson in his testimony before the National Commission on the BP Deepwater Horizon Oil Spill. Following its issues with the Exxon-Valdez tanker spill, Exxon Mobile has the reputation for developing the best safety culture relating to oil and gas operations through what it calls the Operations Integrity Management System (OIMS). Said Tillerson:

And I want to stress that the contractors that we work with are embedded within our OIMS processes as well. We expect our contractors to be as knowledgeable and conversant with our OIMS processes as our own employees. Not every company has this expectation, but we have found that when everyone in the workplace speaks the same language of safety — employees and contractors alike — everyone can work collaboratively, safely and effectively.

Boeing is, of course, a far different situation — with efforts directed now at understanding and remedying the technical problems. But the Boeing case raises similar important questions about quality and safety, even if many, many facts are not yet known. Boeing itself has said that it made a mistake in outsourcing so much of the 787 because it caused coordination issues and delay. But clearly such fragmented outsourcing can also cause unintended and unseen safety and quality issues, despite the high standards to which air frame manufacturers are held.

Moreover, much of this outsourcing relates to suppliers in different nations with large airlines who may purchase the new plane. Although new aircraft have initial bugs which need to be worked out, the question raised by the battery fires is whether Boeing involved the Japanese manufacturer deeply enough in Boeings own safety culture, processes and management, and whether it devoted enough time for proper oversight. Certainly, just the simple fact of the problem, which will cause a multi-month grounding of the plane, suggests that something was amiss in Boeing’s contractor oversight somewhere in the design, manufacturing, assembling and testing processes.

It is unclear at this point what the resolution of the riveting, high visibility BP and Boeing controversies will be. But business leaders should nonetheless act on a core lesson from both examples: they must ensure that their corporations take full operational responsibility and accountability for the safety and quality of the goods and services provided not just by them, but also by third party suppliers.

The apparition of 2008 returns once more. Two recently released JP Morgan Chase (JPM) reports on the causes of the “London Whale” trading losses raise important questions about whether financial service firms can exorcise the spectral issues which were so central to the financial crisis. They read as if JPM and a key headquarters unit — the Chief Investment Office — had not learned a single lesson from the meltdown four years ago. And unfortunately, they suggest that, in our huge, complex financial institutions, major failures of organizational discipline and major losses are likely to recur, despite greater attention to risk management.

These reports — one from a company task force and a second from a review committee of the board — were overshadowed by two items announced the same day: the related news that the bank board had slashed CEO Jamie Dimon’s annual compensation in half — from $23 million in 2011 to $11.5 million in 2012 — because of his “Whale-related” failures, and that JPM had posted a record 2012 net income of $21.3 billion.

But the 129-page internal task force report is significant. It analyzes in some depth the personal and institutional reasons for the more than $6 billion loss in a credit derivatives portfolio traded, paradoxically, by the London branch of JPM’s Chief Investment Office, a unit supposed to invest a pool of funds conservatively in order have liquidity to offset losses elsewhere. Led by Michael Cavanagh, co-Chief Executive Officer of the Corporate and Investment, the task force outlines a series of failures that echo those that beset financial sector creation of interconnected toxic assets in the past. And almost no one has focused on the relationship between JPM’s problems, the past failings in the financial sector and the issues for the sector in the future.

These are not failures associated with well-considered and well-bounded risk taking. Everyone understands this kind of risk taking is core to any business (financial or industrial or consumer) and obviously will not always be crowned with success. Rather, they are blameworthy actions, involving culpability stemming from negligence or worse, and requiring, at the least, private sanctions (firings, demotions, clawbacks, pay cuts) and system remedies. Here is a brief summary of the findings:

London Office. The traders — Bruno Iksil (“the Whale”), Javier Martin-Artajo and Achilles Macris (the boss) — did not understand the complex trades, did not monitor them, doubled down when initial results were poor, did not listen to questions from the risk function and did not communicate the full extent of trading losses.

Headquarters of Chief Investment Office (CIO). Ina Drew, the head of the CIO, failed to review or monitor the trading strategy; failed to ensure that the risk and finance functions were providing appropriate oversight and control of the portfolio in question; did not appreciate the size, complexity, risk and magnitude of the issue in the first quarter of 2012 as conditions worsened; and as a result, gave misleadingly optimistic reports to JPM senior management until problems surfaced dramatically in April-May, 2012. The risk limits set were too vague and broad. And, the Value at Risk (VaR) model was badly flawed, understating risk.

Firm-Wide Functions and Leaders. Generally speaking, firm management did not ensure proper controls and oversight at CIO as its trades became more complex and risky. The company Chief Risk Officer (Barry Zubrow, until January 2012) and the CFO (Doug Braunstein, since replaced) bore significant responsibility for the inadequacies of the risk and finance functions inside CIO — and for the failures of firm-wide risk and finance to spot trouble. CEO Dimon was criticized for failure to understand warning signs in a unit reporting directly to him (calling the trades “a tempest in a teapot” in an April analysts’ call). Dimon himself ultimately said that “[t]hese were egregious mistakes.They were self-inflicted…” In short, there was not robust debate with the right facts at the right level about the portfolio risk.

The Board and the Risk Policy Committee. The board review committee exonerates the board and the Risk Policy committee from any culpability because “the information communicated to the Risk Policy Committee…did not suggest any significant problems in the CIO” until the issue began to break open in April, 2012.” This conclusion is silly on its face because the review committee’s report makes a number of recommendations of changed processes which are so basic that those proposals should be read as criticisms for past failures of the board and the Risk Committee. For example, the review committee says that the Risk Committee should: insist on better context when risk issues are presented; ensure that risk leaders are asked about what really bothers them; assess adequacy of risk resources in all units; conduct regular reviews — and spend more personal time — on the firm’s compliance with risk protocols; ensure that the chief risk officers are truly independent and can challenge business decisions; and define more clearly the lines between the Risk and Audit Committees. Well, no duh.

Virtually every “cause” of the significant trading losses delineated by the internal JPM task force would have been found in earlier internal and independent reports about the sources of problems at many financial institutions during the credit crisis. In addition, the JPM task force does not address other key questions: Why did Dimon let the Chief Investment Office — with the normal role of conservative capital management to offset losses elsewhere — start this kind of speculative trading in the first place? Why were red flags ignored by senior managers in CIO and in the firm? How credible is the report’s conclusion, without published analysis, that “the Firm’s compensation did not unduly incentivize the trading activity that led to the losses”?

Moreover, JP Morgan Chase still has unfinished business with the regulators here and abroad on the trading fiasco. For example, the bank recently entered into a cease and desist order with the Federal Reserve and the Comptroller of the Currency (COC) to work out new regulator-approved processes relating to the issues about the board’s role, risk management, finance and audit identified in the internal Task Force report. And questions of fraud in the London office and inadequate SEC disclosure by JPM are also being pursued by government investigators.

The crucial question raised by the Whale incident — and by the delineation of causes in the internal report — is whether these types of blameworthy acts, with significant consequences, are likely to recur in huge financial institutions because they simply cannot control important corporate or business units with significant capital at risk.

Are these acts likely to recur regardless of internal systems and process, and regardless of regulatory oversight?

The question has special salience because it happened at JP Morgan Chase, which had a reputation for careful risk management; because it happened right under the nose of Jamie Dimon, JPM’s so-called “chief risk officer”; because it happened in a unit reporting directly to Dimon which was supposed to trade conservatively in order to have funds to offset poor bets elsewhere. The bank deserves credit for facing the trading problem forthrightly once it emerged unmistakably as a major issue: Dimon took blame; the company made public a reasonably critical internal report (even if key issues were not addressed); it set a good standard of accountability in using clawbacks and Dimon’s comp reduction for those responsible (see my earlier blog posts ); and it has set forth paper remedies for the specific problems which will be refined with the Fed and the COC.

But, the fact remains: the Whale incident’s replay of these fundamental, blameworthy acts — which characterized the financial melt-down — suggests a basic failing that may defy an effective remedy. This is why the Whale has significance beyond the particular losses and poses an enigma which business and government must ponder.