September 25th, 2008

The real criminals of the financial crisis

In the frenzied search since Meltdown Monday for people to blame for the financial crisis, non-executive directors have been let off surprisingly lightly.

The angry finger of accusation has pointed at all sorts of groups, from greedy hedge-funders to feeble financial authorities, from ignorant politicians to wilfully blind bankers, from silly shareholders to unscrupulous speculators. But non-executives have usually been left off the list of shame.

This is very odd. For if it is the responsibility of anyone to watch over businesses, restrain their excesses and warn them about risk or wrong-doing, it is the non-executives.

This must have struck the most idle of observers when a couple of years ago the charismatic Lord Black, proprietor of the Telegraph group, first found himself in the soup. What were the non-executives doing?
How did they fail to see what was cooking?

They were after all an exceptionally intelligent, influential and experienced group of people; the non-executives on the board of Hollinger, through which Conrad Black owned the Telegraph group, included Henry Kissinger, Lord Weidenfeld, Alfred Taubman, Marie-Josee Kravis and Richard Perle, all of them lords (or ladies) of the universe as Tom Wolfe might have put it. Was it not their duty to keep an eye on things and make a fuss if anything seemed to be amiss?

The same questions must surely apply to the non-executives of all the organisations whose mismanagement has contributed to the current crisis. Don’t the non-executives bear a large share of the blame?
Fools rush in, of course, and it is difficult for outsiders (or, indeed, insiders) to understand the mysterious workings of high finance and management. Whole libraries have been written about the role of non-execs, and perhaps it is indeed very complex.

But the Institute of Directors publishes a very helpful fact-sheet on the role of the non-executive director, which suggests otherwise. “Essentially,” this document says, “the non-executive director’s role is to provide a creative contribution to the board by providing objective criticism”.
NXDs should be of “appropriate calibre”, be capable of “seeing company and business issues in a broad perspective”, have “wide experience” and also perhaps “have some specialist knowledge that may help the board with valuable insights”.

Also “of the utmost importance is their independence of the management of the company and ‘interested parties’. That means they can play a valuable role in monitoring executive management” [my italics].
The bottom line of the NXD’s job is to try to keep the company off the rocks, ensure it doesn’t take unnecessary risks and acts with the utmost probity. Part of this means ensuring that directors and employees are not offered perverse incentives to take ill-considered risks. The man in the queue to the bank can only say that if that is the NXDs’ job, then clearly a lot of them haven’t been doing it very well.

These non-executives cannot claim that they were taken by surprise. Over the past three or four years I have met countless bankers and business people who have said that the market was frighteningly over-heated, that there was too much money pursuing too little real business and that derivatives were excessively risky.

It is impossible for an outsider to know why the NXD system doesn’t work as well as it is intended to. However there is one thing, at least, about NXDs that is very striking. They tend to be extremely busy. It’s not unusual for a high-flying NXD to have several directorships, on top of a very demanding full-time job (as one would expect from someone of the ‘appropriate calibre’).

It is difficult to see how even a lord of the universe could find enough time to monitor several different managements in enough careful detail, to be sure enough of what’s going on. One way or another, some very important non-executives have failed; perhaps it is time to reconsider their duties.